ARS Pharmaceuticals, Inc. (SPRY) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis together with our financial statements and related notes included in “Item 8. Financial Statements and Supplementary Data” in this Annual Report. The following discussion contains forward-looking statements that involve risks and uncertainties. For a complete discussion of forward-looking statements, see the section above entitled “Forward Looking Statements.” Our actual results could differ materially from those expressed or implied in any forward-looking statements as a result of various factors, including those set forth under the caption “Item 1A. Risk Factors.”

Overview

We are a biopharmaceutical company focused on the development of our novel, potentially first-in-class product candidate, neffy (previously referred to as ARS-1) for the emergency treatment of Type I allergic reactions, including anaphylaxis. neffy is a proprietary composition of epinephrine with an innovative absorption enhancer called Intravail®, which allows neffy to provide intranasal delivery of epinephrine.

We believe neffy’s “no needle, no injection” approach will address a significant unmet need in the use of epinephrine, which is currently approved only in injectable formulations for the emergency treatment of Type I allergic reactions. There are approximately 25 to 40 million people in the United States who experience Type I allergic reactions. Of this group, approximately 16 million people have been diagnosed and experienced severe Type I allergic reactions that may lead to anaphylaxis, but only 3.3 million currently have an active epinephrine autoinjector prescription, and of those, only half consistently carry their prescribed autoinjector with them due to the many drawbacks of these devices. In aggregate, we estimate that 90% of patients prescribed an epinephrine device are not achieving an optimal treatment outcome today. These drawbacks include the use of needles in the devices, which can result in patient and caregiver injury as well as hesitation and delays in administration due principally to apprehension and pain of needles, allowing the allergic reaction to progress in severity leading to symptoms that seriously impact patient quality of life, to potential need for emergency services and/or hospitalizations, and to life-threatening symptoms or events. Intra-muscular injections also are subject to dosing errors and risk of accidental blood vessel injections, which can cause a significant spike in the intravascular delivery of epinephrine potentially leading to serious cardiovascular complications or events. We believe neffy’s “no needle, no injection” delivery that eliminates apprehension, pain and safety concerns, small size allowing for ease of portability, ease of use, and high reliability provide it with a user-friendly profile that will increase prescriptions for epinephrine and make it more likely for patients and caregivers to administer epinephrine sooner, achieve more rapid symptom relief and prevent the allergic reaction from progressing to a level of severity that could lead to hospitalization or even death.

Data from our studies of neffy demonstrated nasally delivered epinephrine reached blood levels comparable to those of already approved epinephrine injectable products. Our NDA was accepted for review by FDA in the fourth quarter of 2022 with an anticipated mid-2023 PDUFA target action date and if our NDA is approved, we believe neffy will be the first “no needle, no injection” marketed epinephrine product for the emergency treatment of Type I allergic reactions. However, the timing for regulatory approvals is outside our control, may be delayed and is uncertain.

Since our inception in 2015 as ARS Pharmaceuticals, Inc., we have devoted substantially all of our efforts and financial resources to organizing and staffing our company, business planning, raising capital, performing research and development activities, and providing general and administrative support for these operations. We do not have any products approved for sale and have not generated any product sales. We have funded our operations primarily with proceeds from the Merger, private placement of convertible preferred stock, licensing, supply and distribution arrangements with our commercialization partners, and bank debt. From inception to December 31, 2022, we have raised $262.3 million in cash, cash equivalents and short-term investments, net of transaction costs, from the Merger, net proceeds of $76.3 million from the issuance of convertible preferred and common stock, $27.8 million from our collaboration, licensing, supply and distribution arrangements, and $10.0 million from bank debt. As of December 31, 2022, we had cash, cash equivalents, and short-term investments of $274.4 million.

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We have incurred net losses from operations since our inception. Our net loss was $34.7 million for the year ended December 31, 2022 and as of December 31, 2022 we had an accumulated deficit of $76.9 million. Our net losses may fluctuate significantly from quarter-to-quarter and year-to-year, depending on the timing of our clinical trials, our expenditures on other development activities, the cost for regulatory filings, expenses for pre-commercial activities to establish sales, marketing and distribution capabilities for our product candidates, and our ability to earn potential regulatory and commercial milestones under our collaboration arrangements. We expect our expenses and operating losses will increase substantially as our product candidate, neffy potentially is approved by the FDA and we commence commercialization efforts, any future product candidates advance through clinical trials, we expand our clinical, regulatory, quality, manufacturing and pre-commercial sales and marketing capabilities, and incur additional costs to operate as a public company following the completion of the Merger. If we obtain marketing approval for any of our product candidates, we will incur significant commercialization expenses for marketing, sales, manufacturing and distribution activities, and added expenditures to expand our operational, financial and management systems and increase personnel to support these operations.

