# ARS Pharmaceuticals, Inc. (SPRY) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ARS Pharmaceuticals, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1671858/000095017022005202/sbtx-20211231.htm
Accession: 0000950170-22-005202
Filing date: 2022-03-31
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SPRY/
All MD&A years: /company/SPRY/mda/
Next year: /company/SPRY/mda/fy2022/ (FY 2022)

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

You should read the following discussion and analysis together with our financial statements and related notes included in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that involve risks and uncertainties. For a complete discussion of forward-looking statements, see the section above entitled “Forward Looking Statements.” Our actual results could differ materially from those expressed or implied in any forward-looking statements as a result of various factors, including those set forth under the caption “Item 1A. Risk Factors.”

Overview

We are a biopharmaceutical company focused on leveraging our proprietary ImmunoTAC technology platform to develop systemically delivered, tissue targeted therapeutics for the treatment of chronic viral infections, cancer, and other serious diseases. Our ImmunoTAC platform is the result of a focused effort to discover ways to systemically deliver disease-modifying small molecules in a directed fashion to sites of disease. Our platform enables us to strategically pair proprietary linker-payloads that modulate key disease-modifying pathways with monoclonal antibodies directed to specific disease sites. Many potentially promising systemic therapies fail to maximize their therapeutic potential due to toxicities in healthy tissues. Our approach is designed to expand the therapeutic window and avert unacceptable toxicities by directly targeting specific disease sites where our therapeutics are locally active.

In July 2020, we initiated clinical development of our first ImmunoTAC product candidate, a TLR8 agonist conjugated to a HER2 antibody, SBT6050. Preclinical data suggested that we would be able to demonstrate a therapeutic window and advance SBT6050 through clinical development as a monotherapy and in combination with standard-of-care agents that had a complementary mechanism-of-action. Our Phase 1/1b program was designed to measure safety and tolerability, PK, PD and anti-tumor activity as monotherapy and in combination with pembrolizumab. On March 28, 2022, we made the decision to discontinue our clinical development program for SBT6050 due to limited monotherapy activity and dose-limiting adverse events when used in combination with pembrolizumab. SBT6290, comprised of the same linker payload conjugated to a Nectin4 antibody was expected to show a similar clinical profile and, therefore, we also terminated this program prior to dosing patients. We have prioritized our resources to focus on the development of SBT8230 and early-stage discovery programs.

Our understanding of TLR8 conjugates in preclinical species and in the clinic guides our interpretation of the preclinical characteristics of SBT8230, an ASGR1 antibody conjugated to a TLR8 agonist linker payload for the treatment of cHBV, which is currently in preclinical development. ASGR1 is highly expressed in liver and is restricted in its expression to this organ. Other ASGR1-directed agents, such as those used in RNAi therapies, have shown robust liver localization. SBT8230 shows biodistribution profiles in NHP consistent with these agents, which is distinct from SBT6050 and SBT6290. We believe that efficient liver targeting of SBT8230 via ASGR1 binding has the potential to lead to markedly lower serum exposures of SBT8230 in patients compared to those observed with SBT6050 in the clinic at any dose evaluated. We believe the preclinical to clinical experience for SBT6050, coupled with the NHP PK, PD, and tolerability data for SBT8230, suggest that the clinical safety, PK and PD profiles for SBT8230 has the potential to be notably different than those for SBT6050, given the large differences in serum exposures and overall conjugate disposition for SBT8230 that are expected in patients due to its efficient liver targeting. SBT8230 is designed to elicit an anti-viral immune response by targeting TLR8 activation to the liver. The anti-viral immune response is achieved through activation of myeloid cells and subsequent activation of immune cells that drive an IFNγ signal, which has been observed in the clinic with SBT6050. This has been shown by others to drive seroconversion, an important determinant of a functional cure. We see a significant opportunity in liver-localized immunotherapies as a potential way of achieving durable responses in these patients. We are focused on advancing SBT8230, our liver-targeted conjugate designed to potently activate human myeloid cells in the liver for the treatment of cHBV.

