KINETA, INC./DE - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2020

OR

For the transition period from           to           

Commission file number: 001-37695

Proteostasis Therapeutics, Inc.

(Exact name of registrant as specified in its charter)

(617) 225-0096

(Registrant’s telephone number, including area code)

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

Securities registered pursuant to the Section 12(g) of the Act: None

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.

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 November 12, 2020, there were 52,184,755 shares of the registrant’s common stock, $0.001 par value per share, outstanding.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, or this report, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are often identified by the words, “aim,” “anticipate,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “project,” “seek,” “should,” “target,”  “will,” “would” or the negative of these terms or other comparable terminology intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements about:

You should refer to “Risk Factors” for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this report.

Any forward-looking statements in this report reflect our current views with respect to future events and with respect to our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those described under Part II, Item 1A. Risk Factors and elsewhere in this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

This report contains estimates, projections and other information concerning our industry, the general business environment, and the markets for certain diseases, including estimates regarding the potential size of those markets and the estimated incidence and prevalence of certain medical conditions. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events, circumstances or numbers, including actual disease prevalence rates and market size, may differ materially from the information reflected in this report. Unless otherwise expressly stated, we obtained this industry, business information, market data, prevalence information and other data from reports, research surveys, studies and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data, and similar sources, in some cases applying our own assumptions and analysis that may, in the future, not prove to have been accurate.

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Proteostasis Therapeutics, Inc.

INDEX

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PART I — FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED Financial Statements (Unaudited)

PROTEOSTASIS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.

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PROTEOSTASIS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share amounts)

(Unaudited)

The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.

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PROTEOSTASIS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share amounts)

(Unaudited)

The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.

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PROTEOSTASIS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.

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PROTEOSTASIS THERAPEUTICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Proteostasis Therapeutics, Inc. (the “Company”) was incorporated in Delaware on December 13, 2006. The Company is a clinical stage biopharmaceutical company committed to the discovery and development of novel therapeutics to treat cystic fibrosis (“CF”) through theratyping, or the process of matching modulators to individual response to treatment regardless of cystic fibrosis transmembrane conductance regulator (“CFTR”) mutations. CF is a disease caused by defects in the function or abundance of CFTR protein.

Since its inception, the Company has devoted substantially all of its efforts to organizing and staffing the Company, business planning, raising capital, acquiring and developing product and technology rights, and conducting research and development activities. It has funded its operations to date with proceeds from the sale of preferred stock, the issuance of convertible promissory notes, proceeds from its initial public offering in February 2016, proceeds from its follow-on public offerings, and payments received in connection with collaboration agreements and a research grant, as well as funds from the sale of stock under at-the-market offering programs.

In August 2020, the Company announced that after consideration of various financing and strategic alternatives for its CF portfolio, with the goal of maximizing stockholder value of these assets, it has decided to continue its operations while exploring business and strategic options related to its research and discovery platform and intellectual property portfolio.

On August 14, 2020, the Company formed Pangolin Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Sub”).

After conducting a process of evaluating strategic alternatives for the Company, on August 22, 2020, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Yumanity Therapeutics, Inc., a Delaware corporation (“Yumanity”), Yumanity Holdings, LLC, a Delaware limited liability company (“Holdings) and the Merger Sub, which was subsequently amended on November 6, 2020. Upon the terms and subject to the satisfaction of the conditions described in the Merger Agreement, including approval of the transaction by the Company’s stockholders and Yumanity’s stockholders and the consolidation of Yumanity and Holdings prior to the closing of the transaction, Merger Sub will be merged with and into Yumanity (the “Merger”), with Yumanity surviving the Merger as a wholly-owned subsidiary of the Company. If the Merger is completed, the business of the Company will become the business of Yumanity.

The Merger is expected to be treated by the Company as a reverse merger accounted for as an asset acquisition in accordance with accounting principles generally accepted in the United States (“GAAP”). For accounting purposes, Yumanity is considered to be acquiring the Company in the Merger. In accordance with the accounting guidance under Accounting Standard Updates (or “ASU”) 2017-01, the Merger is considered an asset acquisition. Accordingly, the assets and liabilities of the Company will be recorded as of the closing date of the Merger at the purchase price of the accounting acquirer. The Merger is expected to close in the fourth quarter of 2020, subject to the approval by the Company’s stockholders at a special meeting of the Company’s stockholders to be held on December 16, 2020, as well as other customary conditions. Upon completion of the Merger, the combined company will be renamed Yumanity Therapeutics, Inc., and is expected to trade on the Nasdaq Capital Market under the ticker symbol “YMTX”.

