krtx-10q_20190930.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to ____________

Commission File Number: 001-38958

 

Karuna Therapeutics, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

27-0605902

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

33 Arch Street, Suite 3110

Boston, Massachusetts

02110

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code: (857) 449-2244

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, $0.0001 par value per share

 

KRTX

 

Nasdaq Global Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

 

Non-accelerated filer

 

 

Smaller reporting company

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of October 31, 2019, the registrant had 23,412,754 shares of common stock, $0.0001 par value per share, outstanding.

 

 

 

 


 

Table of Contents

 

 

 

Page

PART I.

FINANCIAL INFORMATION

1

Item 1.

Financial Statements (Unaudited)

1

 

Balance Sheets

1

 

Statements of Operations

2

 

Statements of Comprehensive Loss

3

 

Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

4

 

Statements of Cash Flows

5

 

Notes to Financial Statements (Unaudited)

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

Item 4.

Controls and Procedures

33

PART II.

OTHER INFORMATION

34

Item 1.

Legal Proceedings

34

Item 1A.

Risk Factors

34

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

34

Item 3.

Defaults Upon Senior Securities

34

Item 4.

Mine Safety Disclosures

34

Item 5.

Other Information

34

Item 6.

Exhibits

35

Signatures

36

 

 

i


 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

KARUNA THERAPEUTICS, INC.

BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

 

 

 

September 30,

2019

 

 

December 31,

2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

54,144

 

 

$

8,904

 

Short-term investments

 

 

107,461

 

 

 

4,983

 

Prepaid expenses and other current assets

 

 

2,323

 

 

 

1,709

 

Total current assets

 

 

163,928

 

 

 

15,596

 

Restricted cash

 

 

123

 

 

 

123

 

Property and equipment, net

 

 

176

 

 

 

138

 

Total assets

 

$

164,227

 

 

$

15,857

 

Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable (includes $10 and $112 at September 30, 2019 and December 31,

   2018, respectively, due to related parties)

 

158

 

 

$

269

 

Accrued expenses

 

 

1,319

 

 

 

538

 

Deferred lease obligation, short term portion

 

 

56

 

 

 

 

Derivative liability

 

 

 

 

 

389

 

Total current liabilities

 

 

1,533

 

 

 

1,196

 

Non-current convertible notes, net of discount

 

 

 

 

 

2,516

 

Deferred lease obligation, long term portion

 

 

164

 

 

 

102

 

Total liabilities

 

 

1,697

 

 

 

3,814

 

Commitments and Contingencies (Note 11)

 

 

 

 

 

 

 

 

Redeemable convertible preferred stock

 

 

 

 

 

 

 

 

Redeemable convertible preferred stock, Series Seed, $0.0001 par value; 0 and

   4,412,500 shares authorized and outstanding at September 30, 2019 and

   December 31, 2018, respectively

 

 

 

 

 

1

 

Redeemable convertible preferred stock, Series A, $0.0001 par value; 0 and 3,126,700

   shares authorized and outstanding at September 30, 2019 and December 31, 2018,

   respectively

 

 

 

 

 

41,964

 

Redeemable convertible preferred stock, Series B, $0.0001 par value; 0 shares

   authorized and outstanding at September 30, 2019 and December 31, 2018

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value; 10,000,000 and 0 shares authorized as of

   September 30, 2019 and December 31, 2018, respectively; 0 shares outstanding at

   September 30, 2019 and December 31, 2018

 

 

 

 

 

 

Common stock, $0.0001 par value; 150,000,000 and 12,337,650 shares authorized at

   September 30, 2019 and December 31, 2018, respectively; 23,412,754 and 12

   shares issued and outstanding at September 30, 2019

   and December 31, 2018, respectively

 

 

2

 

 

 

 

Additional paid-in capital

 

 

230,216

 

 

 

1,633

 

Accumulated deficit

 

 

(67,738

)

 

 

(31,555

)

Accumulated other comprehensive income

 

 

50

 

 

 

 

Total stockholders’ equity (deficit)

 

 

162,530

 

 

 

(29,922

)

Total liabilities, redeemable convertible preferred stock and

   stockholders’ equity (deficit)

 

$

164,227

 

 

$

15,857

 

 

The accompanying notes are an integral part of these financial statements

1


 

Karuna Therapeutics, Inc.

