Phathom Pharmaceuticals, Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2019

OR

For the transition period from                    to                   .

Commission File Number: 001-39094

PHATHOM PHARMACEUTICALS, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (650) 325-5156

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

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, a 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 23, 2019, the registrant had 24,526,537 shares of common stock ($0.0001 par value) outstanding.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements (unaudited)

PHATHOM PHARMACEUTICALS, INC.

Combined Balance Sheets

(Unaudited)

(in thousands, except share and par value amounts)

See accompanying notes.

PHATHOM PHARMACEUTICALS, INC.

Combined Statements of Operations and Comprehensive Loss

(Unaudited)

(in thousands, except share and per share amounts)

See accompanying notes

PHATHOM PHARMACEUTICALS, INC.

Combined Statement of Stockholders’ Equity (Deficit)

(Unaudited)

(in thousands, except share amounts)

PHATHOM PHARMACEUTICALS, INC.

Combined Statement of Stockholders’ Equity (Deficit)

(Unaudited)

(in thousands, except share amounts)

See accompanying notes.

PHATHOM PHARMACEUTICALS, INC.

Combined Statement of Cash Flows

(Unaudited)

(in thousands)

See accompanying notes.

PHATHOM PHARMACEUTICALS, INC.

Notes to Unaudited Combined Financial Statements

1. Organization, Basis of Presentation and Summary of Significant Accounting Policies

Organization

Phathom Pharmaceuticals, Inc. (the “Company” or “Phathom”) was incorporated in the state of Delaware in January 2018 under the name North Bridge IV, Inc. On March 13, 2019, the Company changed its name to Phathom Pharmaceuticals, Inc. and merged with YamadaCo IIA, Inc. (“YamadaCo”), a Delaware corporation formed in September 2017, with Phathom being the surviving entity (the “Merger”). All activities of YamadaCo prior to 2018 related to formation and were insignificant. The Company is a late clinical-stage biopharmaceutical company focused on developing and commercializing novel treatments for gastrointestinal diseases.

On October 29, 2019, the Company completed its initial public offering (the “IPO”) and issued 10,997,630 shares of common stock for net proceeds of approximately $191.4 million.  Upon the closing of the IPO, the convertible promissory notes payable were converted into 6,107,918 shares of common stock.  See Note 7 to these financial statements for additional details.

Stock Split and Conversion

During 2018, without consideration of the forward stock split described immediately below, both the Company and YamadaCo issued 1,000 shares of common stock at a purchase price of $1.00 per share, and had no other capital transactions prior to the Merger. Immediately prior to the Merger, the Company effected a 1,559.1183-for-1 forward stock split for each outstanding share of its common stock and, effective upon the closing of the Merger, each issued and outstanding share of YamadaCo was converted into 1,559.1183 shares of the Company’s common stock. Upon completion of the Merger, the Company had 6,760,334 shares of common stock outstanding, with the prior stockholders of each YamadaCo and Phathom holding an equal number of shares. The accompanying combined financial statements and notes to the combined financial statements give retroactive effect to the forward stock split and conversion for all periods presented.

On October 11, 2019, the Company effected a 2.168-for-1 forward stock split of its common stock (the “Forward Stock Split”). The par value of the common stock was not adjusted as a result of the Forward Stock Split and the authorized shares were increased to 50,000,000 shares of common stock in connection with the Forward Stock Split. The accompanying combined financial statements and notes to the combined financial statements give retroactive effect to the Forward Stock Split for all periods presented, unless otherwise indicated.

Basis of Presentation

The Company’s combined financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The accompanying combined financial statements include the accounts of the Company (the receiving entity) and YamadaCo, prior to the Merger. The Company and YamadaCo were entities under the common control of Frazier Life Sciences IX, L.P. (“Frazier”) as a result of, among others, Frazier’s; (i) ownership of a majority of the outstanding capital stock of both companies, (ii) financing of both companies, (iii) control of board of directors of both companies, and (iv) management of both companies. Both the Company and YamadaCo were formed for the purpose of identifying potential assets around which to form an operating company. As the merged entities were under common control, the combined financial statements report the financial position, results of operations and cash flows of the Company and YamadaCo as though the transfer of net assets and equity interests had occurred at the beginning of 2018. All intercompany accounts and transactions have been eliminated in combination.

Liquidity and Capital Resources

From inception to September 30, 2019, the Company has devoted substantially all of its efforts to organizing and staffing the Company, business planning, raising capital, in-licensing its initial product candidate, vonoprazan, meeting with regulatory authorities, and preparing for the planned Phase 3 clinical trials of vonoprazan. The Company has a limited operating history, has never generated any revenue, and the sales and income potential of its business is unproven. The Company has incurred net losses and negative cash flows from operating activities since its inception and expects to continue to incur net losses into the foreseeable future as it continues the development and commercialization of vonoprazan. From inception to September 30, 2019, the Company has funded its operations through the issuance of convertible promissory notes and commercial bank debt.  Additionally, on October 29, 2019, the Company completed its IPO and issued 10,997,630 shares of common stock for net proceeds of approximately $191.4 million.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

The accompanying combined financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities that may result from the outcome of this uncertainty. Management is required to perform a two-step analysis over the Company’s ability to continue as a going concern. Management must first evaluate whether there are conditions and events that raise substantial doubt about the Company’s ability to continue as a going concern (Step 1). If management concludes that substantial doubt is raised, management is also required to consider whether its plans alleviate that doubt (Step 2).

Upon the initial public filing that took place on October 29, 2019, management believes that it has sufficient working capital on hand to fund operations through at least the next twelve months from the date these combined financial statements were available to be issued. There can be no assurance that the Company will be successful in acquiring additional funding, that the Company’s projections of its future working capital needs will prove accurate, or that any additional funding would be sufficient to continue operations in future years.

Use of Estimates

The preparation of the Company’s combined financial statements requires it to make estimates and assumptions that impact the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities in the Company’s combined financial statements and accompanying notes. The most significant estimates in the Company’s combined financial statements relate to accruals for research and development expenses, and the valuation of convertible promissory notes, warrant liabilities and various other equity instruments. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results could differ materially from those estimates and assumptions.

Unaudited Interim Financial Information

The accompanying interim balance sheet as of September 30, 2019, the combined statements of operations and cash flows for the three and nine months ended September 30, 2019 and 2018 and the combined statement of stockholders’ deficit for the three and nine months ended September 30, 2019 and 2018 and the related footnote disclosures are unaudited. In management’s opinion, the unaudited interim financial statements have been prepared on the same basis as the audited combined financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the Company’s financial position as of September 30, 2019 and its results of operations and cash flows for the three and nine months ended September 30, 2019 and 2018 in accordance with GAAP. The results for the nine months ended September 30, 2019 are not necessarily indicative of the results expected for the full fiscal year or any other interim period.

Fair Value Option

As permitted under Accounting Standards Codification (“ASC”) 825, Financial Instruments, (“ASC 825”), the Company has elected the fair value option to account for its convertible promissory notes issued since inception. In accordance with ASC 825, the Company records these convertible promissory notes at fair value with changes in fair value recorded in the combined statements of operations. As a result of applying the fair value option, direct costs and fees related to the convertible promissory notes were recognized in earnings as incurred and not deferred.

Fair Value Measurements

The accounting guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or non-recurring basis. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1: Observable inputs such as quoted prices in active markets.

Level 2: Inputs, other than the quoted prices in active markets that are observable either directly or indirectly.

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

The carrying amounts of the Company’s financial instruments, including cash and cash equivalents classified within the Level 1 designation discussed above, prepaid and other current assets, accounts payable, and accrued liabilities, approximate fair value due to their short maturities. Warrant liabilities and convertible promissory notes are recorded at fair value on a recurring basis.

The Company has no financial assets measured at fair value on a recurring basis. None of the Company’s non-financial assets or liabilities are recorded at fair value on a non-recurring basis. No transfers between levels have occurred during the periods presented.

Liabilities measured at fair value on a recurring basis are as follows (in thousands):

The warrant liabilities consist of an issued and outstanding common stock warrant (the “Takeda Warrant”) and a right to receive an additional common stock warrant (the “Takeda Warrant Right”, and together with the Takeda Warrant, the “Takeda Warrants”) issued to Takeda Pharmaceutical Company Limited (“Takeda”) in connection with a May 2019 license agreement (see Note 3) and warrants (the “Lender Warrants”) issued in connection with a loan and security agreement for commercial bank debt (see Note 5). The Takeda Warrants are accounted for as liabilities as they do not meet all the conditions for equity classification due to (i) insufficient authorized shares for the Takeda Warrant and (ii) the Takeda Warrant Right is not indexed to the Company’s own stock. The Lender Warrants are accounted for as liabilities as they contain a holder put right under which the lenders could require the Company to pay cash in exchange for the warrants. The fair value of the Takeda Warrants is derived from the model used to estimate the fair value the Company’s common stock (see Note 6). The fair value of the Lender Warrants is estimated using a probability-weighted model considering IPO and non-IPO scenarios. The IPO scenarios utilize a binomial lattice model to estimate a distribution of total equity values as of a projected IPO date. The non-IPO scenario utilizes the repurchase price associated with the warrant put right discounted to present value based on venture capital rates of return and the term associated with the put right. As of September 30, 2019, the fair value of the Takeda Warrants was $107.0 million and the fair value of the Lender Warrants was $0.4 million.

