Korro Bio, Inc. (KRRO) FY 2021 MD&A

Item 7. 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 our consolidated financial statements and the related notes and other financial information included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis contains forward-looking statements that involve risks and uncertainties. You should review the section titled “Risk factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described below.

Overview

We are a clinical-stage regenerative medicine company focused on developing therapeutics to activate a person’s innate regenerative potential to restore function. Our focus is on advancing our lead product candidate, FX-322, through clinical studies with the goal of developing and commercializing a medicine to help millions of people with the most common form of hearing loss while continuing to broaden the potential of our regenerative approach in other applications. We believe we are a leading company using mitotic regeneration for cochlear sensory hair cell regeneration and that FX-322 has the potential to meaningfully improve overall hearing function and enhance quality of life for people with this condition.

Our initial therapeutic focus is sensorineural hearing loss, or SNHL, which is the most prevalent type of hearing loss. We are developing FX-322 to treat a major underlying cause of SNHL, which is the loss of hair cells. FX-322 is designed to regenerate hair cells through the activation of progenitor cells already present in the ear. In our Phase 1/2 clinical trial (FX-322-201) evaluating FX-322 in 23 subjects with stable SNHL, we observed a statistically significant and clinically meaningful improvement in key measures of hearing loss, including word recognition, or WR, and clarity of sounds, and FX-322 was observed to be well-tolerated.

In March 2021, we announced topline, day-90 interim data from the Phase 2a clinical trial (FX-322-202), and in June 2021, we announced final results from the Phase 2a clinical trial (FX-322-202). The goals of the FX-322-202 trial were to further establish the hearing signal observed in the Phase 1/2 clinical trial(FX-322-201), evaluate the impact of multiple doses and provide insights on endpoints and patient population for further studies. Both day-90 interim data and the end-of-study results (as of day 210) showed that four weekly injections of FX-322 did not demonstrate improvements in any hearing measures versus placebo, a finding we believe is due to an uncontrolled bias and the limitation to a single baseline measure. We also observed an unexpected increase in WR scores in the placebo group that did not occur in previous FX-322 trials and exceeded well-established published standards, potentially suggesting bias due to trial design. Given this lack of reliability of baseline WR scores of the placebo group, we were unable to evaluate hearing improvements in WR scores for FX-322 dosing regimens versus placebo. Both the interim data and end-of-study results showed a favorable safety and tolerability profile for FX-322.

In March 2021, we also announced data from a Phase 1b clinical trial of FX-322 that was designed to evaluate the impact of injection conditions on tolerability (FX-322-111). The data showed hearing improvement from a single injection of FX-322. In the multi-center, randomized study, subjects with mild to severe SNHL (n=33) were injected in one ear with FX-322 with the untreated ear as the control. Hearing function was tested over the course of 90 days following dosing. Thirty-two subjects completed the 90-day clinical assessment period and, at day 90 following dosing, 34% of these subjects achieved a 10% or greater absolute improvement in WR scores in the treated ear, which was clinically meaningful and statistically significant compared to the untreated ear (p 0.05). This included a subset of subjects that more than doubled their WR scores. Twenty-five subjects were subsequently evaluated during the 8 to 12 months following FX-322 dosing and, as of September 22, 2021, nine subjects, including the five initial responders at day 90, had shown statistically significant hearing improvements when evaluated during this time period. Of the five subjects that showed a statistically significant response and doubled their WR scores at day 90, four of these returned for evaluation and had scores that remained above their baseline word recognition measures, though were below the threshold for statistical significance. In this trial, FX-322 showed a favorable safety profile and was well tolerated.

In May 2021, we announced data from a Phase 1b clinical trial of FX-322 in presbycusis (age-related hearing loss) (FX-322-112). The double-blind, placebo-controlled, randomized, multicenter safety study enrolled 30 individuals aged 66-85 with age-related hearing loss. Study participants were randomized 4:1 to receive either FX-322 or placebo in one ear. Validated hearing measures, as well as safety, otologic and audiologic assessments were also evaluated in the study. By design, the study recruited subjects with no medical history of noise-induced or sudden sensorineural hearing loss (SSNHL), etiologies where FX-322 associated hearing benefits were observed in prior studies, as we continue to separately evaluate subjects with specific forms of hearing loss to better refine cohorts for future studies. While the treatment effect was not

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significant compared to placebo, results from the study showed a favorable safety and tolerability profile with no reported treatment-related serious adverse events.

In December 2021 we announced data from a Phase 1b clinical trial of FX-322 in subjects aged 18-65 with severe SNHL (FX-322-113). The trial enrolled 31 subjects with Severe SNHL, defined as a pure tone average deficit between 71-90 dB. Many subjects with this clinical profile typically would be candidates for cochlear implants. The primary objectives of the study were to assess the local and systemic safety of a single dose of FX-322 and evaluate hearing responses in a more severe adult cohort. Study participants were randomized 4:1 to receive either FX-322 or placebo in one ear. Validated measures of hearing including WR, sentences in noise, and pure tone audiometry were utilized in the study. Safety, otologic and audiologic assessments were conducted at days 30 and 90 following administration of FX-322 or placebo. To gain a more comprehensive understanding of the potential impact of FX-322 in this population, we evaluated hearing using multiple tests of speech perception in both quiet and noisy backgrounds, including the Bamford-Kowal-Bench Sentence-in-Noise exam, or BKB-SIN. In this study, BKB-SIN test improvements were observed in four subjects, all of whom exceeded the 95 percent critical difference of 3.1dB SNR, with two subjects showing a 6dB response. A single placebo subject had a 3.6dB change. In the study, subjects did not show substantial changes in speech perception measures in quiet, the safety profile in the study was favorable and there were no treatment-related serious adverse events reported.

In October 2021, we commenced dosing of a Phase 2b clinical trial of FX-322 (FX-322-208) in subjects with SNHL. FX-322-208 is a randomized, placebo-controlled, multi-center study designed to evaluate the impact of a single administration of FX-322 on speech perception in approximately 124 subjects with either noise-induced or sudden SNHL, the same hearing loss severities and etiologies as those subject in which statistically significant improvements in speech perception were observed in prior FX-322 clinical trials. The study’s primary endpoint is speech perception, a measure of sound clarity and understanding speech. In a Type-C meeting with the U.S. Food and Drug Administration, or the FDA, the FDA agreed that speech perception is an acceptable primary efficacy endpoint.

