Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements included in this Annual Report on Form 10-K, which have been prepared by us in accordance with United States generally accepted accounting principles, or GAAP, and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended. This discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Overview
We are a leading clinical-stage gene therapy company with a mission to free people from a lifetime of genetic disease. Our company is focused on developing potentially curative ex vivo lentiviral-based gene therapies to treat patients with rare diseases following a single dose treatment regimen. Our gene therapies employ hematopoietic stem cells that are harvested from the patient and then modified with a lentiviral vector to insert the equivalent of a functional copy of the gene that is mutated in the target disease. We believe that our approach, which is designed to transform stem cells from patients into therapeutic products, has the potential to provide curative benefit for a range of diseases. Our initial focus is on a group of rare genetic diseases referred to as lysosomal disorders, some of which today are primarily managed with enzyme replacement therapies, or ERTs. These lysosomal disorders have well-understood biologies, identified patient populations, established standards of care yet with significant unmet needs, and represent large market opportunities with approximately $3.4 billion in worldwide net sales in 2021.
Our initial pipeline is comprised of five lentiviral-based gene therapy programs: AVR-RD-04 for the treatment of cystinosis; AVR-RD-02 for the treatment of Gaucher disease type 1; AVR-RD-05 for the treatment of Hunter syndrome; AVR-RD-06 for the treatment of Gaucher disease type 3; and AVR-RD-03 for the treatment of Pompe disease.
AVR-RD-04 is currently being studied for the treatment of cystinosis by our collaborators at the University of California, San Diego, or UCSD, in a Phase 1/2 collaborator-sponsored clinical trial, and as of March 1, 2022 four patients have been dosed. Three patients have been dosed as of March 1, 2022 in our Company-sponsored Phase 1/2 clinical trial of AVR-RD-02 for the treatment of Gaucher disease type 1, which we refer to as the Guard1 clinical trial, and we are actively recruiting additional potential patients for our currently active sites. AVR-RD-05 is being studied for the treatment of Hunter syndrome by our collaborators at The University of Manchester, and a Phase 1/2 investigator-sponsored clinical trial is expected to be initiated in 2023. AVR-RD-06 is our preclinical program for the treatment of Gaucher disease type 3, and we expect to engage with regulatory authorities this year to discuss a potential Phase 2/3 clinical trial. Our AVR-RD-03 program for Pompe disease has completed preclinical development, and we are planning to engage with regulatory authorities this year to discuss a potential path to the clinic with the goal of initiating a clinical trial in 2023. In January 2022 we announced the deprioritization of AVR-RD-01, our investigational gene therapy program for Fabry disease. This decision was made due to several factors, including new clinical data showing variable engraftment patterns from the five most recently dosed patients in the Company’s Phase 2 clinical trial of AVR-RD-01 for the treatment of Fabry disease, which we refer to as the FAB-GT clinical trial. As a result of the deprioritization, the Company has stopped enrollment of its Phase 2 FAB-GT clinical trial and will focus on its other pipeline programs.
Since our inception in 2015, we have devoted substantially all of our resources to organizing and staffing our company, business planning, raising capital, acquiring or discovering product candidates and securing related intellectual property rights, conducting discovery, research and development activities for our programs and planning for potential commercialization. To date, we have not generated any product revenue and have financed our operations primarily through the private placement of our securities and through public offerings of our common stock. Through December 31, 2021, we had received gross cash proceeds of $87.5 million from sales of our preferred stock; gross cash proceeds, before deducting underwriting discounts and commissions and expenses, of $428.1 million from sales of our common stock through our initial public offering and follow-on offerings; and gross cash proceeds, before deducting commissions and expenses, of $23.5 million from sales of our common stock through our “at-the-market” (ATM) facility.
