Prometheus Biosciences, Inc. - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2021

OR

For the transition period from ________to_________.

Commission File Number: 001-40187

PROMETHEUS BIOSCIENCES, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 684-1300

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 May 10, 2021, the registrant had 38,864,841 shares of common stock ($0.0001 par value) outstanding.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1.Financial Statements (unaudited)

PROMETHEUS BIOSCIENCES, INC.

Unaudited Condensed Consolidated Balance Sheets

(in thousands, except share and par value amounts)

See accompanying notes.

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PROMETHEUS BIOSCIENCES, INC.

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except share and per share amounts)

See accompanying notes.

3

PROMETHEUS BIOSCIENCES, INC.

Unaudited Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(in thousands, except share amounts)

See accompanying notes.

4

PROMETHEUS BIOSCIENCES, INC.

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes.

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PROMETHEUS BIOSCIENCES, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

Prometheus Biosciences, Inc. (the Company) was incorporated in the state of Delaware on October 26, 2016 under the name Precision IBD, Inc. and is headquartered in San Diego, California. The Company changed its name to Prometheus Biosciences, Inc. on October 1, 2019. The Company’s business is focused on the discovery, development and commercialization of novel therapeutic and companion diagnostic products for the treatment of immune-mediated diseases, starting first with inflammatory bowel disease (IBD).

In June 2019, the Company acquired Prometheus Laboratories, Inc. (PLI) and the related intangible assets used by PLI. PLI was wholly owned by Nestlé Health Science US Holdings, Inc. and the related intangible assets were owned by Societé Des Produits Nestlé S.A (together, Nestlé) (see Note 6). PLI markets and conducts several laboratory developed tests useful to gastroenterologists in monitoring their IBD patients’ disease state and informing their therapeutic decisions.

On December 31, 2020, the Company completed the spinoff of PLI by making an in-kind distribution of 100% of its interest in PLI to the Company’s stockholders of record on December 30, 2020 (see Note 6).

Reverse Stock Split

On March 5, 2021, the Company effected a one-for-ten reverse stock split of the Company’s common stock (the Reverse Stock Split). The par value and the authorized shares of the common stock were not adjusted as a result of the Reverse Stock Split. All issued and outstanding common stock and the conversion prices and ratio of the convertible preferred stock have been retroactively adjusted to reflect this Reverse Stock Split for all periods presented.

Initial Public Offering

On March 16, 2021, the Company completed its initial public offering (IPO) with the sale of 11,500,000 shares of common stock, which included the exercise in full by the underwriters of their option to purchase 1,500,000 additional shares, at an initial public offering price of $19.00 per share and received gross proceeds of $218.5 million, which resulted in net proceeds to the Company of approximately $199.8 million, after deducting underwriting discounts and commissions of approximately $15.3 million and offering-related transaction costs of approximately $3.4 million.

In addition, in connection with the completion of the Company’s initial public offering on March 16, 2021, all outstanding shares of convertible preferred stock were converted into 25,485,955 shares of the Company’s common stock; outstanding warrants to purchase 148,848 shares of convertible preferred stock were converted into warrants to purchase 14,884 shares of the Company’s common stock; and the Company’s certificate of incorporation was amended and restated to authorize 400,000,000 shares of common stock and 40,000,000 shares of undesignated preferred stock.

Liquidity

The Company has incurred net losses since inception, experienced negative cash flows from operations, and as of March 31, 2021, has an accumulated deficit of $113.1 million. The Company has historically financed its operations primarily through private placements of convertible preferred stock. The Company expects operating losses and negative cash flows from operations to continue for the foreseeable future. The Company believes its current capital resources will be sufficient for the Company to continue as a going concern for at least one year from the issuance date of these condensed consolidated financial statements.

The Company will be required to raise additional capital, however, there can be no assurance as to whether additional financing will be available on terms acceptable to the Company, if at all. If sufficient funds on acceptable terms are not available when needed, it would have a negative impact on the Company’s financial condition and could force the Company to delay, limit, reduce, or terminate product development or future commercialization efforts or grant rights to develop and market product candidates or testing products that the Company would otherwise plan to develop.

Basis of Presentation and Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management 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 condensed consolidated financial statements and

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accompanying notes. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may materially differ from these estimates and assumptions.

On December 31, 2020, the Company completed the spinoff of PLI. The results of operations for the three months ended March 31, 2020 have been presented as discontinued operations in the accompanying condensed consolidated financial statements in accordance with Accounting Standards Codification (ASC) 205-20, Presentation of Financial Statements—Discontinued Operations. Unless otherwise noted, discussion within these notes to the condensed consolidated financial statements relates to continuing operations (see Note 6 for additional information on discontinued operations).

On an ongoing basis, management evaluates its estimates, primarily related to revenue recognition, stock-based compensation, accrued research and development costs, and for periods prior to its IPO, the fair value of common stock, the fair value of the convertible preferred stock, and the fair value of the preferred stock purchase right liability. These estimates are based on historical data and experience, as well as various other factors that management believes to be 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. Estimates relating to the valuation of stock require the selection of appropriate valuation methodologies and models, and significant judgment in evaluating ranges of assumptions and financial inputs.

Unaudited Interim Financial Information

The unaudited financial statements at March 31, 2021, and for the three months ended March 31, 2021 and 2020, have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (SEC), and with GAAP applicable to interim financial statements. These unaudited financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of only normal recurring accruals, which in the opinion of management are necessary to present fairly the Company’s financial position as of the interim date and results of operations for the interim periods presented. Interim results are not necessarily indicative of results for a full year or future periods. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ materially from those estimates. These unaudited financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2020, included in the Prospectus dated March 11, 2021 filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the SEC on March 12, 2021.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and until December 31, 2020, the date at which the spinoff was completed, its wholly-owned subsidiary, PLI, and have been prepared in conformity with GAAP. All intercompany accounts and transactions have been eliminated in consolidation.

Segment Reporting

The Company’s Chief Executive Officer, who is considered to be the chief operating decision maker (CODM), reviews financial information presented on a consolidated basis, accompanied by information about operating segments for purposes of making operating decisions and assessing financial performance. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the CODM in deciding how to allocate resources and in assessing performance.

Prior to the spinoff of PLI in December 2020, the Company determined its operating segments to be the therapeutics and diagnostic services businesses. The therapeutics business derives substantially all of its revenue from collaboration agreements and devotes all of its efforts to development of product candidates and companion diagnostics in the IBD space. The diagnostic services business, which is recorded as discontinued operations, derives its revenue from diagnostic services in the IBD space generated from the conduct of laboratory developed tests. Subsequent to the spinoff, the Company operates in one segment. The Company operates solely in the United States.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. The cash and cash equivalents balance at March 31, 2021 and December 31, 2020 represents cash in readily available checking and money market accounts.

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Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentration of credit risk, consist primarily of cash, cash equivalents, and accounts receivable. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. 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 Financing Costs

At December 31, 2020, financing costs, consisting of legal, accounting, printer and filing fees related to the Company’s IPO, totaled $1.7 million.  Upon the completion of the IPO in March 2021, all of these expenses were offset against the proceeds from the IPO.

Revenue Recognition

The Company recognizes revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers (ASC 606). In accordance with ASC 606, the Company performs the following steps in determining the appropriate amount of revenue to be recognized as it fulfills its obligations under each of these agreements: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when, or as, the Company satisfies each performance obligation. At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

To date, all of the Company’s collaboration revenue has been derived from its collaboration agreement with Millennium Pharmaceuticals, Inc., a subsidiary of Takeda Pharmaceutical Company Limited (collectively, Takeda) and its collaboration agreement with Dr. Falk Pharma GmbH as described in Note 5. The terms of these arrangements include the following types of payments to the Company: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; payments for research and development services provided by the Company; and royalties on net sales of licensed products. At the initiation of an agreement, the Company analyzes whether each unit of account results in a contract with a customer under ASC 606 or in an arrangement with a collaborator subject to guidance under ASC 808, Collaborative Arrangements (ASC 808).

The Company considers a variety of factors in determining the appropriate estimates and assumptions under these arrangements, such as whether the elements are distinct performance obligations, whether there are observable stand-alone prices, and whether any licenses are functional or symbolic. The Company evaluates each performance obligation to determine if it can be satisfied and recognized as revenue at a point in time or over time. Typically, license fees, non-refundable upfront fees, and funding of research activities are considered fixed, while milestone payments are identified as variable consideration which must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price. The Company estimates the amount of variable consideration using the most likely amount, as milestone payments typically only have two possible outcomes. The Company recognizes revenue for sales-based royalty promised in exchange for the license of intellectual property only when the subsequent sale occurs.