We do not expect to generate any revenues from product sales unless and until we successfully obtain regulatory approval for one or more product candidates, if ever. Until such time, if ever, as we can generate substantial product revenue, we may finance our operations through our existing cash, cash equivalents, short-term investments, equity offerings, debt financings and other capital sources which may include collaborations, strategic alliances, marketing, distribution or licensing arrangements or other arrangements with third parties. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. In addition, any future debt agreements may limit our ability to enter into certain debt financings without the consent of the lenders thereunder. Our failure to raise capital or enter into such other arrangements when needed would have a negative impact on our financial condition and may require us to delay, reduce or terminate our research and development programs or other operations, or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

We do not own or operate manufacturing facilities. We currently rely on third-party manufacturers and suppliers for neffy, and we expect to continue to do so to meet our nonclinical, clinical and any commercial activities. Our third-party manufacturers are required to manufacture our product candidates under cGMP requirements and other applicable laws and regulations.

Merger

On November 8, 2022 (the “Closing Date”), privately-held ARS Pharmaceuticals, Inc. (“ARS Pharma ) merged with Silverback Therapeutics, Inc., a Delaware corporation (“Silverback”), a publicly traded company. In accordance with the terms of the agreement and plan of merger and reorganization, dated July 21, 2022, as amended on August 11, 2022 and October 25, 2022 (the “Merger Agreement”), Sabre Merger Sub, Inc. (“Merger Sub”), a wholly-owned subsidiary of Silverback, merged into ARS Pharma, with ARS Pharma surviving as Silverback’s wholly-owned subsidiary. At the completion of the Merger, the prior ARS Pharma equityholders owned 62% and the prior Silverback equityholders owned 38% of the combined company, in each case on a fully diluted basis using the treasury stock method and excluding out-of-money options of Silverback. Upon completion of the Merger, Silverback changed its name to ARS Pharmaceuticals, Inc. As, among other facts, the stockholders of ARS Pharma owned a majority of the combined company, the Merger was treated for accounting purposes as if ARS Pharma had acquired Silverback. As a result of the Merger being accounted for as if ARS Pharma had acquired Silverback, the financial statements of ARS Pharma are presented as the historical financial statements of the combined company for all periods presented.

At the effective time of the Merger (the “Effective Time”), each share of ARS Pharma common stock outstanding immediately prior to the Effective Time, after giving effect to the automatic conversion of all shares of preferred stock of ARS Pharma into shares of ARS Pharma common stock immediately prior to the Effective Time (the “Preferred Stock Conversion”), (excluding shares held as treasury stock by ARS Pharma or held or owned by Silverback, Merger Sub or any subsidiary of Silverback or ARS Pharma and dissenting shares) were automatically converted into the right to receive shares of Silverback common stock equal to the exchange ratio of 1.1819. Outstanding and unexercised options and warrants to purchase shares of ARS Pharma common stock were converted into options and warrants to purchase shares of Silverback common stock.

Recent Events

In September 2020, we entered into a license and supply agreement (the “Recordati License and Supply Agreement”) with Recordati Ireland, Ltd (“Recordati”). Pursuant to the Recordati License and Supply Agreement, we granted Recordati an exclusive, royalty-bearing, sublicensable license under our patents relating to neffy to (i) perform Recordati’s development activities on the epinephrine compositions (“Recordati Licensed Compositions”) and related products (“Recordati Licensed Products”) for commercialization in the EU, United Kingdom, and certain countries in the Middle East, Africa and Eurasia (the “Recordati Territory”), (ii) manufacture (or have manufactured) the Recordati Licensed Products for commercialization in the Recordati Territory, (iii) file and hold regulatory approvals for the Licensed Products in the Recordati Territory, and (iv) commercialize the Recordati Licensed Products in the Recordati Territory (collectively, the “Recordati Rights”).

