# Oric Pharmaceuticals, Inc. (ORIC) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Oric Pharmaceuticals, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1796280/000095017024029298/oric-20231231.htm
Accession: 0000950170-24-029298
Filing date: 2024-03-11
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/ORIC/
All MD&A years: /company/ORIC/mda/
Previous year: /company/ORIC/mda/fy2022/ (FY 2022)
Next year: /company/ORIC/mda/fy2024/ (FY 2024)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties, including those described in the section titled “Special Note Regarding Forward-Looking Statements.” Our actual results and the timing of selected events could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those set forth under the section titled “Risk factors” included elsewhere in this report.

Overview

ORIC Pharmaceuticals is a clinical-stage biopharmaceutical company dedicated to improving patients’ lives by Overcoming Resistance In Cancer.

Our fully integrated discovery and development team is advancing a diverse pipeline of innovative clinical and discovery stage therapies designed to counter resistance mechanisms in cancer by leveraging our expertise within three specific areas: hormone-dependent cancers, precision oncology and key tumor dependencies.

Our clinical stage product candidates include:

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ORIC-114, a brain penetrant, orally bioavailable, irreversible inhibitor designed to selectively target epidermal growth factor receptor (EGFR) and human epidermal growth factor receptor 2 (HER2) with high potency towards exon 20 insertion mutations, for which we licensed development and commercialization rights from Voronoi Inc. (Voronoi) in October 2020 (Voronoi License Agreement). In the fourth quarter of 2021, we filed a Clinical Trial Application (CTA) in South Korea for ORIC-114, which was cleared in the first quarter of 2022. We also filed and cleared an Investigational New Drug Application (IND) with the U.S. Food and Drug Administration (FDA) for ORIC-114 in the third quarter of 2022. We are enrolling a Phase 1b trial of ORIC-114 as a single-agent, in patients with advanced solid tumors with EGFR and HER2 exon 20 alterations, atypical EGFR mutations or HER2 amplifications, and that trial allows patients with CNS metastases that are either treated or untreated but asymptomatic. We reported initial Phase 1b data from this trial at the European Society for Medical Oncology (ESMO) Congress in October 2023, which demonstrated both systemic and intracranial activity across multiple dose levels in a heavily pre-treated patient population. We expect to initiate dose expansion cohorts for ORIC-114 in patients with mutated NSCLC in the first half of 2024 and report updated Phase 1b data in the first half of 2025.

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ORIC-944, an allosteric inhibitor of the polycomb repressive complex 2 (PRC2) via the embryonic ectoderm development (EED) subunit, for which we licensed development and commercialization rights from Mirati Therapeutics, Inc. (Mirati) in August 2020 (Mirati License Agreement). We filed and cleared an IND with the FDA for ORIC-944 in the fourth quarter of 2021. We are enrolling a Phase 1b trial of ORIC-944 as a single-agent, in patients with advanced prostate cancer and reported initial Phase 1b data from this trial in January 2024, demonstrating potential best-in-class drug properties, including clinical half-life consistent with a preclinical prediction of greater than 10 hours, robust target engagement and a favorable safety profile. We expect to initiate a combination study of ORIC-944 with AR inhibitor(s) in metastatic prostate cancer in the first half of 2024 and provide a program update in mid-2024.

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ORIC-533, an orally bioavailable small molecule inhibitor of CD73, a key node in the adenosine pathway believed to play a central role in resistance to chemotherapy- and immunotherapy-based treatment regimens. In the second quarter of 2021, the FDA cleared the IND for ORIC-533, and in the first quarter of 2023, a CTA was cleared in Canada for ORIC-533. We are enrolling a Phase 1b trial of ORIC-533 as a single-agent, in patients with relapsed/refractory multiple myeloma and reported initial Phase 1b data from this trial at the American Society of Hematology (ASH) annual meeting in December 2023. We intend to complete the dose escalation in the first quarter of 2024. We intend to evaluate strategic partnerships to develop ORIC-533 in combination with other immune-based antimyeloma therapies.

Beyond these clinical stage product candidates, we are developing multiple discovery stage precision medicines targeting other hallmark cancer resistance mechanisms.