Additionally, we have incurred significant operating losses. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our current or future product candidates and programs. Our net losses were $119.1 million and $119.7 million for the years
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ended December 31, 2021 and 2020 , respectively. As of December 31, 2021 , we had an accumulated deficit of $ 383.5 million. We expect to continue to incur significant expenses for at least the next several years as we advance our current and future product candidates from discovery through preclinical development and clinical trials and seek regulatory approval of our product candidates. O ur pipeline consists of five investigational gene therapies, two of which are currently in clinical development. As a result, further development of these programs will require us to expend significant resources to advance these candidates. In addition, if we obtain marketing approval for any of our product candidates, we expect to incur significant commercialization expenses related to product manufacturing, marketing, sales and distribution. We may also incur expenses in connection with the in-licensing or acquisition of additional product candidates.
We will need substantial additional funding to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations with proceeds from outside sources, with a majority of such proceeds to be derived from sales of equity, including the net proceeds from our follow-on offerings and sales of common stock under our “ at-the-market” facility, or ATM Facility, as well as proceeds from our Loan and Security Agreement, or Term Loan Agreement, with the lenders party thereto from time to time, or the Lenders, and Silicon Valley Bank, as administrative agent and collateral agent for the Lenders, or the Agent . We may also pursue additional funding from outside sources, including our expansion of, or our entry into, new borrowing arrangements; research and development incentive payments from the Australian government; and our entry into potential future collaboration agreements for one or more of our programs. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. If we fail to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more of our product candidates or delay our pursuit of potential in-licenses or acquisitions.
Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations.
As of December 31, 2021, we had cash and cash equivalents of $189.6 million. We believe that our existing cash and cash equivalents as of December 31, 2021 will enable us to fund our operating expenses and capital expenditure requirements into the first quarter of 2024. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect. See “ Liquidity and Capital Resources. ” To finance our operations beyond that point, we will need to raise additional capital, which cannot be assured.
Components of Our Consolidated Results of Operations
Operating Expenses
Research and Development Expenses
Research and development expenses consist primarily of costs incurred in connection with the discovery and development of our product candidates. We expense research and development costs as incurred. These expenses consist of costs incurred in connection with the development of our product candidates, including:
•
license maintenance fees and milestone fees incurred in connection with various license agreements;
•
expenses incurred under agreements with contract research organizations, or CROs, contract manufacturing organizations, or CMOs, as well as investigative sites and consultants that conduct our clinical trials, preclinical studies and other scientific development services;
•
manufacturing scale-up expenses and the cost of acquiring and manufacturing preclinical and clinical trial materials and commercial materials, including manufacturing validation batches;
•
costs of purchasing lab supplies and non‑capital equipment used in our preclinical activities;
•
employee-related expenses, including salaries, related benefits, travel and stock-based compensation expense for employees engaged in research and development functions;
•
costs related to compliance with regulatory requirements; and
•
allocated facilities costs, depreciation and other expenses, which include rent and utilities.
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We recognize external development costs based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers.
Our direct research and development expenses are tracked on a program-by-program basis for our product candidates and consist primarily of external costs, such as fees paid to outside consultants, CROs, CMOs, and central laboratories in connection with our preclinical development, process development, manufacturing and clinical development activities. Our direct research and development expenses by program also include fees incurred under license agreements. We do not allocate employee costs or facility expenses, including depreciation or other indirect costs, to specific programs because these costs are deployed across multiple programs and, as such, are not separately classified. We use internal resources primarily to oversee the research and discovery as well as for managing our preclinical development, process development, manufacturing and clinical development activities. These employees work across multiple programs and, therefore, we do not track their costs by program.
The table below summarizes our research and development expenses related to our product candidates (in thousands):
Year Ended
December 31,
2021
2020
Fabry
$
12,402
$
11,483
Gaucher
6,748
7,546
Pompe
3,073
5,593
Cystinosis
5,104
1,225
Hunter
2,294
8,728
Other research activities
199
5,138
Unallocated research and development expenses
53,294
47,523
Total research and development expenses
$
83,114
$
87,236
Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. As a result, we expect that our research and development expenses will increase substantially over the next several years, particularly as we increase personnel costs, including stock-based compensation, contractor costs and facilities costs, as we continue to advance the development of our product candidates. We also expect to incur additional expenses related to milestone and royalty payments payable to third parties with whom we have entered into license agreements to acquire the rights to our product candidates.
