MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing in Part II, Item 8 of 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 IA. ''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 aim to improve patient outcomes by advancing a unique pipeline of oncology and neuroscience product candidates developed using our translational bioinformatics platform. We have more than a decade of experience applying translational bioinformatics to generate insights into drug mechanism of action and patient treatment response. Building on this experience, our disease-agnostic discovery platform enables us to create product candidates based on 1) biological insights that are both counterintuitive and deeply rooted in data, and 2) novel chemistry. Our lead product candidate IMM-1-104 is designed to be a highly selective dual-MEK inhibitor that further disrupts KSR to modulate the signaling dynamics of the MAPK pathway. Specifically, it is designed to drive deep cyclic inhibition that deprives tumor cells of the sustained proliferative signaling required for rapid growth, while providing a cadenced, moderate level of signaling sufficient to 117 Table of Contents spare healthy cells. IMM-1-104 is being developed to treat advanced solid tumors in patients harboring RAS mutations, and is translationally guided by our proprietary, human-aligned 3D tumor modeling platform combined with patient-aligned bioinformatics. In addition to IMM-1-104, we have six other oncology programs in the discovery stage that are designed to target components of the MAPK or mTOR pathway, as well as two discovery stage neuroscience programs. We plan to submit an Investigational New Drug application, or IND, for IMM-1-104 to theU.S. Food and Drug Administration , or the FDA, in the third quarter of 2022. In addition, we plan to submit an IND for IMM-6-415 to the FDA in 2023.
We anticipate filing at least one additional IND for our other oncology programs in 2024.
For the period from inception through 2017, we devoted substantially all of our efforts to business planning, service revenue generation, developing tools to aid in drug discovery, and recruiting management and technical staff. Since 2018, we have also focused significant effort on our own internal research and development programs. We have financed our operations through service revenues, the issuance of convertible debt and the sale of convertible preferred stock and common stock.
On
BioArkive is aSan Diego based contract research organization that has previously provided preclinical research services and biosample storage to the Company and other biotechnology companies. BioArkive is in the process of being fully integrated into the Company to exclusively support the Company's internal preclinical research activities for its oncology pipeline. In connection with the acquisition, the Company has assumed the obligations under BioArkive's three lease agreements. The purchase price was paid byImmuneering through the issuance of an aggregate of 379,635 shares ofImmuneering's Class A common stock. The number of shares of common stock issued was calculated using a value based on the average of the daily volume weighted average prices of the common stock on theNasdaq Stock Exchange for the 30-trading day period ending on and including the trading day immediately prior to the closing date. The sellers of BioArkive are restricted from selling these shares for a 6 month period from the date of the acquisition. As such, we estimated that there was an approximate 10% discount for the lack of marketability of the shares. The fair value of the purchase price in the acquisition has been preliminarily estimated to be$7.88 million . Our operations have been financed primarily by service revenues and aggregate net proceeds of approximately$81.4 million from the issuance of convertible notes payable, convertible preferred stock (Series A and B) including gross proceeds of approximately$24.8 million from the issuance of shares in the second tranche of Series B Preferred in April andMay 2021 , common stock, exercise of stock options. OnAugust 3, 2021 , we completed our IPO pursuant to which we issued and sold 8,625,000 shares of Class A common stock, inclusive of 1,125,000 shares sold by us pursuant to the full exercise of the underwriters' option to purchase additional shares. We received aggregate net proceeds of approximately$120.3 million from the IPO, after deducting underwriting discounts and commissions, but before deducting offering costs payable by us, which were$2.1 million . Since inception, we have had significant annual operating losses. Our net loss was approximately$33.5 million , for the year endedDecember 31, 2021 and$17.0 million for the year endedDecember 31, 2020 . As ofDecember 31, 2021 , we had an accumulated deficit of approximately$59.3 million and approximately$150.2 million in cash and cash equivalents and marketable securities. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the change in our accounts payable and accrued expenses. We expect to continue to incur net losses for the foreseeable future, and we expect our research and development expenses, general and administrative expenses, and capital expenditures will continue to increase. In particular, we expect our expenses to increase as we continue our development of, and seek regulatory approvals for, our internally developed product candidates as well as add operational, financial and management informational systems and personnel to support our product development. In addition, if and when we seek and obtain regulatory approval to commercialize any product candidate, we will also incur increased expenses in connection with commercialization and marketing of any such product. Our net losses may fluctuate significantly from quarter-to-quarter 118 Table of Contents
and year-to-year, depending on the timing of our clinical trials and our expenditures on other research and development activities.
