PAXMEDICA, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q) – Marketscreener.com

References to the “Company,” “Paxmedica, Inc.,” “our,” “us,” or “we” refer to Paxmedica, Inc. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the unaudited interim condensed financial statements and the notes thereto contained elsewhere in this report and our final prospectus, or Prospectus, dated August 25, 2022 and filed with the SEC, pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, on August 29, 2022 (File No. 333-239676). Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negative of such terms or other similar expressions. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in our other SEC filings. These statements are based upon information available to us as of the filing date of this report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements.
Overview
We are a clinical stage biopharmaceutical company focusing on the development of anti-purinergic drug therapies (“APT”) for the treatment of disorders with intractable neurologic symptoms, ranging from neurodevelopmental disorders, including autism spectrum disorder (“ASD”), to Myalgic Encephalomyelitis/Chronic Fatigue Syndrome (“ME/CFS”), a debilitating physical and cognitive disorder believed to be viral in origin and now with rising incidence globally due to the long-term effects of SARS-CoV-2 (“COVID-19”). APTs have been shown to block the effects of excess production and extracellular receptor activity of ATP, which acts as both the main energy molecule in all living cells and a peripheral and central nervous system neurotransmitter via receptors that are found throughout the nervous system. Excess purinergic signaling can offset homeostasis and trigger immune responses that result in localized and systemic increases in inflammatory chemokines and cytokines, ultimately stimulating ATP production. APTs may also impact immunologic and inflammatory mechanisms that may be causing or exacerbating symptoms in these seemingly unrelated disorders, which may be caused in part by similar mechanisms of ATP overproduction.
One of our primary points of focus is currently the development and testing of our lead program, PAX-101, an intravenous formulation of suramin, in the treatment of ASD and the advancement of the clinical understanding of using that agent against other disorders such as ME/CFS and Long COVID-19 Syndrome (“LCS”), a clinical diagnosis in individuals who have been previously infected with COVID-19.
In February 2021, we announced positive topline data from our Phase 2 dose-ranging clinical trial evaluating PAX-101 (commonly known as intravenous suramin) for the treatment of the core symptoms of ASD, as described in more detail below. We also intend to submit data to support a New Drug Application (an “NDA”) for PAX-101 under the U.S. Food and Drug Administration’s (the “FDA”) Tropical Disease Priority Voucher Program for the treatment of Human African Trypanosomiasis, a fatal parasitic infection commonly known as African sleeping sickness (“HAT”), leveraging suramin’s historical use in treating HAT outside of the United States. We have exclusively licensed clinical data from certain academic or international government institutions to potentially accelerate PAX-101’s development plans in the United States through this regulatory program and seek approval in the United States for the treatment of East African HAT, which is caused by the parasite Trypanosome brucei rhodesiense, as early as 2024. We are also pursuing the development of next generation APT product development candidates for neurodevelopmental indications. These candidates include PAX-102, our proprietary intranasal formulation of suramin, as well as other new chemical entities that are more targeted and selective antagonists of particular purine receptor subtypes. We believe our lead drug candidate (suramin), if approved by the FDA, may be a significant advancement in the treatment of ASD and a potentially useful treatment for ME/CFS and LCS.
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We have not generated any revenue to date and, through June 30, 2022, we had an accumulated deficit of approximately $17.1 million. To date, we have financed our operations through contributions from our prior members, the issuance of our convertible notes, and the issuance of our Simple Agreement For Equity (“SAFE”) and Series X preferred stock, par value $0.0001 per share (“Series X Preferred Stock”). We expect our expenses to increase significantly in connection with our ongoing activities to develop, seek regulatory approval and commercialization of PAX-101 and our other product candidates. Furthermore, we expect to incur additional costs associated with operating as a public company. Accordingly, we will likely need substantial additional financing to support our continuing operations. We will seek to fund our operations through public or private equity or debt financings or other sources. Adequate additional financing 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 to generate significant revenues to achieve profitability, and we may never do so. Accordingly, there are material risks and uncertainties that raise substantial doubt about our ability to continue as a going concern.