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On February 22, 2023, we entered into the Termination Agreement with Recordati, pursuant to which, among other things, we and Recordati agreed to terminate the Recordati License and Supply Agreement. Pursuant to the Termination Agreement, we will reacquire all of the Recordati Rights and have agreed to pay Recordati a one-time upfront payment of €3.0 million and additional payments upon achievement of certain milestones including: (i) an EMA regulatory milestone payment of €2.0 million, (ii) a milestone payment of €5.0 million upon first commercial sale of a Recordati Licensed Product in the Recordati Territory, and (iii) milestone payments of up to €5.0 million in the aggregate from sales of Recordati Licensed Product(s) in the Recordati Territory.

Financial Overview

Revenues

To date, we have not generated any revenues from the commercial sale of any products, and we may not generate revenues from the commercial sale of any products. We have signed collaboration and license agreements including supply and distribution for neffy with Alfresa Pharma in Japan and Pediatrix in China. The terms of these agreements may include payment to us of one or more of the following: non-refundable, up-front license fees; clinical, regulatory, and/or commercial milestone payments; clinical development fees; and royalties or a transfer price on net sales of licensed products if neffy receives marketing approval in these regions. In addition, we previously entered into the Recordati License and Supply Agreement, which was terminated in February 2023. We expect revenues to fluctuate in future periods based on our ability to meet various regulatory milestones, and contingent on successfully obtaining regulatory approval for neffy in the US and the licensed regions, US product sales, commercial milestones, royalties or transfer price earned from our partner’s net sales and the supply of commercial product as set forth in the agreements described earlier.

Research and Development Expenses

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

Research and development expenses include:

Our external research and development expenses for our clinical stage product candidate consists primarily of fees, materials and other costs paid to CROs, CMOs, consultant and contractors. Our clinical trials and manufacturing costs for the periods presented below reflect an allocation of expenses associated with personnel costs, equity-based compensation expense, and indirect costs incurred in support of overall research and development, such as facilities-related costs.

We expect that our research and development expenses will likely decrease in 2023 based on our planned clinical development and manufacturing activities, as we plan to transition to commercialization efforts for the potential launch of our first product that year. However, the timing for regulatory approvals is outside our control, may be delayed and is uncertain. We cannot determine with certainty the timing of initiation, the duration or the completion costs of current or future clinical trials and the manufacturing costs of our product candidates due to the inherently unpredictable nature of clinical development and manufacturing activities. Clinical development and manufacturing timelines, the probability of success and development costs can differ materially from expectations. We anticipate that we will make determinations as to which product candidates to pursue and how much funding to direct to each product candidate on an ongoing basis in response to the results of ongoing and future clinical trials, regulatory developments and our ongoing assessments as to each product candidate’s commercial potential. In addition, we cannot forecast to what degree our licensing, supply and distribution arrangements would affect our development plans and capital requirements.

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The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors that include:

A change in the outcome of any of these variables with respect to the development of any of our product candidates could significantly change the costs and timing associated with the development of that product candidate. The process of conducting the necessary clinical research and manufacturing to obtain regulatory approval is costly and time-consuming. The actual probability of success for our product candidates or any future candidates may be affected by a variety of factors. We may never succeed in achieving regulatory approval for our product candidates or any future candidates. Further, a number of factors, including those outside of our control, could adversely impact the timing and duration of our product candidates’ or any future candidates’ development, which could increase our research and development expenses.

General and Administrative

General and administrative expenses consist primarily of salaries, benefits, equity-based compensation for personnel in executive, finance, business development, sales and marketing and other corporate administrative functions. General and administrative expenses also include legal fees incurred relating to corporate and patent matters, professional fees incurred for accounting, auditing, tax and administrative consulting services, facility costs, market research costs, and insurance costs.

We anticipate our general and administrative expenses will increase substantially in 2023 as we add sales and marketing personnel, infrastructure and programs to support pre-commercial activities, and if our product candidates receive marketing approval, commercialization activities. We also anticipate increased general and administrative personnel to support our operations, and higher patent and facility related costs. We also expect to incur added audit, legal, regulatory and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, director and officer insurance premiums, board of director fees, and investor relations costs associated with operating as a public company following the Merger.

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Total Other Income (Expense)

Total other income (expense) consists primarily of interest expense from bank debt, interest income from our cash, cash equivalents, and investments, and changes in the fair value of our warrant liability prior to the Merger. As a result of the Merger, the warrant liability was reclassified to equity and fair value adjustments are no longer required.

