Armata Pharmaceuticals, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report, and our audited financial statements and notes thereto as of and for the year ended December 31, 2022 included in our Annual Report on Form 10-K filed on March 16, 2023 with the U.S. Securities and Exchange Commission (the “SEC”).

Our common stock, par value $0.01 per share (the “Common Stock”) is traded on the NYSE American exchange under the symbol “ARMP.” We are currently headquartered in Los Angeles, CA, and we have a research and development facility for product development to support advancing phage products from the bench to the clinic. In addition to microbiology, synthetic biology, formulation, chemistry and analytical laboratories, the facility is equipped with two licensed current good manufacturing practice (“cGMP”) drug manufacturing suites enabling the production, testing and release of clinical trial material.

Statements contained in this Quarterly Report that are not statements of historical fact are forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, statements concerning product development plans, commercialization of our products, the expected market opportunity for our products, the use of bacteriophages and synthetic phages to kill bacterial pathogens, having resources sufficient to fund our operations into the third quarter of 2023, future funding sources, general and administrative expenses, clinical trial and other research and development expenses, costs of manufacturing, costs relating to our intellectual property, capital expenditures, the expected benefits of our targeted phage therapies strategy, the potential market for our products, tax credits and carry-forwards, and litigation-related matters. Words such as “believe,” “anticipate,” “plan,” “expect,” “intend,” “will,” “goal,” “potential” and similar expressions are intended to identify forward-looking statements, though not all forward-looking statements necessarily contain these identifying words. These statements are subject to risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, filed on March 16, 2023 with the SEC, and under Item 1A, “Risk Factors” and elsewhere in this Quarterly Report. These forward-looking statements speak only as of the date on which they were made, and we undertake no obligation to update any forward-looking statements.

Overview

We are a clinical-stage biotechnology company focused on the development of pathogen-specific bacteriophage therapeutics for the treatment of antibiotic-resistant and difficult-to-treat acute and chronic bacterial infections using our proprietary bacteriophage-based technology. Bacteriophages or “phages” have a powerful and highly differentiated mechanism of action that enables binding to and killing specific bacteria, including those forming biofilms, in contrast to traditional broad-spectrum antibiotics. We believe that phages represent a promising approach to treat bacterial infections, especially those that have developed resistance to current standard of care therapies, including the so-called multidrug-resistant or “superbug” strains of bacteria. The increasing rates of bacterial resistance to all current therapies is a significant health security and healthcare threat. We are a leading developer of phage therapeutics administered intravenously as well as locally, and are uniquely positioned to address the growing worldwide threat of antibiotic-resistant bacterial infections.

We are combining our proprietary approach and unique purification procedures and expertise in identifying, characterizing and developing both naturally-occurring and engineered (synthetic) bacteriophages with our proprietary phage-specific cGMP capabilities to advance a broad pipeline of high-quality multi-bacteriophage product candidates that can be tolerated no matter the route of deliverer from intravenously, topically and inhaled.

We are developing and advancing the clinical phage candidate, AP-PA02, for Pseudomonas aeruginosa (“P. aeruginosa”). On October 14, 2020, we received the approval to proceed from the FDA for our IND application for AP-PA02-101, which was a Phase 1b/2a, multicenter, double-blind, randomized, placebo-controlled, single ascending dose (“SAD”) and multiple ascending dose (“MAD”) clinical trial to evaluate the safety and tolerability of inhaled AP-PA02 in subjects with cystic fibrosis (“CF”) and chronic pulmonary P. aeruginosa infection. In the first quarter of 2023, Armata announced positive topline results from the completed “SWARM-P.a.” study. Data indicated that multiple days of inhaled AP-PA02 was well-tolerated with a treatment emergent adverse event (TEAE) profile similar to placebo. Only mild, self-limited adverse events possibly related to study drug were reported in a few CF subjects. Pharmacokinetic findings confirm that AP-PA02 can be effectively delivered to the lungs through nebulization with minimal systemic exposure. SAD and MAD resulted in a proportional increase in exposure as measured in induced sputum. Additionally, achieved exposures were relatively consistent from subject to subject. Bacterial levels of P. aeruginosa in the sputum were measured at several time points and compared to baseline levels prior to study drug administration. Trends suggest improvement in bacterial load reduction for subjects treated with AP-PA02 at end of treatment as compared to placebo after ten days of dosing. Pharmacokinetic/Pharmacodynamic analysis indicates significant microbiological impacts in the subjects with the highest exposures. Importantly, for subjects with the highest average exposure of susceptible phage, there was durability of approximately two-log reduction from end of treatment to end of study (day 28 post dose). This study is supported by the Cystic Fibrosis Foundation (“CFF”), which granted Armata a Therapeutics Development Award of up to $5.0 million.