As further described in Note 4, the Company issued convertible promissory notes to Frazier (the “Frazier Notes”) from January 2018 to April 2019 and issued convertible promissory notes in May 2019 (the “May 2019 Notes”) to investors including Frazier. The Company has elected the fair value option for each of its convertible promissory note issuances. The fair value of the Frazier Notes was estimated using a scenario-based analysis that estimated the fair value of the convertible promissory notes based on the probability-weighted present value of expected future investment returns, considering possible outcomes available to the noteholders, including conversions in subsequent equity financings, change of control transactions, settlement and dissolution. The fair value of the May 2019 Notes is estimated using a scenario-based analysis that estimates the fair value of the convertible promissory notes based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to the noteholders, including various IPO, settlement, equity financing, corporate transaction and dissolution scenarios. As of December 31, 2018, the fair value of the Frazier Notes was $2.0 million and the Frazier Notes were exchanged for May 2019 Notes in May 2019. As of September 30, 2019, the fair value of the May 2019 Notes was $95.2 million.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

The Company adjusts the carrying value of its warrant liabilities and convertible promissory notes to their estimated fair value at each reporting date, with any related increases or decreases in the fair value recorded as change in fair value of warrant liabilities and change in fair value of convertible promissory notes, respectively, in the combined statements of operations.

The following table provides a reconciliation of all liabilities measured at fair value using Level 3 significant unobservable inputs (in thousands):

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. Cash and cash equivalents include cash in readily available checking accounts and money market funds.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses in such accounts and management believes that the Company is not exposed to significant credit risk due to the financial position of the depository institutions in which those deposits are held.

Deferred Offering Costs

The Company has deferred offering costs consisting of legal, accounting and other fees and costs directly attributable to its planned IPO. The deferred offering costs will be offset against the proceeds received upon the completion of the planned IPO. In the event the planned IPO is terminated, all of the deferred offering costs will be expensed within the Company’s statements of operations. As of September 30, 2019, $2.0 million of deferred offering costs were recorded within other long-term assets on the balance sheet. No such costs were included on the combined balance sheet as of December 31, 2018.

Research and Development Expenses and Accruals

All research and development costs are expensed in the period incurred and consist primarily of salaries, payroll taxes, employee benefits, stock-based compensation charges for those individuals involved in research and development efforts, external research and development costs incurred under agreements with contract research organizations and consultants to conduct and support the Company’s planned clinical trials of vonoprazan, and costs related to manufacturing vonoprazan for clinical trials.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

The Company has entered into various research and development contracts with clinical research organizations, clinical manufacturing organizations and other companies. Payments for these activities are based on the terms of the individual agreements, which may differ from the pattern of costs incurred, and payments made in advance of performance are reflected in the accompanying balance sheets as prepaid expenses or accrued liabilities. The Company records accruals for estimated costs incurred for ongoing research and development activities. When evaluating the adequacy of the accrued liabilities, the Company analyzes progress of the services, including the phase or completion of events, invoices received and contracted costs. Significant judgments and estimates may be made in determining the prepaid or accrued balances at the end of any reporting period. Actual results could differ from the Company’s estimates.

In-Process Research and Development

The Company evaluates whether acquired intangible assets are a business under applicable accounting standards.  Additionally, the Company evaluates whether the acquired assets have a future alternative use. Intangible assets that do not have future alternative use are considered acquired in-process research and development.  When the acquired in-process research and development assets are not part of a business combination, the value of the consideration paid is expensed on the acquisition date.  Future costs to develop these assets are recorded to research and development expense as they are incurred.

Stock-Based Compensation

Stock-based compensation expense represents the cost of the grant date fair value of equity awards recognized over the requisite service period of the awards (generally the vesting period) on a straight-line basis. The Company recognizes forfeitures as they occur.

Comprehensive Loss

Comprehensive loss is defined as a change in equity during a period from transactions and other events and circumstances from non-owner sources. The Company’s comprehensive loss was the same as its reported net loss for all periods presented.

Segment Reporting

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker in making decisions on how to allocate resources and assess performance. The Company views its operations and manages its business as one operating segment.

Net Loss Per Share

For the three and nine months ended September 30, 2018 and 2019, the net loss per share was recast to include in the numerator the net losses of both the Company and YamadaCo and include in the denominator the combined weighted-average outstanding shares of both the Company and YamadaCo. Basic net loss per share is computed by dividing the combined net loss by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. The Company has excluded weighted-average unvested shares of 4,550,428 and 3,342,544 shares from the weighted-average number of common shares outstanding for the three and nine months ended September 30, 2019. No shares of common stock were unvested during the year ended September 30, 2018. Diluted net loss per share is computed by dividing the combined net loss by the weighted-average number of common shares and dilutive common stock equivalents outstanding for the period determined using the treasury-stock and if-converted methods. Dilutive common stock equivalents are comprised of unvested common stock, options, warrants and convertible promissory notes. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding as inclusion of the potentially dilutive securities would be antidilutive.

The following potentially dilutive securities were excluded from the computation of diluted net loss per share for the periods presented because their inclusion would have been antidilutive:

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

Recently Adopted Accounting Pronouncements

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This guidance expands the scope of Topic 718, Compensation—Stock Compensation, which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees and is effective for public companies for annual periods beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted as long as ASU No. 2014-09 has been adopted by the Company. The Company adopted this guidance effective January 1, 2018, and the adoption did not have a material impact on the Company's financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires a lessee to recognize a lease liability and a right-of-use asset for all leases with lease terms of more than 12 months. Additionally, certain qualitative and quantitative disclosures will be required in the financial statements. This guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. Companies may adopt this guidance using a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Company adopted this guidance effective January 1, 2018, and the adoption did not have any impact on the Company’s financial statements as the Company did not have any leases at the time of adoption. As the Company enters into future, material lease agreements, the adoption of this guidance is expected to result in a significant increase in the total assets and liabilities reported on the balance sheets.

Recently Issued Accounting Pronouncements

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, modifies and adds disclosure requirements on fair value measurements. The standard is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years, and early adoption is permitted. The Company is currently evaluating the impact the adoption of ASU No. 2018-13 will have on the Company’s financial statements.

2. Related Party Transactions

Frazier is a principal stockholder of the Company and is represented on the Company’s board of directors. For the year ended December 31, 2018 and the nine months ended September 30, 2019, the Company conducted its operations within office space controlled by Frazier and Frazier allocated a portion of the costs associated with this office to the Company. In addition, Frazier paid for various goods and services, such as employee wages, insurance and expense reimbursements and various administrative services associated with the operations of the Company and charged the Company for those expenses. As of September 30, 2019, and December 31, 2018, the Company had outstanding accounts payable balances due to Frazier of $71,000 and $45,000, respectively, related to these shared operating expenses. For the three months ended September 30, 2019 and 2018, the Company incurred $0.2 million and $66,000, respectively, of shared operating expenses. For the nine months ended September 30, 2019 and 2018, the Company incurred $0.3 million and $0.2 million, respectively, of shared operating expenses. In addition to the shared operating expenses, the Company issued convertible promissory notes to Frazier during 2018 and 2019 (see Note 4).

Frazier is a principal stockholder in PCI Pharma Services (“PCI”).  In the third quarter of 2019, the Company engaged PCI for clinical manufacturing services.  As of September 30, 2019, the Company had $0.1 million in prepaid services and $0.2 million outstanding accounts payable and accrued expenses related to these manufacturing services.  For the three and nine months ended September 30, 2019, the Company incurred $0.2 million of expenses related to services performed by PCI.

Mountain Field LLC (“Mountain Field”) is an entity owned by the chairman of the Company’s board of directors. During the year ended December 31, 2018 and the nine months ended September 30, 2019, the Company charged Mountain Field for certain rent and payroll related expenses. These shared expenses were allocated based on usage of the related facilities and time incurred by personnel. As of September 30, 2019, and December 31, 2018, the Company had an outstanding accounts receivable balance from Mountain Field of $0 and $19,000, respectively, related to shared operating expenses. For the three months ended September 30, 2019 and 2018, the Company incurred $0 and $5,000, respectively, for shared expenses. For the nine months ended September 30, 2019 and 2018, the Company charged Mountain Field $0.1 million and $2,000, respectively, for shared expenses.

