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 consolidated 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 titled “Special Note Regarding 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 biotechnology company focused on developing novel therapies for neuronal excitability disorders to address unmet needs in psychiatry, epilepsy, chronic pain, and other disorders of the peripheral and central nervous systems. These disorders often occur when neurons are overly excited or inhibited, leading to an imbalance, and our focus is on restoring homeostasis. We are developing clinically differentiated product candidates focused on validated mechanisms of action with broad therapeutic potential to deliver improved therapeutics for patients with these disorders.
Our lead program is ETX-123, a Kv7.2/3 potassium channel opener. Kv7.2/3 has been clinically validated as a therapeutic target for both epilepsy and pain, with further encouraging clinical data in depression. The first generation Kv7 channel opener, ezogabine (Potiga), was approved for refractory focal onset seizures in 2011 in both the United States and in Europe (where it was known as retigabine, or Trobalt). Flupirtine (Katadolon) was another first generation Kv7.2/3 opener that provided clinical validation and was used in Europe as a treatment for acute pain. These molecules showed clinical efficacy but subsequently had to be withdrawn from the market due to safety issues. Our ETX-123 lead candidate is an NCE designed to harness the efficacy of the Kv7.2/3 channel mechanism while attempting to improve the safety and tolerability relative to earlier molecules, based on our insights into the mechanisms of toxicity and the potency and selectivity profile. We have initiated IND-enabling studies for ETX-123 and plan to initiate Phase 1 studies in the first half of 2024. In addition, we are pursuing further preclinical exploration of several compounds from the same chemical series.
We have incurred significant operating losses since inception, as we have devoted substantially all of our resources to organizing and staffing our company, identifying potential product candidates, business planning, raising capital, undertaking research, executing preclinical studies and clinical development trials, and providing general and administrative support for business activities. We incurred net losses of $45.2 million and $47.5 million for the years ended December 31, 2022 and 2021, respectively. We had an accumulated deficit of $120.9 million and $75.6 million as of December 31, 2022 and December 31, 2021, respectively.
Since our inception, we have funded our operations with an aggregate of $208.3 million in net proceeds from the sale and issuance of shares of our redeemable convertible preferred stock and our initial public offering of our common stock. We had cash, cash equivalents and marketable securities of $123.6 million and $161.4 million as of December 31, 2022 and December 31, 2021, respectively. Based on our current operating plan, we estimate that our cash, cash equivalents and marketable securities will be sufficient to fund our operating expenses and capital expenditure requirements into 2027. 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.
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We expect to continue to incur substantial expenses and operating losses over the foreseeable future, largely driven by our ongoing activities as we:
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initiate and continue research and development, including preclinical, clinical and discovery efforts for ETX-123 and any future product candidates;
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hire and retain additional personnel, such as clinical, manufacturing, quality control, scientific, commercial and administrative personnel;
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maintain, expand and protect our intellectual property portfolio;
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establish sales, marketing, distribution, manufacturing, supply chain and other commercial infrastructure in the future to commercialize various products for which we may obtain regulatory approval; and
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add equipment and physical infrastructure to support our research and development and personnel; acquire or in-license other product candidates and technologies.
We do not have any products approved for sale and have not generated any revenue from product sales since our inception. Our ability to generate product revenue will depend on the successful development, regulatory approval and eventual commercialization of one or more of our product candidates, if approved. We cannot assure you that we will ever be profitable or generate positive cash flow from operating activities.
We will require substantial additional funding to support our continuing operations and further the development of our product candidates. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through the sale of equity, debt financings or other capital sources, which could include income from collaborations, strategic partnerships or other strategic arrangements. To a lesser extent, we also expect to continue to rely on U.K. research and development tax credits and incentives for funding. Adequate funding may not be available when needed or on terms acceptable to us, or at all. If we are unable to raise additional capital as needed, we may have to significantly delay, scale back or discontinue development of our product candidates. Our ability to raise additional funds may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, the credit and financial markets in the United States and worldwide, resulting from increased volatility in the trading prices for shares in the biopharmaceutical industry, the ongoing pandemic, or otherwise. In addition, our ability to continue to benefit from research and development tax credits and incentives will depend on our ability to continue meet the applicable requirements for them. If we fail to obtain necessary capital when needed on acceptable terms, or at all, it could force us to delay, limit, reduce or terminate our product development programs, commercialization efforts or other operations. Insufficient liquidity may also require us to relinquish rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose.
2023 Restructuring
On February 7, 2023, our board of directors approved a restructuring plan to conserve financial resources and better align our workforce with current business needs, as a result of the decision to pause development of ETX-155 and focus on our preclinical Kv7.2/3 program. As part of the Restructuring Plan, we will reduce our workforce by approximately 55% in the first half of 2023.
We estimate that we will incur approximately $17.1 million in charges in connection with the Restructuring Plan, which will be substantially incurred in 2023. These charges primarily relate to employee transition, severance payments, employee benefits, and stock-based compensation. Of the aggregate amount of charges that we estimate we will incur in connection with the Restructuring Plan, we expect that approximately $7.3 million will be in future cash expenditures. The actions associated with the Restructuring Plan are expected to be substantially complete by the third quarter of 2023, subject to local law and consultation requirements.
Components of Operating Results
Operating Expenses
Our operating expenses consist of (i) research and development expenses and (ii) general and administrative expenses.
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Research and Development
Our research and development expenses consist primarily of direct and indirect costs incurred in connection with our discovery efforts, preclinical studies, and clinical trial activities related to our pipeline, including our lead product candidate ETX-123, our recently paused product candidate ETX-155 and our discontinued product candidate ETX-810.
Our direct research and development costs include:
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expenses incurred in connection with research, laboratory consumables and preclinical and clinical trial activities;
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the cost to manufacture drug products for use in our preclinical studies and clinical trials; and
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consulting fees
Our indirect research and development costs include:
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personnel-related expenses such as salaries, bonuses, benefits, and stock-based compensation expense, for our scientific personnel performing research and development activities; and
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facility rent.
Total direct costs and indirect costs are as follows (in thousands):
Year Ended
December 31,
Research and development tax credits (6,683 ) (6,596 )
Total research and development expenses $ 26,214 $ 23,322
We expense research and development costs as incurred. Non-refundable 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. We categorize costs by stage of development clinical or preclinical. Given our stage of development and the utilization of our resources across our various programs, we have not historically tracked our research and development costs by program. Research and development expenses are presented net of reimbursement received for refundable research and development tax credits from the U.K. government.
Research and development costs by stage of development are as follows (in thousands):
Year Ended
December 31,
Research and development tax credits (6,683 ) (6,596 )
Total research and development expenses $ 26,214 $ 23,322
Research and development activities are central to our business model. We expect to continue to incur substantial research and development expenses for the foreseeable future as we advance our current and future product candidates. Our research and development expenses may vary significantly based on factors such as:
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the number and scope of preclinical and IND-enabling studies;
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the number and scope of clinical studies needed for regulatory approval;
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the phases of development of our product candidates;
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the progress and results of our research and development activities;
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the length of time required to enroll eligible subjects and initiate clinical trials;
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the number of subjects that participate in the clinical trials;
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•
potential additional safety monitoring requested by regulatory agencies;
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the duration of subject participation in the trials and follow-up;
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the cost and timing of manufacturing of our product candidates;
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the timing, receipt and terms of any marketing approvals from applicable regulatory authorities;
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the hiring and retention of research and development personnel;
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the degree to which we obtain, maintain, defend and enforce our intellectual property rights; and
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the extent to which we establish collaborations, strategic partnerships or other strategic arrangements and the performance of any related third parties.
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.
General and Administrative
Our general and administrative expenses consist primarily of personnel-related expenses such as salaries, bonuses, benefits, and stock-based compensation, for our personnel in executive, finance and accounting, human resources, business development and other administrative functions. Other significant general and administrative expenses include legal fees relating to intellectual property and corporate matters, professional fees for accounting, audit, regulatory, tax and consulting services, insurance costs, as well as investor and public relations costs.
We expect to continue to incur substantial general and administrative expenses for the foreseeable future 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.