The Company may allocate transaction price using a number of methods including estimating standalone selling price of performance obligations and using the residual approach when the standalone selling price of the license is highly variable or uncertain, and observable standalone selling prices exist for the other goods or services promised in the contract.

The Company receives payments from its collaborators based on terms established in each contract. Upfront payments and other payments may require deferral of revenue recognition to a future period until the Company is unconditional. The Company does not assess whether a contract has a significant financing component if the expectation at contract inception is such that the payment by the customer is akin to a deposit for research and development services.

Research and Development and Clinical Trial Accruals

Research and development costs are charged to expense as incurred. Research and development expenses include certain payroll and personnel expenses, laboratory supplies, consulting costs, external contract research and development expenses, and allocated overhead, including rent, equipment depreciation and utilities. Advance payments for goods or services for future research and development activities are deferred and expensed as the goods are delivered or the related services are performed.

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The Company estimates preclinical studies and clinical trial expenses based on the services performed pursuant to contracts with research institutions and clinical research organizations that conduct and manage preclinical studies and clinical trials on the Company’s behalf. In addition, clinical study and trial materials are manufactured by contract manufacturing organizations. In accruing for these services, the Company estimates the time period over which services will be performed and the level of effort to be expended in each period. These estimates are based on communications with the third-party service providers and the Company’s estimates of accrued expenses and on information available at each balance sheet date. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust the accrual accordingly.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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.

Stock-Based Compensation

The Company expenses stock-based compensation to employees and non-employees over the requisite service period (usually the vesting period) on a straight-line basis, net of actual forfeitures during the period, based on the estimated grant-date fair value of the awards. The Company estimates the fair value of stock option grants using the Black-Scholes option pricing model, and the assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment.

Valuation of Common Stock

Prior to the IPO, given the absence of a public trading market for the Company’s common stock, its board of directors exercised their judgment and considered a number of objective and subjective factors to determine the best estimate of the fair value of the Company’s common stock, such as: contemporaneous valuations performed by independent third-party specialists, its stage of development, including the status of its research and development efforts of its product candidates, the material risks related to its businesses and industry, its results of operations before discontinued operations and financial position, including its levels of capital resources, the prices at which its sold shares of its convertible preferred stock, the rights, preferences and privileges of its convertible preferred stock relative to those of its common stock, the conditions in the biotechnology industry and the economy in general, the stock price performance and volatility of comparable life sciences public companies, as well as recently completed mergers and acquisitions of peer companies, the likelihood of achieving a liquidity event for the holders of its common stock or convertible preferred stock, such as an IPO or a sale of the Company given prevailing market conditions, trends and developments in its industry, external market conditions affecting the life sciences and biotechnology sectors, and the lack of liquidity of its common stock, among other factors.

After the completion of the IPO, the fair value of each share of common stock is based on the closing price of the Company’s common stock as reported by Nasdaq.

Preferred Stock Purchase Right Liabilities

From time to time, the Company enters into convertible preferred stock financings where, in addition to the initial closing, investors agree to buy, and the Company agrees to sell, additional shares of that convertible preferred stock at a fixed price in the event that certain conditions are met or agreed upon milestones are achieved. The Company evaluates this purchase right and assesses whether it meets the definition of a freestanding instrument and, if so, determines the fair value of the purchase right liability and records it on the balance sheet with the remainder of the proceeds raised allocated to convertible preferred stock. The preferred stock purchase right liability is revalued at each reporting period with changes in the fair value of the liability recorded as change in fair value of preferred stock purchase right liability in the statements of operations. Upon the issuance of the shares of Series D-2 convertible preferred stock in January 2021, the preferred stock purchase right liability no longer required liability accounting and the then fair value of the preferred stock purchase right liability was reclassified into stockholders’ equity.

The Company performed the final remeasurement of the preferred stock purchase right liability as of the issuance of the shares of Series D-2 convertible preferred stock and recorded a $1.0 million change in fair value into other income (expense) for the three months ended March 31, 2021.

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Net Loss Per Share

Basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common stock equivalents outstanding for the period determined using the treasury-stock method. The Company has excluded 47,999 and 214,721 weighted-average shares subject to repurchase or forfeiture from the weighted-average number of common shares outstanding for the three months ended March 31, 2021 and 2020, respectively. Dilutive common stock equivalents are comprised of convertible preferred stock and options outstanding under the Company’s stock option plan.

Basic and diluted net loss attributable to common holders per share is presented in conformity with the two- class method required for participating securities as the convertible preferred stock are considered participating securities. The Company’s participating securities do not have a contractual obligation to share in the Company’s losses. As such, the net loss was attributed entirely to common stockholders. Accordingly, for three months ended March 31, 2021 and 2020, there is no difference in the number of shares used to calculate basic and diluted shares outstanding.

Potentially dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (in common stock equivalent shares):

Recent Accounting Standards

From time to time, new accounting standards are issued by the Financial Accounting Standards Board (FASB) or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed, the impact of recently issued standards that are not yet effective will not have a material impact on the Company’s financial position or results of operations upon adoption.

In April 2012, the Jump-Start Our Business Startups Act (the JOBS Act) was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an emerging growth company. As an emerging growth company, the Company may elect to adopt new or revised accounting standards when they become effective for non-public companies, which typically is later than when public companies must adopt the standards. The Company has elected to take advantage of the extended transition period afforded by the JOBS Act and, as a result, will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for emerging growth companies, which are the dates included below.

Adoption of New Accounting Standards

In February 2016, the FASB issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842), which supersedes FASB ASC Topic 840, Leases (Topic 840), and provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method for finance leases or on a straight-line basis over the term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of classification. The Company early adopted this standard on January 1, 2021 by applying the modified retrospective approach (see Note 9).  The Company made accounting policy elections to exclude leases with terms of 12 months or less from the recognition requirements and to not separate lease and non-lease components.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses: Measurement of credit Losses on Financial Instruments (ASU 2016-13), which amends the impairment model by requiring entities to use a forward looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables and available-for sale debt securities. The Company early adopted this standard on January 1, 2021 by applying the modified retrospective approach and determined there was no cumulative-effect transition adjustment required to the opening balance of accumulated deficit for the

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recognition of additional credit losses upon adoption of this standard based on its outstanding accounts receivable, the composition and credit quality of its short-term investments, and current economic conditions as of that date.

In August 2020, the FASB issued ASU No. 2020-06, Debt – Debt with Conversion and Other options (Subtopic 470-20) and Derivative and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40). The amendments in this ASU reduce the number of accounting models for convertible debt instruments and convertible preferred stock, as well as, amend the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusion. In addition, this ASU improves and amends the related EPS guidance. The amendments in this ASU are effective for the Company on January 1, 2024, including interim periods within those fiscal years. The Company early adopted this standard on January 1, 2021 by applying the modified retrospective approach.  The adoption of ASU 2020-06 had no material impact on the Company’s condensed financial statements and accompanying footnotes.

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 nonrecurring 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:

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

The carrying amounts of cash and cash equivalents, prepaid and other assets, accounts payable and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments. Based on the borrowing rates currently available to the Company for loans with similar terms, which is considered a Level 2 input, the Company believes that the fair value of long-term debt approximates its carrying value.

The Company’s financial instruments that are carried at fair value consist of Level 3 liabilities. There were no transfers within the hierarchy during the three months ended March 31, 2021 and 2020. At December 31, 2020, Level 3 liabilities that were measured at fair value on a recurring basis consisted of warrants to purchase shares of convertible preferred stock and a preferred stock purchase right liability. The Company had no Level 3 liabilities at March 31, 2021 as the liabilities for the warrants to purchase shares of convertible preferred stock and the preferred stock purchase right was remeasured and reclassified to stockholders’ equity upon the closing of the Company’s IPO in March 2021 and the issuance of shares of Series D-2 convertible preferred stock in January 2021, respectively.

Convertible Preferred Stock Warrant Liability

The convertible preferred stock warrant liability was recorded at fair value utilizing the Black-Scholes option pricing model using significant unobservable inputs consistent with the inputs used for the Company’s stock-based compensation expense adjusted for the preferred stock warrants’ expected term and the fair value of the underlying preferred stock.

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The assumptions used in the Black-Scholes option pricing model to determine the fair value of the convertible preferred stock warrant liability at the date of the IPO and December 31, 2020 were as follows:

Preferred Stock Purchase Right Liability

At December 31, 2020, the preferred stock purchase right liability was determined using a valuation model that considered: (i) the risk-free rate commensurate with the expected milestone timing of 0.09%; (ii) the probability of the Series D-2 tranche of 80.0%; (iii) volatility of 80.0%; (iv) consideration received for the Series D-1 preferred stock; (v) the number of shares to be issued to satisfy the preferred stock purchase right and at what price; and (vi) certain implied and provided assumptions needed to calibrate the Series D-1 value and the Series D-2 purchase right. Upon the issuance of the shares of Series D-2 convertible preferred stock in January 2021, the liability was remeasured and as a result of closing the sale of shares of Series D-2 convertible preferred stock, a charge of $1.0 million was recorded in the statement of operations for the three months ended March 31, 2021.  