A key advantage of Armata’s phage manufacturing expertise is the purity profiles of our phage products, including AP-SA02, our phage product candidate for Staphylococcus aureus (“S. aureus”); this has enabled Armata to pursue treatment of complicated S. aureus bacteremia, where repetitive intravenous dosing is required. On June 15, 2020, we entered into a Research Project Award agreement (the “MTEC Agreement”) with the Medical Technology Enterprise Consortium (“MTEC”), pursuant to which we received a $15.0 million grant and entered into a three-year program administered by the U.S. Department of Defense (the “DoD”) through MTEC managed by the Naval Medical Research Command with funding from the Defense Health Agency and Joint Warfighter Medical Research Program. On September 29, 2022, the MTEC Agreement was modified to increase the total award by $1.3 million to $16.3 million and extend the term into the third quarter of 2024. The MTEC funds are to partially fund a Phase 1b/2a, multi-center, randomized, double-blind, placebo- controlled dose escalation study that will assess the safety, tolerability, and efficacy of our phage-based candidate, AP-SA02, for the treatment of adults with complicated S. aureus bacteremia. On November 17, 2021, Armata announced that it had received from the FDA the approval to proceed for our Investigational New Drug application for AP-SA02, and in May 2022, we dosed the first patient in the Phase 1b/2a trial (“diSArm” study). The Phase 1b part of the study has been fully enrolled as planned. Initiation of the Phase 2a portion of the study followed Data Review Committee (DRC) review of the positive safety and tolerability data from the Phase 1b portion of the study. On September 26, 2023, Armata announced that the first patient has been dosed in the Phase 2a portion of the diSArm study. Armata continues to accelerate the enrollment of patients into the Phase 2a portion of the study, which we expect will lead to a potential pivotal trial in the fourth quarter of 2024 or in the first quarter of 2025.

On February 22, 2022, Armata announced that it had received from the FDA the approval to proceed for our IND application for AP-PA02, in a second indication, NCFB (non-cystic fibrosis bronchiectasis). We initiated a Phase 2 trial (“Tailwind”) in NCFB in 2022 and reported first patient dosing in the first quarter of 2023. The “Tailwind” study is a Phase 2, multicenter, double-blind, randomized, placebo-controlled study to evaluate the safety, phage kinetics, and efficacy of inhaled AP-PA02 phage therapeutic in subjects with NCFB and chronic pulmonary Pseudomonas aeruginosa infection.

On August 1, 2022, Armata announced that it had received from the FDA the approval to proceed for our IND application for AP-SA02, in a second indication, PJI (periprosthetic joint infection). With progress made in the Phase 1b/2a bacteremia study, we are proceeding with the second application. We are advancing start-up activities for a Phase 1b/2a trial that will assess the safety and tolerability of intravenous and intra-articular AP-SA02 as an adjunct to standard of care antibiotics in adults undergoing debridement, antibiotics, and implant retention for the treatment of periprosthetic joint infections caused by S. aureus.

We are committed to conducting randomized controlled clinical trials required for FDA approval in order to move toward the commercialization of alternatives to traditional antibiotics and provide a potential method of treating patients suffering from drug-resistant and difficult-to-treat bacterial infections.

The following chart summarizes the status of our phage product candidate development programs and partners.

We have incurred net losses since our inception and our operations to date have been primarily limited to research and development and raising capital. As of September 30, 2023, we had an accumulated deficit of $289.0 million. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on completing the development and seeking to obtain regulatory approval of our product candidates.

We currently expect to use our existing cash and cash equivalents for the focused research and development of our current product candidates and for working capital and other general corporate purposes. We expect to continue to incur significant and increasing operating losses at least for the next several years. We do not expect to generate product revenue unless and until we successfully complete development and obtain marketing approval for at least one of our product candidates.