Other Income (Expense)
Change in Fair Value of Redeemable Convertible Preferred Tranche Liability
Our redeemable convertible preferred stock tranche lability was accounted for at fair value at inception, with changes in the fair value recorded in earnings at each reporting period through settlement. Refer to Note 6 of the consolidated financial statements.
Foreign Currency Loss
Our foreign currency loss consists of foreign exchange losses resulting from remeasurement and foreign currency transactions between the British Pound and the U.S. Dollar.
Interest Income, net
Our interest income consists of interest earned on our cash, cash equivalents and short-term investments and adjustments related to amortization of purchase premiums and accretion of discounts of short-term investments.
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Results of Operations
The following table summarizes our results of operations for the years ended December 31, 2022 and 2021 (dollars in thousands):
Year EndedDecember 31, Change
Operating expenses:
Other income (expense):
* - % Not meaningful
Comparison of the Years Ended December 31, 2022 and December 31, 2021
Operating Expenses
Research and Development
Research and development expenses increased 12.4% from $23.3 million for the year ended December 31, 2021 to $26.2 million for the year ended December 31, 2022.
This increase was driven by a $3.6 million increase in personnel-related expenses from increased headcount and stock-based compensation. This increase was partially offset by (i) a $0.6 million decrease in clinical and preclinical expenses, primarily due to the discontinuation of ETX-810 in August 2022, and the postponement of initiating a Phase 2a clinical trials of ETX-155 and (ii) a $0.1 million increase in the refundable research and development tax credits from the U.K. generated due to the overall increase in research and development expenses.
General and Administrative
General and administrative expenses increased 53.2% from $12.4 million for the year ended December 31, 2021 to $18.9 million for the year ended December 31, 2022. The increase is primarily due to a $3.5 million increase in personnel-related expenses from increased headcount and stock-based compensation, a $2.1 million increase in other general and administrative costs that primarily included consulting and legal fees, and a $1.0 million increase in insurance costs.
Other Income (Expense)
Change in Fair Value of Redeemable Convertible Preferred Tranche Liability
For the year ended December 31, 2021, we recognized an $11.7 million charge from the remeasurement of our Series A-1 preferred stock tranche liability immediately prior to settlement.
Foreign Currency Loss
Foreign currency loss increased from a $0.2 million loss for the year ended December 31, 2021 to a $1.5 million loss for the year ended December 31, 2022. The increase was driven by unfavorable changes in foreign currency exchange rates between the British Pound and the U.S. Dollar that were more significant in the current period. These changes affect the remeasurement of our British Pound denominated monetary assets and liabilities, primarily our recoverable research and development tax credits.
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Interest Income, net
Interest income, net increased from $0.1 million for the year ended December 31, 2021 to $1.4 million for the year ended December 31, 2022, which was driven by an increase in investment income. The increase was due to higher rates of return on our investments as a result of rising interest rates in the current period.
Liquidity and Capital Resources
Sources of Liquidity
We primarily generate cash and cash equivalents from the sale of our equity securities, including common stock and redeemable convertible preferred stock, and to a lesser extent from cash received pursuant to U.K. research and development tax credits and incentives. From our inception to December 31, 2022, we raised aggregate proceeds of $208.3 million from the issuance of shares of our redeemable convertible preferred stock and from our initial public offering of our common stock. We have not generated any revenue from product sales or otherwise. We have incurred net losses from operations since our inception and anticipate we will continue to incur net losses for the foreseeable future. As of December 31, 2022 and December 31, 2021, we had cash, cash equivalents and marketable securities of $123.6 million and $161.4 million and an accumulated deficit of $120.9 million and $75.6 million, respectively.
Funding Requirements
We have experienced recurring net losses since inception. Our transition to profitability is dependent upon the successful development, approval and commercialization of our product candidates and achieving a level of revenue adequate to support our cost structure. We do not expect to achieve such revenue and expect to continue to incur losses for the foreseeable future. We believe our cash, cash equivalents and marketable securities of $123.6 million as of December 31, 2022 will be sufficient to meet our working capital and capital expenditure needs for at least the next twelve months.
We expect to continue to incur substantial research and development expenses for the foreseeable future as we advance our current and future product candidates. As a result, we will need significant additional capital to fund our operations, which we may obtain through one or more equity offerings, debt financings or other third-party funding, including potential strategic alliances and licensing or collaboration arrangements. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates, we are unable to estimate the amount of increased capital we will need to raise to support our operations and the outlays and operating expenditures necessary to complete the development of our product candidates and build additional manufacturing capacity, and we may use our available capital resources sooner than we currently expect.
Our future capital requirements will depend on many factors, including:
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the progress of our current and future product candidates through preclinical and clinical development;
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potential delays in our preclinical studies and clinical trials, whether current or planned, or other factors;
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continuing our research and discovery activities;
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initiating and conducting additional preclinical, clinical, or other studies for our product candidates;
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changing or adding additional contract manufacturers or suppliers;
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seeking regulatory approvals and marketing authorizations for our product candidates;
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establishing sales, marketing, and distribution infrastructure to commercialize any products for which we obtain approval;
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acquiring or in-licensing product candidates, intellectual property and technologies;
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making milestone, royalty, or other payments due under any current or future collaboration or license agreements;
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obtaining, maintaining, expanding, protecting, and enforcing our intellectual property portfolio;
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attracting, hiring and retaining qualified personnel;
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potential delays or other issues related to our operations;
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meeting the requirements and demands of being a public company;
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defending against any product liability claims or other lawsuits related to our products; and
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the impact of the ongoing COVID-19 pandemic, which may exacerbate the magnitude of the factors discussed above.
We believe that our existing cash, cash equivalents and marketable securities will enable us to fund our operating expenses and capital expenditure requirements into 2027. We have based our estimates as to how long we expect we will be able to fund our operations on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect, in which case, we would be required to obtain additional financing sooner than currently projected, which may not be available to us on acceptable terms, or at all. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategy.
We will need substantial additional funding to support our continuing operations and pursue our development strategy. Until such time as we can generate significant revenue from sales of our product candidates, if ever, we expect to finance our operations through the sale of equity, debt financings or other capital sources, including potential collaborations with other companies or other strategic transactions. Adequate funding may not be available to us on acceptable terms, or at all. If we are unable to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back, or discontinue the development and commercialization of our product candidates or delay our efforts to expand our product pipeline. We may also be required to sell or license to other parties’ rights to develop or commercialize our product candidates that we would prefer to retain.
Cash Flows
The following table summarized our cash flows (in thousands):
Year Ended'December 31,
Net cash used in operating activities $ (37,369 ) $ (36,072 )
Net cash provided by (used in) investing activities 34,440 (114,970 )
Net cash provided by financing activities — 177,232
Operating activities
In 2022, net cash used in operating activities was $37.4 million. This consisted primarily of net loss of $45.2 million, which was partially offset by non-cash charges of $7.6 million that primarily relate to stock-based compensation of $7.0 million, and changes in our operating assets and liabilities that resulted in a net increase in cash of $0.2 million, primarily related to research and development activities.
In 2021, net cash used in operating activities was $36.1 million. This consisted primarily of net loss of $47.5 million and changes in our operating assets and liabilities that resulted in a net decrease in cash of $4.2 million, primarily related to research and development activities, which was partially offset by the non-cash charges for changes in the fair value of the redeemable convertible preferred stock tranche liability of $11.7 million and stock-based compensation of $3.7 million.
Investing activities
In 2022, net cash provided by investing activities was $34.4 million. This consisted of $122.4 million of proceeds received from maturities of investments in marketable securities, partially offset by purchases of $88.0 million of investments in marketable securities.
In 2021, net cash used in investing activities was $115.0 million. This consisted of purchases of investments in U.S. government debt securities, commercial paper, and corporate bonds.
Financing activities
In 2021, net cash provided by financing activities was $177.2 million, primarily attributable to the proceeds, net of issuance costs, from the issuance of our Series A-1 and Series B redeemable convertible preferred stock, and the issuance of our common stock in our initial public offering.