In November 2021, we introduced our new SNHL investigational therapeutic program, FX-345. This program may offer some advantages as we look to expand the opportunity to treat different types of sensory neural hearing loss. Specifically, FX-345 was designed to achieve broader exposure through a large portion of the cochlea to assess if FX-345 could have an even bigger patient impact or help a broader population than FX-322. Additionally, deeper delivery into the cochlea using FX-345 may extend the reach of our approach. Further, FX-345 has greater flexibility and dose selection and formulation, enabling us to evaluate a range of different dose levels. Cochlear pharmacokinetic measures and human modeling data in a preclinical setting show FX-345 achieves greater exposure through a larger portion of the cochlea for longer time. We anticipate filing an IND for FX-345 in the second half of 2022.

We believe our PCA approach can impact a wide range of degenerative diseases. To that end, in addition to our lead program in hearing, we are working to rapidly advance discovery efforts using our PCA approach to potentially remyelinate nerves in individuals with multiple sclerosis, or MS. MS induces demyelination, stripping axons of the myelin sheaths that support nerve signal conduction and axonal survival. Prior to initiating our internal discovery program against a novel target, we licensed intellectual property from Scripps and Cambridge Enterprise on approaches to promote remyelination of nerve fibers. We continue to engage in sponsoring clinical research to validate this initial approach at Cambridge University. In November 2021, we introduced FREQ-162, an internally discovered preclinical stage compound that has been shown to induce substantially more remyelination than published comparator approaches based on in vivo models. Our efforts are focused on advancing Frequency compounds in preclinical safety studies to enable the initiation of clinical trials in 2023.

Since our formation in 2014, we have devoted substantially all our resources to developing our PCA platform, conducting research and development activities, including product candidate development, recruiting skilled personnel, establishing our intellectual property portfolio, and providing general and administrative support for these operations. We have financed our operations primarily through proceeds from the sale of convertible notes, convertible preferred stock, the common stock and the Astellas Agreement.

Since our formation, we have incurred significant operating losses and have not generated any revenue from the sale of products. Our ability to generate any product revenue or product revenue sufficient to achieve profitability will depend on the successful development and eventual commercialization of one or more of our product candidates. Our net losses were $84.7 million and $26.5 million for the years ended December 31, 2021 and 2020, respectively. As of December 31, 2021, we had an accumulated deficit of $180.1 million. During the periods presented, we do not have any off balance sheet arrangements as defined under SEC rules.

We expect our operating expenses to increase substantially in connection with the expansion of our product development programs around FX-322, FX-345, FREQ-162 and any future programs. In addition, we expect to continue to

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incur significant additional costs associated with operating as a public company. We will not generate revenue from product sales unless and until we successfully complete clinical development, obtain regulatory approval for, and successfully commercialize our product candidates, or until our collaborators do so, which could result in milestone payments or royalties to us. If we obtain regulatory approval for any of our product candidates, we expect to incur significant expenses related to developing our commercialization capability to support product sales, marketing and distribution.

As a result of these anticipated expenditures, we will need additional financing to support our continuing operations. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our cash needs through a combination of public or private equity or debt financings and other sources, which may include current and new collaborations with third parties. Adequate additional financing may not be available to us on acceptable terms, or at all. Our inability to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategy. We cannot be sure that we will ever generate sufficient revenue to achieve profitability.

Because of the numerous risks and uncertainties associated with the development of therapeutics, 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 can generate revenue from 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 required to raise additional capital on terms that are unfavorable to us or we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations.

Our offices are located in states that have lifted many COVID-19 restrictions. As of the date of the filing of this Annual Report, the majority of our non-laboratory based employees continue to work from home two to three days per week, while our laboratory personnel have largely resumed a full in-person schedule in our Lexington, MA facility. We have also taken steps consistent with the FDA’s updated industry guidance for conducting clinical trials. The continuing COVID-19 pandemic, and actions taken to mitigate it, have had and are expected to continue to have an impact on the economies and financial markets of many countries, including the geographical area in which we operate, which could adversely impact our ability to raise additional capital when needed or on acceptable terms, if at all. In addition, COVID-19 may cause disruptions in our business or operations, as well as the business and operations of our CMOs, CROs and other third parties with whom we conduct business. The COVID-19 pandemic may also adversely impact our clinical trials, which could impede, delay, limit or prevent the clinical development of our product candidates and ultimately lead to the delay or denial of regulatory approval of our product candidates, which would materially adversely affect our business and operations, including our ability to generate revenue.

License and collaboration agreements

Astellas Pharma Inc.

In July 2019, we entered into the Astellas Agreement with Astellas, under which we granted Astellas an exclusive, royalty-bearing, sub-licensable, nontransferable license to certain patent rights to research, develop, manufacture, have manufactured, use, seek, and secure regulatory approval for, commercialize, offer for sale, sell, have sold and import, and otherwise exploit licensed products containing both a GSK-3 inhibitor and an HDAC inhibitor, or the Astellas licensed products, including our product candidate FX-322, outside of the United States. We and Astellas have agreed to jointly develop the Astellas licensed products, including carrying out joint studies. Each party has agreed to use commercially reasonable efforts to carry out development activities assigned to it under an agreed-upon development plan. Astellas has agreed to use commercially reasonable efforts to obtain regulatory approval for at least one Astellas licensed product in SNHL and in age-related hearing loss, in each case in one major Asian country and one major European country. We have agreed to use commercially reasonable efforts to obtain regulatory approval for at least one Astellas licensed product in the United States. Astellas has the sole right to commercialize the Astellas licensed products outside of the United States and we have the sole right to commercialize the Astellas licensed products in the United States. Astellas has agreed to use commercially reasonable efforts to commercialize Astellas licensed products in a major Asian country and a major European country following receipt of regulatory approval in such countries.

