Tourmaline Bio, Inc. - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2021

OR

For the transition period from ___________________ to ___________________

Commission File Number: 001-40384

TALARIS THERAPEUTICS, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (502) 398-9250

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, 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 June 1, 2021, the registrant had 41,310,241 shares of common stock, $0.0001 par value per share, outstanding.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

TALARIS THERAPEUTICS, INC.

BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

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

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TALARIS THERAPEUTICS, INC.

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except share and per share amounts)

(unaudited)

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

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TALARIS THERAPEUTICS, INC.

STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ DEFICIT

(in thousands, except share amounts)

(unaudited)

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

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TALARIS THERAPEUTICS, INC.

STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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

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TALARIS THERAPEUTICS, INC

NOTES TO FINANCIAL STATEMENTS

(unaudited)

1. Nature of Business and Liquidity

Talaris Therapeutics, Inc. (“Talaris” or the “Company”) is a late-clinical stage, cell therapy company developing an innovative method of allogeneic hematopoietic stem cell transplantation (“allo-HSCT”), called Facilitated Allo-HSCT Therapy, that the Company believes has the potential to transform the standard of care in solid organ transplantation, certain severe autoimmune diseases and certain severe non-malignant blood, immune and metabolic disorders. The Company believes that these indications, individually and collectively, represent a significant unmet need and commercial opportunity. The Company maintains corporate offices in Boston, Massachusetts and its cell processing facility in Louisville, Kentucky.

Initial Public Offering

As described in Note 13, the Company completed an initial public offering in May 2021. Upon completion of the offering, the Company’s outstanding convertible preferred stock was automatically converted into shares of common stock and non-voting common stock. Prior to the offering, the Company’s board of directors and shareholders approved a one-for-5.35 reverse share split of issued and outstanding common shares and incentive shares and a proportional adjustment to the existing conversion ratios for the Company’s convertible preferred stock.

Liquidity

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. Management has evaluated whether there are conditions and events that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements are issued. Since its inception, the Company has incurred net losses and negative cash flows from operations. During the three months ended March 31, 2021 and the year ended December 31, 2020, the Company incurred a net loss of $9.3 million and $22.7 million, respectively, and used $9.0 million and $19.2 million in cash for operations, respectively. In addition, as of March 31, 2021, the Company had an accumulated deficit of $52.3 million. The Company expects to continue to generate operating losses and negative cash flows for the foreseeable future. The Company currently expects the cash and cash equivalents on hand of $9.9 million and marketable securities of $130.2 million as of March 31, 2021, together with the net proceeds from the Company’s initial public offering (“IPO”), after deducting underwriting discounts and commissions but before deducting offering costs, of approximately $139.5 million in May 2021, will be sufficient to fund its operating expenses and capital requirements for more than 12 months from the date the financial statements are available to be issued.

Additional funding will be needed to finance future clinical, pre-clinical, manufacturing and commercial activities. There is no assurance the Company will be successful in obtaining such additional financing on terms acceptable to it, if at all, and it may not be able to enter into other arrangements. If the Company is unable to obtain funding, it could be forced to delay, reduce or eliminate our research and development programs, portfolio expansion or commercialization efforts, which could adversely affect its business prospects and ability to continue operations.

The Company is subject to risks common to companies in the biopharmaceutical industry. There can be no assurance that the Company’s research and development will be successfully completed, that adequate protection for its intellectual property will be maintained, that any products developed will obtain required regulatory approval, or that any approved products will be commercially viable. Even if the development efforts are successful, it is uncertain when, if ever, the Company will generate significant product sales and ultimately net income.

Coronavirus Pandemic

In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. The worldwide COVID-19 pandemic has affected and may affect in the future the Company’s ability to initiate and complete preclinical studies, delay the initiation and completion of its current and planned clinical trials, disrupt regulatory activities or have other adverse effects on its business, results of operations, financial condition and prospects. In addition, the pandemic has caused substantial disruption in the financial markets and may adversely impact economies worldwide, both of which could adversely affect the Company’s business, operations and ability to raise funds to support its operations.

The Company cannot be certain what the overall impact of the COVID-19 pandemic will be on its business, and it has the potential to adversely affect its business, financial condition, results of operations and prospects.

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2. Summary of Significant Accounting Policies

Basis of Presentation

The financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”).

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make judgments, assumptions, and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of financial statements, and the reported amounts of income and expense during the reporting period. The most significant estimates relate to the determination of fair value of the Company’s common stock, determination of the fair value of stock option grants and estimates related to the amount of accrued research and development expenses as of the balance sheet date. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when the facts and circumstances dictate. These estimates are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. As of March 31, 2021 and December 31, 2020, cash consists primarily of checking and savings deposits and money market fund holdings.

Marketable Securities

The Company classifies its marketable securities as available-for-sale securities, which are carried at their fair value based on the quoted market prices of the securities. Unrealized gains and losses are reported as accumulated other comprehensive loss, a separate component of stockholders’ deficit. Realized gains and losses on available-for-sale securities are included in net loss in the period earned or incurred.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation expense is recognized using the straight-line method over the estimated useful life of each asset. Equipment and furniture and fixtures are depreciated over five or seven year lives. Leasehold improvements are amortized over the shorter of the lease term or the five-year estimated useful life of the asset. Computer equipment and computer software are depreciated over three years. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in loss from operations. Expenditures for repairs and maintenance are expensed as incurred.

Impairment of Long-Lived Assets

The Company evaluates its long-lived assets, which consist primarily of property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. No impairments have been identified as of March 31, 2021 and December 31, 2020.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents. The Company’s investment policy includes guidelines regarding the quality of the financial institutions and financial instruments and defines allowable investments that it believes minimizes the exposure to concentration of credit risk. The Company may invest in money market funds (minimum of $1 billion in assets), U.S. Treasury securities, corporate debt, bank debt, U.S. government-related agency securities, other sovereign debt, municipal debt and commercial paper. These deposits may exceed federally insured limits. The Company has not experienced any losses historically in these accounts and believes that it is not exposed to significant credit risk as our deposits are held at financial institutions that management believes to be of high credit quality.

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Fair Value of Financial Instruments

Fair value is defined as the price that the Company would receive to sell an investment in a timely transaction or pay to transfer a liability in a timely transaction with an independent buyer in the principal market, or in the absence of a principal market, the most advantageous market for the investment or liability. A framework is used for measuring fair value utilizing a three-tier hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 investments) and the lowest priority to unobservable inputs (Level 3 investments).

The three levels of the fair value hierarchy are as follows:

Financial instruments are categorized in their entirety based on the lowest level of input that is significant to the fair value measurement. The assessment of the significance of a particular input to the fair value measurement requires judgment and considers factors specific to the investment.

The Company’s money market funds and marketable securities are carried at fair value determined according to the fair value hierarchy described above (Level 1 and Level 2, respectively).

The Company’s contingent stock liability as of March 31, 2021 and December 31, 2020 (see Note 3) is carried at fair value determined according to the fair value hierarchy described above (Level 3).