We may also use a portion of our existing cash and cash equivalents for the potential acquisition of, or investment in, product candidates, technologies, formulations or companies that complement our business, although we have no current understandings, commitments or agreements to do so. Our existing cash and cash equivalents will not be sufficient to enable us to complete all necessary development of any potential product candidates. Accordingly, we will be required to obtain further funding through one or more other public or private equity offerings, debt financings, collaboration, strategic financing, grants or government contract awards, licensing arrangements or other sources. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and potential disruptions to, and volatility in, financial markets in the United States and worldwide. Adequate additional funding may not be available to us on acceptable terms, or at all. If we are unable to raise capital when needed or on acceptable terms, we may be required to defer, reduce or eliminate significant planned expenditures, restructure, curtail or eliminate some or all of our development programs or other operations, dispose of assets, enter into arrangements that may require us to relinquish rights to certain of our product candidates, technologies or potential markets, file for bankruptcy or cease operations altogether. Any of these events could have a material adverse effect on our business, financial condition and results of operations and result in a loss of investment by our shareholders.

Recent Events

2023 Credit Agreement

On July 10, 2023, we entered into, as borrower, a credit and security agreement (the “Credit Agreement”) with Innoviva Strategic Opportunities LLC (“Innoviva”), a wholly owned subsidiary of Innoviva, Inc. Innoviva, Inc. is a principal shareholder and related party of the Company. The Credit Agreement provides for a secured term loan facility in an aggregate amount of $25.0 million (the “Loan”) at an interest rate of 14.0% per annum and has a maturity date of January 10, 2025. Principal and accrued interest are payable at maturity. Repayment of the Loan is guaranteed by our domestic subsidiaries, and the Loan is secured by substantially all of our assets and our subsidiary guarantors.

The Credit Agreement contains customary affirmative and negative covenants and representations and warranties, including financial reporting obligations and certain limitations on indebtedness, liens, investments, distributions (including dividends), collateral, investments, mergers or acquisitions and fundamental corporate changes. The Credit Agreement also includes customary events of default, including payment defaults, breaches of provisions under the loan documents, certain losses or impairment of collateral and related security interests, the occurrence of certain events that could reasonably be expected to have a “material adverse effect” as set forth in the Credit Agreement, certain bankruptcy or insolvency events, and a material deviation from our operating budget.

The Loan was initially recognized at fair value of $21.2 million and subsequently recorded at the amortized cost net of debt issuance costs and debt discount. Debt issuance costs and debt discount in the amounts of $0.1 million and $3.8 million, respectively, are amortized using the effective interest method to interest expenses over the term of the Loan. The Loan’s annual effective interest rate was 27.31% as of September 30, 2023.

2023 Convertible Credit Agreement

On January 10, 2023, we entered into, as borrower, a secured convertible credit and security agreement (the “Convertible Credit Agreement”) with Innoviva. The Convertible Credit Agreement provides for a secured term loan facility in an aggregate amount of $30.0 million (the “Convertible Loan”) which bears interest at a rate of 8.0% per annum, and was scheduled to mature on January 10, 2024. Concurrently with the execution of the Credit Agreement, we amended certain provisions of the Convertible Credit Agreement, to, among other changes, extend the maturity of the Convertible Loan to January 10, 2025.

Repayment of the Convertible Loan is guaranteed by our domestic subsidiaries and foreign material subsidiaries, and the Convertible Loan is secured by substantially all of our assets and the subsidiary guarantors.

The Convertible Credit Agreement provides that if there is a financing from new investors of at least $30.0

million (a “Qualified Financing”), the outstanding principal amount of, and all accrued and unpaid interest on, the Convertible Loan shall be converted into shares of our Common Stock at a price per share equal to a 15.0% discount to the lowest price per share for Common Stock paid by investors in a Qualified Financing (which price paid by investors in a Qualified Financing may not be less than a 15.0% discount to the closing price of Common Stock immediately prior to the consummation of a Qualified Financing event). The Convertible Credit Agreement also required us to file a registration statement (the “Registration Statement”) for the resale of all securities issued to the lender in connection with any conversion under the Convertible Credit Agreement, which we originally filed on February 13, 2023 and which was declared effective by the SEC on April 6, 2023. The Convertible Credit Agreement also confers upon the lender the option to convert any outstanding Convertible Loan amount, including all accrued and unpaid interest thereon, at the lender’s option, into shares of Common Stock at a price per share equal to the greater of book value or market value per share of Common Stock on the date immediately preceding the effective date of the Convertible Credit Agreement, which was $1.52 (as may be appropriately adjusted for any stock split, combination or similar act).