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Contractual Commitments and Obligations
In the normal course of business, we enter into contracts with contract research organizations (CROs), contract development and manufacturing organizations (CDMOs), and other third parties for preclinical studies and clinical trials, research and development supplies, and other testing and manufacturing services. These contracts do not contain material minimum purchase commitments and generally provide us the option to cancel, reschedule and adjust our requirements based on our business needs, prior to the delivery of goods or performance of services. However, it is not possible to predict the maximum potential amount of future payments under these agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each agreement.
We lease various operating spaces in the U.S. and the U.K. under non-cancelable operating lease arrangements that expire on various dates through January 31, 2025. As of December 31, 2022, our undiscounted future minimum lease payments under non-cancelable lease agreements was approximately $0.5 million.
Off Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of December 31, 2022 and December 31, 2021.
Critical Accounting Policies and Estimates
A summary of the significant accounting policies is provided in Note 2 to our consolidated financial statements.
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management considers an accounting estimate to be critical if:
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it requires a significant level of estimation uncertainty; and
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changes in the estimate are reasonably likely to have a material effect on our financial condition or results of operations.
We believe the following critical accounting policies and estimates describe the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Stock-Based Compensation
We measure our stock-based awards granted to employees, non-employee directors, consultants and independent advisors based on the estimated grant-date fair value of the awards. We use the Black-Scholes option pricing model to estimate the fair value of our stock option awards. The Black-Scholes option pricing model requires us to make assumptions and judgements about the variables used in the calculation, including the fair value of common stock, expected term, expected volatility of our common stock, risk-free interest rate and expected dividend yield. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation is recognized. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation recognized in future periods could be materially different.
Refer to Note 2 and 8 to our consolidated financial statements for further details regarding the development and evaluation of the assumptions used to estimate the fair value of our stock-based awards, and the related effect of stock-based compensation expense on the consolidated financial statements.
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Fair Value of Common Stock
Following the closing of our IPO, the fair market value of our common stock is based on its closing price as reported on the date of grant on the Nasdaq Global Market, on which our common stock is traded. Prior to our IPO, because there was no public market for our common stock, the estimated fair value of our common stock was determined by the board of directors as of the date of each option grant with input from management, considering the most recently available third-party valuation of common stock, and the board of directors’ assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent valuation through the date of the grant.
The assumptions underlying these valuations represented management’s best estimates which involved inherent uncertainties. As a result, if we had used significantly different assumptions or estimates, the fair value of our common stock and stock-based compensation expense could have been materially different.
Refer to Note 2 to our consolidated financial statements for further details regarding the factors considered and valuation approaches utilized in determining the best estimate of fair value of our common stock prior to our IPO.
Redeemable Convertible Preferred Stock Tranche Liability
Our Series A-1 redeemable convertible preferred stock included an obligation whereby the investors agreed to buy, and the Company agreed to sell, additional shares at a fixed price if certain agreed upon milestones were achieved (Series A-1 Tranche Rights). This redeemable convertible preferred stock tranche liability was determined to be a freestanding financial instrument that should be accounted for as a liability at fair value and was revalued at each reporting period until settlement, with changes in the fair value recorded as a change in redeemable convertible preferred stock tranche liability in the consolidated statements of operations and comprehensive loss. Upon the closing of the redeemable convertible preferred stock, the redeemable convertible preferred stock purchase rights liability was extinguished, and the mark-to-market fair value of the liability was included in the carrying value of the redeemable convertible preferred stock issued.
We estimated the fair value of the Series A-1 redeemable convertible preferred stock tranche liability using a probability-weighted present value model that considered the probability of triggering the Series A-1 Tranche Rights through achievement of the clinical development milestones specified in the Series A-1 redeemable convertible preferred stock purchase agreement. Significant estimates and assumptions impacting the fair value measurement included the estimated fair value per share of the underlying Series A-1 redeemable convertible preferred stock, risk-free rate, expected dividend yield, time to liquidity, expected volatility of the price of the underlying redeemable convertible preferred stock and determining the type of option (call option and/or forward contract) and associated probabilities. The most significant assumptions impacting the fair value of the redeemable convertible preferred stock tranche feature included the estimated fair value of our Series A-1 redeemable convertible preferred stock, estimated time to achieve the tranche milestone, and the determination of the type of option (call option and/or forward contract) and associated probability of success of completing the milestone.
We determined the estimated fair value per share of the underlying redeemable convertible preferred stock by taking into consideration the most recent sales of our redeemable convertible preferred stock as well as additional factors that we deemed relevant. We assessed these assumptions and estimates on a quarterly basis as additional information impacting the assumptions became available. The risk-free rate was determined by reference to the U.S. Treasury yield curve for time periods approximately equal to the expected term of the preferred stock tranche feature. We estimated a 0% dividend yield based on the expected dividend yield and the fact that we have never paid or declared dividends. We estimated the time to liquidity by weighting potential timelines associated with reaching various pipeline milestones. We historically have been a private company and lack company-specific historical and implied volatility information of our stock. Therefore, we estimated our expected stock volatility based on the historical volatility of a representative group of public companies in the biotechnology industry for the expected terms. The determination of the type of option is based on the payouts available to the holders of the Series A-1 Tranche Rights and the level of control the investors had over exercising these rights.
These estimates involved inherent uncertainties and the application of significant judgment. As a result, if factors or expected outcomes changed and we used significantly different assumptions or estimates, our redeemable convertible preferred stock tranche liability could have been materially different.
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Internal Controls over Financial Reporting
In connection with the preparation of our consolidated financial statements for the year ended December 31, 2020, we identified material weaknesses in our internal control over financial reporting, two of which remain unremediated as of December 31, 2022. The material weaknesses, and our remediation plan, are disclosed in Item 9A of this Annual Report on Form 10-K.
Emerging Growth Company Status
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (JOBS Act). 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. Other exemptions and reduced reporting requirements under the JOBS Act for emerging growth companies include presentation of only two years audited consolidated financial statements in a registration statement for an initial public offering, an exemption from the requirement to provide an auditor’s report on internal controls over financial reporting pursuant to the Sarbanes-Oxley Act, an exemption from any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation, and less extensive disclosure about our executive compensation arrangements. We have elected to use the 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 that (i) we are no longer an emerging growth company or (ii) we 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 the new or revised accounting pronouncements as of public company effective dates. We will remain an emerging growth company under the JOBS Act until the earliest of (i) the last day of our first fiscal year in which we have total annual gross revenue of $1.24 billion or more, (ii) the date on which we have issued more than $1.0 billion of non-convertible debt instruments during the previous three fiscal years, (iii) the date on which we are deemed a “large accelerated filer” under the rules of the SEC with at least $700.0 million of outstanding equity securities held by non-affiliates, or (iv) December 31, 2026.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
As a smaller reporting company, we are not required to provide the information requested by this item pursuant to Item 305(e) of Regulation S-K.
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Item 8. Financial Statements and Supplementary Data.
Page
Report of Independent Registered Public Accounting Firm (PCAOB ID 238) 84
Consolidated Balance Sheets 85
Consolidated Statements of Operations and Comprehensive Loss 86
Consolidated Statements of Cash Flows 88
Notes to Consolidated Financial Statements 89
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Eliem Therapeutics, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Eliem Therapeutics, Inc. and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations and comprehensive loss, of redeemable convertible preferred stock and stockholders’ equity (deficit) and of cash flows for the years then ended, including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Seattle, Washington
March 6, 2023
We have served as the Company’s auditor since 2021.
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Eliem Therapeutics, Inc.
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
As of December 31,
Assets
Prepaid expenses and other current assets 10,827 11,772
Operating lease right-of-use assets 471 —
Long-term marketable securities — 24,919
Other long-term assets 128 70
Liabilities and stockholders’ equity
Current liabilities:
Operating lease liabilities 300 —
Total current liabilities $ 6,097 $ 6,031
Other long-term liabilities — 7
Operating lease liabilities, net of current portion 180 —
Commitments and contingencies (Note 7)
Stockholders’ equity
Accumulated other comprehensive loss (358 ) (123 )
Total liabilities and stockholders’ equity $ 134,992 $ 173,241
The accompanying notes are an integral part of these consolidated financial statements.