As a consideration for the licensed rights under the Astellas Agreement, Astellas paid us an upfront payment of $80.0 million in July 2019 and has agreed to pay potential development milestones up to $230.0 million. Specifically, we would receive development milestone payments of $65.0 million and $25.0 million upon the first dosing of a subject in Phase 2b clinical trial for SNHL in Europe and Asia, respectively and $100.0 million and $40.0 million upon the first dosing of a subject in a Phase 3 clinical for SNHL in Europe and Asia, respectively. If the Astellas Licensed Products are successfully commercialized, we would be eligible for up to $315.0 million in potential commercial milestone payments and tiered royalties at rates ranging from low to mid-teen percentages. The parties shall share equally, on a 50/50 basis, all out-of-pocket costs and joint study costs for all the joint activities conducted pursuant to the development plans or the joint manufacturing plan. Pursuant to our Exclusive Patent License Agreement, or the MIT License, with the Massachusetts Institute of Technology, or MIT, we are required to pay MIT a royalty on sublicense revenues. A royalty of $16.0 million

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related to the $80.0 million upfront payment received from Astellas was expensed in the quarter ended September 30, 2019 and paid in November 2019. The $80.0 million upfront payment received from Astellas in July 2019 was recorded as deferred revenue and recognized as revenue, using the input method, over the period from execution of the agreement through June 30, 2021, when the Phase 2a clinical trials were completed.

Massachusetts Institute of Technology

In December 2016, we entered into the MIT License, with MIT under which we received an exclusive, worldwide, royalty-bearing license to certain patent rights to develop, make, have made, use, sell, offer to sell, lease, and import products, or the MIT licensed products, and to develop and perform processes, or the MIT licensed processes, which incorporate the licensed technology for the treatment of disease, including but not limited to the prevention and remediation of hearing loss. We are required to use diligent efforts to develop and commercialize the MIT licensed products or processes, and to make such products or processes reasonably available to the public. We are also subject to certain development obligations with regards to a first MIT licensed product. We have satisfied certain obligations related to preclinical studies and the filing of an IND for a first MIT licensed product with our development activities related to FX-322. Our future development obligations are: (i) to commence a Phase III clinical trial for such product within five years of the IND filing for such product, (ii) to file a New Drug Application, or NDA, or equivalent with the FDA or comparable European regulatory agency for such product within nine years of the IND filing for such product, and (iii) to make a first commercial sale of such product within 11 years of the IND filing for such product. We also have certain development obligations with regards to a second MIT licensed product.

Upon entering into the MIT License, we paid a $50 thousand license fee payment and issued shares of our common stock equal to 5% of our then-outstanding capital stock to MIT. We are required to pay certain annual license maintenance fees ranging from $30 thousand to $0.1 million per year prior to first commercial sale of a MIT licensed product and an annual license maintenance fee of $0.2 million every year afterwards, which may be credited to running royalties during the same calendar year, if any. We are also required to make potential milestone payments in an aggregate amount of up to $2.9 million on each MIT licensed product or process. In addition, we agreed to pay a low single-digit royalty on the MIT licensed products and processes and a low-twenties royalty on sub-license revenues.

In March 2022, we entered into an amendment with MIT, removing a patent and certain patent applications from the MIT License Agreement which were unrelated to our hearing and MS programs and which we were not utilizing.

Massachusetts Eye and Ear (Formerly Massachusetts Eye and Ear Infirmary)

In February 2019, we entered into an Non-Exclusive Patent License Agreement, or the MEE License, with the Massachusetts Eye and Ear, or MEE, under which we received a non-exclusive, non-sub-licensable, worldwide, royalty-bearing license to certain patent rights to develop, make, have made, use, sell, offer to sell, lease, and import products, and to develop and perform processes that incorporate the licensed technology for the treatment or prevention of hearing loss, or the MEE licensed products. We are obligated to use diligent efforts to develop and commercialize the MEE licensed products. We met one of our milestone timeline obligations by dosing a first subject in a Phase II trial by December 31, 2020. We are still subject to a milestone timeline obligation to dose a first subject in a Phase III trial by December 31, 2024.

Upon entering into the MEE License, we made a $20 thousand license fee payment. We are obligated to pay certain annual license maintenance fees between $5 thousand and $7.5 thousand per each MEE patent family case number included in the licensed MEE patent rights prior to first commercial sale of an MEE licensed product. We are also obligated to pay a minimum annual royalty payment of $15 thousand per each MEE patent family case number included in the licensed MEE patent rights after first commercial sale of an MEE licensed product. We are also obligated to make milestone payments up to $350 thousand on each product or process that incorporates the licensed patent rights. In addition, we have agreed to pay a low single-digit royalty on products and processes that incorporate the licensed patent rights.

The Scripps Research Institute (California Institute for Biomedical Research)

In September 2018, we entered into a license agreement, or the CALIBR License, with the California Institute for Biomedical Research, or CALIBR, a division of Scripps, under which we received an exclusive, worldwide, royalty-bearing license to certain patent rights to make, have made, use, sell, offer to sell, and import products, or the CALIBR licensed products, which incorporate licensed technology for the treatment of MS. We have agreed to use commercially reasonable efforts to develop, manufacture, and sell at least one CALIBR licensed product. We are also subject to certain milestone timeline obligations, which may be extended in certain circumstances as described in the CALIBR License. In October 2021, we entered into an amendment with CALIBR which updated the milestone obligations to: (i) initiate a Phase II clinical trial

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(or equivalent) for a CALIBR licensed product by December 31, 2023 and (ii) initiate a Phase III clinical trial (or equivalent) for a CALIBR licensed product by December 31, 2025.

Upon entering into the CALIBR License, we made a $1.0 million license fee payment, and are required to make milestone payments in an aggregate amount of up to $26.0 million for each category of CALIBR licensed products. Category 1 is any CALIBR licensed products containing a compound that modulates any muscarinic receptor, and Category 2 is any CALIBR licensed products not included in Category 1 that could differentiate oligodendrocyte precursor cells from in vitro studies and/or are active in animal models relevant to MS. We are also required to pay a mid-single-digit royalty on CALIBR licensed products and a royalty on sub-license revenues ranging from a low-teen percentage to 50%.