On July 10, 2023, in connection with the Credit Agreement with Innoviva, we amended the terms of the Convertible Loan, to, among other changes, extend the maturity of the Convertible Loan to January 10, 2025. We concluded that the amendment is an extinguishment for accounting purposes. We recognized a $1.8 million gain as the change in fair value of the convertible debt before the extinguishment date. We estimated fair value of the combined Loan and the Convertible Loan before and after modification and calculated an extinguishment loss of $3.9 million in the condensed consolidated statements of operations for the three months ended September 30, 2023. The Company recognized a $14.7 million loss as the change in fair value of the Convertible Loan from July 10, 2023, the modification date, to September 30, 2023.

Results of Operations

Comparison of three and nine months ended September 30, 2023 and 2022

*Not meaningful

*Not meaningful

Grant Revenue

We recognized $1.2 million and $1.3 million of grant revenue during the three months ended September 30, 2023 and 2022, and $3.0 million and $4.5 million of grant revenue during the nine months ended September 30, 2023 and 2022, respectively, which represents MTEC’s share of the costs incurred for our AP-SA02 program for the treatment of Staphylococcus aureus bacteremia.

Research and Development

The following table summarize our research and development expenses for the three months ended September 30, 2023 and 2022:

Research and development expenses decreased by $0.4 million, from $8.4 million for the three months ended September 30, 2022 to $8.0 million for the three months ended September 30, 2023.

Clinical trial costs increased by $0.2 million, from $2.3 million for the three months ended September 30, 2022 to $2.5 million for the three months ended September 30, 2023. The increase is primarily due to an increase in AP-PA02 Non-Cystic Fibrosis Bronchiectasis study related costs of $0.4 million and an increase in AP-SA02 Bacteremia study related costs of $0.2 million, offset by a decrease in AP-PA02 Cystic Fibrosis study related costs and AP-SA02 Prosthetic Joint Infection studies related costs of $0.4 million.

Other external research and development costs increased by $0.3 million from $0.9 million for the three months ended September 30, 2022, to $1.1 million for the three months ended September 30, 2023. We recognized $0.5 million credit to research and development expenses related to the milestone payment from CFF during the three months ended September 30, 2022 and no such milestone was recognized during the three months ended September 30, 2023. The remaining change is as a result of a decrease of $0.3 million in laboratory supplies, offset by an increase of $0.1 million in research and development consulting services.

Our expenses by product and by project for the three months ended September 30, 2023 and 2022 were as follows:

Personnel-related costs, including employee payroll and related expenses, decreased by $0.9 million, from $3.1 million for the three months ended September 30, 2022 to $2.1 million for the three months ended September 30, 2023, largely due to a decrease in headcount in our research and development organization in the 2023 period compared to the 2022 period, as well as employee stock-based compensation expenses decrease of $0.4 million primarily due to a decrease in the number of stock options granted and vesting of outstanding equity awards.

Facilities and overheads were relatively steady in the three months ended September 30, 2023 compared to the 2022 period and include rent expense, allocated utility expenses, equipment and IT maintenance costs and non-capitalized equipment costs.

The following table summarizes our research and development expenses for the nine months ended September 30, 2023 and 2022 (except percentages):

Research and development expenses increased by $0.4 million, from $25.4 million for the nine months ended September 30, 2022 to $25.8 million for the nine months ended September 30, 2023.

Clinical trial costs decreased by $0.2 million, from $7.2 million for the nine months ended September 30, 2022, to $7.1 million for the three months ended September 30, 2023. The decrease is primarily due to a decrease in AP-PA02 Cystic Fibrosis Bronchiectasis study related costs of $1.6 million as the study was completed with the last patient enrolled in December 2022 and a decrease in AP-SA02 Bacteremia study related costs of $0.3 million, offset by an increase in AP-PA02 Non-Cystic Fibrosis study related costs of $1.3 million as more patients were enrolled in the study and AP-SA02 Prosthetic Joint Infection studies related costs of $0.2 million.

Other external research and development costs increased by $0.2 million from $3.3 million for the nine months ended September 30, 2022 to $3.5 million for the nine months ended September 30, 2023 as we recognized $0.6 million more credit to research and development expenses related to the milestone payment from CFF during the nine months ended September 30, 2022 compared with the nine months ended September 30, 2023. The remaining change is as a result of a decrease of $1.1 million in laboratory supplies, offset by an increase of $0.8 million in research and development consulting services.