Activity of Liabilities Using Fair Value Level 3 Measurements

The following table summarizes the activity of the financial instruments valued using Level 3 inputs (in thousands):

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following (in thousands):

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Equipment, Net

Equipment, net, consist of the following (in thousands):

Depreciation expense related to property and equipment was $39,000 and $22,000 for the three months ended March 31, 2021 and 2020, respectively.

Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following (in thousands):

Cedars-Sinai Medical Center

In September 2017, the Company entered into an Exclusive License Agreement (License Agreement) with Cedars-Sinai Medical Center (Cedars-Sinai), a related party. Under the terms of the License Agreement, Cedars-Sinai granted the Company an exclusive, worldwide, royalty bearing license with respect to certain patent rights, information and materials related to therapeutic targets and companion diagnostic products, in each case to conduct research, develop, and commercialize therapeutic and diagnostic products for the diagnosis and treatment of IBD. The licensed technology includes information and materials arising out of Cedars-Sinai’s database and biobank, as well as exclusive access to this database and biobank to develop diagnostic and therapeutic products for human use, which biobank is an integral part of the Company’s Prometheus360 platform.

As consideration for the license rights, in September 2017 the Company issued (i) 257,500 shares of fully vested common stock, and (ii) 335,000 shares of unvested restricted common stock, all of which is vested as of December 31, 2020. The fair value of all of the shares were measured at the date of issuance. Additionally, the Company is obligated to pay Cedars-Sinai low- to mid-single digit percentage royalties on net sales of products covered under the License Agreement. The term of, and the Company’s royalty obligations under, the License Agreement expires on a licensed product-by-product and country-by-country basis on the later of ten years from the date of first commercial sale or when there is no longer a valid patent claim covering such licensed product in such country.

In 2017, the Company and Cedars-Sinai also entered into Research agreements, under which the parties can provide research services to each other at pricing specified in individual statements of work. During the three months ended March 31, 2021 and 2020, no services were provided under the agreements.

Collaboration Agreement with Millennium Pharmaceuticals, Inc., a subsidiary of Takeda Pharmaceutical Company Limited

In March 2019, the Company entered into a Companion Diagnostics Development and Collaboration Agreement (the Takeda Collaboration Agreement) with Millennium Pharmaceuticals, Inc., a wholly-owned subsidiary of Takeda. Pursuant to this agreement, the Company established a strategic collaboration under which it will develop a companion diagnostic product (Diagnostic Product) for one selected drug target, with the option for Takeda to select an additional drug target (each, a Collaboration Target). Under the Takeda Agreement, Takeda is responsible for the development and commercialization of any therapeutic clinical candidates that it develops directed against a Collaboration Target for the treatment of IBD (Takeda Drugs), and we are responsible for development and commercialization of the Diagnostic Product(s).

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In consideration of the rights granted to Takeda under the agreement, the Company received a one-time upfront payment of $1.5 million and is eligible to receive future development and regulatory milestone payments of up to $47.9 million for each Collaboration Target, commercial milestone payments of up to $25.0 million in connection with each Collaboration Target for successful commercialization of the applicable Takeda Drug and the associated Diagnostic Product, and sales milestone payments of up to $75.0 million in connection with each Collaboration Target, provided that regulatory approval for the applicable Takeda Drug includes use of the associated Diagnostic Product. In addition, the Company is eligible to receive low-single digit percentage royalties on net sales of all Takeda Drugs. In addition, Takeda is obligated to pay the Company for certain research expenses incurred under the agreement up to $1.8 million. The term of, and the royalty obligations under, the Takeda Agreement expires on a Takeda Drug-by-Takeda Drug and country-by-country basis on the later of (i) ten years from the date of first commercial sale, (ii) when there is no longer a valid patent claim covering a Takeda Drug in such country, and (iii) expiration of any applicable regulatory exclusivity for such Takeda Drug.

At inception and through March 31, 2021, the Company has identified one performance obligation per each target for all the deliverables under the agreement since the delivered elements are not distinct within the context of the contract. Accordingly, the Company will recognize revenue for the transaction price in an amount proportional to the collaboration expenses incurred and the total estimated collaboration expenses over the four-year period over which it expects to satisfy its performance obligations. The Company included one milestone in the transaction price as it was deemed not probable of significant reversal at the inception of the agreement. Due to the uncertainty in the achievement of the developmental and commercial milestones, the variable consideration associated with these future milestone payments has been fully constrained (excluded) from the transaction price until such time that the Company concludes that it is probable that a significant reversal of previously recognized revenue will not occur. These estimates will be re-assessed at each reporting period. In connection with the Takeda Collaboration Agreement, the Company recognized revenue of $0.2 million for each of the three months ended March 31, 2021 and 2020, and had deferred revenue of $1.5 million and $1.7 million as of March 31, 2021. and December 31, 2020, respectively. The Company expects to recognize $0.6 million of the deferred revenue balance during the remainder of 2021.

Dr. Falk Pharma GmbH Collaboration Agreement

In July 2020, the Company entered into a Co-Development and Manufacturing Agreement (the Co-Development Agreement) with Dr. Falk Pharma GMBH (Falk), pursuant to which the parties will co-develop and commercialize, exclusively in their respective territories, therapeutic product candidates targeting members of the TNF super family for the treatment of UC and CD under the Company’s PR600 program. The Company is responsible for regulatory approvals and commercialization of any products in the United States and the rest of the world, other than the Falk territory. Falk is responsible for regulatory approvals and commercialization of any products in the European Union, United Kingdom, Switzerland, the countries of the European Economic Area (excluding Malta and the Republic of Cyprus), Australia and New Zealand (Falk territory).

In consideration of the rights granted to Falk under the Co-Development Agreement, the Company received two upfront payments of $2.5 million each. The first upfront payment was paid upon execution of the Co-Development Agreement and the second was paid when the underlying development plan was finalized, which occurred in December 2020. All non-internal development costs through both the pre-clinical and clinical phases will be funded 25% by Falk and 75% by the Company. In addition, the Co-Development Agreement includes two pre-clinical milestone payments totaling $15.0 million and the Company is eligible to receive low-single to low-double digit percentage royalties on net sales of all products incorporating antibodies covered by the agreement in the Falk territory. The Company agreed to pay Falk a low-single digit royalty on net sales for such products in the Company’s territory. The term of, and the royalty obligations under, the Falk Agreement expires on a country-by-country basis on the later of (i) ten years from the date of first commercial sale, (ii) when there is no longer a valid patent claim covering a Falk Drug in such country, and (iii) expiration of any applicable regulatory exclusivity for such Falk Drug.

At inception and through March 31, 2021, the Company has identified one performance obligation for all the deliverables under the Co-Development Agreement. Accordingly, the Company is recognizing revenue for the transaction price allocated to the performance obligation in an amount proportional to the collaboration expenses incurred and the total estimated collaboration expenses over the seven year period over which it expects to satisfy its performance obligation. The Company included both milestone payments in the transaction price as it was deemed not probable of significant reversal at the inception of the agreement. In connection with the Co-Development Agreement, the Company recognized revenue of $0.6 million for the three months ended March 31, 2021 and had deferred revenue of $4.5 million and $4.8 million as of March 31, 2021 and December 31, 2020, respectively. This deferred revenue balance is expected to be recognized proportionally as expenses are incurred over the estimated seven-year term. The Company expects to recognize $0.8 million of the deferred revenue balance during the remainder of 2021.

A reconciliation of deferred revenue related to the Takeda Collaboration Agreement and the Falk Co-Development Agreement for the three months ended March 31, 2021 is as follows (in thousands):

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On June 30, 2019 (the Closing Date), the Company acquired 100% of the common stock of PLI and the related intangible assets used by PLI for total consideration of approximately $31.7 million, consisting of the issuance of 16.5 million shares of the Company’s Series C convertible preferred stock with a fair value of $16.5 million, the present value of $15.0 million in deferred cash payments due as follows: $5.0 million due on June 30, 2020 and $10.0 million due on June 30, 2021, and acquisition-related contingent consideration consisting of 3,500,000 shares of the of the Company’s Series C convertible preferred stock with a fair value of $3.5 million. The deferred cash payments totaling $15.0 million are not contingent upon any event and to reflect the interest component were discounted at 12%. In June 2020, $5.0 million of deferred cash payments were converted to 5,000,000 shares of Series C convertible preferred stock and in October 2020, $3.8 million of deferred cash payments were converted to 5,088,851 shares of Series D convertible preferred stock. In addition, in January 2021, $6.1 million of deferred cash payments were converted to 7,219,560 shares of Series D-2 shares of convertible preferred stock. As of March 31, 2021 and December 31, 2020, a total of $0 and $5.7 million, respectively, is recorded as Amounts due to Nestlé, current—related party in the accompanying condensed consolidated balance sheets. The acquisition-related contingent consideration stipulated certain revenue thresholds for the Anser^® test during the first calendar year following the acquisition. The shares were released from escrow on June 30, 2020.

