Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is meant to provide material information relevant to an assessment of the financial condition and results of operations of our company, including an evaluation of the amounts and uncertainties of cash flows from operations and from outside resources, so as to allow investors to better view our company from management’s perspective. You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes appearing 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 includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the section entitled “Risk Factors” in Part I, Item 1A 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. You should carefully read the section entitled “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements.
Overview
We are a clinical-stage biotechnology company focused on harnessing the immune system to achieve deep and durable clinical responses to improve the lives of patients with cancer. We have built our geographically precise solutions, or GPS, platform to rapidly engineer novel molecules, including cytokines and other biologics, that are designed to optimize their therapeutic index by geographically localizing their activity inside tumors. Current immuno-oncology, or I-O, therapies have curative potential for patients with cancer; however, their potential is significantly curtailed by systemic toxicity that results from activity of the therapeutic molecule outside the tumor microenvironment, or TME. Our molecules are engineered to localize activity within the TME with minimal systemic effects, resulting in the potential to achieve enhanced anti-tumor activity. We are advancing a number of geographically precise, or tumor-selective, agents through preclinical and clinical development. Our most advanced product candidates are currently in clinical development: XTX101, an anti-cytotoxic T-lymphocyte-associated protein 4, or anti-CTLA 4, monoclonal antibody, or mAb, and XTX202, an interleukin 2, or IL-2, therapy. We are also advancing our tumor-selective IL-12 product candidate, XTX301, with the goal of submitting an investigational new drug application, or IND, to the U.S. Food and Drug Administration, or FDA, in the second half of 2022 for evaluation in patients with solid tumors, and we are currently pursuing preclinical studies for our tumor-selective IL-15 product candidate, XTX401. We also plan to continue to leverage our GPS platform to develop additional immunotherapies, including product candidates with a range of tumor targeting approaches.
Since inception, we have devoted substantially all of our financial resources and efforts to performing research and development activities. We have financed our operations primarily from proceeds raised through private placements of preferred units and convertible preferred stock, a debt financing and our initial public offering, or IPO, of common stock. As of December 31, 2021, we had received an aggregate of $224.5 million in net proceeds from the sale and issuance of preferred units and convertible preferred stock and $10.0 million in net proceeds from a debt financing. On October 26, 2021, we completed our IPO and issued and sold an aggregate of 7,353,000 shares of our common stock at a public offering price of $16.00 per share, and on November 1, 2021, we issued and sold an additional 766,106 shares of common stock at a public offering price of $16.00 per share pursuant to the partial exercise by the underwriters of their option to purchase additional shares. We received aggregate net proceeds of $116.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us. Upon the closing of the IPO, all shares of our then outstanding preferred stock automatically converted into an aggregate of 18,398,248 shares of common stock.
In October 2021, we effected a 1-for-9.5 reverse stock split of our common stock. All historical share and per share information shown herein and in our consolidated financial statements and related notes have been retroactively adjusted to give effect to the reverse stock split.
We have not generated any revenue from product sales, and do not expect to generate any revenue from product sales for at least the next several years, if at all. All of our programs are in early clinical or preclinical development. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual
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commercialization of one or more of our product candidates, if approved. Since inception, we have incurred significant operating losses, including net losses of $75.8 million and $55.2 million for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, we had an accumulated deficit of $160.9 million. We expect to incur significant expenses and operating losses for the foreseeable future. We anticipate that our expenses will continue to increase significantly in connection with our ongoing activities, particularly as we:
● continue to advance our current research programs and conduct additional research programs;
● advance our current product candidates and any future product candidates we may develop into preclinical and clinical development;
● seek marketing approvals for any product candidates that successfully complete clinical trials;
● obtain, expand, maintain, defend and enforce our intellectual property;
● hire additional research, clinical, regulatory, quality, manufacturing and general and administrative personnel;
● establish a commercial and distribution infrastructure to commercialize any products for which we may obtain marketing approval;
● continue to discover, validate and develop additional product candidates;
● continue to manufacture increasing quantities of our current or future product candidates for use in preclinical studies, clinical trials and for any potential commercialization;
● acquire or in-license other product candidates, technologies or intellectual property; and
● incur additional costs associated with current and future research, development and commercialization efforts and operations as a public company.
As a result, we will need substantial additional funding to support our continuing operations and pursue our strategy. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of equity offerings, debt financings and other sources of funding, such as collaborations, licensing arrangements or other strategic transactions. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on acceptable terms, or at all. Our failure to raise capital or enter into such agreements as and when needed could have a material adverse effect on our business, results of operations and financial condition.
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 profitability. Even if we are able to generate revenue from product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then 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 $198.1 million. We believe that our existing cash and cash equivalents will be sufficient to enable us to fund our operating expenses and capital expenditure requirements into 2024.
