SUTRO BIOPHARMA, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion of our financial condition and results of operations in conjunction with our condensed financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2020. In addition to historical financial information, this discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as statements of our plans, objectives, expectations, intentions and belief. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the section titled “Risk Factors” under Part II, Item 1A below. These forward-looking statements may include, but are not limited to, statements related to our expectations regarding the potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations, our future results of operations and financial position, business strategy, market size, potential growth opportunities, preclinical and clinical development activities, efficacy and safety profile of our product candidates, use of net proceeds from our public offerings, our ability to maintain and recognize the benefits of certain designations received by product candidates, the timing and results of preclinical studies and clinical trials, commercial collaborations with third parties and the receipt and timing of potential regulatory designations, approvals and commercialization of product candidates. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “predict,” “target,” “intend,” “could,” “would,” “should,” “project,” “plan,” “expect,” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements . Overview We are a clinical stage drug discovery, development and manufacturing company focused on deploying our proprietary integrated cell-free protein synthesis platform, XpressCF ® , to create a broad variety of optimally designed, next-generation protein therapeutics, initially for cancer and autoimmune disorders. We aim to design therapeutics using the most relevant and potent modalities, including cytokine-based therapeutics, immuno-oncology, or I/O agents, antibody-drug conjugates, or ADCs, and bispecific antibodies that are directed primarily against clinically validated targets where the current standard of care is suboptimal. We believe our platform allows us to accelerate the discovery and development of potential first-in-class and best-in-class molecules by enabling the rapid and systematic evaluation of protein structure-activity relationships to create optimized homogeneous product candidates. Our mission is to transform the lives of patients by using our XpressCF ® Platform to create medicines with improved therapeutic profiles for areas of unmet need. Once identified, production of protein drug candidates can be rapidly and predictably scaled in our current Good Manufacturing Practices compliant manufacturing facility. We have the ability to manufacture our cell-free extract that supports our production of proteins on a large scale using a semi-continuous fermentation process. Our two most advanced product candidates are wholly owned: STRO-001, an ADC directed against CD74, for patients with multiple myeloma and non-Hodgkin lymphoma, or NHL, and STRO-002, an ADC directed against folate receptor-alpha, or FolRα, for patients with ovarian and endometrial cancers. We are developing STRO-001, an optimally designed ADC directed against the cancer target CD74, for multiple myeloma and NHL. STRO-001 was designed and optimized for maximal therapeutic index by placing linker-warheads at specific locations within the antibody using our proprietary XpressCF+™ Platform. The Phase 1 trial for STRO-001 is an open-label study that is evaluating STRO-001 as a monotherapy for patients with multiple myeloma and NHL. The trial is being conducted in two parts: dose escalation and dose expansion. The primary objectives of the trial are to determine the safety and tolerability profile of STRO-001, determine the recommended Phase 2 dose and interval and evaluate preliminary anti-tumor activity. The secondary objectives are to characterize the human pharmacokinetics of STRO-001 and additional safety, tolerability and efficacy measures. 25 STRO-002 was designed and optimized for an improved therapeutic index by placing a precise number of linker-warheads at four specific locations within the antibody using our proprietary XpressCF +™ Platform. Our Phase 1 trial for STRO-002 is an open-label study evaluating STRO-002 as a monotherapy for patients with ovarian and endometrial cancers. The trial is being conducted in two-parts, dose escalation and dose expansion. The primary objectives of the STRO-002 clinical trial are to determine the safety and tolerability profile, to define the recommended Phase 2 dose level and interval and to evaluate preliminary anti-tumor activity. Our secondary objectives are to characterize the human pharmacokinetics and additional safety, tolerability and efficacy measures. Based on our proprietary XpressCF ® platform, we have also entered into multi-target, product-focused collaborations with leaders in the field of oncology, including a cytokine derivatives collaboration with Merck Sharp & Dohme Corp., a subsidiary of Merck & Co., Inc., Kenilworth, NJ, or Merck; a B Cell Maturation Antigen, or BCMA, ADC collaboration with Celgene Corporation, or Celgene, a wholly owned subsidiary of Bristol-Myers Squibb Company, New York, NY, or BMS; and a MUC1-EGFR ADC collaboration with Merck KGaA, Darmstadt Germany (operating in the United States and Canada under the name “EMD Serono”). Our two most advanced product candidates are wholly owned: STRO-001, an