Our expenses by project for the nine months ended September 30, 2023 and 2022 were as follows:

30

Personnel-related costs, including employee payroll and related expenses, decreased by $0.5 million, from $8.6 million for the nine months ended September 30, 2022 to $8.2 million for the three months ended September 30, 2023, largely due to a decrease in recruiting expenses of $0.3 million, as well employee stock-based compensation expenses decrease of $0.3 million due to fewer stock options granted and stock price decrease.

Facilities and overheads increased by $0.8 million in the nine months ended September 30, 2023 compared to the 2022 period largely as a result of an increase in lease expense of $0.9 million related to new lease arrangement entered in prior periods, offset by a decrease of $0.1 million in other facilities and overhead costs.

General and Administrative

General and administrative expenses were $3.6 million and $1.6 million for the three months ended September 30, 2023 and 2022, respectively. The increase of $2.0 million is primarily related to an increase of $1.1 million in legal, accounting and other consulting expenses, an increase of $0.4 million in lease, other facilities and overhead expenses, an increase of $0.1 million in recruiting expenses and a one-time expense of $0.5 million related to the prepaid financing costs.

General and administrative expenses were $8.5 million and $5.6 million for the nine months ended September 30, 2023 and 2022, respectively. The increase of $2.9 million is primarily related to an increase of $2.1 million in legal, accounting and other consulting expenses, an increase of $0.7 million in lease, other facilities and overhead expenses, an increase of $0.1 million in recruiting expenses, a one-time expense of $0.5 million related to the prepaid financing costs and a net decrease of personnel-related costs, including stock-based compensation of $0.5 million.

Interest Income

Interest income for both three months ended September 30, 2023 and 2022 was less than $0.1 million, and for the nine months ended September 30, 2023 and 2022 was $0.1 million and less than $0.1 million, respectively, which was related to interest income accrued on our cash and cash equivalents balances.

Interest Expense

We recognized interest expense for both the three and nine months ended September 30, 2023 of $1.2 million, which relates to the interest expenses and the amortization of debt discount and issuance costs for the Loan received from Innoviva in July 2023. Interest expense is accrued and is payable at the Loan maturity in January 2025.

Change in Fair Value of Convertible Debt

We recognized a loss on change in the fair value of the convertible debt for the three and nine months ended September 30, 2023, of $15.8 million and $13.0 million, respectively. The Convertible Loan received from Innoviva in January 2023 and amended in July 2023 is accounted at fair value using a weighted probability of various settlement scenarios of the Convertible Loan during its term discounted to each reporting date. Conversion option scenarios are valued using an option pricing model with significant assumptions and estimates such as volatility, expected term and risk-free interest rates.

Loss on Convertible Debt Extinguishment

We recognized a loss on convertible debt extinguishment for both three and nine months ended September 30, 2023 of $3.9 million which relates to the amendment to the Convertible Loan on July 10, 2023. The amendment was accounted for as an extinguishment in the third quarter 2023.

Liquidity, Capital Resources and Financial Condition

We have incurred net losses since our inception and have negative operating cash flows. Our cash and cash equivalents of $24.0 million as of September 30, 2023, are expected to fund our operations through the first quarter of 2024. We plan to control our expenses and to raise additional capital through a combination of public and private equity, debt financings, strategic alliances, and grant arrangements. These circumstances raise substantial doubt about our ability to continue as a going concern. While management believes this plan to raise additional funds will alleviate the conditions that raise substantial doubt, these plans are not entirely within its control and cannot be assessed as being probable of occurring. We may not be able to secure additional financing in a timely manner or on favorable terms, if at all.

During the nine months ended September 30, 2023, we received the Convertible Loan in the aggregate amount of $30.0 million and the Loan in the aggregate amount of $25.0 million from Innoviva. The Convertible Loan and the Loan mature in January 2025, and principal and accrued interest are payable at maturity. The Convertible Loan provides for various conversion and repayment options, including the conversion of principal and accrued interest into shares of our Common Stock upon a Qualified Financing and the Company’s option to repay the Convertible loan prior to maturity.