Statements of Operations

(In thousands, except share and per share data)

(Unaudited)

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

5,793

 

 

$

1,417

 

 

$

19,544

 

 

$

4,816

 

General and administrative

 

 

4,103

 

 

 

1,056

 

 

 

16,995

 

 

 

1,548

 

Total operating expenses

 

 

9,896

 

 

 

2,473

 

 

 

36,539

 

 

 

6,364

 

Loss from operations

 

 

(9,896

)

 

 

(2,473

)

 

 

(36,539

)

 

 

(6,364

)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income (expense) (Note 4)

 

 

 

 

 

192

 

 

 

11

 

 

 

(396

)

Interest income

 

 

858

 

 

 

 

 

 

1,425

 

 

 

 

Accretion of debt discount

 

 

 

 

 

(1,324

)

 

 

(945

)

 

 

(1,996

)

Change in fair value of derivative

 

 

 

 

 

(2,633

)

 

 

(135

)

 

 

(429

)

Total other income (expense), net

 

 

858

 

 

 

(3,765

)

 

 

356

 

 

 

(2,821

)

Net loss before income taxes

 

 

(9,038

)

 

 

(6,238

)

 

 

(36,183

)

 

 

(9,185

)

Income tax provision

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common stockholders

 

$

(9,038

)

 

$

(6,238

)

 

$

(36,183

)

 

$

(9,185

)

Net loss per share, basic and diluted (Note 8)

 

$

(0.39

)

 

$

(1,247,600

)

 

$

(4.67

)

 

$

(4,592,500

)

Weighted average common shares outstanding used in

   computing net loss per share, basic and diluted

 

 

22,907,349

 

 

 

5

 

 

 

7,755,137

 

 

 

2

 

 

The accompanying notes are an integral part of these financial statements

2


 

Karuna Therapeutics, Inc.

STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Net loss

 

$

(9,038

)

 

$

(6,238

)

 

$

(36,183

)

 

$

(9,185

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses) gains on short-term investments

 

 

(21

)

 

 

 

 

 

50

 

 

 

 

Comprehensive loss

 

$

(9,059

)

 

$

(6,238

)

 

$

(36,133

)

 

$

(9,185

)

 

The accompanying notes are an integral part of these financial statements

 

3


 

Karuna Therapeutics, Inc.

Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(In thousands, except share data)

(Unaudited)

 

 

 

Series Seed Redeemable

Convertible Preferred

Stock

 

 

Series A Redeemable

Convertible Preferred

Stock

 

 

Series B Redeemable

Convertible Preferred

Stock

 

 

 

Common Stock

 

 

Additional

Paid-in

 

 

Accumulated

 

 

Accumulated

Other

Comprehensive

 

 

Total

Stockholders’

Equity

 

 

 

Shares

 

 

Value

 

 

Shares

 

 

Value

 

 

Shares

 

 

Value

 

 

 

Shares

 

 

Value

 

 

Capital

 

 

Deficit

 

 

Income

 

 

(Deficit)

 

Balance, December 31, 2018

 

 

4,412,500

 

 

$

1

 

 

 

3,126,700

 

 

$

41,964

 

 

 

 

 

$

 

 

 

 

12

 

 

$

 

 

$

1,633

 

 

$

(31,555

)

 

$

 

 

$

(29,922

)

Issuance of Series B

   redeemable convertible

   preferred stock, net of

   issuance costs of $175

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5,422,845

 

 

 

81,927

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

   expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,945

 

 

 

 

 

 

 

 

 

9,945

 

Exercise of common warrants

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

19,986

 

 

 

 

 

 

58

 

 

 

 

 

 

 

 

 

58

 

Exercise of common options

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

38,961

 

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

4

 

Vesting of restricted stock

   units

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

105,163

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

71

 

 

 

71

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(27,145

)

 

 

 

 

 

(27,145

)

Balance, June 30, 2019

 

 

4,412,500

 

 

$

1

 

 

 

3,126,700

 

 

$

41,964

 

 

 

5,422,845

 

 

$

81,927

 

 

 

 

164,122

 

 

$

 

