Apellis Pharmaceuticals, Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2019

OR

For the transition period from                      to                     

Commission File Number: 001-38276

APELLIS PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (502) 241-4114

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 1, 2019, the registrant had 63,888,238 shares of common stock, $0.0001 par value per share, outstanding.

Table of Contents

i

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

APELLIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited condensed consolidated financial statements

1

APELLIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

2

Apellis Pharmaceuticals, Inc.

CONDENSED Consolidated Statements of CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

3

Apellis Pharmaceuticals, Inc.

CONDENSED Consolidated Statements of CHANGES IN STOCKHOLDERS’ EQUITY

COntinued

(Unaudited)

See accompanying notes to unaudited condensed consolidated financial statements

4

Apellis Pharmaceuticals, Inc.

CONDENSED Consolidated Statements of Cash Flows

See accompanying notes to unaudited condensed consolidated financial statements

5

APELLIS PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2018 AND 2019

1. Nature of Organization and Operations

Apellis Pharmaceuticals, Inc. (the “Company”) is a clinical-stage biopharmaceutical company focused on the development of novel therapeutic compounds to treat disease through the inhibition of the complement system, which is an integral component of the immune system, at the level of C3, the central protein in the complement cascade.

The Company was incorporated in September 2009 under the laws of the State of Delaware and has its principal office in Crestwood, Kentucky. The Company plans to relocate its principal office to Waltham, Massachusetts, effective as of January 1, 2020.

The Company’s operations since inception have been limited to organizing and staffing the Company, acquiring rights to product candidates, business planning, raising capital and developing its product candidates.

The Company is subject to risks common in the biotechnology industry including, but not limited to, raising additional capital, development by its competitors of new technological innovations, its ability to successfully complete preclinical and clinical development of product candidates and receive timely regulatory approval of products, market acceptance of the Company’s products, protection of proprietary technology, healthcare cost containment initiatives, and compliance with governmental regulations, including those of the U.S. Food and Drug Administration (“FDA”).

Convertible Notes Offering

On September 16, 2019, the Company completed a private offering of $220,000,000 aggregate principal amount of 3.5% convertible senior notes due 2026 (the “Convertible Notes”). The Company also granted the initial purchasers an option to purchase within a 13-day period from, and including, September 16, 2019 up to an additional $33,000,000 aggregate principal amount of the Convertible Notes, solely to cover over-allotments, which was not exercised and expired as of September 30, 2019.

The net proceeds from the sale of the Convertible Notes were approximately $212,895,000 after deducting the initial purchasers’ discounts and commissions and estimated offering expenses payable by the Company. The Company used $28,380,000 of the net proceeds from the offering to pay the cost of the capped call transactions described below.

On September 16, 2019, the Company entered into an indenture (the “Indenture”) with respect to the Convertible Notes with U.S. Bank National Association, as trustee (the “Trustee”). The Convertible Notes are senior unsecured obligations of the Company and bear interest at a rate of 3.5% per year payable semiannually in arrears on March 15 and September 15 of each year, beginning on March 15, 2020. The Convertible Notes will mature on September 15, 2026, unless earlier converted, redeemed or repurchased in accordance with their terms. See Note 5 – Long-term Debt for additional information.       

Capped Call Transactions

On September 11, 2019, concurrently with the pricing of the Convertible Notes, the Company entered into capped call transactions with two counterparties. The capped call transactions are expected generally to reduce the potential dilution to the Company’s common stock upon any conversion of the Convertible Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted Convertible Notes, as the case may be, in the event that the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions, is greater than the strike price of the capped call transactions, which is initially $39.4625 (the conversion price of the Convertible Notes) and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of such Convertible Notes.  

Development Derivative Liability

On February 28, 2019, the Company entered into a development funding agreement with SFJ Pharmaceuticals Group (“SFJ”) under which SFJ agreed to provide funding to the Company to support the development of APL-2 for the treatment of patients with paroxysmal nocturnal hemoglobinuria (“PNH”) (“SFJ Agreement”).  Pursuant to the agreement, SFJ paid the Company $60,000,000 following the signing of the agreement, and agreed to pay the Company up to an additional $60,000,000 in the aggregate in three equal installments upon the achievement of specified development milestones with respect to the Company’s Phase 3 program for APL-2 in PNH and subject to the Company having cash resources at the time sufficient to fund at least ten months of the Company’s operations. In addition, upon the mutual agreement of the Company and SFJ, at any time after the earlier of the date that

6

the Company has reviewed the primary endpoint data from its PEGASUS Phase 3 trial of APL-2 in patients with PNH and March 31, 2020, SFJ may fund an additional $50,000,000 of the Company’s development costs (the “Additional SFJ Funding”).

On June 7, 2019, the Company and SFJ amended the development funding agreement (the “SFJ Amendment”).  Under the SFJ Amendment, SFJ agreed to make an additional $20,000,000 funding payment to the Company to support the development of APL-2 for the treatment of patients with PNH. This additional $20,000,000 payment is in addition to and not part of the Additional SFJ Funding.

On June 27, 2019, the Company received $40,000,000 from SFJ, consisting of $20,000,000 as the first installment of the additional $60,000,000 upon the achievement of a milestone and the $20,000,000 payable under the SFJ Amendment.

On September 23, 2019, the Company received $20,000,000 from SFJ as the second installment of the additional $60,000,000 upon the achievement of a milestone.

The Company expects that the remaining development milestone under the SFJ Agreement will be achieved and the remaining $20,000,000 of the additional $60,000,000 will be paid during the first quarter of 2020.

Follow-on Public Offerings

On March 11, 2019, the Company issued and sold 6,900,000 shares of its common stock at a price per share of $17.00 in a follow-on public offering (“2019 follow-on offering”).  The Company received net proceeds of $109,603,159 after deducting underwriting discounts and commissions of $7,000,000 and offering costs of $680,891.

On April 23, 2018, the Company issued and sold 5,500,000 shares of its common stock at a price per share of $25.50 in a follow-on public offering (“2018 follow-on offering”).  The Company received net proceeds of $131,324,477 after deducting underwriting discounts and commissions of $8,415,000 and offering costs of $509,973.

     Liquidity and Financial Condition

The accompanying unaudited condensed consolidated financial statements have been prepared on the basis of the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. As of October 30, 2019, the date of issuance of these unaudited condensed consolidated financial statements, the Company believes that its cash and cash equivalents as of September 30, 2019 of $433,994,644 will be sufficient to fund its operations for at least the next twelve months from the date of issuance of the unaudited interim consolidated financial statements. The future viability of the Company beyond that point is dependent on its ability to raise additional capital to finance its operations.

The Company is subject to risks common to other life science companies in the development stage including, but not limited to, uncertainty of product development and commercialization, lack of marketing and sales history, development by its competitors of new technological innovations, dependence on key personnel, market acceptance of products, product liability, protection of proprietary technology, ability to raise additional financing, and compliance with FDA and other government regulations. If the Company does not successfully commercialize any of its product candidates, it will be unable to generate recurring product revenue or achieve profitability. Management’s plans in order to meet its short-term and longer-term operating cash flow requirements include obtaining additional funding.

There are uncertainties associated with the Company’s ability to (1) obtain additional debt or equity financing (2) enter into collaborative agreements with strategic partners, and (3) succeed in its future operations. If the Company is not able to obtain the required capital to fund its operations from any of these, or is not able to obtain such funding on terms that are favorable to the Company, it could be forced to delay, reduce or eliminate its research and development programs or future commercialization efforts and its business could be materially harmed.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Apellis Australia Pty Ltd, Apellis Ireland Ltd and Apellis Switzerland GmbH. All intercompany balances and transactions have been eliminated in consolidation. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and following the requirements of the Securities and Exchange Commission (the “SEC”), for interim reporting. As permitted under those rules, certain footnotes or other

7

financial information that are normally required by U.S. GAAP have been condensed or omitted and, accordingly, the balance sheet as of December 31, 2018 has been derived from audited consolidated financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements. These financial statements have been prepared on the same basis as the Company’s annual financial statements and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of the Company’s financial information. The results of operations for the nine months ended September 30, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019 or for any other interim period or for any other future year.

The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2019.