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Eliem Therapeutics, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except share and per share amounts)
Year Ended December 31,
Operating expenses:
Other income (expense):
Foreign currency loss (1,484 ) (170 )
Total other income (expense) (109 ) (11,808 )
Net loss attributable to common stockholders $ (45,244 ) $ (52,028 )
Comprehensive loss:
Other comprehensive loss:
Unrealized loss on investments, net of tax of $0 (235 ) (123 )
The accompanying notes are an integral part of these consolidated financial statements.
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Eliem Therapeutics, Inc.
Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ (Deficit) Equity
(in thousands, except share and per share amounts)
Shares Amount Shares Amount Capital Loss Deficit Equity
Stock-based compensation — — — — 3,737 — 3,737
Other comprehensive loss — — — — — (123 ) — (123 )
Vesting of restricted stock awards — — 154,869 — — — — —
Stock-based compensation — — — — 6,991 — — 6,991
Other comprehensive loss — — — — — (235 ) — (235 )
The accompanying notes are an integral part of these consolidated financial statements.
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Eliem Therapeutics, Inc.
Consolidated Statements of Cash Flows
(in thousands)
As of December 31,
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash used in operating activities:
Non-cash operating lease expense 443 —
Foreign currency loss (gain) from remeasurement 408 (245 )
Changes in operating assets and liabilities:
Prepaid expenses and other assets 945 (10,260 )
Long-term liabilities — 7
Operating lease liabilities (447 ) —
Net cash used in operating activities $ (37,369 ) $ (36,072 )
Cash flows from investing activities:
Proceeds from maturities of marketable securities 122,403 —
Net cash provided by (used in) investing activities $ 34,440 $ (114,970 )
Cash flows from financing activities:
Proceeds from initial public offering, net of issuance costs — 83,144
Proceeds from exercise of stock options — 149
Net cash provided by financing activities $ — $ 177,232
Effect of exchange rate changes on cash (408 ) 245
Net change in cash and cash equivalents $ (3,337 ) $ 26,435
Cash and cash equivalents at beginning of period 46,922 20,487
Cash and cash equivalents at end of period $ 43,585 $ 46,922
Supplemental disclosure of cash flow information:
Cash paid for leases included in operating cash outflows $ 462 $ —
Supplemental disclosure of non-cash investing and financing activities:
Right-of-use assets obtained in exchange for lease liabilities $ 915 $ —
The accompanying notes are an integral part of these consolidated financial statements.
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ELIEM THERAPEUTICS, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Operations and Basis of Presentation
Organization
Eliem Therapeutics, Inc. (the Company) is a biotechnology company focused on developing novel therapies for neuronal excitability disorders to address unmet needs in psychiatry, epilepsy, chronic pain, and other disorders of the peripheral and central nervous systems. Headquartered in Redmond, Washington, the Company was incorporated on October 18, 2018 as a Delaware corporation.
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements of the Company and its wholly owned subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States (U.S. GAAP). All intercompany transactions and balances have been eliminated in consolidation.
Reverse Stock Split
In July 2021, the Company's board of directors approved an amendment to the Company's certificate of incorporation to effect a reverse split of shares of the Company's common stock on a 1-for-2 basis, which was effected on July 29, 2021 (the Reverse Stock Split). The number of authorized shares and the par values of the common stock were not adjusted as a result of the Reverse Stock Split. In connection with the Reverse Stock Split, the number of authorized shares, outstanding shares, and the conversion ratio for the Company's redeemable convertible preferred stock was proportionately adjusted such that the common stock issuable upon conversion of such preferred stock was decreased in proportion to the Reverse Stock Split. All references to common stock and options to purchase common stock share data, per share data, and related information contained in the consolidated financial statements have been retroactively adjusted to reflect the effect of the Reverse Stock Split for all periods presented.
Initial Public Offering
On August 12, 2021, the Company completed its initial public offering (IPO) of 7,360,000 shares of common stock, including the underwriters' full exercise of their over-allotment option at the IPO price of $12.50 per share. Gross proceeds from the IPO were $92.0 million, and the net proceeds were $83.1 million, after deducting underwriting discounts of $6.4 million and $2.5 million of offering costs payable by the Company. At the closing of the IPO, all of the Company's then outstanding redeemable convertible preferred stock was automatically converted into an aggregate of 15,345,279 shares of common stock. The related carrying value of the redeemable convertible preferred stock of $152.8 million was reclassified to common stock and additional paid-in capital.
Liquidity
Since inception, the Company has experienced recurring losses from operations and generated negative cash flows from operations. The Company has an accumulated deficit of $120.9 million and expects to incur additional losses from operations in the future. The Company estimates the available cash, cash equivalents and marketable securities of $123.6 million as of December 31, 2022 will be sufficient to meet its projected operating requirements for at least the next twelve months from the filing date of these consolidated financial statements.
The Company will need to obtain substantial additional funding to develop and commercialize the Company's clinical programs as currently contemplated. The Company expects to finance future cash needs through equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements and other marketing and distribution arrangements. In addition, the Company expects to continue to rely on capital markets, and to a lesser extent, U.K. research and development tax credits and incentives for funding. There are no assurances that the Company will be able to raise sufficient amounts of funding in the future on acceptable terms, or at all.
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Note 2. Summary of Significant Accounting Policies
A summary of the significant accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements follows:
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Estimates include those related to the accrual of research and development expenses, recoverable research and development tax credits, the valuation of stock-based awards, the valuation of common stock and redeemable convertible preferred stock, and the valuation of redeemable convertible preferred stock tranche liabilities. The Company evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors and adjusts those estimates and assumptions when facts and circumstances dictate. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and marketable securities. The Company’s cash is held by two financial institutions in the U.S. and two financial institutions in the U.K. The Company does not believe that it is subject to unusual credit risk beyond the normal credit risk associated with commercial banking relationships. The Company’s deposits held in the U.S. and U.K. may exceed the Federal Depository Insurance Corporation and Financial Services Compensation Scheme, respectively, insured limits. The Company has investments in money market funds, U.S. Treasury and government agency debt securities, commercial paper, and corporate bonds with high-quality accredited financial institutions.
Comprehensive Loss
Comprehensive loss consists of net loss and unrealized gains or losses on available-for-sale investments. The Company presents comprehensive loss and its components as part of the statements of operations and comprehensive loss.
Risks and Uncertainties
The Company is subject to risks and uncertainties common to early-stage companies in the biotechnology industry, including, but not limited to, development by competitors of new technological innovations, protection of proprietary technology, dependence on key personnel, reliance on single-source vendors and collaborators, availability of raw materials, patentability of the Company’s products and processes and clinical efficacy and safety of the Company’s products under development, compliance with government regulations and the need to obtain additional financing to fund operations. Product candidates currently under development will require significant additional research and development efforts, including extensive preclinical studies, clinical trials, and regulatory approval, prior to commercialization. These efforts will require significant amounts of additional capital, adequate personnel infrastructure and extensive compliance and reporting.
There can be no assurance that the Company’s research and development will be successfully completed, that adequate protection for the Company’s intellectual property will be obtained or maintained, that any products developed will obtain necessary government regulatory approval or that any approved products will be commercially viable. Even if the Company’s product development efforts are successful, it is uncertain when, if ever, the Company will generate revenue from product sales. The Company operates in an environment of rapid technological change and substantial competition from other pharmaceutical and biotechnology companies. In addition, the Company is dependent upon the services of its employees, consultants and other third parties.
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Segments
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker (the CODM). The Company’s CODM is its chief executive officer who reviews financial information together with certain operating metrics principally to make decisions about how to allocate resources and to measure the Company’s performance. Management has determined that the Company operates as a single operating and reportable segment. The Company’s CODM evaluates financial information on a consolidated basis. As the Company operates as one operating segment, all required segment financial information is found in the consolidated financial statements.
Fair Value Measurement
Assets and liabilities recorded at fair value on a recurring basis in the balance sheet are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The Company measures fair value based on a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:
Level 1—Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2—Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the assets or liabilities. These include quotedprices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
In determining fair value, the Company utilizes quoted market prices, or valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.