ADC directed against CD74, for patients with multiple myeloma and non-Hodgkin lymphoma, or NHL, and STRO-002, an ADC directed against folate receptor-alpha, or FolRα, for patients with ovarian and endometrial cancers. STRO-001 is currently enrolling patients in a Phase 1 trial, with updated data reported in December 2020. Based on such reported data, STRO-001 has been generally well-tolerated and, unlike certain other ADCs, no ocular toxicity signals have been observed, with no patients receiving prophylactic corticosteroid eye drops. Dose escalation in the STRO-001 Phase 1 trial is continuing, and the maximum tolerated dose has not yet been reached. We expect to begin the dose expansion portion of the Phase 1 trial in the second half of 2021. The FDA has granted Orphan Drug Designation for STRO-001 for the treatment of multiple myeloma. Our second candidate, STRO-002, is currently enrolling patients in a Phase 1 trial focused on ovarian and endometrial cancers with updated data reported in December 2020. Based on such reported data, STRO-002 has been well-tolerated and no ocular toxicity signals have been observed, with no patients receiving prophylactic corticosteroid eye drops. The dose escalation portion of the STRO-002 Phase 1 trial has been fully enrolled and the dose expansion portion of the trial is ongoing to assess the efficacy, safety and tolerability of STRO-002 at dose levels of 4.3 and 5.2mg/kg . We expect to report updated dose-escalation data for STRO-002 in the second quarter of 2021. For the dose-expansion portion, we dosed the first patient in January 2021 and are treating less heavily pre-treated ovarian cancer patients. We expect to report initial dose-expansion data in the second half of 2021. Additionally, initiation of a STRO-002 combination expansion cohort in ovarian cancer and an expansion cohort for FolR a -selected endometrial cancer are planned for the second half of 2021. Since the commencement of our operations, we have devoted substantially all of our resources to performing research and development and manufacturing activities in support of our own product development efforts and those of our collaborators, raising capital to support and expand such activities and providing general and administrative support for these operations. We have funded our operations to date primarily from upfront, milestone and other payments under our collaboration agreements with Celgene (now BMS), Merck and EMD Serono, the issuance and sale of redeemable convertible preferred stock, our initial public offering, or IPO, of common stock and debt proceeds. We have no products approved for commercial sale and have not generated any revenue from commercial product sales. We had a net loss of $30.4 million and $19.6 million for the three months ended March 31, 2021 and 2020, respectively. We cannot assure you that we will have net income or that we will generate positive cash flow from operating activities in the future. As of March 31, 2021, we had an accumulated deficit of $258.2 million. We do not expect to generate any revenue from commercial product sales unless and until we successfully complete development and obtain regulatory approval for one or more of our product candidates, which we expect will take a number of years. If we obtain regulatory approval for any of our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. We expect our operating expenses to significantly increase as we continue to develop, and seek regulatory approvals for, our product candidates, engage in other research and development activities, expand our pipeline of product candidates, continue to develop our manufacturing facility and capabilities, maintain and expand our intellectual property portfolio, seek regulatory and marketing approval for any product candidates that we may develop, acquire or in-license other assets or technologies, ultimately establish a sales, marketing and distribution infrastructure to commercialize any products for which we may obtain marketing approval and operate as a public company. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on the timing of our clinical trials, our expenditures on other research and development activities and the timing of achievement and receipt of upfront, milestones and other collaboration agreement payments. 26 Impacts of the COVID-19 Pandemic The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the pandemic, impacts on our clinical studies, employee or industry events, and effects on our collaboration partners, suppliers, service providers and manufacturers, all of which are uncertain and cannot be predicted. The COVID-19 pandemic and its adverse effects have become more prevalent in the locations where we, our CROs, suppliers or third-party business partners conduct business. We are beginning to experience the impact of the COVID-19 pandemic on our business through delays in the availability of materials routinely used in biologic therapeutic development and manufacturing, which may cause delays in our research, development and/or manufacturing activities , but overall patient enrollment and treatment remains on track. We may experience more pronounced disruptions in our operations, liquidity, supply chain, facilities, and clinical trials in the future as well. With respect to our clinical trials, we have experienced minor delays in enrollment and occasional delays in data entry by trial sites, but overall enrollment and treatment remains on track. We may in the future experience more significant