The Scripps Research Institute

In September 2018, we entered into a Research Funding and Option Agreement, or the Scripps option agreement, with Scripps (CALIBR is a division of Scripps), under which we provided funding to Scripps to pursue certain MS research activities on selected targets. In the same agreement, we were granted an exclusive option to acquire an exclusive, sublicensable, worldwide license under certain intellectual property arising from the MS research activities on the selected targets. The Scripps option agreement, including the MS research activities and the exclusive option, terminated on December 31, 2021. The CALIBR License remains active.

Cambridge Enterprise Limited

In December 2019, we entered into an Exclusive Patent License Agreement, or the Cambridge License, with Cambridge, under which we received an exclusive, worldwide, royalty-bearing license to certain patent rights to make, have made, use, sell, offer to sell, and import products, or the Cambridge licensed products, which incorporate licensed technology for the treatment of demyelinating diseases. We also have the right to grant sublicenses under the Cambridge License. Cambridge reserves the right to use for itself (as well as the investors and the funder) and the right to grant nonexclusive licenses to other academic institutions for any academic publication, research and teaching and clinical patient care.

We have agreed to use diligent and good faith efforts to develop and commercially exploit at least one Cambridge licensed product. Upon entering into the Cambridge License, we made a $50 thousand license fee payment. We are obligated to pay an annual license fee of $50 thousand. We are also obligated to make milestone payments up to $10.5 million on each Cambridge licensed product. In addition, we have agreed to pay a low single-digit royalty on products that incorporate the licensed patent rights, subject to offset in certain circumstances.

The Cambridge License continues in effect on a country-by-country basis until the expiration or revocation, without right of further appeal, of all licensed issued patents and filed patent applications, unless terminated earlier. We have the right to terminate for any reason upon 90 days’ prior written notice. Each party has the right to terminate immediately if the other party ceases to carry on its business. Either party may also terminate the Cambridge License for material breach if such breach remains uncured for 30 days. Cambridge may also terminate the Cambridge License if we fail to diligently develop and commercially exploit at least one Cambridge licensed product or we or our affiliates or sub-licensees commence any action against Cambridge to declare or render any claim of the licensed patent rights invalid, unpatentable, unenforceable, or not infringed.

Components of our results of operations

Revenue

To date, we have not generated any revenue from product sales and do not expect to generate any revenue from product sales in the foreseeable future. In July 2019, we entered into the Astellas Agreement and received an upfront license fee payment of $80.0 million. In the year ended December 31, 2021, we recognized $14.1 million of the $80.0 million upfront fee as revenue. In the years ended December 31, 2020, we recognized $37.0 million of the $80.0 million upfront fee as revenue.

Research and development expenses

Research and development expenses consist primarily of costs incurred for our research activities. These research and development activities are largely focused on hearing restoration, specifically our lead product candidate FX-322 and new

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investigational therapeutic program FX-345, and MS, specifically early-stage research related to our novel target FREQ-162. These expenses include the following:

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salaries, benefits and other related costs, including stock-based compensation expense, for personnel engaged in research and development functions;

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expenses incurred under agreements with third parties, including contract research organizations, or CROs, and other third parties that conduct preclinical research and development activities and clinical trials on our behalf;

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costs to manufacture our clinical trial material for use in our preclinical studies and clinical trials;

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costs of outside consultants, including their fees and related travel expenses;

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costs of laboratory supplies and acquiring, developing and manufacturing preclinical study and clinical trial materials;

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option and license payments made to third parties, including MIT, Scripps, MEEI and Cambridge, for intellectual property used in research and development activities; and

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facility-related expenses, which include direct depreciation costs and expenses for rent and maintenance of facilities and other operating costs if specifically, identifiable to research activities.

We expense research and development costs as incurred.

We track external research and development costs, including the cost of services, outsourced research and development, clinical trials, contract manufacturing, laboratory equipment and maintenance, and certain other development costs, by product candidate when the costs are specifically identifiable to a product candidate. Internal and external costs associated with infrastructure resources, other research and development costs, facility-related costs, and depreciation and amortization that are not identifiable to a specific product candidate are included in the platform development, early-stage research, and unallocated expenses category.

We expect that our research and development expenses will continue to increase substantially for the foreseeable future as we conduct our Phase 2b trial of FX-322 (FX-322-208) and extension trials of FX-322-111 and FX-322-112, continue ongoing activities related to FX-345 and FREQ-162, initiate additional clinical trials, and continue to discover and develop additional product candidates. We have in the past and may in the future need to engage additional third parties and CROs earlier than we might normally do so in response to limitations on these CROs services as a result of the COVID-19 pandemic to advance these activities. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to increased scale, duration and the higher costs associated with later stage clinical trials.

We cannot determine with certainty the duration and costs of future clinical trials of FX-322 or any other product candidate we may develop or if, when, or to what extent we will generate revenue from the commercialization and sale of any product candidate for which we obtain marketing approval. The duration, costs, and timing of clinical trials and development of FX-322 and any other product candidate we may develop will depend on a variety of factors, including:

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the scope, rate of progress, expense and results of clinical trials of FX-322, as well as of any future clinical trials of other product candidates and other research and development activities that we may conduct;

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the actual probability of success for our product candidates, including their safety and efficacy, early clinical data, competition, manufacturing capability, and commercial viability;

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significant and changing government regulation and regulatory guidance;

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the timing and receipt of any marketing approvals;

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the progress of the development efforts of parties with whom we may enter into collaboration agreements;

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our ability to secure manufacturing supply through relationships with third parties;

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the commercialization of our product candidates, if and when approved;

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the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

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the impact of COVID-19 on our Phase 2b clinical trial of FX-322 (FX-322-208) and extension trials of FX-322-111 and FX-322-112.

A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate.

General and administrative expenses

General and administrative expenses consist primarily of salaries and other related costs, including stock-based compensation, for personnel in our executive, finance, business development, and administrative functions. General and administrative expenses also include legal fees relating to intellectual property and corporate matters; professional fees for accounting, auditing, tax and consulting services; insurance costs; travel expenses; and facility-related expenses, which include direct depreciation costs and expenses for rent and maintenance of facilities, and other operating costs that are not specifically attributable to research and development activities.