Note on the COVID-19 Pandemic
The worldwide COVID-19 pandemic has affected and may affect in the future our ability to initiate and complete preclinical studies, delay the initiation and completion of our current or future clinical trials, disrupt regulatory activities or have other adverse effects on our business, results of operations, financial condition and prospects. In addition, the pandemic has caused substantial disruption in the financial markets and may adversely impact economies worldwide, both of which could adversely affect our business, operations and ability to raise funds to support our operations.
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We are following, and plan to continue to follow, recommendations from federal, state and local governments regarding workplace policies, practices and procedures. In response to the direction from state and local governmental authorities, we have restricted access to our facility to those individuals who must perform critical research, translational medicine, laboratory and other support activities that must be completed on site, limited the number of such people that can be present at our facility at any one time and required that most of our employees work remotely. In addition, we and the third-party manufacturers, contract research organizations, or CROs, and academic collaborators that we engage have faced in the past and may face in the future disruptions that could affect our ability to initiate and complete preclinical studies or clinical trials, including disruptions in procuring items that are essential for our research and development activities, such as, for example, raw materials used in the manufacture of our product candidates, laboratory supplies for our preclinical studies and clinical trials, or animals that are used for preclinical testing, in each case, for which there may be shortages because of ongoing efforts to address the COVID-19 pandemic.
We cannot be certain what the overall impact of the COVID-19 pandemic will be on our business, and it has the potential to adversely affect our business, financial condition, results of operations and prospects. Please refer to our Risk Factors in Part I, Item 1A of this Annual Report on Form 10-K for further discussion of risks related to the COVID-19 pandemic.
Financial Operations Overview
Revenue
We have not generated any revenue since inception and do not expect to generate any revenue from the sale of products for at least the next several years, if at all. If our development efforts for our current or future product candidates are successful and result in regulatory approval or if we enter into collaboration or license agreements with third parties, we may generate revenue in the future from product sales or payments from third-party collaborators or licensors.
Operating Expenses
Research and Development Expenses
Research and development expenses consist primarily of costs incurred for our discovery efforts, research activities and development and testing of our programs and product candidates. These expenses include:
● personnel-related expenses, including salaries, bonuses, benefits and equity-based compensation expense for employees engaged in research and development functions;
● costs incurred with third-party contract development and manufacturing organizations, or CDMOs, to acquire, develop and manufacture materials for both preclinical studies and current or future clinical trials;
● costs of funding research performed by third parties that conduct research and development and preclinical activities on our behalf;
● costs incurred with third-party clinical research organizations, or CROs, and other third parties in connection with the conduct of our current or future clinical trials;
● costs of sponsored research agreements and outside consultants, including their fees, equity-based compensation and related expenses;
● costs incurred to maintain compliance with regulatory requirements;
● fees for maintaining license and other amounts due under our third-party licensing agreements;
● expenses incurred for the procurement of materials, laboratory supplies and non-capital equipment used in the research and development process; and
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● depreciation, amortization and other direct and allocated expenses, including rent, insurance, maintenance of facilities and other operating costs, incurred as a result of our research and development activities.
We expense research and development costs as incurred. We recognize external development costs based on an evaluation of the progress to completion of specific deliverables using information provided to us by our vendors. Payments for these activities are based on the terms of the individual agreements, which may differ from the pattern of costs incurred, and are reflected in our financial statements as prepaid expenses or accrued research and development expenses. Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are capitalized as assets, even when there is no alternative future use for the research and development. The capitalized amounts are expensed as the related goods are delivered or the services are performed.
We use our personnel and infrastructure resources for our discovery efforts, including the advancement of our platform, developing programs and product candidates and managing external research efforts. A significant portion of our research and development costs have been, and will continue to be, external costs. We track these external costs, such as fees paid to CDMOs, CROs, preclinical study vendors and other third parties in connection with our manufacturing and manufacturing process development, clinical trials, preclinical studies and other research activities by program. Due to the number of ongoing programs and our ability to use resources across several projects, personnel-related expenses and indirect or shared operating costs incurred for our research and development programs are not recorded or maintained on a program-by-program basis.
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. We expect that our research and development expenses will continue to increase for the foreseeable future as we advance our programs and product candidates into and through clinical development, and as we continue to develop additional product candidates. We also expect our discovery research efforts and our related personnel costs will increase and, as a result, we expect our research and development expenses, including costs associated with equity-based compensation, will increase above historical levels. In addition, we may incur additional expenses related to milestone and royalty payments payable to third parties with whom we have entered into, or may enter into, license, acquisition and option agreements to acquire the rights to future products and product candidates.
At this time, we cannot reasonably estimate or know the nature, timing and projected costs of the efforts that will be necessary to complete the development of, and obtain regulatory approval for, any of our product candidates or programs. This is due to the numerous risks and uncertainties associated with drug development, including the uncertainty of:
● the scope, timing, costs and progress of preclinical and clinical development activities;
● the number and scope of preclinical and clinical programs we decide to pursue;
● our ability to maintain our current research and development programs and to establish new ones
● our ability to establish an appropriate safety profile for our product candidates with IND-enabling studies;
● our ability to hire and retain key research and development personnel;
● the costs associated with the development of any additional product candidates we develop or acquire through collaborations;
● the effects of COVID-19 to our research and development employees, contractors and those who may participate in our planned studies.
● our successful enrollment in and completion of clinical trials;
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● our ability to successfully complete clinical trials with safety, potency and purity profiles that are satisfactory to the FDA or any comparable foreign regulatory authority;
● our receipt of regulatory approvals from applicable regulatory authorities;
● our ability to successfully develop, obtain regulatory approval for, and then successfully commercialize, our product candidates;
● our ability to commercialize products, if and when approved, whether alone or in collaboration with others;
● the continued acceptable safety profiles of the product candidates following approval;
● our ability to establish and maintain agreements with third-party manufacturers for clinical supply for our clinical trials and commercial manufacturing, if our product candidates are approved;
● the terms and timing of any collaboration, license or other arrangement, including the terms and timing of any milestone payments thereunder; and
● our ability to obtain and maintain patent, trade secret and other intellectual property protection and regulatory exclusivity for our product candidates if and when approved.
A change in any of these variables with respect to the development of any of our product candidates would significantly change the costs, timing and viability associated with the development of that product candidate. We may never succeed in obtaining regulatory approval for any product candidate we may develop.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel-related costs, including salaries, benefits, recruiting and equity-based compensation, for personnel in our executive, finance, legal, business development, human resources and other administrative functions. General and administrative expenses also include legal fees relating to corporate matters; professional and consulting fees for accounting, auditing, tax, human resources and administrative consulting services; insurance costs; and facility-related expenses, which include depreciation costs and other allocated expenses for rent, maintenance of facilities and other general administrative costs. These costs relate to the operation of the business and are in support of but separate from the research and development function and our individual development programs. Costs to secure and defend our intellectual property are expensed as incurred and are classified as general and administrative expenses.
We anticipate that our general and administrative expenses will increase in the future as we increase our headcount and infrastructure to support the expected growth in our research and development activities. We also expect to incur increased expenses associated with operating as a public company, including increased costs of accounting, audit, legal, regulatory and tax-related services attributable to maintaining compliance with exchange listing standards and Securities and Exchange Commission, or SEC, requirements, director and officer insurance costs and investor and public relations costs.
We also expect to incur additional intellectual property-related expenses as we file patent applications to protect intellectual property arising from our research and development activities.
Other Income (Expense), Net
Other income (expense), net consists primarily of gains or losses associated with changes in the fair value of contingent liabilities associated with the consummation of specified transactions, including an initial public offering, interest expense principally on the note payable under our debt arrangement with Pacific Western Bank, or PacWest, and interest income earned from our cash and cash equivalents. Upon completion of our IPO in October 2021, our contingent liability with
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PacWest and our other contingent derivative liability became due and payable. These fees were paid during the fourth quarter of 2021 and as a result, no further gains or losses will be recognized related to those contingent liabilities.
Income Taxes
Since our inception, we have not recorded any U.S. federal or state income tax benefits for the net losses we have incurred in each year or for our earned research and development tax credits, due to our uncertainty of realizing a benefit from those items. As of December 31, 2021, we had federal and state net operating loss, or NOL, carryforwards of approximately $149.5 million and $141.0 million, respectively, which may be available to offset future taxable income. As of December 31, 2021, federal NOLs of $144.6 million have an indefinite carryforward period. The remaining federal NOL carryforwards and our state NOL carryforward will expire beginning in 2035. These loss carryforwards are available to reduce future federal taxable income, if any. As of December 31, 2021, we also had federal and state research and development carryforwards of approximately $2.8 million and $1.4 million, respectively, which may be available to offset any future income tax and which will begin to expire in 2033. These loss and credit carryforwards are subject to review and possible adjustment by the appropriate taxing authorities.
Utilization of our NOL carryforwards and research and development credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future in accordance with Section 382 of the Internal Revenue Code of 1986, or Section 382, as well as similar state provisions. These ownership changes may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and taxes, respectively. In general, an ownership change as defined by Section 382 results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a three-year period. Since our formation, we have raised capital through the issuance of units and capital stock on several occasions. These financings may have resulted in a change of control as defined by Section 382. We have not yet completed a detailed study of our inception to date ownership change activity.
In addition, we have not yet conducted a study of our research and development credit carry forwards. Such a study may result in an adjustment to our research and development credit carryforwards; however, until a study is completed and any adjustment is known, no amount is being presented as an uncertain tax position. A full valuation allowance has been provided against our research and development credits, and, if an adjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be no impact to the balance sheet or statement of operations and comprehensive loss if an adjustment were required.
Income taxes are determined at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits and other permanent differences. Our income tax provision may be significantly affected by changes to our estimates.
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Results of Operations
Comparison of the Years Ended December 31, 2021 and 2020
The following table summarizes our results of operations for the years ended December 31, 2021 and 2020 (in thousands):
Year Ended
December 31,
2021
2020
Change
Operating expenses
Research and development
$
51,188
$
43,910
$
7,278
General and administrative
23,856
10,653
13,203
Total operating expenses
75,044
54,563
20,481
Loss from operations
(75,044)
(54,563)
(20,481)
Other income (expense), net
Other expense, net
(756)
(656)
(100)
Total other income (expense), net
(756)
(656)
(100)
Net loss
$
(75,800)
$
(55,219)
$
(20,581)
Research and Development Expenses
The following table summarizes our research and development expenses for the years ended December 31, 2021 and 2020 (in thousands):
Year Ended
December 31,
2021
2020
Change
XTX202
$
14,143
$
14,866
$
(723)
XTX101
5,941
11,554
(5,613)
Other early programs and indirect research and development
15,292
9,483
5,809
Personnel-related (including equity-based compensation)
15,812
8,007
7,805
Total research and development expenses
$
51,188
$
43,910
$
7,278
Research and development expenses increased by $7.3 million from $43.9 million for the year ended December 31, 2020 to $51.2 million for the year ended December 31, 2021. The increase in research and development expenses was primarily due to the following:
● $7.8 million increase in personnel-related costs, driven primarily by higher research and development headcount and related increases of approximately $6.8 million in salaries, bonuses and benefits, and an approximately $1.0 million increase in equity-based compensation;
● $5.8 million increase in other early programs and indirect research and development expenses, driven primarily by increases in external expenses related to preclinical research and development activities;
● $5.6 million decrease in expenses incurred to advance our XTX101 program, driven primarily by decreases of approximately $6.3 million in manufacturing activities and approximately $1.2 million in preclinical development activities, partially offset by an increase of approximately $1.9 million in clinical development activities; and
● $0.7 million decrease in expenses incurred to advance our XTX202 program, driven primarily by a non-recurring $6.0 million upfront payment incurred during the year ended December 31, 2020 under our license agreement with AskGene Pharma, Inc., or AskGene, partially offset by increases of approximately $2.5 million in manufacturing activities, approximately $1.5 million in preclinical development activities and approximately $1.1 million in clinical development activities.
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General and Administrative Expenses
The following table summarizes our general and administrative expenses for the years ended December 31, 2021 and 2020 (in thousands):
Year Ended
December 31,
2021
2020
Change
Personnel-related (including equity-based compensation)
$
12,708
$
5,206
$
7,502
Professional and consulting fees
8,248
4,120
4,128
Facility-related and other general and administrative expenses
2,900
1,327
1,573
Total general and administrative expenses
$
23,856
$
10,653
$
13,203
General and administrative expenses increased by $13.2 million from $10.7 million for the year ended December 31, 2020 to $23.9 million for the year ended December 31, 2021. The increase in general and administrative expenses was primarily due to the following:
● $7.5 million increase in personnel-related costs, driven primarily by higher general and administrative headcount and related increases of approximately $3.8 million in salaries, bonuses and benefits, and an approximately $2.7 million increase in equity-based compensation;
● $4.1 million increase in professional and consulting fees, driven primarily by an increase in accounting, legal and other services related to transitioning to and operating as a publicly traded company; and
● $1.6 million increase in facility-related and other general and administrative expenses, driven primarily by increases in directors and officers insurance costs incurred upon becoming a publicly traded company, certain information technology related costs and other corporate related costs associated with increased overall corporate headcount.
Other Income (Expense), Net
Total other income (expense), net was $0.8 million of other expense for the year ended December 31, 2021 compared to other expense of $0.7 million for the year ended December 31, 2020, or a change of $0.1 million. The change was primarily driven by an increase in the value of certain contingent liabilities associated with the probability of the consummation of our IPO.
Liquidity and Capital Resources
Sources of Liquidity
Since our inception, we have incurred significant operating losses and negative cash flows from operations. We have not yet commercialized any of our product candidates, which are in preclinical or early clinical development, and we do not expect to generate revenue from sales of any products for several years, if at all. To date, we have financed our operations primarily from proceeds raised through private placements of preferred units and convertible preferred stock, a debt financing and our IPO. As of December 31, 2021, we have received an aggregate of $224.5 million in net proceeds from the sale and issuance of preferred units and convertible preferred stock and $10.0 million in net proceeds from our debt financing. On October 26, 2021, we completed our IPO and issued and sold an aggregate of 7,353,000 shares of our common stock at a public offering price of $16.00 per share, and on November 1, 2021, we issued and sold an additional 766,106 shares of common stock at a public offering price of $16.00 per share pursuant to the partial exercise by the underwriters of their option to purchase additional shares. We received aggregate net proceeds of $116.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us. As of December 31, 2021, we had cash and cash equivalents of $198.1 million.
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Cash Flows
The following table provides information regarding our cash flows for each period presented (in thousands):
Year Ended
December 31,
2021
2020
Net cash provided by (used in):
Operating activities
$
(80,751)
$
(36,091)
Investing activities
(1,100)
(2,188)
Financing activities
260,668
10,029
Net increase (decrease) in cash, cash equivalents and restricted cash
$
178,817
$
(28,250)
Operating Activities
Our cash flows from operating activities are greatly influenced by our use of cash for operating expenses and working capital requirements to support our business. We have historically experienced negative cash flows from operating activities as we invested in developing our pipeline, platform, drug discovery efforts and related infrastructure. The cash used in operating activities resulted primarily from our net losses adjusted for non-cash charges, which are generally due to equity-based compensation, depreciation and amortization, as well as changes in components of operating assets and liabilities, which are generally due to increased expenses and timing of vendor payments.
During the year ended December 31, 2021, net cash used in operating activities of $80.8 million was primarily due to our net loss of $75.8 million and changes in operating assets and liabilities of $11.8 million, partially offset by net non-cash expenses of $6.9 million.
During the year ended December 31, 2020, net cash used in operating activities of $36.1 million was primarily due to our net loss of $55.2 million, partially offset by changes in operating assets and liabilities of $16.6 million and net non-cash expenses of $2.5 million.
Investing Activities
During the years ended December 31, 2021 and 2020, net cash used in investing activities of $1.1 million and $2.2 million, respectively, was primarily due to purchases of property and equipment.
Financing Activities
During the year ended December 31, 2021, net cash provided by financing activities of $260.7 million consisted primarily of proceeds from the sale and issuance of our Series B convertible preferred stock, the sale and issuance of our Series C convertible preferred stock and from the sale and issuance of common stock from our IPO.
During the year ended December 31, 2020, net cash provided by financing activities of $10.0 million consisted primarily of proceeds from the sale and issuance of our Series B preferred units.
Funding Requirements
We expect our expenses to increase substantially in connection with our ongoing research and development activities, particularly as we advance the current and planned clinical development of our product candidates and expand the research efforts and preclinical activities associated with our other existing programs and discovery platform. In addition, we expect to incur additional costs associated with operating as a public company. As a result, we expect to incur substantial operating losses and negative operating cash flows for the foreseeable future.
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Inflation generally affects us by increasing our cost of labor and certain services. We do not believe that inflation had a material effect on our financial statements included elsewhere in this Annual Report on Form 10-K. However, our operations may be adversely affected by inflation in the future.
As of December 31, 2021, we had cash and cash equivalents of $198.1 million. We believe that our existing cash and cash equivalents will be sufficient to enable us to fund our operating expenses and capital expenditure requirements into 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.
Because of the numerous risks and uncertainties associated with product development, and because the extent to which we may enter into collaborations with third parties for the development of our product candidates is unknown, we may incorrectly estimate the timing and amounts of increased capital outlays and operating expenses associated with completing the research and development of our product candidates. Our funding requirements and timing and amount of our operating expenditures will depend on many factors, including, but not limited to:
● the scope, progress, results and costs of research and development for our current and future product candidates, including our current and planned clinical trials for our most advanced product candidates, XTX101 and XTX202, and ongoing preclinical development for our current and future product candidates;
● the scope, prioritization and number of our research and development programs;
● the scope, costs, timing and outcome of regulatory review of our product candidates;
● the costs of securing manufacturing materials for use in preclinical studies, clinical trials and, for any product candidates for which we receive regulatory approval, use as commercial supply;
● our ability to seek, establish and maintain a collaboration to develop XTX101 with a collaborator, including the financial terms and any cost-sharing arrangements of any such collaboration;
● the costs and timing of future commercialization activities for any of our product candidates for which we receive regulatory approval;
● the amount and timing of revenue, if any, received from commercial sales of any product candidates for which we receive regulatory approval;
● the costs and timing of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property and proprietary rights and defending any intellectual property-related claims;
● the extent to which we may acquire or in-license other products, product candidates, technologies or intellectual property, as well as the terms of any such arrangements;
● the impacts of the COVID-19 pandemic; and
● the costs of continuing to expand our operations and operating as a public company.
Identifying potential product candidates and conducting preclinical studies 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 regulatory approval and achieve product sales. In addition, our product candidates, if approved, may not achieve commercial success. Our commercial revenues, if any, will be derived from sales of products that we do not expect to be commercially available for several years, if ever. Accordingly, we will need to obtain substantial additional funds to achieve our business objectives.
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Our expectation with respect to our ability to fund current planned operations is based on estimates that are subject to risks and uncertainties. Our operating plan may change as a result of many factors currently unknown to management and there can be no assurance that the current operating plan will be achieved in the time frame anticipated by us, and we may need to seek additional funds sooner than planned.
Adequate additional funds may not be available to us on acceptable terms, or at all. Market volatility resulting from the COVID-19 pandemic or other factors could also adversely impact our ability to access capital as and when needed. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of such securities may include liquidation or other preferences that adversely affect the rights of our stockholders. Additional 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 and may require the issuance of warrants, which could potentially dilute the ownership interest of our stockholders.
If we raise additional funds through collaborations, strategic alliances or licensing arrangements with third parties, 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 have to significantly delay, reduce or eliminate some or all of our product development or future commercialization efforts, or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.
Contractual Obligations
Overview
In the normal course of business, we enter into agreements that contain contractual obligations, of which the most significant to date include our loan and security agreement, facility lease and certain licensing agreements.
Loan and Security Agreement
In November 2019, we entered into a loan and security agreement with PacWest, as amended by a first amendment, dated March 12, 2021, and a second amendment, dated May 10, 2021, under which we borrowed $10.0 million. Borrowings under the loan and security agreement are collateralized by substantially all of our assets, excluding intellectual property, with interest on the term loan balance accruing at a variable annual rate equal to the greater of (i) the prime rate, as defined in the loan and security agreement, plus 0.25% or (ii) 5.00%. Interest-only payments on the term loan balance were required to be paid on a monthly basis through May 21, 2021. Subsequent to the interest-only period, we made equal monthly payments of principal plus interest and were required to do so until the scheduled loan maturity date of November 2023. In addition, under the initial loan agreement, as amended, we were obligated to pay a one-time $0.5 million fee to PacWest upon the occurrence of specified liquidation events, including an initial public offering.
In September 2021, we entered into an amendment to our loan and security agreement, pursuant to which we borrowed $10.0 million under a new term loan and used the proceeds of such new term loan to repay the outstanding balance on the prior term loan. In addition, as a result of the amendment, prior to December 31, 2022, we have the ability to request one or more additional term loans in an aggregate principal amount of $10.0 million. As a result of the amendment, interest on amounts outstanding accrues at a variable annual rate equal to the greater of (i) the prime rate plus 0.25% or (ii) 4.75%, and we are required to make interest-only payments on any outstanding balances through December 31, 2022. Subsequent to the interest-only period, we will be required to make equal monthly payments of principal plus interest until the loan matures on June 30, 2024. In addition, under the loan and security agreement, as amended, the one-time fee we were obligated to pay to PacWest upon the occurrence of specified liquidation events, including an initial public offering, was increased from $0.5 million to an amount between $0.8 million and $1.0 million depending on the timing and occurrence of specified events, including upon the closing of the IPO. We paid the one-time fee of $0.8 million to PacWest in October 2021 upon the closing of the IPO. As a result of the amendment, we are also obligated to pay PacWest a fee of 1.0% of the aggregate principal amounts then outstanding if any term loans are repaid prior to
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September 17, 2022, which is approximately one year from the date of the amendment to our loan and security agreement. The loan and security agreement, as amended, contains customary representations, warranties and covenants and also include customary events of default, including payment defaults, breaches of covenants, a change of control and occurrence of a material adverse effect.
Lease Agreement
We lease building space for our corporate headquarters at 828 Winter Street in Waltham, Massachusetts under a non-cancellable operating lease that expires in March 2030. Our operating lease includes the option to extend the term for a period of five years at the then-market rental rate. As of December 31, 2021, the remaining required payments for our operating lease, not including the optional extension period, are approximately $15.0 million. For further information regarding our operating lease agreement, please see Note 8 to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
Other Contractual Obligations
We are party to certain agreements that require us to pay third parties upon achievement of certain development, regulatory or commercial milestones or upon the consummation of specified transactions. Amounts related to contingent payments are not considered contractual obligations as they are contingent on the successful achievement of certain development, regulatory and commercial milestones that may not be achieved or upon the consummation of specified transactions that may not occur. We have not included payments contingent upon the achievement of certain development, regulatory or commercial milestones on our consolidated balance sheets. For further information regarding certain of our license agreements and amounts that could become payable in the future under those agreements, please see Note 7 to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
In addition, we are party to certain agreements with contract research organizations for clinical trials and clinical supply manufacturing and with vendors for preclinical research studies and other services and products for operating purposes. Such contracts are generally cancellable by us for convenience with up to 90 days of notice. We may be subject to certain termination fees or wind-down costs upon termination of these agreements. The exact amount of such costs are generally not fixed or estimable.
Critical Accounting Policies and Use of Estimates
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated 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 consolidated financial statements, as well as the reported 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 more detail in the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies used in the preparation of our consolidated financial statements require the most significant judgments and estimates.
Research and Development Expenses and Related Accruals
Research and development expenses are comprised of costs incurred in performing research and development activities, including salaries, equity-based compensation and benefits, facilities costs and laboratory supplies, depreciation, manufacturing expenses and external costs of outside vendors engaged to conduct planned clinical development, preclinical development, manufacturing and manufacturing process development and other research support activities. All costs associated with research and development activities are expensed as incurred.