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There were no transfers into or out of Level 3 for any of the periods presented.
The Company’s fair value measurements as of December 31, 2022 and 2021 were as follows (in thousands):
Level 1 Level 2 Level 3 Balance
Assets:
Cash equivalents:
Marketable securities:
U.S. government agency debt securities — 3,361 — 3,361
Level 1 Level 2 Level 3 Balance
Assets:
Cash equivalents:
Marketable securities:
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less from the purchase date to be cash equivalents. As of December 31, 2022 and 2021, the Company's cash equivalents consisted of money market funds.
Investments in Marketable Securities
Marketable securities are classified as available-for-sale, primarily consisting of U.S. Treasury and government agency debt securities, commercial paper, and corporate bonds, and are reported at fair value. Unrealized holding gains and losses are reflected as a separate component of stockholders' equity in accumulated other comprehensive loss until realized. The cost of debt securities is adjusted for amortization of purchase premiums and accretion of discounts to maturity. Such amortization and accretion is included in interest income, net in the statements of operations and comprehensive loss. Realized gains and losses on the sale of these securities are recognized in interest income, net in the consolidated statement of operations and comprehensive loss. The cost of marketable securities sold is based on the specific identification method.
The Company periodically reviews its available-for-sale securities to assess for credit impairment. Some of the factors considered in assessing impairment include the extent to which the fair value is less than the amortized cost basis, adverse conditions related to the security, an industry or geographic area, changes to security rating or sector credit ratings, and other relevant market data.
Research and Development Expenses
Research and development expenses consist primarily of research and development services and, to a lesser extent, personnel-related expenses such as salaries, bonuses, benefits, and stock-based compensation, professional service fees, and other related costs such as facility rent, partially offset by fully refundable U.K. research and development tax credits.
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Research and development expenses include estimates of the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. Management estimates accrued expenses as of each balance sheet date in the consolidated financial statements based on facts and circumstances known at that time. Examples of estimated accrued research and development expenses include those related to fees paid to:
•
vendors in connection with preclinical development activities;
•
contract research organizations (CROs) in connection with preclinical studies and clinical trials; and
•
contract development and manufacturing organizations (CDMOs) in connection with the production of preclinical and clinical trial materials.
All research and development costs are expensed in the period incurred, based on the estimates of the services received and efforts expended considering a number of factors, including, progress towards completion of the research, development and manufacturing activities, invoicing to date under the contracts, communication from the CROs, CDMOs and other companies of any actual costs incurred during the period that have not yet been invoiced and the costs included in the contracts and purchase orders. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which advance payments are made or payments made to vendors will exceed the level of services provided and result in a prepayment of the expense.
Research and Development Tax Credits
The Company receives tax credits from the U.K. government based on claims made under the Small Medium Enterprises (SME) research and development tax relief program. Qualifying expenditures largely relate to research and development activities performed by third parties on our behalf, as well as employment costs for research staff and consumables incurred. The research and development tax credits are recognized when the qualifying expenditure has been incurred and there is reasonable assurance that the reimbursement will be received.
Each reporting period, the Company evaluates its eligibility for the SME program based on criteria established by HM Revenue and Customs (“HMRC”) and records a reduction to research and development expense for the amount of the credit estimated to be claimed based on qualifying expenses and information available at that time. The Company qualified for tax credits under the SME program for the year ended December 31, 2021 and expects to qualify for the year ending December 31, 2022.
The following table outlines the changes to the research and development tax credit receivable, including amount recognized as an offset to research and development expense, during the years ended December 31, 2022 and 2021:
Year Ended December 31,
Balance at beginning of period $ 6,523 $ 2,633
Receipt of credit claims (5,462 ) (2,377 )
Foreign currency loss (1,252 ) (329 )
As of December 31, 2022 and 2021, the tax credit receivable was $6.5 million and $6.5 million respectively, all of which is classified within the prepaid expenses and other current assets line item in the consolidated balance sheets.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel-related expenses such as salaries, bonuses, benefits, and stock-based compensation, for our personnel in executive, finance and accounting, human resources, business development 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, as well as investor and public relations costs. General and administrative costs are expensed as incurred.
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Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist primarily of receivables from refundable research and development tax credits from the U.K. government and operating expenses paid in advance.
Leases
The Company adopted ASU No. 2016-02, Leases (Topic 842) on January 1, 2022, as discussed below in the section titled “Recently Adopted Accounting Pronouncements”. Under Accounting Standards Codification (ASC) Topic 842, Leases, the Company determines if an arrangement is a lease at inception.
The Company leases office space in the U.S. and the U.K. under non-cancelable operating leases. Operating lease right-of-use (ROU) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized based on the present value of lease payments over the lease term at the commencement date of the lease. ROU assets also include any initial direct costs incurred and any lease payments made at or before the lease commencement date, less any lease incentive received. The Company uses the rate implicit in the lease in determining the present value of lease payments and, if that rate is not readily determinable, the Company uses its incremental borrowing rate commensurate with the lease term based on the information available at the date of lease commencement. The incremental borrowing rate reflects the rate of interest that a lessee would have to pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Short-term leases with an initial term of 12 months or less are not recorded on the balance sheet. The Company does not have material short-term lease costs. Lease expense for lease payments is recognized on a straight-line basis over the lease term. For real estate leases, the Company does not separate lease and non-lease components. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
The Company’s non-lease components are primarily related to property taxes, insurance, and common area maintenance, which vary based on future outcomes, and are recognized as rent expense when incurred.
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Accretion and Classification of Redeemable Convertible Preferred Stock
The holders of the Company’s redeemable convertible preferred stock had the option to redeem their shares beginning in October 2026. As a result, these shares were considered probable of becoming redeemable since the redemption option depends solely on the passage of time. The Company accreted changes in the redemption value over the period from the date of issuance to the earliest redemption date of October 2026. In October 2020, the Company amended the terms of its Certificate of Incorporation to remove the redemption option of their Series A and Series A-1 redeemable convertible preferred stock, which was accounted for as a modification, and the Company ceased accretion.
Upon completion of the IPO on August 12, 2021, all of the Company's then outstanding redeemable convertible preferred stock were converted on a 1-for-1 basis to shares of common stock. As of December 31, 2022 and 2021, the Company had no redeemable convertible preferred stock outstanding.
Redeemable Convertible Preferred Stock Tranche Liability
The Company’s Series A-1 redeemable convertible preferred stock included tranche rights that were determined to be freestanding financial instruments that should be accounted for as a liability at fair value (Note 6). This redeemable convertible preferred stock tranche liability was revalued at each reporting period until settlement with changes in the fair value recorded as a change in redeemable convertible preferred stock tranche liability in the consolidated statements of operations and comprehensive loss. Upon the closing of the redeemable convertible preferred stock, the redeemable convertible preferred stock purchase rights liability was extinguished, and the mark-to-market fair value of the liability was included in the carrying value of the redeemable convertible preferred stock issued.
The Series A-1 redeemable convertible preferred tranche liability was settled on March 9, 2021 with the achievement of milestones set forth in the Series A-1 stock purchase agreement.
Stock-Based Compensation
The Company measures its stock-based awards granted to employees, non-employee directors, consultants and independent advisors based on the estimated grant-date fair value of the awards. For awards with only service conditions, including stock options and restricted stock awards, compensation expense is recognized over the requisite service period using the straight-line method. For awards that include performance conditions, compensation expense is not recognized until the performance condition is probable to occur. The Company uses the Black-Scholes option pricing model to estimate the fair value of its stock option awards. The Black-Scholes option pricing model requires the Company to make assumptions and judgements about the variables used in the calculations, including the fair value of common stock, expected term, expected volatility of the Company’s common stock, risk-free interest rate and expected dividend yield. As the stock-based compensation is based on awards ultimately expected to vest, it is reduced by forfeitures, which the Company accounts for as they occur.
Fair Value of Common Stock
Following the closing of the Company’s IPO, the fair market value of the Company's common stock is based on its closing price as reported on the date of grant on the Nasdaq Global Market, on which the Company’s common stock is traded.
