SPRUCE BIOSCIENCES, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the financial statements and the related notes to those statements included later in this Annual Report. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, particularly in Item 1A. “Risk Factors” and “Special Note Regarding Forward-Looking Statements.” Unless otherwise indicated, all references in this Annual Report to “Spruce,” the “company,” “we,” “our,” “us” or similar terms refer to Spruce Biosciences, Inc. Overview We are a late-stage biopharmaceutical company focused on developing and commercializing novel therapies for rare endocrine disorders with significant unmet medical need. We are initially developing our wholly-owned product candidate, tildacerfont, as the potential first non-steroidal therapy to offer markedly improved disease control and reduce steroid burden for patients suffering from classic congenital adrenal hyperplasia, or CAH. Classic CAH is a serious and life-threatening disease with no known novel therapies approved in approximately 50 years. In a 12-week Phase 2a proof-of-concept clinical trial, tildacerfont-treated adult patients suffering from classic CAH who had poor disease control despite being on standard of care therapy achieved approximately 80% reductions in hormones that are key indicators of poor disease control. Furthermore, 171 subjects across seven clinical trials to date have been administered tildacerfont with no drug-related SAEs reported. We have initiated CAHmelia-203, a placebo-controlled, double-blind Phase 2b clinical trial in adult patients with classic CAH with poor disease control and anticipate topline results in the first half of 2022. We have also initiated CAHmelia-204, a second Phase 2b clinical trial in adult patients with classic CAH with good disease control focused on glucocorticoid reduction and anticipate topline results in the second half of 2022. Based on post-hoc analyses of our clinical data to date, we have chosen to target two distinct groups of classic CAH patients with either good disease control or poor disease control. These two groups, which together make up the entire classic CAH patient population, have differing disease challenges centered on excessive adrenal androgen levels or excessive glucocorticoid usage, both of which have the potential to be addressed by treatment with tildacerfont, if approved. We believe our strategy to study CAH patients in these two enriched sub-populations may enable us to observe clinically meaningful outcomes. Additionally, we believe these two clinical trials will provide sufficient patient exposures for our registrational safety database. Assuming positive results in CAHmelia-204, we plan to meet with the FDA and comparable foreign regulatory authorities to discuss registration. Since our inception in November 2014, we have focused primarily on raising capital, establishing and protecting our intellectual property portfolio, organizing and staffing our company, business planning, and conducting preclinical and clinical development of, and manufacturing development for, our product candidate, tildacerfont. We have no products approved for commercial sale and have not generated any revenue to date, and we continue to incur significant research and development and other expenses related to our ongoing operations. Our ability to generate product revenue sufficient to achieve profitability, if ever, will depend on the successful development of tildacerfont and any future product candidates. We intend to build a highly specialized commercial organization to support the commercialization of tildacerfont, if approved, in the United States and Europe. Given a relatively small number of endocrinologists and specialists treat a large proportion of patients with classic CAH, we believe this market can be effectively addressed with a modest-sized targeted commercial sales force, alongside various high-touch patient initiatives. If tildacerfont is approved for additional indications, we plan to leverage our rare disorder commercial infrastructure and expertise to efficiently address those patient populations. We may also either build a commercial infrastructure or opportunistically seek strategic collaborations to benefit from the resources of biopharmaceutical companies specialized in either relevant disease areas or geographies. We rely, and expect to continue to rely, on third parties for the manufacture of tildacerfont for preclinical studies and clinical trials, as well as for commercial manufacture if tildacerfont obtains marketing approval. We also rely, and expect to continue to rely, on third parties to package, label, store, and distribute tildacerfont, if marketing approval is obtained. We believe that this strategy allows us to maintain a more efficient infrastructure by 101 Table of Contents eliminating the need for us to invest in our own manufacturing facilities, equipment, and personnel while also enabling us to focus our expertise and resources on the development of tildacerfont . Since inception, we have incurred significant losses and negative cash flows from operations. During the year ended December 31, 2020, we incurred a net loss of $29.5 million and used $27.5 million of cash in operations. As of December 31, 2020, we had an accumulated deficit of $60.8 million, and we do not expect positive cash flows from operations for the foreseeable future. We expect to continue to incur significant and increasing losses for the foreseeable future, and our net