Takeda became a common stockholder of the Company as of May 7, 2019 in connection with the May 2019 license agreement (see Note 3).

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

3. Commitments and Contingencies

License Agreement

On May 7, 2019, the Company entered into a license agreement with Takeda pursuant to which it was granted an exclusive license to commercialize vonoprazan fumarate in the United States, Canada and Europe (the “Takeda License”). The Company also has the right to sublicense its rights under the agreement, subject to certain conditions. The agreement will remain in effect, on a country-by-country and product-by-product basis, until the later of (i) the expiration of the last to expire valid patent claim covering vonoprazan fumarate alone or in combination with at least one other therapeutically active ingredient, (ii) the expiration of the applicable regulatory exclusivity and (iii) 15 years from the date of first commercial sale, unless earlier terminated. The Company may terminate the Takeda License upon six months’ written notice. The Company and Takeda may terminate the Takeda License in the case of the other party’s insolvency or material uncured breach. Takeda may terminate the Takeda License if the Company challenges, or assists in challenging, licensed patents.

In consideration of the Takeda License, the Company (i) paid Takeda $25.0 million in cash, (ii) issued Takeda 1,084,000 shares of its common stock at a fair value of $5.9 million, (iii) issued the Takeda Warrant to purchase 7,588,000 shares of its common stock at an exercise price of $0.00004613 per share at an initial fair value of $47.9 million, and (iv) issued the Takeda Warrant Right to receive an additional common stock warrant should Takeda’s fully-diluted ownership of the Company represent less than a certain specified percentage of the fully-diluted capitalization, including shares issuable upon conversion of outstanding convertible promissory notes, calculated immediately before the closing of the Company’s IPO, with a nominal initial fair value due to the low probability of issuance. The Takeda Warrant Right expired upon completion of our IPO, and no additional warrant was issued. In addition, the Company is obligated to pay Takeda up to an aggregate of $250.0 million in sales milestones upon the achievement of specified levels of product sales, and a low double-digit royalty rate on aggregate net sales of licensed products, subject to certain adjustments. The Company incurred $0.1 million of transaction costs in connection with the Takeda License. The Takeda Warrant has an exercise price of $0.00004613 per share, expires on May 7, 2029 and becomes exercisable upon (i) certain change of control transactions of the Company or (ii) the consummation of an IPO by the Company.

The transaction has been accounted for as an asset acquisition as substantially all of the fair value is concentrated in a group of similar assets. The $78.9 million fair value of the consideration paid for these research and development assets, which have no alternative future use, was recorded as in-process research and development in the Company’s combined statement of operations for the nine months ended September 30, 2019.

Contingencies

In the event the Company becomes subject to claims or suits arising in the ordinary course of business, the Company would accrue a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

4. Convertible Promissory Notes

Frazier Convertible Note Financing

From January 2018 to April 2019, the Company issued the Frazier Notes for an aggregate of $2.4 million and bearing interest at per annum rates ranging from 1.68% to 2.55%. Of the Frazier Notes, $1.9 million were issued in 2018 and $0.5 million were issued in April 2019. Due to certain embedded features within the Frazier Notes, the Company elected to account for these notes and all their embedded features under the fair value option. The Company recorded changes in the fair value of the Frazier Notes in the combined statements of operations until May 2019, when the Frazier Notes and related accrued interest were exchanged, at their then fair value of $2.4 million, for the May 2019 Notes. For the three and nine months ended September 30, 2018, and the nine months ended September 30, 2019, the Company recognized $18,000 of expense, $22,000 of expense, and $50,000 of income, respectively, in change in fair value of convertible promissory notes in the combined statements of operations related to changes in the fair value of the Frazier Notes. For the three and nine months ended September 30, 2018 and the nine months ended September 30, 2019, the Company recognized $4,000, $8,000 and $15,000, respectively, of interest expense in connection with the Frazier Notes. No interest expense or changes in fair value related to the Frazier Notes were recorded in the three months ended September 30, 2019, as the Frazier Notes were exchanged in May 2019.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

May 2019 Convertible Note Financing

In May 7, 2019, the Company entered into a note purchase agreement under which it issued the unsecured May 2019 Notes for an aggregate of $90.3 million, resulting in gross proceeds to the Company of $87.8 million in cash and $2.4 million related to the exchange of the Frazier Notes and related accrued interest for the May 2019 Notes. Including the conversion of the Frazier Notes, Frazier purchased $20.0 million of the May 2019 Notes. The May 2019 Notes bear interest at a rate of 6% per annum and are subordinated to borrowings under the Company’s loan and security agreement (see Note 5). The May 2019 Notes become payable upon demand of the holders of at least 60% of the outstanding principal amount of the May 2019 Notes, including Frazier, on May 7, 2020 (the “Maturity Date”), and become due and payable on May 7, 2022, subject to earlier conversion or repayment in the event the Company completes certain equity financings or a change of control. The May 2019 Notes can be converted/redeemed as follows (i) automatically converted upon a qualified equity financing, with a conversion price of the lesser of 80% of the price paid per share in such financing or the conversion cap price per share, (ii) optionally converted upon a non-qualified equity financing with a conversion price of 80% of the price paid per share in such financing, (iii) optionally converted any time after the Maturity Date, with a conversion price per share of the conversion cap price per share, (iv) automatically upon an IPO with a conversion price per share of the lesser of 80% of the IPO price per share, or the conversion cap price per share, and (v) upon certain corporate transactions, receive cash equal to the greater of (A) two times the then outstanding principal and accrued interest and (B) an amount equal to the amount that would be received as if the May 2019 Notes were converted with a conversion price of the conversion cap price per share. The conversion cap price per share is defined as $500.0 million less the outstanding principal and accrued interest divided by the total of (1) the total number of common shares outstanding immediately prior to conversion, (2) the number of common shares issuable upon exercise or conversion of exercisable or convertible securities, and (3) the number of shares of capital stock reserved for issuance under the Company’s equity incentive plan.

The note purchase agreement includes, among others, covenants related to delivery of certain financial reports, certain registration rights, voting provisions regarding the composition of the Company’s board of directors, and limitations on the Company’s ability to pay dividends, incur additional indebtedness or consummate certain changes of control. The note purchase agreement also contains customary events of default, including bankruptcy, the failure to make payments when due, and certain material adverse changes. Upon the occurrence of an event of default, subject to any specified cure periods, all amounts owed by the Company may be declared immediately due and payable. As of September 30, 2019, the Company was in compliance with all applicable covenants under the note purchase agreement.

Due to certain embedded features within the May 2019 Notes, the Company elected to account for these notes and all their embedded features under the fair value option. For the three and nine months ended September 30, 2019, the Company recognized $2.5 million and $4.9 million respectively, of other expense in the combined statements of operations related to increases in the fair value of the May 2019 Notes. For the three and nine months ended September 30, 2019, the Company recognized $1.4 million and $2.2 million, respectively, of interest expense in connection with the May 2019 Notes. As of September 30, 2019, the outstanding principal and accrued interest on the May 2019 Notes was $90.3 million and $2.2 million, respectively. The principal and accrued interest of the May 2019 Notes automatically converted upon the IPO on October 29, 2019, converting into 6,107,918 shares of common stock; refer to Note 7 for further information.

5. Long-Term Debt

Long-term debt consists of the following (in thousands):

On May 14, 2019, the Company entered into a loan and security agreement (the “Loan Agreement”, and all amounts borrowed thereunder the “Term Loans”) with Silicon Valley Bank (“SVB”), as administrative and collateral agent, and lenders including SVB and WestRiver Innovation Lending Fund VIII, L.P. (“WestRiver”). The Company borrowed $25.0 million (“Term Loan A”) at the inception of the Loan Agreement and has the right to borrow an additional $25.0 million (“Term Loan B”). Term Loan B is available through March 31, 2020, provided that (i) the Company has received at least $150.0 million of net cash proceeds in connection with the issuance and sale, subsequent to April 1 2019, of its equity securities and subordinated debt, (ii) the Company has initiated Phase 3 clinical trials for vonoprazan, and (iii) no event of default has occurred.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

The Term Loans bear interest at a floating rate of the higher of the Wall Street Journal Prime rate plus 1.75% (7.25% at September 30, 2019) or 7.25%. The monthly payments consist of interest-only through June 1, 2021 or, in the event of positive data with respect to the Company’s Phase 3 clinical trial in both indications for vonoprazan sufficient to file an NDA with the FDA, through June 1, 2022. Subsequent to the interest-only period, the Term Loans will be payable in equal monthly installments of principal, plus accrued and unpaid interest through the maturity date of May 1, 2024. In addition, the Company is obligated to pay a final payment fee of 8.25% of the original principal amount of the Term Loans. As of September 30, 2019, the final payment fee of $2.1 million has been recorded as an other long-term liability.