Research and Development Expenses

Research and development expenses include (i) employee-related expenses, including salaries, benefits, travel and stock-based compensation expense; (ii) external research and development expenses incurred under arrangements with third parties, such as contract research organization agreements, investigational sites, and consultants; (iii) the cost of acquiring, developing, and manufacturing clinical study materials; (iv) costs associated with preclinical and clinical activities and regulatory operations; (v) costs incurred in development of intellectual property; and (vi) an allocated portion of facilities and other infrastructure costs associated with our research and development activities. Costs incurred in connection with research and development activities are expensed as incurred.

The Company enters into consulting, research, and other agreements with commercial entities, researchers, universities, and others for the provision of goods and services. Such arrangements are generally cancelable upon reasonable notice and payment of costs incurred. Costs are considered incurred based on an evaluation of the progress to completion of specific tasks under each contract using information and data provided by the respective vendors, including the Company’s clinical sites. These costs consist of direct and indirect costs associated with specific projects, as well as fees paid to various entities that perform certain research on behalf of the Company. Depending upon the timing of payments to the service providers, the Company recognizes prepaid expenses or accrued expenses related to these costs. These accrued or prepaid expenses are based on management’s estimates of the work performed under service agreements, milestones achieved, and experience with similar contracts. The Company monitors each of these factors and adjusts estimates accordingly.

Stock-Based Compensation

The Company measures all stock options and other stock-based awards granted to employees, nonemployees, and directors based on the fair value on the date of the grant and recognizes stock-based compensation expense of those awards over the requisite service period, which is generally the vesting period of the respective award. Generally, the Company issues stock option awards with only service-based vesting conditions and records the expense for these awards using the straight-line method. The Company’s policy is to account for forfeitures when they occur.

The Company classifies stock-based compensation expense in its statement of operations in the same manner in which the award recipient’s payroll costs are classified or in which the award recipients’ service payments are classified.

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The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Company is a private company and lacks company-specific historical and implied volatility information. Therefore, it estimates its expected stock volatility based on the historical volatility of a publicly traded set of peer companies and expects to continue to do so until it has adequate historical data regarding the volatility of its own traded stock price. The expected term of the Company’s stock options has been determined utilizing the “simplified” method for awards that qualify as “plain-vanilla” options. The expected term of stock options granted to non-employees is equal to the contractual term of the option award. The risk-free interest rate is determined by reference to the US Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award. Expected dividend yield is zero because the Company has never paid cash dividends on common stock and does not expect to pay any cash dividends in the foreseeable future.

In determining the exercise prices for options granted, the Company has considered the estimated fair value of the common stock as of the measurement date. The estimated fair value of the common stock has been determined at each grant date based upon a variety of factors, including the illiquid nature of the common stock, arm’s-length sales of the Company’s capital stock (including convertible preferred stock), the effect of the rights and preferences of the preferred shareholders, and the prospects of a liquidity event. Among other factors are the Company’s financial position and historical financial performance, forecasted future operations of the Company, an evaluation or benchmark of the Company’s competition, and the current business climate in the marketplace. Significant changes to the key assumptions underlying the factors used could result in different fair values of common stock at each valuation date.

Income Taxes

The Company accounts for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or in the Company’s tax returns. Deferred tax assets and liabilities are determined on the basis of the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Changes in deferred tax assets and liabilities are recorded in the provision for income taxes. The Company assesses the likelihood that its deferred tax assets will be recovered from future taxable income and, to the extent it believes, based upon the weight of available evidence, that it is more likely than not that all or a portion of the deferred tax assets will not be realized, a valuation allowance is established through a charge to income tax expense. Potential for recovery of deferred tax assets is evaluated by estimating the future taxable profits expected and considering prudent and feasible tax planning strategies.

The Company accounts for uncertainty in income taxes recognized in the financial statements by applying a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination by the taxing authorities. If the tax position is deemed more likely than not to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. The provision for income taxes includes the effects of any resulting tax reserves, or unrecognized tax benefits, that are considered appropriate as well as the related net interest and penalties.

The Company provides reserves for potential payments of tax to various tax authorities related to uncertain tax positions. These reserves are based on a determination of whether and how much of a tax benefit taken by the Company in its tax filings or positions is more likely than not to be realized following resolution of any potential contingencies present related to the tax benefit. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense. The Company had no significant uncertain tax positions as of March 31, 2021 and December 31, 2020.

Basic and Diluted Net Loss Per Share

The Company calculates basic and diluted net loss per share using the two-class method. The two-class method requires income available to common stockholders for the period to be allocated between common stock and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed. The Company’s Series A convertible preferred stock, Series A-1 convertible preferred stock and Series B convertible preferred stock are participating securities. These participating securities do not contractually require the holders of such shares to participate in the Company’s losses. As such, net losses for the years presented were not allocated to the Company’s participating securities. Accordingly, basic net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period, without consideration of potential dilutive securities. Diluted net loss per share is computed by dividing the net loss by the sum of the weighted average number of common shares outstanding during the period plus the dilutive effects of potentially dilutive securities outstanding during the period. Potentially dilutive securities include vested and unexercised stock options, restricted stock issued upon early exercise of stock options, convertible preferred shares and contingent stock liabilities. The dilutive effect of stock options and contingent stock liabilities are computed using the treasury stock method and the dilutive effect of convertible preferred shares is calculated using the if-converted method. The Company has generated a net loss for all periods presented, therefore diluted net loss per share is the same as basic net loss per share since the inclusion of potentially dilutive securities would be anti-dilutive.

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Segments

Operating segments are defined as components of an entity for which separate financial information is made available and is regularly evaluated by the chief operating decision maker (“CODM”) in making decisions regarding resource allocation and assessing performance. The Company’s CODM is the chief executive officer and operations are managed as a single segment for the purposes of assessing performance and making operating decisions.

Comprehensive Loss

Comprehensive loss represents net loss for the period plus the results of certain other changes in stockholders’ deficit. The Company’s comprehensive loss included unrealized gains related to marketable securities for the three months ended March 31, 2021 and 2020.

Recently Issued Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments—Credit Losses, (“ASC 326”), which introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new model will apply to (1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost; (2) loan commitments and certain other off-balance-sheet credit exposures; (3) debt securities and other financial assets measured at fair value through other comprehensive income; and (4) beneficial interests in securitized financial assets. The Company adopted ASC 326 in January 2021, and had no material impact on the financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), and subsequently has issued additional guidance (collectively, “ASC 842”), which requires companies to generally recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. ASC 842 will be effective for the Company on January 1, 2022, with early adoption permitted. The Company is in the process of evaluating its lease contracts under the new standard and the adoption of ASC 842 is expected to result in the recognition of additional lease liability and right-to-use assets on the balance sheet.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (ASC 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU No. 2018-13 removes certain disclosures, modifies certain disclosures, and adds additional disclosures. ASU No. 2018-13 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2019. The adoption of ASU 2018-13 in January 2020 had no material impact on the financial statements.