Convertible Notes
Between April and July 2022, we issued the senior secured convertible promissory notes (the “2022 Notes”) with a principal balance totaling approximately $1.5 million. The 2022 Notes contain an original issue discount totaling $0.2 million and we received net proceeds of approximately $1.3 million. The 2022 Notes bear interest at 10% per annum and mature 12 months from the issuance date. The 2022 Notes are secured by all assets and personal property of the Company. The note holders have the right to convert all or any portion of the outstanding principal balance and accrued interest into shares of the Company’s common stock, up to a beneficial ownership limitation of 9.99% of the number of shares of common stock outstanding at the time of conversion. The per-share conversion price is equal to 80% of the initial offering price of our common stock, or $4.20 per share (based on the Company’s initial public offering price of $5.25 per share). In connection with the 2022 Notes, the Company issued warrants to purchase 195,140 shares of the Company’s common stock. The warrants have an exercise price of 80% of the initial offering price of our common stock, or $4.20 per share (based on the Company’s initial public offering price of $5.25 per share) and expire five years from the issuance date.
During the six months ended June 30, 2022, the Company entered into its 2022 Notes with a principal balance of $1.2 million. The June 2022 Notes contain an original issue discount totaling $0.1 million and the Company received proceeds of $1.0 million (net of fees paid). As of June 30, 2022, the outstanding principal balance of the 2022 Notes was $1.2 million. In connection with the 2022 Notes issued during the six months ended June 30, 2022, the Company issued common stock warrants to purchase 164,284 shares of the Company’s common stock.
Initial Public Offering
On August 9, 2022, the Company entered into an underwriting agreement relating to the public offering of its common stock. The Company agreed to sell 1,545,454 shares of its common stock to the underwriters, at a purchase price per share of $4.83 (the offering price to the public of $5.25 per share minus the underwriters’ discount), pursuant to the Company’s registration statement on Form S-1 (File No. 333-239676), as amended, under the Securities Act, that was filed by the Company under Rule 462(b) under the Securities Act. The Company also granted the underwriters a 45-day option to purchase up to 231,818 additional shares of common stock to cover over-allotments. On August 30, 2022, the Company received net proceeds from its public offering of approximately $6.8 million, net of underwriter fees and commissions of approximately $0.8 million, and offering costs of approximately $0.5 million. In connection with its public offering the Company issued 108,181 warrants to purchase shares of the Company’s common stock with an exercise price of $6.5625 per share.
Series X Preferred Stock
On August 1, 2022, the Company authorized 500,000 shares of Series X Preferred Stock. The stated value of the Series X preferred stock is $100 per share. The holders of the Series X preferred stock have no voting rights and are not entitled to dividends. Upon consummation of the Company’s initial public offering, all outstanding shares of Series X preferred stock automatically converted into shares of common stock at the initial public offering price, subject to the beneficial ownership limitation of 9.99% of the number of shares of common stock outstanding at the time of conversion.
On August 2, 2022, the Company issued 3,200 shares of Series X Preferred Stock at a purchase price of $100 per share. The Company received net proceeds of approximately $0.3 million, net of fees.
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Financial Operations Overview
Revenue
To date, we have not generated any revenue. Our ability to generate product revenue, which we do not expect will occur in the near term, if ever, will depend on the successful development and eventual commercialization of our current, and any potential future, product candidates.
Research and Development Expenses
Research and development expenses consist of costs incurred for the development of PAX-101 and our other product candidates, which include:
? the cost of acquiring, developing and manufacturing pre-clinical trial
materials;
? costs for consultants and contractors associated with chemistry, manufacturing
and controls, or CMCs, pre-clinical activities and regulatory operations;
? expenses incurred under agreements with contract research organizations, or
CROs, that conduct our pre-clinical trials; and
? employee-related expenses, including salaries for those employees involved in
the research and development process.
Research and development costs are expensed as incurred. Costs for certain activities, such as preclinical studies and clinical trials, are generally recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors and collaborators.
General and Administrative Expense
Our general and administrative expenses include costs associated with our executive, accounting, information technology and human resources functions. These expenses consist principally of payroll, employee benefits, travel, and professional services fees such as consulting, audit, tax and legal fees, and general corporate costs. We expense all general and administrative expenses as incurred.
We expect our general and administrative expenses to increase primarily as a result of costs related to us operating as a public company, such as additional legal, accounting, corporate governance, and investor relations expenses, and directors’ and officers’ insurance premiums.