Further support for investigating TLR8 agonism for the treatment of cHBV comes from selgantolimod (GS-9688), an existing untargeted, orally administered TLR8 agonist being developed by Gilead Sciences. Selgantolimod has generated anti-viral immune responses in a cHBV animal model. The clinical development of this untargeted TLR8 agonist has shown promise, but we believe that toxicity prevented the use of a sufficient dose to elicit optimal clinical activity. We believe liver-localized TLR8 agonism could better realize the potential for effective therapy and potentially lead to functional cure, which is defined as sustained loss of HBsAg in the blood, in patients suffering from cHBV. We presented a preclinical update on SBT8230 in the fourth quarter of 2021. In the first quarter of 2022, we began a Phase 1-enabling toxicology study. We plan to complete a Phase 1 regulatory submission in the fourth quarter of 2022 and begin a Phase 1 SAD study in healthy volunteers in the first half of 2023. After completing the SAD study, we anticipate initiating a Phase 1 MAD study in patients with chronic HBV, who are virally suppressed on NRTI therapy.

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In addition, our internal discovery programs are focused on evaluating and developing new antigen binding domains specific for targets of interest (including antibodies), next-generation linker technologies, and both agonist and antagonist small molecule payloads, that may be combined to create novel tissue-targeted antibody conjugates. The integration of medicinal chemistry, bioconjugation, protein engineering, bioinformatics, pharmacology, and translational medicine expertise focused on developing tissue-targeted therapies allows us to leverage key learnings from our previous clinical program to bring forward the next generation of therapeutics. We anticipate providing an update on our discovery pipeline in the fourth quarter of 2022.

Our ImmunoTAC platform drives our development pipeline of tissue targeted therapeutic candidates as summarized in the chart below:

We have incurred significant operating losses since our inception. As of December 31, 2021, we had an accumulated deficit of $186.2 million. Our net losses were $89.5 million and $32.9 million for the years ended December 31, 2021 and 2020, respectively. Our losses have resulted primarily from research and development activities and general and administrative expenses. We do not have any products approved for sale and have not generated any revenue from product sales or otherwise.

We expect we will continue to incur significant losses for the foreseeable future as we continue our development of, and seek regulatory approvals for, our product candidates and begin to commercialize any approved products, seek to expand our product pipeline, invest in our organization and technology platform, as well as incur expenses associated with operating as a public company. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on a variety of factors including the timing and scope of our preclinical studies and clinical trials. Accordingly, until such time as we can generate significant revenue from sales of our product candidates, if ever, we expect to finance our cash needs through equity offerings, debt financings or other capital sources, including potential collaborations, licenses or other similar arrangements.

On March 28, 2022, our board of directors approved a corporate restructuring plan to discontinue our clinical development programs for SBT6050 and SBT6290 and to prioritize resources on the development of SBT8230 and early-stage discovery programs (the Restructuring Plan). In connection with the Restructuring Plan, our workforce will be reduced by 27%, with substantially all of the reduction in personnel expected to be completed by July 15, 2022. We initiated the reduction in force on March 31, 2022 and expect to provide severance payments, continuation of group health insurance coverage, and other benefits for a specified period to the affected employees. We currently estimate that we will incur costs of approximately $2.0 million for termination benefits related to the Restructuring Plan, all of which will be cash expenditures paid in 2022.

Components of Our Results of Operations

Operating Expenses

Our operating expenses consist of (i) research and development expenses and (ii) general and administrative expenses.

Research and Development

Our research and development expenses consist primarily of direct and indirect costs incurred in connection with the development of our ImmunoTAC technology platform, product candidates, discovery efforts and preclinical studies and clinical trial activities related to our program pipeline.

Our direct costs include:

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expenses incurred under agreements with CROs and other vendors that conduct our preclinical and clinical activities;

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•
expenses associated with manufacturing our product candidates including under agreements with CDMOs and other vendors; and

•
consulting fees.