3. Fair Value of Financial Assets and Liabilities

The following table presents information about the Company’s financial instruments that are measured at fair value on a recurring basis and indicates the fair value hierarchy of the inputs the Company utilized to determine such fair value (in thousands):

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The contingent stock liability in the table above represents the fair value of contingent equity consideration equal to 65,186 shares of common stock contingently issuable to the University of Louisville Research Foundation Inc. (“ULRF”) in connection with its amended and restated exclusive license agreement with the Company (see Note 8). A rollforward of the contingent common stock liability, which is measured at fair value for the three months ended March 31, 2021 and the year ended December 31, 2020, is represented as follows (in thousands):

Valuation techniques used to measure fair value maximize the use of relevant observable inputs and minimize the use of unobservable inputs. The Company’s contingent stock liability is classified within Level 3 of the fair value hierarchy because its fair value measurement is based, in part, on significant inputs not observed in the market, which incorporates assumptions and estimates to value the Company’s common stock. As there has been no public market for the Company’s common stock to date, the estimated fair value has been determined by the Company’s board of directors with input from management, considering the most recently available third-party valuations of common stock, and the board of directors’ assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent valuation. Historically, these third-party valuations of the Company’s common stock were performed contemporaneously when events have occurred which management believes would have an impact on the valuation of the Company. The Company’s common stock valuation was prepared using the option-pricing method, (“OPM”), which uses a market approach to estimate enterprise value. Company management utilized an internal estimate for the common stock valuation as of March 31, 2021. The same underlying assumptions from the OPM method utilized by the Company’s third-party valuation expert to determine the common stock value as of January 25, 2021 were utilized by the Company. Company management adjusted the time-based present value factor to account for the change in expected timing to IPO as well as increased the percentage of the IPO valuation scenario for the March 31, 2021 estimate. Changes in the fair value of the contingent stock liability are recognized within interest and other income, net in the statement of operations. The fair values of the Company’s common stock used to value the contingent stock liability as of March 31, 2021 and December 31, 2020 were $11.23 and $5.72, respectively.

4. Marketable Securities

The fair value of the Company’s marketable securities as of March 31, 2021 and December 31, 2020 is based on level 1 and level 2 inputs. The Company’s investments consist mainly of U.S. government and agency securities, government-sponsored bond obligations and certain other corporate debt securities. Fair value is determined by taking into consideration valuations obtained from third-party pricing services. The third-party pricing services utilize industry standard valuation models, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities; issuer credit spreads; benchmark securities; and other observable inputs. There were no transfers between levels within the hierarchy during the three months ended March 31, 2021 and the year ended December 31, 2020. The Company has assessed U.S. government treasuries as level 1 and all other marketable securities as level 2 within the fair value hierarchy of ASC 820. The Company classifies its entire investment portfolio as available-for-sale as defined in ASC 320, Debt Securities. Securities are carried at fair value with the unrealized gains (losses) reported in other comprehensive loss.

As of March 31, 2021 and December 31, 2020, none of the Company’s investments were determined to be other than temporarily impaired.

The following table summarizes the Company’s investments (in thousands):

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5. Prepaid and Other Current Assets

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

6. Property and Equipment, Net

Property and equipment, net consisted of the following (in thousands):

Depreciation expense was $0.1 million and $0.4 million for the three months ended March 31, 2021 and the year ended December 31, 2020, respectively.

7. Accrued Expenses

Accrued expenses consisted of the following (in thousands):

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8. Commitments and Contingencies

Leases

The Company currently has three active lease agreements for office and laboratory space and related equipment. The primary lease is located on the University of Louisville campus in Louisville, Kentucky (the “Louisville Lease”). This lease has a termination date in November 2023, with an option to extend for three additional years at the Company’s discretion. In May 2020, the Company added additional office and laboratory space to the Louisville Lease. The Company maintains a lease for office space in Wellesley, Massachusetts, with a termination date in March 2021. The Company entered into a month to month lease agreement for the office space in Wellesley effective as of April 2021. The Company maintains a third lease for ancillary office space also in Louisville, Kentucky. This lease has a termination date in December 2021.

The future minimum rent payments relating to all three of the Company’s facility operating leases under the terms and conditions existing as of March 31, 2021, are summarized as follows (in thousands):

The Company incurred rent expense of $0.1 million and $0.1 million for the three months ended March 31, 2021 and 2020, respectively.

License Agreement

In October 2018, the Company entered an amended and restated exclusive license agreement with ULRF related to certain licensed patent rights and know-how related to human facilitating cells for its Facilitated Allo-HSCT Therapy approach. Pursuant to the ULRF License Agreement, ULRF granted the Company an exclusive, worldwide license under such patents and a nonexclusive royalty-bearing, worldwide license for such know-how to research, develop, commercialize and manufacture FCR001 and products containing FCR001 in all fields, without limitation. ULRF also granted the Company the right to grant sublicenses in accordance with the ULRF License Agreement. Under the terms of the agreement, the Company is obligated to compensate ULRF three percent of net sales of all licensed products sold, one third of any non-royalty sublicensing income, and up to $1.625 million in regulatory and sales milestones on each licensed product upon the occurrence of specific events as outlined in the license agreement; and annual license maintenance fees.

In addition, upon execution of the ULRF License Agreement, the Company granted contingent equity consideration equal to 65,186 shares of common stock to ULRF. On or prior to the Company’s first underwritten public offering or any transaction that is treated as a deemed liquidation event, the Company may either issue to ULRF the 65,186 shares in common stock or make a cash payment equal to the 65,186 shares of common stock multiplied by either the price per share of common stock in the underwritten public offering or by the price per share of common stock received in connection with such deemed liquidation event. At March 31, 2021 and December 31, 2020, the Company measured the fair value of the contingent equity consideration and recorded a contingent stock liability of $0.7 million and $0.4 million, respectively, in other liabilities (see Note 3).

As described in Note 13, the Company issued 48,889 shares of common stock to ULRF and provided cash payment of approximately $0.3 million in lieu of issuing the remaining 16,297 shares of common stock after the completion of the Company’s initial public offering.  

The Company incurred $0.1 million in expense in February 2021 related to an annual maintenance fee pursuant to the license agreement for the year ended December 31, 2021. The Company incurred a $0.1 million milestone payment to ULRF in June 2020 which was recorded as research and development expense. The Company also incurred $0.1 million in expense in February 2020 related to the annual maintenance fee for the year ended December 31, 2020.  

Legal Proceedings

The Company is not currently a party to any material legal proceedings. At each reporting date, the Company evaluates whether a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. The Company expenses as incurred the costs related to its legal proceedings.

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9. Convertible Preferred Stock

Issuances of Convertible Preferred Stock

In November 2018, the Company issued 22,500,000 shares of Series A Convertible Preferred Stock at $1.00 per share for gross cash proceeds of $22.5 million. The Company incurred issuance costs of $2.0 million, which have been recorded as a reduction to the value of Series A Convertible Preferred Stock in mezzanine equity in the accompanying balance sheets. In connection with the initial issuance of the Series A Convertible Preferred Stock, the purchasers received the right to purchase, and the Company had the obligation to sell, additional shares of Series A Convertible Preferred Stock at $1.00 per share and a unit, comprised of one share of Series A-1 Convertible Preferred Stock and one product interest right (each a “Unit”), at $1.25 per Unit (together, the “Tranche Rights”) upon achieving certain milestones related to the Company’s research and clinical developments in a series of tranches (the “Tranche 2,” “Tranche 3,” and “Tranche 4”) milestones.

In December 2019, the Tranche 2 milestone was met and the Company issued an additional 17,500,000 shares of Series A Convertible Preferred Stock at $1.00 per share for gross cash proceeds of $17,500,000 and 16,000,000 Units (consisting of 16,000,000 shares of Series A-1 Convertible Preferred Stock and 16,000,000 shares of product interest rights) at $1.25 per Unit for gross cash proceeds of $20.0 million. The Company incurred issuance costs of $1.3 million in relation to Tranche 2, which have been recorded as a reduction to the value of Series A-1 Convertible Preferred Stock in mezzanine equity in the accompanying balance sheets.