Future Capital Requirements

We will need to raise additional capital in the future to continue to fund our operations. Our future funding requirements will depend on many factors, including:

• the costs and timing of our research and development activities;
• the progress and cost of our clinical trials and other research and development activities;
• manufacturing costs associated with our targeted phage therapies strategy and other research and development activities;
• the costs of completing the construction and improvements of our leased premises to be used as our new headquarters. As of September 30, 2023, the total projected construction costs of our new leased headquarter in Los Angeles are estimated to be approximately $28.6 million. As of September 30, 2023, we incurred a total of $19.3 million and the remaining costs are expected to be incurred through the second quarter of 2024. We expect to receive $7.3 million of the tenant improvement allowance from the landlord before our construction is completed, which we recognized as other receivable in our condensed consolidated balance sheet as of September 30, 2023. The estimated total construction costs may change as the project progresses;
• the terms and timing of any collaborative, licensing, acquisition or other arrangements that we may establish;
• whether and when we receive future Australian tax rebates, if any;
• the costs and timing of seeking regulatory approvals;
• the costs of filing, prosecuting and enforcing any patent applications, claims, patents and other intellectual property rights; and
• the costs of potential lawsuits involving us or our product candidates.

We may seek to raise capital through a variety of sources, including:

• the public equity market;
• private equity financings;
• collaborative arrangements, government grants or strategic financings;
• licensing arrangements; and
• public or private debt.

Any additional fundraising efforts may divert our management team from their day-to-day activities, which may adversely affect our ability to develop and commercialize our product candidates. Our ability to raise additional funds will depend, in part, on the success of our product development activities, including our targeted phage therapies strategy and any clinical trials we initiate, regulatory events, our ability to identify and enter into in-licensing or other strategic arrangements, and other events or conditions that may affect our value or prospects, as well as factors related to financial, economic and market conditions, many of which are beyond our control. We cannot be certain that sufficient funds will be available to us when required or on acceptable terms. If we are unable to secure additional funds on a timely basis or on acceptable terms, we may be required to defer, reduce or eliminate significant planned expenditures, restructure, curtail or eliminate some or all of our development programs or other operations, dispose of technology or assets, pursue an acquisition of our company by a third party at a price that may result in a loss on investment for our shareholders, enter into arrangements that may require us to relinquish rights to certain of our product candidates, technologies or potential markets, file for bankruptcy or cease operations altogether. Any of these events could have a material adverse effect on our business, financial condition and results of operations. Moreover, if we are unable to obtain additional funds on a timely basis, there will be substantial doubt about our ability to continue as a going concern and an increased risk of insolvency and loss of investment by our shareholders. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to our existing shareholders. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, financial markets in the United States and worldwide.

Cash Flows

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

Cash Flows Used in Operating Activities

Net cash used in operating activities was $39.3 million and $22.0 million for the nine months ended September 30, 2023 and 2022, respectively.

Cash used in operating activities in the nine months ended September 30, 2023 was primarily due to our net loss for the period of $49.2 million, adjusted by non-cash items of $20.1 million and a decrease of $10.2 million in our net operating assets and liabilities. The non-cash items consist of $13.0 million related to a loss from change in fair value of convertible debt, $3.9 million related to a loss on convertible debt extinguishment, $1.2 million of non-cash interest expense on the Loan, $0.7 million related to stock-based compensation expense, $0.7 million related to depreciation and amortization expense and $0.7 million related to change in right-of-use asset. The decrease in our net operating assets and liabilities was primarily due to a decrease of $9.7 million in operating lease liability, which primarily relates to payments to the construction of office and laboratory and manufacturing space at our new leased facility in Los Angeles, CA, which we expect to complete by the second quarter of 2024, a decrease of $0.3 million in accounts payable and accrued liabilities, a decrease of $0.1 million in accrued compensation, partially offset by an increase of $0.1 million in prepaid expenses and other current assets.

Cash used in operating activities in the nine months ended September 30, 2022 was primarily due to our net loss for the period of $26.6 million, adjusted by non-cash net loss of $2.9 million and a net change of $1.7 million in our net operating assets and liabilities. The non-cash amounts consisted of $2.3 million related to stock-based compensation expense and $0.6 million related to depreciation and amortization expense. The changes in our net operating assets and liabilities were primarily due to an increase of $2.7 million in operating lease liability, an increase of $0.8 million in accrued compensation, an increase of $0.6 million in accounts payable and accrued liabilities, partially offset by an increase of $2.4 million in prepaid expenses and other current assets.

Cash Flows Used in Investing Activities

Net cash used in investing activities was $5.7 million and $2.7 million for the nine months ended September 30, 2023 and 2022, respectively, which is attributable to purchases of laboratory and manufacturing equipment in connection with the construction of a new office, laboratory and manufacturing space at our leased facility in Los Angeles, CA. We expect our spending for property and equipment will decease following the completion of such construction by the second quarter of 2024.