In December 2020, in order to achieve the Company’s strategic objectives, the Company’s board of directors approved the spinoff of PLI by making an in-kind distribution of 100% of its interest in PLI to the Company’s stockholders of record on December 30, 2020.

In connection with the spinoff, which was effected on December 31, 2020, the Company assigned PLI specific intellectual property to PLI; entered into a transition services agreement whereby the Company agreed to provide PLI with certain transition services including general and administrative, finance and clinical operations support; and entered into a sublease agreement under which the Company will continue to occupy approximately 40,000 square feet in the PLI facility for a term of one year.

Post spinoff, the Company retained obligations under the Oxford loan and for the deferred cash payments to Nestlé.

The major line items constituting the loss of PLI for the three months ended March 31, 2020, which are reflected in the accompanying condensed consolidated statements of operations as discontinued operations, are as follows:

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Commitments and Contingencies

At the acquisition date, PLI was involved with several legal proceedings and claims against it. All claims against PLI remained obligations of PLI and effective upon the spinoff, the Company has no remaining obligations with respect to these claims.

As of March 31, 2021, long-term debt consists of the following (in thousands):

In January 2020, the Company entered into a Loan and Security Agreement with Oxford Finance LLC and its affiliates (Oxford) (the Oxford Loan) which provides for total borrowings of up to $25.0 million, of which $7.5 million was drawn upon execution of the agreement. Interest accrues at an annual rate at the greater of (a) the 30-day U.S. LIBOR rate reported the last business day of the month that immediately precedes the month in which the interest will accrue, or (b) 2.01%, plus 5.98%, with a minimum annual rate of 7.99%. From March 1, 2020 through February 28, 2023, the Company is required to make interest only payments. Beginning March 1, 2023, in addition to interest payments, the monthly payments will include an amount equal to the outstanding principal divided by 24 months. At maturity (or earlier prepayment), the Company is also required to make a final payment equal to 4.0% of the original principal amount borrowed and 3% of the future amount to be funded. At March 31, 2021, no amounts remain available for borrowing under the Oxford Loan due to the expiration of the provision that allowed for additional borrowings.

The Oxford Loan is collateralized by a first priority security interest in substantially all of the Company’s current and future assets, other than its intellectual property, and contains customary conditions of borrowing, events of default and covenants, including covenants that restrict the Company’s ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of the Company’s capital stock. Should an event of default occur, including the occurrence of a material adverse change, the Company could be liable for immediate repayment of all obligations under the Oxford Loan. In December 2020, the Oxford Loan Agreement was amended to allow the PLI spinoff and to release PLI from all obligations pursuant to the Oxford Loan.

In addition, warrants to purchase 112,500 shares of Series C convertible preferred stock were issued to Oxford in conjunction with the execution of the agreement at an exercise price of $1.00 per share. The warrants have a ten-year life and are exercisable immediately. The warrant became exercisable for an aggregate of 14,884 shares of the Company’s common stock at an exercise price of $7.558 per share upon the completion of the IPO. The fair value of the warrant, the debt issuance costs and the final payment totaling approximately $0.6 million are being amortized to interest expense using the effective interest method over the term of the debt.

As of March 31, 2021, future minimum principal and interest payments under the Oxford Loan, including the final payment, are as follows (in thousands):

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Amended Certificate of Incorporation

In March 2021, the Company amended its Certificate of Incorporation to authorize 400,000,000 shares of common stock and 40,000,000 shares of preferred stock.

Convertible Preferred Stock

In connection with the completion of the Company’s IPO on March 16, 2021, all outstanding shares of convertible preferred stock were converted into 25,485,955 shares of the Company’s common stock and outstanding warrants to purchase 148,848 shares of convertible preferred stock were converted into warrants to purchase 14,884 shares of the Company’s common stock.

As of December 31, 2020, the Company’s convertible preferred stock was classified as temporary equity on the accompanying balance sheet in accordance with authoritative guidance for the classification and measurement of potentially redeemable securities whose redemption is based upon certain change in control events outside of the Company’s control.

Series C Convertible Preferred Stock

In March 2020, the Company sold 28,063,500 shares of Series C convertible preferred stock and received net cash proceeds totaling $28.0 million.

Series D Convertible Preferred Stock

In October 2020, the Company entered into a Series D convertible preferred stock purchase agreement (Series D SPA) under which it issued 61,066,216 shares of Series D-1 convertible preferred stock, for cash, at a price of $0.7558 per share, for net proceeds of $46.2 million (the Initial Series D Closing). In addition, 5,088,851 shares of Series D-1 convertible preferred stock were issued to Nestlé in satisfaction of a deferred purchase price obligation of $3.8 million. The Series D SPA contained provisions that potentially obligates the Company to issue an additional 94,007,051 shares of Series D-2 convertible preferred stock at $0.8510 per share in an additional closing, 7,231,311 of which is issuable to Nestlé for satisfaction of deferred purchase price obligations of $6.2 million, upon the approval by the Company’s board of directors, or at the option of the investors who participated in the Initial Series D Closing, or upon the achievement of certain milestones as defined in the Series D SPA, which purchase right terminates upon certain specified events, including an initial public offering of the Company, if any.

The Company determined its obligation to issue additional shares of the Company’s Series D-2 convertible preferred stock in the Initial Series D Closing represented a freestanding financial instrument that required liability accounting. This freestanding preferred stock purchase right liability for the additional closing was recorded at fair value, with changes in fair value recognized in the statements of operations. As of the Initial Series D Closing, the estimated fair value of the preferred stock purchase right liability was $3.9 million. In January 2021, 93,995,300 shares of Series D-2 convertible preferred stock were issued, of which, 7,219,560 were issued to Nestlé for the satisfaction of deferred purchase price obligations of $6.1 million.  Upon the closing of the sale of these shares, the preferred stock purchase right liability was remeasured to fair value and the change in fair value of $1.0 million was recorded in the statement of operations for the three months ended March 31, 2021.  The liability was then reclassified to stockholders’ equity.

The authorized, issued and outstanding shares of convertible preferred stock as of December 31, 2020 consist of the following (in thousands, except share and per share amounts):

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Equity Incentive Plans

In 2017, the Company adopted the 2017 Equity Incentive Plan (the 2017 Plan), which as amended, had 5,524,354 shares of common stock reserved for issuance. Under the 2017 Plan, the Company could grant stock options, stock appreciation rights, restricted stock, restricted stock units and other awards to individuals who are employees, non-employee directors or consultants of the Company or its subsidiaries. The maximum term of the options granted under the 2017 Plan was no more than ten years. Grants generally vested at 25% one year from the vesting commencement date and ratably each month thereafter for a period of 36 months, subject to continuous service. The 2017 Plan allowed for the early exercise of all stock options granted if authorized by the board of directors at the time of grant.

In February 2021, the board of directors adopted, and the Company’s stockholders approved, the 2021 Incentive Award Plan (the 2021 Plan), which became effective in connection with the IPO. Pursuant to the 2021 Plan, the Company ceased granting awards under the 2017 Plan. Under the 2021 Plan, the Company may grant stock options, restricted stock, dividend equivalents, restricted stock units, stock appreciation rights, and other stock or cash-based awards to individuals who are then employees, officers, non-employee directors or consultants of the Company. The number of shares initially available for issuance under awards granted pursuant to the 2021 Plan is the sum of (1) 3,600,000 shares of common stock, plus (2) any shares subject to outstanding awards under the 2017 Plan as of the effective date of the 2021 Plan that become available for issuance under the 2021 Plan thereafter in accordance with its terms. In addition, the number of shares of common stock available for issuance under the 2021 Plan will be increased annually on the first day of each fiscal year during the term of the 2021 Plan, beginning with the 2022 fiscal year, by an amount equal to the lesser of (a) 5% of the shares of common stock outstanding on the final day of the immediately preceding calendar year or (b) such smaller number of shares as determined by the Company’s board of directors. At March 31, 2021, 3,548,062 shares remain available for issuance under the 2021 Plan.