In August 2020, the holders of Series A-1 Convertible Preferred Stock voted to amend the Preferred Stock and Unit Purchase Agreement (“SPA”) and waive the requirements of the Tranche 3 milestone. The Company issued an additional 12,000,000 Units (consisting of 12,000,000 shares of Series A-1 Convertible Preferred stock and 12,000,000 shares of product interest rights) at $1.25 per Unit for gross cash proceeds of $15.0 million.

In September 2020, the Company issued 62,499,993 shares of Series B Convertible Preferred Stock at $1.84 per share for gross cash proceeds of $115.0 million. The Company incurred issuance costs of $0.5 million in relation to the issuance of Series B Convertible Preferred Stock, which have been recorded as a reduction to the value of Series B Convertible Preferred Stock in mezzanine equity in the accompanying balance sheets.

In conjunction with the Series B Convertible Preferred Stock financing in September 2020, all holders of the Company’s preferred stock entered into an amendment to the SPA to terminate all rights, liabilities and obligations in respect to the Tranche 4 milestone.

Tranche Rights

The Company determined that the Tranche Rights did not meet the definition of a freestanding financial instrument because the Tranche Rights are not legally detachable from the initial Series A Convertible Preferred Stock issued. The Company made this determination due to the express prohibition of the transfer of the Tranche Rights. Further, the Company determined that the Tranche Rights do not meet the definition of an embedded derivative that would require bifurcation from the initial Series A Preferred Stock issued. Therefore, at the initial issuance of the Series A Convertible Preferred Stock in November 2018, there was no separate recognition of the Tranche Rights.

Product Interest Rights

After the first commercial sale of product, the product interest right entitles the holders to a product interest payment for each product interest right held equal to 1/48,000,000 multiplied by 9% of net product sales on a territory-by-territory basis. If the Company enters into a license of rights to develop and/or commercialize a product, the holder is entitled to a product interest payment for each product interest right equal to 1/48,000,000 multiplied by 30% of licensing income. If the holder does not participate or events occur in which the holder transfers its ownership, it must determine to transfer either its shares or the unit purchase right. If the holder elects to receive a product interest payment, then a corresponding total number of Series A-1 Convertible Preferred Stock initially underlying a Unit (the “Unit Share”), will be canceled and forfeited. The total number of Unit Shares canceled and forfeited will be determined by dividing the product interest payment received by the fair value of the Unit Share at such time. The product interest right payment term shall commence upon the first commercial sale of product, on a territory-by-territory basis, and continue until the fifteenth anniversary thereafter, or any earlier date that there are no remaining product interest rights outstanding.

If at any time, the Unit is transferred, the holder must elect to transfer either (i) the Unit share underlying the Unit or (ii) the product interest right underlying the Unit. If the holder elects to transfer the Unit Share, the corresponding product interest right underlying the Unit shall be automatically canceled, forfeited, and extinguished for no consideration. If the holder elects to transfer the product interest right, the corresponding Unit Share unit shall be automatically canceled and forfeited for no consideration.

The Company determined the product interest rights did not meet the definition of a freestanding financial instrument because the product interest rights are not legally detachable or separately exercisable from the Unit Shares. Further, the Company determined that

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the product interest rights do not meet the definition of an embedded derivative that would require bifurcation from the Unit Share. Therefore, upon issuance of Units in December 2019, there was no separate recognition of the product interest rights.

In March 2021, the Company entered into a termination agreement with the holders of Series A and Series A-1 Convertible Preferred Stock to terminate the Product Interest Rights Agreement between the parties effective immediately prior to, but subject to the closing of the Company’s initial public offering. The termination agreement cancelled all product interest rights associated with the Series A-1 Convertible Preferred Stock. There was no value offered in exchange for the cancellation.

Rights and Privileges of Convertible Preferred Stock

The rights and privileges of the Series A, Series A-1 and Series B Convertible Preferred Stock (together, “Convertible Preferred Stock”) are as follows:

Voting Rights—The holders of each series of Convertible Preferred Stock are entitled to vote on all matters and shall have the number of votes equal to the number of shares of common stock into which the preferred stock is convertible.

Dividends—The Company shall not declare, pay, or set aside any dividends on shares of any other class or series of capital stock (other than dividends on shares of common stock payable in shares of common stock), unless the holders of the Convertible Preferred Stock receive a dividend on each outstanding share of Convertible Preferred Stock in an amount at least equal to (i) in the case of a dividend on common stock or any class or series that is convertible into common stock, that dividend per share of Convertible Preferred Stock as would equal the product of (A) the dividend payable on each share of such class or series determined, if applicable, as if all shares of such class or series had been converted into common stock and (B) the number of shares of common stock issuable upon conversion of a share of the applicable series of Convertible Preferred Stock or (ii) in the case of a dividend on any class or series that is not convertible into common stock, at a rate per share of the applicable series of Convertible Preferred Stock determined by (A) dividing the amount of the dividend payable on each share of such class or series of capital stock by the original issuance price of such class or series of capital stock and (B) multiplying such fraction by an amount equal to the original issue price of the applicable series of Convertible Preferred Stock. No dividends were declared or paid during the three months ended March 31, 2021 and the year ended December 31, 2020.

Liquidation Preference—In the event of any voluntary or involuntary liquidation, dissolution, or winding-up of the Company, the holders of shares of Convertible Preferred Stock will receive, in preference to any distribution to the holders of common stock an amount per share equal to the greater of (i) the applicable original issue price of such series of Convertible Preferred Stock, plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have been payable had all shares of Convertible Preferred Stock been converted into common stock immediately prior to such liquidation, dissolution, winding-up, or deemed liquidation event. If upon any such liquidation, dissolution, or winding-up of the Company or deemed liquidation event, the assets available for distribution to the Company’s stockholders are not sufficient to pay the holders of Convertible Preferred Stock the full amount to which they shall be entitled, the holders of Convertible Preferred Stock shall share ratably in any distribution of the assets available for distribution in proportion to the respective amounts, which would otherwise be payable in respect of the shares held by them upon such distribution if all amounts payable on or with respect to such shares were paid in full.

In the event of a deemed liquidation event, if the Company does not effect a dissolution within 90 days after such deemed liquidation event, each holder of Convertible Preferred Stock has the right to require the redemption of such shares, and if voting together as a majority, has the right to require redemption of all outstanding Convertible Preferred Stock in accordance with the liquidation preferences afforded to holders of the Convertible Preferred Stock. Any shares of Convertible Preferred Stock that are redeemed or otherwise acquired by the Company or any of its subsidiaries be automatically and immediately canceled and retired and shall not be reissued, sold, or transferred. Neither the Company nor any of its subsidiaries may exercise any voting or other rights granted to the holders of Convertible Preferred Stock following redemption. A Deemed Liquidation Event shall include a merger or consolidation (other than one in which the capital stock of the Company outstanding immediately prior to such merger or consolidation continue to represent a majority by voting power of the capital stock of the surviving corporation) or a sale, lease, transfer, exclusive license, or other disposition of all or substantially all of the assets of the Company.