We have incurred significant losses since the commencement of our operations. Our net loss for the year ended December 31, 2023, was $100.7 million and we had an accumulated deficit of $434.9 million as of December 31, 2023. Our losses and accumulated deficit have resulted primarily from costs incurred in connection with research and development activities including in-licensing and to a lesser extent from general and administrative costs associated with our operations. We expect to incur significant losses for the foreseeable future, and we anticipate these losses will increase significantly as we continue our development of ORIC-114 and ORIC-944 and any future product candidates from discovery through preclinical development and into clinical trials as we seek regulatory

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approval for these product candidates. Our net losses may fluctuate significantly from period to period, depending on the timing of and expenditures on our planned research and development activities.

On January 20, 2024, we entered into a securities purchase agreement with a select group of institutional and accredited healthcare specialist investors for the private placement of 12,500,000 shares of common stock at a price of $10.00 per share, resulting in gross proceeds of $125.0 million. The purchase price per share represents a premium to ORIC's 5-day trailing average stock price at the time of sale. After deducting expenses related to the private placement of $0.2 million, the net proceeds we received from the private placement were $124.8 million. The private placement closed on January 23, 2024.

On June 24, 2023, we entered into a securities purchase agreement with a select group of institutional and accredited healthcare specialist investors for the private placement of 9,285,710 shares of common stock at a price of $7.00 per share and pre-funded warrants to purchase 2,857,142 shares of common stock at a purchase price of $6.9999 per pre-funded warrant, resulting in gross proceeds of $85.0 million. The pre-funded warrants have an exercise price of $0.0001 per share of common stock, were immediately exercisable and will remain exercisable until exercised in full. The purchase price per share represents a premium to the market price at the time of sale. After deducting offering expenses related to the private placement of $0.2 million, the net proceeds we received from the private placement were $84.8 million. The private placement closed on June 27, 2023.

On December 21, 2022, we entered into a securities purchase agreement with Pfizer pursuant to which we sold 5,376,344 shares of our common stock at a price of $4.65 per share to Pfizer for gross proceeds of $25.0 million. We sold the shares to Pfizer in a registered direct offering conducted without an underwriter or placement agent and pursuant to an effective shelf registration statement. After deducting offering expenses of $0.4 million, the net proceeds we received from the direct offering were $24.6 million. The transaction closed on December 23, 2022.

On May 6, 2021, we entered into an "at-the-market" (ATM) sales agreement with Jefferies LLC as our sales agent, under which we may offer and sell from time to time up to $150 million of our common stock in negotiated transactions or transactions that are deemed to be an ATM offering. On July 8, 2021, we raised gross proceeds of $50.0 million through the sale of 2,597,402 shares in an ATM offering, with participation based on unsolicited interest received from a healthcare specialist fund. We sold such shares at a purchase price per share of $19.25, a premium to the market price at the time of sale. After deducting commissions and other offering expenses related to the ATM offering of $1.9 million, the net proceeds we received from the transaction were $48.1 million.

Components of Operating Results

Research and Development Expenses

Research and development expenses account for a significant portion of our operating expenses and consist primarily of external and internal costs incurred in connection with the discovery and development of our product candidates.

External expenses include:

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payments to third parties in connection with the clinical development of our product candidates, including contract research organizations (CROs) and consultants;

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the cost of manufacturing products for use in our preclinical studies and clinical trials, including payments to contract manufacturing organizations (CMOs) and consultants;

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payments to third parties in connection with the preclinical development of our product candidates, including outsourced professional scientific development services, consulting research fees and sponsored research arrangements with third parties;

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laboratory supplies; and

•
allocated facilities, depreciation and other expenses, which include direct or allocated expenses for IT, rent and maintenance of facilities.

We may also incur in-process research and development expense as we acquire or in-license assets from other parties. Technology acquisitions are expensed or capitalized based upon the asset achieving technological feasibility in accordance with management’s assessment regarding the ultimate recoverability of the amounts paid and the potential for alternative future use. Acquired in-process research and development costs that have no alternative future use are immediately expensed.

Internal expenses include employee-related costs such as salaries, related benefits and non-cash stock-based compensation expense for employees engaged in research and development functions.

We expense research and development costs in the periods in which they are incurred. External expenses are recognized based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers or our estimate of the level of service that has been performed at each reporting date. We track external costs by program, clinical or

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preclinical. We do not track internal costs by program because these costs are deployed across multiple programs and, as such, are not separately classified.

Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages, primarily due to the increased size and duration of later-stage clinical trials. As a result, we expect that our research and development expenses will increase substantially in the foreseeable future as we advance our product candidates through preclinical studies and clinical trials; continue to discover and develop additional product candidates and expand our pipeline; maintain, expand, protect and enforce our intellectual property portfolio; and hire additional personnel.

The successful development of our product candidates is highly uncertain, and we do not believe it is possible at this time to accurately project the nature, timing and estimated costs of the efforts necessary to complete the development of, and obtain regulatory approval for, any of our product candidates. To the extent our product candidates continue to advance into clinical trials, as well as advance into larger and later-stage clinical trials, our expenses will increase substantially and may become more variable. We are also unable to predict when, if ever, we will generate revenue from our product candidates to offset these expenses. Our expenditures on current and future preclinical and clinical development programs are subject to numerous uncertainties in timing and cost to completion. The duration, costs and timing of preclinical studies and clinical trials and development of our product candidates will depend on a variety of factors, including:

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the timing and progress of preclinical and clinical development activities;

•
the number and scope of preclinical and clinical programs we decide to pursue;

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our ability to maintain our current research and development programs and to establish new ones;

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establishing an appropriate safety profile with IND-enabling toxicology studies;

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successful patient enrollment in, and the initiation and completion of, clinical trials;

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the successful completion of clinical trials with safety, tolerability and efficacy profiles that are satisfactory to the FDA or any comparable foreign regulatory authority;

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the receipt of regulatory approvals from applicable regulatory authorities;

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the timing, receipt and terms of any marketing approvals from applicable regulatory authorities;

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our ability to establish licensing or collaboration arrangements;

•
the performance of our future collaborators, if any;

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obtaining and retaining research and development personnel;

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establishing commercial manufacturing capabilities or making arrangements with third-party manufacturers;

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development and timely delivery of commercial-grade product formulations that can be used in our planned clinical trials and for commercial launch;

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obtaining, maintaining, defending and enforcing patent claims and other intellectual property rights;

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launching commercial sales of our product candidates, if approved, whether alone or in collaboration with others; and

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maintaining a continued acceptable safety profile of our products following approval.

Any changes in the outcome of any of these factors could significantly impact the costs, timing and viability associated with the development of our product candidates.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries, related benefits and stock-based compensation expense for personnel in executive, finance and administrative functions. General and administrative expenses also include allocated facilities, depreciation and other expenses, which include direct or allocated expenses for rent and maintenance of facilities and insurance, not otherwise included in research and development expenses, as well as professional fees for legal, patent, consulting, investor and public relations, accounting and audit services. We expect that our general and administrative expenses will increase substantially in the foreseeable future as we increase our headcount to support the continued research and development of our programs and the growth of our business.

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Other Income, Net

Other income, net primarily consists of interest income generated from our interest-bearing money market accounts and investments.

Results of Operations

The following table supplements the discussion below and summarizes our results of operations for the years ended December 31, 2023 and 2022 (in thousands):

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2023","","","2022","","","Change"],["Operating expenses:"],["Research and development","","$","85,172","","","$","61,680","","","$","23,492"],["General and administrative","","","25,608","","","","25,087","","","","521"],["Acquired in-process research and development","","","\u2014","","","","5,000","","","","(5,000",")"],["Total operating expenses","","","110,780","","","","91,767","","","","19,013"],["Loss from operations","","","(110,780",")","","","(91,767",")","","","(19,013",")"],["Other income, net","","","10,083","","","","2,645","","","","7,438"],["Net loss","","$","(100,697",")","","$","(89,122",")","","$","(11,575",")"]]
[[/GREPCENT_TABLE]]

Research and Development Expenses

Research and development expenses were $85.2 million for the year ended December 31, 2023, compared to $61.7 million for 2022, an increase of $23.5 million. The increase was driven by a net increase in external expenses of $20.2 million related to the advancement of ORIC-114 and ORIC-944, offset by a decrease in ORIC-101 costs due to the discontinuation of the program in the first quarter of 2022 and timing of ORIC-533 manufacturing. Higher personnel costs of $3.3 million, including additional non-cash stock-based compensation of $0.7 million, also contributed to the increase.