The successful development and commercialization of our product candidates is highly uncertain. At this time, we cannot reasonably estimate or know the nature, timing and costs of the efforts that will be necessary to complete the preclinical and clinical development of any of our product candidates or when, if ever, material net cash inflows may commence from any of our product candidates. This uncertainty is due to the numerous risks and uncertainties associated with product development and commercialization, including the uncertainty of:
•
the scope, progress, outcome and costs of our preclinical development activities, clinical trials and other research and development activities;
•
establishing an appropriate safety profile with IND-enabling studies;
•
successful patient enrollment in, and the design, initiation and completion of, clinical trials;
•
the timing, receipt and terms of any marketing approvals from applicable regulatory authorities;
•
establishing commercial manufacturing capabilities or making arrangements with third-party manufacturers;
•
development and timely delivery of commercial-grade drug formulations that can be used in our clinical trials and for commercial launch;
•
obtaining, maintaining, defending and enforcing patent claims and other intellectual property rights;
•
significant and changing government regulation;
•
launching commercial sales of our product candidates, if and when approved, whether alone or in collaboration with others;
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•
maintaining a continued acceptable safety profile of the product candidates following approval; and
•
the risks disclosed in the section entitled “Risk Factors” of this Annual Report on Form 10-K.
We may never succeed in achieving regulatory approval for any of our product candidates. We may obtain unexpected results from our clinical trials. We may elect to discontinue, delay or modify clinical trials of some product candidates or focus on others. Any changes in the outcome of any of these variables with respect to the development of our product candidates in preclinical and clinical development could mean a significant change in the costs and timing associated with the development of these product candidates. For example, if the FDA, or another regulatory authority were to delay our planned start of clinical trials or require us to conduct clinical trials or other testing beyond those that we currently expect, or if we experience significant delays in enrollment in any of our planned clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development of that product candidate. Identifying potential product candidates and conducting preclinical testing and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain marketing approval and achieve product sales. In addition, our product candidates, if approved, may not achieve commercial success.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries, related benefits, travel and stock-based compensation expense for personnel in executive, finance and administrative functions. General and administrative expenses also include professional fees for legal, consulting, accounting and audit services.
We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our continued research activities and development of our product candidates. We also anticipate that we will continue to incur increased accounting, audit, legal, compliance, director and officer insurance costs as well as investor and public relations expenses associated with being a public company. We anticipate the additional costs for these services will substantially increase our general and administrative expenses. Additionally, if and when we believe a regulatory approval of a product candidate appears likely, we anticipate an increase in payroll and other commercialization-related expenses as a result of our preparation for commercial operations, especially as it relates to the sales and marketing of our product candidate.
Other (Expense) Income, net
Other (expense) income, net primarily consists of interest income earned on our cash and cash equivalents, changes in foreign currency, and interest expense related to our Term Loan Agreement.
Consolidated Results of Operations
Comparison of the Years Ended December 31, 2021 and 2020
The following table summarizes our consolidated results of operations (in thousands):
Year Ended
December 31,
2021
2020
Change
Operating expenses:
Research and development
$
83,114
$
87,236
$
(4,122
)
General and administrative
35,727
32,992
2,735
Total operating expenses
118,841
120,228
(1,387
)
Loss from operations
(118,841
)
(120,228
)
1,387
Other (expense) income:
Interest (expense) income, net
(224
)
719
(943
)
Other expense
(61
)
(203
)
142
Total other (expense) income, net
(285
)
516
(801
)
Net loss
$
(119,126
)
$
(119,712
)
$
586
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Research and Development Expenses
Research and development expenses decreased by $4.1 million to $83.1 million for the year ended December 31, 2021, from approximately $87.2 million for the year ended December 31, 2020. This decrease was attributable to $9.1 million in non-recurring license fees incurred in 2020, which included an $8.0 million expense related to a one-time, upfront fee paid as consideration for in-licensing the Hunter syndrome program, a $1.2 million decrease in non-cash stock-based compensation, and a $0.5 million decrease in other expenses. These decreases were partially offset by a $6.7 million increase in personnel-related costs.