Fair Value of Restricted Stock Units Granted
On January 1, 2022, the Company granted 1,342,667 restricted stock units, or RSUs, with a fair value of approximately $14.6 million to employees, officers and directors of the Company. The RSUs are subject to service conditions (vesting of 33.34% on May 1, 2022, with the remaining units vesting on each three-month anniversary thereafter) and performance conditions in the form of a liquidity event. Vesting of the RSUs is subject to all grantees continuous service with the Company, and no vesting shall occur if the Company has not completed a Qualified Offering or a Change of Control (each as defined therein) on or before the vesting date. In the event that neither a Qualified Offering nor a Change of Control has occurred prior to December 31, 2022, then all RSUs shall be forfeited for no consideration. Because a Qualified Offering or Change of Control is not considered probable of achievement until consummation, compensation cost measured at the grant date is not recognized until such event occurs.
During the six months ended June 30, 2022, 291,500 RSU’s (granted on January 1, 2022) were forfeited due to terminations of two of the Company’s employees and two of its board members.
In August 2022, the Company modified the remaining 1,086,500 RSUs granted on January 1, 2022 to provide that 33.34% of each of those RSUs would vest on May 1, 2022, with an additional 8.3325% of each grant vesting each quarter thereafter, provided that if neither (i) the expiration of the 6-month period following an initial public offering nor (ii) a change in control has occurred prior to the applicable vesting date, any RSUs that would have vested thereunder shall not vest until such expiration of the 6-month period following an initial public offering or change in control occurs (provided further that if neither an initial public offering nor a change in control occurs on or prior to December 31, 2022, then all of the related RSUs will be forfeited). Vesting in all cases generally is subject to the grantee’s continued employment with the Company or a subsidiary thereof on the applicable vesting date. This improbable to improbable modification resulted in a new measurement of compensation cost based on the underlying fair value of the Company’s common stock on the date of the modification of approximately $5.7 million.
On August 26, 2022, the Company consummated its initial public offering and based on the modification above, 33.34% of each of the remaining 1,086,500 RSU’s would vest on February 26, 2023, with an additional 8.3325% of each grant vesting each quarter thereafter.
During the three months ended June 30, 2022 and 2021, the Company recorded stock-based compensation expense related to the canceled stock options of approximately $0.1 million and $0.3 million, respectively. During the six months ended June 30, 2022 and 2021, the Company recorded stock-based compensation expense related to the canceled stock options of approximately $0.3 million and $0.8 million, respectively. The unamortized stock-based compensation expense as of June 30, 2022 is approximately $0.4 million.
Impact of COVID-19
Based on our current assessment, we do not expect any material impact on our long-term development timeline and our liquidity due to the worldwide COVID-19 pandemic. However, the COVID-19 pandemic could adversely impact our clinical trial operations, including our ability to recruit and retain patients and principal investigators and site staff who, as healthcare providers, may have heightened exposure to COVID-19 if an outbreak worsens in their geography, or have other adverse effects on our business, results of operations and financial condition. We are continuing to assess the effect on our operations by monitoring the spread of COVID-19 and the resulting global pandemic and the actions implemented to combat the virus throughout the world.
Results of Operations
General and administrative expenses were approximately $0.8 million and $1.1 million for the three months ended June 30, 2022 and 2021, respectively. The $0.3 million decrease in general and administrative expenses was primarily due to decreases of $0.2 million of stock-based compensation and $0.4 million of bonuses, payroll, and related expenses, offset by an increase of $0.3 million for legal and professional fees.
Research and development expenses were approximately $0.15 million for the three months ended June 30, 2022 and approximately $0.9 million for the three months ended June 30, 2021. The $0.75 million decrease in research and development expenses was primarily attributable to lower costs incurred in connection with our research activities, including lower costs associated with clinical trials, consultants, clinical trial materials, regulatory filings, facilities, laboratory expenses and other supplies.
Of the $0.15 million in research and development expenses incurred during the three months ended June 30, 2022, $0.13 million was associated with activities related to the HAT indication, and $0.02 million was associated with activities related to the ASD indication. These activities included, but were not limited to, milestone payments in connection with the recently completed ASD trial.