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;

•
facility and equipment related expenses, consisting of indirect and allocated expenses for rent, depreciation, and equipment maintenance; and

•
other unallocated research and development expenses incurred in connection with our research and development programs, including laboratory materials and supplies and license fees.

We expense research and development costs as incurred. Advance payments for goods and services that will be used over time for research and development are capitalized and recognized as goods are delivered or as the related services are performed. In-licensing fees and other costs to acquire technologies used in research and development that have not yet received regulatory approval and that are not expected to have an alternative future use are expensed when incurred. We track direct costs by stage of program, clinical or preclinical. However, we do not track indirect costs on a program specific or stage of program basis because these costs are deployed across multiple programs and, as such, are not separately classified.

We expect that our research and development expenses will decrease in 2022 due to discontinuation of the clinical development of SBT6050 and SBT6290 and the Restructuring Plan. However, following 2022, we expect that our research and development expenses will begin to increase again for the foreseeable future as we continue the development of our preclinical and discovery programs, particularly as they move into later stages of development which increases costs considerably. We cannot reasonably determine the timing of initiation, the duration or the completion costs of these future preclinical studies and clinical trials due to the inherently unpredictable nature of preclinical and clinical development. Clinical and preclinical development timelines, the probability of success and development costs can differ materially from expectations. We anticipate that we will make determinations as to which development candidates and discovery programs to pursue and how much funding to direct to each product candidate or program on an ongoing basis in response to the results of ongoing and future preclinical studies and clinical trials, regulatory developments and our ongoing assessments as to each product candidate’s commercial potential.

General and Administrative

General and administrative expenses consist primarily of personnel-related expenses, including employee salaries, bonuses, benefits, and 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.

We expect that our general and administrative expenses will decrease in 2022 due to the Restructuring Plan. However, following 2022, we expect that our general and administrative expenses will begin to increase again to the extent needed to support growth in our research and development activities. We also expect to continue 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 SEC requirements, director and officer insurance costs, and investor and public relations costs.

Interest Income (Expense), Net

Interest income (expense), net includes interest earned on our cash, cash equivalents, and long-term investments carried at fair value, and interest expense on our borrowings.

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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:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Dollar","","","%"],["","","2021","","","2020","","","Change","","","Change"],["","","(in thousands, except percentages)"],["Operating expenses:"],["Research and development","","$","61,501","","","$","24,577","","","$","36,924","","","","150","%"],["General and administrative","","","28,083","","","","8,341","","","","19,742","","","","237"],["Total operating expenses","","","89,584","","","","32,918","","","","56,666","","","","172"],["Loss from operations","","","(89,584",")","","","(32,918",")","","","(56,666",")","","","172"],["Interest income (expense), net","","","106","","","","(29",")","","","135","","","*"],["Net loss","","$","(89,478",")","","$","(32,947",")","","$","(56,531",")","","","172","%"]]
[[/GREPCENT_TABLE]]

* Not meaningful

Research and Development Expenses

The following table summarizes our research and development expenses for the years ended December 31, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Dollar","","","%"],["","","2021","","","2020","","","Change","","","Change"],["","","(in thousands, except percentages)"],["Direct costs:"],["SBT6050","","$","15,150","","","$","4,710","","","$","10,440","","","","222","%"],["SBT6290","","","9,217","","","","3,049","","","","6,168","","","","202"],["Preclinical programs","","","7,932","","","","3,059","","","","4,873","","","","159"],["Total direct costs","","","32,299","","","","10,818","","","","21,481","","","","199"],["Indirect costs:"],["Personnel-related expenses, including stock-based compensation","","","23,045","","","","9,657","","","","13,388","","","","139"],["Facility and equipment related expenses","","","2,972","","","","2,426","","","","546","","","","23"],["Other unallocated research and development expenses","","","3,185","","","","1,676","","","","1,509","","","","90"],["Total research and development expenses","","$","61,501","","","$","24,577","","","$","36,924","","","","150","%"]]
[[/GREPCENT_TABLE]]

An investigational new drug application for SBT6290 was cleared by the FDA in the fourth quarter of 2021 and we opened enrollment for a Phase 1 clinical trial of SBT6290 in the first quarter of 2022, which is now discontinued. As a result, we have separated direct costs for the development of SBT6290 from preclinical programs for the year ended December 31, 2021 and, for comparability purposes, the year ended December 31, 2020. This change had no effect on net loss, total research and development expenses, stockholders' equity, or cash flows as previously reported.