Fair Value of Financial Instruments

The Company is required to disclose information on the fair value of financial instruments and inputs that enable an assessment of the fair value.  The three levels of the fair value hierarchy prioritize valuation inputs based upon the observable nature of those inputs as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities;

Level 2 – Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly;

Level 3 – Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability. 

The Company’s financial instruments, in addition to those presented in Note 5, Long-Term Debt, and Note 7, Fair Value Measurements, include cash and cash equivalents, the Australian research and development credit, accounts payable and accrued liabilities.  Management believes that the carrying amounts of cash and cash equivalents, the Australian research and development credit, accounts payable and accrued expenses approximate the fair value due to the short-term nature of those instruments.

Cash and Cash Equivalents

Cash and cash equivalents are defined as cash in banks and investment instruments having maturities of three months or less from their acquisition date. The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents are valued at cost, which approximates their fair value.

Foreign Currency

The financial position and results of operations of the Company's Australian and Swiss subsidiaries is measured using the foreign subsidiary's local currency. Revenues and expenses of the subsidiaries have been translated into U.S. dollars at average exchange rates prevailing during the period from January 1, through September 30, 2019. Assets and liabilities have been translated at the rates of exchange on the balance sheet date. The resulting translation gain and loss adjustments are recorded directly as a separate component of stockholders’ equity.

In 2018, due to the growth in volume of research contracts and intercompany loans exclusively denominated in local currency, effective August 1, 2018, the functional currency of the Company’s Australian subsidiary was changed from the U.S. dollar to the Australian dollar. The impact of the change in functional currency was not material to the audited consolidated financial statements for the year ended December 31, 2018.  

Reclassifications

Certain prior year amounts have been reclassified to conform to the 2019 presentation.

8

3. Accrued Expenses

Accrued expenses are as follows:

4. Development Derivative Liability

On February 28, 2019, the Company entered into the SFJ Agreement under which SFJ agreed to provide funding to the Company to support the development of APL-2 for the treatment of patients with PNH.  Pursuant to the agreement, SFJ paid the Company $60,000,000 following the signing of the agreement, and agreed to pay the Company up to an additional $60,000,000 in the aggregate in three equal installments upon the achievement of specified development milestones with respect to the Company’s Phase 3 program for APL-2 in PNH and subject to the Company having cash resources at the time sufficient to fund at least 10 months of the Company’s operations. In addition, upon the mutual agreement of the Company and SFJ, at any time after the earlier of the date that the Company has reviewed the primary endpoint data from its PEGASUS Phase 3 trial of APL-2 in patients with PNH and March 31, 2020, SFJ may fund an additional $50,000,000 of the Company’s development costs.

On June 7, 2019, the Company and SFJ amended the development funding agreement.  Under the SFJ Amendment, SFJ agreed to make an additional $20,000,000 funding payment to the Company to support the development of APL-2 for the treatment of patients with PNH. This additional $20,000,000 payment is in addition to and not part of the Additional SFJ Funding.

On June 27, 2019, the Company received $40,000,000 from SFJ, consisting of $20,000,000 as the first installment of the additional $60,000,000 upon the achievement of a milestone and the $20,000,000 payable under the SFJ Amendment.

On September 23, 2019, the Company received $20,000,000 from SFJ as the second installment of the additional $60,000,000 upon the achievement of a milestone.

The Company expects that the remaining development milestone under the SFJ Agreement will be achieved and the remaining $20,000,000 of the additional $60,000,000 will be paid during the first quarter of 2020.

Under the SFJ Agreement following regulatory approval by the FDA or EMA for the use of APL-2 as a treatment for PNH the Company will be obligated to pay SFJ an initial payment of up to $5,000,000 (or a total of $10,000,000 if regulatory approval is granted by the FDA and the EMA) and then up to an additional $226,000,000 in the aggregate (or up to $452,000,000 if regulatory approval is granted by the FDA and the EMA) in six additional annual payments with the majority of the payments being made from the third anniversary to the sixth anniversary of regulatory approval. Such payments will be proportionately adjusted in the event that the actual funding from SFJ is lower or greater than $120,000,000 (including as a result of the payment of the Additional SFJ Funding but excluding the $20,000,000 funding payment made under the SFJ Amendment). Additionally, the Company granted a security interest in all of its assets, excluding intellectual property and license agreements to which it is a party. In connection with the grant of the security interest, the Company agreed to certain affirmative and negative covenants, including restrictions on its ability to pay dividends, incur additional debt or enter into licensing transactions with respect to its intellectual property, other than specified types of licenses.

The SFJ Agreement is presented as a derivative liability on the balance sheet as of September 30, 2019. The liability was initially recorded at the value of the $60,000,000 aggregate cash received pursuant to the contractual terms, which was determined to have been fair value, and subsequently remeasured at March 31, 2019 as a level 3 derivative, with the change in fair value of $736,000 recorded for the three months ended March 31, 2019 in loss from remeasurement of development derivative liability on the income statement. The Company received an additional $40,000,000 in June 2019 and the derivative liability under the SFJ Agreement (as amended) was subsequently remeasured at June 30, 2019 as a level 3 derivative, with the change in fair value of $9,104,000 recorded for the three months ended June 30, 2019 in loss from remeasurement of development derivative liability on the income statement.  The Company received an additional $20,000,000 in September 2019 and the derivative liability under the SFJ Agreement (as amended) was subsequently remeasured at September 30, 2019 as a level 3 derivative, with the change in fair value of $263,000

9

recorded for the three months ended September 30, 2019 in loss from remeasurement of development derivative liability on the income statement, with a remeasured fair value of $130,103,000 as of September 30, 2019 on the consolidated balance sheet.

The derivative is valued using a scenario-based discounted cash flow method, whereby each scenario makes assumptions about the probability and timing of cash flows, and such cash flows are present valued using a risk-adjusted discount rate. The analysis is calibrated such that the value of the derivative as of the date of the SFJ Agreement was consistent with an arm’s-length transaction. Key inputs to the level 3 fair value model include (i) the probability and timing of achieving stated development milestones to receive the next tranches of funding, (ii) the probability and timing of achieving FDA and EMA approval, (iii) SFJ’s cost of borrowing (8.0%), and (iv) the Company’s cost of borrowing (16.49%).

SFJ’s implied cost of borrowing was 8.0% and the Company’s implied cost of borrowing was 16.49% as of the reporting date. These implied costs of borrowing were determined assuming the SFJ Agreement was initially executed with arm’s-length terms. If the SFJ Agreement was instead not determined to be an arm’s-length transaction, then implied discount rates could differ.

5. Long-term Debt

Convertible Senior Notes

On September 16, 2019, the Company completed a private offering of Convertible Notes with an aggregate principal amount of $220,000,000.

The net proceeds from the sale of the Convertible Notes were approximately $212,895,000 after deducting the initial purchasers’ discounts and commissions and estimated offering expenses payable by the Company. The Company used $28,380,000 of the net proceeds from the offering to pay the cost of the capped call transactions described below.

The Convertible Notes are senior unsecured obligations of the Company and bear interest at a rate of 3.5% per year payable semiannually in arrears on March 15 and September 15 of each year, beginning on March 15, 2020. The Convertible Notes will mature on September 15, 2026, unless earlier converted, redeemed or repurchased in accordance with their terms.

The Convertible Notes are convertible into shares of the Company’s common stock at an initial conversion rate of 25.3405 shares per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $39.46 per share of common stock).  The conversion rate is subject to customary anti-dilution adjustments. In addition, following certain events that occur prior to the maturity date or if the Company deliver a notice of redemption, the Company will increase the conversion rate for a holder who elects to convert its Convertible Notes in connection with such corporate event or a notice of redemption, as the case may be, in certain circumstances as provided in the indenture.

Prior to March 15, 2026, the Convertible Notes are convertible only upon the occurrence of certain events. On or after March 15, 2026 until the close of business on the second scheduled trading day immediately preceding the maturity date of the Convertible Notes, holders may convert the Convertible Notes at any time. Upon conversion of the Convertible Notes, the Company will pay or deliver, as the case may be, cash, shares of the Company’s common stock or a combination of cash and shares of common stock, at the Company’s election.