Based upon our current business plans, we believe that our existing cash and cash equivalents and marketable securities will be sufficient to fund our development activities and other operations into the third 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. To finance our operations beyond that point we will need to raise additional capital, which cannot be assured. We have not had any internally developed products approved for sale. We do not expect to generate any product sales unless and until we successfully complete development and obtain regulatory approval for one or more of our internally developed product candidates. If we obtain regulatory approval for any of our internally developed product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. As a result, until such time, if ever, that we can generate substantial product revenue, we expect to finance our cash needs through service revenue, equity offerings, debt financings or other capital sources, including collaborations, licenses or similar arrangements. However, we may be unable to raise additional funds or enter into such other arrangements when needed or on favorable terms, if at all. Any failure to raise capital as and when needed could have a negative impact on our financial condition and on our ability to pursue our business plans and strategies, including our research and development activities. If we are unable to raise capital, we will need to delay, reduce or terminate planned activities to reduce costs. InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic. In particular, the ongoing pandemic related to COVID-19 and its variants has resulted in federal, state and local governments and private entities mandating various restrictions, including travel restrictions, access restrictions, restrictions on public gatherings, and stay at home orders. The effect of these orders, government imposed quarantines and measures we have taken, such as implementing work-at-home policies, may negatively impact productivity, disrupt our business and/or could adversely affect our development plans and results. We cannot presently predict the scope and severity of any potential business shutdowns or disruptions, but if we or any of the third parties with whom we engage, including personnel at third-party manufacturing facilities and other third parties with whom we conduct business, were to experience shutdowns or other business disruptions, our ability to conduct our business in the manner and on the timeline presently planned could be materially and adversely impacted. It is unknown how long these conditions will last and what the complete effect will be on us. While to date we have been able to continue to execute our overall business plan, some of our business activities have been slowed and taken longer to complete, particularly with respect to our process for recruiting new employees, and we continue to adjust to the challenges of operating in a largely remote setting with our employees. Overall, we recognize the challenges the pandemic may pose to our business, will continue to closely monitor events as they develop and plan for alternative and mitigating measures that we can implement if needed.
Components of Our Results of Operations
Revenue
Our revenue is generated by providing computational biology professional services to pharmaceutical and biotechnology companies. We charge an agreed upon rate per hour based on the aggregate level of personnel assigned to work on the project or a fixed fee for a defined scope of work. Our contracts specify the period of time over which these professional services will be provided. We recognize revenue over time by measuring the progress toward complete satisfaction of the performance obligation using a single method of measuring progress, which depicts the performance in transferring control of the associated services to the customer. We use input methods to measure the progress toward the complete satisfaction of performance obligations and evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition. Any such adjustments are recorded on a cumulative catch-up basis, which would affect revenue and net loss in the period of adjustment. We expect revenue to continue to decrease as we have deprioritized new services work in order to focus on developing our wholly owned pipeline. We expect that, by the end of 2022, revenue associated with this computational biology professional services business will be eliminated. 119
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We are in the process of discontinuing biosample storage, which was acquired through the BioArkive transaction, to external parties and expect it to complete in the second half of 2022. The revenue earned associated with this is immaterial to the financial statements and is expected to continue decrease until these external services are discontinued.