delays in enrollment, participant dosing, distribution of clinical trial materials, study monitoring and data analysis that could materially adversely impact our business, results of operations and overall financial performance in future periods. Specifically, we may experience impact from changes in how we and companies worldwide conduct business due to the COVID-19 pandemic, including but not limited to restrictions on travel and in-person meetings, the speed and breadth of mass vaccinations for COVID-19 and the efficacy of such vaccines, delays in site activations and enrollment of clinical trials, prioritization of hospital resources toward pandemic effort, delays in review by the FDA and comparable foreign regulatory agencies, and disruptions in our supply chain for our product candidates. As of the filing date of this Form 10-Q, the extent to which the COVID-19 pandemic may impact our financial condition, results of operations or guidance is uncertain. The effect of the COVID-19 pandemic will not be fully reflected in our results of operations and overall financial performance until future periods. See the section titled “Risk Factors” for further discussion of the possible impact of the COVID-19 pandemic on our business. Financial Operations Overview Revenue We have no products approved for commercial sale and have not generated any revenue from commercial product sales. Our total revenue to date has been generated principally from our collaboration and license agreements with BMS, Merck and EMD Serono, and to a lesser extent, from manufacturing, supply and services and products we provide to the above collaborators and to Vaxcyte. We derive revenue from collaboration arrangements, under which we may grant licenses to our collaboration partners to further develop and commercialize our proprietary product candidates. We may also perform research and development activities under the collaboration agreements. Consideration under these contracts generally includes a nonrefundable upfront payment, development, regulatory and commercial milestones and other contingent payments, and royalties based on net sales of approved products. Additionally, the collaborations may provide options for the customer to acquire from us materials and reagents, clinical product supply or additional research and development services under separate agreements. We assess which activities in the collaboration agreements are considered distinct performance obligations that should be accounted for separately. We develop assumptions that require judgement to determine whether the license to our intellectual property is distinct from the research and development services or participation in activities under the collaboration agreements. At the inception of each agreement, we determine the arrangement transaction price, which includes variable consideration, based on the assessment of the probability of achievement of future milestones and contingent payments and other potential consideration. We recognize revenue over time by measuring our progress towards the complete satisfaction of the relevant performance obligation using an appropriate input or output method based on the nature of the service promised to the customer. For arrangements that include multiple performance obligations, we allocate the transaction price to the identified performance obligations based on the standalone selling price, or SSP, of each distinct performance obligation. In instances where SSP is not directly observable, we develop assumptions that require judgment to determine the SSP for each performance obligation identified in the contract. These key assumptions may include full-time equivalent, or FTE, personnel effort, estimated costs, discount rates and probabilities of clinical development and regulatory success. Please see further discussion on the revenue recognition treatment of performance obligations under Critical Accounting Policies and Estimates. 27 Operating Expenses Research and Development Research and development expenses represent costs incurred in performing research, development and manufacturing activities in support of our own product development efforts and those of our collaborators, and include salaries, employee benefits, stock-based compensation, laboratory supplies, outsourced research and development expenses, professional services and allocated facilities-related costs. We expense both internal and external research and development costs as they are incurred. Non-refundable advance payments for services that will be used or rendered for future research and development activities are recorded as prepaid expenses and recognized as expenses as the related services are performed. We expect our research and development expenses to increase in the future as we advance our product candidates into and through preclinical studies and clinical trials, pursue regulatory approval of our product candidates, expand our pipeline of product candidates and continue to develop our manufacturing and research and development facilities and capabilities. The process of conducting the necessary preclinical and clinical research to obtain regulatory approval is costly and time consuming. The actual probability of success for our product candidates may be affected by a variety of factors including: the safety and efficacy of our product candidates, early clinical data, investment in our clinical programs, the ability of collaborators to successfully develop our licensed product