General and Administrative Expenses
General and administrative expenses increased by $2.7 million to $35.7 million for the year ended December 31, 2021, from $33.0 million for the year ended December 31, 2020. This increase was attributable to a $4.2 million increase in non-cash stock-based compensation and a $1.5 million increase in personnel-related costs, offset in part by a decrease in other expenses, primarily related to facilities costs, professional fees and legal fees, of $3.0 million.
Other (Expense) Income, net
Other (expense) income, net was $(0.3) million for the year ended December 31, 2021, compared to $0.5 million of other income, net for the year ended December 31, 2020. The change was primarily due to a decrease of $0.6 million related to a decrease in interest income and $0.2 million in interest expense related to the Term Loan Agreement which was entered into during 2021.
Liquidity and Capital Resources
Since our inception, we have not generated any revenue and have incurred significant operating losses and negative cash flows from our operations. We have funded our operations to date primarily with proceeds from the sale of preferred stock and our common stock through our initial public offering, or IPO, and we have raised additional capital through subsequent follow-on offerings and our ATM Facility, as well as through our Term Loan Agreement . Through December 31, 2021, we had received gross cash proceeds of $87.5 million from sales of our preferred stock; gross cash proceeds, before deducting underwriting discounts and commissions and expenses, of $428.1 million from sales of our common stock through our IPO and follow-on public offerings; $23.5 million in gross proceeds from the sale of our common stock under our ATM Facility; and we had drawn $15.0 million in term loans under our Term Loan Agreement.
On July 1, 2019, we filed a shelf registration statement on Form S-3 with the SEC, or the July 2019 Shelf, which covers the offering, issuance and sale by us of up to an aggregate of $200.0 million of our common stock, preferred stock, debt securities, warrants and/or units. We simultaneously entered into a Sales Agreement with Cowen and Company, LLC, as sales agent, to provide for the offering, issuance and sale by us of up to $50.0 million of our common stock from time to time in ATM offerings under the July 2019 Shelf. The July 2019 Shelf was declared effective by the SEC on July 10, 2019.
On December 20, 2019, we filed a shelf registration statement on Form S-3 with the SEC, or the December 2019 Shelf, which covers the offering, issuance and sale by us of up to an aggregate of $250.0 million of our common stock, preferred stock, debt securities, warrants and/or units. The December 2019 Shelf was declared effective by the SEC on January 14, 2020.
In July 2019, we closed an underwritten public offering, or the July 2019 Follow-On Offering, under the July 2019 Shelf of 7,475,000 shares of our common stock at a public offering price of $18.50 per share, which included 975,000 shares of our common stock resulting from the full exercise of the underwriters’ option to purchase additional shares at the public offering price, less underwriting discounts and commissions. The net proceeds to us from this offering, after deducting underwriting discounts and commissions and other offering expenses payable by us, were $129.5 million.
In February 2020, we closed an underwritten public offering, or the February 2020 Follow-On Offering, under the December 2019 Shelf of 4,350,000 shares of our common stock at a public offering price of $23.00 per share, less underwriting discounts and commissions. The net proceeds to us from this offering, after deducting underwriting discounts and commissions and other offering expenses payable by us, were $93.6 million.
In June 2020, we sold an aggregate of 384,140 shares of common stock under the ATM Facility for net proceeds, after deducting commissions and other offering expenses payable by us, of $8.1 million.