The following table summarizes our external and internal costs for the years ended December 31, 2023 and 2022 (in thousands):

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2023","","","2022","","","Change"],["External costs:"],["ORIC-114","","$","11,718","","","$","3,869","","","$","7,849"],["ORIC-944","","","20,846","","","","5,872","","","","14,974"],["ORIC-533","","","4,189","","","","5,981","","","","(1,792",")"],["Preclinical, other unallocated costs and discontinued costs","","","23,817","","","","24,665","","","","(848",")"],["Total external costs","","","60,570","","","","40,387","","","","20,183"],["Internal costs","","","24,602","","","","21,293","","","","3,309"],["Total research and development expenses","","$","85,172","","","$","61,680","","","$","23,492"]]
[[/GREPCENT_TABLE]]

We expect our research and development expenses to increase substantially for the foreseeable future as we continue to invest in research and development activities related to developing our product candidates, including investments in manufacturing, as our programs advance into later stages of development and as we conduct additional clinical trials.

General and Administrative Expenses

General and administrative expenses were $25.6 million for the year ended December 31, 2023, compared to $25.1 million for 2022, an increase of $0.5 million. This increase was primarily due to higher personnel costs, including additional non-cash stock-based compensation of $0.1 million.

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Acquired In-Process Research and Development Expenses

Acquired in-process research and development expenses were $5.0 million for the year ended December 31, 2022, due to a development milestone payment made in accordance with the Voronoi License Agreement.

Liquidity and Capital Resources

Sources of Liquidity

On January 20, 2024, we entered into a securities purchase agreement with a select group of institutional and accredited healthcare specialist investors for the private placement of 12,500,000 shares of common stock at a price of $10.00 per share, resulting in gross proceeds of $125.0 million. The private placement closed on January 23, 2024.

On June 24, 2023, we entered into a securities purchase agreement with a select group of institutional and accredited healthcare specialist investors for the private placement of 9,285,710 shares of common stock at a price of $7.00 per share and pre-funded warrants to purchase 2,857,142 shares of common stock at a purchase price of $6.9999 per pre-funded warrant, resulting in gross proceeds of $85.0 million. The private placement closed on June 27, 2023.

On December 21, 2022, we entered into a securities purchase agreement with Pfizer pursuant to which we sold 5,376,344 shares of our common stock at a price of $4.65 per share to Pfizer for gross proceeds of $25.0 million. We sold the shares to Pfizer in a registered direct offering conducted without an underwriter or placement agent and pursuant to an effective shelf registration statement. The transaction closed on December 23, 2022.

On May 6, 2021, we entered into an ATM sales agreement with Jefferies LLC as our sales agent, under which we may offer and sell from time to time up to $150 million of our common stock in negotiated transactions or transactions that are deemed to be an ATM offering. On July 8, 2021, we raised gross proceeds of $50.0 million, before deducting commissions and other offering expenses, through the sale of 2,597,402 shares in an ATM offering, with participation based on unsolicited interest received from a healthcare specialist fund. We sold such shares at a purchase price per share of $19.25, a premium to the market price at the time of sale.

Future Funding Requirements

To date, we have not generated any revenue. We do not expect to generate any meaningful revenue unless and until we obtain regulatory approval of and commercialize any of our product candidates, and we do not know when, or if at all, that will occur. We will continue to require substantial additional capital to develop our product candidates and fund operations for the foreseeable future. Moreover, we expect our expenses to increase in connection with our ongoing activities, particularly as we continue the development of and seek regulatory approvals for our product candidates. Further, we are subject to all the risks incident in the development of new pharmaceutical products, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may harm our business. Our expenses will increase if, and as, we:

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advance our product candidates through preclinical and clinical development;

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seek regulatory approvals for any product candidates that successfully complete clinical trials;

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seek to discover and develop additional product candidates;

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establish a sales, marketing, medical affairs and distribution infrastructure to commercialize any product candidates for which we may obtain marketing approval and intend to commercialize on our own or jointly;

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expand our operational, financial and management systems and increase personnel, including personnel to support our development, manufacturing and commercialization efforts and our operations as a public company;

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maintain, expand, protect and enforce our intellectual property portfolio; and

•
acquire or in-license other product candidates and technologies.