Conversion

Conversion Ratio—Each share of Convertible Preferred Stock shall be convertible, at the option of the holder thereof, at any time into such number of fully paid and nonassessable shares of common stock as is determined by dividing the applicable original issue price by the applicable conversion price (Series A original issue price is $1.00 per share and applicable conversion price is $5.35 per share; Series A-1 original issue price is $1.25 and applicable conversion price is $6.69 per share; Series B original issue price is $1.84 per share and applicable conversion price is $9.84 per share), subject to adjustment in the case of termination or fractional shares.

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Mandatory Conversion—All outstanding shares of Convertible Preferred Stock are automatically convertible based upon either (a) the closing of a firm-commitment underwritten public offering in which the aggregate gross proceeds to the Company of at least $60,000,000 of gross proceeds to the Company and have an offering price to the public of at least $9.84 per share or (b) the vote or written consent of holders of at least a majority of the Convertible Preferred Stock outstanding at that time with respect to the conversion of the Convertible Preferred Stock then all outstanding shares of Convertible Preferred Stock shall automatically be converted into shares of common stock at the then effective conversion rate and such shares may not be reissued. Upon the completion of the Company’s initial public offering in May 2021, all Convertible Preferred Stock was converted to shares of common stock or non-voting common stock.

10. Common Stock

Common Stock Reserved

The number of shares of common stock that have been reserved for the potential conversion of Preferred Stock, and outstanding stock options granted and stock options available for grant under the Company’s 2018 Equity Incentive Plan (the “2018 Plan”) are as follows:

11. Stock-Based Compensation

2018 Equity Incentive Plan

The Company’s 2018 Plan, as amended, provides for the Company to sell or issue common stock or restricted common stock or to grant incentive stock options or nonqualified stock options for the purchase of common stock, to employees, nonemployees and members of the board of directors of the Company. The 2018 Plan is administered by the board of directors or at the discretion of the board of directors by the compensation committee of the board. The exercise prices, vesting periods, and other restrictions are determined at the discretion of the compensation committee of the board of directors, except that the exercise price per share of stock options may not be less than 100% of the fair market value of the share of common stock on the date of grant and the contractual term of stock option may not be greater than 10 years. Stock options granted to date typically vest over four years.

The total number of shares of common stock that may be authorized under the 2018 Plan is 5,454,915 shares, of which 408,410 remained available for future grant as of March 31, 2021. 2,997,524 shares were authorized under the 2018 Plan as of March 31, 2020, of which 655,607 remained available for future grant as of March 31, 2020. As the 2018 Plan is designed to maintain the fully diluted percentage of total authorized shares, the shares authorized under the plan increased with the additional preferred stock issuances disclosed in Note 9.

Stock Option Valuation

The assumptions used to determine the fair values of stock options granted to employees and directors are presented as follows:

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Summary of Option Activity

The Company’s stock option activity regarding employees, directors, and nonemployees is summarized as follows (in thousands excepts share and per share amounts):

Additional information with regard to stock option activity involving employees and directors is as follows (in thousands except per share amounts):

As of March 31, 2021, total unrecognized compensation cost related to the unvested awards to employees, directors, and nonemployees is $10.7 million, which is expected to be recognized over a weighted-average period of 3.5 years.

Stock-Based Compensation

The Company recorded stock-based compensation expense regarding its employees, directors, and nonemployees as follows (in thousands):

12. Net Loss Per Share Attributable to Common Stockholders

Net Loss Per Share

The following table summarizes the computation of basic and diluted net loss per share attributable to common stockholders of the Company (in thousands except share and per share amounts).

The Company’s potential dilutive securities, which include convertible preferred stock, contingent stock liabilities, restricted stock related to early exercise of common stock options and common stock options, have been excluded from the computation of diluted net

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loss per share as the effect would be antidilutive. Therefore, the weighted average number of common shares outstanding used to calculate both basic and diluted net loss per share attributable to common stockholders is the same. The following potential dilutive securities, presented on an as converted basis, were excluded from the calculation of net loss per share due to their anti-dilutive effect:

13. Subsequent Events

The Company has evaluated subsequent events through June 14, 2021, the date the financial statements were available to be issued. The Company has concluded no subsequent events have occurred that require disclosure, except for those referenced below.

Third Amended and Restated Charter

On April 30, 2021, the Company’s stockholders approved the third amended and restated certificate of incorporation of the Company, which included the authorization of 10,000,000 shares of undesignated preferred stock with a par value of $0.0001 and a decrease in the number of authorized shares of common stock from 197,755,748 shares of class A common stock and 133,217,386 shares of class B common stock to 140,000,000 shares of voting common stock and 10,000,000 shares of non-voting common stock, respectively.

2021 Stock Option and Incentive Plan and 2021 Employee Stock Purchase Plan

On April 15, 2021 and April 30, 2021, the Company’s board of directors and stockholders, respectively, approved the 2021 Stock Option and Incentive Plan (“2021 Plan”), terminated the 2018 Plan with respect to any unissued awards under the plan and approved the 2021 Employee Stock Purchase Plan (“2021 ESPP”). The 2021 Plan and 2021 ESPP became effective on the date immediately prior to the effectiveness of the Company’s registration statement on Form S-1 for its proposed IPO. The 2021 Plan and 2021 ESPP provide for the issuance of up to 3,015,907 and 852,971 of share-based awards, respectively.

Reverse Share Split

The Company’s board of directors and shareholders approved a one-for-5.35 reverse share split of issued and outstanding common shares and incentive shares and a proportional adjustment to the existing conversion ratios for the Company’s convertible preferred stock effective as of April 30, 2021. Accordingly, all share and per share amounts for all periods presented in the accompanying financial statements and notes have been retroactively adjusted, where applicable, to reflect the reverse share split.

Initial Public Offering

On May 11, 2021, the Company completed an initial public offering. The net proceeds from the offering, after deducting underwriting discounts and commissions but before deducting offering costs, were $139.5 million. Upon completion of the offering, all Convertible Preferred Stock outstanding was converted to shares of common stock or non-voting common stock.

Contingent Equity Settlement

On May 11, 2021, coincident with the completion of the initial public offering, the Company issued to ULRF 48,889 shares of common stock together with $277,049 in a cash payment in full satisfaction of the contingent stock liability described in Note 8. 

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

You should read the following discussion and analysis of our financial condition and results of operations together with the “Selected Financial Data” section of this Quarterly Report on Form 10-Q (this “Quarterly Report”) and our financial statements and the related notes appearing elsewhere in this Quarterly Report. This discussion and other parts of this Quarterly Report contain forward-looking statements that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the “Risk Factors” section of this Quarterly Report.

Overview

We are a late-clinical stage, cell therapy company developing an innovative method of allogeneic hematopoietic stem cell transplantation (“allo-HSCT”) that we believe has the potential to transform the standard of care in solid organ transplantation, certain severe autoimmune diseases and certain severe non-malignant blood, immune and metabolic disorders. In the organ transplant setting, which is our initial focus, we believe our proprietary therapeutic approach, which we call Facilitated Allo-HSCT Therapy, could prevent organ rejection without the morbidity and mortality that has been associated with the use of lifelong immunosuppression. Beyond the organ transplant setting, our Facilitated Allo-HSCT Therapy also has the potential to treat a range of severe non-malignant blood, immune and metabolic disorders, in each case with potential for similar outcomes to what has previously been observed with HSCT, while mitigating the toxicities, morbidities and extended hospital stay associated with the fully myeloablative conditioning typically required by HSCT. We believe that these indications, individually and collectively, represent a significant unmet need and commercial opportunity.