Cost of Revenue
Our cost of revenue expenses consists primarily of costs related to providing professional services to our customers. These costs include salaries, bonuses, benefits, and stock-based compensation expense, depreciation, facilities, and other outside services. Operating Expenses
Our operating expenses consist of (i) research and development expenses and (ii) general and administrative expenses.
Research and Development
Research and development expenses account for a significant portion of our operating expenses. Our research and development expenses consist primarily of direct and indirect costs incurred in connection with the development of our research platform, product candidates, discovery efforts and preclinical studies related to our program pipeline.
Our direct costs include:
expenses incurred under agreements with CROs and other vendors that conduct our
? preclinical activities on our behalf; including laboratory expenses related to
the execution of preclinical studies on our behalf;
? expenses associated with the manufacturing of our product candidates and
preclinical material, including fees paid to contract manufacturers; and
? consulting fees and expenses related to preparation of initiation of clinical
trials Our indirect costs include:
personnel-related expenses, consisting of employee salaries, bonuses, benefits
? and stock-based compensation expense and recruiting costs for personnel engaged
in research and development activities; and
facility and equipment related expenses, consisting of indirect and allocated
? expenses for rent, depreciation, maintenance of facilities, insurance, and
other supplies.
We expense research and development costs as incurred. Our direct research and development expenses are not currently tracked on a program-by-program basis, but we anticipate tracking costs on a program-by-program basis at the time IMM-1-104 enters clinical trials, which we expect to occur in the fourth quarter of 2022, assuming our IND application is accepted. We use our personnel and infrastructure resources across multiple research and development programs directed toward identifying and developing product candidates. Due to the inherently unpredictable nature and numerous risks and uncertainties associated with product development and the current stage of development of our product candidates and programs, we cannot reasonably estimate or know the nature, timing and estimated costs necessary to complete the remainder of the development of our product candidates or programs. We are also unable to predict if, when, or to what extent we will obtain approval and generate revenues from the commercialization and sale of any of our product candidates. The duration, costs and timing of preclinical studies and clinical trials and development of our product candidates will depend on a variety of factors, such as:
? successful completion of preclinical studies and initiation of clinical trials
for future product candidates;
? successful enrollment and completion of clinical trials for our current product candidates; 120 Table of Contents
? data from our clinical programs that support an acceptable risk-benefit profile
of our product candidates in the intended patient populations;
acceptance by the FDA or other applicable regulatory agencies of IND
? applications, clinical trial applications and/or other regulatory filings for
our product candidates;
? expansion and maintenance of a workforce of experienced scientists and others
to continue to develop our product candidates;
? successful application for and receipt of marketing approvals from applicable
regulatory authorities;
? obtainment and maintenance of intellectual property protection and regulatory
exclusivity for our product candidates;
? making of arrangements with contract manufacturing organizations for, or
establishment of, commercial manufacturing capabilities;
establishment of sales, marketing and distribution capabilities and successful
? launch of commercial sales of our product candidates, if and when approved,
whether alone or in collaboration with others;
? acceptance of our product candidates, if and when approved, by patients, the
medical community and third-party payors;
? effective competition with other therapies;
? obtainment and maintenance of coverage, adequate pricing and adequate
reimbursement from third-party payors, including government payors;
? maintenance, enforcement, defense and protection of our rights in our
intellectual property portfolio;
? avoidance of infringement, misappropriation or other violations with respect to
others' intellectual property or proprietary rights; and
? maintenance of a continued acceptable safety profile of our products following
receipt of any marketing approvals.
A change in the outcome of any of these variables with respect to the development of any of our product candidates could significantly change the costs and timing associated with the development of that product candidate.