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In November 2020, we closed an underwritten public offering , or the November 2020 Follow-On Offering, of 5,000,000 shares of our common stock at a public offering price of $15.00 per share , less underwriting discounts and commissions . The net proceeds to us from the November 2020 Follow- On Offering, after deducting underwriting discounts and commissions and other offering expenses payable by us , were $70 .2 million .
In May 2021, we sold an aggregate of 1,829,268 shares of common stock under the ATM Facility for net proceeds, after deducting commissions and other offering expenses payable by us, of $14.5 million. As of December 31, 2021, approximately $26.5 million of common stock remained available for future issuance under the ATM Facility.
On November 2, 2021, or the Closing Date, we entered into the Term Loan Agreement. The Term Loan Agreement provided for (i) on the Closing Date, $30.0 million aggregate principal amount of term loans available through October 31, 2023; (ii) an additional $20.0 million in term loan facilities available through October 31, 2023 upon the achievement of certain regulatory or clinical milestones prior to the time of draw, or the Milestone Funding; and (iii) an additional discretionary $15.0 million term loan facility available upon our request and approval by the Agent and the Lenders, or, collectively, the Term Loans. We drew $15.0 million in term loans on the Closing Date. A s a result of the deprioritization of our Fabry disease program, we are no longer able to draw the $20.0 million of Milestone Funding per the terms of the Term Loan Agreement. The loan repayment schedule provides for interest only payments until November 1, 2024, followed by consecutive monthly payments of principal and interest. All unpaid principal and accrued and unpaid interest with respect to each term loan is due and payable in full on October 1, 2026.
As of December 31, 2021, we had cash and cash equivalents of $189.6 million. Cash in excess of immediate requirements is invested primarily with a view to liquidity and capital preservation. We believe that our existing cash and cash equivalents as of December 31, 2021 will enable us to fund our operating expenses and capital expenditure requirements into the first quarter of 2024.
Cash Flows
The following table summarizes our cash flows for each of the periods presented (in thousands):
Year Ended
December 31,
2021
2020
Net cash used in operating activities
$
(98,025
)
$
(98,803
)
Net cash used in investing activities
(2,461
)
(1,177
)
Net cash provided by financing activities
30,371
172,619
Net (decrease) increase in cash, cash equivalents and restricted
cash
$
(70,115
)
$
72,639
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Operating Activities
During the year ended December 31, 2021, operating activities used $98.0 million of cash and cash equivalents, resulting from our net loss of $119.1 million, partially off-set by net cash provided by changes in our operating assets and liabilities of $1.3 million and non-cash charges of $19.8 million. Net cash provided by changes in our operating assets and liabilities for the year ended December 31, 2021 consists primarily of a $2.1 million increase in accrued expenses and other current liabilities, a $0.4 million decrease in other assets, and a $0.8 million increase in accounts payable, partially offset by a $2.0 million increase in prepaid expenses and other current assets. The increase in accrued expenses and other current liabilities was primarily due to an increase in accrued compensation and benefit costs.
During the year ended December 31, 2020, operating activities used $98.8 million of cash and cash equivalents, resulting from our net loss of $119.7 million, partially off-set by net cash provided by changes in our operating assets and liabilities of $4.2 million and non-cash charges of $16.7 million. Net cash provided by changes in our operating assets and liabilities for the year ended December 31, 2020 consists primarily of a $3.9 million increase in accrued expenses and other current liabilities, a $1.1 million decrease in prepaid expenses and other current assets and a $0.1 million decrease in other assets, partially offset by a $0.9 million decrease in accounts payable. The increase in accrued expenses and other current liabilities was primarily due to a $3.4 million increase in accrued compensation and benefit costs.
Investing Activities
Net cash used in investing activities was $2.5 million for the year ended December 31, 2021 compared to $1.2 million for the year ended December 31, 2020. The increase in cash used in investing activities was primarily due to an increase in purchases of property and equipment.
Financing Activities
Net cash provided by financing activities was $30.4 million for the year ended December 31, 2021 compared to $172.6 million for the year ended December 31, 2020. The decrease in cash provided by financing activities was primarily due to the $14.6 million in proceeds raised through our ATM Facility in 2021 and $15.0 million raised through the Term Loan Agreement in 2021, as compared to proceeds of $164.1 million raised collectively from the February 2020 Follow-On Offering and November 2020 Follow-On Offering, and proceeds of $8.1 million raised from our ATM Facility in 2020.
Funding Requirements
We expect our expenses to increase substantially in connection with our ongoing activities, particularly as we advance the preclinical activities and clinical trials of our product candidates. Our expenses will also increase as we:
•
continue our development of our product candidates, including continuing enrollment in the ongoing collaborator-sponsored clinical trial of AVR-RD-04 and our ongoing clinical trial of AVR-RD-02;
•
initiate additional clinical trials and preclinical studies for our other current and future product candidates;
•
seek to identify and develop or in-license or acquire additional product candidates and technologies;
•
seek to industrialize our ex vivo lentiviral gene therapy approach into a robust, scalable and, if approved, commercially viable process;
•
seek marketing approvals for our product candidates that successfully complete clinical trials, if any;
•
establish a sales, marketing and distribution infrastructure to commercialize any product candidates for which we may obtain marketing approval;
•
hire and retain additional personnel, such as clinical, quality control, and scientific personnel;
•
expand our infrastructure, office space and facilities to accommodate our employee base, including adding equipment and physical infrastructure to support our research and development; and
•
continue to incur additional public company-related costs.
We believe that our $189.6 million of existing cash and cash equivalents as of December 31, 2021, will enable us to fund our operating expenses and capital expenditure requirements into the first quarter of 2024. We have based these
91
estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. If we receive regulatory approval for any of our product candidates, we expect to incur significant commercialization expenses related to product manufacturing, sales, marketing and distribution, depending on where we choose to commercialize.
Until such time, if ever, that we can generate product revenue sufficient to achieve profitability, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaboration agreements, government and other third-party funding, strategic alliances, licensing arrangements or marketing and distribution arrangements. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through government and other third-party funding, collaboration agreements, strategic alliances, licensing arrangements or marketing and distribution arrangements, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market products or product candidates that we would otherwise prefer to develop and market ourselves.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of December 31, 2021 and the effects that such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):
Payments Due by Period
Total
Less than
1 Year
1 to 3
Years
4 to 5
Years
More than
5 Years
Operating lease commitments (1)
$
1,725
$
1,297
$
428
$
—
$
—
Total
$
1,725
$
1,297
$
428
$
—
$
—
(1)
Represents future minimum lease payments under our non-cancelable operating leases for office and laboratory space, which are located in Cambridge, Massachusetts and Toronto, Canada. Those leases will expire from January 2023 to June 2025. The minimum lease payments above do not include any related common area maintenance charges or real estate taxes.
We enter into contracts in the normal course of business with CROs, CMOs and other third parties for clinical trials, preclinical research studies and testing and manufacturing services. 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. These payments are not included in the preceding table as the amount and timing of such payments are not known.
In addition, pursuant to our license agreements with UHN, BioMarin, The University of Manchester, Papillon Therapeutics and the Lund University rights holders, we are required to make certain milestone and royalty payments to our licensors. See “Business—License Agreements” for additional details regarding our payment obligations to these licensors.
Critical Accounting Policies and Significant Judgments and Estimates
Our consolidated financial statements are 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 judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and the disclosure of contingent assets and liabilities in our 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.
While our significant accounting policies are described in more detail in Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements appearing elsewhere in this Annual Report, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements.
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Accrued Research and Development Expenses
As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contracts 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 cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. The majority 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 the consolidated financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of these estimates with the service providers and make adjustments if necessary. Examples of estimated accrued research and development expenses include fees paid to:
•
vendors, including central laboratories, in connection with preclinical development activities;
•
CROs and investigative sites in connection with preclinical and clinical studies; and
•
CMOs in connection with drug substance and drug product formulation 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 research institutions and CROs that conduct and manage preclinical studies and clinical trials 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 accruing service fees, we estimate the time period over which services will be performed 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 the estimate, we adjust the accrual or the amount of prepaid expenses 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 reporting amounts that are too high or too low in any particular period. To date, there have not been any material adjustments to our prior estimates of accrued research and development expenses.
Stock-Based Compensation
We measure stock options and other stock-based awards granted to employees and members of our board of directors for their services as directors based on the fair value on the date of the grant and recognize the corresponding compensation expense of those awards over the requisite service period, which is generally the vesting period of the respective award. We have issued stock options, restricted stock and restricted stock units with service-based vesting conditions.
Modifications to stock-based awards are treated as an exchange of the original award for a new award with total compensation equal to the grant-date fair value of the original award plus any incremental value of the modification. The incremental value is based on the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
Prior to the adoption of Accounting Standards Update (ASU) No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07) , as discussed in Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements appearing elsewhere in this Annual Report, the measurement date for non-employee awards was generally the date the services were completed, resulting in financial reporting period adjustments to stock-based compensation during the vesting terms for changes in the fair value of the awards. After the adoption of ASU 2018-07, the measurement date for non-employee awards is the later of the adoption date of ASU 2018-07, or the date of grant, without change in the fair value of the award.
We estimate the fair value of each stock option grant using the Black-Scholes option-pricing model, which uses as inputs the estimated fair value of our common stock and assumptions we make for 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.
We determined the assumptions for the Black-Scholes option-pricing model as discussed below. Each of these inputs is subjective and generally requires significant judgment to determine.
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Determination of the Fair Value of Common Stock. The fair value of our common stock is determined based on the quoted market price of our common stock. Prior to our IPO, there was no public market for our common stock, and consequently, the estimated fair value of our common stock was determined by our board of directors as of the date of each option grant, with input from management, considering third-party valuations of our common stock as well as our board of directors’ assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent third-party valuation through the date of the grant. These third-party valuations were performed in accordance with the guidance outlined in the American Institute of Certified Public Accountants’ Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. F ollowing the closing of our IPO, it was no longer necessary for our board of directors to estimate the fair market value of our common stock in connection with our accounting for granted equity awards.
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Expected Term. The expected term represents the period that the stock-based awards are expected to be outstanding. The expected term of stock options granted has been determined using the simplified method, which uses the midpoint between the vesting date and the contractual term.
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Risk-Free Interest Rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant for zero-coupon U.S. Treasury constant maturity notes with terms approximately equal to the stock-based award’s expected term.
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Expected Volatility. Because we do not have long-term trading history of our common stock, the expected volatility was derived from the average historical stock volatilities of several public companies within our industry that we consider to be comparable to our business over a period equivalent to the expected term of the stock-based awards.
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Dividend Rate. The expected dividend is zero as we have not paid and do not anticipate paying any dividends in the foreseeable future.
If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.
Emerging Growth Company Status
We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. We may take advantage of these exemptions until we are no longer an emerging growth company. Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. We have elected to use the extended transition period for complying with new or revised accounting standards and, as a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates. We may take advantage of these exemptions up until the last day of the fiscal year following the fifth anniversary of our IPO or such earlier time that we are no longer an emerging growth company. We would cease to be an emerging growth company if we have more than $1.07 billion in annual revenue, we have more than $700.0 million in market value of our stock held by non-affiliates or we issue more than $1.0 billion of non-convertible debt securities over a three-year period.
Off-Balance Sheet Arrangements
We did not have, during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission.
Recently Issued Accounting Pronouncements
A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in Note 2 “Summary of Significant Accounting Policies” to our audited financial statements appearing elsewhere in this Annual Report.
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