Of the approximately $0.9 million in research and development expenses incurred during the three months ended June 30, 2021, approximately $0.6 million was associated with activities related to the HAT indication, and approximately $0.3 million was associated with activities related to the ASD indication. These activities included regulatory advisory services and IV formulation work for HAT as well as work related to our ASD clinical trial.
The estimated aggregate costs expected to be incurred for the research and development activities relating to the filing of an NDA for HAT and an IND for ASD are approximately $11.8 million, which we expect to fund with the proceeds of our initial public offering and future capital raising activities, if necessary.
Other Income (Expenses), net
Other income was approximately $0.9 million for the three months ended June 30, 2022 compared with other expenses of $4.15 million for the three months ended June 30, 2021. The increase of $5.05 million was comprised of a $3.25 million net change of income recognized for the change in fair value of our warrant liability and a $2.2 million net change of income recognized for the change in fair value of our SAFE investment, offset by the loss on issuance of our 2022 Notes of $0.3 million and the change in fair value of our 2022 Notes of $0.1 million.
The change in fair value of our SAFE investment was primarily due to challenging market conditions, which resulted in a lower probability that the SAFE would convert to shares of common stock or that the investor would be repaid. The primary driver of the lower valuation was due to a lower probability of an initial public offering as a result of challenging market conditions. As of December 31, 2021 the probability of an initial public offering was 95% and as of June 30, 2022 the probability of an IPO was 55%.
General and administrative expenses were approximately $1.7 million and $2.4 million for the six months ended June 30, 2022 and 2021, respectively. The $0.7 million decrease in general and administrative expenses was primarily due to decreases of $0.5 million of stock-based compensation, $0.5 million of bonus expense and $0.1 million of other operating expenses, offset by an increase of $0.4 million for legal and professional fees.
Research and development expenses were approximately $1.2 million for the six months ended June 30, 2022 and approximately $1.3 million for the three months ended June 30, 2021. The $0.1 million decrease in research and development expenses was primarily attributable to lower costs incurred in connection with our research activities, including lower costs associated with clinical trials, consultants, clinical trial materials, regulatory filings, facilities, laboratory expenses and other supplies.
Of the $1.2 million in research and development expenses incurred during the six months ended June 30, 2022, $1.1 million was associated with activities related to the HAT indication, and $0.1 million was associated with activities related to the ASD indication. These activities included, but were not limited to, milestone payments in connection with the recently completed ASD trial.
Of the approximately $1.3 million in research and development expenses incurred during the six months ended June 30, 2021, approximately $0.9 million was associated with activities related to the HAT indication, and approximately $0.4 million was associated with activities related to the ASD indication. These activities included regulatory advisory services and IV formulation work for HAT as well as work related to our ASD clinical trial.
The estimated aggregate costs expected to be incurred for the research and development activities relating to the filing of an NDA for HAT and an IND for ASD are approximately $11.8 million, which we expect to fund with the proceeds of our initial public offering and future capital raising activities, if necessary.
Other Income (Expenses), net
Other income was approximately $4.8 million for the six months ended June 30, 2022 compared with other expenses of $9.7 million for the six months ended June 30, 2021. The increase of $14.5 million was comprised of a $5.9 million net change of income recognized for the change in fair value of our warrant liability and a $6.2 million net change of income recognized for the change in fair value of our SAFE, and $2.8 million of interest expense recorded in connection with the conversion of our senior secured convertible promissory notes in 2021, offset by the loss on issuance of our 2022 Notes of $0.3 million and the change in fair value of our 2022 Notes of $0.1 million recorded in the 2022 period.
The change in fair value of our warrant liability of $6.0 million was primarily due to a lower valuation of our stock price as of June 30, 2022 ($5.30 per share) compared to December 31, 2021 ($10.87 per share). The change in fair value of our SAFE investment was primarily due to challenging market conditions, which resulted in a lower probability that the SAFE would convert to shares of common stock or that the investor would be repaid. The primary driver of the lower valuation was due to a lower probability of an initial public offering as a result of challenging market conditions. As of December 31, 2021 the probability of an initial public offering was 95% and as of June 30, 2022 the probability of an IPO was 55%.