Prior to the Company’s IPO, because there was no public market for the Company’s common stock, the estimated fair value of the Company’s common stock was determined by the board of directors as of the date of each option grant with input from management, considering the most recently available third-party valuation of common stock, and the board of directors’ assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent valuation through the date of the grant. Management believes that the board of directors has the relevant experience and expertise to determine fair value of the common stock. Third-party valuations were performed in accordance with the guidance outlined in the American Institute of Certified Public Accountants’ Accounting and Valuation Guide, Valuation of Privately-Held-Company EquitySecurities Issued as Compensation. Management has considered numerous factors in determining the best estimate of fair value of our common stock,including the following:
•
valuations performed by independent third-party specialists;
•
the Company’s operating results, financial position, and capital resources;
•
the Company’s stage of development and material risks related to its business;
•
the progress of the Company’s research and development programs;
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•
business conditions and projects;
•
the lack of marketability of the Company’s common stock and its redeemable convertible preferred stock as a private company;
•
the prices at which the Company sold shares of redeemable convertible preferred stock to outside investors in arms-length transactions;
•
the rights, preferences, and privileges of the Company’s redeemable convertible preferred stock relative to those of the Company’s common stock;
•
the analysis of IPOs and the market performance of similar companies in the biotechnology industry;
•
the likelihood of achieving a liquidity event for securityholders, such as an initial public offering or a sale of the Company, given prevailing market conditions;
•
the hiring of key personnel and the experience of management;
•
trends and developments in the industry; and
•
external market conditions affecting the life sciences and biotechnology industry sectors.
For valuations performed prior to the completion of the IPO on August 12, 2021, in accordance with the Practice Aid, the Company determined that the Hybrid Method, was the most appropriate method for determining the fair value of its common stock based on its stage of development and other relevant factors.
The Hybrid Method is a combination of an Option Pricing Method (OPM) scenario and one or more scenarios using a Probability Weighted Expected Return Method (PWERM). The Hybrid Method estimates the probability-weighted value across multiple scenarios, and uses the OPM to estimate the allocation of value within one or more of those scenarios. Weighting allocations are assigned to the OPM and PWERM methods factoring possible future liquidity events. The Company applied the Hybrid Method when it considered both an IPO and trade sale scenarios.
The OPM uses option theory to value the various classes of a company’s securities in light of their respective claims to the enterprise value. Total stockholders’ deficit value is allocated to the various share classes based upon their respective claims on a series of call options with strike prices at various value levels depending upon the rights and preferences of each class. A Black-Scholes closed form option pricing model is employed in this analysis, with an option term assumption that is consistent with the expected time to a liquidity event and a volatility assumption based on the estimated stock price volatility of a peer group of comparable public companies over a similar term.
The PWERM values each class of equity based on an analysis of the range of potential future enterprise values of the company and the manner in which those values would accrue to the owners of the different classes of equity. This method involves estimating the overall value of the subject company under various liquidity event scenarios and allocating the value to the various share classes based on their respective claim on the proceeds as of the date of each event. These different scenarios typically include an initial public offering, an acquisition, or a liquidation of the business, each resulting in a different value. For each scenario, the future value of each share class is calculated and discounted to a present value. The results of each scenario are then probability weighted in order to arrive at an estimate of fair value for each share class as of a current date.
The assumptions underlying these valuations represented management’s best estimates, which involved inherent uncertainties and the application of management’s judgment. As a result, if the Company had used significantly different assumptions or estimates, the fair value of its common stock and stock-based compensation expense could have been materially different.
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Income Taxes
Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts or existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of enactment. The Company assesses the likelihood that its deferred tax assets will be recovered from future taxable income and, to the extent it believes, based upon the weight of available evidence, that it is more likely than not that all or a portion of the deferred tax assets will not be realized, a valuation allowance is established through a charge to income tax expense. Potential for recovery of deferred tax assets is evaluated by estimating the future taxable profits expected and considering prudent and feasible tax planning strategies.
The Company recognizes the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained upon examination by the tax authorities, based on the merits of the position. The Company’s policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense or benefit. To date, there have been no interest or penalties charged in relation to the unrecognized tax benefits.
Foreign Currency
The Company’s reporting currency is the U.S. dollar. The functional currency of the Company and its subsidiaries is the U.S. dollar. Monetary assets and liabilities resulting from transactions denominated in currencies other than the functional currency are remeasured in the functional currency at exchange rates prevailing at the balance sheet date, and income items and expenses are translated into U.S. dollars at the average exchange rate in effect during the period. Exchange gains and losses resulting from remeasurement and foreign currency transactions are included in the determination of net loss.
Net Loss Per Share
Basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period, adjusted for outstanding shares that are subject to repurchase.
Diluted net loss per share attributable to common stockholders is computed by giving effect to all potentially dilutive securities outstanding for the period using the treasury stock method or the if-converted method based on the nature of such securities. For periods in which the Company reports net losses, diluted net loss per common share attributable to common stockholders is the same as basic net loss per share attributable to common stockholders, because potentially dilutive common shares are not assumed to have been issued if their effect is anti-dilutive.
Prior to completion of the IPO on August 12, 2021 (at which time the Company's then outstanding redeemable convertible preferred stock were converted on a 1-for-1 basis to shares of common stock, thereby eliminating the cumulative preferred stock dividend), basic net loss per share attributable to common stockholders was computed using the two-class method required for multiple classes of common stock and participating securities based upon their respective rights to receive dividends as if all income for the period has been distributed. The two-class method requires loss available to common stockholders for the period to be allocated between common and participating securities based upon their respective rights to share in undistributed earnings as if all loss for the period had been distributed. The Company’s participating securities included the Company’s redeemable convertible preferred stock, as the holders were entitled to receive dividends on a pari passu basis in the event that a dividend was paid on common stock. The holders of redeemable convertible preferred stock did not have a contractual obligation to share in losses of the Company, and therefore during periods of loss there was no allocation required under the two-class method.
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Emerging Growth Company Status
The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (JOBS Act). 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. The Company has elected to avail itself of 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 that it (i) is no longer an emerging growth company or (ii) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these consolidated financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.
Recently Adopted Accounting Pronouncements
On January 1, 2022, the Company adopted ASU No. 2016-02, Leases (Topic 842) using the modified retrospective transition method (which permitted the Company to not restate the comparative period presented) and elected the package of practical expedients to not reassess whether any expired or existing contracts are or contain leases, carry forward its historical lease classification and not reassess initial direct costs for existing leases. The Company elected to not separate non-lease components from the associated lease components and to not recognize ROU assets and lease liabilities for leases with a term of twelve months or less. Upon adoption of ASC 842, the Company recorded operating ROU assets of $0.9 million, operating lease liabilities of $0.9 million, and derecognized deferred rent and other lease liabilities of $12,000. There was no material impact to the Company’s statements of operations and comprehensive loss upon adoption. Results and disclosures for the year ended December 31, 2022 are presented under ASC 842. Prior period amounts before January 1, 2022 have not been adjusted and continue to be reported in accordance with the Company’s historical accounting under previous lease guidance, ASC 840: Leases (Topic 840).
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The standard simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and also improves consistent application by clarifying and amending existing guidance. The effective date of this update for non-public companies is for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022. The Company adopted ASU 2019-12 on January 1, 2022, which did not have a material impact on its consolidated financial statements.
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Recently Issued Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard changes how entities will measure credit losses for most financial assets, including accounts and notes receivables. The standard will replace today’s “incurred loss” approach with an “expected loss” model, under which companies will recognize allowances based on expected rather than incurred losses. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The effective date of this update for non-public companies is for fiscal years beginning after December 15, 2022 and interim periods therein. The Company estimates that adoption will not have a material impact on its consolidated financial statements.