We were incorporated as Regenerex, Inc. in 2018 under the laws of the State of Delaware, having converted from a limited liability company under the name Regenerex LLC. In 2019, we changed our corporate name from Regenerex, Inc. to Talaris Therapeutics, Inc.

Since our inception, we have devoted substantially all of our resources to developing our lead product candidate, FCR001, building our intellectual property portfolio, business planning, raising capital and providing general and administrative support for these operations. To date, we have principally financed our operations through private placements of convertible preferred stock, together with payments under a former research collaboration with Novartis, Inc. and research grants. Through March 31, 2021, we had received net proceeds of $186.2 million from sales of our convertible preferred stock.

We have incurred significant operating losses since inception. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of our product and any future product candidates. Our net loss was $9.3 million for the three months ended March 31, 2021, $22.7 million for year ended December 31, 2020 and $18.2 million for the year ended December 31, 2019. As of March 31, 2021, we had an accumulated deficit of $46.5 million. We expect to continue to incur net losses for the foreseeable future, and we expect our research and development expenses, general and administrative expenses and capital expenditures to continue to increase. In particular, we expect our expenses to increase as we continue our development of, and seek regulatory approvals for, our product candidates, as well as hire additional personnel, pay fees to outside consultants, lawyers and accountants, and incur other increased costs associated with being a public company. In addition, if we obtain marketing approval for any product candidates, we expect to incur significant commercialization expenses related to product manufacturing, marketing, sales and distribution. We may also incur expenses in connection with the in-licensing or acquisition of additional product candidates. Furthermore, we expect to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations, compliance and other expenses that we did not incur as a private company. As a result, we will need substantial additional funding to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through the sale of equity, debt financings, or other capital sources, which may include collaborations with other companies or other strategic transactions. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. If we fail to raise capital or enter into such agreements as and when needed, we may have to significantly delay, reduce or eliminate the development and commercialization of one or more of our product candidates or delay our pursuit of potential in-licenses or acquisitions.

Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations.

Based upon our current operating plan, we believe that our existing cash and cash equivalents and marketable securities of $140.1 million as of March 31, 2021, together with the net proceeds from the Company’s IPO, after deducting underwriting discounts and commissions but before deducting offering costs, of $139.5 million in May 2021, will be sufficient to fund our operating expenses and capital expenditure requirements at least into 2025. We have based this estimate on assumptions that may prove to be wrong, and

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we could exhaust our available capital resources sooner than we expect. To finance our operations beyond that point we will need to raise additional capital, which cannot be assured.

Impact of COVID-19 on Our Business

The worldwide COVID-19 pandemic and recent emergence of variants of the virus have affected and may affect in the future our ability to initiate and complete preclinical studies, delay the initiation and completion of our current and planned clinical trials, disrupt regulatory activities or have other adverse effects on our business, results of operations, financial condition and prospects. In addition, the pandemic has caused substantial disruption in the financial markets and may adversely impact economies worldwide, both of which could adversely affect our business, operations and ability to raise funds to support our operations.

We are following, and plan to continue to follow, recommendations from federal, state and local governments regarding workplace policies, practices and procedures. In response to the direction from state and local governmental authorities, we have limited the access to our facility to those individuals who are not performing critical research and laboratory support activities that must be completed on site, limited the total number of such people that can be present at our facility at any one time and required any employees working in our facility to receive negative COVID-19 tests before entering site. Timely enrollment in planned clinical trials is dependent upon clinical trial sites which have been adversely affected by global health matters, such as COVID-19. For example, screening and enrollment in our ongoing FREEDOM-1 Phase 3 clinical trial in the United States have been adversely impacted by the COVID-19 pandemic. In addition, we and the third-party manufacturers, contract research organizations (“CROs”), and academic collaborators that we engage may face future disruptions that could affect our ability to initiate and complete preclinical studies or clinical trials, including disruptions in procuring items that are essential for our research and development activities, such as, for example, raw materials used in the manufacture of our product candidates and laboratory supplies for our preclinical studies and clinical trials, in each case, for which there may be shortages because of ongoing efforts to address the COVID-19 pandemic.    

We cannot be certain what the overall impact of the COVID-19 pandemic will be on our business, and it has the potential to adversely affect our business, financial condition, results of operations and prospects.

License Agreement

In October 2018, we entered an amended and restated exclusive license agreement (“ULRF License Agreement”) with University of Louisville Research Foundation (“ULRF”) related to certain licensed patent rights and know-how related to human facilitating cells for our Facilitated Allo-HSCT Therapy approach. Pursuant to the ULRF License Agreement, ULRF granted us an exclusive, worldwide license under such patents and a nonexclusive royalty-bearing, worldwide license for such know-how to research, develop, commercialize and manufacture FCR001 and products containing FCR001 in all fields, without limitation. ULRF also granted us the right to grant sublicenses in accordance with the ULRF License Agreement. Under the terms of the agreement, we are obligated to compensate ULRF three percent of net sales of all licensed products sold, one third of any non-royalty sublicensing income, and up to $1.625 million in regulatory and sales milestones on each licensed product upon the occurrence of specific events as outlined in the license agreement; and annual license maintenance fees. As of March 31, 2021, we have paid ULRF $0.1 million in milestone payments and $0.1 million in annual maintenance fees, for a total of $0.2 million.

In addition, upon execution of the ULRF License Agreement, we granted contingent equity consideration equal to 65,186 shares of common stock to ULRF. On or prior to our first underwritten public offering or any transaction that is treated as a deemed liquidation event, we may either issue to ULRF the 65,186 shares in common stock or make a cash payment equal to the 65,186 shares of common stock multiplied by either the price per share of common stock in the underwritten public offering or by the price per share of common stock received in connection with such deemed liquidation event. At March 31, 2021 and December 31, 2020, we measured the fair value of the contingent equity consideration and recorded a contingent stock liability of $0.7 million and $0.4 million, respectively, in other liabilities (see Note 3 in accompanying audited financial statements).

Coincident with the completion of our initial public offering in May 2021, we issued to ULRF 48,889 shares of common stock in addition to $277,049 in a cash payment to fully satisfy the contingent stock liability to ULRF (see Note 15 in the accompanying financial statements).

Components of Our Results of Operations

Revenue

We have not generated any revenue since our inception and do not expect to generate any revenue from the sale of products in the future, if at all. If our product candidates we are currently developing and that we may develop in the future are successful and result in marketing approval or if we enter into collaboration or license agreements with third parties, we may generate revenue in the future from a combination of product sales or payments from such collaboration or license agreements.