The process of conducting the necessary preclinical and clinical research to obtain regulatory approval is costly and time-consuming. The actual probability of success for our product candidates may be affected by a variety of factors. We may never succeed in achieving regulatory approval for any of our product candidates. Further, a number of factors, including those outside of our control, could adversely impact the timing and duration of our product candidates' development, which could increase our research and development expense. We may obtain unexpected results from our preclinical studies and clinical trials. We may elect to discontinue, delay or modify clinical trials of some product candidates or focus on others. A change in the outcome of any of these factors could mean a significant change in the costs and timing associated with the development of our current and future preclinical and clinical product candidates. For example, if the FDA or another regulatory authority were to require us to conduct clinical trials beyond those that we currently anticipate will be required for the completion of clinical development, or if we experience significant delays in execution of or enrollment in any of our preclinical studies or clinical trials, we could be required to expend significant additional financial resources and time on the completion of preclinical and clinical development. We expect that our research and development expenses will substantially increase for the foreseeable future as we continue to implement our business strategy, which includes advancing our product candidates through clinical development, expanding our research and development efforts, including hiring additional personnel to support our research and development efforts, and seeking regulatory approvals for our product candidates that successfully complete clinical trials. In addition, product candidates in later stages of clinical development generally incur 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 our research and development expenses to increase as our product candidates advance into later stages of clinical development. As of the date of this Annual Report on Form 10-K, we cannot reasonably determine or accurately project total program-specific expenses through commercialization. There are numerous factors associated with the successful commercialization of any of our product candidates, including future trial design and various regulatory requirements, many of which cannot be determined with accuracy at this time based on our
stage of development. 121 Table of Contents General and Administrative Our general and administrative expenses consist primarily of personnel-related expenses, including employee salaries, bonuses, benefits, stock-based compensation, and recruiting costs for personnel in executive, finance, and other administrative functions. Other significant general and administrative expenses include legal fees relating to intellectual property and corporate matters, professional fees for accounting, tax and consulting services, insurance costs, travel expenses and facility related expenses not otherwise included in research and development expenses. We expect our general and administrative expenses will substantially increase for the foreseeable future as we continue to increase our general and administrative headcount to support our continued research and development activities and, if any product candidates receive marketing approval, commercialization activities, as well as to support our operations generally. As we expand our operations, we also expect to incur increased expenses associated with operating as a public company, including costs related to accounting, audit, legal, regulatory, and tax-related services associated with maintaining compliance with exchange listing and rules and regulations of theSEC , Sarbanes-Oxley Act, director and officer insurance costs, and investor and
public relations costs. Other Income (Expense) Interest income Interest income consists of interest earned on our cash and cash equivalents balances and our marketable securities. The primary objective of our investment policy is capital preservation.
Other expense
Other expense consists of the amortization of premiums or accretion of discounts related to our marketable securities.
Income tax benefit
Income tax benefit is due to a release of a valuation reserve during 2021 as a result of the business combination.
122 Table of Contents Results of Operations
Comparison of the Years Ended