The Company may elect to prepay all or a portion of the Term Loans prior to maturity, subject to a prepayment fee of up to 2.0% of the then outstanding principal balance and payment of a pro rata portion of the final payment fee. After repayment, no Term Loan amounts may be borrowed again.

The borrowings under the Loan Agreement are collateralized by substantially all of the Company’s assets, excluding intellectual property and certain other assets. The Loan Agreement includes affirmative and negative covenants. The affirmative covenants include, among others, covenants requiring the Company to maintain its legal existence and governmental approvals, deliver certain financial reports, maintain insurance coverage and satisfy certain requirements regarding its operating accounts. The negative covenants include, among others, limitations on the Company’s ability to incur additional indebtedness and liens, merge with other companies or consummate certain changes of control, acquire other companies, engage in new lines of business, make certain investments, pay dividends, transfer or dispose of assets, amend certain material agreements or enter into various specified transactions. The Loan Agreement also contains customary events of default, including bankruptcy, the failure to make payments when due, and a material adverse change. Upon the occurrence of an event of default, subject to any specified cure periods, all amounts owed by the Company would begin to bear interest at a rate that is 4.00% above the rate effective immediately before the event of default and may be declared immediately due and payable by SVB, as collateral agent. As of September 30, 2019, the Company was in compliance with all applicable covenants under the Loan Agreement.

In connection with the Loan Agreement, the Company issued the Lender Warrants to purchase stock of the Company. The Lender Warrants become exercisable only if the Company borrows Term Loan B, and the number, class and per share price of the shares subject to the warrants is dependent on the terms of certain future equity financing transactions of the Company, including an IPO. The Lender Warrants expire ten years from the date of issuance, subject to earlier termination on September 30, 2020 if the Company does not draw down Term Loan B on or before March 31, 2020. The Lender Warrants include a put option pursuant to which, in the event that the Company does not draw down Term Loan B on or before March 31, 2020, the warrant holders may require that the Company repurchase the warrants for a total aggregate repurchase price of $0.5 million. The put right is exercisable through September 30, 2020.

The initial $0.4 million fair value of the Lender Warrants, the $2.1 million final payment fee and $0.2 million of debt issuance costs have been recorded as debt discount and are being amortized to interest expense using the effective interest method over the term of the Term Loans. For the three and nine months ended September 30, 2019, the Company recognized $0.6 million and $0.9 million of interest expense, including amortization of the debt discount, in connection with the Loan Agreement. As of September 30, 2019, the Company had outstanding Term Loans of $25.0 million and accrued interest of $0.2 million.

Future minimum principal and interest payments under the Term Loans, including the final payment fee, as of September 30, 2019 are as follows (in thousands):

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

6. Stockholders’ Deficit

Common Stock

In March 2019, subsequent to the Merger, the Company sold 1,491,072 shares of the Company’s common stock to Frazier.

In March 2019, the founders granted the Company a repurchase right for the 3,373,408 shares of common stock originally purchased in 2018. The Company has the right, but not the obligation, to repurchase unvested shares in the event the founder’s relationship with the Company is terminated, subject to certain limitations, at the original purchase price of the stock. The repurchase right lapsed for 843,352 shares in March 2019 and the repurchase right for the remaining 2,530,056 shares lapses in equal monthly amounts over the following 48-month period ending in March 2023. The fair value of the founder shares at the date the repurchase right was granted is being recognized as stock-based compensation expense on a straight-line basis over the vesting period. As of September 30, 2019, 2,213,808 shares of common stock were subject to repurchase by the Company and the associated repurchase liability was not significant. The amount of recognized and unrecognized stock-based compensation related to the founder stock was immaterial for all periods presented.

In May 2019, the Company issued Takeda 1,084,000 shares of common stock in connection with the Takeda License.

For the period from January 1, 2019 to May 6, 2019, the Company issued 2,524,852 shares of common stock to various employees and consultants of the Company for aggregate proceeds of approximately $1,000. Upon issuance, these shares were subject to a repurchase option by the Company at the original purchase price of the shares. The repurchase rights generally lapse as to 25% of the shares on the first anniversary of the vesting commencement date, and the repurchase right lapses as to 1/48th of the shares each one-month period thereafter, subject to the purchaser remaining continuously an employee, consultant or director of the Company.

On October 29, 2019, the Company completed its IPO and issued 10,997,630 shares of common stock for net proceeds of approximately $191.4 million.

Equity Incentive Plan

The Company’s 2019 Equity Incentive Plan (the “Existing Incentive Plan”) provides for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, and other stock awards to eligible recipients, including employees, directors or consultants of the Company. As of September 30, 2019, the Company had 2,231,739 shares of common stock authorized for issuance under the Existing Incentive Plan, of which 814,951 shares remained available for grant. In May 2019, the Company issued 16,260 shares of common stock under a restricted stock award, of which 6,775 were unvested as of September 30, 2019. For the nine months ended September 30, 2019, 1,400,258 stock options and 16,260 restricted stock awards were granted under the Existing Incentive Plan.

A summary of the Company’s unvested shares is as follows:

For accounting purposes, unvested shares of common stock are considered issued, but not outstanding until they vest.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

Stock Options

The fair value of each employee and non-employee stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Company, prior to the IPO on October 29, 2019, is a private company and lacks company-specific historical and implied volatility information. Therefore, it estimates its expected volatility based on the historical volatility of a publicly traded set of peer companies. Due to the lack of historical exercise history, the expected term of the Company’s stock options for employees has been determined utilizing the “simplified” method for awards. The expected term of stock options granted to non-employees is equal to the contractual term of the option award. The risk-free interest rate is determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award. Expected dividend yield is zero based on the fact that the Company has never paid cash dividends and does not expect to pay any cash dividends in the foreseeable future.

A summary of the Company’s stock option activity and related information is as follows:

The estimated weighted-average fair value of employee and nonemployee director stock options granted during 2019 was $5.12.  As of September 30, 2019, the Company had $3.8M of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted-average period of 3.72 years.

Valuation Assumptions

The weighted-average assumptions used to estimate the fair value of stock options using the Black-Scholes option valuation model and the resulting weighted average fair value of stock options granted were as follows:

Stock-Based Compensation Expense

Stock-based compensation expense recognized for all equity awards, including founder stock, has been reported in the combined statements of operations as follows (in thousands):

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

For the three and nine months ended September 30, 2019, the vested fair value of the restricted stock awards was $37,000 and $66,000, respectively. There was no stock-based compensation expense for the nine months ended September 30, 2018.

7. Subsequent Events

Reclassification of Takeda Warrant

On October 11, 2019, the Company increased its authorized shares to 50,000,000.  As a result, there were sufficient authorized shares for the Takeda Warrant.  The Company will record an adjustment to the fair value of the Takeda Warrant as of October 11, 2019 and reclassify the balance from warrant liabilities to additional paid-in capital.

Initial Public Offering

On October 29, 2019, the Company completed its IPO whereby it sold 10,997,630 shares of common stock at a public offering price of $19.00 per share. In aggregate, the Company received net proceeds of approximately $191.4 million, after deducting underwriting discounts, commissions and offering costs of $17.6 million.

In addition, each of the following occurred in connection with the completion of our IPO on October 29, 2019:

The following table summarizes certain actual balance sheet data and pro forma balance sheet data to reflect the activities related to the Company’s IPO noted above, as of September 30, 2019 (in thousands):

In connection with the closing of its IPO on October 29, 2019, the Company will record an additional non-cash charge related to the final fair value adjustment of the convertible promissory notes payable. This final fair value adjustment is excluded from the table above.

Phathom Pharmaceuticals, Inc.

Notes to Combined Financial Statements − (Continued)

(Information as of September 30, 2019 and thereafter and for the nine months ended September 30, 2018 and 2019 is unaudited)

2019 Incentive Award Plan

In October 2019, the board of directors adopted, and the Company’s stockholders approved the 2019 Equity Incentive Plan (the “2019 Plan”), which will become effective in connection with the IPO. Under the 2019 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and other awards to individuals who are then employees, officers, non-employee directors or consultants of the Company or its subsidiaries. An aggregate of 2,700,000 shares of the Company’s common stock will initially be available for issuance under awards granted pursuant to the 2019 Plan. The number of shares initially available for issuance will be increased by (i) the number of shares subject to stock options or similar awards granted under the Existing Incentive Plan that expire or otherwise terminate without having been exercised in full after the effective date of the 2019 Plan and unvested shares issued pursuant to awards granted under the Existing Incentive Plan that are forfeited to or repurchased by the Company after the effective date of the 2019 Plan, with the maximum number of shares to be added to the 2019 Plan pursuant to clause (i) above equal to 1,416,788 shares, and (ii) an annual increase on January 1 of each calendar year beginning in 2020 and ending in 2029, equal to the lesser of (a) 5% of the shares of common stock outstanding on the final day of the immediately preceding calendar year and (b) such smaller number of shares as determined by the board of directors.

Approval of the Employee Stock Purchase Plan

In October 2019, the board of directors adopted, and the Company’s stockholders approved, the Employee Stock Purchase Plan (the “ESPP”), which will become effective in connection with the IPO. The ESPP permits participants to purchase common stock through payroll deductions of up to 20% of their eligible compensation, which includes a participant’s gross base compensation for services to the Company, including overtime payments and excluding sales commissions, incentive compensation, bonuses, expense reimbursements, fringe benefits and other special payments. A total of 270,000 shares of common stock is initially reserved for issuance under the ESPP. In addition, the number of shares available for issuance under the ESPP will be annually increased on January 1 of each calendar year beginning in 2020 and ending in 2029, by an amount equal to the lesser of: (i) 1% of the shares outstanding on the final day of the immediately preceding calendar year and (ii) such smaller number of shares as is determined by the board of directors.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition results of operations in conjunction  with the unaudited interim financial statements included in this Quarterly Report on Form 10-Q  and with our audited financial statements and notes thereto for the year ended December 31, 2018 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in in the Prospectus dated October 24, 2019 filed pursuant to Rule 424(b) under the Securities Act with the Securities and Exchange Commission on October 28, 2019, or the Prospectus.

Forward Looking Statements

The following discussion and other parts of this quarterly report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, the Exchange Act. All statements other than statements of historical facts contained in this quarterly report, including statements regarding our future results of operations and financial position, business strategy, research and development plans and costs, the timing and likelihood of regulatory filings and approvals, commercialization plans, pricing and reimbursement, the potential to develop future product candidates, the timing and likelihood of success of the plans and objectives of management for future operations, and future results of anticipated product development efforts, are forward-looking statements. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations. The forward-looking statements in this quarterly report are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, operating results, business strategy, short-term and long-term business operations and objectives. These forward-looking statements speak only as of the date of this quarterly report and are subject to a number of risks, uncertainties and assumptions, including those described in the Prospectus under the heading “Risk Factors.” The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.

Overview

We are a late clinical-stage biopharmaceutical company focused on developing and commercializing novel treatments for gastrointestinal, or GI, diseases. Our initial product candidate, vonoprazan, is an oral small molecule potassium-competitive acid blocker, or P-CAB. P-CABs are a novel class of medicines that block acid secretion in the stomach. Vonoprazan has rapid, potent, and durable anti-secretory effects and  has demonstrated clinical benefits over the current standard of care as a single agent in the treatment of gastroesophageal reflux disease, or GERD, and in combination with antibiotics for the treatment of Helicobacter pylori, or H. pylori, infection. Takeda Pharmaceutical Company Limited, or Takeda, developed vonoprazan and has received marketing approval in nine countries in Asia and Latin America. Vonoprazan generated over $500 million in net sales in its fourth full year on the market since its approval in Japan in late 2014. In May 2019, we in-licensed the U.S., European, and Canadian rights to vonoprazan from Takeda. We plan to initiate two pivotal Phase 3 clinical trials of vonoprazan in the fourth quarter of 2019. We believe that the successful completion of our Phase 3 clinical trials, together with the existing clinical data, will support regulatory submissions in 2021 and 2022 for marketing approval for the treatment of H. pylori infection and erosive esophagitis, respectively. We have received qualified infectious disease product (QIDP) and Fast Track designations from the U.S. Food and Drug Administration, or FDA, for vonoprazan in combination with certain antibiotics for the treatment of H. pylori infection. QIDP designation also provides potential eligibility for priority review and extension of any regulatory exclusivity awarded if approved. If approved, we plan to independently commercialize vonoprazan in the United States. We also plan to seek commercial partnerships for vonoprazan in Europe and Canada, expand development of vonoprazan across indications, dosing regimens and alternative formulations and packaging, and in-license or acquire additional clinical or commercial stage product candidates for the treatment of GI diseases in a capital efficient manner.

We commenced our operations in 2018 and have devoted substantially all of our resources to date to organizing and staffing our company, business planning, raising capital, in-licensing our initial product candidate, vonoprazan, meeting with regulatory authorities, preparing for our planned Phase 3 clinical trials of vonoprazan, and providing other general and administrative support for these operations. Our operations to date have been funded primarily through the issuance of convertible promissory notes and commercial bank debt. From our inception through September 30, 2019, we have raised aggregate gross proceeds of $90.3 million from the issuance of convertible promissory notes and $25.0 million of commercial bank debt. As of September 30, 2019, we had cash and cash equivalents of $74.5 million. On October 29, 2019, in connection with our initial public offering, or IPO, we sold 10,997,630 shares of common stock, which included the exercise in full by the underwriters of their option to purchase 1,434,473 additional shares at a public offering price of $19.00 per share. The net proceeds were approximately $191.4 million, after deducting underwriting discounts and commissions and estimated offering costs.  Based on our current operating plan, we believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash requirements through at least the next 24 months.

We do not have any products approved for sale and have incurred net losses since our inception. Our net losses for the nine months ended September 30, 2018 and 2019 were $0.8 million and $157.1 million, respectively. Our net losses for the nine months ended September 30, 2019 included non-cash charges related to the change in fair value of warrant liabilities of $59.0 million, change in fair value of convertible promissory notes of $4.9 million, the issuance to Takeda of 1,084,000 shares of our common stock at a fair value of $5.9 million and issuance of the Takeda Warrant at an initial fair value of $47.9 million.  As of September 30, 2019, we had an accumulated deficit of $158.4 million. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on the timing of our clinical development activities, other research and development activities and pre-commercialization activities. We expect our expenses and operating losses will increase substantially as we advance vonoprazan through clinical trials, seek regulatory approval for vonoprazan, expand our clinical, regulatory, quality, manufacturing and commercialization capabilities, incur significant commercialization expenses for marketing, sales, manufacturing and distribution if we obtain marketing approval for vonoprazan, protect our intellectual property, expand our general and administrative support functions, including hiring additional personnel, and incur additional costs associated with operating as a public company.

We have never generated any revenue and do not expect to generate any revenues from product sales unless and until we successfully complete development and obtain regulatory approval for vonoprazan, which will not be for several years, if ever. Accordingly, until such time as we can generate significant revenue from sales of vonoprazan, if ever, we expect to finance our cash needs through equity offerings, our existing loan and security agreement, or Loan Agreement, debt financings, or other capital sources, including potential collaborations, licenses and other similar arrangements. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. Our failure to raise capital or enter into such other arrangements when needed would have a negative impact on our financial condition and could force us to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

Financial Operations Overview

Our combined financial statements include the accounts of Phathom (the receiving entity) and YamadaCo IIA prior to being merged into a single entity effective March 13, 2019. Phathom and YamadaCo IIA were entities under common control of Frazier Life Sciences IX, L.P., or Frazier, as a result of, among other things, Frazier’s: (i) ownership of a majority of the outstanding capital stock of both companies; (ii) financing of both companies; (iii) control of the board of directors of both companies; and (iv) management of both companies. Both Phathom and YamadaCo IIA were formed for the purpose of identifying potential assets around which to form an operating company. As the merged entities were under common control, the combined financial statements report the financial position, results of operations and cash flows of Phathom and YamadaCo IIA as though the transfer of net assets and equity interests had occurred at the beginning of 2018. All intercompany accounts and transactions have been eliminated in combination.

License Agreement with Takeda

On May 7, 2019, we and Takeda entered into an exclusive license to commercialize vonoprazan fumarate in the United States, Canada and Europe, or the Takeda License, pursuant to which we in-licensed the U.S., European, and Canadian rights to vonoprazan. During the term of the Takeda License, we and our affiliates are not permitted to commercialize any pharmaceutical product, other than vonoprazan, that treats acid-related disorders, except for certain generic and OTC competing products in specified circumstances. We will be responsible at our cost for the development, manufacture and commercialization of vonoprazan products. We are required to use commercially reasonable efforts to develop and commercialize the vonoprazan products in our licensed territory.

Under the Takeda License, Takeda has the sole right and authority, with our input, to prepare, file, prosecute, and maintain all Takeda and joint patents on a worldwide basis at its own cost. We are responsible, at our cost, for preparing, filing, prosecuting, and maintaining patents on inventions made solely by us in connection with vonoprazan, subject to input from Takeda.

We paid Takeda upfront consideration consisting of a cash fee of $25.0 million, 1,084,000 shares of our common stock, a warrant to purchase 7,588,000 shares of our common stock at an exercise price of $0.00004613 per share, or the Takeda Warrant, and issued Takeda a right to receive an additional common stock warrant, or the Takeda Warrant Right, if Takeda’s fully-diluted ownership of the Company represented less than a certain specified percentage of the fully-diluted capitalization, including shares issuable upon conversion of outstanding convertible promissory notes, calculated immediately prior to the closing of our IPO.  The Takeda Warrant Right expired upon completion of our IPO, and no additional warrant was issued. We agreed to make milestone payments to Takeda upon achieving certain tiered aggregate annual net sales of licensed products in the United States, Europe and Canada up a total maximum milestone amount of $250.0 million. We also agreed to make tiered royalty payments at percentages in the very low to mid double digits on net sales of licensed products, subject to specified offsets and reductions. Royalties will be payable, on a product-by-product and country-by-country basis from the first commercial sale of such product in such country, until the latest of expiration of the licensed patents covering the applicable product, expiration of regulatory exclusivity in such country, or 15 years following first commercial sale in such country.

Components of Results of Operations

Operating Expenses

Research and Development

To date, our research and development expenses have related to the development of vonoprazan. Research and development expenses are recognized as incurred and payments made prior to the receipt of goods or services to be used in research and development are capitalized until the goods or services are received.

Research and development expenses include:

We plan to substantially increase our research and development expenses for the foreseeable future as we continue the development of vonoprazan. We cannot determine with certainty the timing of initiation, the duration or the completion costs of current or future clinical trials and nonclinical studies of vonoprazan or any future product candidates due to the inherently unpredictable nature of clinical and preclinical development. Clinical and preclinical development timelines, the probability of success and development costs can differ materially from expectations. In addition, we cannot forecast which product candidates may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

Our future clinical development costs may vary significantly based on factors such as:

In-Process Research and Development

In-process research and development expenses relate to the Takeda License, and include the $78.9 million purchase price of the acquired research and development assets. The purchase price of the Takeda License consisted of the following: (i) $25.0 million in cash; (ii) issuance to Takeda of 1,084,000 shares of our common stock at a fair value of $5.9 million; (iii) issuance of the Takeda Warrant at an initial fair value of $47.9 million; (iv) issuance of the Takeda Warrant Right, with a nominal initial fair value due to the low probability of issuance; and (v) $0.1 million of transaction costs incurred by us. The fair value of the Takeda Warrant and Takeda Warrant Right were determined using the methodologies described below under “Change in Fair Value of Warrant Liabilities,” and the fair value of the common stock was determined using the methodologies described below under “Critical Accounting Policies and Significant Judgments and Estimates—Common Stock Valuations.”

General and Administrative

General and administrative expenses consist of salaries and employee-related costs, including stock-based compensation, for personnel in executive, finance and other administrative functions, legal fees relating to intellectual property and corporate matters, and professional fees for accounting and consulting services. We anticipate that our general and administrative expenses will increase in the future to support our continued research and development activities, pre-commercial preparation activities for vonoprazan and, if any future product candidate receives marketing approval, commercialization activities. We also anticipate increased expenses related to audit, legal, regulatory, and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, director and officer insurance premiums, and investor relations costs associated with operating as a public company.

Interest Income

Interest income consists of interest on our money market fund.

Interest Expense

Interest expense consists of (i) interest on our convertible promissory notes at per annum interest rates ranging from 1.68% to 6.00% and (ii) interest on our outstanding commercial bank debt at a floating per annum interest rate (7.25% as of September 30, 2019) and amortization of the commercial bank debt discount recorded in connection with the  fair value of warrants issued to the lenders, debt issuance costs incurred and the obligation to make a final payment fee.

Change in Fair Value of Warrant Liabilities

In connection with the Takeda License, we issued the Takeda Warrant and Takeda Warrant Right, or together the Takeda Warrants. In connection with our commercial bank debt, we issued the lenders warrants to purchase our capital stock, or the Lender Warrants. The Takeda Warrants are accounted for as liabilities as they do not meet all the conditions for equity classification due to (i) insufficient authorized shares for the Takeda Warrant and (ii) the Takeda Warrant Right is not indexed to our own stock. The Lender Warrants are accounted for as liabilities as they contain a holder put right under which the lenders could require us to pay cash in exchange for the warrants. We adjust the carrying value of our warrant liabilities to their estimated fair value at each reporting date, with any change in fair value of the warrant liabilities recorded as an increase or decrease to change in fair value of warrant liabilities in the combined statements of operations.

The fair value of the Takeda Warrants is derived from the model used to estimate the fair value of our common stock and the fair value of the Lender Warrants is estimated using a probability-weighted model considering IPO and non-IPO scenarios. The IPO scenarios utilize a binomial lattice model to estimate a distribution of total equity values as of a projected IPO date. The non-IPO scenario utilizes the repurchase price associated with the warrant put right discounted to present value based on venture capital rates of return and the term associated with the put right. After the closing of the IPO, the Lender Warrants will continue to be accounted for at fair value.

On October 11, 2019, we increased our authorized shares of common stock to 50,000,000.  As a result, there were sufficient authorized shares of common stock for the Takeda Warrant.  We recorded an adjustment to the fair value of the Takeda Warrant as of October 11, 2019, and reclassified the balance from warrant liabilities to additional paid-in capital.

Upon the closing of the IPO, (i) the Takeda Warrant Right expired without effect since no fair value has been allocated to it, and (ii) the Lender Warrants, as a result of a put option, will continue as warrant liabilities adjusted to fair value at each reporting date.  

.  

Change in Fair Value of Convertible Promissory Notes

We issued convertible promissory notes in 2018 and 2019 for which we have elected the fair value option. We adjust the carrying value of our convertible promissory notes to their estimated fair value at each reporting date, with any change in fair value of the convertible promissory notes recorded as an increase or decrease to change in fair value of convertible promissory notes in our combined statements of operations.

Prior to their exchange into convertible promissory notes issued in May 2019, the fair value of convertible promissory notes issued from inception through April 2019 was estimated using a scenario-based analysis that estimated the fair value of the convertible promissory notes based on the probability-weighted present value of expected future investment returns, considering possible outcomes available to the noteholders, including conversions in subsequent equity financings, change of control transactions, settlement and dissolution. The fair value of the convertible promissory notes issued in May 2019 is estimated using a scenario-based analysis that estimates the fair value of the convertible promissory notes based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to the noteholders, including various IPO, settlement, equity financing, corporate transaction and dissolution scenarios.

The notes issued in May 2019 and related accrued interest were converted into 6,107,918 shares upon completion of the IPO.

Results of Operations

Comparison of the Nine Months Ended September 30, 2018 and 2019

The following table summarizes our results of operations for the nine months ended September 30, 2018 and 2019 (in thousands):

Research and Development Expenses. We had minimal research and development expenses for the nine months ended September 30, 2018, as we had not yet entered into the Takeda License. The $7.6 million of research and development expenses for the nine months ended September 30, 2019 consisted of $6.3 million of clinical development of vonoprazan and $1.3 million of personnel-related expenses.

In-Process Research and Development Expenses. We had no in-process research and development expenses for the nine months ended September 30, 2018. The $78.9 million of in-process research and development expenses for the nine months ended September 30, 2019 consisted of the purchase price for the research and development assets we acquired as part of the Takeda License.  The purchase price of the Takeda License consisted of the following: (i) $25.0 million in cash; (ii) issuance to Takeda of 1,084,000 shares of our common stock at a fair value of $5.9 million; (iii) issuance of the Takeda Warrant at an initial fair value of $47.9 million; (iv) issuance of the Takeda Warrant Right, with a nominal initial fair value due to the low probability of issuance; and (v) $0.1 million of transaction costs incurred by us.

General and Administrative Expenses. General and administrative expenses were $0.8 million and $4.0 million for the nine months ended September 30, 2018 and 2019, respectively. The increase of $3.2 million was due to increases of $0.7 million in legal

fees related to corporate and intellectual property matters, $0.9 million in professional services expenses for accounting, audit, tax, valuation and other services, $1.0 million in personnel-related expenses, $0.3 million of consulting services expenses, and $0.3 million of other operating expenses.

Other Income (Expense). Other expense of $30,000 for the nine months ended September 30, 2018 consisted of $8,000 of interest expense on our outstanding convertible promissory notes and $22,000 of other expense related to the increase in fair value of those convertible promissory notes. Other expense of $66.6 million for the nine months ended September 30, 2019 consisted of $4.9 million of other expense related to the increase in the fair value of our convertible promissory notes, $59.1 million of other expense related to the increase in the fair value of warrant liabilities, $2.2 million of interest expense on our outstanding convertible promissory notes, $0.9 million of interest expense on outstanding commercial bank debt, and $0.5 million of interest income.

Comparison of the Three Months Ended September 30, 2018 and 2019

The following table summarizes our results of operations for the three months ended September 30, 2018 and 2019 (in thousands):

Research and Development Expenses. We had minimal research and development expenses for the three months ended September 30, 2018, as we had not yet entered into the Takeda License. The $4.4 million of research and development expenses for the three months ended September 30, 2019 consisted of $3.3 million of clinical development of vonoprazan and $1.1 million of personnel-related expenses.

General and Administrative Expenses. General and administrative expenses were $0.3 million and $1.8 million for the three months ended September 30, 2018 and 2019, respectively. The increase of $1.5 million was due to increases of $0.1 million in legal fees related to corporate and intellectual property matters, $0.5 million in professional services expenses for accounting, audit, tax, valuation and other services, $0.3 million in personnel-related expenses, $0.1 million of consulting services expenses, and $0.5 million of other operating expenses.

Other Income (Expense). Other expense of $22,000 for the three months ended September 30, 2018 consisted of $4,000 of interest expense on our outstanding convertible promissory notes and $18,000 of other expense related to the increase in fair value of those convertible promissory notes. Other expense of $61.8 million for the nine months ended September 30, 2019 consisted of $2.5 million of other expense related to the increase in the fair value of our convertible promissory notes, $57.7 million of other expense related to the increase in the fair value of warrant liabilities, $1.4 million of interest expense on our outstanding convertible promissory notes, $0.6 million of interest expense on outstanding commercial bank debt, and $0.4 million of interest income.

Liquidity and Capital Resources

We have incurred net losses and negative cash flows from operations since our inception and anticipate we will continue to incur net losses for the foreseeable future. As of September 30, 2019, we had cash and cash equivalents of $74.5 million.

Commercial Bank Debt

On May 14, 2019, we entered into the Loan Agreement with Silicon Valley Bank, or SVB, as administrative and collateral agent,

and lenders SVB and WestRiver Innovation Lending Fund VIII, L.P.. We borrowed $25.0 million, or Term Loan A, at the inception of the Loan Agreement and have the right to borrow an additional $25.0 million, or Term Loan B, and which we collectively refer to as the Term Loans. Term Loan B is available through March 31, 2020, provided that (i) we have received at least $150.0 million of net cash proceeds in connection with the issuance and sale, subsequent to April 1, 2019, of our equity securities and subordinated debt, (ii) we have initiated Phase 3 clinical trials for vonoprazan, and (iii) no event of default has occurred. As of September 30, 2019, we had outstanding Term Loans of $25.0 million and accrued interest of $0.2 million.

The Term Loans bear interest at a floating rate of the higher of the Wall Street Journal Prime rate plus 1.75% (7.25% at September 30, 2019) or 7.25%. The monthly payments consist of interest-only through June 1, 2021 or, in the event of positive data with respect to our Phase 3 clinical trials in both indications for vonoprazan sufficient to file a new drug application, or NDA, with the FDA, through June 1, 2022. Subsequent to the interest-only period, the Term Loans will be payable in equal monthly installments of principal, plus accrued and unpaid interest through the maturity date of May 1, 2024. In addition, we are obligated to pay a final payment fee of 8.25% of the original principal amount of the Term Loans. We may elect to prepay all or a portion of the Term Loans prior to maturity, subject to a prepayment fee of up to 2.0% of the then outstanding principal balance and payment of a pro rata portion of the final payment fee. After repayment, no Term Loan amounts may be borrowed again. The borrowings under the Loan Agreement are collateralized by substantially all of our assets, excluding intellectual property and certain other assets. We have agreed not to encumber our intellectual property assets without SVB’s prior written consent unless a security interest in the underlying intellectual property is necessary to have a security interest in the accounts and proceeds that are part of the assets securing the Term Loans, in which case our intellectual property will automatically be included within the assets securing the Term Loans.

The Loan Agreement contains certain customary affirmative and negative covenants and events of default. The affirmative covenants include, among others, covenants requiring us to maintain our legal existence and governmental approvals, deliver certain financial reports, maintain insurance coverage and satisfy certain requirements regarding our operating accounts. The negative covenants include, among others, limitations on our ability to incur additional indebtedness and liens, merge with other companies or consummate certain changes of control, acquire other companies, engage in new lines of business, make certain investments, pay dividends, transfer or dispose of assets, amend certain material agreements or enter into various specified transactions. Upon the occurrence of an event of default, subject to any specified cure periods, all amounts owed by us would begin to bear interest at a rate that is 4.00% above the rate effective immediately before the event of default and may be declared immediately due and payable by SVB, as collateral agent. As of September 30, 2019, we were in compliance with all applicable covenants under the Loan Agreement.

In connection with the Loan Agreement, we issued the Lender Warrants, which become exercisable only if we borrow Term Loan B, and the number, class and per share exercise price of the shares subject to the warrants is dependent on the terms of certain future equity financing transactions of the Company, including an IPO. The Lender Warrants expire ten years from the date of issuance, subject to earlier termination on September 30, 2020 if we do not draw down Term Loan B on or before March 31, 2020. The Lender Warrants include a put option pursuant to which, in the event that we do not draw down Term Loan B on or before March 31, 2020, the warrant holders may require us to repurchase the warrants for a total aggregate repurchase price of $0.5 million. The put right is exercisable through September 30, 2020.

Convertible Note Financings

From January 2018 to April 2019, we issued an aggregate of $2.4 million of convertible promissory notes to Frazier, or the Frazier Notes, bearing interest at per annum rates ranging from 1.68% to 2.55%. In May 2019, these notes and related accrued interest were exchanged, at their then fair value of $2.4 million, for the May 2019 convertible promissory notes described below.

On May 7, 2019, we entered into a note purchase agreement under which we issued an aggregate of $90.3 million of unsecured convertible promissory notes, or the May 2019 Notes, resulting in gross proceeds to us of $87.8 million in cash and $2.4 million related to the exchange of the Frazier Notes. Including the conversion of the Frazier Notes, Frazier purchased $20.0 million of the May 2019 Notes. The May 2019 Notes bear interest at a rate of 6% per annum and are subordinated to borrowings under our Loan Agreement. The May 2019 Notes become payable upon demand of the holders of at least 60% of the outstanding principal amount of the May 2019 Notes, including Frazier, on May 7, 2020, or the Maturity Date, and become due and payable on May 7, 2022, subject to earlier conversion or repayment in the event we complete certain equity financings or a change of control. The note purchase agreement includes certain customary covenants and events of default. The May 2019 Notes automatically converted upon the IPO on October 29, 2019, converting into the issuance of 6,107,918 shares of common stock, representing the outstanding principal amount of the notes at the date of automatic conversion

Funding Requirements

Based on our current operating plan, we believe that our existing cash and cash equivalents, together with the net proceeds from our IPO, will be sufficient to meet our anticipated cash requirements through at least the next 24 months. In particular, we expect the net proceeds will allow us to complete our planned Phase 3 clinical trials of vonoprazan in the treatment of erosive esophagitis and H. pylori infection. However, our forecast of the period of time through which our financial resources will be adequate to support our

operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. We have based this estimate on assumptions that may prove to be wrong, and we could deplete our capital resources sooner than we expect. Additionally, the process of testing product candidates in clinical trials is costly, and the timing of progress and expenses in these trials is uncertain.

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

Until such time, if ever, as we can generate substantial product revenues to support our cost structure, we expect to finance our cash needs through equity offerings, the Loan Agreement, debt financings, or other capital sources, including potential collaborations, licenses and other similar arrangements. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be or could be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing and equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise funds through collaborations, or other similar arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or grant licenses on terms that may not be favorable to us and/or may reduce the value of our common stock. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market our product candidates even if we would otherwise prefer to develop and market such product candidates ourselves.

Including our existing cash and cash equivalents, including with the net proceeds from our initial public offering which closed on October 29, 2019, we believe that we have sufficient working capital on hand to fund operations such that there is no substantial doubt as to our ability to continue as a going concern at the date the combined financial statements were available to be issued. There can be no assurance that we will be successful in acquiring additional funding, that our projections of its future working capital needs will prove accurate, or that any additional funding would be sufficient to continue operations in future years.Cash Flows

The following table sets forth a summary of the net cash flow activity for each of the periods indicated (in thousands):

Operating Activities

Net cash used in operating activities was approximately $0.7 million and $13.1 million for the nine months ended September 30, 2018 and 2019, respectively. The net cash used in operating activities the nine months ended September 30, 2018 was primarily due to our net loss in each period. The net cash used in operating activities for the nine months ended September 30, 2019 was due to our net loss of $157.1 million, adjusted for $143.1 million of noncash charges and a $0.8 million net change in operating assets and liabilities. Noncash charges consisted of our in-process research and development charges of $78.9 million related to the Takeda License, $4.9 million related to the change in fair value of convertible promissory notes, $59.0 million related to the change in fair value of warrant liabilities, and $0.2 million of amortization of debt discounts on our commercial bank debt. The net change in operating assets and liabilities related to a $2.3 million increase in accrued interest on our outstanding convertible promissory notes and commercial bank debt and a $1.6 million increase in accounts payable and accrued expenses in support of the growth in our operating activities, partially offset by a $3.1 million increase in prepaid clinical activities.

Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2019 was primarily due to the cash we paid, including transaction costs, to acquire the Takeda License. We had no investing activities for the year ended December 31, 2018.

Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2018 was primarily due to proceeds from our issuance of convertible promissory notes. Net cash provided by financing activities for the nine months ended September 30, 2019 was $111.9 million, due to $88.3 million of net proceeds from our issuance of convertible promissory notes, $24.9 million of net proceeds from our commercial bank debt and offset by $1.3 million net proceeds related to the IPO.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our combined financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of our combined financial statements requires us to make estimates and assumptions that affect the reported

amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities in our combined financial statements and accompanying notes. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 1 to our combined financial statements included elsewhere in the Prospectus, we believe that the following accounting policies are the most critical for fully understanding and evaluating our financial condition and results of operations.

Accrued Research and Development Expenses

As part of the process of preparing our combined financial statements, we are required to estimate our accrued expenses as of each balance sheet date. This process involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of the actual cost. We make estimates of our accrued expenses as of each balance sheet date based on facts and circumstances known to us at that time. We periodically confirm the accuracy of our estimates with the service providers and make adjustments, if necessary. The significant estimates in our accrued research and development expenses include the costs incurred for services performed by our vendors in connection with research and development activities for which we have not yet been invoiced.

We base our expenses related to research and development activities on our estimates of the services received and efforts expended pursuant to quotes and contracts with vendors that conduct research and development on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the research and development expense. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual or prepaid expense accordingly. Advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made.

Although we do not expect our estimates to be materially different from amounts actually incurred, if our estimates of the status and timing of services performed differ from the actual status and timing of services performed, it could result in us reporting amounts that are too high or too low in any particular period. To date, there have been no material differences between our estimates of such expenses and the amounts actually incurred.

In-Process Research and Development

We evaluate whether acquired intangible assets are a business under applicable accounting standards. Additionally, we evaluate whether the acquired assets have a future alternative use. Intangible assets that do not have future alternative use, such as the Takeda License, are considered acquired in-process research and development. When the acquired in-process research and development assets are not part of a business combination, the value of the consideration paid is expensed on the acquisition date. Future costs to develop these assets are recorded to research and development expense as they are incurred.

Fair Value of Warrant Liabilities and Convertible Promissory Notes

As described above, our warrant liabilities and convertible promissory notes are revalued at each reporting period with changes in the fair value of the liabilities recorded as a component of other income (expense) in the combined statements of operations. There are significant judgments and estimates inherent in the determination of the fair value of these liabilities. If we had made different assumptions including, among others, those related to the timing and probability of various corporate scenarios, discount rates, volatilities and exit valuations, the carrying values of our warrant liabilities and convertible promissory notes, and our net loss and net loss per common share could have been significantly different.

Stock-Based Compensation Expense

Stock-based compensation expense represents the cost of the grant date fair value of equity awards recognized over the requisite service period of the awards (generally the vesting period) on a straight-line basis with forfeitures recognized as they occur. Through September 30, 2019, our stock-based compensation expense consisted of our issuance of restricted stock awards, or RSAs, for which the fair value is determined based on the fair value of the underlying common stock and stock options. As of September 30, 2019, unrecognized stock-based compensation expense was $3.8 million, which is expected to be recognized over a weighted-average period of approximately 3.72 years.

Other Company Information

JOBS Act

As an emerging growth company under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, we can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. We intend to rely on other exemptions provided by the JOBS Act, including without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of Sarbanes-Oxley. As a result, our combined financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.

We will remain an emerging growth company until the earliest of (i) the last day of the fiscal year following the fifth anniversary of the consummation of our IPO, (ii) the last day of the fiscal year in which we have total annual gross revenue of at least $1.07 billion, (iii) the last day of the fiscal year in which we are deemed to be a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock held by non-affiliates exceeded $700.0 million as of the last business day of the second fiscal quarter of such year, or (iv) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.

Recent Accounting Pronouncements

See Note 1 to our combined financial statements appearing elsewhere in the Prospectus.

Off-Balance Sheet Arrangements

During the periods presented we did not have, nor do we currently have, any off-balance sheet arrangements as defined under SEC rules.

Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our cash and cash equivalents consist of cash in readily available checking accounts and money market funds. As a result, the fair value of our portfolio is relatively insensitive to interest rate changes. Our outstanding convertible promissory notes bear interest at a fixed rate. Our long-term debt bears interest at a variable rate. A 10% increase or decrease in the interest rate on our long-term debt would not have a material effect on our financial position, results of operations or cash flows.

Effects of Inflation

Inflation generally affects us by increasing our cost of labor and research and development contract costs. We do not believe inflation has had a material effect on our results of operations during the periods presented.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2019, there have been no material changes surrounding our market risk, including interest rate risk, foreign currency exchange risk, and inflation risk, from the discussion provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk” in the Prospectus.

Item 4.Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic and current reports that we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable and not absolute assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in

achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this quarterly report. Based on such evaluation, our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the three months ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.Legal Proceedings

We are not currently subject to any material legal proceedings. From time to time, we may be involved in legal proceedings or subject to claims incident to the ordinary course of business. Regardless of the outcome, such proceedings or claims can have an adverse impact on us because of defense and settlement costs, diversion of resources and other factors, and there can be no assurances that favorable outcomes will be obtained.

Item 1A.Risk Factors

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information included in this Quarterly Report on Form 10-Q and in the Prospectus dated October 24, 2019 filed pursuant to Rule 424(b) under the Securities Act with the SEC on October 29, 2019, including our financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before making an investment decision to purchase or sell shares of our common stock. If any of the following risks are realized, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline, and you could lose part or all of your investment. The risks described below are not the only ones that we may face, and additional risks or uncertainties not known to us or that we currently deem immaterial may also impair our business and future prospects.

Risks Related to Our Limited Operating History, Financial Position and Capital Requirements

We have a limited operating history, have incurred significant operating losses since our inception and expect to incur significant losses for the foreseeable future. We may never generate any revenue or become profitable or, if we achieve profitability, we may not be able to sustain it.

Biopharmaceutical product development is a highly speculative undertaking and involves a substantial degree of risk. We are a late clinical-stage biopharmaceutical company with a limited operating history upon which you can evaluate our business and prospects. We commenced operations in 2018, and to date, we have focused primarily on organizing and staffing our company, business planning, raising capital, in-licensing our initial product candidate, vonoprazan, meeting with regulatory authorities, and preparing for our planned Phase 3 clinical trials of vonoprazan. As a company, we have not yet demonstrated an ability to successfully complete any clinical trials, obtain regulatory approvals, manufacture a commercial scale product or arrange for a third party to do so on our behalf, or conduct sales and marketing activities necessary for successful product commercialization. Consequently, any predictions made about our future success or viability may not be as accurate as they could be if we had a history of successfully developing and commercializing biopharmaceutical products.

We have incurred significant operating losses since our inception. If vonoprazan is not successfully developed and approved in the United States, Europe and/or Canada, we may never generate any revenue. We have incurred cumulative net losses since our inception and, as of September 30, 2019, we had an accumulated deficit of $158.4 million. Substantially all of our losses have resulted from expenses incurred in connection with in-licensing and developing vonoprazan and from general and administrative costs associated with our operations. Vonoprazan and any future product candidates will require substantial additional development time and resources before we will be able to apply for or receive regulatory approvals and begin generating revenue from product sales. We expect to continue to incur losses for the foreseeable future, and we anticipate these losses will increase substantially as we continue our development of, seek regulatory approval for, and potentially commercialize vonoprazan and seek to identify, assess, acquire, in-license, or develop additional product candidates.

To become and remain profitable, we must succeed in developing and eventually commercializing products that generate significant revenue. This will require us to be successful in a range of challenging activities, including completing clinical trials and preclinical studies of vonoprazan and any future product candidates, obtaining regulatory approval for these product candidates and manufacturing, marketing and selling any products. We are only in the preliminary stages of most of these activities. We may never succeed in these activities and, even if we do, may never generate revenues that are significant enough to achieve profitability. In addition, we have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biopharmaceutical industry. Because of the numerous risks and uncertainties associated with biopharmaceutical product development, we are unable to accurately predict the timing or amount of increased expenses or when, or if, we will be able to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would depress the value of our company and could impair our ability to raise capital, expand our business, continue our product development efforts, diversify our product candidate pipeline or even continue our operations. A decline in the value of our company could also cause you to lose all or part of your investment.