Research and development expenses were $61.5 million and $24.6 million for the years ended December 31, 2021 and 2020, respectively. The increase of $36.9 million was due primarily to an increase of $10.4 million in direct costs related to the development of SBT6050 as we continued to advance the program through a Phase 1/1b clinical trial. The increase was also due to an increase of $6.2 million in direct costs related to the development of SBT6290 as we advanced the program through FDA clearance of its investigational new drug application and prepared to initiate a Phase 1 clinical trial in the first quarter of 2022 and due to an increase in direct costs for our preclinical programs of $4.9 million as we continued to advance SBT8230 and other preclinical research efforts. The remaining increase was due to increases in personnel-related expenses of $13.4 million resulting from increased headcount during the year ended December 31, 2021 as well as increases in salaries, bonuses, stock-based compensation, and recruiting expenses. To a lesser extent, the increase in research and development expenses was due to facility and equipment related expenses of $0.5 million, and other unallocated research and development expenses of $1.5 million.

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General and Administrative Expenses

General and administrative expenses were $28.1 million and $8.3 million for the years ended December 31, 2021 and 2020, respectively. The increase of $19.7 million was due primarily to an increase of $13.5 million in personnel-related expenses due to increased headcount during the year ended December 31, 2021, including executives that were new in 2020 being present for a full year in 2021, as well as increases in salaries, bonuses, stock-based compensation, and recruiting expenses. To a lesser extent, the increase in general and administrative expenses was due to an increase in professional fees of $5.4 million primarily attributable to legal, insurance, and outside consultant costs, and $0.8 million in other various general and administrative expenses as we operated as a public company for the full year of 2021.

Interest Income (Expense), Net

Interest income (expense), net was $0.1 million and $(29,000) for the years ended December 31, 2021 and 2020, respectively. The change of $0.1 million was primarily due to a decrease in principal on our notes payable and an increase in our cash balance. Also contributing to the change was the investment in higher interest-bearing assets during the period.

Liquidity and Capital Resources

We have incurred net losses and negative cash flows from operations since our inception and anticipate we will continue to incur net losses for the foreseeable future. Since our inception, we have funded our operations almost exclusively with proceeds from the sale and issuance of shares of our redeemable convertible preferred stock and common stock, and debt financings. We will need to raise substantial additional capital in the future.

As of December 31, 2021, we had $319.1 million in cash, cash equivalents, restricted cash, and investments. The following table sets forth a summary of the net cash flow activity for the years ended December 31, 2021 and 2020:

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2021","","","2020"],["","","(in thousands)"],["Net cash (used in) provided by:"],["Operating activities","","$","(66,760",")","","$","(31,196",")"],["Investing activities","","","(66,478",")","","","(917",")"],["Financing activities","","","614","","","","408,506"],["Net increase (decrease) in cash, cash equivalents, and restricted cash","","$","(132,624",")","","$","376,393"]]
[[/GREPCENT_TABLE]]

Operating Activities

During the year ended December 31, 2021, net cash used in operating activities was $66.8 million. This consisted primarily of a net loss of $89.5 million, partially offset by non-cash charges of $21.2 million and a decrease in our operating assets and liabilities of $1.5 million. The non-cash charges primarily consisted of stock-based compensation expense of $19.2 million, non-cash lease expense of $1.2 million, and depreciation expense of $0.8 million. The decrease in our operating assets and liabilities was primarily due to an increase in accounts payable and accrued expenses of $6.0 million. The decrease was partially offset by a decrease in lease liability of $1.1 million and an increase in prepaid expenses and other assets of $3.4 million.