We expect that our general and administrative expenses will increase in the future as we increase our personnel headcount to support our business. In addition, we expect to continue to incur increased expenses associated with being a public company, including costs of accounting, audit, legal, regulatory, and tax-related services associated with maintaining compliance with the requirements of The Nasdaq Stock Market LLC and the SEC; director and officer insurance costs; and investor and public relations costs.

Interest income

Interest income consists of interest earned on cash equivalents and marketable securities.

Interest expense

Interest expense consists of interest paid on our term loan.

Realized (loss) gain on investments

Realized (loss) gain on investments represents the loss or gain realized on our marketable securities.

Foreign exchange gain (loss)

Foreign exchange gain (loss) represents the gain or loss recorded as a result of remeasuring the financial statements of our foreign subsidiaries.

Other expense, net

Other expense, net consists of amortization expense and accretion income on investments.

Income taxes

Since our inception in 2014, we have generated cumulative federal and state net operating loss and research and development credit carryforwards for which we have not recorded any net tax benefit due to uncertainty around utilizing these tax attributes within the respective carryforward periods.

As of December 31, 2021, we had federal net operating loss carryforwards of approximately $149.1 million and Massachusetts state operating loss carryforwards of approximately $83.5 million which may be available to offset future taxable income. The U.S. federal net operating loss carryforwards include $22.4 million available to reduce future taxable income through 2037 and approximately $126.7 million which do not expire and are available to reduce future taxable income indefinitely. The state net operating loss carryforwards are available to offset future taxable income through 2041. As of December 31, 2021, we also had federal and Massachusetts research and development tax credit carryforwards of $5.2 million and $2.1 million, respectively, which are available to offset federal and state tax liabilities through 2041 and 2036, respectively. Realization of future tax benefits is dependent on many factors, including our ability to generate taxable income within the net operating loss carryforward period. Net operating loss and tax credit carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50%, as provided under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, respectively, as well as similar state provisions. These ownership changes may limit the number of carryforwards that can be

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utilized annually to offset future taxable income. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50% over a three-year period. We have completed several financings and have conducted a study to assess whether a change of control has occurred or whether there have been multiple changes of control since inception and have determined that an ownership change did occur in March 2017. Accordingly, utilization of $12.4 million of the U.S. net operating loss carryforwards which were incurred prior to March 2017 (pre-ownership change) is limited under Section 382. After the Section 382 limitations, we may utilize approximately $10.8 million of our pre-ownership change net operating loss carryforwards based upon an annual usage of approximately $1.6 million for each of the next five years after the ownership change and approximately $0.2 million for each of the 15 years thereafter. The remaining pre-ownership change net operating losses of approximately $1.6 million were written off due to expiration under limitation. The limitation has been determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate. These carryforwards may be subject to further annual limitations under Section 382 in the event of future changes in ownership. Additionally, we have determined an ownership changed occurred in October of 2019 as a result of the IPO. Accordingly, utilization of approximately $46.1 million of the U.S. net operating loss carryforwards incurred prior to October 2019 is also limited under Section 382. We have determined we will be able to utilize the entire $46.1 million of our pre-ownership change net operating loss carryforwards based upon the limitations calculated from the October 2019 ownership change. These carryforwards may be subject to further annual limitations under Section 382 in the event of future changes in ownership.

Results of operations

Comparison of years ended December 31, 2021 and 2020

The following table summarizes our results of operations for the years ended December 31, 2021 and 2020:

Revenue

Revenue was $14.1 million for the year ended December 31, 2021 compared to $37.0 million for the year ended December 31, 2020. In July 2019, we entered into the Astellas Agreement and received an upfront license fee payment of $80.0 million. In accordance with ASC 606, we recognized the $80.0 million as revenue over the period that research and development services and the Phase 2a clinical study for FX-322 were provided using the input method. These research and development services concluded in June 2021.

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Research and development expenses

The $10.3 million of costs related to FX-322 incurred for the year ended December 31, 2021 consisted primarily of $8.4 million of clinical costs associated with ongoing trials, including FX-322-208 which is new in 2021, and $1.9 million of drug development and manufacturing costs. The $9.4 million of costs related to FX-322 incurred for the year ended December 31, 2020 consisted primarily of $6.7 million of clinical costs associated with the Phase 2a and other related clinical trials of FX-322 and $2.7 million related to drug development and manufacturing. The overall increase from the year ended December 31, 2020 is due primarily to the clinical trial activity in the year ended December 31, 2021.

The $5.5 million of costs related to FX-345 incurred for the year ended December 31, 2021 consisted of drug development and manufacturing costs, including $3.1 million related to preclinical safety. The $1.9 million of costs related to FX-345 for the year ended December 31, 2020 consisted primarily of $1.5 million of in vitro and in vivo testing. The overall increase from the year ended December 31, 2020 is due primarily to our efforts to advance our new SNHL investigational therapeutic program, FX-345.

The $6.6 million of costs related to MS incurred for the year ended December 31, 2021 consisted of drug development and manufacturing, including $3.0 million in preclinical safety, $1.6 million in outsourced chemistry, and $0.9 million in in vitro and in vivo testing. Similarly, the $4.5 million of costs related to MS incurred for the year ended December 31, 2020 consisted of drug development and manufacturing, including $1.2 million in both preclinical safety and in vitro and in vivo testing. The overall increase from the year ended December 31, 2020 is due primarily to our focus on the advancement of our novel target, FREQ-162.

The $38.5 million of platform development, early-stage research and unallocated expenses incurred for the year ended December 31, 2021 consisted primarily of $25.6 million of employee-related costs, including $9.6 million of stock-based compensation expense, $6.9 million in facility-related costs, and $2.3 million of outsourced research and development expense. This increase of $15.0 million from the year ended December 31, 2020 is primarily attributable to an increase of $8.4 million in employee-related expenses associated with increased headcount to support pre-clinical and clinical development across hearing and MS programs, a $4.3 million increase in rent, including utilities and maintenance, or CAM, charges related to our new office space, and a $0.8 million increase in depreciation related to equipment purchases for our new office space.