As of December 31, 2023, we had $235.0 million in cash, cash equivalents and investments. In January 2024, we raised $125.0 million in gross proceeds through a private placement and as of January 31, 2024, had an unaudited balance of $351.8 million in cash, cash equivalents and investments. We expect our current cash, cash equivalents and investments will be sufficient to fund our current operating plan into late 2026. However, our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. In order to complete the development of our product candidates and to build the sales, marketing and distribution infrastructure that we believe will be necessary to commercialize our product candidates, if approved, we will require substantial additional funding. Until we can generate a sufficient amount of revenue from the commercialization of our product candidates, we

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may seek to raise any necessary additional capital through the sale of equity, debt financings or other capital sources, which could include income from collaborations, strategic partnerships or marketing, distribution or licensing arrangements with third parties or from grants. 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 or could be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, including restricting our operations and limiting our ability to incur liens, issue additional debt, pay dividends, repurchase our common stock, make certain investments or engage in merger, consolidation, licensing or asset sale transactions. If we raise funds through collaborations, strategic partnerships and other similar arrangements with third parties, we may be required to grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves. We may be unable to raise additional funds or to enter into such agreements or arrangements on favorable terms, or at all. If we are unable to raise additional funds when needed, we may be required to delay, reduce or eliminate our product development or future commercialization efforts.

We have based our projections of operating capital requirements on our current operating plan, which is based on several assumptions that may prove to be incorrect and we may use all of our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate the exact amount and timing of our working capital requirements. Our future funding requirements will depend on many factors, including:

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the scope, progress, results and costs of researching and developing our product candidates, and conducting preclinical studies and clinical trials;

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the costs, timing and outcome of regulatory review of our product candidates;

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the costs of future activities, including product sales, medical affairs, marketing, manufacturing and distribution, for any of our product candidates for which we receive marketing approval;

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the costs of manufacturing commercial-grade products and sufficient inventory to support commercial launch;

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the revenue, if any, received from commercial sale of our products, should any of our product candidates receive marketing approval;

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the cost and timing of hiring new employees to support our continued growth;

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the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims;

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the ability to establish and maintain collaborations on favorable terms, if at all;

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the extent to which we acquire or in-license other product candidates and technologies; and

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the timing, receipt and amount of sales of, or milestone payments related to or royalties on, our current or future product candidates, if any.

A change in the outcome of any of these or other factors 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. Furthermore, our operating plan may change in the future, and we may need additional funds to meet operational needs and capital requirements associated with such operating plan.

Cash Flows

The following table summarizes the sources and uses of our cash (in thousands):

[[GREPCENT_TABLE]]
[["","","December 31,"],["","","2023","","","2022"],["Net cash used in operating activities","","$","(85,688",")","","$","(75,143",")"],["Net cash used in investing activities","","","(43,403",")","","","(109,248",")"],["Net cash provided by financing activities","","","85,658","","","","25,225"],["Net decrease in cash, cash equivalents and restricted cash","","$","(43,433",")","","$","(159,166",")"]]
[[/GREPCENT_TABLE]]

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Operating Activities

Net cash used in operating activities during the year ended December 31, 2023, of $85.7 million was primarily attributable to our net loss of $100.7 million, offset by non-cash expenses of $10.1 million, which were primarily driven by stock-based compensation, and $4.9 million in changes to working capital related to timing of payments.

Net cash used in operating activities during the year ended December 31, 2022, of $75.1 million was primarily attributable to our net loss of $89.1 million, offset by non-cash expenses of $14.4 million, which were primarily driven by stock-based compensation.

Investing Activities

Net cash used in investing activities during the year ended December 31, 2023, of $43.4 million was primarily attributable to purchases of investments, net of maturities.

Net cash used in investing activities during the year ended December 31, 2022, of $109.2 million was primarily attributable to purchases of investments, net of maturities.

Financing Activities

Net cash provided by financing activities during the year ended December 31, 2023, of $85.7 million was primarily attributable to net proceeds received in connection with our private placement in June 2023.

Net cash provided by financing activities during the year ended December 31, 2022, of $25.2 million was primarily attributable to net proceeds received in connection with our registered direct offering in December 2022.

Contractual Obligations and Commitments

Our contractual obligations and commitments as of December 31, 2023, consist of future payments under our operating leases. See Note 8 to our audited financial statements for detail regarding our operating leases.

In addition, we have entered into contracts in the normal course of business with CROs, CMOs and other third parties for preclinical research studies and testing, clinical trials and manufacturing services. These contracts do not contain any minimum purchase commitments and are cancelable by us upon prior notice. Payments due upon cancellation consist only of payments for services provided and expenses incurred, including non-cancelable obligations of our service providers, up to the date of cancellation. We have entered into agreements with certain vendors for the provision of goods and services, which includes manufacturing services with CMOs and development services with CROs. These agreements may include certain provisions for purchase obligations and termination obligations that could require payments for the cancellation of committed purchase obligations or for early termination of the agreements. The amount of the cancellation or termination payments vary and are based on the timing of the cancellation or termination and the specific terms of the agreement.

We do not currently have, nor did we have any off-balance sheet arrangements, as defined in the rules and regulations of the SEC, during the periods presented.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (US GAAP). The preparation of these financial statements in conformity with US GAAP requires management to make estimates and assumptions that impact the reported amounts of assets, liabilities, expenses, and the disclosure of contingent assets and liabilities in our financial statements and accompanying notes. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are described in more detail in the notes to our audited financial statements, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

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Research and Development Expenses

As part of the process of preparing our financial statements, we are required to estimate research and development costs incurred during the period, which impacts the amount of accrued expenses and prepaid balances related to such costs as of each balance sheet date. This process involves reviewing open contracts and purchase orders, communicating with our personnel and service providers 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 the 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.

Research and development costs are expensed in the periods in which they are incurred. External costs consist primarily of payments to outside consultants, third-party CROs, CMOs, clinical trial sites and central laboratories in connection with our discovery and preclinical activities, process development, manufacturing and clinical development activities. External costs also include laboratory supplies as well as allocated facilities, depreciation and other expenses. External expenses are recognized based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers or our estimate of the level of service that has been performed at each reporting date. We allocate external costs by program, clinical or preclinical. Internal costs consist primary of employee-related costs including salaries, related benefits and stock-based compensation expense for employees engaged in research and development functions. We do not allocate internal costs by program because these costs are deployed across multiple programs and, as such, are not separately classified.

Stock-Based Compensation

Stock-based compensation expense represents the grant date fair value of employee, officer, director and non-employee stock option and restricted stock unit grants, estimated in accordance with the applicable accounting guidance and recognized over the vesting period, which approximates the requisite service period of the awards. We recognize forfeitures as they occur.

The fair value of stock options is estimated using a Black-Scholes-Merton valuation model on the date of grant. The Black-Scholes-Merton option-pricing model requires inputs based on certain highly subjective assumptions. Changes to these assumptions can materially affect the fair value of stock options and ultimately the amount of stock-based compensation expense recognized in our financial statements. These assumptions include:

Fair value of common stock—The fair value of our common stock is determined based upon the closing market price on the date of grant.

Risk-free interest rate—The risk-free rate assumption is based on U.S. Treasury instruments with maturities similar to the expected term of our stock options.

Expected volatility—The expected volatility is computed using historical volatility for a period equal to the expected term. Given the limited period of time the Company's stock has been traded, expected volatility is based on the Company's historical volatility and the historical volatility of a group of similar companies that are publicly traded.

Expected term—The expected term represents the length of time the stock-based awards are expected to be outstanding. We have opted to use the “simplified method” for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option, which is generally 10 years.

Expected dividend yield—To date, we have not issued any dividends and do not expect to issue dividends over the life of the options and therefore have estimated the dividend yield to be zero.

The assumptions underlying these valuations represent our best estimates, which involve inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation expense could be materially different. The fair value of restricted stock units is equal to the closing price of the Company's stock on the date of grant.

Recently Issued Accounting Pronouncements

A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in Note 2 to our audited financial statements.

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Emerging Growth Company and Smaller Reporting Company Status

Section 107 of the JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition time to comply with new or revised accounting standards as applicable to public companies. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected not to use the extended transition, which election is irrevocable. As a result, our financial statements may not be comparable to other emerging growth companies that elect to take advantage of the extended transition period.

We will remain an emerging growth company until the earliest to occur of: (1) the last day of the fiscal year in which we have more than $1.235 billion in annual revenue; (2) the date we qualify as a “large accelerated filer,” with at least $700.0 million of equity securities held by non-affiliates; (3) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period; and (4) December 31, 2025.

We are also a smaller reporting company as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an emerging growth company. We may take advantage of certain of the scaled disclosures available to smaller reporting companies and will be able to take advantage of these scaled disclosures for so long as our voting and non-voting common stock held by non-affiliates is less than $250.0 million measured on the last business day of our second fiscal quarter, or our annual revenue is less than $100.0 million during the most recently completed fiscal year and our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.