 

$

11,640

 

 

$

(58,700

)

 

$

71

 

 

$

(46,989

)

Issuance of common stock

   upon initial public offering,

   net of $7.2 million in under-

   writing discounts and

   commissions and $2.4

   million in offering costs

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,414,842

 

 

 

1

 

 

 

93,043

 

 

 

 

 

 

 

 

 

93,044

 

Automatic conversion of

   preferred stock

 

 

(4,412,500

)

 

 

(1

)

 

 

(3,126,700

)

 

 

(41,964

)

 

 

(5,422,845

)

 

 

(81,927

)

 

 

 

16,833,790

 

 

 

1

 

 

 

123,891

 

 

 

 

 

 

 

 

 

123,892

 

Stock-based compensation

   expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,642

 

 

 

 

 

 

 

 

 

1,642

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(21

)

 

 

(21

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,038

)

 

 

 

 

 

(9,038

)

Balance, September 30, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

23,412,754

 

 

 

2

 

 

 

230,216

 

 

 

(67,738

)

 

 

50

 

 

 

162,530

 

 

 

 

Series Seed Redeemable

Convertible Preferred

Stock

 

 

Series A Redeemable

Convertible Preferred

Stock

 

 

Series B Redeemable

Convertible Preferred

Stock

 

 

 

Common Stock

 

 

Additional

Paid-in

 

 

Accumulated

 

 

Accumulated

Other

Comprehensive

 

 

Total

Stockholders’

Equity

 

 

 

Shares

 

 

Value

 

 

Shares

 

 

Value

 

 

Shares

 

 

Value

 

 

 

Shares

 

 

Value

 

 

Capital

 

 

Deficit

 

 

Income

 

 

(Deficit)

 

Balance, December 31, 2017

 

 

4,412,500

 

 

$

1

 

 

 

 

 

$

 

 

 

 

 

$

 

 

 

 

 

 

$

 

 

$

675

 

 

$

(14,043

)

 

$

 

 

$

(13,368

)

Stock-based compensation

   expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

128

 

 

 

 

 

 

 

 

 

128

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,947

)

 

 

 

 

 

(2,947

)

Balance, June 30, 2018

 

 

4,412,500

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

803

 

 

 

(16,990

)

 

 

 

 

 

(16,187

)

Issuance of Series A

   redeemable convertible

   preferred stock, net of

   issuance costs of $121

 

 

 

 

 

 

 

 

3,126,700

 

 

 

41,964

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

   expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

415

 

 

 

 

 

 

 

 

 

415

 

Exercise of common warrants

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,238

)

 

 

 

 

 

(6,238

)

Balance, September 30, 2018

 

 

4,412,500

 

 

$

1

 

 

 

3,126,700

 

 

$

41,964

 

 

 

 

 

$

 

 

 

 

12

 

 

$

 

 

$

1,218

 

 

$

(23,228

)

 

$

 

 

$

(22,010

)

 

The accompanying notes are an integral part of these financial statements

 

4


 

Karuna Therapeutics, Inc.

Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended

September 30,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(36,183

)

 

$

(9,185

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

11,587

 

 

 

517

 

Accretion of debt discount

 

 

945

 

 

 

1,996

 

Non-cash interest income

 

 

(787

)

 

 

 

Change in fair value of derivative liability

 

 

135

 

 

 

429

 

Depreciation and amortization expense

 

 

37

 

 

 

2

 

Non-cash interest (income) expense

 

 

(11

)

 

 

396

 

Warrant expense

 

 

 

 

 

26

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accrued expenses

 

 

781

 

 

 

(16

)

Prepaid expenses and other current assets

 

 

(614

)

 

 

(2,076

)

Deferred lease obligation

 

 

118

 

 

 

 

Accounts payable

 

 

(111

)

 

 

(602

)

Net cash used in operating activities

 

 

(24,103

)

 

 

(8,513

)

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of short-term investments

 

 

(131,641

)

 

 

 

Maturities of short-term investments

 

 

30,000

 

 

 

 

Acquisition of property and equipment

 

 

(75

)

 

 

 

Net cash used in investing activities

 

 

(101,716

)

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from initial public offering, net of $7.2 million in underwriting

   discounts and commissions

 