In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging —Contracts in Entity’s Own Equity (Subtopic 815-40)—Accounting For Convertible Instruments and Contracts in an Entity’s Own Equity. The standard simplifies accounting for convertible instruments by removing major separation models required under current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument with no separate accounting for embedded conversion features. ASU 2020-06 removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The standard also simplifies the diluted net income per share calculation in certain areas. The effective date of this update for non-public companies is for fiscal years beginning after December 15, 2023, including interim periods therein. Early adoption is permitted for fiscal years beginning after December 15, 2020 and interim periods therein. The Company estimates that adoption will not have a material impact on its consolidated financial statements.
There were no other significant updates to the recently issued accounting standards other than as disclosed herewith for the year ended December 31, 2022. Although there are several other new accounting pronouncements issued or proposed by the FASB, the Company does not believe any of those accounting pronouncements have had or will have a material impact on its financial position or operating results.
Reclassifications
The Company reclassified certain prior period balances on its consolidated balance sheet, statements of operations and comprehensive loss, and statement of cash flows to conform to the current period presentation. These balances related to amounts incurred from related party transactions with Carnot Pharma, LLC. The services related to these transactions were completed in 2022 and the Company's services agreement with Carnot Pharma, LLC was terminated in 2022. These reclassifications had no effect on total liabilities, loss from operations, or net cash used in operating activities.
Note 3. Investments
Investments consists of available-for-sale securities as follows (in thousands):
Amortized Cost Unrealized Gain Unrealized Loss Estimated FairValue
Short-term marketable securities:
U.S. government agency securities 3,353 8 — 3,361
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Amortized Cost Unrealized Gain Unrealized Loss Estimated Fair Value
Short-term marketable securities:
Total short-term marketable securities $ 89,594 $ — $ (36 ) $ 89,558
Long-term marketable securities:
Total long-term marketable securities $ 25,006 $ — $ (87 ) $ 24,919
All the commercial paper, U.S. Treasury and government agency debt securities, and corporate bonds designated as short-term marketable securities have a contractual maturity date that is equal to or less than one year from the respective balance sheet date. Those that are designated as long-term marketable securities have a contractual maturity date that is more than one year from the respective balance sheet date.
Accrued interest receivable is excluded from the amortized cost and estimated fair value of the Company's marketable securities. Accrued interest receivable of $0.1 million and $0.5 million as of December 31, 2022 and December 31, 2021, respectively, is presented separately within the prepaid expenses and other current assets line items in the Company's consolidated balance sheets.
Investments in a continual unrealized loss position for less than 12 months consist of the following (in thousands):
Fair Value Fair Value
U.S. Treasury securities $ 26,506 $ —
Commercial paper — 3,995
Total available-for-sale securities $ 28,483 $ 64,109
Investments in a continual unrealized loss position for greater than 12 months consist of the following (in thousands):
Fair Value Fair Value
Corporate bonds $ 14,649 $ —
U.S. Treasury securities 3,945 —
Total available-for-sale securities $ 18,594 $ —
As of December 31, 2022, the Company did not intend, nor was the Company more likely than not to be required, to sell its available-for-sale investments before the recovery of the amortized cost basis, which may be maturity. Therefore, the Company believes it is more likely than not that its marketable securities in an unrealized loss position will be held until maturity or the recovery of the cost basis of the investment. Based on the Company's assessment, it concluded that none of the available-for-sale investments held as of December 31, 2022 were considered to be impaired, as such, no impairment loss related to other-than-temporary declines in market value was recorded for the year ended December 31, 2022. There was no material realized gain or loss on available-for-sale securities in the periods presented.
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Note 4. Certain Balance Sheet Accounts
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
Recoverable research and development tax credits $ 6,492 $ 6,523
Prepaid research and development expenses 2,549 2,906
Total prepaid expenses and other current assets $ 10,827 $ 11,772
Accrued Expenses
Accrued expenses consist of the following (in thousands):
Accrued research and development expenses 1,902 2,159
Note 5. Redeemable Convertible Preferred Stock
Upon completion of the IPO on August 12, 2021, all of the Company’s then outstanding shares of redeemable convertible preferred stock were converted into an aggregate of 15,345,279 shares of common stock. As of December 31, 2022 and 2021, the Company had no redeemable convertible preferred stock outstanding.
Prior to conversion, the holders of the Series A, Series A-1, and Series B redeemable convertible preferred stock had various rights, preferences, privileges, and restrictions, with respect to voting, dividends, liquidation, and conversion.
In March 2021, Series A-1 preferred stockholders exercised their tranche rights in connection with milestone achievements related to Phase 1 clinical trial results of ETX-155. As a result, the Company issued an additional 4,358,972 shares of Series A-1 redeemable convertible preferred shares for gross proceeds of $34.0 million. Upon exercise of the tranche rights, the Company reclassified the $12.3 million in preferred stock tranche liability to Series A-1 redeemable convertible preferred stock on the consolidated balance sheet.
In May 2021, the Company issued 3,846,150 shares of Series B redeemable convertible preferred stock for gross proceeds of $60.0 million.
As of December 31, 2022 and 2021, the Company had no dividends in arrears as all shares of redeemable convertible preferred stock converted to common stock upon the completion of the IPO.
Note 6. Redeemable Convertible Preferred Stock Tranche Liability
Upon issuance in October 2020, the purchasers of Series A-1 redeemable convertible preferred stock also received tranche rights (Series A-1 Tranche Rights), which provided them the right to purchase additional shares of Series A-1 redeemable convertible preferred stock in an additional future tranche. This tranche was for the purchase of Series A-1 and was valued based upon the Company achieving certain future milestones and utilized a valuation model that reflected both potential outcomes of success or failure to meet the milestone.
The Series A-1 redeemable convertible preferred tranche liability was valued at $0.86 per share upon issuance. There was no change in value from the date of issuance and December 31, 2020.
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The Company estimated the fair value of the Series A-1 Tranche Rights using a probability-weighted present value model that considered the probability of triggering the Series A-1 Tranche Rights through achievement of the clinical development milestones specified in the Series A-1 purchase agreement. These estimates were based, in part, on subjective assumptions. Changes to these assumptions could have had a significant impact on the reported fair value of the Series A-1 Tranche Rights.
The following reflects the significant quantitative inputs used in the valuation of the redeemable convertible preferred stock tranche liability:
Series A-1
Tranche
Call Option
Estimated fair value of redeemable convertible preferred stock $6.94 - $11.10
Discount rate 0.10 %
Dividend yield 0 %
Expected term (years) 0.25 - 0.45
Expected volatility N/A
Probability of milestone achievement 80% - 100%
Strike price $ 7.80
Fair value of each tranche feature $0.86 - $3.32
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The Series A-1 redeemable convertible preferred tranche liability was settled on March 9, 2021 with the achievement of milestones set forth in the Series A-1 stock purchase agreement. The fair value of the liability was remeasured prior to settlement, resulting in the Company recognizing a loss in the consolidated statement of operations and comprehensive loss of $11.7 million during the year ended December 31, 2021. Immediately thereafter, the balance of the redeemable convertible preferred stock tranche liability of $12.3 million was reclassified to Series A-1 redeemable convertible preferred stock.
A rollforward of the redeemable convertible preferred stock tranche liability is as follows (in thousands):
Change in fair value 11,718
Balance at December 31, 2021 $ —
Note 7. Commitments and Contingencies
Operating Leases
The Company leases office space in the U.S. and U.K. under non-cancelable operating leases.
In May 2021, the Company entered into an agreement for office space in Cambridge, U.K. The term of this lease is for a period of 24 months, which commenced on July 1, 2021.
In November 2021, the Company entered into an agreement to lease approximately 5,000 square feet of office space in Bellevue, Washington. The term of this lease is for a period of 39 months, which commenced on November 1, 2021. The lease contains rent escalation clauses and an option to extend the term of the lease for an additional 3-year period at a market rate determined according to the lease. At the inception of the lease and as of December 31, 2022, the Company was not reasonably certain that it will exercise its option to extend the lease, therefore, the period covered by this option is not included within the lease term.
As of December 31, 2022, the remaining weighted-average lease term was 1.6 years. The weighted-average incremental borrowing rate used to determine the operating lease liability was 7.5%.
The Company incurred $0.5 million and $0.2 million in rent expense for the years ended December 31, 2022 and 2021, respectively.