During the year ended December 31, 2020, net cash used in operating activities was $31.2 million. This consisted primarily of a net loss of $32.9 million and an increase in our operating assets and liabilities of $2.6 million, partially offset by charges of $4.4 million. The charges primarily consisted of stock-based compensation expense of $2.6 million, lease expense of $1.1 million, and depreciation expense of $0.6 million. The increase in our operating assets and liabilities was primarily due to an increase in prepaid expenses and other assets of $3.5 million and a decrease in our lease liability of $0.9 million, partially offset by an increase in accounts payable and accrued expenses of $1.8 million after adjusting for items. The increase in prepaid expenses and other assets was primarily due to the purchase of $2.6 million in prepaid insurance.

Investing Activities

During the year ended December 31, 2021, cash used in investing activities was $66.5 million. This consisted of purchases of U.S. Treasury Securities of $65.1 million and purchases of property and equipment of $1.4 million.

During the year ended December 31, 2020, cash used in investing activities was $0.9 million due to purchases of property and equipment.

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Financing Activities

During the year ended December 31, 2021, cash provided by financing activities was $0.6 million. This was primarily driven by proceeds from the exercise of common stock options and the employee stock purchase plan of $1.5 million, which was partially offset by $0.8 million of principal payments on the term loan payable.

During the year ended December 31, 2020, cash provided by financing activities was $408.5 million. This consisted primarily of net proceeds received from the issuance of our common stock in connection with our initial public offering of $255.7 million, net proceeds received from the issuance of shares of our redeemable convertible preferred stock of $153.4 million, and proceeds from the exercise of common stock options of $0.2 million, which were partially offset by principal payments on the term loan payable of $0.7 million.

Future Funding Requirements

We believe that our cash, cash equivalents, restricted cash, and investments of $319.1 million at December 31, 2021 will be sufficient to fund our operating expenses and capital expenditure requirements into the second half of 2026 following the Restructuring Plan. 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. We have based this estimate on assumptions that may prove to be wrong, and we could deplete our capital resources sooner than we expect. Additionally, the process of testing product candidates in clinical trials is costly, and the timing of progress and expenses in these trials is uncertain.

Our future capital requirements will depend on many factors, including:

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the initiation, trial design, progress, timing, costs and results of drug discovery, preclinical studies and clinical trials of our product candidates, and in particular future clinical trials for SBT8230;

•
the number and characteristics of product candidates that we pursue;

•
the outcome, timing and costs of seeking FDA, EMA and any other regulatory approvals;

•
the costs of manufacturing our product candidates and commercial manufacturing activities;

•
the costs associated with hiring additional personnel and consultants as our preclinical, manufacturing and clinical activities increase;

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the receipt of marketing approval and revenue received from any commercial sales of any of our product candidates, if approved;

•
the cost of commercialization activities for any of our product candidates, if approved, including marketing, sales and distribution costs;

•
the emergence of competing therapies and other adverse market developments;

•
the ability to establish and maintain strategic collaboration, licensing or other arrangements and the financial terms of such agreements;

•
the extent to which we in-license or acquire other products and technologies;

•
the amount and timing of any payments we may be required to make pursuant to our current or future license agreements;

•
the costs involved in preparing, filing, prosecuting, maintaining, expanding, defending and enforcing patent claims, including litigation costs and the outcome of such litigation;

•
our need and ability to retain key management and hire scientific, technical, business, and medical personnel;

•
our implementation of additional internal systems and infrastructure, including operational, financial and management information systems;

•
our costs associated with expanding our facilities or building out our laboratory space;

•
the effects of the recent disruptions to and volatility in the credit and financial markets in the United States and worldwide from the COVID-19 pandemic; and

•
the costs of operating as a public company.