On August 22, 2020, due to the entry into of the Merger Agreement with Yumanity, the Company’s Board of Directors (the “Board”) committed to reducing its workforce by approximately 79% to a total of five full-time employees, who will remain with the Company until the closing of the Merger to assist with its day-to-day business operations, including the maintenance of the sale and disposition of the Company’s intellectual property and assets relating to its cystic fibrosis clinical program (the “CF Assets”), and those activities necessary to complete the proposed Merger. The Company has also retained its core intellectual property, licenses, collaborations with research institutions and universities, and proprietary equipment. The Company has incurred certain restructuring costs related to a reduction in its workforce, totaling $2.4 million through September 30, 2020. At September 30, 2020, the Company has have accrued one-time termination benefits of $1.6 million, of which the majority of this amount is anticipated to be incurred in the fourth quarter of 2020. In addition to restructuring costs, the Company has incurred approximately $1.6 million in other merger-related costs, which are included in the general and administrative costs on the Company’s statement of operations and consists primarily of professional fees.

Although the Company has entered into the Merger Agreement and intends to consummate the Merger, there is no assurance that it will be able to successfully consummate the Merger on a timely basis, or at all. If, for any reason, the Merger does not close, the Company’s Board may elect to, among other things, attempt to complete another strategic transaction like the Merger, attempt to sell or otherwise dispose of the Company’s various assets, resume the Company’s research and development activities and continue to operate the Company’s business or dissolve and liquidate its assets. If the Company decides to dissolve and liquidate its assets, it would be required to pay all of its debts and contractual obligations, and set aside certain reserves for potential future claims, and there can be no assurances as to the amount or timing of available cash left, if any, to distribute to the Company’s stockholders after paying its debts and other obligations and setting aside funds for reserves. If the Company were to continue its business, it would need to raise a substantial amount of cash to fund ongoing operations and future development activities for its existing product candidates.

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The Company has not generated any commercial revenue since inception. As a result, the Company has incurred recurring losses and requires significant cash resources to execute its business plans. In accordance with ASC 205-40, Going Concern (“ASC 205-40”), the Company has evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the consolidated financial statements are issued. As of September 30, 2020, the Company had an accumulated deficit of $363.6 million. The Company has incurred losses and negative cash flows from operations since its inception. During the nine months ended September 30, 2020, the Company incurred losses of $26.9 million and used $29.2 million of cash in operations. The Company expects that its operating losses and negative cash flows will continue for the foreseeable future. The Company currently expects that its cash, cash equivalents and short-term investments of $40.8 million will be sufficient to fund its operating expenses and capital requirements, based upon its current operating plan, for at least 12 months from the date that these consolidated financial statements are issued.

The novel coronavirus (“COVID-19”) pandemic continues to rapidly evolve and has already resulted in a significant disruption of global financial markets and may affect the Company’s operations and those of third parties on which the Company relies. While the potential economic impact brought by, and the duration of, the COVID-19 pandemic is difficult to assess or predict, the impact of the COVID-19 pandemic on the global financial markets may reduce the Company’s ability to access capital, which could negatively impact the Company’s short-term and long-term liquidity and the Company’s and Yumanity’s ability to complete the Merger on a timely basis or at all. The ultimate impact of the COVID-19 pandemic is highly uncertain and subject to change. The Company does not yet know the full extent of potential delays or impacts on its business, financing or other activities or on healthcare systems or the global economy as a whole. However, these effects could have a material impact on the Company’s liquidity, capital resources, operations and business and those of the third parties on which the Company relies.

Unaudited Interim Consolidated Financial Information

The condensed balance sheet as of December 31, 2019 was derived from audited financial statements but does not include all disclosures required by GAAP. The accompanying condensed consolidated financial statements, as of September 30, 2020 and for the three and nine months ended September 30, 2020, are unaudited and have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto for the year ended December 31, 2019 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on March 10, 2020. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, as necessary for the fair statement of the Company’s financial position as of September 30, 2020, results of its operations for the three and nine months ended September 30, 2020, stockholders’ equity for the three and nine months ended September 30, 2020, and cash flows for the nine months ended September 30, 2020, have been made. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results of operations to be expected for the year ending December 31, 2020.

Summary of Significant Accounting Policies

The Company’s significant accounting policies, which are disclosed in the audited financial statements for the year ended December 31, 2019 and the notes thereto, are included in the Company’s Annual Report on Form 10-K that was filed with the SEC on March 10, 2020 (the “Annual Report”). There were no changes to significant accounting policies during the three and nine months ended September 30, 2020.