Results of Operations

Comparison of the Years Ended December 31, 2022 and 2021:

The following table summarizes our results of operations for the years ended December 31, 2022 and 2021 (in thousands, except percentages):

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(1) Includes stock-based compensation expense as follows (in thousands):

Revenues. Revenue under collaboration agreements was $1.3 million and $5.5 million for the years ended December 31, 2022 and 2021, respectively. The revenues for the years ended December 31, 2022 and 2021 include the recognition of revenue for the portion of upfront and clinical and regulatory milestone payments under our collaborations with Alfresa and Recordati that have been allocated to research and development services provided for during the years. Revenue under these collaboration agreements decreased $1.2 million from 2021 to 2022. The remaining decrease from 2021 to 2022 is due to the recognition of an upfront payment of $3.0 million under our collaboration and distribution agreement with Pediatrix signed in March 2021 relating to the issuance and delivery of a technology license, with no comparable activity in 2022. We expect revenues to fluctuate in future periods based on our ability to meet various regulatory milestones, and contingent on successfully obtaining regulatory approval for neffy in the licensed regions, commercial milestones, royalties or transfer price earned from our partner’s net sales and the supply of commercial product as set forth in these agreements.

Research and Development Expenses. Research and development expenses were $18.4 million and $20.3 million for the years ended December 31, 2022 and 2021, respectively. The decrease of $1.9 million was primarily due to a $3.1 million decrease in clinical trial costs associated with neffy and a $1.9 million decrease in stock-based compensation. These aggregated decreases were partially offset by $1.1 million in in-process research and development acquired in the Merger, a $1.0 million increase in license fees for the milestone payment to Aegis upon the FDA’s acceptance of our US NDA filing, and a $0.9 million increase in regulatory consulting costs.

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General and Administrative Expenses. General and administrative expenses were $18.5 million and $4.7 million for the years ended December 31, 2022 and 2021, respectively. The increase of $13.8 million was primarily due to a $4.9 million increase in stock-based compensation of which $3.0 million was for the replacement of stock awards held by Silverback employees and directors in connection with the Merger and $1.3 million for the vesting of previously issued performance-based options, a $3.6 million increase in outside services associated with marketing and consulting, a $2.3 million increase in legal fees, a $2.2 million increase in payroll and related expenses, and a $0.6 million increase in insurance costs.

Total Other Income (Expense). Total other income was $0.8 million for the year ended December 31, 2022 and total other expense was $0.8 million for the year ended December 31, 2021. The difference of $1.6 million was primarily due to a $1.8 million increase in interest income from our cash, cash equivalents, and investments partially offset by a $0.1 million loss due to the change in fair value of the preferred stock warrant liability.

Liquidity and Capital Resources

Sources of Liquidity and Capital

Since our inception, we have not generated any revenue from any product sale and have incurred significant operating losses and negative cash flows from our operations. We have not yet commercialized any of our product candidates and we do not expect to generate revenue from sales of any product candidates until the second half of 2023 or after, if at all. We have funded our operations to date primarily with proceeds from the Merger, the sale of preferred and common stock, revenue earned under collaboration, licensing, supply and distribution agreements and bank debt. From inception to December 31, 2022, we have raised $262.3 million in cash, cash equivalents and short-term investments, net of transaction costs, from the Merger, net proceeds of $76.3 million from the issuance of convertible preferred and common stock, $27.8 million from our collaboration, licensing, supply and distribution arrangements, and $10.0 million from bank debt. As of December 31, 2022, we had cash, cash equivalents, and short-term investments of $274.4 million.

Cash flows

The following table summarizes our cash flows for the years ended December 31, 2022 and 2021 (in thousands):

Operating Activities

During the year ended December 31, 2022, net cash used in operating activities was $40.1 million. This consisted primarily of a net loss of $34.7 million and an increase in our operating assets and liabilities of $12.8 million, partially offset by non-cash charges of $7.4 million. The increase in our operating assets and liabilities was primarily due to a decrease in accounts payable and accrued liabilities of $10.3 million, an increase in prepaid and other assets of $1.2 million, and a decrease in contract liability of $1.3 million. The non-cash charges primarily consisted of non-cash stock-based compensation of $5.8 million, acquired in-process research and development of $1.1 million, depreciation, amortization and accretion expense of $0.3 million, and change in fair value of warrant liability of $0.1 million.