losses may fluctuate significantly from period to period, depending on the timing of expenditures on our planned research and development activities. In October 2020, we consummated our initial public offering, or IPO, and issued 6,900,000 shares of common stock for net proceeds of $93.4 million, after deducting underwriting discounts and commissions and offering expenses. Since inception through December 31, 2020, we have raised aggregate gross financing proceeds of $224.0 million, including $103.5 million from our IPO in October 2020, $116.0 million from the sale of our redeemable convertible preferred stock and $4.5 million from the issuance of debt. As of December 31, 2020, we had cash and cash equivalents of $157.2 million. We believe, based on our current operating plan, that our cash and cash equivalents will be sufficient to fund our operations for at least the next 12 months. We have based this projection on assumptions that may be inaccurate and as a result, we may utilize our capital resources sooner than we expect. We expect our expenses will increase significantly in connection with our ongoing activities, as we: ▪ advance tildacerfont through our ongoing Phase 2b clinical trials in adult patients with classic CAH; ▪ pursue regulatory approvals of tildacerfont in adult patients with classic CAH; ▪ advance clinical development of tildacerfont in additional indications, including pediatric classic CAH and a subpopulation of females with a rare form of polycystic ovary syndrome, or PCOS; ▪ build a highly specialized commercial organization to support the commercialization of tildacerfont, if approved, in the United States and Europe; ▪ build a commercial infrastructure or opportunistically seek strategic collaborations to benefit from the resources of biopharmaceutical companies specialized in either relevant disease areas or geographies, if tildacerfont is approved for additional indications; ▪ identify additional indications and formulations for which to investigate tildacerfont in the future and expand our pipeline of product candidates; ▪ implement operational, financial, and management information systems; ▪ hire additional personnel; ▪ operate as a public company; and ▪ obtain, maintain, expand, and protect our intellectual property portfolio. Our business has been and could continue to be adversely affected by the evolving COVID-19 pandemic. For example, the COVID-19 pandemic has resulted in and could result in delays to our clinical trials for numerous reasons including additional delays or difficulties in enrolling patients, diversion of healthcare resources away from the conduct of clinical trials, interruption or delays in the operations of the FDA or other regulatory authorities, and delays in clinical sites receiving the supplies and materials to conduct our clinical trials. At this time, the extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted. 102 Table of Contents Components of Results of Operations Operating Expenses We classify operating expenses into two main categories: (i) research and development expenses and (ii) general and administrative expenses. Research and Development Expenses Our research and development expenses consist of external and internal expenses incurred in connection with our research activities and development programs. These expenses include: ▪ external expenses, consisting of: o clinical development—expenses associated with CROs engaged to manage and conduct clinical trials; o preclinical studies—expenses associated with preclinical studies performed by vendors; o manufacturing—expenses associated with contract manufacturing; labeling, packaging, distribution of clinical trial supplies, and consulting; o other research and development—expenses associated with quality and regulatory compliance; and ▪ internal expenses, consisting of personnel, including expenses for salaries, bonuses, benefits, stock-based compensation, as well as allocation of certain expenses. To date, these expenses have been incurred to advance tildacerfont. These expenses will primarily consist of expenses for the administration of clinical trials as well as manufacturing costs for clinical material supply. We expect that significant additional spending will be required to progress tildacerfont through clinical development and regulatory approval. Research and development expenses are recognized as they are incurred. If deposits are required by external vendors, a portion of the deposit is included as a prepaid expense until sufficient progress has occurred to amortize the deposit to expense in the statement of operations. General and Administrative Expenses General and administrative expenses consist primarily of personnel-related costs (including salaries, bonuses, benefits, and stock-based compensation expense) for personnel in executive, finance, and other administrative functions. General and administrative expenses also include legal fees, professional fees paid for accounting, auditing, consulting, tax, and investor relations services, insurance costs, facility costs not otherwise included in research and development expenses, and public company expenses such as costs associated with compliance with the rules and regulations of the U.S. Securities and Exchange Commission, or the SEC, and those of the Nasdaq Stock Market, Inc., or Nasdaq, listing rules. We expect that our general and administrative expenses will continue to increase in the foreseeable future as additional administrative personnel and