Risks and Uncertainties

The Company is monitoring the potential impact of the ongoing COVID-19 pandemic, if any, on the carrying value of certain assets. To date, the Company has not experienced material business disruption, nor has it incurred impairment of any assets as a result of the COVID-19 pandemic. The extent to which these events may impact the Company’s business, clinical development and regulatory efforts, and the value of its common stock, will depend on future developments, which are highly uncertain and cannot be predicted at this time. The duration and intensity of these impacts and resulting disruption to the Company’s operations is uncertain and the Company will continue to assess the financial impact. In addition, to the extent the ongoing COVID-19 pandemic adversely affects the Company’s business and results of operations, including the ability to execute the proposed Merger, it may also have the effect of heightening many of the other risks and uncertainties discussed in the Annual Report.

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Use of Estimates

The preparation of financial statements in conformity with 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 condensed consolidated financial statements include, but are not limited to, revenue recognition, the accrual for research and development expenses, and the valuation the derivative liability. 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.

Reclassifications

Certain prior year amounts have been reclassified for consistency with the current year presentation. An adjustment has also been made to the condensed statement of cash flows for the period ended September 30, 2019, to reclassify non-cash lease expense out of depreciation and amortization.

Consolidation

These consolidated financial statements include Pangolin Merger Sub, Inc., the Company’s wholly-owned subsidiary. All intercompany transactions and balances are eliminated in consolidation.

Recently Adopted Accounting Pronouncements

ASU No. 2018-13, Fair Value Measurement (Topic 820): Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued ASU No. 2018-13, Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). The new standard modifies the disclosure requirements on fair value measure in Topic 820, including removals of existing disclosures, modifications of existing disclosures, and additions of new disclosures. Certain amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair values measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim of annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted for any removed or modified disclosure. The new standard is effective for the Company on January 1, 2020. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The FASB subsequently issued amendments to ASU 2016-13, which have the same effective date and transition date of January 1, 2022, as the Company is a smaller reporting company. These standards require that credit losses be reported using an expected losses model rather than the incurred losses model that is currently used, and establishes additional disclosures related to credit risks. For available-for-sale debt securities with unrealized losses, these standards now require allowances to be recorded instead of reducing the amortized cost of the investment. These standards limit the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and requires the reversal of previously recognized credit losses if fair value increases. Based on the composition of the Company’s investment portfolio and other financial assets, current market conditions and historical credit loss activity, the adoption of these standards is not expected to have a material impact on the Company’s condensed consolidated financial statements.

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The following table summarizes the Company’s short-term investments as of September 30, 2020 and December 31, 2019 (in thousands):

Short-term investments represent holdings of available-for-sale debt securities and are reported at fair value with unrealized gains and losses reported net of taxes, if material, in other comprehensive income. The Company did not have any realized gains or losses on its short-term investments for the three and nine months ended September 30, 2020 and 2019, respectively. There were no other-than-temporary impairments recognized for the three and nine months ended September 30, 2020 and 2019, respectively.

The following tables present information about the Company’s financial assets and liabilities measured at fair value on a recurring basis and indicate the level of the fair value hierarchy utilized to determine such fair values (in thousands):

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During the periods ended September 30, 2020 and December 31, 2019, there were no transfers between Level 1, Level 2, and Level 3.

The derivative liability relates to a cash settlement option associated with the change of control provision in the Company’s Cystic Fibrosis Foundation, Inc. (“CFF”) agreement, which meets the definition of a derivative. The fair value of the derivative liability is based on significant inputs not observable in the market, which represents a Level 3 measurement within the fair value hierarchy. The fair value of the derivative instrument was originally determined using the Monte-Carlo simulation analysis. In determining the fair value of the derivative liability, the inputs impacting fair value include the fair value of the Company’s common stock, expected term of the derivative instrument, expected volatility of the common stock price, risk-free interest rate, expected sales-based milestone payments, discount rate, probability of a change of control event, and the probability that the counterparty would elect to accept the alternative cash payment in lieu of its right to the future sales-based milestone payments.

The fair value of the derivative liability was not material at September 30, 2020 and December 31, 2019.

Prepaids and other current assets consisted of the following (in thousands):

Accrued expenses consisted of the following (in thousands):

As of September 30, 2020, the Company had short-term borrowings of $0.4 million consisting of a Commercial Insurance Premium Finance and Security Agreement (the “Finance and Security Agreement”) entered into on February 27, 2020. The Finance and Security Agreement has a ten-month repayment period with an annual interest rate of 2.59% and a maturity of December 11, 2020. Collateral under the Finance and Security Agreement includes the right, title, and interest in the underlying business insurance policies. As of September 30, 2020, the Company has paid less than $0.1 million in interest on short-term borrowings.