Liquidity and Capital Resources
We were formed as a Delaware limited liability company on April 5, 2018 and converted into a Delaware corporation on April 15, 2020. As of June 30, 2022, we had an accumulated deficit since inception of approximately $17.1 million. Since inception, we have not generated revenue from product sales and have incurred net losses and negative cash flows from our operations. From inception through June 30, 2022, we have funded our operations through contributions from TardiMed Sciences, LLC (“TardiMed”), the issuance of senior secured convertible promissory notes of approximately $4.2 million, and our SAFE of $5.0 million.
Convertible Notes
Between April and July 2022, we issued the 2022 Notes with a principal balance totaling approximately $1.5 million. The 2022 Notes contain an original issue discount totaling approximately $0.2 million and we received net proceeds of approximately $1.3 million. The 2022 Notes bear interest at 10% per annum and mature 12 months from the issuance date. The 2022 Notes are secured by all assets and personal property of the Company. The note holders have the right to convert all or any portion of the outstanding principal balance and accrued interest into shares of the Company’s common stock, up to a beneficial ownership limitation of 9.99% of the number of shares of common stock outstanding at the time of conversion. The per-share conversion price is equal to 80% of the initial offering price, or $4.20 per share (based on the Company’s initial public offering price of $5.25 per share). In connection with the 2022 Notes, the Company issued the warrants to purchase 195,140 shares of the Company’s common stock. The warrants have an exercise price of 80% of the initial offering price, or $4.20 per share (based on the Company’s initial public offering price of $5.25 per share) and expire five years from the issuance date.
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On August 3, 2022, the Company entered into a conversion agreement with certain holders of the 2022 Notes, pursuant to which the holders agreed to convert $1.0 million of the principal balance at the consummation of the Company’s initial public offering at the conversion price of $4.20 per share. On August 26, 2022, $1.0 million of convertible notes outstanding were converted into 238,094 shares of the Company’s common stock.
On August 3, 2022, the Company entered into a conversion agreement with an additional holder of the 2022 Notes, pursuant to which the holder agreed to convert $255,555 of the principal balance at the consummation of the Company’s initial public offering into 2,555 shares of Series X preferred stock. On August 26, 2022, $255,555 of convertible notes outstanding were converted into 2,555 shares of the Company’s Series X preferred stock. The 2,555 shares of Series X preferred stock are convertible into shares of common stock at the initial offering price of $5.25 per share, subject to the beneficial ownership limitation.
SAFE
In March 2021, we entered into the SAFE with an investor, pursuant to which we received gross proceeds in an aggregate amount equal to $5.0 million.
Series X Preferred Stock
On August 2, 2022, the Company issued 3,200 shares of Series X preferred stock in a private placement, at a purchase price of $100 per share, and received net proceeds of approximately $0.3 million, after deducting expenses (the “Series X Private Placement”). The Series X Private Placement constituted a qualified offering under the terms of the SAFE and the $5.0 million outstanding under the SAFE automatically converted into 100,000 shares of Series X preferred stock.
On August 26, 2022, upon the consummation of the Company’s initial public offering, 61,689 shares of the Series X preferred stock were converted into 1,175,000 shares of the Company’s common stock. As of August 26, 2022, 45,317 shares of Series X preferred stock remain outstanding.
Warrant Exchange Agreement
On August 3, 2022, the Company entered into a warrant exchange agreement (the “Warrant Exchange Agreement”) with a holder of certain warrants to purchase the Company’s common stock. The warrants were issued in connection with the Company’s 2020 Notes (as defined below). Pursuant to the Warrant Exchange Agreement, the Company agreed to exchange 750,000 warrants for 375,000 shares of common stock (or, to the extent that the holder would exceed the beneficial ownership limitation contained in the Warrant Exchange Agreement, an equivalent number of shares of Series X preferred stock) at the consummation of the Company’s initial public offering. On the August 26, 2022, in connection with its Warrant Exchange Agreement, the Company exchanged 750,000 warrants for 350,000 shares of its common stock and 1,250 shares of its Series X preferred stock.
Series Seed Preferred Stock
On August 5, 2022, the Company entered into exchange agreements with the holders of the Company’s Series Seed preferred stock, par value $0.0001 per share (the “Series Seed Preferred Stock”). The Company and the holders agreed to exchange all shares of outstanding Series Seed Preferred Stock into 1,557,435 shares of common stock immediately prior to the effectiveness of its registration statement filed in connection with the Company’s initial public offering.