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Operating Expenses

Research and Development Expenses

Research and development expenses consist primarily of costs incurred in connection with the development and research of our novel cell therapy, as well as unrelated discovery program expenses. We expense research and development costs as incurred. These expenses include:

The Company enters into consulting, research, and other agreements with commercial entities, researchers, universities, and others for the provision of goods and services. Such arrangements are generally cancelable upon reasonable notice and payment of costs incurred. Costs are considered incurred based on an evaluation of the progress to completion of specific tasks under each contract using information and data provided by the respective vendors, including the Company’s clinical sites. These costs consist of direct and indirect costs associated with specific projects, as well as fees paid to various entities that perform certain research on behalf of the Company. Depending upon the timing of payments to the service providers, the Company recognizes prepaid expenses or accrued expenses related to these costs. These accrued or prepaid expenses are based on management’s estimates of the work performed under service agreements, milestones achieved, and experience with similar contracts. The Company monitors each of these factors and adjusts estimates accordingly.

The successful clinical development and subsequent commercialization of product candidates is highly uncertain. This is due to the numerous risks and uncertainties with product development and commercialization, including significant variations in our clinical development costs as well as the following factors:

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We may never succeed in obtaining regulatory approval for any of our current and future product candidates, including FCR001. We may obtain unexpected results from our preclinical studies and clinical trials including FREEDOM-1, FREEDOM-2, and FREEDOM-3. We may elect to discontinue, delay or modify clinical trials of some product candidates or focus on others. A change in the outcome of any of these factors could mean a significant change in the costs and timing associated with the development of our current and future preclinical and clinical product candidates. For example, if the FDA or another regulatory authority were to require us to conduct clinical trials for FCR001 beyond those that we currently anticipate will be required for the completion of clinical development, or if we experience significant delays in execution of any of our preclinical studies or execution or enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time on the completion of preclinical and clinical development. A change in the outcome of any of these variables with respect to the development of our product candidates could significantly change the costs and timing associated with the development of that product candidate. We may never succeed in obtaining regulatory approval for any of our product candidates.

Research and development activities account for a significant portion of our operating expenses. We expect our research and development expenses to increase for the foreseeable future as we continue to implement our business strategy, which includes advancing FCR001 through clinical development of FREEDOM-1, FREEDOM-2 and FREEDOM-3 as well as other product candidates into clinical development, expanding our research and development efforts, including hiring additional personnel to support our research efforts, our clinical and product development efforts, and seeking regulatory approvals for our product candidates that successfully complete clinical trials.

We use our personnel and infrastructure resources across multiple research and development programs directed toward identifying and developing product candidates. Our direct research and development expenses are tracked on a program-by-program basis and consist primarily of external costs, including fees paid to consultants, contractors and CROs in connection with our development activities and the cost of acquiring, developing, and manufacturing clinical study materials. At this time, we do not fully allocate personnel costs to individual programs as many of our personnel are deployed across multiple programs.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related costs for personnel in executive, finance, corporate and business development, and administrative functions. General and administrative expenses also include legal fees relating to patent and corporate matters, professional fees for accounting, auditing, tax and administrative consulting services, insurance costs and other operating costs, including an allocated portion of facilities and other infrastructure costs associated with our general and administrative activities.

We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support development of our product candidates and our continued research activities. We also anticipate that we will incur increased accounting, audit, legal, regulatory, compliance and director and officer insurance costs as well as investor and public relations expenses associated with being a public company.

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Other Income (Expense), Net

Other income (expense), net is comprised of interest income earned on cash reserves in our operating account and on our marketable securities, amortization expense and accretion income on our marketable securities and expense incurred in relation to the change in fair value of our contingent stock liability with ULRF.

Results of Operations

Comparison of 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:

Research and development expenses

Research and development activities are central to our business model. We expect that our research and development expenses will continue to increase substantially for the foreseeable future as we advance FCR001 through clinical trials, including our FREEDOM- 1 Phase 3 clinical trial, and we continue to develop additional product candidates.

Research and development expenses were $6.5 million for the three months ended March 31, 2021, compared to $3.5 million for the three months ended March 31, 2020. The increase of $2.9 million was primarily due to:

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General and Administrative Expenses

The following table summarizes our general and administrative expenses to support our business activities for the three months ended March 31, 2021 and 2020

General and administrative expenses were $2.5 million for the three months ended March 31, 2021 compared to $1.4 million for the three months ended March 31, 2020. The increase in general and administrative costs of $1.1 million was primarily due to:

Other Income (Expense), Net

Other income (expense), net in the three months ended March 31, 2021 was comprised of $0.3 million in interest income from our marketable securities and operating cash balance, $(0.2) million of net amortization expense on our marketable securities and $(0.4) million in expense related to a fair value adjustment of our contingent stock liability. Other income, net in the three months ended March 31, 2020 was comprised of $0.1 million of interest income and net accretion income on our marketable securities.

Liquidity and Capital Resources

Since our inception, we have incurred significant operating losses. We have not yet commercialized any products and we do not expect to generate revenue from sales of products for several years, if at all. Since 2018, we have funded our operations primarily with proceeds from the sale of our convertible preferred stock. Through March 31, 2021, we had received net proceeds of $186.2 million from sales of our convertible preferred stock.

Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. Our primary use of cash is to fund operating expenses, which consist primarily of research and development expenditures, and to a lesser extent, general and administrative expenditures. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the change in our outstanding accounts payable and accrued expenses. As of March 31, 2021, we had cash and cash equivalents of $9.9 million and marketable securities of $130.2 million.

Cash Flows

The following table summarizes our sources and uses of cash for each of the periods presented:

Cash Flow from Operating Activities

During the three months ended March 31, 2021, operating activities used $9.0 million of cash, due to our net loss of $9.3 million and $1.3 million of cash used from changes in our operating assets and liabilities, partially offset by non-cash charges of $1.6 million. Net cash used from changes in our operating assets and liabilities primarily consisted of a $0.9 million decrease in accounts payable and accrued expenses driven by our 2020 annual bonus payout in February 2021 and an increase in current assets of $0.4 million driven by

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an increase in our tax credit receivable. Non-cash charges primarily consisted of $0.8 million of stock-based compensation expense, $0.4 million of expense related to the fair value adjustment of our contingent stock liability and $0.4 million of depreciation on fixed assets and amortization of marketable securities.

During the three months ended March 31, 2020, operating activities used $5.2 million of cash, due to our net loss of $4.8 million and $0.6 million from a decrease in accounts payable and accrued expenses, partially offset by non-cash charges of $0.2 million. $0.6 million decrease in accounts payable and accrued expense primarily driven by our 2019 annual bonus payout in February 2020. Non-cash charges primarily consisted of $0.1 million of depreciation expense and $0.1 million of stock-based compensation expense.

Cash Flow from Investing Activities

During the three months ended March 31, 2021, investing activities provided $1.3 million of cash, due to maturities of marketable securities of $35.8 million, partially offset by purchases of marketable securities of $34.3 million and purchases of property and equipment of $0.2 million.

During the three months ended March 31, 2020, investing activities used $19.5 million of cash, due to purchases of marketable securities of $19.1 million and purchases of property and equipment of $0.3 million.

Cash Flow from Financing Activities

During the three months ended March 31, 2021, net cash provided by financing activities was an immaterial amount primarily consisting of proceeds from exercise of stock options.

There were no financing activities during the three months ended March 31, 2020.