2016 Stock Option and Incentive Plan

On February 3, 2016, the Company’s stockholders approved the 2016 Stock Option and Incentive Plan (the “2016 Plan”), which became effective on February 9, 2016. The 2016 Plan provides for the grant of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock units, restricted stock awards and other stock-based awards. The number of shares initially reserved for issuance under the 2016 Plan was 1,581,839 shares. The number of shares of common stock that may be issued under the 2016 Plan will automatically increase each January 1, beginning January 1, 2017, by the lesser of 3% of the shares of the Company’s common stock outstanding on the immediately preceding December 31, or an amount determined by the Company’s board of directors or the compensation committee of the board of directors. The shares of common stock underlying any awards that are forfeited, canceled, repurchased, or are otherwise terminated by the Company under the 2016 Plan and the 2008 Equity Incentive Plan, as amended (the “2008 Plan”) will be added back to the shares of common stock available for issuance under the 2016 Plan. On January 1, 2020, an additional 1,563,498 shares were reserved for issuance under the 2016 Plan. As of September 30, 2020, the total number of shares of the Company’s common stock reserved for issuance under the 2016 Plan was 6,914,838, of which 2,749,403 shares are available for future issuance under the 2016 Plan.

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2016 Employee Stock Purchase Plan

On February 3, 2016, the Company’s stockholders approved the 2016 Employee Stock Purchase Plan (the “2016 ESPP”), which became effective in connection with the completion of the Company’s initial public offering. A total of 138,757 shares of common stock were initially reserved for issuance under the 2016 ESPP. In addition, the number of shares of common stock that may be issued under the 2016 ESPP will automatically increase each January 1, beginning January 1, 2017, by the lesser of (i) 138,757 shares of common stock, (ii) 1% of the Company’s shares of common stock outstanding on the immediately preceding December 31, or (iii) an amount determined by the Company’s board of directors or the compensation committee of the board of directors.

During the nine months ended September 30, 2020, 59,232 shares of common stock were issued pursuant to the 2016 ESPP. As of September 30, 2020, the total number of shares reserved under the 2016 ESPP was 552,537 shares. The Company recognized less than $0.1 million of stock-based compensation during the three and nine months ended September 30, 2020 related to the 2016 ESPP.

Restricted Stock Units (RSUs)

On February 4, 2020, the Company’s Board approved payment to be made to a nonemployee through a grant of RSUs based on the February 4, 2020 closing share price of the Company’s common stock. The requisite service period for the awards was from February 4, 2020 to August 4, 2020 (the vesting period). The Company recognized employee stock-based compensation expense for the RSU grant on a straight-line basis over the vesting period of the awards. As of September 30, 2020, 4,519 RSUs have vested and the Company recognized less than $0.1 million of stock-based compensation expense during the three and nine months ended September 30, 2020.

On June 29, 2020, the Company’s Board approved the grant of RSU awards with an aggregate fair market value equal to the RSU value of $1.2 million (each, an “Award”) to two consultants (each, a “Grantee”) in consideration for services. Each Award shall vest in full immediately prior to, but subject to the occurrence of, a specific strategic event (the “Vesting Date”), so long as the respective Grantee remains in service to the Company through the Vesting Date. If the Awards vest as provided for above, the Company shall issue a number of shares of stock equal to the RSU value, divided by the volume-weighted average price per share of the Company’s stock for the 10-day period ending on the Vesting Date. The Company also has the option to issue each Grantee the respective cash equivalent of the Award in part or in full satisfaction of the delivery of the stock in connection with the vesting of each Award. The Company believes equity classification of the RSUs is appropriate as the Company, not the Grantee, has the ability to determine whether to settle the Awards in cash or shares as of the reporting date and it reasonably expects to deliver the share equivalent of the Awards at the settlement date. As of September 30, 2020, the Company did not recognize compensation costs associated with the Awards as the occurrence of such strategic event is outside of the Company’s control and therefore, cannot be considered probable.  

Stock-Based Compensation

Stock-based compensation expense, including shares issued to consultants for services, was classified in the statements of operations as follows (in thousands):

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The following table summarizes the Company’s stock option activity for the nine months ended September 30, 2020 (in thousands except share and per share amounts):

The grant date fair value of options granted during the period was $1.8 million, or $1.09 per share on a weighted-average basis, and will be recognized as compensation expense over the requisite service period of four years.

As of September 30, 2020, there was $1.6 million of unrecognized compensation cost related to employee and nonemployee unvested stock options granted under the 2016 Plan, which is expected to be recognized over a weighted-average remaining service period of 2.1 years. Stock compensation costs have not been capitalized by the Company.

Prior to 2013, the Company issued options to purchase 203,964 shares of common stock to nonemployees, primarily members of the Company’s scientific advisory board, that vest upon the achievement of specified development and clinical milestones. As of September 30, 2020, options for the purchase of 83,250 shares held by nonemployees remained unvested, pending achievement of the specified milestones.

On August 22, 2020, due to the entry into the Merger Agreement with Yumanity, the Company’s Board committed to reducing its workforce by approximately 79% to a total of five full-time employees, who will remain with the Company until the closing of the proposed Merger to assist with its day-to-day business operations, including the maintenance of the rights of all or any part of the Company’s intellectual property portfolio relating to its cystic fibrosis clinical programs (the “CF Assets”), and those activities necessary to complete the proposed Merger. All employees affected by the workforce reduction are eligible to receive, among other things, severance payments based on the applicable employee’s level and years of service with the Company and the continuation of group health insurance coverage for a specified time period post-termination. In addition, certain affected employees are eligible for an extension of the post-termination exercise period for their outstanding stock options. Each affected employee’s eligibility for the severance benefits was contingent upon such employee’s execution of a separation agreement, which includes a general release of claims against the Company.

The following table represents activity related to the Company’s restructuring costs liability for nine months ended September 30, 2020 (in thousands):

As a result of the workforce reduction, the Company has recorded restructuring costs, primarily related to severance-related payments, in the amount of $2.4 million. The Company expects to incur total restructuring costs between $4.2 million to $4.7 million related to the Company’s restructuring plan.  

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Genentech

In December 2018, the Company entered into a Technology Transfer and License Agreement (the “Genentech Agreement”) with Genentech, Inc. (“Genentech”) under which the Company granted Genentech an exclusive worldwide license for technology and materials relating to potential therapeutic small molecule modulators of an undisclosed target within the proteostasis network. The rights do not include CFTR modulators and are unrelated to the Company’s investigational medicines or other ongoing research programs in cystic fibrosis. In connection with the terms of the Genentech Agreement, the Company was entitled to a nonrefundable cash payment of $5.0 million following the successful completion of the technology and materials transfer to Genentech and future milestone payments in the aggregate of approximately $96.0 million upon the achievement of specified development, regulatory, and commercial milestones. In addition, Genentech is obligated to pay the Company tiered royalties in the low single-digits based on net sales of products covered by the licenses granted under the Genentech Agreement. There are no cancellation, termination, or refund provisions in the Genentech Agreement that contain material financial consequences to the Company. Unless earlier terminated, the Genentech Agreement continues in full force and effect until the passing or expiration of all royalty payment obligations. Reciprocal termination rights under the agreement include termination for breach and termination for bankruptcy. Genentech may terminate the Genentech Agreement in its entirety, for convenience, upon thirty days’ notice to the Company.

The Company evaluated the Genentech Agreement in accordance with the provisions of Accounting Standards Codification Topic 606, Revenue from Contracts with Customers (“ASC 606”). The Company’s obligations under the Genentech Agreement are the following promises: (i) exclusive license to certain intellectual property associated with a specific target, and (ii) technology and materials transfer related to the intellectual property underlying the licensed technology. The Company determined that the exclusive license is not distinct from the associated technology and materials transfer because the customer cannot benefit from, or utilize, the license without the technology and materials transfer. Specifically, the Company concluded that the exclusive license is not capable of being distinct from the associated technology and materials transfer because Genentech does not have the knowledge or expertise to fully exploit potential product candidates without the accompanying technology and materials provided pursuant to the transfer, and no other third party can perform the transfer due to the Company’s proprietary knowledge and specialized expertise with respect to the licensed intellectual property. Accordingly, the Company concluded that these promises should be combined into a single performance obligation (the “License and Transfer Performance Obligation”).

The Company measured the transaction price solely in reference to the $5.0 million payment due upon receipt of notice from Genentech regarding the satisfactory completion of the technology and materials transfer. None of the variable consideration payable under the arrangement has been included in the transaction price. As of September 30, 2020, the Company has not achieved any research, development, regulatory, or commercial milestones, or earned any royalties under the Genentech Agreement. The Company utilizes “the most likely” amount method to estimate the amount of research, development, and regulatory milestone payments to be received. As part of the evaluation for the research and development milestone payments, the Company considers several factors including the stage of research and development of the compounds included in the arrangement, the risk associated with the remaining research and development work required to achieve the milestone, and the Company’s level of involvement in the research and development activities.

Regulatory milestone payments are triggered upon the first commercial sale following receipt of regulatory approval from the FDA or other global regulatory authorities; therefore, such amounts will be excluded from the transaction price until the associated regulatory approval is received. The commercial milestone payments and royalties are subject to the royalty recognition constraint whereby such amounts will be recognized as revenue upon the later of: (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the payment has been allocated has been satisfied, or partially satisfied, because the exclusive license is deemed to be the sole or predominant item to which the payments relate. As all performance obligations are satisfied, the Company will recognize royalty revenue at the date the sales occur. The Company did not adjust the promised amount of consideration for the effects of a significant financing component because the Company expects that the period between when the promised goods and services are transferred and when the customer pays for those goods and services will be one year or less. There were no changes in the transaction price for the nine months ended September 30, 2020.

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The transaction price of $5.0 million allocated to the combined performance obligation was recognized as revenue in February 2019 at the point in time that Genentech provided notice regarding the satisfactory completion of the technology and materials transfer. Upon that successful execution of the technology and materials transfer, control was deemed to be transferred for both the exclusive license and the technology and materials transfer promises, therefore the risks and rewards of ownership had been conveyed. As of September 30, 2020, the Company did not have any receivables or deferred revenue related to the Genentech Agreement because no payments under the arrangement became due, nor had the underlying performance obligation been satisfied.

The Company did not record a federal or state income tax benefit for its losses for the three and nine months ended September 30, 2020 and 2019, respectively, due to the conclusion that a full valuation allowance is required against the Company’s deferred tax assets. All the Company’s losses before income taxes were generated in the United States.

Basic and diluted net loss per share was calculated as follows (in thousands, except share and per share amounts):

The following common stock equivalents have been excluded from the computation of diluted weighted-average shares outstanding, because such securities had an antidilutive impact:

The Company has an operating lease for office and laboratory space for its corporate headquarters in Boston, Massachusetts. The lease commenced in January 2018 and rent payments began in April 2018. This lease has a ten-year initial term with an option to extend for seven additional years.

The Company has the right to terminate the lease in the event of the inability to use the space due to substantial damage while the lessor has the right to terminate the lease if the Company defaults on the lease financial obligations. Per the terms of the lease agreement, the Company does not have any residual value guarantees. In calculating the present value of the lease payments, the Company utilized its incremental borrowing rate, which is based on rates that would be incurred to borrow on a collateralized basis over a term equal to the lease payments in a similar economic environment. The Company has allocated all the contract considerations to the one lease component. This may result in the initial and subsequent measurement of the balances of the right-of-use asset and lease liability for leases being greater than if the policy election was not applied. The Company’s real estate lease in Boston is considered a net lease, as the non-lease components (i.e., common area maintenance) are paid separately from rent, based on actual costs incurred. Therefore, the variable non-lease components were not included in the right-of-use asset and liability and are reflected as an expense in the period incurred.

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As of September 30, 2020, and December 31, 2019, assets under operating lease were $11.7 million and $12.6 million, respectively. The elements of lease expense were as follows (in thousands): 

Future lease payments under noncancelable leases as of September 30, 2020 (in thousands):

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The following discussion and analysis of our financial condition and the results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, or Quarterly Report, and our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission, or the SEC, on March 10, 2020, or the Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business, includes forward looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the “Risk Factors” section in our Annual Report and in this Quarterly Report, our actual results could differ materially from the results described, in or implied by, the forward-looking statements contained in the following discussion and analysis. Such factors may be amplified by the COVID-19 pandemic and its potential impact on our business and the global economy.

Overview

We are a clinical stage biopharmaceutical company committed to the discovery and development of novel therapeutics to treat cystic fibrosis, or CF, through theratyping, or the process of matching modulators to individual response to treatment regardless of cystic fibrosis transmembrane conductance regulator, or CFTR, mutations. CF is a disease caused by defects in the function or abundance of CFTR protein.

Since our inception in 2006, we have devoted substantially all our resources to organizing and staffing our company, business planning, raising capital, acquiring and developing product and technology rights, and conducting research and development activities for our product candidates. We do not have any products approved for sale and have not generated any revenue from product sales. We have funded our operations to date with proceeds received from equity offerings, the issuance of convertible promissory notes and, to a lesser extent, payments received in connection with collaboration agreements and a research grant.

In addition, we have entered into a sales agreement with H.C. Wainwright & Co., LLC, or HCW, with respect to an at-the-market, or ATM, offering program, or the ATM program. As of December 31, 2019, we have sold 987,653 shares of our common stock for total net proceeds of approximately $3.5 million under the ATM program. We did not sell any shares of our common stock under the ATM program during the nine months ended September 30, 2020.

To date, we have not generated significant revenue and have incurred significant operating losses. Our net losses were $8.2 million and $26.9 million for the three and nine months ended September 30, 2020, respectively. As of September 30, 2020, we had an accumulated deficit of $363.6 million. We require additional funding to fund our CF-focused pipeline and namely, our CHOICES program, and to advance our proprietary combination therapy candidates posenacaftor, dirocaftor, and nesolicaftor, through regulatory approval and into commercialization, if approved.

In August 2020, we announced that after consideration of various financing and strategic alternatives for our CF portfolio, with the goal of maximizing stockholder value of these assets, we have decided to continue our operations while exploring business and strategic options related to our research and discovery platform and intellectual property portfolio.

After conducting a diligent and extensive process of evaluating our strategic alternatives and careful evaluation and consideration of those proposals, and following extensive negotiation, on August 22, 2020, we entered into an Agreement and Plan of Merger and Reorganization, or the Merger Agreement, with Yumanity Therapeutics, Inc., a Delaware corporation, or Yumanity, Yumanity Holdings, LLC, a Delaware limited liability company, or Holdings, and Pangolin Merger Sub, Inc., a Delaware corporation and our wholly-owned subsidiary, or the Merger Sub. Upon the terms and subject to the satisfaction of the conditions described in the Merger Agreement, including approval of the transaction by our stockholders and Yumanity’s stockholders and the consolidation of Yumanity and Holdings prior to the closing of the Merger, Merger Sub will be merged with and into Yumanity, or the Merger, with Yumanity surviving the Merger as our wholly-owned subsidiary and the surviving corporation of the Merger. If the Merger is completed, our business will become the business of Yumanity.

On August 22, 2020, due to the entry into of the Merger Agreement with Yumanity, our Board of Directors, or the Board, committed to reducing our workforce by approximately 79% to a total of five full-time employees, who will remain with us until the closing of the Merger to assist with our day-to-day business operations, including the maintenance of the sale and disposition of intellectual property and assets relating to our cystic fibrosis clinical program, or the CF Assets, and those activities necessary to complete the proposed Merger. We have retained our core intellectual property, licenses, collaborations with research institutions and universities, and proprietary equipment. We have incurred certain restructuring charges related to a reduction in our workforce, totaling $2.4 million through September 30, 2020. At September 30, 2020 we have accrued one-time termination benefits of $1.7 million, of which the majority are anticipated to be incurred in the fourth quarter of 2020. We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated stand-alone operating expenses and capital expenditures for the foreseeable

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future; however, there can be no assurances as to the amount or timing of available cash, if any, left to distribute to our stockholders after paying the debts and our other obligations and setting aside funds for potential future claims.

We and Yumanity believe that the Merger will result in a clinical-stage biopharmaceutical company focused on discovering and developing disease-modifying treatments for neurodegenerative diseases based on Yumanity’s discovery engine and pipeline of novel targets and product candidates.

We may not be successful in completing the Merger. If, for any reason, the Merger does not close and the Merger Agreement is terminated, the Board may elect to, among other things, attempt to complete another strategic transaction including a transaction similar to the Merger, continue to operate our business or to dissolve and liquidate our assets. If we decides to dissolve and liquidate our assets, we would be required to pay all of our debts and contractual obligations, and to set aside certain reserves for potential future claims. As of September 30, 2020, we had cash and cash equivalents and short-term investments totaling approximately $40.8 million.

COVID-19 Business Update

The novel coronavirus, or COVID-19, pandemic continues to rapidly evolve and has already resulted in a significant disruption of global financial markets and may affect our operations and those of third parties on which we rely. While the potential economic impact brought by, and the duration of, the COVID-19 pandemic is difficult to assess or predict, the impact of the COVID-19 pandemic on the global financial markets may reduce our ability to access capital, which could negatively impact our short-term and long-term liquidity and our ability and Yumanity’s ability to complete the Merger on a timely basis or at all. The ultimate impact of the COVID-19 pandemic is highly uncertain and subject to change. We do not yet know the full extent of potential delays or impacts on our business, financing or other activities or on healthcare systems or the global economy as a whole. However, these effects could have a material impact on our liquidity, capital resources, operations and business and those of the third parties on which we rely.

Components of our Results of Operations

Revenue

To date, we have not generated any revenue from product sales and do not expect to generate any revenue from the sale of products in the foreseeable future. We did not recognize any revenue during the three and nine months ended September 30, 2020. All our revenue during the nine months ended September 30, 2019 was derived from our Genentech Agreement.

Operating Expenses

Research and Development Expenses

Research and development expenses, which include costs of research services incurred in connection with our collaboration agreements and research grant, have historically consisted primarily of costs incurred in connection with the discovery and development of our product candidates, which include:

We expense research and development costs as incurred. We recognize external development costs based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers.

Our direct research and development expenses are tracked on a program-by-program basis and consist primarily of external costs, such as fees paid to consultants, central laboratories, contractors, CROs, and CMOs in connection with our clinical trials and preclinical development activities. We do not allocate employee costs, costs associated with our platform technology, facility expenses, including depreciation, or other indirect costs, to specific product development programs because these costs are deployed across multiple product development programs and, as such, are not separately classified. We use internal resources to manage our preclinical development activities and perform data analysis for such activities. These employees work across multiple development programs and, therefore, we do not track their costs by program.

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The table below summarizes our research and development expenses incurred by program (in thousands):

In August 2020, after consideration of various financing and strategic alternatives for our CF portfolio, with the goal of maximizing stockholder value of these assets, our Board approved our entry into the proposed Merger. As a result of this decision, we stopped further research and development of our product pipeline and our pre-clinical programs, including the Unfolded Protein Response, or UPR, program, to reduce operating expenses. As a result, our research and development expenses for the fiscal year ending December 31, 2020 will decrease as compared to the fiscal year ended December 31, 2019.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related benefits, travel, and stock-based compensation for personnel in executive, finance, and administrative functions. General and administrative expenses also include facilities, which include direct and allocated expenses for rent and maintenance of facilities, depreciation, insurance, and supplies, as well as professional fees for legal, consulting, accounting, and audit services.

We anticipate that our general and administrative expenses in the fiscal year ending December 31, 2020 will decrease from the fiscal year ended December 31, 2019, with the exception of severance payments, as we continue to focus our efforts on preserving cash while we seek to maximize stockholder value. Over the longer term, however, these expenses could increase due to professional fees associated with the proposed Merger with Yumanity.

Restructuring Costs

Restructuring costs consist primarily of severance-related costs associated with the reduction in force in connection with the proposed Merger with Yumanity.

Interest Income

Interest income consists of interest earned on cash equivalents and short-term investments held by us during the reporting periods.

Interest Expense

Interest expense consists of interest paid on our short-term borrowings during the reporting periods.

Other Income (Expense), Net

Other income (expense), net, primarily consists of the amortization of premiums and discounts on our short-term investments and the gains or losses associated with the changes in the fair values of our derivative liability.

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Critical Accounting Policies and Significant Judgments and Estimates

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of our financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements, and notes thereto, which are contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 10, 2020.  

During the nine months ended September 30, 2020, there were no material changes to our critical accounting policies. Our critical accounting policies are described under the heading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Critical Accounting Policies and Significant Judgments and Estimates,” in our Annual Report on Form 10-K for the year ended December 31, 2019 and the notes to the financial statements appearing elsewhere in this Quarterly Report. We believe that of our critical accounting policies, the following accounting policies involve the most judgment and complexity:

Accordingly, we believe the policies set forth above are critical to fully understanding and evaluating our financial condition and results of operations. If actual results or events differ materially from the estimates, judgments and assumptions used by us in applying these policies, our reported financial condition and results of operations could be materially affected.

Results of Operations

Comparison of Three Months Ended September 30, 2020 and 2019

The following table summarizes our results of operations for the three months ended September 30, 2020 and 2019 (in thousands):

Revenue

There was no revenue for the three months ended September 30, 2020 or 2019.

Research and Development Expenses

Research and development expenses decreased to $1.2 million for the three months ended September 30, 2020, compared to $10.1 million for the three months ended September 30, 2019 due to our strategic shift in strategy related to our pursuit of the Merger with Yumanity. The decrease of $8.9 million was related to a decrease of approximately $5.4 million in clinical-related research activities as we wind down our CF programs, $2.7 million in employee-related expenses as we reduced our workforce, $0.5 million in professional fees, and $0.3 million in facility expenses.

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General and Administrative Expenses

General and administrative expenses were $4.5 million for the three months ended September 30, 2020, compared to $3.2 million for the three months ended September 30, 2019. The increase of $1.3 million in general and administrative expenses was primarily due to an increase of $1.5 million in professional fees primarily related to our proposed Merger with Yumanity, $0.2 million in facility expenses, and $0.2 million in insurance expenses, offset by a decrease of $0.6 million in employee-related expenses.

Restructuring Costs

Restructuring costs were $2.4 million for the three months ended September 30, 2020, consisting primarily of severance-related costs associated with a reduction in force in connection with the proposed Merger with Yumanity. There were no restructuring costs for the three months ended September 30, 2019.

Interest Income

Interest income was less than $0.1 million for the three months ended September 30, 2020, compared to $0.2 million for the three months ended September 30, 2019. The decrease of $0.2 million in interest earned on cash equivalents and short-term investments is due to a decrease in average balance of invested cash held during the three months ended September 30, 2020, compared to the three months ended September 30, 2019.

Interest Expense

Interest expense was less than $0.1 million for the three months ended September 30, 2020 and consisted of interest paid on short-term borrowings. There was no interest expense for the three months ended September 30, 2019.

Other Income, Net

Other income was less than $0.1 million and $0.2 million for the three months ended September 30, 2020 and 2019, respectively. The decrease of $0.1 million in other income is primarily due to a decrease in net accretion of discounts on short-term securities in the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

Comparison of Nine Months Ended September 30, 2020 and 2019

The following table summarizes our results of operations for the nine months ended September 30, 2020 and 2019 (in thousands):