services are required to manage these functions of a public company, as we advance tildacerfont through clinical development and regulatory approval. Interest Expense Interest expense consists of interest incurred and non-cash amortization of debt discount and issuance costs in connection with the Term Loan with Silicon Valley Bank. 103 Table of Contents Other Income, Net Other income, net primarily consists of interest income earned on our cash and cash equivalents. Results of Operations Comparisons of the Year Ended December 31, 2020 and 2019 The following table summarizes our results of operations for the periods presented (in thousands): Year Ended December 31, 2020 2019 Change Operating expenses: Research and development $ 23,854 $ 10,817 $ 13,037 General and administrative 5,562 2,290 3,272 Total operating expenses 29,416 13,107 16,309 Loss from operations (29,416 ) (13,107 ) (16,309 ) Interest expense (323 ) (65 ) (258 ) Other income, net 200 84 116 Net loss $ (29,539 ) $ (13,088 ) $ (16,451 ) Research and Development Expenses Research and development expenses were $23.9 million for the year ended December 31, 2020, compared to $10.8 million for the year ended December 31, 2019. The overall increase in research and development expenses was primarily related to an increase in clinical development, manufacturing, preclinical studies and personnel costs, associated with our progressing clinical development. The following table sets forth the primary external and internal research and development expenses for the periods presented below (in thousands). Year Ended December 31, 2020 2019 Change External expenses: Clinical development $ 12,747 $ 4,323 $ 8,424 Manufacturing 4,132 1,940 2,192 Preclinical studies 1,744 707 1,037 Other research and development 685 412 273 Internal expenses: Personnel 4,376 3,301 1,075 Allocated overhead 170 134 36 Total research and development expenses $ 23,854 $ 10,817 $ 13,037 General and Administrative Expenses General and administrative expenses were $5.6 million for the year ended December 31, 2020, compared to $2.3 million for the year ended December 31, 2019. The overall increase in general and administrative expenses was primarily driven by an increase of $1.6 million in professional and consultant service fees related to becoming and operating as a public company, an increase of $1.0 million in personnel-related expenses, and an increase of $0.5 million in administrative expenses primarily related to an increase in directors’ and officers’ liability insurance premiums. Interest Expense Interest expense was $0.3 million for the year ended December 31, 2020, compared to $0.1 million for the year ended December 31, 2019. The increase was due to interest expense incurred in 2020 on the Term Loan with Silicon Valley Bank, which we entered into in September 2019. 104 Table of Contents Other Income, Net Other income, net was $0.2 million for the year ended December 31, 2020, compared to $0.1 million for the year ended December 31, 2019. The increase was primarily due to interest income on higher cash and cash equivalents balances in 2020. Liquidity and Capital Resources Liquidity Since our inception, we have not generated any revenue from product sales and have incurred significant operating losses and negative cash flows from operations. We anticipate that we will continue to incur net losses for the foreseeable future. As of December 31, 2020, we had an accumulated deficit of $60.8 million. As of December 31, 2020, we had cash and cash equivalents of $157.2 million. In October 2020, we consummated our IPO and issued 6,900,000 shares of common stock for net proceeds of $93.4 million, after deducting underwriting discounts and commissions and offering expenses. We believe, based on our current operating plan, that our cash and cash equivalents will be sufficient to fund our operations for at least the next 12 months. Loan Agreement In September 2019, we entered into the Loan Agreement with Silicon Valley Bank providing for the Term Loan. Pursuant to the Loan Agreement, we requested $2.5 million from the first tranche in connection with the entry into the Loan Agreement, which is currently outstanding, and we drew the second tranche of $2.0 million in December 2019. In April 2020, we and Silicon Valley Bank entered into the Deferral Agreement whereby we and Silicon Valley Bank agreed to extend the repayment dates of all monthly payments of principal due and the maturity date with respect to the Term Loan by six months. In March 2021, we entered into First Amendment with Silicon Valley Bank. The First Amendment increased the aggregate principal amount of the Term Loan commitment by Silicon Valley Bank to up to $30.0 million. Up to $20.0 million is available under the first tranche of the Term Loan, or the First Tranche, $5.0 million of which was advanced immediately to repay the outstanding obligations under the Term Loan prior to the First Amendment with the remainder of the First Tranche commitments available through December 31, 2021, and up to $10.0 million is available under the second tranche, or the Second Tranche, subject to the completion of certain clinical and financial milestones which Second Tranche commitment is available through December 31, 2022. Pursuant to the First Amendment, the Term Loan will mature on January 1, 2026. As of March 22, 2021, we have $5.0 million outstanding under the Term Loan. The Loan Agreement, as amended by the Deferral Agreement and the First Amendment, provides for