During the year ended December 31, 2021, net cash used in operating activities was $17.6 million. This consisted primarily of a net loss of $20.2 million and an increase in our operating assets and liabilities of $0.4 million, partially offset by non-cash charges of $3.0 million. The increase in our operating assets and liabilities was primarily due to a decrease in contract liability of $2.5 million, partially offset by a decrease in prepaid and other assets of $1.2 million and an increase in accounts payable and accrued liabilities of $1.0 million. The non-cash charges primarily consisted of stock-based compensation of $2.8 million and depreciation, amortization and accretion expense of $0.2 million.

Investing Activities

During the year ended December 31, 2022, the cash and cash equivalents used in investing activities was primarily due to $0.2 million in purchases of property and equipment. During the year ended December 31, 2021, the cash and cash equivalents used in investing activities was primarily due to $0.1 million in purchases of property and equipment.

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Financing Activities

During the year ended December 31, 2022, the cash and cash equivalents provided by financing activities was primarily due to $198.8 million in net proceeds from the Merger. In addition, we acquired $63.5 million in short-term investments through the Merger. Also, during the year ended December 31, 2022, we used cash of $8.7 million for repayment of the bank note. During the year ended December 31, 2021, the cash and cash equivalents provided by financing activities was primarily due to $54.8 million of proceeds from the issuance of Series D convertible preferred stock in August 2021 plus $0.2 million from common stock option exercises, partially offset by $1.8 million repayments on the bank note.

Future Funding Requirements

Based on our current operating plan, we believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash requirements through at least the next three years. In particular, we expect our cash, cash equivalents, and short-term investments will allow us to fund our expenses related to the FDA’s review of our NDA for neffy, fund proof of concept clinical trials of neffy for additional indications, fund pre-commercial manufacturing and sales and marketing activities, and if and when neffy is approved by the FDA, fund our commercial launch. However, our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. We have based this estimate on assumptions that may prove to be wrong, and we could deplete our capital resources sooner than we expect. Additionally, the process of testing product candidates in clinical trials is costly, and the timing of progress and expenses in these trials is uncertain.

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

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Until such time, if ever, as we can generate substantial product revenues to support our cost structure, we expect to finance our cash needs through a combination of our existing cash, cash equivalents, short-term investments, equity offerings, debt financings and other capital sources which may include collaborations, strategic alliances, marketing, distribution or licensing arrangements or other arrangements with third parties. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be or could be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing and equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. In addition, our current or future debt agreements may limit our ability to incur additional debt. If we raise funds through additional collaborations, or other similar arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, development programs or product candidates or grant licenses on terms that may not be favorable to us and/or may reduce the value of our common stock.

Our ability to raise additional funds may be adversely impacted by potential worsening global economic conditions and disruptions to and volatility in the credit and financial markets in the US, including due to recent bank failures, and worldwide resulting from macroeconomic factors. Because of the numerous risks and uncertainties associated with product development, we cannot predict the timing or amount of increased expenses and cannot assure you that we will ever be profitable or generate positive cash flow from operating activities.

Material Cash Requirements

Under our license agreement with Aegis, we have payment obligations of up to $20.0 million contingent upon our achievement of certain regulatory and commercial milestones and are required to make royalty payments in connection with the sale of products developed under that agreement. We are unable to estimate the timing or likelihood of achieving additional milestones or royalty payments under this agreement. We are also responsible for reimbursing Aegis for patent costs incurred in connection with prosecuting and maintaining patent rights that are specific to epinephrine or epinephrine products.

Pursuant to the Termination Agreement with Recordati, we have payment obligations of up to €10.0 million contingent upon our achievement of certain regulatory and commercial milestones, and up to €5.0 million based on a low double-digit percentage of sales of sales of Recordati Licensed Product(s) in the Recordati Territory We are unable to estimate the timing or likelihood of achieving these milestones and sales-based payments under this agreement.

In October 2021, we entered into a lease agreement to rent office space with a lease commencement date of December 2021. The lease has a term of 38 months. Annual rent expense is $0.2 million and is subject to annual increases of 3%, plus our share of operating expenses and taxes.

We enter into contracts in the normal course of business with third-party contract organizations and vendors for clinical studies, manufacturing and other services and products. These contracts generally provide for termination after a notice period.

To date, we have not recognized any reserves related to uncertain tax positions. As of December 31, 2022, we had no accrued interest or penalties related to uncertain tax positions.

Critical Accounting Policies and Significant Judgements and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenues recognized under collaboration agreements, accruals for research and development expenses and valuation of equity awards. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be 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. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies and estimates are described in more detail in Note 2- Summary of Significant Accounting Policies to our consolidated financial statements, we believe the following accounting policies and estimates to be most critical to the preparation of our consolidated financial statements.

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Revenue

Our revenues generally consist of licenses and research services under license and collaboration agreements.

We recognize revenue when we transfer promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To determine revenue recognition for contracts with customers we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligation(s) in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligation(s) in the contract; and (v) recognize revenue when (or as) we satisfy the performance obligation(s). At contract inception, we assess the goods or services promised within each contract, assess whether each promised good or service is distinct and identify those that are performance obligations. We recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

The upfront payments and fees received prior to satisfying the relevant revenue recognition criteria are recorded as contract liability in the balance sheet and recognized as revenue when the related revenue recognition criteria are met.

Collaboration agreements typically contain multiple elements, or performance obligations, including research and development services and technology licenses. Our assessment of what constitutes a separate performance obligation requires us to apply judgement. Specifically, we have to identify which goods and services we are required to provide under the contract are distinct. For our collaboration agreements, we have identified several performance obligations at the inception of the contract since the delivered elements are deemed capable of being distinct within the context of the contract. Accordingly, the initial transaction price is allocated to the various performance obligations where we recognized revenue related to the license, which was delivered upon contract inception, and the remaining performance obligation is recognized as the underlying services are provided under the cost-based input method over the research terms. Using the cost-based input method, we recognize revenue based on actual costs incurred as a percentage of total estimated costs as we complete our performance obligations. Any cumulative effect of revisions to estimated costs to complete our performance obligations is recorded in the period in which changes are identified and amounts can be reasonably estimated. This approach requires us to use significant judgement and make estimates of future expenditures. If our estimates or judgements change over the course of the collaboration, they may affect the timing and amount of revenue that it recognizes in the current and future periods.

The transaction price for a contract represents the amount to which we are entitled in exchange for providing goods and services to the customer. The transaction price does not include amounts subject to uncertainties unless it is probable that there will be no significant reversal of revenue when the uncertainty is resolved. Apart from the upfront license payment and certain milestones, all other fees we may earn under our collaborative agreements are subject to significant uncertainties of product development and commercial sales targets. The transaction price of an agreement is allocated to each performance obligation on a relative stand-alone selling price basis, for which we recognize revenue as or when the performance obligations under the contract are satisfied.

Accrued Research and Development

We have entered into various agreements with CROs, CMOs, and other service providers. Our research and development accruals are estimated based on the level of services performed, progress of the studies, including the phase or completion of events, and contracted costs. The estimated costs of research and development provided, but not yet invoiced, are included in accrued liabilities on the balance sheet. If the actual timing of the performance of services or the level of effort varies from the original estimates, we will adjust the accrual accordingly. Payments made to third parties under these arrangements in advance of the performance of the related services are recorded as prepaid expenses and other current assets until the services are rendered. Although we do not expect our estimates to be materially different from amounts actually incurred, if our estimates of the status and timing of services performed differ from the actual status and timing of services performed, it could result in us reporting amounts that are too high or too low in any particular period. To date, our estimated accruals have not differed materially from actual costs incurred.

Stock-Based Compensation

Stock-based compensation expense represents the grant date fair value of equity awards recognized in the period using the Black-Scholes option pricing model. We recognize the expense for equity awards on a straight-line basis over the requisite service periods of the awards, which is usually the vesting period. Forfeitures are recognized as they occur. Estimating the fair value of equity awards pursuant to the Black-Scholes option pricing model requires us to make assumptions regarding a number of variables, including the risk-free interest rate, the expected stock price volatility, the expected term of stock options, the expected dividend yield and the fair value of the underlying common stock on the date of grant. Changes in these assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized.

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The Black-Scholes option pricing model utilizes inputs which are highly subjective assumptions and generally require significant judgment. We determine these assumptions in the following manner:

Recent Accounting Pronouncements

See Note 2- Summary of Significant Accounting Policies to our consolidated financial statements for information about recent accounting pronouncements, the timing of their adoption, and our assessment, if any, of their potential impact on our financial condition and results of operations.