 

95,453

 

 

 

 

Payment of initial public offering costs

 

 

(2,409

)

 

 

 

Proceeds from issuance of Series B redeemable convertible preferred stock,

   net of issuance costs

 

 

74,825

 

 

 

 

Proceeds from issuance of Series A redeemable convertible preferred stock,

   net of issuance costs

 

 

 

 

 

15,877

 

Proceeds from issuance of convertible notes

 

 

3,128

 

 

 

9,000

 

Proceeds from exercise of warrant

 

 

58

 

 

 

 

Proceeds from exercise of stock options

 

 

4

 

 

 

 

Net cash provided by financing activities

 

 

171,059

 

 

 

24,877

 

Net increase in cash, cash equivalents and restricted cash

 

 

45,240

 

 

 

16,364

 

Cash, cash equivalents and restricted cash at beginning of period

 

 

9,027

 

 

 

1,942

 

Cash, cash equivalents and restricted cash at end of period

 

$

54,267

 

 

$

18,306

 

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flows information

 

 

 

 

 

 

 

 

Conversion of redeemable convertible preferred stock into common stock

 

$

123,892

 

 

$

-

 

Conversion of convertible notes, accrued interest and discount upon

   conversion to preferred stock

 

$

7,102

 

 

$

26,087

 

 

The accompanying notes are an integral part of these financial statements

5


 

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

Note 1. Nature of the Business

Karuna Therapeutics, Inc. (the “Company”) was incorporated under the laws of the State of Delaware in July 2009 as Karuna Pharmaceuticals, Inc. and is headquartered in Boston, Massachusetts. In March 2019, the Company changed its name to Karuna Therapeutics, Inc. The Company is focused on the development of novel therapies to address disabling neuropsychiatric conditions characterized by significant unmet medical need.

Since the Company’s inception, it has focused substantially all of its efforts and financial resources on organizing and staffing the Company, acquiring and developing its technology, raising capital, building its intellectual property portfolio, undertaking preclinical studies and clinical trials and providing general and administrative support for these activities. The Company has not generated any product revenue related to its primary business purpose to date and is subject to a number of risks similar to those of other early stage companies, including dependence on key individuals, regulatory approval of products, uncertainty of market acceptance of products, competition from substitute products and larger companies, compliance with government regulations, protection of proprietary technology, dependence on third parties, product liability and the need to obtain adequate additional financing to fund the development of its product candidates.

Forward Stock Split

On June 14, 2019, the Company effected a one-for-1.2987 stock split of its issued and outstanding shares of common stock and a proportional adjustment to the existing conversion ratios for each series of the Company’s redeemable convertible preferred stock (see Note 5). Accordingly, all share and per share amounts for all periods presented in the accompanying financial statements and notes thereto have been adjusted retroactively, where applicable, to reflect this stock split and adjustment of the redeemable convertible preferred stock conversion ratios.

Initial Public Offering

On June 27, 2019, the Company’s registration statement on Form S-1 relating to its initial public offering of its common stock (“IPO”) was declared effective by the Securities and Exchange Commission (“SEC”). In the IPO, which closed on July 2, 2019, the Company issued and sold 6,414,842 shares of common stock, including full exercise of the underwriters’ over-allotment option to purchase an additional 836,718 shares, at a public offering price of $16.00 per share. The aggregate net proceeds to the Company from the IPO, inclusive of proceeds from the over-allotment exercise, were approximately $93.0 million after deducting underwriting discounts and commissions of $7.2 million and offering expenses of $2.4 million. Upon closing of the IPO, all 12,962,045 shares of the Company’s redeemable convertible preferred stock then outstanding converted into an aggregate of 16,833,790 shares of common stock.

Liquidity

The Company’s financial statements have been prepared on the basis of continuity of operations, realization of assets and the satisfaction of liabilities in the ordinary course of business. The Company experienced negative operating cash flows of $24.1 million for the nine months ended September 30, 2019 and had an accumulated deficit of $67.7 million as of September 30, 2019. The Company expects to continue to generate operating losses for the foreseeable future.