Prior to September 20, 2023, the Company may not redeem the Convertible Notes. The Company may redeem for cash all or a portion of the Convertible Notes, at its option, on or after September 20, 2023 if the last reported sale price of the Company’s common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which the Company provides a notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

If the Company undergoes a “fundamental change,” as defined in the Indenture, prior to maturity, subject to certain conditions, holders may require the Company to repurchase for cash all or any portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

Pursuant to Accounting Standards Codification (“ASC”) Subtopic 470-20 Convertible Debt, the Company used an effective interest rate of 10.5% to determine the liability component of the Convertible Notes. This resulted in the recognition of $145,065,803

10

as the liability component of the Convertible Notes and the recognition of the residual amount of $74,934,197 as the debt discount with a corresponding increase to additional paid in capital for the equity component of the Convertible Notes. Aggregate debt issuance costs of $7,105,000 was allocated to the liability and equity components in the amounts of $4,684,966 and $2,420,034, respectively.  

Interest expense for the Convertible Notes was $468,964 from inception through September 30, 2019, which included amortization of the discount on the Convertible Notes of $224,655, accrued semi-annual coupon payable of $235,278 and amortization of debt issuance costs of $9,031. As of September 30, 2019, $4,675,935 of debt issuance costs was recorded on the consolidated balance sheet as a reduction to the carrying amount of the Convertible Notes.

The aggregate balance of the Convertible Notes, net of unamortized debt issuance costs, as of September 30, 2019 was $140,614,523.

Capped Call Transactions

On September 11, 2019, concurrently with the pricing of the Convertible Notes, the Company entered into capped call transactions with two counterparties. The capped call transactions are expected generally to reduce the potential dilution to the Company’s common stock upon any conversion of Convertible Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted Convertible Notes, as the case may be, in the event that the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions, is greater than the strike price of the capped call transactions, which is initially $39.4625 (the conversion price of the Convertible Notes) and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of such Convertible Notes. If, however, the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions, exceeds the cap price of the capped call transactions, which is initially $63.14 per share, representing a premium of 100% above the last reported sale price of $31.57 per share of its common stock on The Nasdaq Global Select Market on September 11, 2019, there would nevertheless be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that such market price exceeds the cap price of the capped call transactions.

Pursuant to ASC 815-40 Derivatives and Hedging, the Company determined that the capped call transactions should be classified as equity instruments and the capped call premium paid in the amount of $28,380,000 was recorded as a reduction to additional paid-in capital as of September 30, 2019.

Term Loan Facility

On October 20, 2017, the Company entered into a loan and security agreement with Silicon Valley Bank (“SVB”) to provide for a $20,000,000 term loan facility (the “term loan facility”). Borrowings under the term loan facility accrued interest at a floating rate per annum equal to the WSJ prime rate plus 1.50%. Under the agreement, the Company was required to make monthly interest-only payments through November 1, 2019 and was required to make 24 equal monthly payments of principal, plus accrued interest, from November 1, 2019 through October 1, 2021, when all unpaid principal and interest became due and payable.

On March 26, 2019, the Company voluntarily repaid all outstanding amounts due and owed, including applicable termination fees, under the term loan facility.  The final payment of $21,802,403 totaled per diem interest of $101,111 and $21,701,292 for the outstanding balance of the term loan which included (i) a final payment equal to 8% of the original principal amount of the term loan of $1,600,000, and (ii) a prepayment fee contractually owed of $100,000 plus other fees of $1,292 which resulted in a total loss on extinguishment of debt of $1,208,132.

In connection with the Company’s entry into the term loan facility, the Company issued to SVB a warrant to purchase 14,064 shares of the Company’s common stock with an exercise price per share of $5.484. The warrant has a ten-year term and includes a put option pursuant to which, in the event of an acquisition, change in control or dissolution or winding up of the Company, or the expiration of the warrant, SVB may require the Company to repurchase the warrant for a total aggregate purchase price of $250,000.

Promissory Note

On October 19, 2017, the Company issued and sold an unsecured promissory note in the principal amount of $7,000,000 to Golda Darty Partners S.A. (“GDP”). The promissory note accrued interest at a rate per annum of 8.0%, and was due and payable quarterly in arrears on the 19th day of each April, July, October and January. The promissory note had a maturity date of October 19, 2022 when the $7,000,000 would be due and payable in its entirety. The promissory note was contractually subordinated to the Company’s obligations to SFJ under the SFJ Agreement.

11

On September 16, 2019, the Company voluntarily repaid all outstanding amounts due and owed under the promissory note, except for a small amount of interest subsequently repaid.  The payment of $7,118,904 totaled per diem interest of $118,904 and $7,000,000 for the outstanding principal balance of the promissory note.

In connection with the issuance and sale of the above promissory note, the Company issued to GDP a warrant to purchase 93,764 shares of the Company’s common stock at a price per share of $5.484, which was exercised in whole in October 2017. The Company recorded the fair value of the warrant in the aggregate amount of $430,160 as a discount to the promissory note. This amount was being accreted as additional interest expense over the term of the promissory note.  Upon the repayment of the promissory note, the Company recorded a loss on extinguishment of debt of $293,083 due to the remaining discount.

6. Leases

On January 1, 2019, The Company adopted ASU 2016-02 Leases (Topic 842) using a modified retrospective method.  The Company recognized $5,511,865 of lease assets and liabilities.  There was no impact to retained earnings upon adoption of Topic 842.  The underlying assets of the Company’s leases primarily relate to office space leases, but also include some equipment leases. The Company determines if an arrangement qualifies as a lease at its inception. During 2019, the Company leased additional office space resulting in an initial recognition value of $8,617,256 of lease assets and liabilities.  

As a practical expedient permitted under Topic 842, the Company has elected to account for the lease and non-lease components as a single lease component for all leases of which it is the lessee.  Lease payments, which may include lease and non-lease components, are included in the measurement of the Company’s lease liabilities to the extent that such payments are either fixed amounts or variable amounts that depend on a rate or index as stipulated in the lease contract. When the Company cannot readily determine the rate implicit in the lease, the Company determines its incremental borrowing rate by using the rate of interest that it would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment.

The Company enters into lease agreements with terms generally ranging from 2-7 years. Some of the Company’s lease agreements include Company options to extend the lease on a month to month basis or for set periods for up to five years. Many leases also include options to terminate the leases within one year or per other contractual terms. Renewal and termination options were generally not included in the lease term for the Company’s existing operating leases.

As of September 30, 2019, all leases were classified as operating lease assets and liabilities.  Operating lease assets were $13,332,783 and operating lease liabilities were $13,559,403 at September 30, 2019.  At September 30, 2019, the weighted average remaining lease term of operating leases was 5.35 years and the weighted average discount rate used to measure the outstanding operating lease liabilities leases was 8.24%.

For the three and nine months ended September 30, 2019, the total lease cost for operating lease expense was: $561,748 and $1,448,128, respectively.

Supplemental cash flow information related to operating leases for the nine months ended September 30, 2019 is as follows:

12

The maturity of the Company’s operating lease liabilities as of September 30, 2019 are as follows:

Comparative disclosures under ASC 840:

Rental expense under operating leases totaled $189,883 and $468,214 for the three and nine months ended September 30, 2018, respectively.

As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting standard, ASC 840, Leases, future minimum rental payments for lease obligations with initial terms in excess of one year as of December 31, 2018 were as follows:

7. Fair Value Measurements

The Company is required to disclose information on the fair value of financial instruments and inputs that enable an assessment of the fair value.  The three levels of the fair value hierarchy prioritize valuation inputs based upon the observable nature of those inputs as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities;

Level 2 – Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly or indirectly;

Level 3 – Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability. 

The following tables present information about the Company’s financial instruments and the related the fair value hierarchy of the valuation techniques utilized to determine such fair value:

13

As of December 31, 2018, the fair value of the Company's promissory note was $7,401,203, based on discounted cash flows, market-based expectations for interest rates, credit risk and the contractual terms of the debt instrument. The term loan facility paid interest at a variable interest rate and accordingly the carrying amount approximated fair value at December 31, 2018. The common stock warrant liability is valued based upon the underlying value of the Company’s stock.