monthly cash interest-only payments following the funding date of each respective tranche and continuing thereafter through December 31, 2022 to the extent that the Company does not borrow any part of the Second Tranche or December 31, 2023 if the Company has borrowed some or all of the Second Tranche. Outstanding principal balances under the Term Loan, as amended by the First Amendment, bear interest at a floating per annum rate equal to (A) if the Company does not borrow under the Second Tranche, the greater of (x) 1% above the prime rate or (y) 4.25%; or (B) if the Company does borrow under the Second Tranche, the greater of (x) 3% above the prime rate or (y) 6.25%. Following the interest-only period, the outstanding Term Loan balance will be payable in (i) 37 consecutive monthly payments (or 25 if the Company borrows under the Second Tranche) after the end of the interest-only period and continuing on the same day of each month thereafter, in amounts that would fully amortize such Term Loan balance, as of the first business day of the first month following the amendment interest-only period, over the repayment period, plus (ii) monthly payments of accrued but unpaid interest. The final payment due on the maturity date shall include all outstanding principal and all accrued unpaid interest and an End of Term Payment totaling (x) 6% of the original funded principal amount of the First Tranche if the Company does not borrow under the Second Tranche, or (y) 9.5% of the total original funded principal amount under the First and Second Tranche if the Company does borrow under the Second Tranche. 105 Table of Contents We may prepay amounts outstanding under the Term Loan at any time provided certain notification conditions are met, in which case, all outstanding principal plus accrued and unpaid interest, the end of term payment, a prepayment fee between 1% and 3% of the principal amount of the first and second tranches, and any bank expenses become due and payable. The Loan Agreement contains certain covenants that limit our ability to engage in certain transactions that may be in our long-term best interest, including entering into a change in control transaction. The Loan Agreement also contains certain covenants that limit our ability to obtain additional debt financing, including incurring debt from third parties not permitted under the Loan Agreement or incurring liens or encumbrances on our property. While we have not previously breached and are currently in compliance with the covenants contained in the Loan Agreement, we may breach these covenants in the future. Our ability to comply with these covenants may be affected by events and factors beyond our control. In the event that we breach one or more covenants, Silicon Valley Bank may choose to declare an event of default and require that we immediately repay all amounts outstanding under the Loan Agreement, terminate any commitment to extend further credit and foreclose on the collateral. In addition, if an event of default occurs under the Loan Agreement, Silicon Valley Bank may, among other things, accelerate the Term Loan or do any acts it considers necessary or reasonable to protect its security interest in the collateral under the Term Loan. Events of default include the occurrence of a material adverse change in our business, operations, or condition (financial or otherwise). The occurrence of any of these events could have a material adverse effect on our business, financial condition, and results of operations. In connection with the first and second tranches under the Loan Agreement prior to the First Amendment, we issued a warrant to purchase up to an aggregate of 49,609 shares of common stock at $1.44 per share. We determined the initial fair value of the warrant to be $0.1 million using the Black-Scholes option-pricing model. The fair value of the warrant was recorded to equity and also as a debt discount, which is amortized to interest expense using the effective interest method over the term of the Term Loan. The warrant was net-exercised for 46,358 shares of our common stock in November 2020. Funding Requirements To date, we have not generated any revenue. We do not expect to generate any meaningful revenue unless and until we obtain regulatory approval and commercialize tildacerfont or any future product candidates, and we do not know when, or if at all, that will occur. We will continue to require additional capital to develop tildacerfont and fund operations for the foreseeable future. Our primary uses of cash are to fund our operations, which consist primarily of research and development expenses related to our clinical development programs, and to a lesser extent, general and administrative expenses. At this time, we cannot reasonably estimate or know the nature, timing, and estimated costs of the efforts that will be necessary to complete the development of, and obtain regulatory approval for, tildacerfont or any of our future product candidates. We expect our research and development expenses to increase significantly in the foreseeable future as we continue to invest in research and development activities related to developing tildacerfont, as tildacerfont continues to advance into later stages of development for the treatment of classic CAH in adult patients, as we conduct clinical trials of tildacerfont in pediatric classic CAH and a rare form of PCOS, as we seek regulatory approvals for tildacerfont, and incur expenses associated with hiring additional personnel to support our research and development efforts. The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, the successful development of tildacerfont is highly uncertain, and we may never succeed in achieving regulatory approval for tildacerfont in classic CAH in adult patients or other indications. In addition, we expect to incur additional costs associated with operating as a public company. We may seek to raise capital through equity or debt financings, collaborative agreements or other arrangements with other companies, or through other sources of financing. Adequate additional funding may not be available to us on acceptable terms or at all. Our failure to raise capital as and when needed could have a negative 106 Table of Contents impact on our financial condition and our ability to pursue our business strategies. We anticipate that we will need to raise substantial additional capital, the requirements of which will depend on many factors, including: ▪ the progress, costs, trial design, results of, and timing of our ongoing and planned clinical trials of tildacerfont; ▪ the outcome, costs and timing of seeking and obtaining FDA and any other regulatory approvals; ▪ the number and characteristics of product candidates that we may pursue; ▪ our ability to manufacture sufficient quantities of tildacerfont; ▪ our plan to expand our research and development activities; ▪ the costs associated with manufacturing tildacerfont and establishing commercial supplies and sales, marketing, and distribution capabilities; ▪ the costs associated with securing and establishing commercialization; ▪ the costs of acquiring, licensing, or investing in product candidates; ▪ our ability to maintain, expand, and defend the scope of our intellectual property portfolio, including the amount and timing of any payments we may be required to make, or that we may receive, in connection with the licensing, filing, prosecution, defense, and enforcement of any patents or other intellectual property rights; ▪ our need and ability to retain key management and hire scientific, technical, business, and medical personnel; ▪ the effect of competing products and product candidates and other market developments; ▪ the timing, receipt, and amount of sales from tildacerfont and any future product candidates, if approved; ▪ our need to implement additional internal systems and infrastructure, including financial and reporting systems; ▪ the economic and other terms, timing of, and success of any collaboration, licensing, or other arrangements which we may enter in the future; and ▪ the effects of the disruptions to and volatility in the credit and financial markets in the United States and worldwide from the COVID-19 pandemic. If we raise additional funds by issuing equity securities, our stockholders will experience dilution. If we raise additional capital through debt financing, we may be subject to covenants that restrict our operations including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our common stock, make certain investments, and engage in certain merger, consolidation, or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. We may be unable to raise additional funds or to enter into such agreements or arrangements on favorable terms, or at all. Our ability to raise additional funds may be adversely impacted by potential worsening global economic conditions and the disruptions to, and volatility in, the credit and financial markets in the United States and worldwide resulting from the COVID-19 pandemic and actions taken to slow its spread, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability. If the equity and credit markets deteriorate, it may make any necessary debt or equity financing more difficult, more costly and more dilutive. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back, or discontinue the development or commercialization of tildacerfont or other research and development initiatives. We also could be required to seek collaborators for tildacerfont and any future product candidates at an earlier stage than otherwise would be desirable or on terms that are less favorable than might otherwise be available or relinquish or license on unfavorable terms our rights to tildacerfont and any future product candidates in markets where we otherwise would seek to pursue development or commercialization ourselves. 107 Table of Contents The amount and timing of our future funding requirements will depend on many factors including the pace and results of our development efforts. We cannot assure you that we will ever be profitable or generate positive cash flow from operating activities. Summary Statement of Cash Flows The following table sets forth the primary sources and uses of cash, cash equivalents, and restricted cash for the periods presented below (in thousands): Year Ended December 31, 2020 2019 Net cash used in operating activities $ (27,519 ) $ (12,617 ) Net cash used in investing activities (74 ) (4 ) Net cash provided by financing activities 181,035 12,433 Net increase (decrease) in cash, cash equivalents, and restricted cash $ 153,442 $ (188 ) Cash Used in Operating Activities For the year ended December 31, 2020, net cash used in operating activities was $27.5 million, which consisted of a net loss of $29.5 million, partially offset by and a net change of $1.2 million in our net operating assets and liabilities and by $0.9 million in non-cash charges. The net change in our operating assets and liabilities was primarily due to a