The Company expects that its cash and cash equivalents and short-term investments of $161.6 million as of September 30, 2019 will be sufficient to fund its operating expenses and capital expenditure requirements through at least 12 months from the date of issuance of these financial statements. The future viability of the Company beyond that point is dependent on its ability to raise additional capital to fund its operations.

If the Company is unable to obtain funding, the Company could be forced to delay, reduce or eliminate some or all of its research and development programs, product portfolio expansion or commercialization efforts, which could adversely affect its business prospects, or the Company may be unable to continue operations. Although management continues to pursue these plans, there is no assurance that the Company will be successful in obtaining sufficient funding on terms acceptable to the Company to fund continuing operations, if at all.

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NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Use of Estimates

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Any reference in these notes to applicable guidance is meant to refer to the authoritative United States generally accepted accounting principles as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASUs”) of the Financial Accounting Standards Board (“FASB”).

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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Significant estimates and assumptions reflected in these financial statements include, but are not limited to, the accrual for research and development expenses, the valuation of stock-based awards and prior to the IPO, the valuation of common stock, and derivative liabilities. Estimates are periodically reviewed in light of changes in circumstances, facts and experience. Changes in estimates are recorded in the period in which they become known. Actual results could differ from those estimates.

Unaudited Interim Financial Information

The accompanying balance sheet as of September 30, 2019, the statements of operations, comprehensive loss, and cash flows for the three and nine months ended September 30, 2019 and 2018, and the statements of redeemable convertible preferred stock and stockholders’ equity (deficit) for the three and nine months ended September 30, 2019 and 2018 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2019 and the results of its operations and its cash flows for the three and nine months ended September 30, 2019 and 2018. Certain information and footnote disclosures typically included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. Accordingly, these unaudited interim financial statements should be read in conjunction with the Company’s financial statements as of and for the year ended December 31, 2018, which are included in the Company’s prospectus related to the Company’s IPO, filed June 28, 2019 (File No. 333-231863) with the SEC, pursuant to Rule 424(b) under the Securities Act of 1933, as amended. The results for the three and nine months ended September 30, 2019, are not necessarily indicative of results to be expected for the year ending December 31, 2019, any other interim periods, or any future year or period.

Cash and Cash Equivalents

The Company considers all short-term, highly liquid investments with original maturities of 90 days or less at acquisition date to be cash equivalents.

Short-term Investments

The Company’s short-term investments are classified as available-for-sale and are carried at fair value with the unrealized gains and losses reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary are included as a component of other income (expense), net based on the specific identification method.

Concentration of Manufacturing Risk

The Company is dependent on third-party manufacturers to supply products for research and development activities in its programs. In particular, the Company relies and expects to continue to rely on a small number of manufacturers to supply it with its requirements for the active pharmaceutical ingredients and formulated drugs related to these programs. These programs could be adversely affected by a significant interruption in the supply of active pharmaceutical ingredients and formulated drugs.

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Deferred Offering Costs

The Company capitalizes certain legal, professional accounting and other third-party fees that are directly associated with in-process equity financings as deferred offering costs until such financings are consummated. After consummation of the equity financing, these costs are recorded in stockholders’ equity (deficit) as a reduction of additional paid-in capital generated as a result of the offering. Should an in-process equity financing be abandoned, the deferred offering costs will be expensed immediately as a charge to operating expenses in the statements of operations. As of September 30, 2019 and December 31, 2018, there were no deferred offering costs outstanding. All deferred offering costs accumulated during 2019 and associated with the Company’s IPO were recorded as a reduction of additional paid-in capital upon the close of the Company’s IPO on July 2, 2019.

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash equivalents, short-term investments, prepaid expenses, interest receivable, accounts payable, accrued expenses, convertible notes and derivatives embedded within the convertible notes. The carrying amount of prepaid expenses, interest receivable, accounts payable and accrued expenses are considered a reasonable estimate of their fair value, due to the short-term maturity of these instruments. The Company’s cash equivalents, short-term investments, convertible notes, and derivative liabilities are carried at fair value, determined according to the fair value hierarchy described below (see Note 10).