As of September 30, 2019, the fair value of debt component of the Company's convertible notes was $140,614,523, based on the discounted cash flows for comparable straight debt instrument. The convertible notes accrue a semi-annual coupon at an annual rate of 3.5%, which was included in accrued expenses in the consolidated balance sheet at September 30, 2019.

The fair value of the SFJ Agreement is presented as a derivative liability based on level 3 inputs.  The derivative is valued using a scenario-based discounted cash flow method, whereby each scenario makes assumptions about the probability and timing of cash flows, and such cash flows are present valued using a risk-adjusted discount rate. The analysis is calibrated such that the value of the derivative as of the date of the SFJ Agreement was consistent with an arm’s-length transaction. Key inputs to the level 3 fair value model include (i) the probability and timing of achieving stated development milestones to receive the next tranches of funding, (ii) the probability and timing of achieving FDA and EMA approval, (iii) SFJ’s cost of borrowing (8.0%), and (iv) the Company’s cost of borrowing (16.49%).

SFJ’s implied cost of borrowing was 8.0% and the Company’s implied cost of borrowing was 16.49% as of the reporting date. These implied costs of borrowing were determined assuming the SFJ Agreement was initially executed with arm’s-length terms. If the SFJ Agreement was instead not determined to be an arm’s-length transaction, then implied discount rates could differ.

8. Refundable Research and Development Credit and Income Taxes

The Company earns non-income related refundable Australian research and development credits that are settled and paid to the Company annually. The associated income from the credits are an offset to research and development expenses.

The Company’s income tax provision is computed based on the federal statutory rate and the average state statutory rates, net of the related federal benefit. For the three months and nine months ended September 30, 2019 and 2018, there were no current or

14

deferred income tax expenses or benefits due to the Company’s net losses, research and development credits and increases in its deferred tax asset valuation allowance during those periods.  

The Company’s estimate of the realizability of the deferred tax asset is dependent on estimates of projected future levels of taxable income. In analyzing future taxable income levels, the Company considered all evidence currently available, both positive and negative.  Based on this analysis, the Company has recorded a valuation allowance for all deferred tax assets as of September 30, 2019.

9. Commitments and Contingencies

The Company contracts to conduct research and development activities with third parties.  Certain of these contracts commit the company to pay future milestone payments up to $15,000,000 or to pay royalty fees ranging from 3-6% if any of the research results in regulatory approval or commercial revenue for a product.  The scope of the services under the research and development contracts can be modified and the contracts cancelled by the Company upon written notice. In some instances, the contracts may be cancelled by the third party upon written notice. If the Company were to cancel these contracts as of September 30, 2019, the Company would be required to pay certain termination costs and other fees of approximately $1,707,100 that would be incurred in future periods.

The Company also has certain payment and other obligations under the SFJ Agreement, which are discussed above in Note 4.

10. Net Loss per Share

Since the Company was in a loss position for all periods presented, basic net loss per common share is the same as diluted net loss per common share for all periods presented as the inclusion of all potential common shares outstanding would have been anti-dilutive. Convertible notes and shares outstanding presented below were excluded from the calculation of diluted net loss per share, prior to the use of the treasury stock method, as their effect is anti-dilutive:

11. Related Party Transaction

Effective as of May 1, 2018, the Company entered into a subscription license agreement and a services agreement with Revon Systems, Inc. (“Revon”).  Under the subscription license agreement, Revon granted the Company an exclusive license to use the Revon software platform and applications for any purpose with respect to the Company's programs in age-related macular degeneration, hemolytic diseases and complement-dependent nephropathies for an annual license fee of $175,000 for a two year initial term and an option to obtain a perpetual, exclusive license thereafter for $350,000. Under the services agreement, Revon provided development services with respect to the Revon software to the Company for $250,000 during the first year. Prior to the acquisition of Revon by an unrelated third party in July 2019, the Company paid the remainder of the annual license fee due for the second year, exercised the option for the perpetual license and discontinued the services agreement.

Each of Cedric Francois, the Company’s chief executive officer, Pascal Deschatelets, the Company’s chief operating officer, and Alec Machiels, a member of the board of directors, is an affiliate of Revon. The Board approved the Revon agreements after review by a subcommittee of the disinterested members of the Board and determination by the full Board that the terms of the Revon agreements were fair, reasonable and in the best interests of the Company. The exercise of the option for the perpetual license was approved in accordance with the Company’s related party transaction policy.       

15

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements and related notes for the year ended December 31, 2018 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2019, which we refer to as the 2018 Annual Report on Form 10-K.

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, contained in this Quarterly Report on Form 10-Q, including statements regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans and objectives of management and expected market growth are forward-looking statements. The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “target,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. The following information and any forward-looking statements should be considered in light of factors discussed elsewhere in this Quarterly Report on Form 10-Q particularly including those risks identified in Part II—Item 1A “Risk Factors” and our other filings with the SEC.

Overview

We are a clinical-stage biopharmaceutical company focused on the development of novel therapeutic compounds to treat disease through the inhibition of the complement system, which is an integral component of the immune system, at the level of C3, the central protein in the complement cascade. We believe that this approach can result in broad inhibition of the principal pathways of the complement system and has the potential to effectively control a broad array of complement-dependent autoimmune and inflammatory diseases.

We have the most advanced clinical program targeting C3 with Phase 3 clinical trials of our lead product candidate, APL-2, in multiple indications.  We believe that APL-2 has the potential to be a best-in-class treatment that may address the limitations of existing treatment options or provide a treatment option where there currently is none.  APL-2 has already shown activity that we believe is clinically meaningful in clinical trials for several distinct medical conditions, including geographic atrophy in age-related macular degeneration, or GA; paroxysmal nocturnal hemoglobinuria, or PNH; and cold agglutinin disease, or CAD. In addition to conducting trials for these indications, we have also initiated an exploratory clinical trial of APL-2 in patients with glomerular diseases with complement involvement.

We initiated a Phase 3 clinical program consisting of two Phase 3 clinical trials evaluating APL-2 in patients with GA in September 2018.  In our Phase 2 clinical trial of APL-2 in patients with GA, treatment with APL-2 resulted in a significant reduction in the rate of GA lesion growth over 12 months. In June 2018, we initiated a Phase 3 clinical trial evaluating APL-2 in patients with PNH who exhibit signs of anemia (characterized by a hemoglobin level of less than 10.5 g/dL in the inclusion criteria) while being treated with eculizumab, an approved therapy for PNH that is marketed as Soliris. We completed enrollment in this trial in June 2019 and expect to announce top line results from this trial in January 2020.  In September 2019, we initiated a second Phase 3 clinical trial in patients with PNH with patients who have not been previously treated with eculizumab. In our ongoing Phase 1b trials in PNH, patients have achieved improvements in transfusion dependency, hemoglobin levels and other hematological indicators that we believe are clinically meaningful. In our ongoing Phase 2 clinical trials of APL-2 in patients with CAD and warm antibody autoimmune hemolytic anemia, or wAIHA, patients have achieved increased hemoglobin levels, reduced reticulocytes and bilirubin levels, and reduced lactate dehydrogenase levels.  We intend to disclose our plans and timing for further clinical development of APL-2 for patients with CAD in early 2020.  We do not intend to pursue further development of our clinical program in wAIHA at the present time.  We are also conducting a clinical trial of APL-2 for the treatment of glomerular diseases with complement involvement. We plan to present preliminary clinical data on C3 glomerulopathy, or C3G, from our clinical trial of APL-2 for the treatment of patients with glomerular diseases at the Annual Meeting of American Society of Nephropathy in November 2019.

We are also developing additional novel compounds targeting C3 and plan to conduct clinical trials of these compounds in additional complement-dependent diseases. We plan to develop APL-9 for the prevention of complement immune system activation coincident with adeno-associated virus (AAV) vector administration for gene therapies. APL-9 is a second generation C3 modulator and is designed to be intravenously administered for acute use.

16

We hold worldwide commercialization rights to APL-2, APL-9 and other novel compounds targeting C3.