As of December 31, 2022, the annual future minimum lease payments due under the Company's non-cancelable operating leases are as follows:
Amount
(In thousands)
Total undiscounted lease payments $ 508
Present value adjustment (28 )
Total operating lease liabilities $ 480
Legal Proceedings
From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and that such expenditures can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. As December 31, 2022, we are not party to any material legal matters or claims.
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Indemnification
In the ordinary course of business, the Company enters into agreements that may include indemnification provisions. Pursuant to such agreements, the Company may indemnify, hold harmless, and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third-party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. The Company has never incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. The Company intends to enter into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by Delaware corporate law. The Company currently has directors’ and officers’ insurance coverage that reduces its exposure and enables the Company to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is immaterial.
Note 8. Stock-Based Compensation
2019 Plan
In 2019, the Company adopted the 2019 Equity Incentive Plan (the 2019 Plan). The 2019 Plan provides for the Company to grant qualified stock options, non-qualified stock options, and restricted stock awards to employees, non-employee directors and consultants of the Company under terms and provisions established by the board of directors. Under the terms of the 2019 Plan, options are granted at an exercise price no less than fair value of the Company’s common stock on the grant date, except in certain cases related to employees outside of the U.S. However, for any employee who is a 10% or greater stockholder, options are granted at an exercise price no less than 110% of the fair value of the Company’s common stock on the grant date. Option awards granted typically have 10-year terms measured from the option grant date. However, if any employee is a 10% or greater stockholder, the awards have 5-year terms measured from the option grant date. While no shares are available for future issuance under the 2019 Plan, it continues to govern outstanding equity awards granted thereunder.
2021 Plan and ESPP
The compensation committee of the Company's board of directors adopted and the Company's stockholders approved the 2021 Equity Incentive Plan (2021 Plan) and the 2021 Employee Stock Purchase Plan (the ESPP), which became effective immediately prior to the effectiveness of the Company's IPO. The 2021 Plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock units, stock appreciation rights and other stock-based awards. The Company's employees, officers, directors and consultants are eligible to receive awards under the 2021 Plan. Under the terms of the 2021 Plan, options are granted at an exercise price no less than fair value of the Company’s common stock on the grant date, except in certain cases related to significant corporate transactions. Option awards granted typically have 10-year terms measured from the option grant date. As of December 31, 2022, the total number of shares authorized for issuance under the 2021 Plan was 3,887,174. In addition, the number of shares of common stock reserved for issuance under our 2021 Plan will automatically increase on January 1 of each year, beginning on January 1, 2022, and continuing through and including January 1, 2031, by 5% of the total number of shares of common stock outstanding on December 31 of the immediately preceding calendar year, or a lesser number of shares determined by our board prior to the applicable January 1st.
The ESPP allows employees, including executive officers, to contribute up to 15% of their earnings, subject to certain limitations, for the purchase of the Company's common stock at a price per share equal to the lower of (a) 85% of the fair market value of a share of common stock on the first day of the offering period, or (b) 85% of the fair market value of a share of common stock on the last day of the offering period. As of December 31, 2022, there were 521,555 shares of common stock reserved for future issuance under our ESPP plan. The number of shares of common stock reserved for issuance under our ESPP will automatically increase on January 1 of each calendar year, beginning on January 1, 2022 and continuing through and including January 1, 2031, by the lesser of (1) 1% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year or (2) a number of shares determined by our board. Shares subject to purchase rights granted under our ESPP that terminate without having been exercised in full will not reduce the number of shares available for issuance under the ESPP.
As of December 31, 2022, no shares have been granted or purchased under the ESPP.
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Stock Options
Awards with vesting conditions under both plans typically include either: (i) vesting 25% on the first anniversary of the grant date with the remainder vesting monthly over the following three years or (ii) monthly vesting over four years.
The activity for stock options is as follows:
Weighted
Average
Weighted Remaining Aggregate
Average Contract Intrinsic
Options Exercise Terms Values
Outstanding Price (in years) (in thousands)
Options cancelled and forfeited (84,634 ) 3.87
Options exercised — — —
(1) Excludes 45,000 stock options awards outstanding for the period ended December 31, 2022, subject to only performance conditions that have been assessed and deemed not probable.
The aggregate intrinsic value disclosed in the above table is based on the difference between the exercise price of the stock option and the fair value of the Company’s common stock as of the respective period-end dates. The weighted-average grant-date fair value of stock options granted during the years ended December 31, 2022 and 2021 was $4.00 per share and $7.39 per share, respectively.
The Black-Scholes option pricing model for employee and nonemployee stock options incorporates the following assumptions:
•
Fair Value of Common Stock — Prior to the completion of the Company's IPO, the fair value of the Company's common stock was determined byusing straight-line interpolation between the value of common stock derived from valuations performed by independent third party specialists, further described in Note 2 to the consolidated financial statements Summary of Significant Accounting Policies – Fair Value of Common Stock. After the completion of the Company's IPO, the fair value of each share of common stock is based on the closing price of the Company's common stock on the date of grant as reported on the Nasdaq Global Market.
•
Volatility — The expected stock price volatilities are estimated based on the historical and implied volatilities of comparable publicly tradedcompanies as the Company does not have sufficient history of trading its common stock.
•
Risk-free Interest Rate — The risk-free interest rates are based on US Treasury yields in effect at the grant date for notes with comparable termsas the awards.
•
Expected Term — The expected term represents the period that the Company’s stock options are expected to be outstanding and is determinedusing the simplified method (based on the mid-point between the vesting date and the end of the contractual term).
•
Dividend Yield — The expected dividend yield assumption is based on the Company’s current expectations about its anticipated dividend policy.
The fair value of the Company’s stock option awards was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for the years ended December 31, 2022 and 2021:
Year Ended December 31,
Expected dividend yield 0.00% 0.00%
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Restricted Stock
The Company has restricted stock awards with service conditions that vest 25% on the first anniversary of the grant date and monthly thereafter. The restricted stock awards are subject to repurchase by the Company at the original purchase price in the event that the award recipient’s employment or relationship is terminated prior to the shares vesting.
The activity for restricted stock awards is as follows:
Weighted-AverageGrant-Date Fair
Number of Shares Value
Granted — —
Forfeited — —
The fair value of restricted stock awards vested during the years ended December 31, 2022 and 2021 was approximately $0.6 million and $0.1 million, respectively.
The following table shows stock-based compensation for stock options and restricted stock awards included in the Company’s consolidated statements of operations and comprehensive loss (in thousands):
Year Ended December 31,
Research and development expense $ 2,538 $ 987
General and administrative expense 4,453 2,750
Total stock-based compensation expense $ 6,991 $ 3,737
As of December 31, 2022, there was $18.1 million of unrecognized compensation cost related to unvested stock options and $1.5 million of unrecognized compensation cost related to unvested restricted stock awards granted, which is expected to be recognized over a weighted average period of 2.75years and 2.34years, respectively.
Note 9. Net Loss Per Share Attributable to Common Stockholders
The following table shows the computation of basic and diluted net loss per share (in thousands, except share and per share data):
Year Ended December 31,
Net loss attributable to common stockholders $ (45,244 ) $ (52,028 )
The following outstanding shares of potentially dilutive securities were excluded from the computation of the diluted net loss per share attributable to common stockholders for the periods presented because their effect would have been anti-dilutive:
Year Ended December 31,
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Note 10. Income Taxes
The components of net loss before tax provision from income taxes are as follows (in thousands):
Year Ended December 31,
The following table presents a reconciliation of the Company’s expected tax computed at the U.S. statutory federal income tax rate to the total provision for income taxes (in thousands):
Year Ended December 31,
U.S. federal taxes at statutory rate $ (9,497 ) $ (9,959 )
State taxes, net of federal benefit 1 4
Foreign rate differential 471 397
Non-deductible expenses 1 (11 )
Mark-to-market adjustment — 2,461
Stock-based compensation 742 480
U.K. tax rate change impact on deferred income taxes (1,390 ) (1,845 )
Change in valuation allowance 6,971 5,524