The Company’s stock option activity for the three months ended March 31, 2021 is summarized in the following table:

The total intrinsic value of options exercised during the three months ended March 31, 2021 and 2020 was $0.2 million and $0.1 million, respectively. The total intrinsic value of options vested during the three months ended March 31, 2021 and 2020 was $2.8 million and $0.1 million, respectively.

The grant date fair value of stock options was determined using the Black-Scholes option pricing model with the following assumptions:

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Expected Term—The expected term of options granted represents the period of time that the options are expected to be outstanding. Due to the lack of historical exercise history, the expected term of the Company’s employee stock options has been determined utilizing the simplified method for awards that qualify as plain-vanilla options.

Expected Volatility—The estimated volatility was based on the historical volatility of the common stock of a group of publicly traded companies deemed comparable to the Company.

Risk-Free Interest Rate—The risk-free interest rate is the implied yield in effect at the time of the option grant based on U.S. Treasury securities with contract maturities similar to the expected term of the Company’s stock options.

Dividend Rate—The Company has not paid any cash dividends on common stock since inception and does not anticipate paying any dividends in the foreseeable future. Consequently, an expected dividend yield of zero was used.

Early Exercise Liability

The unvested shares of the early-exercised options are held in escrow until the stock option becomes fully vested or until the employee’s termination, whichever occurs first. The right to repurchase these shares lapses over the four-year vesting period. As of March 31, 2021 and December 31, 2020, the early exercise liability was approximately $0.1 million. For accounting purposes, the early exercise of options is not considered to be a substantive exercise until the underlying awards vest.

The following table summarizes the activity of the unvested common stock issued pursuant to an early exercise of stock option awards for the three months ended March 31, 2021:

Employee Stock Purchase Plan

In February 2021, the Company’s board of directors approved the 2021 Employee Stock Purchase Plan (the ESPP), which became effective upon the pricing of the Company’s IPO on March 16, 2021. The ESPP permits participants to purchase common stock through payroll deductions of up to 20% of their eligible compensation. Initially, a total of 360,000 shares of common stock was reserved for issuance under the ESPP. In addition, the number of shares of common stock available for issuance under the ESPP will be annually increased on the first day of each fiscal year during the term of the ESPP, beginning with the 2022 fiscal year, by an amount equal to the lessor of: (i) 1% of the total number of shares of common stock outstanding on December 31st of the preceding calendar year; or (ii) such other amount as the Company’s board of directors may determine. Stock compensation expense for the three months ended March 31, 2021 related to the ESPP was immaterial.

Stock-Based Compensation Expense

The following table summarizes the components of stock-based compensation expense recognized in the accompanying statements of operations (in thousands):

The total unrecognized compensation cost related to unvested stock-based awards as of March 31, 2021 was $14.4 million and is expected to be recognized over a weighted average period of 3.7 years.

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Leases

As a result of the PLI spinoff on December 31, 2020, the Company entered into a sublease agreement with PLI for approximately 40,000 square feet currently occupied in the PLI facility. The sublease agreement is for one year with an option to renew for an additional year. The monthly payment is $80,000 and total remaining payment obligations at March 31, 2021 and December 31, 2020 are $0.7 million and $1.0 million, respectively.

In March 2021, the Company executed a non-cancellable lease agreement for office and laboratory space in San Diego, California. The lease has an initial term of ten years, following the commencement date with an option to extend the lease for an additional five-year term. The lease provides for initial monthly rental payments of approximately $0.2 million with rent escalation and the Company is also responsible for certain operating expenses and taxes throughout the lease term. In addition, the Company is entitled to up to $6.3 million of tenant improvement allowance, which the Company has not received as of March 31, 2021. The Company expects the lease to commence by the first quarter of 2022. At March 31, 2021, as the Company had not taken control of the space and the lease term had not yet commenced, no operating lease right-of-use assets or operating lease liabilities for the space has been recorded.

Litigation

From time to time, the Company may become involved in legal proceedings or be subject to claims arising in the ordinary course of its business. Regardless of outcome, legal proceedings or claims can have an adverse impact on the company because of defense and settlement costs, diversion of resources and other factors, and there can be no assurances that favorable outcomes will be obtained.

Indemnification Agreements

In the ordinary course of business, the Company may provide indemnification of varying scope and terms to vendors, lessors, business partners and other parties with respect to certain matters including, but not limited to, losses arising out of breech of such agreements or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with officers and members of its board of directors that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is, in many cases, unlimited. To date, the Company has not incurred any material costs as a result of such indemnifications. At March 31, 2021, no claims exist under indemnification arrangements and accordingly, no amounts have been accrued in its condensed consolidated financial statements as of March 31, 2021.

As discussed in Note 5, in September 2017, the Company entered into the Agreement with Cedars-Sinai. As consideration for the license rights, the Company issued (i) 257,500 common stock shares at par value of $0.0001 per share, and (ii) 335,000 unvested restricted common stock shares at par value of $0.0001 per share. The parties also entered into additional license agreements as well as research agreements, under which the parties can provide research services to each other at pricing specified in the individual statements of work. During the three months ended March 31, 2021 and 2020, no services were provided under the research agreements.

During the three months ended March 31, 2021, the Company incurred compensation related expenses for one employee who is an immediate family member of a former member of the Company’s board of directors. These expenses totaled $0.1 million for the three months ended March 31, 2021, which is included in in research and development expenses in the accompanying condensed consolidated statement of operations. During the three months ended March 31, 2020, the Company incurred compensation related expenses for two employees, each of whom is an immediate family member of a different former member of the Company’s board of directors. These expenses totaled $0.2 million for the three months ended March 31, 2020, of which $0.1 million is included in general and administrative expenses in the accompanying condensed consolidated statement of operations and $0.1 million is included in research and development expenses.

As of December 31, 2020, the Company has a $5.7 million liability recorded within Amounts due to Nestlé, current—related party in the condensed consolidated balance sheet. As disclosed in Note 6, this amount relates to deferred consideration for the acquisition of PLI and was satisfied with the issuance of 7,219,560 shares of Series D-2 convertible preferred stock in January 2021 (see Note 8).

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The Company has an ongoing collaboration with Regents of the University of California, where a former member of its board of directors is employed. During each of the three months ended March 31, 2021 and 2020, the Company incurred $0.2 million and $0.1 million, respectively, in expense related to this collaboration that was recorded in Loss from discontinued operations in the accompanying condensed consolidated statements of operations for the three months ended March 31, 2020 and research and development expenses in the accompanying condensed consolidated statement of operations for the three months ended March 31, 2021.

As a result of the PLI spinoff on December 31, 2020, the Company entered into a transition services agreement under which it assumed a $1.1 million liability related to the payout of the PLI bonus for the year ended December 31, 2020. This amount is included in the amount payable to PLI in the accompanying condensed consolidated balance sheets. Additionally, pursuant to this agreement, the Company will be providing PLI certain transitional services, including general and administrative, finance and clinical operations support, and PLI is providing the Company with certain transitional services, including providing for the use of facilities under a sublease, in each case for specified monthly service fees. The initial term of the agreement is for one year, subject to earlier termination and extension thereafter. During the three months ended March 31, 2021, the Company paid PLI $1.6 million in accordance with the terms of this agreement.

Effective January 1, 2018, the Company maintains a defined contribution 401(k) plan available to eligible employees. Employee contributions are voluntary and are determined on an individual basis, limited to the maximum amount allowable under federal tax regulations. The Company, at its discretion, may make certain contributions to the 401(k) plan. Company contributions made during the three months ended March 31, 2021 and 2020 were $43,000 and $46,000, respectively.

The current COVID-19 pandemic, which is impacting worldwide economic activity, poses the risk that the Company or its employees, contractors, suppliers, and other partners may be prevented from conducting business activities for an indefinite period of time, including due to shutdowns that may be requested or mandated by governmental authorities. The extent to which the COVID-19 pandemic will impact the Company’s business will depend on future developments that are highly uncertain and cannot be predicted at this time.

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

The following discussion and analysis and the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2020 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Prospectus dated March 11, 2021 filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the Securities Act), with the Securities and Exchange Commission (SEC) on March 12, 2021 (the Prospectus).