In our clinical trials of APL-2 for the treatment of PNH, we are currently using an off-the-shelf, FDA-cleared device that allows patients to self-administer APL-2 through subcutaneous infusion. We are developing, with a third-party manufacturer, a custom, on-body drug delivery system that is intended to further improve the ease of self-administration of APL-2.  Initial clinical testing in a Phase 1 trial with healthy volunteers indicates that the pharmacokinetic (PK) profile of APL-2 administered subcutaneously at 2x weekly at a dose of 1,080 mg, both with the 510(k) approved device used in the PEGASUS Phase 3 trial and with the custom delivery system, is comparable to that of APL-2 administered once daily at a dose between 270 mg and 360 mg.

Since our commencement of operations in May 2010, we have devoted substantially all of our resources to developing our proprietary technology, developing product candidates, undertaking preclinical studies and conducting clinical trials for APL-2, building our intellectual property portfolio, organizing and staffing our company, business planning, raising capital, preparing for the commercial launch of our products, and providing general and administrative support for these operations.

On February 28, 2019, we entered into a development funding agreement, which we refer to as the SFJ Agreement, with SFJ Pharmaceuticals Group or SFJ, under which SFJ agreed to provide funding to us to support the development of APL-2 for the treatment of patients with PNH.  Pursuant to the agreement, SFJ paid us $60.0 million following the signing of the agreement, and agreed to pay us up to an additional $60.0 million in the aggregate in three equal installments upon the achievement of specified development milestones with respect to our Phase 3 program for APL-2 in PNH and subject to our having cash resources at the time sufficient to fund at least 10 months of our operations. In addition, upon the mutual agreement of us and SFJ, at any time after the earlier of the date that we have reviewed the primary endpoint data from our PEGASUS Phase 3 trial of APL-2 in patients with PNH and March 31, 2020, SFJ may fund an additional $50.0 million of our development costs which we refer to as the Additional SFJ Funding.

On June 7, 2019, we amended the development funding agreement, which we refer to as the SFJ Amendment. Under the SFJ Amendment, SFJ agreed to make an additional $20.0 million funding payment to us to support the development of APL-2 for the treatment of patients with PNH. This additional $20.0 million is in addition to and not part of the Additional SFJ Funding.

On June 27, 2019, we received $40.0 million from SFJ, consisting of $20.0 million as the first installment of the additional $60.0 million upon the achievement of a milestone and the $20.0 million payable under the SFJ Amendment.

On September 23, 2019, we received $20.0 million from SFJ, as the second installment of the additional $60.0 million due to the achievement of a milestone. We expect that the remaining development milestones under the SFJ Agreement will be achieved and the remaining $20.0 million of the additional $60.0 million will be paid during the first quarter of 2020.

On March 11, 2019, we issued and sold 6,900,000 shares of our common stock in a follow-on offering at a public offering price of $17.00 per share for net proceeds of $109.6 million, after deducting underwriting discounts and commissions of $7.0 million and estimated offering expenses of $0.7 million.  

On September 16, 2019, we issued and sold $220.0 million aggregate principal amount of 3.5% convertible senior notes due 2026, or Convertible Notes, in a private offering. The net proceeds from the sale of the notes were approximately $212.9 million after deducting the initial purchasers’ discounts and commissions and estimated offering expenses payable. We used $28.4 million of the net proceeds from the offering to pay the cost of the capped call transactions described below. The Convertible Notes are convertible into shares of our common stock at an initial conversion rate of 25.3405 shares per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $39.46 per share of common stock). The initial conversion price represents a premium of approximately 25.0% over the last reported sale price of $31.57 of our common stock on the Nasdaq Global Select Market on September 11, 2019. The conversion rate is subject to customary anti-dilution adjustments. In addition, following certain events that occur prior to the maturity date or if we deliver a notice of redemption, we will increase the conversion rate for a holder who elects to convert its Convertible Notes in connection with such corporate event or a notice of redemption, as the case may be, in certain circumstances as provided in the Indenture.

Prior to March 15, 2026, the Convertible Notes are convertible only upon the occurrence of certain events. On or after March 15, 2026 until the close of business on the second scheduled trading day immediately preceding the maturity date of the notes, holders may convert the notes at any time. Upon conversion of the Convertible Notes, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of common stock, at our election.

Prior to September 20, 2023, we may not redeem the Convertible Notes. We may redeem for cash all or a portion of the notes, at its option, on or after September 20, 2023 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date

17

on which we provide a notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date

To date, we have financed our operations primarily through $472.5 million in net proceeds from public offerings of our common stock, including our initial public offering, or IPO, $212.9 million in net proceeds from the private offering of Convertible Notes, $112.6 million in proceeds from the private placement of shares of our convertible preferred stock, $120.0 million from the SFJ Agreement, $20.0 million in proceeds from borrowings under a term loan facility with Silicon Valley Bank, and $7.0 million in proceeds from our issuance and sale of a promissory note. The amounts due and owed under the term loan facility and the promissory note have been repaid in full.

We have not generated any revenue from product sales. We have incurred significant annual net operating losses in each year since our inception and expect to continue to incur net operating losses for the foreseeable future. Our net losses were $191.5 million and $90.6 million for the nine months ended September 30, 2019 and September 30, 2018, respectively. As of September 30, 2019, we had an accumulated deficit of $468.3 million. We expect to continue to incur significant expenses and increasing operating losses for the next several years. Our net losses may fluctuate significantly from quarter to quarter and year to year. We anticipate that our expenses will increase significantly if and as we continue to develop and conduct clinical trials in our current and new indications with APL-2, including ongoing the Phase 3 clinical trials in GA and PNH and the ongoing and planned clinical trials in CAD, glomerular diseases with complement involvement, and other indications; initiate and continue research and preclinical and clinical development efforts for any future product candidates, such as APL-9; seek to identify and develop additional product candidates for complement-dependent diseases; seek regulatory and marketing approvals for our product candidates that successfully complete clinical trials, if any; establish sales, marketing, distribution and other commercial infrastructure in the future to commercialize any products for which we may obtain marketing approval; require the manufacture of larger quantities of product candidates for clinical development and, potentially, commercialization; maintain, expand and protect our intellectual property portfolio; hire and retain additional personnel, such as clinical, quality control and scientific personnel; add operational, financial and management information systems and personnel, including personnel to support our product development and help us comply with our obligations as a public company; and add equipment and physical infrastructure to support our research and development programs.

As of September 30, 2019, we had cash and cash equivalents of $434.0 million. We believe that our cash and cash equivalents as of September 30, 2019, will be sufficient to fund our operating expenses and capital expenditures into the fourth quarter of 2020. We believe that our cash and cash equivalents as of September 30, 2019 will be sufficient to fund our operations for at least the next twelve months from the date of issuance of the unaudited interim consolidated financial statements.

We plan to relocate our principal office to Waltham, Massachusetts, effective as of January 1, 2020.

Financial Operations Overview

Revenue 

We have not generated any revenue from product sales and do not expect to generate any revenue from the sale of products in the near future. In the future, we will seek to generate revenue primarily from a combination of product sales and collaborations with strategic partners.

Research and Development Expenses 

Research and development expenses consist primarily of costs incurred for our research activities, including our drug discovery efforts, and the development of our product candidates, which include:

Research and development costs are expensed as incurred. Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are

18

expensed as the related goods are delivered or the services are performed. We have not provided program costs since inception because historically we have not tracked or recorded our research and development expenses on a program-by-program basis.

The following summarizes our most advanced research and development programs:

The successful development of our product candidates is highly uncertain. Accordingly, at this time, we cannot reasonably estimate the nature, timing and costs of the efforts that will be necessary to complete the remainder of the development of these product candidates. We are also unable to predict when, if ever, material net cash inflows will commence from APL-2 or any other potential product candidates. This is due to the numerous risks and uncertainties associated with developing therapeutics, including the uncertainties of:

A change in the outcome of any of these variables with respect to the development of any of our product candidates would significantly change the costs and timing associated with the development of that product candidate.

Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect research and development costs to increase significantly for the

19

foreseeable future as our product candidate development programs progress. However, we do not believe that it is possible at this time to accurately project total program-specific expenses through commercialization. There are numerous factors associated with the successful commercialization of any of our product candidates, including future trial design and various regulatory requirements, many of which cannot be determined with accuracy at this time based on our stage of development. Additionally, future commercial and regulatory factors beyond our control will impact our clinical development programs and plans.