General and administrative expenses

The $37.2 million of general and administrative expenses for the year ended December 31, 2021 consisted primarily of $21.1 million of employee-related costs, including $12.1 million in stock-based compensation expense, $7.6 million of professional services expense, $1.7 million in rent, including utilities and CAM charges, and $1.2 million in depreciation expense. General and administrative expenses increased $10.1 million from December 31, 2020 due to an increase of $8.2 million in employee-related costs as we increase our general and administrative headcount to manage our growth and the impact of being a public company, and increases of $1.0 million and $0.8 million in rent, including utilities and CAM charges, and depreciation expense, respectively.

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Interest income

Interest income was $0.4 million for the year ended December 31, 2021 compared to $1.0 million for the year ended December 31, 2020, due to changes in interest rates from the previous year.

Interest expense

Interest expense was $0.8 million for the year ended December 31, 2021. There was no interest expense for the year ended December 31, 2020. This increase is due to interest expense on our term loan which commenced in December 2020.

Realized (loss) gain on investments

Realized loss on investments was $23 thousand for the year ended December 31, 2021 compared to a gain of $84 thousand for the year ended December 31, 2020 due to changes in the composition of investments year over year.

Foreign exchange gain (loss)

Foreign exchange gain was $16 thousand for the year ended December 31, 2021 compared to a loss of $4 thousand for the year ended December 31, 2020. The increase of $20 thousand was due to differences in foreign exchange remeasurement of the financial statements of our foreign subsidiaries.

Other expense, net

Other expense, net was $0.3 million for the year ended December 31, 2021. This expense represents amortization expense on investments, partially offset by accretion income on investments. There was no comparable expense for the year ended December 31, 2020.

Income taxes

Income tax expense, which represents taxes on interest income earned by our subsidiary, Frequency Therapeutics Securities Corporation, a Massachusetts Securities Corporation, was $15 thousand for the year ended December 31, 2021.

Liquidity and capital resources

Since our inception, we have incurred significant operating losses. We expect to continue to incur significant expenses and operating losses for the foreseeable future as we advance the preclinical and clinical development of our product candidates. We expect that our research and development and general and administrative costs will continue to increase, in connection with conducting preclinical studies and clinical trials for our product candidates, contracting with contract manufacturing organizations, or CMOs, to support preclinical studies and clinical trials, expanding our intellectual property portfolio, and providing general and administrative support for our operations particularly as we continue to operate as a public company. As a result, we will need additional capital to fund our operations, which we may obtain from additional equity or debt financings, collaborations, licensing arrangements or other sources.

We do not currently have any approved products and have never generated any revenue from product sales. We have financed our operations primarily through proceeds from private and public securities financings, the upfront payment under the Astellas Agreement, and our term loan. To date, we have raised approximately $378.2 million, including from grants and option exercises. Our cash, cash equivalents and marketable securities totaled $142.4 million as of December 31, 2021. As of December 31, 2021, we had $0.8 million of current debt and $14.2 million of non-current debt related to the Term Loan.

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In December 2020, we entered into a Loan and Security Agreement with a commercial bank for a Term Loan with a principal balance of $15 million. We will make monthly interest only payments through November 30, 2022. The principal balance and interest will be repaid in equal monthly installments after the interest only period and continue through May 1, 2024. Advances under the Loan Agreement will bear an interest rate equal to the greater of either (i) 1.50% plus the Prime Rate (as reported in The Wall Street Journal, subject to an interest rate floor of zero) or (ii) 4.75%.

In December 2021, we entered into an Equity Distribution Agreement with Oppenheimer & Co. Inc., or Oppenheimer, to sell shares of our common stock, having aggregate gross sales proceeds of up to $125.0 million, from time to time, through an “at the market” equity offering program under which Oppenheimer acts as sales agent, or the ATM program. As of December 31, 2021, we have not sold any shares of common stock under the ATM program.

Cash flows

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

Cash flows for the year ended December 31, 2021

Operating activities

Net cash used in operating activities for the year ended December 31, 2021 was $76.1 million, consisting of a net loss of $84.7 million as we incurred expenses associated with our FX-322 program, platform development and early-stage research, and general and administrative expenses. In addition, we had non-cash charges of $26.0 million for depreciation, stock-based compensation expense, non-cash lease expense, non-cash interest expense and loss on disposal of assets. Net cash used in operating activities was also impacted by a net $17.3 million decrease in operating assets and liabilities, including a decrease of $14.1 million in deferred revenues from the upfront payment under the Astellas Agreement, a $2.3 million decrease in accounts payable, a decrease in accrued expenses of $0.8 million, and a $0.2 million increase in prepaid expenses and other assets.

Investing activities

Net cash used in investing activities for the year ended December 31, 2021 was $66.1 million, which was attributable to $92.4 million of purchases of marketable securities and $2.9 million of purchases of property and equipment, partially offset by $29.2 million in redemptions of marketable securities.

Financing activities

Net cash provided by financing activities for the year ended December 31, 2021 was $1.4 million, primarily attributable to $1.3 million in proceeds from the exercise of stock options and $60 thousand in proceeds from the Employee Stock Purchase Plan.

Cash flows for the year ended December 31, 2020

Operating activities

Net cash used in operating activities for the year ended December 31, 2020 was $45.2 million, consisting of a net loss of $26.5 million as we incurred expenses associated with our FX-322 program, platform development and early-stage research, and general and administrative expenses. In addition, we had non-cash charges of $11.6 million for depreciation, stock-based compensation expense, and non-cash lease expense. Net cash used in operating activities was also impacted by a net $30.2 million decrease in operating assets and liabilities, including a decrease of $37.0 million in deferred revenues from the upfront payment under the Astellas Agreement, and increases in accounts payable, accrued expenses and prepaid expense and other current assets of $4.3 million, $3.1 million, and $0.6 million, respectively.

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Investing activities

Net cash provided by investing activities for the year ended December 31, 2020 was $10.4 million, which was attributable to $43.4 million of redemptions of available for sale securities, partially offset by $26.3 million of available for sale securities and $6.7 million of purchases of property and equipment, $2.6 million of which is related to the buildout of our new Lexington office.

Financing activities

Net cash provided by financing activities for the year ended December 31, 2020 was $56.7 million, primarily attributable to $40.1 million in net proceeds from the July 2020 Private Placement, $15.0 million in proceeds from the Term Loan, and $1.5 million in proceeds from the exercise of stock options.

Funding requirements

Our operating expenses increased substantially in the years ended December 31, 2021 and 2020 and are expected to increase substantially in the future in connection with our ongoing activities, particularly as we advance FX-322 through clinical trials and as we research and develop additional product candidates, including FX-345 and FREQ-162, conduct preclinical activities, studies for INDs, and initiation of human clinical trials. In addition, we expect to incur additional general and administrative costs to build the infrastructure necessary to manage the growth of our research and development efforts and requirements of operating as a public company.

Specifically, our costs and expenses will increase as we:

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advance the clinical development of FX-322;

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pursue the preclinical and clinical development of other product candidates using our PCA platform, including FX-345 and FREQ-162;

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in-license or acquire the rights to other products, product candidates or technologies;

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maintain, expand, and protect our intellectual property portfolio;

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hire additional personnel in research, manufacturing, and regulatory and clinical development, as well as management personnel; and

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expand our operational, financial, investor relations, and management systems and increase personnel, including personnel to support our operations as a public company.

We believe that our existing cash, cash equivalents, and marketable securities, will enable us to fund our operating expenses and capital expenditure requirements through the end of 2023. We have based this estimate on assumptions that may prove to be incorrect, and we could utilize our available capital resources sooner than we expect.

Because of the numerous risks and uncertainties associated with the research, development, and commercialization of therapeutics, it is difficult to estimate with certainty the amount of our working capital requirements. Our future funding requirements will depend on many factors, including:

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the progress, costs, and results of our clinical development and clinical trials for FX-322;

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the progress, costs, and results of our additional research and preclinical development programs, including FX-345 and FREQ-162;

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the outcome, timing and cost of meeting regulatory requirements established by the FDA and comparable foreign regulatory authorities, if applicable, for our product candidates;

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business and operations interruptions resulting from the COVID-19 global pandemic;

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the costs and timing of internal process development, manufacturing activities, and clinical trial management associated with FX-322 and other product candidates, including FX-345 and FREQ-162, we advance through preclinical and clinical development;

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our ability to establish and maintain strategic collaborations, licensing or other agreements and the financial terms of such agreements;

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•
the scope, progress, results, and costs of any product candidates that we may derive from our PCA platform or any other product candidates we may develop alone or with collaborators;

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the extent to which we in-license or acquire rights to other products, product candidates, or technologies;

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additions or departures of key scientific or management personnel;

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the costs and timing of preparing, filing, and prosecuting patent applications, maintaining and protecting our intellectual property rights, and defending against any intellectual property-related claims; and

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the costs and timing of future commercialization activities, including product manufacturing, marketing, sales, and distribution for any product candidates for which we or our collaborators obtain marketing approval.

Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our cash needs through a combination of public or private equity or debt financings and other sources, which may include current and new collaborations with third parties. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through other sources, such as collaboration agreements, strategic alliances, licensing arrangements or marketing and distribution arrangements, we may have to relinquish valuable rights to our technologies, future revenue streams, product development, and 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 when needed, we may be required to delay, limit, reduce, or terminate our product development or future commercialization efforts or grant rights to develop and market products or product candidates that we would otherwise prefer to develop and market ourselves.

Contractual obligations and commitments

The following is a summary of our contractual obligations and commitments as of December 31, 2021:

(1)
Represents future minimum lease payments under our operating leases for office and laboratory space at our Lexington, Massachusetts and Farmington, Connecticut facilities (see Note 14 of notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information on these lease agreements).

We have not included future milestone payments under our collaboration and license agreements in the table above since the payment obligations under these agreements are contingent upon future events, such as the achievement of specified product development milestones or generating product sales, and we are unable to estimate the timing or likelihood of achieving these milestones or generating future product sales. We are also required to spend certain minimum amounts on research and development of licensed products or processes under the MIT License, which are not included in the table above. See “—License and collaboration agreements” for more information regarding our payment obligations under these agreements.

We also enter into contracts in the normal course of business with CROs, CMOs, universities, and other third parties for preclinical research studies, clinical trials and testing and manufacturing services. These contracts generally do not contain minimum purchase commitments and are cancelable by us upon prior written notice although, purchase orders for clinical materials are generally non-cancelable. Payments due upon cancellation consist only of payments for services provided or expenses incurred, including noncancelable obligations of our service providers, up to the date of cancellation or upon completion of a manufacturing run. These payments are not included in the table above as the amount and timing of such payments are not known or are not material.

Critical accounting policies and use of estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our consolidated financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue, costs and expenses, and the

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disclosure of contingent assets and liabilities in our consolidated financial statements. We base our estimates on historical experience, known trends and events, and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are described in more detail in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements.

Revenue recognition

We account for contracts with customers in accordance with Accounting Standards Codification (“ASC”), Topic 606, Revenue from Contracts with Customers (“ASC 606”), including all amendments thereto. This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as collaborative arrangements and leases. Our disclosure in the accompanying consolidated financial statements reflects the Company’s accounting policies in compliance with this standard.

Under ASC 606, an entity recognizes revenue when or as its customer obtains control of promised goods or services, in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. To recognize revenue for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price, including variable consideration, if any; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies its performance obligations. We only apply the five-step model to contracts when it is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services it transfers to the customer. Once a contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and identifies as a performance obligation each promise to transfer to the customer either (a) a good or service (or bundle of goods and services) that is distinct, or (b) a series of distinct goods and services that are substantially the same and have been the same pattern of transfer to the customer.

We assess whether each promised good or service is distinct for the purpose of identifying the performance obligations in the contract. This assessment involves subjective determinations and requires management to make judgments about the individual promised goods or services and whether such are separable from the other aspects of the contractual relationship. Promised goods and services are considered distinct provided that: (i) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct) and (ii) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract). In assessing whether a promised good or service is distinct, we consider factors such as the research, manufacturing and commercialization capabilities of the collaboration partner (the “customer” in this type of arrangement) and the availability of the associated expertise in the general marketplace. We also consider the intended benefit of the contract in assessing whether a promised good or service is separately identifiable from other promises in the contract. If a promised good or service is not distinct, an entity is required to combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. For each arrangement that results in revenues, we identify all performance obligations, which may include, for example, a license to IP and know-how, research and development activities, and/or manufacturing services.

In addition to any upfront payment, if the consideration promised in a contract includes a variable amount, we estimate the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. We determine the amount of variable consideration by using the expected value method or the most likely amount method. We include the estimated variable consideration in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. At the end of each subsequent reporting period, we re-evaluate the estimated variable consideration included in the transaction price and any related constraint, and if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis in the period of adjustment.

If an arrangement includes development and regulatory milestone payments, we evaluate whether the milestones are considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method. There is considerable judgment involved in determining whether it is probable that a significant revenue reversal would not occur. If it is probable that a significant revenue reversal will not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our control or of the licensee such as regulatory

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approvals, are generally not considered probable of being achieved until those approvals are received. At the end of each subsequent reporting period, we re-evaluate the probability of achievement of all milestones subject to constraint and, if necessary, adjusts its estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect revenues and earnings in the period of adjustment.

For contracts that include sales-based royalties (including milestone payments based on the level of sales) promised in the exchange for licenses of intellectual property, and the license is deemed to be the predominant item to which the royalties relate, we recognize royalty revenue and sales-based milestone payments at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied. In determining the transaction price, we adjust the promised amount of consideration for the effects of the time value of money if the timing of payments provides the Company or the Company’s customer with a significant benefit of financing the transfer of goods and services. We do not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between payment by the licensees and the transfer of the promised goods or services to the licensees will be one year or less. We assess each of its revenue generating arrangements in order to determine whether a significant financing component exists. We recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) each performance obligation is satisfied, either at a point in time or over time. For performance obligations satisfied over time, we measure progress toward completion of its performance obligations using an input method based on our efforts and inputs to satisfy its performance obligations relative to total expected inputs to the satisfaction of that performance obligation.

Amounts received from a customer prior to revenue recognition are recorded as deferred revenue. Amounts received from a customer that are expected to be recognized as revenue within the 12 months following the balance sheet date are classified as a current liability in the consolidated balance sheets.

Our only revenue recognized since inception is related to the Astellas Agreement. At commencement of the Astellas Agreement, we estimated the performance obligation, the completion of the Phase 2a clinical trial of (FX-322-202), would be satisfied by June 30, 2021. As such, we recognized revenue over time as we satisfied this performance obligation.

Accrued research and development expenses

As part of the process of preparing our consolidated 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 personnel to identify services that have been performed on our behalf, and estimating the level of service performed and the associated costs incurred for the services when we have not yet been invoiced or otherwise notified of the actual costs. Most 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 our consolidated financial statements based on facts and circumstances known to us at that time. Examples of estimated accrued research and development expenses include fees paid to the following:

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CROs and other third parties in connection with performing research and development activities and conducting preclinical studies and clinical trials on our behalf;

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Vendors in connection with preclinical development activities; and

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CMOs and other vendors in connection with product manufacturing and development and distribution of preclinical supplies.

We base our expenses related to preclinical studies on our estimates of the services received and efforts expended pursuant to quotes and contracts with CROs that conduct and manage preclinical studies and clinical trials and CMOs that manufacture product for our research and development activities 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 fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual or amount of prepaid expense 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 cause us to report amounts that are too high or too low in any particular period. To date, we have not made any material adjustments to our prior estimates of accrued research and development expenses.

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Leases

The Company elected to early adopt ASC 842, Leases, as of January 1, 2020 and elected the transition method under ASU 2016-02 whereby the Company records a right-to-use asset and a lease liability on the consolidated balance sheet for all leases with terms longer than 12 months. The Company also elected to apply the package of practical expedients intended to ease transition. Accordingly, the Company has only applied ASC 842 to leases existing at January 1, 2020. The Company determines if an arrangement is, or contains, a lease at inception. Operating leases are included in operating lease right-of-issue (“ROU”) assets, other current liabilities, and operating lease liabilities on the consolidated balance sheets.

ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments to be made over the lease term. The ROU asset also includes any lease payments made at or before the lease commencement date and excludes lease incentives received. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. The lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Operating lease expense is recognized on a straight-line basis over the lease term. The Company has elected to not apply the recognition requirements of ASC 842 for short-term leases, which is defined as a lease that, at the lease commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the Company is reasonably certain to exercise.

For real estate lease agreements entered into or modified after the adoption of ASC 842 that include lease and non-lease components, the Company has elected to account for the lease and non-lease components, such as common area maintenance charges, as a single lease component.

Since the adoption of ASC 842 in 2020, we have entered into one new lease resulting in right of use assets and lease liabilities balances of $31.4 million and $30.6 million, respectively, at December 31, 2021.

Stock-based compensation

We measure stock options and other stock-based awards granted to our employees, directors, consultants, advisors based on the fair value on the date of the grant, awards, net of actual forfeitures, over the requisite service period, which is generally the vesting period of the respective award. For stock-based awards granted to non-employees, compensation expense is recognized over the period during which services are rendered by such non-employees until completed.

We estimate the fair value of each stock option grant on the date of grant using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our stock options, the risk-free interest rate for a period that approximates the expected term of our stock options, and our expected dividend yield.

Recent accounting pronouncements

A description of recent accounting pronouncements that may potentially impact our financial position, results of operations, or cash flows is disclosed below:

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The FASB has subsequently issued amendments to ASU 2016-13, which have the same effective date and transition date. These standards require that credit losses be reported using an expected losses model rather than the incurred losses model that was previously used, and establishes additional disclosures related to credit risks. For available-for-sale debt securities with unrealized losses, this standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. These standards limit the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and requires the reversal of previously recognized credit losses if fair value increases. This standard will become effective for the Company on January 1, 2023. The Company is still evaluating the impact of this standard on its consolidated financial statements.

There are no other recent accounting pronouncements that we believe will have a material impact on our consolidated financial statements.

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