Forward-Looking Statements

This Quarterly Report on Form 10-Q (Quarterly Report) contains 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, the anticipated timing, costs, design and conduct of our ongoing and planned preclinical studies and clinical trials for our product candidates, our plans to use our Prometheus360 product platform to expand our pipeline of product candidates and develop marketable products, the anticipated timing and costs of our development of companion diagnostics, the potential benefits from our collaboration arrangements with third parties and our plans to enter into additional arrangements, the timing and likelihood of regulatory filings and approvals for our product candidates and companion diagnostics, our ability to commercialize our product candidates, if approved, the impact of COVID-19 on our business, the pricing and reimbursement of our product candidates, if approved, and testing products, the potential to develop future product candidates, the timing and likelihood of success, plans and objectives of management for future operations, and future results of anticipated product development efforts, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. 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 business, financial condition and results of operations. 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 Part II, Item 1A, “Risk Factors” of this report. 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. Moreover, we operate in an evolving environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties. 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 biotechnology company pioneering a precision medicine approach to the discovery, development, and commercialization of novel therapeutic and companion diagnostic products for the treatment of immune-mediated diseases, starting first with inflammatory bowel disease (IBD). We leverage our proprietary precision medicine platform, Prometheus360^™, which includes one of the world’s largest GI bioinformatics databases, to identify novel therapeutic targets and develop therapeutic candidates to engage those targets. In parallel, we are developing companion diagnostic tests designed to identify patients more likely to respond to our therapeutic candidates. We have a robust pipeline of therapeutic development programs for the treatment of IBD. Our goal is to revolutionize the treatment of IBD with a precision medicine approach for patients with significant unmet medical needs.

Our lead product candidate, PRA023, is an IgG1 humanized mAb that has been shown to block TL1A, a target associated with both intestinal inflammation and fibrosis that was clinically validated in a third-party Phase 2a clinical trial in UC. PRA023 has the potential to substantially improve outcomes for moderate-to-severe IBD patients predisposed to increased TL1A expression. We are developing PRA023 for the treatment of ulcerative colitis (UC) and Crohn’s disease (CD), and initiated a Phase 1a clinical trial in normal healthy volunteers in December 2020. Assuming favorable safety results in this trial, we expect to commence in parallel in the third quarter of 2021 a Phase 2 randomized placebo-controlled clinical trial in patients with moderate-to-severe UC and an open-label Phase 2a clinical trial in patients with moderate-to-severe CD, with data expected in the second half of 2022 for both indications.

Our PR600 program targets a member of the TNF super family. It has been shown that blocking this target inhibits disease in multiple third-party IBD animal models. We have identified multiple genetic variants linked to patient subpopulations with a

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complicated course of disease and intend to leverage Prometheus360 in combination with functional assays to identify patients with these genetic variants. We expect to submit an investigational new drug application (IND) for a therapeutic candidate from the PR600 program in the second half of 2022.  Our PR300 program targets an orphan G-protein coupled receptor (GPCR) expressed predominantly in the gastrointestinal (GI) tract that we believe has important functions underlying intestinal epithelial integrity and innate immune cell function.

In addition, we have several additional discovery programs with different mechanisms of action targeting UC and/or CD that are in the discovery stage of development. We also continue to evaluate numerous other drug targets identified through Prometheus360 for therapeutic utility for potential drug discovery development. The research and development of therapeutic product candidates and companion diagnostics comprises our therapeutics business segment.

On June 30, 2019, we acquired from Nestlé Prometheus Laboratories, Inc. (PLI), which markets and conducts several laboratory developed tests useful to gastroenterologists in monitoring their IBD patients’ disease state. Prior to our acquisition of PLI in June 2019, we had devoted substantially all of our resources to organizing and staffing our company, business planning, raising capital, developing our Prometheus360 platform, discovering and identifying potential product candidates, establishing our intellectual property portfolio and conducting research and preclinical studies, and providing other general and administrative support for these operations.

On December 31, 2020, we completed the spinoff of PLI by making an in-kind distribution of 100% of our interest in PLI to our stockholders of record on December 30, 2020. Except as specifically indicated, the discussion of our operations excludes the operations of PLI, which are reported as a discontinued operation in the accompanying condensed consolidated financial statements included elsewhere in this Quarterly Report and in the following discussion.

We do not expect to generate any revenue from therapeutic product sales until we successfully complete development and obtain regulatory approval for one or more of our therapeutic product candidates and companion diagnostics, which we expect will take a number of years and may never occur.

We have incurred operating losses in each year since inception. Our net losses, including those generated from PLI, were $29.7 million and $37.1 million for the years ended December 31, 2019 and 2020, respectively, and $13.9 million for the three months ended March 31, 2021. As of March 31, 2021, we had an accumulated deficit of $113.1 million. We expect our expenses and operating losses will increase substantially as we conduct our ongoing and planned preclinical studies and clinical trials, continue our research and development activities, develop and validate companion diagnostics, utilize third parties to manufacture our product candidates and related raw materials, hire additional personnel, protect our intellectual property and incur additional costs associated with being a public company, including 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. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on the timing of our preclinical studies and clinical trials and our expenditures on other research and development activities, as well as the generation of any services and collaboration revenue.

From inception and to the date of our initial public offering (IPO) in March 2021, we had raised a total of $175.6 million to fund our operations from gross proceeds from the sale and issuance of convertible preferred stock and $7.5 million from proceeds under our loan and security agreement (the Loan Agreement) with Oxford Finance LLC and its affiliates (Oxford). In March 2021, we completed our IPO with the sale of 11,500,000 shares of common stock, which included the exercise in full by the underwriters of their option to purchase 1,500,000 additional shares, at an initial public offering price of $19.00 per share and received net of approximately $199.8 million.  As of March 31, 2021, we had cash and cash equivalents of $311.2 million.

If we obtain regulatory approval for any of our therapeutic product candidates and companion diagnostics, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. As we continue to advance our pipeline of diagnostic products, we expect to incur additional costs associated with conducting clinical studies to demonstrate the utility of our products and support reimbursement efforts. Accordingly, until such time as we can generate significant revenue from sales of our product candidates, if ever, we expect to finance our cash needs through equity offerings, debt financings or other capital sources, including potential additional 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.

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COVID-19

The current COVID-19 worldwide pandemic has presented substantial public health and economic challenges and is affecting our employees, patients, physicians and other healthcare providers, communities and business operations, as well as the U.S. and global economies and financial markets. International and U.S. governmental authorities in impacted regions are taking actions in an effort to slow the spread of COVID-19, including issuing varying forms of “stay-at-home” orders, and restricting business functions outside of one’s home. While it is not possible at this time to estimate the impact that COVID-19 could have on our business in the future, particularly as we advance our product candidates to clinical development, the continued spread of COVID-19 and the measures taken by the governmental authorities could disrupt the supply chain and the manufacture or shipment of drug substances and finished drug products for our product candidates for use in our research, preclinical studies and clinical trials, delay, limit or prevent our employees and CROs from continuing research and development activities, impede our clinical trial initiation and recruitment and the ability of patients to continue in clinical trials, impede testing, monitoring, data collection and analysis and other related activities, any of which could delay our preclinical studies and clinical trials and increase our development costs, and have a material adverse effect on our business, financial condition and results of operations. The COVID-19 outbreak could also potentially affect the business of the U.S. Food and Drug Administration (FDA), European Medicines Agency (EMA) or other regulatory authorities, which could result in delays in meetings related to our ongoing and planned clinical trials. The COVID-19 pandemic and mitigation measures have had and may continue to have an adverse impact on global economic conditions which could have an adverse effect on our business and financial condition, including impairing our ability to raise capital when needed. The extent to which the COVID-19 pandemic impacts our results will depend on future developments that are highly uncertain and cannot be predicted, including new information that may emerge concerning the virus and the actions to contain its impact.

License and Collaboration Agreements

Our Collaboration with Cedars-Sinai Medical Center

We entered into an exclusive license agreement (the Cedars-Sinai License Agreement) with Cedars-Sinai Medical Center (Cedars-Sinai) in September 2017, pursuant to which Cedars-Sinai granted us an exclusive, worldwide license with respect to certain patents, information and materials related to therapeutic targets and companion diagnostic products, to conduct research, develop, and commercialize therapeutic and diagnostic products for the diagnosis and treatment of IBD. The licensed technology includes information and materials arising out of Cedars-Sinai’s database and biobank, as well as exclusive access to this database and biobank to develop diagnostic and therapeutic products for human use, which biobank is an integral part of our Prometheus360 platform. As upfront consideration for the license agreement, we issued to Cedars-Sinai 257,500 shares of fully vested common stock and 335,000 shares of restricted common stock, which shares fully vested in September 2020. We are obligated to pay Cedars-Sinai low- to mid-single digit percentage royalties on net sales of therapeutic and diagnostic products covered under the agreement, including any related companion diagnostic products, as well any diagnostic products we develop under the Takeda collaboration agreement discussed below, subject to the terms and conditions set forth in the Cedars-Sinai License Agreement.