General and Administrative Expenses 

General and administrative expenses consist primarily of employee-related expenses including salaries, bonuses, benefits and share-based compensation. Other significant costs include facility costs not otherwise included in research and development expenses, legal fees relating to patent and corporate matters, and fees for accounting and consulting services.

We anticipate that our general and administrative expenses will increase in the future to support continued research and development activities, potential commercialization of our product candidates and increased costs of operating as a public company. These increases will likely include increased costs related to the hiring of additional personnel and fees to outside consultants, attorneys and accountants, among other expenses. Additionally, we anticipate increased costs associated with being a public company including expenses related to services associated with maintaining compliance with exchange listing and SEC requirements, insurance costs and investor relations costs.

Critical Accounting Policies and Estimates 

This discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The following critical accounting policies are described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our 2018 Annual Report on Form 10-K and the notes to the unaudited condensed financial statements included in Item 1, “Unaudited Financial Statements,” of this Quarterly Report on Form 10-Q. We believe that of our critical accounting policies, the following accounting policies are the most critical to fully understanding and evaluating our financial condition and results of operations:  

In addition, we identified the following policies as a new critical policy that reflects significant judgments or uncertainties, and potentially may result in materially different results under different assumptions and conditions.

Convertible Notes

On September 16, 2019, we completed a private offering of Convertible Notes with an aggregate principal amount of $220.0 million.

The notes are convertible into shares of the Company’s common stock at an initial conversion rate of 25.3405 shares per $1,000 principal amount of the Convertible Notes (equivalent to an initial conversion price of approximately $39.46 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments. In addition, following certain events that occur prior to the maturity date or if the Company deliver a notice of redemption, the Company will increase the conversion rate for a holder who elects to convert its notes in connection with such corporate event or a notice of redemption, as the case may be, in certain circumstances as provided in the Indenture. The Convertible Notes will also be subject to redemption at our option, on or after September 20, 2022, if certain conditions are met.  The redemption price is equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

Pursuant to Accounting Standards Codification (“ASC”) Subtopic 470-20 Convertible Debt, the Company used an effective interest rate of 10.5% to determine the liability component of the convertible notes. This resulted in the recognition of $145.1 million

20

as the liability component of the notes and the recognition of the residual amount of $74.9 million as the debt discount with a corresponding increase to additional paid in capital for the equity component of the notes. Aggregate debt issuance costs of $7.1 million was allocated to the liability and equity components in the amounts of $4.7 million and $2.4 million, respectively.  

Capped Call Transactions

On September 11, 2019, concurrently with the pricing of the Convertible Notes, we entered into capped call transactions with two counterparties. The capped call transactions are expected generally to reduce the potential dilution to the Company’s common stock upon any conversion of notes and/or offset any cash payments the Company is required to make in excess of the principal amount of the Convertible Notes, as the case may be, in the event that the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions, is greater than the strike price of the capped call transactions, which is initially $39.4625 (the conversion price of the Convertible Notes) and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of such notes. If, however, the market price per share of the Company’s common stock, as measured under the terms of the capped call transactions, exceeds the cap price of the capped call transactions, which is initially $63.14 per share, representing a premium of 100% above the last reported sale price of $31.57 per share of its common stock on The Nasdaq Global Select Market on September 11, 2019, there would nevertheless be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that such market price exceeds the cap price of the capped call transactions.

Pursuant to ASC 815-40 Derivatives and Hedging, we determined that the capped call transactions should be classified as equity instruments and the capped call premium paid in the amount of $28.4 million was recorded as a reduction to additional paid-in capital.

Development Derivative Liability  

Following regulatory approval by the FDA or the European Medicines Agency, or the EMA, for the use of APL-2 as a treatment for PNH we will be obligated to pay SFJ an initial payment of up to $5.0 million (or a total of $10.0 million if regulatory approval is granted by the FDA and the EMA) and then up to an additional $226.0 million in the aggregate (or up to $452 million if regulatory approval is granted by the FDA and the EMA) in six additional annual payments with the majority of the payments being made from the third anniversary to the sixth anniversary of regulatory approval. Such payments will be proportionately adjusted in the event that the actual funding from SFJ is lower or greater than $120 million (including as a result of the payment of the Additional SFJ Funding but excluding the $20 million funding payment made under the SFJ Amendment). Additionally, we granted a security interest in all of our assets, excluding intellectual property and license agreements to which it is a party. In connection with the grant of the security interest, we agreed to certain affirmative and negative covenants, including restrictions on our ability to pay dividends, incur additional debt or enter into licensing transactions with respect to its intellectual property, other than specified types of licenses.

The SFJ Agreement is presented as a derivative liability on the balance sheet as of September 30, 2019. The liability was initially recorded at the value of the $60.0 million of aggregate cash received pursuant to the contractual terms, which was determined to have been fair value. The SFJ Agreement (as amended) was subsequently remeasured at June 30, 2019 as a level 3 derivative, with the change in fair value of $9.8 million recorded for the six months ended June 30, 2019 in loss from remeasurement of development derivative liability on the income statement. The SFJ Agreement (as amended) was subsequently remeasured at September 30, 2019 as a level 3 derivative, with the additional change in fair value of $0.3 million recorded for the three months ended September 30, 2019 in loss from remeasurement of development derivative liability on the income statement.  As a result of the remeasurements, the change in fair value resulted in a loss from remeasurement of development derivative liability of $10.1 million recorded on the income statement for the nine months ended September 30, 2019.

The derivative is valued using a scenario-based discounted cash flow method, whereby each scenario makes assumptions about the probability and timing of cash flows, and such cash flows are present valued using a risk-adjusted discount rate. The analysis is calibrated such that the value of the derivative as of the date of the SFJ Agreement was consistent with an arm’s-length transaction. Key inputs to the level 3 fair value model include (i) the probability and timing of achieving stated development goals to receive the next tranches of funding, (ii) the probability and timing of achieving FDA and EMA approval, (iii) SFJ’s cost of borrowing (8.0%), and (iv) our cost of borrowing (16.49%).

SFJ’s implied cost of borrowing was 8.0% and our implied cost of borrowing was 16.49% as of the reporting date. These implied costs of borrowing were determined assuming the SFJ Agreement was initially executed with arm’s-length terms. If the SFJ Agreement was instead not determined to be an arm’s-length transaction, then implied discount rates could differ.

If actual results or events differ materially from the estimates, judgments and assumptions used by us in applying these policies, our reported financial condition and results of operations could be materially affected.

21

Results of Operations

Comparison of Three Months Ended September 30, 2018 and 2019

The following table summarizes our results of operations for the three months ended September 30, 2018 and 2019, together with the dollar increase or decrease and percentage change in those items:

Research and Development Expenses

The following table summarizes our research and development expenses incurred during the three months ended September 30, 2018 and 2019, together with the dollar increase or decrease and percentage change in those items:

Research and development expenses increased by $21.8 million to $51.3 million for the three months ended September 30, 2019 from $29.5 million for the three months ended September 30, 2018, an increase of 73.7%. The increase in research and development expenses was primarily attributable to an increase of $9.7 million in clinical trial costs, an increase of $2.5 million in manufacturing expenses, an increase of $6.2 million in personnel related costs primarily due to the hiring of additional personnel, an increase of $2.2 million in pre-clinical study expenses, and an increase of $1.3 million related to research and development supporting activities, offset by a decrease of $0.1 million in device development expenses. The increases to research and development expenses relate to the continued advancement of our clinical trial programs.  We expect our research and development expenses to continue to increase as the number of patients in our trials increases and the number of ongoing trials increases.

General and Administrative Expenses

General and administrative expenses increased by $12.3 million to $18.6 million for the three months ended September 30, 2019, from $6.3 million for the three months ended September 30, 2018, an increase of 197.3%. The increase in general and administrative expenses was primarily attributable to an increase in employee related costs of $6.0 million due to the hiring of additional personnel, an increase in professional and consulting fees of $6.0 million, an increase in general office costs of $1.0 million and an increase of $0.2 million in insurance costs offset by a decrease of $0.7 million in license agreement costs and $0.2 million in director stock compensation expense.