candidates, competition, manufacturing capability and commercial viability. We may never succeed in achieving regulatory approval for any of our product candidates. As a result of the uncertainties discussed above, we are unable to determine the duration and completion costs of our research and development projects or when and to what extent we will generate revenue from the commercialization and sale of our product candidates. The following table summarizes our research and development expenses incurred during the periods indicated. The internal costs include personnel, facility costs and research and scientific related activities associated with our pipeline. The external program costs reflect external costs attributable to our clinical development candidates and preclinical candidates selected for further development. Such expenses include third-party costs for preclinical and clinical studies and research, development and manufacturing services, and other consulting costs. Three Months Ended March 31, 2021 2020 (in thousands) Internal costs: Research and drug discovery $ 5,960 $ 4,553 Process and product development 3,370 2,660 Manufacturing 7,816 5,541 Clinical development 900 512 Total internal costs 18,046 13,266 External Program Costs: Research and drug discovery 324 255 Toxicology and translational science 410 319 Process and product development 162 58 Manufacturing 1,724 2,343 Clinical development 1,896 1,378 Total external program costs 4,516 4,353 Total research and development expenses $ 22,562 $ 17,619 28 General and Administrative Our general and administrative expenses consist primarily of personnel costs, expenses for outside professional services, including legal, human resources, audit, accounting and tax services and allocated facilities-related costs. Personnel costs include salaries, employee benefits and stock-based compensation. We expect to incur additional expenses operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and listing standards applicable to companies listed on the Nasdaq Global Market, additional insurance expenses, investor relations activities and other administrative and professional services. We also expect to increase the size of our administrative function to support the anticipated growth of our business, and as we continue to advance our product candidates into and through the clinic, we expect the growth of our business to require increased general and administrative expenses. Interest Income Interest income consists primarily of interest earned on our invested funds. Unrealized Loss on Equity Securities Unrealized loss on equity securities consists of the remeasurement of our investment in Vaxcyte common stock. Interest and Other Expense, Net Interest expense includes interest incurred on our debt and amortization of debt issuance costs. Additionally, the Company identified a financing component under the Merck 2018 Agreement and recorded interest expense associated with the upfront payment. Other income (expense) in the three months ended March 31, 2021 and 2020 includes changes in values attributable to the arrangement with the Leukemia & Lymphoma Society, Inc. and the Call Option Plan (each as defined in the notes to our financial statements included elsewhere in this report). Comparison of the Three Months Ended March 31, 2021 and 2020 Three Months Ended March 31, 2021 2020 Change Change (%) (in thousands) Revenues $ 14,660 $ 7,152 $ 7,508 105 % Operating expenses Research and development 22,562 17,619 4,943 28 % General and administrative 11,107 8,713 2,394 27 % Total operating expenses 33,669 26,332 7,337 28 % Loss from operations (19,009 ) (19,180 ) 171 (1 )% Interest income 197 641 (444 ) (69 )% Unrealized loss on equity securities (10,689 ) – (10,689 ) * Interest and other expense, net (858 ) (1,056 ) 198 (19 )% Net loss $ (30,359 ) $ (19,595 ) $ (10,764 ) 55 % * Percentage not meaningful 29 Revenue We have recognized revenue as follows during the periods indicated: Three Months Ended March 31, 2021 2020 Change Change (%) (in thousands) Bristol Myers Squibb Company ("BMS") $ 1,239 $ 2,045 $ (806 ) (39 )% Merck Sharp & Dohme Corporation (“Merck”) (1) $ 11,883 $ 2,777 $ 9,106 328 % Merck KGaA, Darmstadt, Germany (operating in the United States and Canada under the name “EMD Serono”) $ 220 2,294 (2,074 ) (90 )% Vaxcyte (2) $ 1,318 36 1,282 * Total revenue $ 14,660 $ 7,152 $ 7,508 105 % (1) Merck was a related party until the closing of our public offering on May 14, 2020. (2) Vaxcyte was a related party until the closing of its initial public offering on June 16, 2020. * Percentage not meaningful Total revenue increased by $7.5 million, or 105%, during the three months ended March 31, 2021 compared to the three months ended March 31, 2020. This was due to an increase of $9.1 million of Merck revenue, which reflects a $8.1 million increase in revenue from ongoing performance of research and development services, of which $5.9 million was associated with the contingent third program that was fully recognized upon the determination that the related performance obligation had terminated during the first quarter of 2021, and an increase of $1.4 million in clinical trial materials supply, partially offset by a $0.4 million decrease related to the financing component associated with the upfront payment, and an increase of $1.3 million of Vaxcyte revenue under our supply agreement. These increases were partially offset by a decrease of $2.1 million in EMD Serono revenue and a decrease of $0.8 million in BMS revenue. Research and Development Expense Research and development expense increased by $4.9 million, or 28%, during the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The increase was due primarily to increases of $2.1 million in personnel-related expenses due to higher headcount, $2.0 million in laboratory supplies and production materials-related expenses, and $1.1 million in facility-related expenses, partially offset by a $0.3 million decrease in consulting and outside services. General and Administrative Expense General and administrative expense increased by $2.4 million, or 27% during the three months ended March 31, 2021 compared to the three months ended March 31, 2020. The increase was due primarily to increases of $1.5 million in personnel-related expenses due to higher headcount, $0.2 million in insurance and external services, $0.2 million in equipment-related expenses, and $0.5 million in facility-related expenses. Interest Income Interest income decreased by $0.4 million during the three months ended March 31, 2021 compared to the three months ended March 31, 2020, due primarily to a decrease in the amortization of premiums on investments. Unrealized Loss on Equity Securities Unrealized loss on equity securities was $10.7 million during the three months ended March 31, 2021, as compared to zero for the three months ended March 31, 2020. The unrealized loss on equity securities was entirely due to the remeasurement of the estimated fair value of our investment in Vaxcyte common stock. Interest and Other Expense, Net Interest and other expense, net, decreased by $0.2 million during the three months ended March 31, 2021 compared to the three months ended March 31, 2020, due primarily to a $0.1 million decrease in other expenses related to the 30 remeasurement of the vested c all o ption s under the Call Option Plan and a $0. 4 million decrease in interest expense associated with the financing component related to the 2018 Merck Agreemen t , partially offset by a $0. 2 million increase in interest expense related to our outstanding debt . Liquidity and Capital Resources Sources of Liquidity To date, we have incurred significant net operating losses, and negative cash flows from operations. Our operations have been funded primarily by payments received from our collaborators, and net proceeds from equity sales and debt. As of March 31, 2021, we had cash, cash equivalents and marketable securities of $294.9 million, equity securities of $31.0 million, outstanding debt of $24.7 million and an accumulated deficit of $258.2 million. 2021 Milestone Payment from Merck On April 14, 2021, we announced that Merck, known as MSD outside the United States and Canada, will make to us a $15 million milestone payment for the initiation of an IND enabling toxicology study for the first program in its collaboration to develop novel cytokine derivative therapeutics for cancer and autoimmune disorders. 2020 Public Offerings On May 14, 2020, we closed a public offering of 12,650,000 shares of our common stock at a public offering price of $7.75 per share, which included the exercise in full of the underwriters’ option to purchase 1,650,000 shares of common stock. Our net proceeds from this offering, after deducting underwriting discounts and commissions and other offering expenses, was approximately $91.4 million. On December 11, 2020, we closed a public offering of 6,900,000 shares of our common stock at a public offering price of $21.00 per share, which included the exercise in full of the underwriters’ option to purchase 900,000 shares of common stock. Our net proceeds from this offering, after deducting underwriting discounts and commissions and other offering expenses, was approximately $135.8 million. At-The-Market Sales During the year ended December 31, 2020, we sold an aggregate of 2,614,286 shares of our common stock through our At-the-Market ATM facility, or ATM Facility, pursuant to a sales agreement dated October 4, 2019 with Cowen and Company, LLC, as sales agent. The gross proceeds from these sales were approximately $24.6 million, before deducting fees of approximately $0.8 million, resulting in net proceeds of approximately $23.8 million. Vaxcyte, Inc. Equity Ownership In June 2020, Vaxcyte closed an initial public offering of its common stock at a price per share of $16.00. The Vaxcyte common stock held by us is measured at fair value at each reporting period based on the closing price of Vaxcyte’s common stock on the last trading day of each reporting period, adjusted for a discount for lack of marketability due to the presence of a lock-up agreement during certain periods in 2020, with any unrealized gains and losses recorded in our statements of operations. The lock-up agreement expired in December 2020. As of March 31, 2021, we held 1,567,324 shares of Vaxcyte common stock with an estimated fair value of $31.0 million. Term Loan For a description of our Loan and Security Agreement with Oxford Finance LLC and Silicon Valley Bank, please see Note 6 to our condensed financial statements. Funding Requirements Based upon our current operating plan, we believe that our existing capital resources will enable us to fund our operating expenses and capital expenditure requirements through at least the next twelve months after the date of this filing. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. We will continue to require additional financing to advance our current product candidates into and through clinical development, to develop, acquire or in-license other potential product candidates, pay our obligations and to fund operations for the foreseeable future. 