Operating activities
During the six months ended June 30, 2022, net cash used in operating activities was $1.4 million, which primarily included our net income of approximately $1.9 million, adjusted for non-cash expenses of approximately $4.5 million including the change in fair value of our SAFE liability of $3.0 million and the change in fair value of our warrant liability of $2.2 million, offset by stock-based compensation of approximately $0.3 million, loss on issuance of debt of $0.3 million recorded in connection with the issuance of our 2022 Notes and the change in fair value of our 2022 Notes of $0.1 million. The net change in operating assets and liabilities was approximately $1.2 million and was primarily due to increases in accounts payable and accrued expenses.
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During the six months ended June 30, 2021, net cash used in operating activities was approximately $2.8 million which primarily included our net loss of approximately $13.4 million, adjusted for non-cash expenses of approximately $10.5 million, including the change in fair value of our warrant liability of $3.7 million, the change in fair value of our SAFE of $3.2 million, amortization of debt discount of $2.6 million related to our convertible promissory notes, stock-based compensation of $0.8 million, and other expenses of $0.2 million. The net change in operating assets and liabilities was approximately $0.1 million due to increases in accounts payable and accrued expenses of $0.2 million, offset by $0.1 million for deferred offering costs.
Investing Activities
There were no investing activities for the six months ended June 30, 2022 and 2021.
Financing activities
During the six months ended June 30, 2022, net cash provided by financing activities was approximately $1.0 million, consisting of proceeds received from the issuance of our 2022 Notes and warrants.
During the six months ended June 30, 2021, net cash provided by financing activities was $5.0 million, consisting of proceeds received from our SAFE agreement.
2020 Notes Issuance
In July 2020, we issued the July 2020 Notes in an aggregate principal amount of approximately $0.1 million with an interest rate of 8% per annum, and in October 2020, we issued unsecured convertible promissory notes, or the October 2020 Notes, and together with the July 2020 Notes, the 2020 Notes, in an aggregate principal amount of approximately $3.0 million with an interest rate of 10% per annum until July 26, 2021, and 15% thereafter.
During the year ended December 31, 2021, all of the 2020 Notes were converted in accordance with their terms into an aggregate of 1,137,594 shares of common stock. In connection with the October 2020 Notes, we also issued an aggregate of 1,034,176 warrants to purchase shares of common stock, which are exercisable at an exercise price of $3.00.
Funding requirements
As of June 30, 2022, we had a cash balance of approximately $9,000. Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.
We anticipate incurring additional losses for the foreseeable future and may never become profitable. We expect our expenses to increase in connection with our ongoing activities, particularly as we continue the research and development of product candidates. Furthermore, we expect to continue to incur additional costs as a public company. Accordingly, we will likely need to obtain substantial additional funding. If we are unable to raise capital or otherwise obtain funding when needed or on attractive terms, we could be forced to delay, reduce or eliminate our research and development programs or future commercialization efforts. These factors raise substantial doubt about our ability to continue as a going concern.
We will seek to obtain additional capital through the sale of debt or equity financings or other arrangements such as, collaborations, strategic alliances and licensing arrangements to fund operations; however, there can be no assurance that we will be able to raise needed capital under acceptable terms, if at all. The sale of additional equity securities may dilute existing stockholders and may contain senior rights and preferences compared to currently outstanding shares of common and preferred stock. Debt securities issued or other debt financing incurred may contain covenants and limit our ability to pay dividends or make other distributions to stockholders. If we are unable to obtain such additional financing, future operations would need to be scaled back or discontinued.
Contractual obligations and commitments
As of September 30, 2022, the 2022 Notes outstanding principal balance totals approximately $216,000. The notes bear interest at 10% per annum and mature between April and July 2023.
Off-balance sheet arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. We therefore believe that we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
Critical accounting policies and significant judgments and estimates
Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the balance sheet and the reported amounts of expenses during the reporting period. In accordance with U.S. GAAP, we evaluate our estimates and judgments on an ongoing basis. The most significant estimates relate to the valuation of our common stock, SAFE liability and warranty liability, and our election to adopt the fair value option for our convertible notes. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of expenses that are not readily apparent from other sources. Actual results may differ materially and adversely from these estimates. To the extent there are material differences between the estimates and actual results, our future results of operations will be affected.
We define our critical accounting policies as those accounting principles that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations, as well as the specific manner in which we apply those principles. While our significant accounting policies are more fully described in Note 2 to our financial statements, we believe the following are the critical accounting policies used in the preparation of our financial statements that require significant estimates and judgments:
Stock-Based Compensation
We expense stock-based compensation to employees, non-employees and board members over the requisite service period based on the estimated grant-date fair value of the awards and actual forfeitures. We account for forfeitures as they occur. Stock-based awards with graded vesting schedules are recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award.
The determination of the grant date fair value of options using an option pricing model is affected principally by our estimated fair value of shares of our common stock and requires management to make a number of other assumptions, including the expected term of the option, the expected volatility of the underlying shares, the risk-free interest rate and the expected dividend yield. The assumptions used in our Black-Scholes option-pricing model represent management’s best estimates at the time of measurement. These estimates are complex, involve a number of variables, uncertainties and assumptions and the application of management’s judgment, as they are inherently subjective. If any assumptions change, our stock-based compensation expense could be materially different in the future. These assumptions are estimated as follows:
?Fair Value of Common Stock. See the subsection titled “- Fair Value of Common Stock” below.
?Expected Term. The expected term represents the period that our options are expected to be outstanding. We calculated the expected term using the simplified method for options based on the average of each option’s vesting term and the contractual period during which the option can be exercised, which is typically 10 years following the date of grant.
?Expected Volatility. The expected volatility was based on the historical share volatility of several comparable publicly traded companies over a period of time equal to the expected term of the options, as we did not have any trading history to use the volatility of our own common stock. The comparable companies were chosen based on their size, stage in life cycle and area of specialty. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available.
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?Risk-Free Interest Rate. The risk-free interest rate was based on the yields of U.S. Treasury securities with maturities appropriate for the term of the award.
?Expected Dividend Yield. We have not paid dividends on our common stock nor do we expect to pay dividends in the foreseeable future. Therefore, we used an expected dividend yield of zero.
Fair Value of Common Stock
Prior to the Company’s initial public offering, there was no public market for our common stock. As such, the estimated fair value of our common stock and underlying stock options has been determined at each grant date by our board of directors, with input from management, based on the information known to us on the grant date.
Beginning in May 2020, we determined the estimated fair value of our common stock using the Hybrid Method, which incorporated the Option Pricing Model (“OPM”) and the Probability Weighted Expected Return Method (“PWERM”), estimating the probability- weighted value across multiple scenarios by using the OPM to estimate the allocation of value within one or more of those scenarios. The Hybrid Method was utilized given there was transparency into one or more near- term potential exits but there existed uncertainty regarding what would occur if the near-term exit plans did not materialize. Under the PWERM, the values of the various equity interests were estimated based upon an analysis of future values for our company, assuming various potential future outcomes. Share value was based upon the probability-weighted present value of expected future investment returns, considering each of the possible future outcomes available to us, as well as the rights of each share class. The future outcomes modeled included an initial public offering, a dissolution or continued operation as a private company until a later exit date. To estimate our total equity value, a combination of the Backsolve Methodology (“backsolving” the implied enterprise value based on the price paid for each new preferred security sold), a discounted cash flow analysis and a guideline publicly traded company method was used for scenario options, based on the fact pattern that existed as of the particular valuation date. After deriving the indicated values of equity under the scenario options, the present value of the class specific equity allocations were calculated. After calculating the present values as applicable to the scenarios, the probability of each scenario occurring was multiplied by the indications of value under each scenario. The sum of the probability-weighted values for our common stock was then divided by our total common stock outstanding as of the relevant valuation date.
In addition to considering the results of these third-party valuation reports, our board of directors used assumptions based on various objective and subjective factors, combined with management judgment, to determine the fair value of our common stock as of the grant date, including:
the prices at which we sold shares of preferred stock and the superior rights
? and preferences of the preferred stock relative to our common stock at the time
of each grant;
? external market conditions affecting the life sciences research and development
industry and trends within the industry;
? our stage of development and business strategy;
? our financial condition and operating results, including our levels of
available capital resources and forecasted results;
? developments in our business;
? the progress of our research and development efforts;
? equity market conditions affecting comparable public companies; and
? general market conditions and the lack of marketability of our common stock.