Future Funding Requirements

We expect our expenses to increase substantially in connection with our ongoing activities, particularly as we advance the late-stage clinical development of our product candidates. In addition, we expect to incur additional costs associated with operating as a public company. The timing and amount of our operating expenditures will depend largely on:

We believe that the net proceeds from our initial public offering, together with our existing cash and cash equivalents and marketable securities as of March 31, 2021, will enable us to fund our operating expenses and capital expenditure requirements at least into 2025. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect. We expect that we will require additional funding to (i) further develop FCR001 in our ongoing Phase 3

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registrational trial, FREEDOM-1, through evaluation of its primary endpoint, including in-house manufacturing and quality assurance of clinical trial material, third-party clinical trials costs, clinical development and trial management, and personnel associated with each; (ii) continue research and development of FCR001 in additional pipeline programs such as living donor kidney transplant delayed tolerance induction and scleroderma in our FREEDOM-2 and FREEDOM-3 trials, respectively, through evaluation of their primary endpoints, including in-house manufacturing and quality assurance of clinical trial material, third-party clinical trials costs, clinical development and trial management, and personnel associated with each; (iii) develop expanded CMC operations to facilitate scale-up and commercialization of FCR001, or to engage a third-party manufacturer to undertake such commercialization; and (iv) develop our preclinical programs towards IND filings and/or into clinical trials. If we receive regulatory approval for any of product candidates, we expect to incur significant commercialization expenses related to product manufacturing, sales, marketing and distribution, depending on where we choose to commercialize those product candidates ourselves.

Developing pharmaceutical products, including conducting preclinical studies and clinical trials, is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain marketing approval for any product candidates or generate revenue from the sale of any product candidate for which we may obtain marketing approval. In addition, our product candidates, if approved, may not achieve commercial success. Our commercial revenues, if any, will be derived from sales of drugs that we do not expect to be commercially available for many years, if ever. Accordingly, we will need to obtain substantial additional funds to achieve our business objectives.

Adequate additional funds may not be available to us on acceptable terms, or at all. We do not currently have any committed external source of funds. Until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of equity offerings, royalty-based financings, debt financings, collaborations, strategic alliances, and marketing, distribution or licensing arrangements with third parties. To the extent that we raise additional capital through the sale of equity or convertible debt securities, ownership interest may be materially diluted, and the terms of such securities could include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing, royalty-based financing and preferred equity financing, if available, may involve agreements that include restrictive covenants that limit our ability to take specified actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise funds through royalty-based financings, collaborations, strategic alliances or marketing, distribution 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 or other arrangements when needed, we may be required to delay, reduce or eliminate 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.

Contractual Obligations

The following table summarizes our contractual obligations as of March 31, 2021 and the effects that such obligations are expected to have on our liquidity and cash flows in future periods:

Apart from the contracts with payment commitments that we have reflected in the table, we have entered into other contracts in the normal course of business with certain CROs and other third parties for nonclinical research studies and testing, as well as clinical trials. These contracts do not contain any minimum purchase commitments and are cancelable by us upon prior notice and, as a result, are not included in the table of contractual obligations and commitments above. Payments due upon cancellation consist only of payments for services provided and expenses incurred, including non-cancelable obligations of our service providers, up to the date of cancellation.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. The preparation of our financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, costs and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the

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circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are described in more detail in Note 2 to our financial statements appearing at the beginning of this Quarterly Report, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

Research and Development Contract Costs and Accruals

As part of the process of preparing our financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contracts and purchase orders, communicating with our applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met; however, some require advance payments. We make estimates of our accrued expenses as of each balance sheet date in the financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of these estimates with the service providers and make adjustments, if necessary. Examples of estimated accrued research and development expenses include fees paid to:

We base the expense recorded related to external research and development on our estimates of the services received and efforts expended pursuant to quotes and contracts with multiple CROs that supply, conduct and manage clinical trials on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the expense. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we adjust the accrual or the amount of prepaid expenses accordingly. Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in reporting amounts that are too high or too low in any particular period. To date, there have not been any material adjustments to our prior estimates of accrued research and development expenses.

Stock-Based Compensation Expense

We measure stock-based awards granted to employees, directors, and nonemployees based on their fair value on the date of the grant and recognize compensation expense for those awards over the requisite service period, which is generally the vesting period of the respective award. For stock-based awards with service-based vesting conditions, we recognize compensation expense using the straight-line method. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model, which requires inputs based on certain subjective assumptions, including the expected stock price volatility, the expected term of the option, the risk-free interest rate for a period that approximates the expected term of the option, and our expected dividend yield. The fair value of each option to purchase common stock award is estimated on the date of grant based on the fair value of our common stock on that same date.

Determination of the Fair Value of Common Stock

As there had been no public market for our common stock prior to the closing of our initial public offering, the estimated fair value of our common stock has been determined by our board of directors as of the date of each option grant with input from management, considering our most recently available third-party valuations of common stock, and our board of directors’ assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent valuation through the date of the grant. These independent third-party valuations of our equity instruments were performed contemporaneously with identified value inflection points. Our common stock valuation was prepared using the option-pricing method (“OPM”), which used a market approach to estimate our enterprise value, as well as the probability-weighted expected return method (“PWERM”) and the hybrid method, a combination of OPM and PWERM.

These third-party valuations were performed in accordance with the guidance outlined in the American Institute of Certified Public Accountants’ Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. We account for equity-based compensation in accordance with ASC 718, Compensation-Stock Compensation (“ASC 718”). In accordance with ASC 718, compensation cost is measured at estimated fair value and is included as compensation expense over the vesting period

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during which service is provided in exchange for the award. Our common stock valuation was prepared using the OPM, which used a market approach to estimate our enterprise value.

The OPM treats common stock and preferred stock as call options on the total equity value of a company, with exercise prices based on the value thresholds at which the allocation among the various holders of a company’s securities changes. Under this method, the common stock has value if the funds available for distribution to stockholders exceed the value of the liquidation preferences at the time of a liquidity event, such as a strategic sale or merger. The common stock is modeled as a call option on the underlying equity value at a predetermined exercise price. In the model, the exercise price is based on a comparison with the total equity value rather than, as in the case of a regular option, a comparison with a per share stock price. Thus, common stock is considered to be a call option with a claim on the enterprise at an exercise price equal to the remaining value immediately after the preferred stock liquidation preference is paid. The OPM uses the Black-Scholes option pricing model to price the call options. This model defines the fair value of securities as functions of the current fair value of a company and uses assumptions such as the anticipated timing of a potential liquidity event and the estimated volatility of the equity securities.

The PWERM is a scenario-based analysis that estimates the value per share of common stock based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes considered by the Company, as well as the economic and control rights of each share class. The OPM, PWERM and/or the hybrid methods were used for our January 2021 valuations.

The assumptions used to determine the fair values of stock options granted to employees and directors during the three months ended March 31, 2021 and 2020, are presented as follows:

The assumptions underlying these valuations were highly complex and subjective and represented management’s best estimates, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used significantly different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could be materially different.

Once a public trading market for our common stock was established in connection with the completion of our initial public offering, our board of directors no longer have to estimate the fair value of our common stock in connection with our accounting for granted stock options and other such awards we may grant, as the fair value of our common stock will be determined based on the quoted market price of our common stock.

Grant of Stock-Based Awards

The following table sets forth by grant date the number of shares subject to options granted between January 1, 2021 and March 31, 2021, the per share exercise price of the options, the fair value of common stock per share on each grant date, and the per share estimated fair value of the options: