Xencor Inc

1. Summary of Significant Accounting Policies

Description of Business

Xencor, Inc. (we, us, our, or the Company) was incorporated in California in 1997 and reincorporated in Delaware in September 2004. We are a clinical-stage biopharmaceutical company focused on discovering and developing engineered monoclonal bispecific antibody and cytokine therapeutics to treat patients with cancer and autoimmune diseases who have unmet medical needs. We create our product candidates using our proprietary XmAb technology platforms, which focus on the portion of an antibody that interacts with multiple segments of the immune system, referred to as the Fc domain, which is constant and interchangeable among antibodies. Our engineered Fc domains, the XmAb technology, can increase antibody immune inhibition, improve cytotoxicity, extend half-life and most recently are used to create bispecific antibodies and cytokines.

Our operations are based in Pasadena, California and San Diego, California.

Consolidation and Basis of Presentation

The Consolidated Financial Statements include the accounts of Xencor, Inc. and its subsidiary Gale Therapeutics Inc., which was incorporated in December 2023. Since we own less than 100% of Gale, the Company records net loss attributable to non-controlling interests in its consolidated statements of income (loss) equal to the percentage of the economic or ownership interests retained in Gale by the non-controlling party.

The Company’s consolidated financial statements as of December 31, 2023, 2022, and 2021 and for the years then ended have been prepared in accordance with accounting principles generally accepted in the United States (U.S.).

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, other comprehensive gain (loss) and the related disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to its accrued clinical trial and manufacturing development expenses, stock-based compensation expense, evaluation of intangible assets, investments, leases and other assets for evidence of impairment, fair value measurements, and contingencies. Significant estimates in these financial statements include estimates made for royalty revenue, accrued research and development expenses, stock-based compensation expenses, intangible assets, incremental borrowing rate for right-of-use asset and lease liability, estimated standalone selling price of performance obligations, estimated time for completing delivery of performance obligations under certain arrangements, the likelihood of recognizing variable consideration, the carrying value of equity instruments without a readily determinable fair value, and recoverability of deferred tax assets.

Recent Accounting Pronouncements

Pronouncements Not yet Effective

In June 2022, the Financial Accounting Standards Board (FASB) issued ASU No. 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions, which is effective for fiscal years beginning on and after December 15, 2023, and interim periods within those fiscal years. The standard clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and is not considered in measuring fair value. The Company does not anticipate that the standard will have a significant impact on its financial statements.

In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740) - Improvements to Income Tax Disclosures, which is effective for fiscal years beginning on and after December 15, 2024, and interim periods within those fiscal years. The standard provides more transparency about income tax information through improvements to income tax disclosures primarily related to the rate reconciliation and income taxes paid information.The Company does not anticipate that the standard will have a significant impact on its financial statements.

Variable Interest Entity

A Variable Interest Entity (VIE) is a legal entity that, by design, 1) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, 2) has equity investors that lack the power to direct the entity's activities, 3) has investors with limited obligation to absorb expected losses, or 4) has investors who do not have the right to receive the residual returns of the entity. The primary beneficiary of a VIE is the party with the controlling financial interest and has the power to direct the activities of the VIE that most significantly impact the entity's economic performance and has the obligation to absorb losses of the VIE, or the right to receive benefits of the VIE that could be potentially significant to the VIE.

On December 19, 2023 we entered into the Gale License and Gale Services Agreements. See Note 10, We consolidated Gale's financial statements in which we have direct controlling financial interest based on the VIE model.

We consider all the facts and circumstances, including our role in establishing Gale and our ongoing rights and responsibilities to assess where we have the power to direct the activities of Gale. In general, the parties that make the most significant decisions affecting the VIE and have the right to remove those decision-makers unilaterally or by majority vote are deemed to have the power to direct the activities of a VIE.

At Gale's inception, we determined whether we were the primary beneficiary and if Gale should be consolidated based on facts and circumstances. Under the rules of determining whether an entity is a VIE, we determined that Gale is a VIE and we are the primary beneficiary.

Liability Related to the Sale of Future Royalties

We record a liability related to the sale of future Monjuvi royalties as debt, amortized under the effective interest rate method over the estimated life of the Monjuvi Royalty Sale Agreement. See Note 11. The amortization of the liability related to the sale of future royalties is based on our current estimate of future royalty payments. Royalty revenue will be recognized as earned, and the payments made will be a reduction of the liability when paid.

Non-Cash Interest Expense on the Liability Related to the Sale of Future Royalties

The total expected royalty payments less the net proceeds received will be recorded as non-cash interest expense over the life of the liability. Interest is imputed on the unamortized portion using the effective interest method and expense is recorded based on the timing of the payments received over the term of the Monjuvi Royalty Sale Agreement. The actual interest rate will be affected by the timing of royalty payments made and changes in the forecasted revenue.

Deferred Income Related to the Sale of Future Royalties

We record a liability related to the sale of future Ultomiris royalties as deferred income, amortized under the units-of-revenue method by computing a ratio of the proceeds received to the total expected payments over the term of the Ultomiris Royalty Sale Agreement. See Note 11. The amortization of the liability related to the sale of future royalties is based on our current estimate of future royalty payments. Royalty revenue will be recognized as earned and the payments made will be a reduction of the liability when paid.

Revenue Recognition

We have, to date, earned revenue from research and development collaborations, which may include research and development services, licenses of our internally developed technologies, licenses of our internally developed drug candidates, or combinations of these.

The terms of our license, research and development, and collaboration agreements generally include non-refundable upfront payments, research funding, co-development payments and reimbursements, license fees, and milestone and other contingent payments to us for the achievement of defined collaboration objectives and certain clinical, regulatory and sales-based events, as well as royalties on sales of any commercialized products.

The terms of our licensing agreements include non-refundable upfront fees, annual licensing fees, and contractual payment obligations for the achievement of pre-defined preclinical, clinical, regulatory and sales-based events by our partners. The licensing agreements also include royalties on sales of any commercialized products by our partners.

We recognize revenue through the five-step process in accordance with Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

Deferred Revenue

Deferred revenue arises from payments received in advance of the culmination of the earnings process. We have classified deferred revenue for which we stand ready to perform within the next 12 months as a current liability. We recognize deferred revenue as revenue in future periods when the applicable revenue recognition criteria have been met. There wasno deferred revenue reported at December 31, 2023. The total amount reported as deferred revenue was $30.3 million at December 31, 2022.

Accounts Receivable

Accounts receivable primarily consists of royalty and milestone revenues receivable from our license and collaboration agreements, as well as receivables arising from cost-sharing development activities. Pursuant to the Ultomiris and Monjuvi Royalty Sale Agreements, a portion of the proceeds we received from the purchasers related to the sale of accounts receivable on royalty and milestone revenue earned at September 30, 2023. Payments for these receivables were paid directly to the purchasers prior to the year-ended December 31, 2023. We did not record an allowance for doubtful accounts at December 31, 2023 or 2022 due to an immaterial allowance as a result of our evaluation of credit risk under ASC 326. We expect to collect all receivables within the terms, which are generally between 30 and 60 days.

Research and development expenses include costs we incur for our own and for our collaborators’ research and development activities. Research and development costs are expensed as incurred. These costs consist primarily of salaries and benefits, including associated stock-based compensation, laboratory supplies, facility costs, and applicable overhead expenses of personnel directly involved in the research and development of new technology and products, as well as fees paid to other entities that conduct certain research and development activities on our behalf. We estimate preclinical study and clinical trial expenses based on the services performed pursuant to the contracts with research institutions and clinical research organizations that conduct and manage preclinical studies and clinical trials on our behalf based on the actual time and expenses they incurred. Further, we accrue expenses related to clinical trials based on the level of patient enrollment and activity according to the related agreement. We monitor patient enrollment levels and related activity to the extent reasonably possible and adjust estimates accordingly.

We capitalize acquired research and development technology licenses and third-party contract rights where such assets have an alternative use and amortize the costs over the shorter of the license term or the expected useful life. We review the license arrangements and the amortization period on a regular basis and adjust the carrying value or the amortization period of the licensed rights if there is evidence of a change in the carrying value or useful life of the asset.

Cash and Cash Equivalents

We consider cash equivalents to be only those investments which are highly liquid, readily convertible to cash and which mature within three months from the date of purchase.

Restricted Cash

As of December 31, 2023, we had an outstanding letter of credit (LOC) collateralized by a money market account of $0.4 million, to the benefit of the landlord related to the Company’s San Diego facility lease. The terms of the lease provide that the amount of the LOC will be reduced on a ratable basis over the term of the lease. The original amount of the LOC was classified as long-term restricted cash as of December 31, 2023.

Marketable Debt and Equity Securities

The Company has an investment policy that includes guidelines on acceptable investment securities, minimum credit quality, maturity parameters, and concentration and diversification. The Company invests its excess cash primarily in marketable debt securities issued by investment grade institutions.

The Company considers its marketable debt securities to be available-for-sale and does not intend to sell these securities, and it is not more likely than not the Company will be required to sell the securities before recovery of the amortized cost basis. These assets are carried at fair value and any impairment losses and recoveries related to the underlying issuer’s credit standing are recognized within other income (expense), while non-credit related impairment losses and recoveries are recognized within accumulated other comprehensive income (loss). There wereno impairment losses or recoveries recorded for the years ended in December 31, 2023 and 2022, respectively. Accrued interest on marketable debt securities is included in marketable securities’ carrying value. Accrued interest was $2.3 million and $1.3 million at December 31, 2023 and 2022, respectively. Each reporting period, the Company reviews its portfolio of marketable debt securities, using both quantitative and qualitative factors, to determine if each security’s fair value has declined below its amortized cost basis. During the years ended December 31, 2023 and 2022, the Company recorded an unrealized gain of $8.2 million and an unrealized loss of $5.4 million, respectively, in its portfolio of marketable debt securities. The unrealized loss was due to the changing interest rate environment and is not due to changes in the credit quality of the underlying securities. The unrealized gain and loss were recorded in other comprehensive income (loss) for the years then ended.

The Company receives equity securities in connection with certain licensing transactions with its partners. These investments in an equity security are carried at fair value with changes in fair value recognized each period and reported within other income (expense). For equity securities with a readily determinable fair value, the Company remeasures these equity investments at each reporting period until such time that the investment is sold or disposed. If the Company sells an investment, any realized gains or losses on the sale of the securities will be recognized within other income (expense) in the Statement of Comprehensive Income (Loss) in the period of sale.

The Company also has investments in equity securities without a readily determinable fair value, where the Company elects the measurement alternative to record at their initial cost minus impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The Company didnot record an impairment charge for the year ended December 31, 2023. During the year ended December 31, 2022, the Company recorded an impairment charge of $0.1 million in connection with equity securities without a readily determinable fair value.

During the years ended December 31, 2023 and 2022, the Company recorded a net loss of $0.4 million and net gain of $23.4 million, respectively, in connection with its equity investments.

Concentrations of Risk

Cash, cash equivalents, restricted cash, and marketable debt securities are financial instruments that potentially subject the Company to concentrations of risk. We invest our cash in corporate debt securities and U.S. sponsored agencies with strong credit ratings. We have established guidelines relative to diversification and maturities that are designed to help ensure safety and liquidity. These guidelines are periodically reviewed to take advantage of trends in yields and interest rates.

Cash, cash equivalents, and restricted cash are maintained at financial institutions, and at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. Amounts on deposit in excess of federally insured limits at December 31, 2023 and 2022 approximated$53.8 million and $53.6 million, respectively.

We have payables with twoservice providers that represent 38% of our total payables and with two service providers that represented 45% of our total payables at December 31, 2023 and 2022, respectively. We rely onsix critical suppliers for the manufacture of our drug product for use in our clinical trials. While we believe that there are alternative vendors available, a change in manufacturing vendors could cause a delay in the availability of drug product and result in a delay of conducting and completing our clinical trials. No other vendor accounted for more than 10% of total payables at December 31, 2023 or 2022.

We have receivables with three customers and service providers that represent 76%of our total receivables and with four customers and service providers that represent 91% of our total receivables at December 31, 2023 and 2022, respectively. The receivables are related to cost share reimbursement and royalty revenues from our licensing and collaboration agreements. No other customer accounted for more than 10% of total receivables at December 31, 2023 or 2022.

Fair Value of Financial Instruments

Our financial instruments primarily consist of cash and cash equivalents, marketable debt securities, accounts receivable, accounts payable, and accrued expenses. Marketable debt securities and cash equivalents are carried at fair value. The fair value of a financial instrument is the amount that would be received in an asset sale or paid to transfer a liability in an orderly transaction between unaffiliated market participants. The fair value of the other financial instruments closely approximate their fair value due to their short maturities.

The Company accounts for recurring and non-recurring fair value measurements in accordance with FASB ASC 820, Fair Value Measurements and Disclosures. ASC 820 defines fair value, establishes a fair value hierarchy for assets and liabilities measured at fair value, and requires expanded disclosure about fair value measurements. The ASC 820 hierarchy ranks the quality of reliable inputs, or assumptions, used in the determination of fair value and requires assets and liabilities carried at fair value to be classified and disclosed in one of the following three categories:

Level 1—Fair value is determined by using unadjusted quoted prices that are available in active markets for identical assets or liabilities.

Level 2—Fair value is determined by using inputs other than Level 1 quoted prices that are directly or indirectly observable. Inputs can include quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in markets that are not active. Related inputs can also include those used in valuation or other pricing models, such as interest rates and yield curves that can be corroborated by observable market data.

Level 3—Fair value is determined by inputs that are unobservable and not corroborated by market data. Use of these inputs involves significant and subjective judgments to be made by the reporting entity – e.g. determining an appropriate discount factor for illiquidity associated with a given security.

The Company measures the fair value of financial assets using the highest level of inputs that are reasonably available as of the measurement date. The assets recorded at fair value are classified within the hierarchy as follows for the periods reported (in thousands):

Our policy is to record transfers of assets between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. During the years ended December 31, 2023 and 2022, there were no transfers between Level 1 and Level 2.

Property and Equipment

Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Expenditures for repairs and maintenance are charged to expense as incurred, while renewals and improvements are capitalized. Useful lives by asset category are as follows:

Patents, Licenses, and Other Intangible Assets

The cost of acquiring licenses is capitalized and amortized on the straight-line basis over the shorter of the term of the license or its estimated economic life, ranging from 1 to 20 years. Third-party costs incurred for acquiring patents are capitalized. Capitalized costs are accumulated until the earlier of the period that a patent is issued, or we abandon the patent claims. Cumulative capitalized patent costs are amortized on a straight-line basis from the date of issuance over the shorter of the patent term or the estimated useful economic life of the patent, ranging from 2 to 27 years. Our senior management, with advice from outside patent counsel, assesses three primary criteria to determine if a patent will be capitalized initially: i) technical feasibility, ii) magnitude and scope of new technical function covered by the patent compared to the company’s existing technology and patent portfolio, particularly assessing the value added to our product candidates or licensing business, and iii) legal issues, primarily assessment of patentability and prosecution cost. We review our intellectual property on a regular basis to determine if there are changes in the estimated useful life of issued patents and if any capitalized costs for unissued patents should be abandoned. Capitalized patent costs related to abandoned patent filings are charged off in the period of the decision to abandon. During 2023, 2022, and 2021, we abandoned previously capitalized patent and licensing related charges of $1.3 million, $1.5 million, and $0.9 million, respectively.

The carrying amount and accumulated amortization of patents, licenses, and other intangibles is as follows (in thousands):

Amortization expense for patents, licenses, and other intangible assets was $1.3 million, $1.4 million, and $1.2 million for the years ended December 31, 2023, 2022, and 2021, respectively.

Future amortization expense for patents, licenses, and other intangible assets recorded as of December 31, 2023, and for which amortization has commenced, is as follows:

The above amortization expense forecast is an estimate. Actual amounts of amortization expense may differ from estimated amounts due to additional intangible asset acquisitions, impairment of intangible assets, accelerated amortization of intangible assets, and other events. As of December 31, 2023, the Company has $9.7 million of intangible assets which are in-process and have not been placed in service, and accordingly amortization on these assets has not commenced.

Long-Lived Assets

Management reviews long-lived assets which include fixed assets and amortizable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset (or asset group) may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

We did not recognize a loss from impairment for the years ended December 31, 2023, 2022, or 2021.

Income Taxes

We account for income taxes in accordance with accounting guidance which requires an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

We assess our income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances, and information available at the reporting date. For those tax positions where there is greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is a 50% or less likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. We did not have any material uncertain tax positions at December 31, 2023 or 2022.

Our policy is to recognize interest and penalties on taxes, if any, as a component of income tax expense.

The Tax Cuts and Jobs Act of 2017 (TCJA) enacted on December 22, 2017 included several key provisions impacting the accounting for and reporting of income taxes. The most significant provisions reduced the U.S. corporate statutory tax rate from 35% to 21%, eliminated the corporate Alternative Minimum Tax (AMT) system, and made changes to the carryforward of net operating losses beginning on January 1, 2018. The TCJA changed the income tax treatment of research and development expenses requiring such costs to be capitalized and amortized over several years beginning effective January 1, 2022. We recorded a federal tax expense of $5.8 million and $0.7 million for the years ended December 31, 2023 and 2022, respectively.

Stock-Based Compensation

We recognize compensation expense using a fair-value-based method for costs related to all share-based payments, including stock options, restricted stock units (RSUs), and shares issued under our Employee Stock Purchase Plan (ESPP). Stock-based compensation cost related to employees and directors is measured at the grant date, based on the fair-value-based measurement of the award using the Black-Scholes method, and is recognized as expense over the requisite service period on a straight-line basis. We account for forfeitures when they occur. We recorded stock-based compensation and expense for stock-based awards to employees, directors, and consultants of approximately $53.8 million, $48.9 million, and $37.0 million for the years ended December 31, 2023, 2022, and 2021, respectively.

Net Income (Loss) Per Share

Basic net income (loss) per common share attributable to Xencor is computed by dividing the net income (loss) attributable to Xencor by the weighted-average number of common shares outstanding during the period without consideration of common stock equivalents. Diluted net income (loss) per common share attributable to Xencor is computed by dividing the net income (loss) attributable to Xencor by the weighted-average number of common stock equivalents outstanding for the period. Potentially dilutive securities consisting of stock issuable pursuant to outstanding options and restricted stock units (RSUs), and stock issuable pursuant to the 2013 Employee Stock Purchase Plan (ESPP) are not included in the per common share calculation in periods when the inclusion of such shares would have an anti-dilutive effect.

Basic and diluted net income (loss) per common share attributable to Xencor is computed as follows:

Basic net income (loss) per common share is computed by dividing the net income or loss attributable to Xencor by the weighted-average number of common shares outstanding during the period.

Potentially dilutive securities were included in the calculation of diluted net income per common share attributable to Xencor for 2021. In 2023 and 2022, we excluded all options and awards from the calculations because we reported net losses in the period, and the inclusion of such shares would have had an antidilutive effect.

For the years ended December 31, 2023 and 2022, all outstanding potentially dilutive securities were excluded from the calculation as the effect of including such securities would have been anti-dilutive. For the year ended December 31, 2021, we excluded 1,196,268 shares of options and RSUs from the calculation of diluted net income per common share because the inclusion of such shares would have had an anti-dilutive effect.

Segment Reporting

The Company determines its segment reporting based upon the way the business is organized for making operating decisions and assessing performance. The Company has onlyone operating segment related to the development of pharmaceutical products.

2. Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss). For the years ended December 31, 2023, 2022, and 2021, the only component of other comprehensive income (loss) is net unrealized gain (loss) on marketable debt securities. There were no material reclassifications out of accumulated other comprehensive loss during the year ended December 31, 2023.

3. Marketable Debt and Equity Securities

The Company’s marketable debt securities held as of December 31, 2023 and 2022 are summarized below:

The maturities of the Company’s marketable debt securities as of December 31, 2023 are as follows:

The unrealized losses on available-for-sale investments and their related fair values as of December 31, 2023 and 2022 are as follows:

The unrealized losses from the listed securities are due to a change in the interest rate environment and not a change in the credit quality of the securities.

The Company’s equity securities include securities with a readily determinable fair value. These investments are carried at fair value with changes in fair value recognized each period and reported within other income (expense). Equity securities with a readily determinable fair value and their fair values (in thousands) as of December 31, 2023 and 2022 are as follows:

The Company also has an investment in an equity security without a readily determinable fair value. The Company elects the measurement alternative to record these investments at their initial cost and evaluates such investments at each reporting period for evidence of impairment or observable price changes in orderly transactions for the identical or a similar investment of the same issuer. During the year ended December 31, 2022, the Company recorded an impairment charge of $0.1 million related to the Astria preferred stock. Equity securities without a readily determinable fair value and their carrying values (in thousands) as of December 31, 2023 and 2022 are as follows:

In 2018, the Company received common and preferred stock in Astria (formerly Quellis Biosciences, Inc.) in connection with a licensing transaction. In January 2023, the Company exchanged its preferred shares for additional shares of common stock in Astria. The common stock has a readily determinable fair value, and difference in the fair value of the common stock and the carrying value of the preferred stock has been recorded as a gain in equity securities for the year ended December 31, 2023. The Company accounts for the shares in Astria common stock at their fair value each reporting period and the adjustment in the fair value of the Astria common stock has been recorded in unrealized gain (loss) on equity securities for the year ended December 31, 2023.

The Company records its investment in the shares of Astria preferred stock as an equity interest without a readily determinable fair value. The Company elected to record the original shares of preferred stock at their initial cost and to review the carrying value for impairment or other changes in carrying value at each reporting period. The Company subsequently recorded impairment charges of $0.1 million and $0.8 million related to its investment in Astria’s preferred stock in 2022 and 2021, respectively.

In 2017, the Company received shares of common stock of INmune Bio, Inc. (INmune) and an option to acquire additional shares of INmune’s common stock in connection with a licensing transaction. In June 2021, the Company entered into an Option Cancellation Agreement with INmune and received $15.0 million in proceeds and an additional shares of INmune common stock in exchange for the initial option. During 2021, the Company determined that it should no longer account for its investment in INmune under the equity method. In September 2021, the Company exercised its second option to purchase 108,000 shares of INmune common stock for $0.8 million and the Company recorded a gain of $0.9 million on the purchase. The Company's current share holdings, which consist of common stock of INmune, have a readily determinable fair value, and the adjustment in the fair value of the shares of INmune common stock was recorded in gain (loss) on equity securities for the year ended December 31, 2023.

In December 2021, the Company received shares of common stock of Viridian Therapeutics, Inc. (Viridian) in connection with the Viridian Agreement. In December 2022, the Company received additional shares of common stock of Viridian in connection with the Second Viridian Agreement (defined below). The shares of Viridian common stock are classified as equity securities with a readily determinable fair value and the adjustment in the fair value of the shares of Viridian common stock was recorded in gain (loss) on equity securities for the year ended at December 31, 2023.

In 2020, the Company received an equity interest in Zenas BioPharma (Cayman) Limited (Zenas), in connection with the Zenas Agreement (defined below). The Company elected the measurement alternative to carry the Zenas equity at cost minus impairment, plus or minus changes resulting from observable price changes in orderly transactions for an identical or a similar investment of the same issuer. In 2021, the Company received a warrant to receive equity from Zenas in connection with the Second Zenas Agreement (defined below). In 2021, the Company purchased a convertible promissory note from Zenas. In 2022, the Zenas warrant was exchanged for additional equity in Zenas. In 2022, the convertible note and accrued interest through the conversion date were exchanged for equity shares in Zenas. During 2022, the Company recognized an unrealized gain of $21.9 million from the warrant exchange and the conversion of the promissory note. In 2023, Zenas initiated a Phase 3 trial and we received a milestone of additional equity in Zenas with a fair value of $10.0 million. The Company recorded the additional equity at its fair value. During the year ended December 31, 2023, there was no impairment related to this investment.

Unrealized gains and losses recognized on equity securities (in thousands) during the year ended December 31, 2023 and 2022 consist of the following:

4. Sale of Additional Common Stock

Under the terms of the Stock Purchase Agreement (defined below), Johnson & Johnson Innovation, JJDC, Inc. (JJDC), purchased $25.0 million of newly issued unregistered shares of the Company’s common stock, priced at a 30-day volume-weighted average price of $33.4197 per share as of October 1, 2021. The Company issued 748,062 shares of common stock to JJDC on November 12, 2021. The issued shares are subject to customary resale restrictions pursuant to Rule 144 of the Securities Act of 1933.

5. Property and Equipment

Property and equipment consist of the following:

Leasehold and tenant improvements consist primarily of leasehold construction at our new Pasadena headquarters.

Depreciation expense related to property and equipment in 2023, 2022, and 2021 was $10.1 million, $7.4 million, and $6.3 million, respectively.

6. Income Taxes

Our effective tax rate differs from the statutory federal income tax rate, primarily as a result of the changes in valuation allowance. The provision for current federal income taxes for the years ended December 31, 2023 and 2022 were $5.8 million and $0.7 million, respectively. There wasno provision for taxes for the years ended December 31, 2021. There is no state income tax provision for the years ended December 31, 2023, 2022 and 2021, respectively.

A reconciliation of the federal statutory income tax to our effective income tax is as follows (in thousands):

The tax effect of temporary differences that give rise to a significant portion of the deferred tax assets and liabilities at December 31, 2023 and 2022 is presented below (in thousands):

The Tax Cuts and Jobs Act of 2017 (TCJA) was enacted in December 2017 and made substantial changes in the U.S. tax system. The significant changes made by the TCJA include a reduction in the maximum corporate income tax rate and the requirement that research and development costs incurred after December 31, 2021 to be capitalized and amortized over several years. We have recorded a deferred asset for each year ended December 31, 2023 and 2022, respectively. for such capitalized research and development costs. We have net deferred tax assets relating primarily to capitalized research and development costs, net operating loss carryforwards and research and development tax credit carryforwards. Due to the uncertainty surrounding the realization of the benefits of our deferred tax assets in future tax periods, we have placed a valuation allowance against our deferred tax assets at December 31, 2023 and 2022. The Company recognizes valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company’s net deferred income tax asset is not more likely than not to be realized due to the lack of sufficient sources of future taxable income and cumulative losses that have resulted over the years. During the year ended December 31, 2023, the valuation allowance increased by $43.1 million. The Company’s tax years starting in 2019 through 2022 remain open to potential examination by the U.S. and state taxing authorities due to carryforwards of net operating losses and income tax credits.

As of December 31, 2023, we had cumulative net operating loss carryforwards for federal and state income tax purposes of $54.2 million and $158.8 million, respectively, and available tax credit carryforwards of approximately $33.6 million for federal income tax purposes and $24.8 million for state income tax purposes, which can be carried forward to offset future taxable income, if any. All of the federal net operating loss carryforwards were incurred prior to January 1, 2018, which are subject to carryforward limitations. To the extent allowed by law, taxing authorities may examine prior periods where net operating losses were carried forwards and were claimed and offset against current year taxable income, and make adjustments up to the amount of the net operating loss carryforward amount.

Our federal net operating loss carryforwards expire starting in 2027, state net operating loss carryforwards expire starting in 2035, and federal tax credit carryforwards begin to expire in 2034. Utilization of our net operating loss and tax credit carryforwards are subject to a substantial annual limitation under Section 382 of the Code due to the fact that we have experienced ownership changes. As a result of these changes, certain of our net operating loss and tax credit carryforwards may expire before we can use them.

7. Stock-Based Compensation

In 2013 , our Board of Directors and our stockholders approved the 2013 Equity Incentive Plan (the 2013 Plan). The 2013 Plan provides for the grant of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards, and other stock awards. The 2013 Plan had aten-year term and would expire on December 3, 2023.

In June 2023, the Board and shareholders approved the 2023 Equity Incentive Plan (the 2023 Plan), which became effective as of June 14, 2023. We suspended the 2013 Plan, and no additional award may be granted under the 2013 Plan. The 2023 Plan reserve consists of 3,000,000 shares and the remaining available shares from the 2013 Plan as of the effective date of the 2023 Plan. In addition, any shares of common stock covered by awards granted under the 2013 Plan that terminate on or after June 14, 2023 by expiration, forfeiture, cancellation, or other means without the issuance of such shares will be added to the 2023 Plan reserve.

The 2013 Plan provided for an automatic increase in the number of shares annually on January 1 by 4% of the total number of issued and outstanding shares of common stock as of December 31 of the immediately preceding year. On January 1, 2023, pursuant to approval by the Board, the total number of shares of common stock available for issuance under the 2013 Plan was increased by 2,399,908 shares. The 2023 Plan does not include a provision for an automatic increase in shares, also known as an Evergreen provision.

As of December 31, 2023, the total number of shares of common stock available for issuance under the 2023 Plan was 19,434,971, which includes 16,932,548 shares of common stock that were available for issuance under the Prior Plans as of the effective date of the 2023 Plan. As of December 31, 2023, a total of 16,616,038 options have been granted under the 2013 Plan and 2023 Plan.

As of December 31, 2023, the Company has awarded 2,994,168 RSUs to certain employees pursuant to the 2013 Plan and 2023 Plan. Vesting of these awards will be annually over equal installments, either atwo orthree-year vesting period, and is contingent on continued employment terms. The fair value of these awards is determined based on the intrinsic value of the stock on the date of grant and will be recognized as stock-based compensation expense over the requisite service period.

In November 2013, our Board of Directors and stockholders approved the 2013 Employee Stock Purchase Plan (2013 ESPP), which became effective as of December 5, 2013. Under the ESPP our employees may elect to have between 1-15% of their compensation withheld to purchase shares of the Company’s common stock at a discount. The ESPP had an initialtwo-year term that included four six-month purchase periods, and employee withholding amounts could be used to purchase Company stock during eachsix-month purchase period. The initialtwo-year term ended in December 2015 and, pursuant to the provisions of the ESPP, subsequenttwo-year terms began automatically upon the end of the previous term. The total number of shares that can be purchased with the withholding amounts are based on the lower of 85% of the Company’s common stock price at the initial offering date or 85% of the Company’s stock price at each purchase date.

As of December 31, 2023, the total number of shares of common stock available for issuance under the ESPP is 1,041,340. Under the 2013 ESPP, the total number shares of common stock available for issuance under the ESPP will automatically increase annually on January 1 by the lesser of (i)1% of the total number of issued and outstanding shares of common stock as of December 31 of the immediately preceding year, or (ii)621,814 shares of common stock. Pursuant to approval by our board, the total number of shares of common stock available for issuance under the ESPP was increased by 599,977 shares on January 1, 2023.

As of December 31, 2023, we have issued a total of 733,478 shares of common stock under the ESPP.

Total employee, director and non-employee stock-based compensation expense recognized was as follows:

Information with respect to stock options outstanding is as follows:

The following table summarizes stock option activity for the years ended December 31, 2023 and 2022:

(1)The weighted average exercise price per share is determined using exercise price per share for stock options.

(2)The aggregate intrinsic value is calculated as the difference between the exercise price of the option and the fair value of our common stock for in-the-money options at December 31, 2023 and 2022.

(3)The total intrinsic value of stock options exercised was $4.8 million, $1.6 million, and $9.2 million for the years ended December 31, 2023, 2022 and 2021 respectively.

We estimated the fair value of employee and non-employee awards using the Black-Scholes valuation model. The fair value of employee stock options is being amortized on a straight-line basis over the requisite service period of the awards. Management estimates the probability of non-employee awards being vested based upon an evaluation of the non-employee achieving their specific performance goals.

Options are issued at the fair market value of our stock on the date of grant.

The fair value of employee stock options was estimated using the following weighted average assumptions for the years ended December 31, 2023, 2022 and 2021:

The expected term of stock options represents the average period the stock options are expected to remain outstanding. The expected stock price volatility for our stock options for the years ended December 31, 2023, 2022, and 2021 was determined using a blended volatility by examining the historical volatility for industry peer companies and the volatility of our stock from the effective date that our shares were publicly traded on a national stock exchange.

We determined the average expected life of stock options based on the anticipated time period between the measurement date and the exercise date by examining the option holders’ past exercise patterns.

The risk-free interest rate assumption is based on the U.S. Treasury instruments, for which the term was consistent with the expected term of our stock options.

The expected dividend assumption is based on our history and expectation of dividend payouts. We have not paid dividends and did not have any dividend payout at December 31, 2023.

The following table summarizes RSU activity for the years ended December 31, 2023:

As of December 31, 2023 and 2022, the unamortized compensation expense related to unvested stock options was $49.2 million and $52.6 million, respectively. The remaining unamortized compensation expense will be recognized over the next 2.39 years. At December 31, 2023 and 2022, the unamortized compensation expense was $1.8 million and $1.2 million respectively under our ESPP. The remaining unamortized expense will be recognized over the next 1.94 years. At December 31, 2023 and 2022, the unamortized compensation expense related to unvested restricted stock units was $29.6 million and $28.3 million, respectively. The remaining unamortized compensation expense will be recognized over the next 1.90 years.

8. Leases

The Company leases office and laboratory space in Monrovia, California undertwo separate leases; one lease expired in January 2023, and a second lease will expire in December 2025. The second lease includes an option to renew for an additional five years at then market rates. The initial lease expired in January 2023, and the Company has assessed that it is unlikely to exercise the lease term extension option for the second lease that will expire in December 2025. For the year ended December 31, 2023, there wereno ROU assets obtained in exchange for new operating lease liabilities.

The Company leases additional office space in San Diego, California under a lease that expired December 31, 2023.

In August 2023, the Company entered into a Sublease Agreement for office space in San Diego, California. The term of the Sublease Agreement begins in September 2023 and ends in December 2027. For the year ended December 31, 2023, ROU assets obtained in exchange for new operating lease liabilities were $2.5 million. In connection with the Sublease Agreement, the Company provided a $0.4 million Letter of Credit (LOC) to the landlord. The Letter of Credit will decline ratably over the term of the lease. In connection with the LOC, Company entered into a Cash Collateral Agreement for $0.4 million, which is classified as restricted cash in the Consolidated Balance Sheets.

In June 2021, the Company entered into an 18-month lease for office space in Monrovia, California. The lease began August 1, 2021 and terminated January 31, 2023. For the year ended December 31, 2023, there wereno ROU assets obtained in exchange for new operating lease liabilities.

In June 2021, the Company entered into an Agreement of Lease (the Halstead Lease) relating to 129,543 rentable square feet, for laboratory and office space, in Pasadena, California. The term of the Halstead Lease became effective intwo phases. The first phase commenced on July 14, 2021 and encompasses 83,083 square feet while the second phase commences no later than July 1, 2025 and encompasses an additional 46,460 square feet. The term of the Halstead Lease is 13 years from the first phase commencement date. The Company received delivery of the first phase premises on July 1, 2021 and completed construction of office, laboratory, and related improvements in 2023. The Company placed the new facility into service in February 2023. The Halstead Lease provides the Company with improvement allowances of up to $17.0 million and $3.3 million in connection with the Phase 1 and Phase 2 building improvements, respectively. The initial base monthly rent is $386,336, or $4.65 per square foot, and includes increases ofthree percent annually. The Company will also be responsible for its proportionate share of operating expenses, tax expense, and utility costs.

In July 2021, the Halstead Lease was amended to clarify the start date of the new lease to August 1, 2022 and to amend other provisions of the Halstead Lease to reflect the new start date of the lease. In August 2022, the Halstead lease was amended to increase the amount of the tenant allowance by $5.0 million with a corresponding increase in total rental payments. The Company is eligible to receive total tenant allowance under the lease for the phase 1 space of $22.0 million and the initial base rent is increased to $416,246, or $5.01 per square foot. The second phase premises was made available on December 1, 2022. For the year ended December 31, 2023, there wereno ROU assets obtained in exchange for new operating lease liabilities.

The Company’s lease agreements do not contain any residual value guarantees or restrictive covenants.

The following table reconciles the undiscounted cash flows for the operating leases at December 31, 2023 to the operating lease liabilities recorded on the balance sheet (in thousands):

The following table summarizes lease costs, cash, and other disclosures for the years ended December 31, 2023, 2022, and 2021 (in thousands):

9. Commitments and Contingencies

Contingencies

From time to time, the Company may be subject to various litigation and related matters arising in the ordinary course of business. The Company does not believe it is currently subject to any material matters where there is at least a reasonable possibility that a material loss may be incurred.

We are obligated to make future payments to third parties under in-license agreements, including sublicense fees, royalties, and payments that become due and payable on the achievement of certain development and commercialization milestones. As the amount and timing of sublicense fees and the achievement and timing of these milestones are not probable and estimable, such commitments have not been included on our balance sheet. We have also entered into agreements with third party vendors which will require us to make future payments upon the delivery of goods and services in future periods.

Guarantees

In the normal course of business, we indemnify certain employees and other parties, such as collaboration partners and other parties that perform certain work on behalf of, or for the Company or take licenses to our technologies. We have agreed to hold these parties harmless against losses arising from our breach of representations or covenants, intellectual property infringement or other claims made against these parties in performance of their work with us.

These agreements typically limit the time within which the party may seek indemnification by us and the amount of the claim. It is not possible to prospectively determine the maximum potential amount of liability under these indemnification agreements since we have not had any prior indemnification claims on which to base the calculation. Further, each potential claim would be based on the unique facts and circumstances of the claim and the particular provisions of each agreement. We are not aware of any potential claims and we did not record a liability as of December 31, 2023 and 2022.