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Until such time, if ever, as we can generate substantial product revenues to support our cost structure, we expect to finance our cash needs through equity offerings, debt financings or other capital sources, including potential collaborations, licenses or other similar arrangements. 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 equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, or declaring dividends. If we raise funds through strategic collaborations or other similar arrangements with third parties, we may have to relinquish valuable rights to our platform technology, future revenue streams, research programs or product candidates or may have to grant licenses on terms that may not be favorable to us and/or may reduce the value of our common stock. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts. Our ability to raise additional funds may be adversely impacted by potential worsening global economic conditions and disruptions to and volatility in the credit and financial markets in the United States and worldwide resulting from the ongoing COVID-19 pandemic or otherwise. Because of the numerous risks and uncertainties associated with product development, we cannot predict the timing or amount of increased expenses and cannot assure you that we will ever be profitable or generate positive cash flow from operating activities.

Material Cash Requirements

Our material cash requirements include the following contractual and other obligations as of December 31, 2021:

[[GREPCENT_TABLE]]
[["","","Payments Due by Period"],["","","Total","","","Less than 1 year","","","1-3 Years","","","3-5 Years","","","More than 5 years"],["Operating lease obligations (1)","","$","6,917","","","$","1,481","","","$","4,250","","","$","1,186","","","$","\u2014"],["Total","","$","6,917","","","$","1,481","","","$","4,250","","","$","1,186","","","$","\u2014"]]
[[/GREPCENT_TABLE]]

(1)
Refer to Note 6 to our financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Under our license agreements, we have payment obligations that are contingent upon future events such as our achievement of specified development, regulatory and commercial milestones and are required to make royalty payments in connection with the sales of products developed under those agreements. As of December 31, 2021 and 2020, we were unable to estimate the timing or likelihood of achieving the milestones or making future product sales and, therefore, any related payments are not included in the table above. For additional details regarding these agreements, see Part I, Item 1 of this Annual Report on Form 10-K under the section titled “License Agreement”.

In October 2019, we entered into a cell line license agreement with WuXi Biologics (Hong Kong) Limited (WuXi Bio), pursuant to which we received a non-exclusive, worldwide, sublicensable license under certain of WuXi Bio’s intellectual property rights, know-how and biological materials (the WuXi Bio Licensed Technology) to make, use, sell, offer for sale and import developed through the use of the WuXi Bio Licensed Technology (the WuXi Bio Licensed Product). In consideration for the license, we paid a license fee of $100,000 to WuXi Bio which was recorded in research and development expense in 2019. In 2020 we incurred an additional license fee of $50,000 to WuXi Bio which was recorded in research and development expense in 2020.

Additionally, if we do not engage WuXi Bio to manufacture the WuXi Bio Licensed Products for our clinical and commercial supplies, we are required to make aggregate milestone payments of up to $10.8 million to WuXi Bio upon the achievement of certain sales milestones. To date, other than the license fee, no payments have been made under this agreement.

We enter into contracts in the normal course of business with vendors for clinical studies, preclinical studies, research supplies and other services and products for operating purposes. These contracts generally provide for termination after a notice period, and, therefore, are cancelable contracts and not included in the table above.

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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 U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses, stock-based compensation, and valuation allowances for deferred tax assets. We base our estimates on historical experience, known trends and events, and various other factors that are 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 that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are more fully described in Note 2 to our audited financial statements appearing in Part II, Item 8 of this Annual Report on Form-10-K. Not all of our significant accounting policies require that we make estimates and assumptions that we believe are critical accounting estimates. Our estimates relating to research and development expenses, stock-based compensation, and income taxes have had or are reasonably likely to have a material impact on our financial statements and we consider them to be our critical accounting policies and critical accounting estimates.

Research and Development Expenses

All research and development costs are expensed in the period incurred. Advance payments, including nonrefundable amounts, for goods or services that will be used or rendered for future research and development activities are capitalized until such goods are delivered or the related services are performed, or such time when we do not expect the goods to be delivered or services to be performed. We estimate the period over which such services will be performed and the level of effort to be expended in each period. If actual timing of performance or the level of effort varies from the estimate, we will adjust the amounts recorded accordingly. We have not experienced any material differences between accrued or prepaid costs and actual costs since our inception.