22

Loss from Remeasurement of Development Derivative Liability

Loss from remeasurement of development derivative liability was $0.3 million for the three months ended September 30, 2019.  On February 28, 2019, we entered into the SFJ agreement under which SFJ agreed to provide funding to us to support the development of APL-2 for the treatment of patients with PNH. The liability was initially recorded at the value of the $60.0 million aggregate cash received pursuant to the contractual terms, which was determined to have been fair value.  The agreement was amended on June 7, 2019 to allow for additional funding. In June 2019, we achieved a $20.0 million development milestone under the terms of the agreement and received $20.0 million of additional funding under the SFJ Amendment. The liability was subsequently remeasured at June 30, 2019 as a level 3 derivative. A loss for the six months ended June 30, 2019 of $9.8 million was recorded as a loss from remeasurement of development derivative liability. In August 2019, we achieved a $20.0 million development milestone under the terms of the agreement which was received in September 2019. The SFJ Agreement (as amended) was subsequently remeasured at September 30, 2019 as a level 3 derivative, with the additional change in fair value of $0.3 million recorded for the three months ended September 30, 2019 in loss from remeasurement of development derivative liability on the income statement.

Interest Expense

Interest expense was $0.6 million for the three months ended September 30, 2019 and for the three months ended September 30, 2018. The interest expense for the three months ended September 30,2018 was primarily attributable to interest expense incurred on our long-term debt under the term loan facility that we repaid in March 2019. The interest expense for the three months ended September 30, 2019 is primarily due to the repayment of the promissory note and related interest on September 16, 2019 as well as the amortization of the discount on the Convertible Notes.

Interest Income

Interest income was $1.4 million for the three months ended September 30, 2019, an increase of $0.5 million, compared to $0.9 million for the three months ended September 30, 2018. The increase in interest income earned during the three months ended September 30, 2019 was due to the interest earned on our cash and cash equivalents, which increased as a result of the completion of our follow-on offering in March 2019, the payments to us under the SFJ agreement and the Convertible Notes offering in September 2019.

Other (Expense)/Income, Net

Other (expense)/income, net during the three months ended September 30, 2019, increased $0.04 million compared to the three months ended September 30, 2018.

Comparison of Nine Months Ended September 30, 2018 and 2019

The following table summarizes our results of operations for the nine months ended September 30, 2018 and 2019, together with the dollar increase or decrease and percentage change in those items:

23

Research and Development Expenses

The following table summarizes our research and development expenses incurred during the nine months ended September 30, 2018 and 2019, together with the dollar increase and percentage change in those items:   

Research and development expenses increased by $68.0 million to $142.5 million for the nine months ended September 30, 2019 from $74.5 million for the nine months ended September 30, 2018, an increase of 91.3%. The increase in research and development expenses was primarily attributable to an increase of $25.7 million in clinical trial costs, an increase of $23.1 million in manufacturing expenses, an increase of $13.8 million in personnel related costs primarily due to the hiring of additional personnel, an increase of $4.5 million in preclinical study expenses, and an increase of $1.1 million related to research and development supporting activities, offset by a decrease of $0.2 million in device development expenses. The increases to research and development expenses relate to the continued advancement of our clinical trial programs.  We expect our research and development expenses to continue to increase as the number of patients in our trials increases and the number of ongoing trials increases.

General and Administrative Expenses

General and administrative expenses increased by $23.3 million to $39.6 million for the nine months ended September 30, 2019, from $16.2 million for the nine months ended September 30, 2018, an increase of 143.6%. The increase in general and administrative expenses was primarily attributable to an increase in employee related costs of $12.0 million, an increase in professional and consulting fees of $10.5 million, an increase in office, travel and related costs of $2.0 million and an increase in insurance costs of $0.3 million. These increases were offset by a decrease of $1.1 million in license agreement costs and a decrease of $0.4 million in director stock option compensation. The increased employee related costs of $12.0 million consisted of $10.3 million related to an increase in salaries and benefits primarily due to the hiring of additional personnel and $1.5 million in recruitment expense and $0.3 in temporary labor. The increased professional and consulting fees of $10.5 million primarily consisted of an increase in consulting fees of $9.5 million, an increase of $1.3 million in legal fees, offset by a decrease of $0.3 million in other professional fees.

Loss on Extinguishment of Debt

On March 26, 2019, we repaid all outstanding amounts due and owed, including applicable termination fees, under our term loan facility with Silicon Valley Bank. The final payment included the outstanding balance of the term loan as well as (i) a prepayment fee contractually owed of $0.1 million, (ii) a final payment equal to 8% of the original principal amount of the term loan, or $1.6 million, and (iii) per diem interest of $0.1 million, for a total payment of $21.8 million, which resulted in a loss on extinguishment of debt of $1.2 million.  On September 16, 2019, we repaid outstanding amounts due and owed on the promissory note.  The remaining discount on the promissory note related to the issuance of warrants in connection with the issuance of the promissory note resulted in a loss on extinguishment of debt of $0.3 million.  

Loss from Remeasurement of Development Derivative Liability

Loss from remeasurement of development derivative liability was $10.1 million for the nine months ended September 30, 2019.  On February 28, 2019, we entered into the SFJ agreement under which SFJ agreed to provide funding to us to support the development of APL-2 for the treatment of patients with PNH.  The agreement was amended on June 7, 2019 to provide for additional funding and we received $20.0 million upon execution of the SFJ Amendment in June 2019.  In each of June and September of 2019, we achieved a $20.0 million development milestone under the terms of the agreement and received an aggregate of $40.0 million of additional funding under the amendment.  The change in fair value of the derivative liability is due to the remeasurement at September 30, 2019 which resulted in a loss of $10.1 million for the nine months ended September 30, 2019. The derivative liability was remeasured as a level 3 derivative.

24

Interest Income

Interest income was $3.6 million for the nine months ended September 30, 2019, an increase of $2.1 million, compared to $1.5 million for the nine months ended September 30, 2018. The increase in interest income earned during the nine months ended September 30, 2019 was due to the interest earned on our cash and cash equivalents, which increased as a result of the completion of our follow-on offering in March 2019, the payments to us under the SFJ agreement and the Convertible Note offering.

Interest Expense

Interest expense was $1.4 million for the nine months ended September 30, 2019, an increase of $0.1 million, compared to $1.3 million for the nine months ended September 30, 2018. The interest expense for the nine months ended September 30, 2018 was primarily attributable to interest expense incurred on our long-term debt under the term loan facility that we repaid in March 2019. The interest expense for the nine months ended September 30, 2019 is primarily due to the repayment of the promissory note and related interest on September 16, 2019 as well as the amortization of the discount on the Convertible Notes.

Other expense, net

Other (expense)/income, net during the nine months ended September 30, was approximately the same as compared to the nine months ended September 30, 2018.

Liquidity and Capital Resources 

Sources of Liquidity

On November 13, 2017, we issued and sold 10,714,000 shares of common stock in our IPO at a public offering price of $14.00 per share for net proceeds of $137.2 million after deducting underwriting discounts and commissions of $10.5 million and other offering expenses of approximately $2.3 million. On November 13, 2017, upon the closing of the IPO, all shares of preferred stock then outstanding converted into an aggregate of 30,070,034 shares of common stock. In addition, on December 13, 2017, we issued and sold an additional 981,107 shares of common stock at the IPO price of $14.00 per share pursuant to the underwriters’ partial exercise of their option to purchase additional shares of common stock, resulting in net proceeds of approximately $12.8 million, after underwriting discounts and commissions of $1.0 million.

On April 23, 2018, we issued and sold 5,500,000 shares of our common stock in a follow-on offering at a public offering price of $25.50 per share. We received net proceeds of $131.3 million, after deducting underwriting discounts and commissions of $8.4 million and offering expenses of $0.5 million.  

On March 11, 2019, we issued and sold 6,900,000 shares of our common stock in a follow-on offering at a public offering price of $17.00. We received net proceeds of $109.6 million after deducting underwriting discounts and commissions of $7.0 million and offering costs of $0.7 million.

On September 16, 2019, we completed a private offering of $220.0 million aggregate principal amount of Convertible Notes. We received net proceeds of approximately $212.9 million after deducting the initial purchasers’ discounts and commissions and offering costs of $7.1 million.