The following table summarizes our results of operations for the periods indicated: Year Ended December 31, Change 2021 2020 $ % (in thousands, except percentages) Revenue$ 2,080 $ 2,311 $ (231) (10.0) % Cost of revenue 1,153 1,280 (127) (9.9) % Gross profit 927 1,031 (104) (10.1) % Operating expenses Research and development 26,541 15,004 11,537 76.9 % General and administrative 8,272 3,110 5,162 166.0 % Total operating expenses 34,813 18,114 16,699 92.2 % Loss from operations (33,886) (17,083) (16,803) 98.4 % Other income (expense) Interest income 170 43 127 295.3 % Other expense (127) - (127) N/M % Loss before income taxes (33,843) (17,040) (16,803) 98.6 Income tax benefit 307 - 307 N/M % Net loss$ (33,536) $ (17,040) N/M - Not meaningful Revenue The following table summarizes the revenue recognized for the periods indicated: Year Ended December 31, Change 2021 2020 $ % (in thousands, except percentages) Revenue$ 2,080 $ 2,311 $ (231) (10.0) % Revenue decreased by approximately$0.2 million , or 10% to approximately$2.1 million for the year endedDecember 31, 2021 compared to approximately$2.3 million for the year endedDecember 31, 2020 . The decrease in revenue was due to approximately$0.3 million related to customer agreements that were completed in 2020, offset by a$0.1 million increase in new customers in the year ended
December 31, 2021 . 123 Table of Contents Cost of Revenue The following table summarizes the components of cost of revenue expenses for the periods indicated: Year Ended December 31, Change 2021 2020 $ % (in thousands, except percentages) Employee related costs$ 934 $ 1,087 $ (153) (14.1) % Stock-based compensation expense 103 108 (5) (4.6) % Outside contract research services - 6 (6) (100.0) % Facilities and other allocated expenses 108 74 34 45.9 % Depreciation 8 5 3 60.0 % Total cost of revenue$ 1,153 $
1,280
Cost of revenue decreased by approximately
Research and Development
The following table summarizes the components of our research and development expenses for the periods indicated:
Year Ended December 31, Change 2021 2020 $ % (in thousands, except percentages) Employee related costs$ 8,001 $ 5,505 $ 2,496 45.3 %
Stock-based compensation expense 769 503 266 52.9 % Outside contract research services 17,307 8,646 8,661 100.2 % Facilities and other allocated expenses 434 330 104 31.5 % Depreciation 30 20 10 50.0 % Total research and development$ 26,541 $
15,004
Research and development expenses increased by approximately$11.5 million , or 76.9%, to approximately$26.5 million for the year endedDecember 31, 2021 compared to approximately$15.0 million for the year endedDecember 31, 2020 . The increase of approximately$11.5 million was primarily due to approximately$8.7 million of outside contract research services for our preclinical candidates resulting from an increased number of discovery programs and increased spending on later stage preclinical efforts. The increase also includes approximately$2.5 million of additional employee-related costs, primarily due to an increase in headcount, approximately$0.3 million increase for stock-based compensation expense and$0.1 million increase for facilities and other allocated expenses. 124 Table of Contents General and Administrative
The following table summarizes the components of our general and administrative expenses for the periods indicated:
Year Ended December 31, Change 2021 2020 $ % (in thousands, except percentages) Employee related costs$ 4,506 $ 1,426 $ 3,080 216.0 %
Stock-based compensation expense 931
476 455 95.6 % Professional fees 1,803 836 967 115.7 % Public relations 262 289 (27) (9.3) % Outside consultants 75 18 57 316.7 %
Facilities and other allocated expenses 125 38 87 228.9 % Other 570 27 543 2,011.1 % Total general and administrative$ 8,272 $
3,110
General and administrative expenses increased by approximately$5.2 million , or 166.0%, to approximately$8.3 million for the year endedDecember 31, 2021 compared to approximately$3.1 million for the year endedDecember 31, 2020 . The increase of approximately$5.2 million was primarily due to increased employee-related costs of approximately$3.1 million as a result of increased headcount, increased professional fees incurred for accounting, auditing, legal, public relations and tax services of approximately$1.0 million , increased facilities expenses of approximately$0.1 million , approximately$0.5 million increase in stock-based compensation expense and$0.5 million increase in other, which is primarily related to franchise tax expense.
Other Income (expense)
Interest income increased by approximately
Other expense increased by
Liquidity and Capital Resources
Sources of Liquidity
Since our inception, we have financed our operations through service revenues, the issuance of convertible notes payable, convertible preferred stock, common stock, and the exercise of stock options. As ofDecember 31, 2021 , we had an accumulated deficit of$59.3 million and$150.2 million in cash and cash equivalents and marketable securities. Cash and cash equivalents are comprised of deposits at major financial banking institutions and highly liquid investments with an original maturity of three months or less at the date of purchase. Our primary use of cash is to fund operating expenses, which consist primarily of research and development expenditures, and to a lesser extent, general and administrative expenditures. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, reflected in the change in our outstanding accounts payable and accrued expenses. Since our inception, we have incurred significant operating losses. We have not yet commercialized any of our product candidates, and we do not expect to generate revenue from sales of any product candidates for the next several years, if at all. To date, our operations have been financed primarily by service revenues and aggregate net proceeds of approximately$81.4 million from the issuance of convertible notes payable, convertible preferred stock including gross proceeds of approximately$24.8 million from the issuance of shares in the second tranche of Series B Preferred in April andMay 2021 , common stock, the exercise of stock options. InAugust 2021 , we completed our IPO pursuant to which we issued and sold 8,625,000 shares of Class A common stock, inclusive of 1,150,000 shares sold by us pursuant to the full exercise of the underwriters' option to purchase additional shares. We received aggregate net proceeds of approximately 125 Table of Contents
As ofDecember 31, 2021 , we have contractual obligations related to various leases of$0.7 million for 2022,$0.9 million for 2023,$0.9 million for 2024,$0.9 million for 2025,$0.8 million for 2026 and$4.5 million for the periods thereafter. We have no off-balance sheet arrangements that have a material current effect or that are reasonably likely to have a material future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
Cash Flows
The following table summarizes our sources and uses of cash for the periods indicated: Year Ended December 31, 2021 2020 (in thousands) Net cash (used in) provided by: Operating activities$ (30,851) $ (14,621) Investing activities (75,616) (53) Financing activities 144,265 37,982
Net increase in cash and cash equivalents
During the year endedDecember 31, 2021 , operating activities used approximately$30.9 million of cash, primarily resulting from our net loss of approximately$33.5 million , deferred tax benefit of$0.3 million , and cash provided by changes in our operating assets and liabilities of approximately$0.9 million , partially offset by stock-based compensation expense of approximately$1.8 million , net amortization of premium (accretion of discount) on marketable securities of$0.1 million , and$0.2 million right of use amortization and depreciation. During the year endedDecember 31, 2020 , operating activities used approximately$14.6 million of cash, primarily resulting from our net loss of approximately$17.0 million , partially offset by stock-based compensation expense of approximately$1.1 million and cash provided by changes in our operating assets and liabilities of approximately$1.3 million .
During the year endedDecember 31, 2021 and 2020, investing activities used approximately$75.6 million , and approximately$0.1 million respectively. For the year 2021, cash used from investing was primarily related to purchases of marketable securities of approximately$75.6 million , approximately$0.1 million for the purchases of property and equipment, and cash acquired in business combination of approximately$0.1 million . For 2020 cash used in investing was a result of purchases of property and equipment of approximately$0.1 million .
Net Cash Provided by Financing Activities
During the year endedDecember 31, 2021 , net cash provided by financing activities was approximately$144.3 million , consisting primarily of approximately$24.8 million in net proceeds received from the issuance of Series B preferred stock, approximately$118.2 million from the net proceeds from our initial public offering, approximately$0.9 million in net proceeds from the exercise of warrants and approximately$0.4 million from the exercise of stock options.
During the year ended
126 Table of Contents Future Funding Requirements
We expect that our expenses will increase substantially in connection with our ongoing activities, particularly as we advance the preclinical activities and clinical trials for our product candidates in development. The timing and amount of our operating and capital expenditures will depend largely on:
? the impacts of the pandemic related to COVID-19 and its variants and potential
future pandemics;
? the costs and results of our potential future clinical trials for our other
product candidates;
the scope, progress, results and costs of discovery research, preclinical
? development, laboratory testing and clinical trials for our other product
candidates;
? the costs, timing and outcome of regulatory review of our product candidates;
our ability to enter into contract manufacturing arrangements for supply of
? active pharmaceutical ingredient, or API, and manufacture of our product
candidates and the terms of such arrangements;
? the payment or receipt of milestones and receipt of other collaboration-based
revenues, if any;
the costs and timing of any future commercialization activities, including
? product manufacturing, sales, marketing and distribution, for any of our
product candidates for which we may receive marketing approval;
? the amount and timing of revenue, if any, received from commercial sales of our
product candidates for which we receive marketing 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 acquire or in-license other products, product
candidates, technologies or data referencing rights;
? our ability to establish and maintain strategic collaborations, licensing or
other arrangements and the financial terms of such arrangements;
? our ability to access the private and public capital markets or to obtain
financing at commercially reasonable rate;
? the ability to receive additional non-dilutive funding, including grants from
organizations and foundations; and
? the costs of operating as a public company.
We believe that our existing cash, cash equivalents and marketable securities, will enable us to fund our operating expenses and capital expenditure requirements into the third quarter of 2024. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.
Critical Accounting Policies and Use of Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles inthe United States , or GAAP. 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 to our consolidated financial statements appearing at the end of this Annual Report on Form 10-K, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.
Research and Development Costs
We incur substantial expenses associated with manufacturing and clinical trials. Accounting for clinical trials relating to activities performed by contract research organizations, or CROs, and other external vendors requires management to 127 Table of Contents exercise significant estimates in regard to the timing and accounting for these expenses. We estimate costs of research and development activities conducted by service providers, which include the conduct of sponsored research, preclinical studies and contract manufacturing activities. The diverse nature of services being provided under CROs and other arrangements, the different compensation arrangements that exist for each type of service and the lack of timely information related to certain clinical activities complicates the estimation of accruals for services rendered by CROs and other vendors in connection with clinical trials. Because payments of research and development activities do not always line up with the provision of such services, the balance sheet may reflect either an accrued or prepaid position. In estimating the duration of a clinical study, we evaluate the start-up, treatment and wrap up periods, compensation arrangements and services rendered attributable to each clinical trial and fluctuations are regularly tested against payment plans and trial completion assumptions. We estimate these costs based on factors such as estimates of the work completed and budget provided and in accordance with agreements established with our collaboration partners and third-party service providers. We make significant judgments and estimates in determining the accrued liabilities and prepaid expense balances in each reporting period. As actual costs become known, we adjust our accrued liabilities or prepaid expenses. We have not experienced any material differences between accrued costs and actual costs incurred since our inception. Our expenses related to clinical trials will be based on estimates of patient enrollment and related expenses at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that may be used to conduct and manage clinical trials on our behalf. We will accrue expenses related to clinical trials based on contracted amounts applied to the level of patient enrollment and activity. If timelines or contracts are modified based upon changes in the clinical trial protocol or scope of work to be performed, we will modify our estimates of accrued expenses accordingly on a prospective basis.
Stock-Based Compensation
We measure stock-based awards granted to employees, non-employees and directors based on their fair value on the date of the grant using the Black-Scholes option-pricing model for options or the difference between the purchase price per share of the award, if any, and the fair value of our common stock for restricted common stock awards. Compensation expense for those awards is recognized over the requisite service period, which is generally the vesting period of the award for employees and directors and the period during which services are performed for non-employees. We use the straight-line method to record the expense of awards with service-based vesting conditions. The Black-Scholes option-pricing model uses as inputs the 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.
Off-balance Sheet Arrangements
During the periods presented, we did not have, nor do we currently have, any off-balance sheet arrangements as defined in the rules and regulations of theSEC .
Recently Issued Accounting Pronouncements
A description of recently issued accounting pronouncements that may potentially impact our financial position, results of operations or cash flows is disclosed in Note 2 to our consolidated financial statements appearing at the end of this Annual Report on Form 10-K.
Emerging Growth 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 consolidated financial statements, an exemption from the requirement to provide an auditor's report on internal 128 Table of Contents controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act, an exemption from any requirement that may be adopted by thePublic Company Accounting Oversight Board , 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 to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our consolidated 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 the end of the fiscal year following the fifth anniversary of our IPO, although if the market value of our common stock that is held by non-affiliates exceeds$700 million as ofJune 30 of any year 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 EGC as ofDecember 31 of the applicable year. We also would cease to be an EGC if we issue more than$1.0 billion of non-convertible debt over a three-year period.
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