31 We may seek to raise any necessary additional capital through a combination of public or private equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements , marketing and distribution arrangements , or other sources of financing . Adequate additional funding may not be available to us on acceptable terms, or at all. Any failure to raise capital as and when needed could have a negative impact on our financial condition and on our ability to pursue our business plans and strategies , and may cause us to delay, reduce the scope of or suspend one or more of our pre-clinical and clinical studies, research and development programs or commercialization efforts , and may necessitate us to delay, reduce or terminate planned activities in order to reduce costs. Due to the numerous risks and uncertainties associated with the development and commercialization of our product candidates and the extent to which we may enter into additional collaborations with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical studies. To the extent we raise additional capital through new collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our product candidates, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we do raise additional capital through public or private equity or convertible debt offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Cash Flows The following table summarizes our cash flows during the periods indicated: Three Months Ended March 31, 2021 2020 (in thousands) Net Cash used in operating activities $ (30,430 ) $ (18,734 ) Net cash (used in) provided by investing activities (121,730 ) 41,637 Net cash provided by financing activities 1,826 15,702 Net (decrease) increase in cash, cash equivalents and restricted cash $ (150,334 ) $ 38,605 Cash Flows from Operating Activities Cash used in operating activities for the three months ended March 31, 2021 was $30.4 million. Our net loss of $30.4 million included $10.7 million of unrealized loss on equity securities as a result of the remeasurement of the estimated fair value of our investment in Vaxcyte common stock, non-cash charges of $4.0 million for stock-based compensation, $1.3 million for depreciation and amortization, and $0.5 million for the amortization of premium on our marketable securities. Cash used in operating activities also reflected a net decrease in operating assets and liabilities of $16.5 million, due to an increase of $1.7 million in accounts receivable from our collaborators, an increase of $3.1 million in prepaid expenses and other assets, a decrease of $7.8 million in our deferred revenue balance from revenue recognized under our collaboration agreements, a decrease of $4.3 million in accrued compensation expense primarily due to bonuses paid in connection with certain company goal achievements, and a decrease of $0.7 million in accounts payable and other liabilities due to timing of payments, offset by an increase of $1.0 million in deferred rent from our sublease. Cash used in operating activities for the three months ended March 31, 2020 was $18.7 million. Our net loss of $19.6 million was reduced by non-cash charges of $2.7 million for stock-based compensation and $1.1 million for depreciation and amortization. Cash used in operating activities also reflected a net decrease in operating assets and liabilities of $2.9 million, due to an increase of $2.8 million in accounts receivable from research and development services revenues from our collaborators, a decrease of $3.1 million in accrued compensation expense primarily due to bonuses paid in connection with certain company goal achievements, a decrease of $0.7 million in other liabilities due to timing of payments, an increase of $2.3 million in our deferred revenue balance due to the $5.0 million received from Merck upon their exercise of an option to extend the research term of the collaboration’s first cytokine-derivative program by one year, which payment was earned in March 2020 and received in April 2020, offset by revenue recognized under our collaboration agreements, and a decrease of $1.4 million in prepaid expenses and other assets. 32 Cash Flows from Investing Activities Cash used in investing activities of $121.7 million for the three months ended March 31, 2021 was primarily related to purchases of marketable securities of $164.6 million and purchases of property and equipment of $2.4 million, principally for leasehold improvements to the premises under the Sublease, offset partially by maturities and sales of marketable securities of $45.3 million. Cash provided by investing activities of $41.6 million for the three months ended March 31, 2020 was primarily related to maturities of marketable securities of $37.5 million and sales of marketable securities of $8.5 million, offset partially by purchases of marketable securities of $3.6 million and purchases of property and equipment of $0.8 million principally related to laboratory and manufacturing equipment. Cash Flows from Financing Activities Cash provided by financing activities of $1.8 million for the three months ended March 31, 2021 was primarily related to $1.3 million of proceeds received from the exercise of common stock options and $0.5 million of net proceeds received from participants in our employee equity plans. Cash provided by financing activities of $15.7 million for the three months ended March 31, 2020 was primarily related to $25.0 million of gross proceeds from our debt refinancing and $0.7 million of proceeds received from participants of our employee stock purchase plan and exercise of common stock options, partially offset by a $10.0 million repayment of the August 2017 Loan. Off-Balance Sheet Arrangements We have not entered into any off-balance sheet arrangements, as defined under SEC rules. JOBS Act Accounting Election We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided 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 will remain an emerging growth company until the earliest of (i) the last day of our first fiscal year (a) following the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenues of at least $1.07 billion, or (ii) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th and (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period. Critical Accounting Policies and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in the notes to our financial statements included elsewhere in this filing, we believe that the following critical accounting policies are most important to understanding and evaluating our reported financial results. 33 Revenue Recognition We have no products approved for commercial sale and have not generated any revenue from commercial product sales. Our total revenue to date has been generated principally from our collaboration and license agreements with BMS, Merck and EMD Serono, and to a lesser extent, from manufacturing, supply and services and products we provide to the above collaborators and Vaxcyte. Collaboration revenue We derive revenue from collaboration arrangements, under which we may grant licenses to our collaboration partners to further develop and commercialize our proprietary product candidates. We may also perform research and development activities under the collaboration agreements. Consideration under these contracts generally includes a nonrefundable upfront payment, development, regulatory and commercial milestones and other contingent payments, and royalties based on net sales of approved products. Additionally, the collaborations may provide options for the customer to acquire from us materials and reagents, clinical product supply or additional research and development services under separate agreements. We assess which activities in the collaboration agreements are considered distinct performance obligations that should be accounted for separately. We develop assumptions that require judgement to determine whether the license to our intellectual property is distinct from the research and development services or participation in activities under the collaboration agreements. At the inception of each agreement, we determine the arrangement transaction price, which includes variable consideration, based on the assessment of the probability of achievement of future milestones and contingent payments and other potential consideration. We also evaluate estimates of our resources, which are used as the basis of measurement for revenue to be recognized on an input basis. For arrangements that include multiple performance obligations, we allocate the transaction price to the identified performance obligations based on the SSP of each distinct performance obligation. In instances where SSP is not directly observable, we develop assumptions that require judgment to determine the SSP for each performance obligation identified in the contract. These key assumptions may include full-time equivalent, or FTE, personnel effort, estimated costs, discount rates and probabilities of clinical development and regulatory success. Upfront Payments : For collaboration arrangements that include a nonrefundable upfront payment, if the license fee and research and development services cannot be accounted for as separate performance obligations, the transaction price is deferred and recognized as revenue over the expected period of performance using a cost-based input methodology. We use judgement to assess the pattern of delivery of the performance obligation. In addition, amounts paid in advance of services being rendered may result in an associated financing component to the upfront payment. Accordingly, the interest on such borrowing cost component will be recorded as interest expense and revenue, based on an appropriate borrowing rate applied to the value of services to be performed by us over the estimated service performance period. License Grants: For collaboration arrangements that include a grant of a license to our intellectual property, we consider whether the license grant is distinct from the other performance obligations included in the arrangement. For licenses that are distinct, we recognize revenues from nonrefundable, upfront payments and other consideration allocated to the license when the license term has begun and we have provided all necessary information regarding the underlying intellectual property to the customer, which generally occurs at or near the inception of the arrangement. 