net increase in accounts payable and accrued expenses of $3.7 million and a $0.3 million net increase in accrued compensation and noncurrent assets and liabilities, partially offset by a net increase in prepaid expenses and other current assets of $2.9 million. The non-cash charges of $0.9 million consisted of stock-based compensation expense, non-cash lease expense, and depreciation and amortization expense. For the year ended December 31, 2019, net cash used in operating activities was $12.6 million, which consisted of a net loss of $13.1 million, partially offset by a net change of $0.3 million in our net operating assets and liabilities and $0.2 million in non-cash charges. The net change in our operating assets and liabilities was primarily due to a net increase in accrued compensation of $0.6 million, partially offset by a net decrease in accounts payable and accrued expenses of $0.2 million and a net increase in prepaid expenses of $0.1 million. The non-cash charges of $0.2 million primarily consisted of stock-based compensation expense and depreciation expense. Cash Used in Investing Activities For the year ended December 31, 2020 and 2019, cash used in investing activities was less than $0.1 million and related to the purchase of property and equipment. Cash Provided by Financing Activities For the year ended December 31, 2020, cash provided by financing activities was $181.0 million, consisting primarily of net proceeds from the issuance of common stock in connection with our IPO and the issuance and sale of Series B redeemable convertible preferred stock. For the year ended December 31, 2019, cash provided by financing activities was $12.4 million, consisting primarily of net proceeds of $7.9 million from the issuance and sale of Series A redeemable convertible preferred stock and net proceeds of $4.5 million from the issuance of a term loan. 108 Table of Contents Contractual Obligations and Commitments The following table summarizes our contractual obligations and commitments as of December 31, 2020 (in thousands): Payments Due by Period Less than 1 Year 1 to 3 Years 4 to 5 Years More than 5 years Total Operating lease obligations $ 377 $ 942 $ 957 $ — $ 2,276 Long-term debt obligations 2,571 1,929 — — 4,500 Total $ 2,948 $ 2,871 $ 957 $ — $ 6,776 We enter into contracts in the normal course of business with third-party contract manufacturing organizations and CROs for clinical trials, non-clinical studies and testing, drug substance and product manufacturing and other services for operating purposes. These contracts are generally cancelable by us upon prior written notice after a certain period. Payments due upon cancellation consist only of payments for services provided or expenses incurred, including noncancelable obligations of our service providers, up to the date of cancellation. We have also entered into the License Agreement under which we are obligated to make aggregate milestone payments upon the achievement of specified milestones as well as royalty payments. The payment obligations under the License Agreement are contingent upon future events, such as our achievement of specified milestones or generating product sales. As of December 31, 2020, we were unable to estimate the timing or likelihood of achieving these milestones or generating future product sales. See the section titled “License Agreement with Lilly and Company” above. Off-Balance Sheet Arrangements We did not have off-balance sheet arrangements during the periods presented, and we do not currently have any off-balance sheet arrangements, as defined in the rules and regulations of the SEC. Critical Accounting Policies, Significant Judgments and Use of Estimates Our financial statements have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses, as well as the related disclosure of contingent assets and liabilities as of the date of the financial statements. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. While our significant accounting policies are described in the notes to our financial statements, we believe that the following critical accounting policies are most important to understanding and evaluating our reported financial results. Accrued Research and Development Expenses We record accruals for estimated costs of preclinical, clinical, and manufacturing development, within accrued expenses which are significant components of research and development expenses. A substantial portion of our ongoing research and development activities is conducted by third-party service providers, including CROs. Our contracts with CROs generally include fees such as initiation fees, investigator grants, clinical safety, data management, laboratory expenses, project management, and pass-through expenses. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided to us under such contracts. We accrue the costs 109 Table of Contents incurred under agreements with these third parties based on estimates of actual work completed in accordance with the respective agreements. We determine the estimated costs through discussions with internal personnel and external service providers as to the progress, or stage of completion or actual timeline (start-date and end-date) of the services and the agreed-upon fees to be paid for such services. Payments made to third parties under these arrangements in advance of the performance of the related services by the third parties are recorded as prepaid expenses until the services are rendered. If the actual timing of the performance of services or the level of effort varies from the estimate, we adjust accrued expenses or prepaid expenses accordingly, which impact research and development expenses. 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 reporting amounts that are too high or too low in any particular period. Payments associated with licensing agreements to acquire exclusive licenses to develop, use, manufacture and commercialize products that have not reached technological feasibility and do not have alternate commercial use are expensed as incurred. Stock-Based Compensation Expense We account for stock-based compensation expense by measuring and recognizing compensation expense for all share-based awards made to employees and non-employees based on estimated grant-date fair values. We use the straight-line method to allocate compensation cost to reporting periods over the requisite service period, which is generally the vesting period. We recognize actual forfeitures by reducing the stock-based compensation expense in the same period as the forfeitures occur. We estimate the fair value of share-based awards to employees and non-employees using the Black-Scholes option-pricing valuation model. The Black-Scholes model requires the input of subjective assumptions, including fair value of common stock, expected term, expected volatility, risk-free interest rate, and expected dividend yield, which are described in greater detail below. Estimating the fair value of equity-settled awards as of the grant date using the Black-Scholes option pricing model is affected by assumptions regarding several complex variables. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized. These inputs are subjective and generally require significant analysis and judgment to develop. These inputs are as follows: • Fair value of common stock— Prior to the IPO, the fair value of our common stock was determined by the Board of Directors since it was not publicly traded. The Board of Directors determined fair value of the common stock at the time of grant of the option by considering a number of objective and subjective factors including valuation reports prepared by third-party valuation firms, valuation of comparable companies, sales of redeemable convertible preferred stock to third parties, operating and financial performance, the lack of liquidity of capital stock, and general and industry specific economic outlook, amongst other factors. Following the IPO, the fair market value of our common stock is determined based on the closing price of our common stock on the Nasdaq Global Select Market. • Expected term—The expected term represents the period that our options granted are expected to be outstanding and is determined using the simplified method for employees (based on the mid-point between the vesting date and the end of the contractual term) and is based on the remaining contractual term for non-employees. We have very limited historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior for our stock option grants. • Expected volatility—Since we were a privately-held company until October 2020, we do not have sufficient historical data regarding the volatility of our common stock. Accordingly, the expected volatility was estimated based on the average volatility for comparable publicly traded biopharmaceutical companies over a period equal to the expected term of the stock option grants. The comparable companies were chosen based on their market capitalization, stage of development, area of specialty, and stock-specific attributes. We will continue to apply this process until enough historical information regarding the volatility of our own stock price becomes available. 110 Table of Contents • Risk-free interest rate—The risk-free interest rate is based on the U.S. constant maturity rates with remaining terms similar to the expected term of the options. • Expected dividend yield—We have never paid dividends on our common stock and have no plans to pay dividends on our common stock. Therefore, we used an expected dividend yield of zero. For options granted to non-employee consultants, the fair value of these options is also measured using the Black-Scholes option-pricing model reflecting the same assumptions as applied to employee options in each of the reported periods, other than the expected term which is assumed to be the remaining contractual life of the option. We will continue to use judgment in evaluating the expected volatility, expected terms, and interest rates utilized for our stock-based compensation expense calculations on a prospective basis. JOBS Act We are an “emerging growth company” as defined in the JOBS Act. The JOBS Act permits emerging growth companies to take advantage of an extended transition period to comply with new or revised accounting standards, delaying the adoption of these accounting standards until they would apply to private companies. We have elected to use this extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates. We could be an emerging growth company until December 31, 2025, although circumstances could cause us to lose that status earlier, including if we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act or if we have total annual gross revenue of $1.07 billion or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of the following December 31 or, if we issue more than $1.0 billion in non-convertible debt during any three year period before that time, we would cease to be an emerging growth company immediately.