Our Collaboration with Takeda

In March 2019, we entered into a companion diagnostics development and collaboration agreement (the Takeda Agreement) with Millennium Pharmaceuticals, Inc., a wholly owned subsidiary of Takeda Pharmaceutical Company Limited (Takeda). Pursuant to this agreement, we established a strategic collaboration to develop a companion diagnostic product (Diagnostic Product) for one selected drug target, with the option for Takeda to select an additional drug target (each, a Collaboration Target). Under the Takeda Agreement, Takeda is responsible for the development and commercialization of any therapeutic clinical candidates that it develops directed against a Collaboration Target for the treatment of IBD (Takeda Drugs) and we are responsible for development and commercialization of the Diagnostic Product(s). We received an upfront payment of $1.5 million in April 2019 and are also eligible to receive certain development, regulatory, commercial and sales milestone payments, and low-single digit royalties on net sales of Takeda Drugs, subject to the terms and conditions set forth in the Takeda Agreement.

Our Collaboration with Dr. Falk Pharma

We entered into a co-development and manufacturing agreement (the Falk Agreement) with Dr. Falk Pharma GmbH (Falk) in July 2020, pursuant to which we will co-develop and commercialize, exclusively in our respective territories, therapeutic product candidates targeting members of the TNF super family for the treatment of UC and CD under our PR600 development program. We are responsible for regulatory approvals and commercialization of any products in the United States and the rest of the world, other than the Falk territory. Falk is responsible for regulatory approvals and commercialization of any products in the European Union, United Kingdom, Switzerland, the countries of the European Economic Area (excluding Malta and the Republic of Cyprus), Australia and New Zealand (Falk territory). Under the Falk Agreement, Falk agreed to fund 25% of our third party development costs. In addition, Falk is obligated to make future development milestone payments, and a mid-single digit to low-double digit royalty on net

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sales of all products incorporating antibodies covered by the agreement in the Falk territory and we agreed to pay Falk a low-single digit royalty on net sales for such products in our territory, subject to the terms and conditions set forth in the Falk Agreement.

For additional information regarding the Cedars-Sinai License Agreement, Takeda Agreement and Falk Agreement, as well as other agreements pursuant to which we in-license certain intellectual property rights, see “Business—License and Collaboration Agreements” in our Prospectus.

Components of Results of Operations

Revenue

Collaboration revenue

We currently derive all of our revenue from our collaboration agreements. For the foreseeable future, we expect to generate revenue from services performed under the Takeda Agreement and Falk Agreement. We may receive a combination of upfront payments and milestone payments under our current and/or future collaboration agreements.

We do not expect to generate any revenue from the sale of therapeutic products unless and until such time that our therapeutic product candidates and companion diagnostics have advanced through clinical development and regulatory approval, if ever. We expect that any revenue we generate, if at all, will fluctuate from quarter-to-quarter as a result of the timing and amount of payments relating to such services and milestones and the extent to which any of our therapeutic product candidates are approved and successfully commercialized. If we fail to complete preclinical and clinical development of therapeutic product candidates or obtain regulatory approval for them, our ability to generate future revenues, and our results of operations and financial position would be adversely affected.

Operating Expenses

Research and Development

Research and development expenses consist of external and internal costs associated with our research and development activities, including our discovery and research efforts, the preclinical and clinical development of our product candidates and the development and validation of our companion diagnostics. Our research and development expenses include:

The following table summarizes our research and development expenses by product candidate for the periods indicated (in thousands):

We expect our research and development expenses to increase for the foreseeable future as we continue to conduct our ongoing research and development activities, advance our preclinical research programs toward clinical development, including conducting IND-enabling studies, develop companion diagnostics, and conduct clinical trials. The process of conducting preclinical studies and clinical trials necessary to obtain regulatory approval is costly and time consuming. We may never succeed in achieving marketing approval for any of our product candidates.

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The timelines and costs with research and development activities are uncertain and can vary significantly for each product candidate and development program and are difficult to predict. We anticipate we will make determinations as to which programs to pursue and how much funding to direct to each program on an ongoing basis in response to preclinical and clinical results, regulatory developments, ongoing assessments as to each program’s commercial potential, and our ability to maintain or enter into new collaborations, to the extent we determine the resources or expertise of a collaborator would be beneficial for a given program. We will need to raise substantial additional capital in the future. In addition, we cannot forecast which development programs 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 development costs may vary significantly based on factors such as:

General and Administrative

General and administrative expenses consist primarily of employee-related expenses, including salaries, benefits and stock-based compensation, for employees in our finance, accounting, legal, business development and support functions. Other general and administrative expenses include allocated facility, information technology and depreciation related costs not otherwise included in research and development expenses and professional fees for auditing, tax, intellectual property and legal services. Costs related to filing and pursuing patent applications are recognized as general and administrative expenses as incurred since recoverability of such expenditures is uncertain.

We expect our general and administrative expenses will increase for the foreseeable future to support our increased research and development activities and increased costs of operating as a public company. These increased costs will likely include increased expenses related to audit, legal, regulatory and tax 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 and Other Income (Expense)

Interest income

Interest income consists primarily of interest earned on our cash and cash equivalents.

Interest expense

Interest expense consists of interest expense incurred in connection with our borrowings under the Loan Agreement and non-cash interest expense associated with the deferred purchase payments for PLI.

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Change in fair value of preferred stock purchase liability

In connection with the issuance of our Series D convertible preferred stock in 2020, the investors agreed to buy, and we agreed to sell, additional shares of such preferred convertible stock at the original issue price upon the achievement of pre-defined milestones. These contractual obligations were required to be accounted for as liabilities and remeasured to fair value at each reporting date, with any change in the fair value reported as a component of other income (expense). In January 2021, with the issuance of the Series D-2 convertible preferred stock, this contractual obligation was settled and the preferred stock purchase right liability was remeasured to fair value on the purchase date and reclassified to permanent equity.

Change in fair value of preferred stock warrant liability

Changes in the fair value of preferred stock warrant liabilities relates to warrants for the purchase of convertible preferred stock issued in connection with our Loan Agreement. These warrants were converted into warrants for the purchase of common stock in connection with our IPO and were reclassified into stockholders’ equity.  Accordingly, no further fair value adjustments for these warrants are expected.

Loss From Discontinued Operations

On December 31, 2020, we completed the spinoff of PLI by making an in-kind distribution of 100% of our interest in PLI to our stockholders of record on December 30, 2020. The results of PLI have been classified as discontinued operations for the three months ended March 31, 2020.

Results of Operations

Comparison of the Three Months Ended March 31, 2021 and 2020

The following table summarizes our results of operations for the three months ended March 31, 2021 and 2020 (in thousands):

Revenue

Revenue was $0.8 million for the three months ended March 31, 2021 compared to $0.2 million for the three months ended March 31, 2020 due to additional revenue generated from the Falk Agreement.

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Research and Development Expenses

Research and development expenses were $7.8 million for the three months ended March 31, 2021 compared to $4.3 million for the three months ended March 31, 2020. The increase of $3.5 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily driven by a $3.0 million increase in expenses related to research and development expenses for our product candidates and a $0.5 million increase in expenses related to personnel costs due to increased headcount to support increased development activities.

General and Administrative Expenses

General and administrative expenses were $5.2 million for the three months ended March 31, 2021 compared to $2.4 million for the three months ended March 31, 2020. The increase of $2.8 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily driven by one-time transaction costs indirectly related to our IPO of $1.8 million with the remainder due to increases in corporate personnel costs due to the expansion of our executive team.

Other Income (Expense), Net

Interest expense

Interest expense was $0.7 million for the three months ended March 31, 2021 compared to interest expense of $0.5 million for the three months ended March 31, 2020. The increase of $0.2 million for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 was primarily related to interest expense associated with our borrowings under our Loan Agreement and non-cash interest expense incurred in connection with the deferred purchase price of PLI.

Change in Fair Value of Convertible Preferred Stock Purchase Right Liability

The change in fair value of convertible preferred stock purchase right liability increased $1.0 million due to the increase in the fair value of the outstanding Series D-2 preferred stock purchase right liability as a result of closer time proximity to achieving different outcome scenarios and higher probabilities of occurrence. Upon the exercise of the preferred stock purchase right with the issuance of Series D-2 convertible preferred stock in January 2021, we remeasured the Series D-2 preferred stock purchase right liability to fair value and reclassified the resulting value to temporary equity on the balance sheet.

Loss from discontinued operations

For the for the three months ended March 31, 2020, revenue from PLI totaled $10.0 million and total operating expenses totaled $16.2 million.

Liquidity and Capital Resources

Sources of Liquidity

From our inception and to the date of our IPO, we received aggregate gross proceeds of $175.6 million from the sale of convertible preferred stock, $7.5 million from borrowings under our Loan Agreement with Oxford and $8.2 million from amounts received under the Takeda and Falk Agreements. In March 2021, we completed our initial public offering (IPO) with the sale of 11,500,000 shares of common stock, which included the exercise in full by the underwriters of their option to purchase 1,500,000 additional shares, at an initial public offering price of $19.00 per share and received gross proceeds of $218.5 million, which resulted in net proceeds to us of approximately $199.8 million, after deducting underwriting discounts and commissions of approximately $15.3 million and offering-related transaction costs of approximately $3.4 million.  As of March 31, 2021, we had cash and cash equivalents of $311.2 million.

Oxford Loan and Security Agreement

In January 2020, we entered into the Loan Agreement with Oxford, which provided for total borrowings of up to $25.0 million, of which $7.5 million was drawn upon execution of the agreement. No additional amounts remain available for borrowing. Interest accrues at an annual rate equal to the sum of (I) the greater of (a) the 30-day U.S. LIBOR rate reported the last business day of the month that immediately precedes the month in which the interest will accrue, and (b) 2.01%, plus (II) 5.98%. Notwithstanding the foregoing, the annual rate shall at no time be less than 7.99%. From March 1, 2020 through February 28, 2023, we are required to make interest only payments. Beginning March 1, 2023, in addition to interest payments, the monthly payments will include an amount equal to the outstanding principal divided by 24 months. At maturity (or earlier prepayment), we are also required to make a final payment equal to 4.0% of the original principal amount borrowed and 3% of the future amount to be funded.

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The Loan Agreement is collateralized by substantially all of our assets, excluding intellectual property, which is subject to a negative pledge. The Loan Agreement contains customary affirmative and negative covenants and events of default applicable to us. The affirmative covenants include, among others, covenants requiring us to maintain governmental approvals, deliver certain financial reports, maintain insurance coverage and protect material intellectual property. The negative covenants include, among others, restrictions on us transferring collateral, incurring additional indebtedness, engaging in mergers or acquisitions, paying cash dividends or making other distributions, making investments, creating liens, selling assets and making any payment on subordinated debt, in each case subject to certain exceptions.

In connection with execution of the Loan Agreement, we issued Oxford a warrant to purchase 112,500 shares of our Series C convertible preferred stock at an exercise price of $1.00 per share, exercisable at any time following issuance. The preferred stock warrant has a term of ten years. The warrant became exercisable for an aggregate of 14,884 shares of our common stock at an exercise price of $7.558 per share upon the completion of our IPO.

Future Capital Requirements

As of March 31, 2021, we had cash and cash equivalents in the amount of $311.2 million. Based upon our current operating plans, we believe that our existing cash and cash equivalents, will be sufficient to fund our operations for at least the next 24 months. 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 conducting preclinical studies and testing product candidates in clinical trials is costly, and the timing of progress and expenses in these studies and trials is uncertain.

Our future capital requirements are difficult to forecast and will depend on many factors, including but not limited to:

Other than our collaboration agreements, we have no other committed sources of capital. Until we can generate a sufficient amount of product revenue to finance our cash requirements, if ever, we expect to finance our future cash needs primarily through equity offerings, 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. 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

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affect the rights of our common stockholders. Our Loan Agreement with Oxford involves, and any future debt financing and preferred 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 additional funds through other collaborations or licensing 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. 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 commercialization efforts or grant rights to develop and market product candidates to third parties that we would otherwise prefer to develop and market ourselves.

Cash Flows

The following table shows a summary of our cash flows for the periods presented (in thousands):

Operating Activities

Cash used by operating activities from continuing operations was $19.0 million during the three months ended March 31, 2021 as compared to cash used in operating activities of $4.3 million during the three months ended March 31, 2020. The increase of $14.7 million was primarily the result of the increase in net loss between the two periods of $7.0 million and increased payments in connection with an increase in research and development activities, our expansion of our executive team and us becoming a public company.

Investing Activities

Including the operations of PLI, net cash used by investing activities was $0.3 million during the three months ended March 31, 2021 as compared to net cash used in investing activities $1.0 million during the three months ended March 31, 2020, due to cash purchases of property and equipment.

Financing Activities

Net cash provided by financing activities was $276.3 million during the three months ended March 31, 2021 as compared to $35.3 million during the three months ended March 31, 2020. During the three months ended March 31, 2021, we received proceeds of $202.5 million from the sale of our common stock in our IPO, net of issuance costs paid during the period, and proceeds of $73.7 million from the sale of shares of our Series D-2 convertible preferred stock, net of issuance costs. During the three months ended March 31, 2020, we received $28.0 million from the issuance of our Series C convertible preferred stock, net of issuance costs, and $7.3 million from proceeds under the Loan Agreement with Oxford.

Critical Accounting Polices and Estimates

This management discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities revenue and expenses.

On an ongoing basis, we evaluate these estimates and judgments. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue and expenses that are not readily apparent from other sources. Actual results may differ materially from these estimates.

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Our significant accounting policies are described in more detail in Note 2 to our consolidated financial statements included in the Prospectus dated March 11, 2021 filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the SEC on March 12, 2021 and in Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report.  We believe that the accounting policies related to revenue recognition, stock-based compensation and accrued research and development costs are the most critical to understanding and evaluating our historical and future performance.

Recent Accounting Pronouncements

See Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report for a description of recent accounting pronouncements.

Contractual Obligations and Commitments

During the three months ended March 31, 2021, other than the one item discussed below, there have been no material changes outside of the ordinary course of business in the composition of these contractual obligations or commitments as discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations and Commitments” in the Prospectus.

In March 2021, the Company executed a non-cancellable lease agreement for office and laboratory space in San Diego, California. The lease has an initial term of ten years, following the commencement date with an option to extend the lease for an additional five-year term. The lease provides for initial monthly rental payments of approximately $0.2 million with rent escalation and the Company is also responsible for certain operating expenses and taxes throughout the lease term. The Company expects the lease to commence by the first quarter of 2022 (see Note 9 to our condensed consolidated financial statements included elsewhere in this Quarterly Report).  The table included in the Prospectus as of December 31, 2020 does not include amounts for the payment obligations entered into in connection with this lease agreement.

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 the rules and regulations of the SEC.

JOBS Act

As an emerging growth company under the Jumpstart Our Business Startups Act of 2012 (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 elected to avail ourselves of this exemption from new or revised accounting standards and, therefore, will not 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 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.

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Not required.

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 by us in our reports that we file or submit pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), 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 Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Under the supervision and with participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based on this evaluation and the material weakness previously identified and further discussed below, our Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective at the reasonable level of assurance.

Material Weakness in Internal Control over Financial Reporting

We identified deficiencies in our internal controls over financial reporting related to a lack of controls in the financial closing and reporting process, including a lack of segregation of duties and the documentation and design of formalized processes and procedures in the revenue cycle. In March 2021, we reported these deficiencies to the Audit Committee of our Board of Directors and a material weakness related to these deficiencies existed at December 31, 2020.

Remediation Efforts related to the Material Weakness During 2020 and 2021

The material weakness in our internal controls over financial reporting relates to a lack of controls in the financial closing and reporting process, including a lack of segregation of duties and the documentation and design of formalized processes and procedures in the revenue cycle that existed as a result of our limited number of accounting personnel.  This resulted in a reasonable possibility that a material misstatement of our annual or interim financial statements may not be prevented or detected on a timely basis. To remediate the deficiencies described above and prevent similar deficiencies in the future, in the third quarter of 2020, we began to take steps to address the material weakness through our remediation plan, which included the hiring of a Chief Financial Officer and the engagement of external advisors to provide financial accounting assistance in the short term. We have plans to hire additional personnel to improve the segregation of duties in our financial closing and reporting process. In addition, we plan to engage external advisors to evaluate and document the design and operating effectiveness of our internal controls and assist with the remediation and implementation of our internal controls as required.

Although we have begun the implementation of these remediation efforts, the deficiencies will not be considered fully remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. Any actions we have taken or may take to remediate these deficiencies are subject to continued management review supported by testing, as well as oversight by the Audit Committee of our Board of Directors.

We cannot provide complete assurance that other material weaknesses or significant deficiencies will not occur in the future or that we will be able to remediate such weaknesses or deficiencies in a timely manner. The occurrence of such material weaknesses or our inability to remediate these deficiencies could impair our ability to accurately and timely report our financial position, results of operations or cash flows.

Changes in Internal Control over Financial Reporting

The Company is implementing remedial procedures to address the material weakness in our internal controls over financial reporting. These remedial procedures will continue throughout the remainder of fiscal 2021 and had no impact on our internal control over financial reporting during the period covered by this report.

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PART II. OTHER INFORMATION

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.

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 March 11, 2021 filed pursuant to Rule 424(b) under the Securities Act with the SEC on March 12, 2021, 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.

Summary of Risks Related to Our Business

The principal risks and uncertainties affecting our business include the following:

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