34 Milestone and Contingent Payments : At the inception of the arrangement and at each reporting date thereafter, we assess whether we should include any milestone and contingent payments or other forms of variable consideration in the transaction price using the most likely amount method. If it is probable that a significant reversal of cumulative revenue would not occur upon resolution of the uncertainty , the associated milestone value is included in the transaction price . At the end of each subsequent reporting period, we re-evaluate the probability of achievement of each such milestone and any related constraint and , if necessary, adjust our estimate of the overall transaction price. Since milestone and contingent payments may become payable to us upon the initiation of a clinical study or filing for or receipt of regulatory approval, we review the relevant facts and circumstances to determine when we should update the transaction price, which may occur before the triggering event. When we update the transaction price for milestone and contingent payments, we allocate the changes in the total transaction price to each performance obligation in the agreement on the same basis as the initial allocation. Any such adjustments are recorded on a cumulative catch-up basis in the period of adjustment , which may result in recognizing revenue for previously satisfied performance obligations in such period. Our collaborators generally pay milestones and contingent payments subsequent to achievement of the triggering event. Research and Development Services : For amounts allocated to our research and development obligations in a collaboration arrangement, we recognize revenue over time using a cost-based input methodology, representing the transfer of goods or services as activities are performed over the term of the agreement. Materials Supply: We provide materials and reagents, clinical materials and services to certain of our collaborators under separate agreements. The consideration for such services is generally based on FTE personnel effort used to manufacture those materials reimbursed at an agreed upon rate in addition to agreed-upon pricing for the provided materials. The amounts billed are recognized as revenue as the performance obligations are met by us. Research and Development We record accrued expenses for estimated costs of our research and development activities conducted by third party service providers, which include outsourced research and development expenses, professional services and contract manufacturing activities. We record the estimated costs of research and development activities based upon the estimated amount of services provided but not yet invoiced, and include these costs in current liabilities in the balance sheets and within research and development expense in the statements of operations. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized and recognized as an expense as the goods are delivered or the related services are performed. For outsourced research and development expenses, such as professional fees payable to third parties for preclinical studies, clinical trials and research services and other consulting costs, we estimate the expenses based on the services performed, pursuant to contracts with research institutions that conduct and manage preclinical studies, clinical trials and research services on our behalf. We estimate these expenses based on discussions with internal management personnel and external service providers as to the progress or stage of completion of services and the contracted fees to be paid for such services. If the actual timing of the performance of services or the level of effort varies from the original estimates, we will adjust the accrual accordingly. 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. Stock-Based Compensation We recognize compensation costs related to stock-based awards granted to employees based on the estimated fair value of the awards on the date of grant. We account for forfeitures of stock-based awards as they occur. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The grant date fair value of the stock-based awards is generally recognized on a straight-line basis over the requisite service period, which is generally the vesting period of the respective awards. 35 The Black-Scholes option-pricing model requires the use of highly subjective assumptions to determine the fair value of stock-based awards, including the expected term and the expected volatility of the underlying stock. These assumptions include: ▪ Expected term —The expected term represents the period that the stock-based awards are expected to be outstanding. We use the “simplified” method to determine the expected life of options granted, which calculates the expected term as the average of the weighted-average vesting term and the contractual term of the option. ▪ Expected volatility—Since we have limited information available on the volatility of our common stock due to its short trading history, the expected volatility is estimated based on the average historical volatilities of common stock of comparable publicly traded entities over a period equal to the expected term of the stock option grants. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available. ▪ Risk-free interest rate —The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the expected term of the options. ▪ Expected dividend —We have never paid dividends on our common stock and have no plans to pay dividends on our common stock. Therefore, we use an expected dividend yield of zero. We will continue to use judgment in evaluating the expected volatility and expected terms utilized for our stock-based compensation calculations on a prospective basis. There have been no material changes to our critical accounting policies and estimates discussed in our Annual Report on Form 10-K for the year ended December 31, 2020. Recent Accounting Pronouncements See Note 2 to our financial statements included elsewhere in this report for more information. 36