The Company follows the guidance in FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value and establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

Level 1:

Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

Level 2:

Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

Level 3:

Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions reflect those that market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

Convertible Notes and Derivative Liabilities

In connection with the issuance of the Wellcome Trust Convertible Notes and the Convertible Notes (see Note 4), the Company had identified embedded derivatives, which were recorded as liabilities on the Company’s balance sheets and were remeasured to fair value at each reporting date until the derivative was settled. Changes in the fair value of the derivative liabilities are recognized as change in fair value of derivative in the statements of operations. The fair value of the derivative liabilities were determined at each period end using a with and without method, which assesses the likelihood and timing of events that would result in either a conversion or change-of-control feature being triggered, as well as changes in the market conditions.

Upon issuance of the notes, each note was recorded at cost, net of the derivative liability. The discount on each note was amortized as interest expense to the date such note was expected to convert using the effective interest rate method and is reflected in the statements of operations as accretion of debt discount.

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The Company classified its derivative liabilities in the balance sheet as current or non-current based on its expectation of when the derivative will be settled, consistent with the assumptions used when determining the fair value of the derivative liabilities.

Redeemable Convertible Preferred Stock

Prior to the IPO, the Company recorded all shares of redeemable convertible preferred stock at their respective fair values on the dates of issuance, net of issuance costs. The redeemable convertible preferred stock was recorded outside of permanent equity because upon the occurrence of certain deemed liquidation events, the majority of the holders could opt to redeem the shares at the liquidation preference and these events, including a merger, acquisition or sale of substantially all of the assets, was considered not solely within the Company’s control. Prior to the IPO, the Company had not adjusted the carrying values of the redeemable convertible preferred stock to its redemption value because it was uncertain whether or when a deemed liquidation event would occur. Upon closing of the IPO, all 12,962,045 shares of the Company’s redeemable convertible preferred stock then outstanding converted into an aggregate of 16,833,790 shares of common stock.

Leases

Leases are classified at their inception as either operating or capital leases based on the economic substance of the agreement. The Company recognizes rent expense for its operating leases, inclusive of rent escalation provisions and rent holidays, on a straight-line basis over the respective lease term. Additionally, the Company recognizes tenant improvement allowances under the operating leases as a deferred lease obligation and amortizes the tenant improvement allowances as a reduction to rent expense on a straight-line basis over the respective lease term. At September 30, 2019 and December 31, 2018, no capital leases were recorded in the balance sheets.

Research and Development Costs

Research and development costs are expensed as incurred. Research and development costs include salaries and bonuses, stock compensation, employee benefits, consulting costs and external contract research and development and manufacturing expenses.

Upfront payments and milestone payments made for the licensing of technology are expensed as research and development in the period in which they are incurred. Advance payments for goods or services to be received in the future for use in research and development activities are recorded as prepaid expenses. The prepaid amounts are expensed as the related goods are delivered or the services are performed.

Research Contract Costs and Accruals

The Company accrues for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical studies and clinical trials, and contract manufacturing activities. The Company records the estimated costs of research and development activities based upon the estimated amount of services provided and includes these costs in accrued liabilities in the balance sheets and within research and development expense in the statements of operations. When evaluating the adequacy of the accrued liabilities, the Company analyzes progress of the research studies or clinical trials and manufacturing activities, including the phase or completion of events, invoices received and contracted costs. Significant judgments and estimates may be made in determining the accrued balances at the end of any reporting period. Actual results could differ from the Company’s estimates. The Company’s historical accrual estimates have not been materially different from the actual costs.

Stock-Based Compensation

The Company measures all stock options and other stock-based awards based on the date of the grant and recognizes compensation expense of those awards over the requisite service period, which is generally the vesting period of the respective award. The Company has mainly issued stock options with service-based vesting conditions and records the expense for these awards using the straight-line method. The Company has also issued stock options with performance-based vesting conditions and records the expense for these awards at the time that the achievement of the performance becomes highly probable or complete. The Company recognizes adjustments to stock-based compensation expense for forfeitures as they occur. The Company classifies stock-based compensation expense in its statements of operations in the same manner in which the award recipient’s payroll costs are classified or in which the award recipients’ service payments are classified.

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The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Company historically has been a private company and lacked company-specific historical and implied volatility information. Therefore, it estimated its expected stock volatility based on the historical volatility of a publicly traded set of peer companies and expects to do so until such time as it has adequate his