Application of these approaches involves the use of estimates, judgment and assumptions that are highly complex and subjective, such as those regarding our expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies and the probability of possible future events. Changes in any or all of these estimates and assumptions or the relationships between the assumptions impact our valuations as of each valuation date and may have a material impact on the valuation of our common stock.
Table of Contents
Following the Company’s initial public offering, a public trading market for our common stock has been established and it will no longer be necessary for our board of directors to estimate the fair value of our common stock in connection with our accounting for granted stock options and other such awards we may grant, as the fair value of our common stock will be determined based on the closing price of our common stock as reported on the date of grant.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates.
Convertible Notes
In accordance with Accounting Standards Codification 825, Financial Instruments (“ASC 825”), the Company has elected the fair value option for recognition of its convertible notes. In accordance with ASC 825, the Company recognizes these convertible notes at fair value with changes in fair value recognized in the condensed statements of operations. The fair value option may be applied instrument by instrument, but it is irrevocable. As a result of applying the fair value option, direct costs and fees related to the convertible notes were recognized in general and administrative expense. Accrued interest for the notes has been included in the change in fair value of convertible notes in the condensed statements of operations.
Warrant Liability
We account for certain common stock warrants outstanding as a liability at fair value and adjust the instruments to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until exercised, and any change in fair value is recognized in our statements of operations. The fair value of the warrants issued by us have been estimated using the Monte Carlo simulation.
Simple Agreement for Future Equity
The Company accounts for a SAFE as a liability at fair value and adjusts the instrument to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until a triggering event, equity financing or a liquidity/dissolution occurs, and any change in fair value is recognized in the Company’s statements of operations. The fair value of the SAFE has been estimated using the Backsolve method which utilizes the Option Pricing Method.
Accrued Outsourcing Costs
Substantial portions of our preclinical studies and clinical trials are performed by third-party laboratories, medical centers, CROs and other vendors. These CROs generally bill monthly or quarterly for services performed, or bill based upon milestone achievement. For preclinical studies, we accrue expenses based upon estimated percentage of work completed and the contract milestones remaining. Clinical trial costs are a significant component of research and development expenses and include costs associated with third-party contractors. We outsource a substantial portion of our clinical trial activities, utilizing external entities such as CROs, independent clinical investigators, and other third-party service providers to assist us with the execution of its clinical studies. For each clinical trial that we conduct, certain clinical trial costs are expensed immediately, while others are expensed over time based on the number of patients in the trial, the attrition rate at which patients leave the trial, and/or the period over which clinical investigators or CROs are expected to provide services. Our estimates depend on the timeliness and accuracy of the data provided by the CROs regarding the status of each program and total program spending. We periodically evaluate the estimates to determine if adjustments are necessary or appropriate based on information it receives.
Research and development expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation, for personnel serving our development functions, and other internal operating expenses, the cost of clinical studies, and the cost of our drug candidate for clinical study. In addition, research and development expenses include payments to third parties for the development of our product candidates and the estimated fair value for the issuance of equity for the license rights to products in development (prior to marketing approval). Our expenses related to clinical trials are primarily related to activities at CROs that design, gain approval for and conduct clinical trials on our behalf. Such amounts are then recognized as an expense as the related goods are delivered or the services are performed.
Recent accounting pronouncements
See Note 2 to our financial statements for a description of recent accounting pronouncements applicable to our financial statements.
Emerging Growth Company and Smaller Reporting Company Status
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (“JOBS Act”), and we may remain an emerging growth company for up to five years following the completion of our initial public offering. For so long as we remain an emerging growth company, we are permitted and intend to rely on certain exemptions from various public company reporting requirements, including not being required to have our internal control over financial reporting audited by our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and any golden parachute payments not previously approved and an exemption from compliance with the requirements regarding the communication of critical audit matters in the auditor’s report on financial statements.
Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have elected to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will not be subject to the same new or revised accounting standards as public companies that are not emerging growth companies. As a result of this election, our financial statements may not be comparable to those of companies that are not emerging growth companies.
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