Cash Flows from Financing Activities

Cash provided by financing activities for the nine months ended September 30, 2023 was $54.0 million, which consisted primarily of proceeds from issuance of convertible debt, net of issuance costs of $29.1 million, proceeds from issuance of long-term debt, net of issuance costs of $24.9 million, and proceeds from exercise of stock options of less than $0.1 million.

Cash provided by financing activities for the nine months ended September 30, 2022 was $44.5 million, which consisted primarily of proceeds from sale of common stock, net of offering costs of $44.4 million, and proceeds from exercise of stock options of $0.1 million.

Off-Balance Sheet Arrangements

As of September 30, 2023, we did not have off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate estimates and assumptions, including but not limited to those related to convertible debt, stock-based compensation expense, accruals for research and development costs, lease assets and liabilities, the valuation of deferred tax assets, valuation of uncertain income tax positions, impairment of goodwill and intangible assets and impairment of long-lived assets. We base our estimates on historical experience and on various other assumptions 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.

Refer to Note 3 to the consolidated financial statements and critical accounting policies and estimated included in our Form 10-K filed with the SEC on March 16, 2023. There were no material changes to our critical accounting policies from December 31, 2022, except the accounting and estimates related to the convertible loan received in January 2023.

Convertible Loan

In January 2023, we entered into the Convertible Credit Agreement with Innoviva. The Convertible Credit Agreement provides for the Convertible Loan in an aggregate amount of $30.0 million, which bears interest at a rate of 8.0% per annum, and was scheduled to mature on January 10, 2024. In July 2023, in connection with the Credit Agreement with Innoviva, we amended the terms of the Convertible Loan, to, among other changes, extend the maturity of the Convertible Loan to January 10, 2025. The Convertible Loan includes various conversion and repayment options, including the conversion of principal and accrued interest into shares of our Common Stock upon a Qualified Financing and the Company’s option to repay the Convertible Loan prior to maturity. Refer to Note 7 to the condensed consolidated financial statements included elsewhere in this Form 10-Q for additional details.

We account for the Convertible Loan at fair value and changes in fair value are remeasured each reporting period and are included in other income (expense) in the consolidated statements of operations during each reporting period. We estimate the fair value using a weighted probability of various settlement scenarios during the Convertible Loan term discounted to each reporting date. To estimate the fair value of the conversion option scenarios, we use an option pricing model with significant assumptions, such as volatility, expected term and risk-free interest rates. Changes in volatility, expected term, fair value of our Common Stock and probabilities of scenarios significantly impact the fair value of the Convertible Loan.

As of September 30, 2023, we estimated the fair value of the Convertible Loan to be $49.7 million. For the three and nine months ended September 30, 2023, we recognized loss from change in fair value of convertible debt of $15.8 million and $13.0 million, respectively, in the condensed consolidated statements of operations and comprehensive loss.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and are not required to provide the information required under this item.

Disclosure Controls and Procedures

Under the supervision of our Chief Executive Officer and Corporate Controller, we evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act (the “Exchange Act”) as of September 30, 2023. Based on that evaluation, our Chief Executive Officer and Corporate Controller have concluded that our disclosure controls and procedures were effective as of September 30, 2023 to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Corporate Controller, as appropriate to allow timely discussion regarding required disclosures.

In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Changes in Internal Control over Financial Reporting

As disclosed in the Company’s Current Report on Form 8-K, filed with the SEC on September 20, 2023, Richard Rychlik, the Company’s Corporate Controller, was promoted to serve as the Company’s principal financial officer effective as of September 15, 2023, replacing Julianne Averill of Danforth Advisors, LLC, who resigned as Chief Financial Officer on the same day. The promotion of Mr. Rychlik was part of the Company’s plan to transition more of its financing and accounting functions, including internal controls over financial reporting, to Company personnel and reduce its reliance on outside advisors. Other than as set forth in the preceding sentence, there was no change in our internal control over financial reporting (as defined by Rules 13a-15(d) and 15d-15(d) of the Exchange Act) that occurred during the three months ended September 30, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our business is subject to a number of risks, including those identified in Item 1A of Part I of our 2022 Form 10-K. There have been no material changes to the risk factors described in our 2022 Form 10-K.