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As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued expenses as of each balance sheet date. 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 the actual cost. The majority of our service providers invoice us monthly in arrears for services performed or when contractual milestones are met. We make estimates of our accrued expenses as of each balance sheet date based on facts and circumstances known to us at that time. We periodically confirm the accuracy of our estimates with certain service providers and make adjustments if necessary. The significant estimates in our accrued research and development expenses include the costs incurred for services performed by our vendors in connection with research and development activities for which we have not yet been invoiced. In certain instances, we prepay for services to be provided in the future. These amounts are initially capitalized and subsequently expensed as the services are performed.
We base our expenses related to research and development activities on our estimates of the services received and efforts expended pursuant to quotes and contracts with vendors that conduct research and development 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 research and development expense. 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 our estimate, we adjust the accrual or prepaid balance accordingly. Nonrefundable advance payments for goods and services that will be used in future research and development activities are initially capitalized and subsequently expensed when the activity has been performed or when the goods have been received rather than when the payment is made.
Although we do not expect our estimates to be materially different from amounts incurred, if our estimates of the status and timing of services performed differ from the actual status and timing of services performed, it could result in us reporting accrued amounts that are too high or too low in any particular period. To date, there have been no material differences between our estimates of such expenses and the amounts incurred.
Equity-Based Compensation
As described in Note 1 to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, in June 2020, we completed a series of transactions resulting in the reorganization of our corporate structure. Prior to such reorganization, our former parent company, Xilio Therapeutics, LLC, granted incentive units, which we accounted for as equity-classified awards. In connection with the reorganization, the incentive units were exchanged for shares of our vested and unvested restricted common stock. We issue equity-based awards to employees, directors and non-employees, generally in the form of stock options.
We measure employee equity-based compensation based on the grant date fair value of the equity-based awards and recognize equity-based compensation expense on a straight-line basis over the requisite service period of the awards, which is generally the vesting period of the respective award, in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation—Stock Compensation , or ASC 718. For awards subject to performance conditions, we recognize equity-based compensation expense using an accelerated recognition method over the remaining period when we determine that achievement of the milestone is probable. We recognize forfeitures as they occur. We classify equity-based compensation expense in the consolidated statements of operations and comprehensive loss in the same manner in which the award recipient’s salary and related costs are classified or in which the award recipient’s service payments are classified, as applicable.
Determination of the Fair Value of Equity-Based Awards
We estimate the fair value of our stock options and, prior to our corporate reorganization, incentive units granted with service-based conditions using the Black-Scholes option pricing model, which requires inputs of subjective assumptions, including: (i) the expected volatility of our common stock, (ii) the expected term of the award, (iii) the risk-free interest rate, (iv) expected dividends and (v) the fair value of our common stock. We completed our IPO in October 2021, and as a result there has not been a significant amount of time for which there has been a public market for the trading of our
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common stock, including a lack of company-specific historical and implied volatility data, therefore we base the estimate of expected volatility on the historical volatilities of a representative group of publicly traded guideline companies. For these analyses, we select companies with comparable characteristics and with historical share price information that approximates the expected term of the equity-based awards. We compute the historical volatility data using the daily closing prices for the selected companies’ shares during the equivalent period that approximates the calculated expected term of our stock options. We will continue to apply this method until a sufficient amount of historical information regarding the volatility of our own stock price becomes available. We estimate the expected term of our stock options granted to employees and directors using the simplified method, whereby the expected term equals the average of the vesting term and the original contractual term of the option. We utilize this method as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. The expected dividend yield is assumed to be zero as we have no current plans to pay any dividends on common stock. We have elected to use the expected term for stock options granted to non-employees, using the simplified method, as the basis for the expected term assumption. However, we may elect to use either the contractual term or the expected term for stock options granted to non-employees on an award-by-award basis.
Determination of Fair Value of Common Units and Common Stock
Subsequent to the completion of our IPO in October 2021, the fair value of our common stock has been determined based on the share price of our common stock on the Nasdaq Global Select Market. If applicable, the current share price is adjusted to reflect material nonpublic information known to the company but unavailable to market participants at the time of the grant.
Prior to the completion of our IPO in October 2021, there was no public market for either our common stock, common units or incentive units. The estimated fair value of our common units and common stock and the strike price of our incentive units was approved by our board of directors, with input from management, as of the date of each award grant, considering the most recently available independent third-party valuations of our common stock and common units and our board of directors assessment, with input from management, of additional objective and subjective factors that we believed were relevant and which may have changed from the date of the most recent valuation through the date of the grant. These independent 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 . We estimated the value of our equity using market approaches. The market approach includes using the market adjusted equity value method, guideline initial public offering, or IPO, transactions method and the recent transaction method which “back solves” to a preferred price. The hybrid approach is a scenario-based analysis and where one or more of the scenarios allocate the equity value utilizing the option-pricing method, or OPM. We allocated equity value to our common units, incentive units and preferred units or to our shares of common stock and shares of our convertible preferred stock, as the case may be, using either an OPM or a hybrid method, which is a hybrid between the OPM and the probability-weighted expected return method. The OPM treats common securities and preferred securities as call options on the total equity value of a company, with exercise prices based on the value thresholds at which the allocation among the various holders of a company’s securities changes. Under this method, the common units and incentive units and common stock have value only if the funds available for distribution to members exceed the value of the preferred security liquidation preference at the time of the liquidity event, such as a strategic sale or a merger. When using the market approach to determine the equity value, we allocated the equity value to our common units, incentive units and preferred units or to our shares of common stock, warrants and shares of our convertible preferred stock, as the case may be, using the OPM. When using the hybrid approach, we estimated the probability-weighted value across multiple scenarios but used the OPM to estimate the allocation of value within at least one of the scenarios. In addition to a scenario using the OPM, the hybrid method also considers an IPO scenario in which the shares of convertible preferred stock are assumed to convert to common stock. The future value of the common stock in the IPO scenario was discounted back to the valuation date at an appropriate risk adjusted discount rate. In the hybrid method, the present value indicated for each scenario was probability weighted to arrive at an indication of value for our common stock.
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In addition to considering the results of these third-party valuations, our board of directors considered various objective and subjective factors to determine the fair value of our equity instruments as of each grant date, which may have been later than the most recently available third-party valuation date, including:
● the lack of liquidity of our equity as a private company;
● the prices of our preferred units and convertible preferred stock sold to outside investors in arm’s length transactions and the rights, preferences and privileges of our preferred units and convertible preferred stock as compared to those of our common units and common stock, including the liquidation preferences of our convertible preferred stock;
● the progress of our research and development efforts, including the status of preclinical studies for our product candidates;
● our stage of development and business strategy and the material risks related to our business and industry;
● the achievement of enterprise milestones, including entering into strategic collaborative and license agreements;
● the valuation of publicly traded companies in the life sciences and biotechnology sectors, as well as recently completed mergers and acquisitions of peer companies;
● any external market conditions affecting the biotechnology industry and trends within the biotechnology industry;
● the likelihood of achieving a liquidity event, such as an initial public offering or a sale of our company, given prevailing market conditions; and
● the analysis of initial public offerings and the market performance of similar companies in the biotechnology industry.
For financial statement purposes, we performed common unit valuations at various dates, which resulted in valuation of our common units of $2.09, $4.47 and $5.51 per unit as of May 2019, February 2020, and May 2020, respectively. We performed common stock valuations at various dates, which resulted in valuation of our common stock of $5.51, $5.89, $6.65, $10.07 and $11.69 per share as of July 2020, January 2021, March 2021, May 2021 and July 2021, respectively. Each valuation is stated after giving effect to the 1-for-9.5 reverse stock split of our common stock effected on October 15, 2021 in connection with our IPO.
There are significant judgments and estimates inherent in these valuations. These judgments and estimates included assumptions regarding our future operating performance, the stage of development of our product candidates, the timing and probability of a potential initial public offering or other liquidity event and the determination of the appropriate valuation methodology at each valuation date. The assumptions underlying these valuations represented management’s best estimates, which involved inherent uncertainties and the application of management judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our equity-based compensation expense could be materially different.
Emerging Growth Company and Smaller Reporting Company Status
As an emerging growth company, or EGC, under the Jumpstart Our Business Startups Act of 2012, or JOBS Act, we may delay the adoption of certain accounting standards until such time as those standards apply to private companies. Other exemptions and reduced reporting requirements under the JOBS Act for EGCs include presentation of only two years of audited financial statements in a registration statement for an IPO, an exemption from the requirement to provide an auditor’s report on internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002,
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an exemption from any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation, and less extensive disclosure about our executive compensation arrangements.
In addition, the JOBS Act provides that an EGC can take advantage of an extended transition period for complying with new or revised accounting standards. This provision allows an EGC to delay the adoption of some accounting standards until those standards would otherwise apply to private companies. We have elected not to “opt out” of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we can adopt the new or revised standard at the time private companies adopt the new or revised standard and may do so until such time that we either (1) irrevocably elect to “opt out” of such extended transition period or (2) no longer qualify as an emerging growth company. 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 may remain classified as an EGC until December 31, 2026, although if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time or if we have annual gross revenues of $1.07 billion or more in any fiscal year, we would cease to be an emerging growth company as of December 31 of the applicable year. We also would cease to be an EGC if we issue more than $1 billion of non-convertible debt over a three-year period.
We are also a “smaller reporting company,” meaning that the market value of our shares held by non-affiliates is less than $700 million and our annual revenue was less than $100 million during the most recently completed fiscal year. We may continue to be a smaller reporting company if either (i) the market value of our shares held by non-affiliates is less than $250 million or (ii) our annual revenue was less than $100 million during the most recently completed fiscal year and the market value of our shares held by non-affiliates is less than $700 million. If we are a smaller reporting company at the time we cease to be an emerging growth company, we may continue to rely on exemptions from certain disclosure requirements that are available to smaller reporting companies.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, see Note 2 of the notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are a smaller reporting company, as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, and are not required to provide the information required under this item.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.