Stock-Based Compensation

We recognize stock-based compensation expense for stock options on a straight-line basis over the requisite service period and account for forfeitures as a reduction of stock-based compensation expense as they occur. Our stock-based compensation costs are based upon the grant date fair value of options estimated using the Black-Scholes option pricing model. The Black-Scholes option pricing model utilizes inputs which are highly subjective assumptions and generally require significant judgment. These assumptions include:

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Fair Value of Common Stock. For all periods prior to our initial public offering, the fair value of the shares of common stock underlying our share-based awards was estimated on each grant date by our board of directors. To determine the fair value of our common stock underlying option grants, our board of directors considered, among other things, input from management, valuations of our common stock prepared by unrelated third-party valuation firms in accordance with the guidance provided by the American Institute of Certified Public Accountants 2013 Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (the Practice Aid). Following the closing of our initial public offering, the fair market value of our common stock is based on its closing price as reported on the primary stock exchange on which our common stock is traded.

•
Expected Term. The expected term represents the period that the options granted are expected to be outstanding. The expected term of stock options issued is determined using the simplified method (based on the mid-point between the vesting date and the end of the contractual term) as we have concluded that our stock option exercise history does not provide a reasonable basis upon which to estimate expected term.

•
Expected Volatility. Given our limited historical stock price volatility data, we derived the expected volatility from the average historical volatilities over a period approximately equal to the expected term of comparable publicly traded companies within our peer group that were deemed to be representative of future stock price trends as we have limited trading history for our common stock. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available.

•
Risk-Free Interest Rate. The risk-free interest rate is based on the U.S. Treasury zero-coupon issues in effect at the time of grant for periods corresponding with the expected term of the options.

•
Expected Dividend Yield. We have never paid dividends on our common stock and do not anticipate paying any dividends in the foreseeable future. Therefore, we used an expected dividend yield of zero.

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Income Taxes

We recognize deferred income taxes for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. In evaluating our valuation allowance, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance. Due to our lack of earnings history and uncertainties surrounding our ability to generate future taxable income, the net deferred tax assets have been fully offset by a valuation allowance.

As of December 31, 2021, we had net operating loss carryforwards for income tax purposes of approximately $160.3 million. If not used, $18.2 million of this carryforward will begin to expire in 2036 and $142.1 million has no expiration. We also have research and development tax credits of approximately $2.7 million which will begin to expire in 2037 if left unused.

Under Sections 382 and 383 of the Code, substantial changes in our ownership may limit the amount of NOL and research and development credit carryforwards that could be used annually in the future to offset taxable income. The tax benefits related to future utilization of federal and state NOL carryforwards, credit carryforwards, and other deferred tax assets may be limited or lost if cumulative changes in ownership exceeds 50% within any three-year period. We have not completed a Section 382/383 analysis under the Code regarding the limitation of NOL and credit carryforwards. If a change in ownership were to have occurred, the annual limitation may result in the expiration of NOL carryforwards and credits before utilization.

As of December 31, 2021, we did not have any liabilities for unrecognized income tax benefits associated with uncertain tax positions, including any interest and penalties.

Recent Accounting Pronouncements

See Note 2 to our audited financial statements appearing in Part II, Item 8 of this Annual Report on Form 10-K for additional information.

Emerging Growth Company Status

We are an emerging growth company, as defined in the JOBS Act. For so long as we remain an emerging growth company, we are permitted and intend to rely on certain exemptions from various public company reporting requirements, including not being required to have our internal control over financial reporting audited by our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and any golden parachute payments not previously approved.

Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have elected to use this extended transition period for complying with certain new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.

We will remain an emerging growth company until the earliest to occur of: (i) the last day of the fiscal year in which we have at least $1.07 billion in annual revenue; (ii) the date upon which we are deemed to be a “large accelerated filer,” as defined in Rule 12b-2 under the Exchange Act; (iii) the date on which we have issued more than $1.0 billion in nonconvertible debt securities during the prior three-year period; and (iv) December 31, 2025.