Prior to our IPO, we financed our operations primarily through $112.6 million in proceeds from the private placement of shares of our convertible preferred stock, $20.0 million in proceeds from borrowings under our term loan facility with Silicon Valley Bank, and $7.0 million in proceeds from our issuance and sale of a promissory note to GDP.

Agreement with SFJ

On February 28, 2019, we entered into the SFJ agreement, under which SFJ agreed to provide funding to us to support the development of APL-2 for the treatment of patients with PNH. Pursuant to the agreement, SFJ paid us $60.0 million following the signing of the agreement, and has agreed to pay us up to an additional $60.0 million in the aggregate in three equal installments upon the achievement of specified development milestones with respect to our Phase 3 program for APL-2 in PNH and subject to our having cash resources at the time sufficient to fund at least 10 months of our operations. In addition, upon the mutual agreement between us and SFJ, at any time after the earlier of the date that we have reviewed the primary endpoint data from its PEGASUS Phase 3 trial of APL-2 in patients with PNH and March 31, 2020, SFJ may fund an additional $50.0 million of our development costs.

25

On June 7, 2019, we amended the funding agreement with SFJ. Under the amendment, SFJ agreed to make an additional $20.0 million of funding payment to us to support the development of APL-2 for the treatment of patients with PNH. This additional $20.0 million is in addition to and not part of the Additional SFJ Funding.

On June 27, 2019, we received $40.0 million from SFJ, consisting of $20.0 million as the first installment of the additional $60.0 million upon the achievement of a milestone and the $20.0 million payable under the SFJ Amendment. On September 23, 2019, we received $20.0 million from SFJ as the second installment of the additional $60.0 million due to the achievement of a milestone and the $20.0 million payable under the SFJ Amendment. We expect that the remaining development milestones under the SFJ Agreement will be achieved and the remaining $20.0 million will be paid during the first quarter of 2020.

Following regulatory approval by the U.S. Food and Drug Administration, or the FDA, or the European Medicines Agency, or the EMA, for the use of APL-2 as a treatment for PNH we will be obligated to pay SFJ an initial payment of up to $5.0 million (or a total of $10.0 million if regulatory approval is granted by the FDA and the EMA) and then up to an additional $226.0 million in the aggregate (or up to $452.0 million if regulatory approval is granted by the FDA and the EMA) in six additional annual payments with the majority of the payments being made from the third anniversary to the sixth anniversary of regulatory approval. Such payments will be proportionately adjusted in the event that the actual funding from SFJ is lower or greater than $120.0 million (including as a result of the payment of the Additional SFJ Funding but excluding the $20 million funding made under the SFJ Amendment). Additionally, we granted a security interest in all of our assets, excluding intellectual property and license agreements to which we are a party. In connection with the grant of the security interest, we agreed to certain affirmative and negative covenants, including restrictions on our ability to pay dividends, incur additional debt or enter into licensing transactions with respect to its intellectual property, other than specified types of licenses.

Indebtedness

Term Loan Facility

On October 20, 2017, we entered into a loan and security agreement with Silicon Valley Bank providing for a $20.0 million term loan facility, which we refer to as the term loan facility.

Borrowings under the term loan facility accrued interest at a floating rate per annum equal to the WSJ prime rate plus 1.50%. Under the agreement, we were required to make monthly interest-only payments through November 1, 2019 and were required to make 24 equal monthly payments of principal, plus accrued interest, from November 1, 2019 through October 1, 2021, when all unpaid principal and interest were to become due and payable.

On March 26, 2019, we repaid all outstanding amounts due and owed, including applicable termination fees, under the term loan facility. The final payment included the outstanding balance of the term loan as well as (i) a prepayment fee contractually owed of $0.1 million, (ii) a final payment equal to 8% of the original principal amount of the term loan, or $1.6 million, and (iii) per diem interest of $0.1 million, for a total payment of $21.8 million, which resulted in a loss on extinguishment of debt of $1.2 million.  

 In connection with our entry into the term loan facility, we issued to Silicon Valley Bank a warrant to purchase 14,064 shares of our common stock, with an exercise price per share of $5.484. The warrant has a ten-year term and includes a put option pursuant to which, in the event of an acquisition, change in control or dissolution or winding up of our company, or the expiration of the warrant, Silicon Valley Bank may require us to repurchase the warrant for a total aggregate purchase price of $250,000.

Promissory Note

On October 19, 2017, we issued and sold an unsecured promissory note in the principal amount of $7.0 million to GDP. The note accrued interest at a rate per annum of 8.0% and was due and payable quarterly in arrears on the 19th day of each April, July, October and January. The promissory note had a maturity date of October 19, 2022. The promissory note is contractually subordinated to our obligations to SFJ under the SFJ agreement. On September 16, 2019, we repaid outstanding amounts due and owed, under the promissory note.

26

In connection with the issuance and sale of the $7.0 million promissory note, we issued to GDP a warrant to purchase 93,764 shares of our common stock at a price per share of $5.484, which was exercised in October 2017 prior to the IPO. The warrant was exercisable at any time but would have expired if unexercised by the closing date of our IPO. We recorded the fair value of the warrant in the aggregate amount of $0.4 million as a discount to the promissory note. This amount is being accreted as additional interest expense over the term of the promissory note. Upon the repayment of the promissory note, this discount resulted in a loss on extinguishment of debt of $0.3 million.

Convertible Notes

On September 16, 2019, we completed a private offering of Convertible Notes with an aggregate principal amount of $220.0 million.  The Convertible Notes are senior unsecured obligations and bear interest at a rate of 3.5% per year payable semiannually in arrears on March 15 and September 15 of each year, beginning on March 15, 2020. The Convertible Notes will mature on September 15, 2026, unless earlier converted, redeemed or repurchased in accordance with their terms.

The net proceeds from the sale of the Convertible Notes were approximately $212.9 million after deducting the initial purchasers’ discounts and commissions and estimated offering expenses payable. We used $28.4 million of the net proceeds from the offering to pay the cost of the capped call transactions described below.

The Convertible Notes are convertible into shares of our common stock at an initial conversion rate of 25.3405 shares per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $39.46 per share of common stock). The conversion rate is subject to customary anti-dilution adjustments. In addition, following certain events that occur prior to the maturity date or if we deliver a notice of redemption, we will increase the conversion rate for a holder who elects to convert its Convertible Notes in connection with such corporate event or a notice of redemption, as the case may be, in certain circumstances as provided in the Indenture.

Prior to March 15, 2026, the Convertible Notes are convertible only upon the occurrence of certain events. On or after March 15, 2026 until the close of business on the second scheduled trading day immediately preceding the maturity date of the Convertible Notes, holders may convert the Convertible Notes at any time. Upon conversion of the Convertible Notes, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of common stock, at our election.

Prior to September 20, 2023, we may not redeem the Convertible Notes. We may redeem for cash all or a portion of the Convertible Notes, at its option, on or after September 20, 2023 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which we provide a notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

If we undergo a “fundamental change,” as defined in the Indenture, prior to maturity, subject to certain conditions, holders may require us to repurchase for cash all or any portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

The Indenture contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the Trustee or the holders of at least 25% in principal amount of the outstanding Convertible Notes may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be due and payable.

On September 11, 2019, concurrently with the pricing of the Convertible Notes, we entered into capped call transactions with two counterparties. The capped call transactions are expected generally to reduce the potential dilution to our common stock upon any conversion of Convertible Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Convertible Notes, as the case may be, in the event that the market price per share of our common stock, as measured under the terms of the capped call transactions, is greater than the strike price of the capped call transactions, which is initially $39.4625 (the conversion price of the Convertible Notes) and is subject to anti-dilution adjustments substantially similar to those applicable to the conversion rate of such Convertible Notes. If, however, the market price per share of our common stock, as measured under the terms of the capped call transactions, exceeds the cap price of the capped call transactions, which is initially $63.14 per share, representing a premium of 100% above the last reported sale price of $31.57 per share of our common stock on The Nasdaq Global Select Market on September 11, 2019, there would nevertheless be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that such market price exceeds the cap price of the capped call transactions.

27

Cash Flows

The following table provides information regarding our cash flows for the nine months ended September 30, 2019 and 2018: