Apellis Pharmaceuticals, Inc. - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2021

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: (617) 977-5700

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, a 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 April 23, 2021, the registrant had 80,496,771 shares of common stock, $0.0001 par value per share, outstanding.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

APELLIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements

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APELLIS PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME/(LOSS)

(Unaudited)

(Amounts in thousands, except per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements

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Apellis Pharmaceuticals, Inc.

CONDENSED Consolidated Statements of CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(Amounts in thousands)

See accompanying notes to unaudited condensed consolidated financial statements

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Apellis Pharmaceuticals, Inc.

CONDENSED Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

See accompanying notes to unaudited condensed consolidated financial statements  

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APELLIS PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2021 and 2020

(unaudited)

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 Waltham, Massachusetts.

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”). Additionally, the Company is subject to risks arising from the Coronavirus Disease 2019 (COVID-19) pandemic, which could have adverse effects upon its business and operations, including on its ability to initiate, conduct and complete clinical trials, delay the initiation of planned and future clinical trials and could disrupt regulatory activities.

Adoption of ASU 2020-06 Debt – Debt with Conversion and Other Options (Subtopic 470-20)

Effective January 1, 2021, the Company early adopted ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) which reduces complexity in applying GAAP to certain financial instruments with characteristics of liability and equity. The ASU removes the guidance that requires entities to account for beneficial conversion features and cash conversion features in equity, separately from the host convertible debt or preferred stock. The ASU further revises the guidance to require entities to calculate diluted earnings per share for convertible instruments by using the if-converted method. In addition, entities must presume share settlement for purposes of calculating diluted earnings per share when an instrument may be settled in cash or shares. The impact of the adoption of the statement increased net debt outstanding and decreased net equity by $149.7 million as of January 1, 2021. Of the $149.7 million decrease to net equity, $16.0 million was recorded to retained earnings. See Note 5, Long Term Debt for additional information.

Convertible Notes Exchange

In January 2021, the Company entered into separate, privately negotiated exchange agreements to modify the conversion terms with certain holders of its convertible notes issued in September 2019 (the “2019 Convertible Notes”). Under the terms of these exchange agreements, the holders exchanged approximately $126.1 million in aggregate principal amount of 2019 Convertible Notes held by them for an aggregate of 3,906,869 shares of common stock issued by the Company. The Company also issued 69,491 shares for settlement of issuance costs paid to the Company’s advisor. The Company recognized a total loss on conversion of debt in the unaudited condensed consolidated statement of operations of $39.5 million. As of March 31, 2021, the Company held as treasury Convertible Notes the $126.1 million principal amount of exchanged notes and such notes have not been cancelled. See Note 5, Long Term Debt for additional information.

Liquidity and Going Concern

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 April 28, 2021, the date of issuance of these unaudited condensed consolidated financial statements, the Company believes that its cash and cash equivalents of $265.4 million and marketable securities of $458.2 million as of March 31, 2021 will be sufficient to fund its operations and capital expenditure requirements for at least the next twelve months from the date of issuance of these unaudited condensed consolidated

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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. The Company’s plans 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 on terms that are favorable to the Company (2) enter into collaborative agreements with strategic partners to obtain funding, and (3) succeed in its future operations. If the Company is not able to obtain the required funding for its operations, or is not able to obtain funding on a timely basis 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 Bermuda Limited, Apellis Germany GmbH, Apellis Ireland Ltd, Apellis Netherlands B.V., Apellis Switzerland GmbH, Apellis UK Limited, APL DEL Holdings LLC, APL Sales Corp I, LLC, APL PRG I, Corp. and Apellis MA Securities Corp. 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 financial information that are normally required by U.S. GAAP have been condensed or omitted and, accordingly, the consolidated balance sheet as of December 31, 2020 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 three months ended March 31, 2021 are not necessarily indicative of the results to be expected for the year ending December 31, 2021 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, 2020 included in the Company’s Annual Report on Form 10-K filed with the SEC on February 25, 2021.

Licensing and Collaboration Revenue

The Company analyzes license and collaboration arrangements pursuant to FASB ASC Topic 808, Collaborative Arrangement Guidance and Considerations, (“ASC 808”) to assess whether such arrangements, or transactions between arrangement participants, involve joint operating activities performed by parties that are both active participants in the activities and exposed to significant risks and rewards dependent on the commercial success of such activities or are more akin to a vendor-customer relationship. In making this evaluation, the Company considers whether the activities of the collaboration are considered to be distinct and deemed to be within the scope of the collaborative arrangement guidance or if they are more reflective of a vendor-customer relationship and, therefore, within the scope of FASB ASC Topic 606, Revenue from Contracts with Customer, (“ASC 606”). This assessment is performed throughout the life of the arrangement based on changes in the responsibilities of all parties in the arrangement.

For elements of collaboration arrangements that are not accounted for pursuant to guidance in ASC 606, an appropriate recognition method is determined and applied consistently, generally by analogy to the revenue from contracts with customers guidance. Amounts related to transactions with a counterparty in a collaborative arrangement that is not a customer are presented as collaboration revenue and in a separate line item from revenue recognized from contracts with customers, if any, in the Company’s consolidated statements of operations.

Pursuant to ASC 606, for arrangements or transactions between arrangement participants determined to be within the scope of the contracts with customers guidance, the Company performs the following steps to determine the appropriate amount of revenue to

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be recognized as the Company fulfills its obligations: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

The Company evaluates the performance obligations promised in the contract that are based on goods and services that will be transferred to the customer and determine whether those obligations are both (i) capable of being distinct and (ii) distinct in the context of the contract. Goods or services that meet these criteria are considered distinct performance obligations. The Company estimates the transaction price based on the amount expected to be received for transferring the promised goods or services in the contract. The consideration may include fixed consideration or variable consideration. At the inception of each arrangement that includes variable consideration, the Company evaluates the amount of potential transaction price and the likelihood that the transaction price will be received. The Company utilizes either the most likely amount method or expected value method to estimate the amount expected to be received based on which method best predicts the amount expected to be received. The amount of variable consideration that is included in the transaction price may be constrained and is included in the transaction price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Arrangements that include rights to additional goods or services that are exercisable at a customer’s discretion are generally considered options. The Company assesses if these options provide a material right to the customer and, if so, these options are considered performance obligations. The Company has not currently identified any such material rights.

Revenue is recognized when, or as, the Company satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when, or as, the customer obtains control of that asset. For performance obligations that are satisfied over time, the Company recognizes revenue using an input or output measure of progress that best depicts the satisfaction of the relevant performance obligation.

After contract inception, the transaction price is reassessed at every period end and updated for changes such as resolution of uncertain events. Any change in the overall transaction price is allocated to the performance obligations on the same methodology as at contract inception.

See Note 11, License and Collaboration Agreements, for further discussion related to the Collaboration and License Agreement with Swedish Orphan Biovitrum AB (Publ) (“Sobi”).

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, Note 7, Marketable Securities, and Note 9, Fair Value Measurements, include cash and cash equivalents, other receivables, accounts payable and accrued liabilities. Management believes that the carrying amounts of certain cash and cash equivalents, other receivables, 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 condensed consolidated balance sheets for certain cash and cash equivalents are valued at cost, which approximates their fair value. See Note 9, Fair Value Measurements, for additional information.

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Restricted Cash

The Company is contingently liable under unused letters of credit with a bank, related to the Company’s customs import bond and facility lease agreements of $1.6 million and $1.3 million as of March 31, 2021 and December 31, 2020, respectively. The Company records as restricted cash the collateral used to secure these letters of credit.

Foreign Currency

The financial position and results of operations of the Company's Australian, Irish and German subsidiaries are 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 respective periods. 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. The financial position and results of operations of the Company’s Swiss subsidiary are measured and reported in U.S. dollars and transactions are translated to U.S. dollars at the end of the period.

3. Prepaid Assets and Accrued Expenses

Prepaid assets include $14.1 million and $8.0 million of prepaid research and development costs as of March 31, 2021 and December 31, 2020, respectively.

Accrued expenses are as follows (in thousands):

4. Development Derivative Liability

On February 28, 2019, the Company entered into a development funding agreement, (the “SFJ Agreement”), with SFJ Pharmaceuticals Group (“SFJ”), under which SFJ agreed to provide funding to the Company to support the development of pegcetacoplan for the treatment of patients with PNH. SFJ paid the Company $60.0 million following the signing of the agreement, and agreed to pay the Company up to an additional $60.0 million in the aggregate in three equal installments upon the achievement of specified development milestones with respect to the Company’s Phase 3 program for pegcetacoplan 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.  

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 $20.0 million funding payment to the Company to support the development of pegcetacoplan for the treatment of patients with PNH.

As of March 31, 2021, the Company has received a total of $140.0 million from SFJ as the Company met milestones as identified in the agreement. The Company did not receive any funds under the SFJ agreement in 2021. In the three months ended March 31, 2020, the Company received $20.0 million, from SFJ.

Under the SFJ Agreement following regulatory approval by the FDA or EMA for the use of pegcetacoplan as a treatment for PNH the Company 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. Additionally, the Company granted a security interest

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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 condensed consolidated balance sheet and is considered a level three derivative, and, as such, is recorded at fair value and remeasured each quarter. The change in fair value due to the remeasurement of the development derivative liability resulted in a $17.1 million loss and a $68.4 million loss for the three months ended March 31, 2021 and 2020, respectively, recorded on the unaudited condensed consolidated statement of operations. The development derivative liability has a remeasured fair value of $275.0 million on the consolidated balance sheet at March 31, 2021. At March 31, 2021, $6.2 million of the $275.0 million of the development derivative liability fair market value is included in current liabilities.

The following table presents a rollforward of the development derivative liability (in thousands):

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 (11.76%).

SFJ’s implied cost of borrowing was 8.0% and the Company’s implied cost of borrowing was 11.76% 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 the 2019 Convertible Notes with an aggregate principal amount of $220.0 million issued pursuant to an indenture (the “Indenture”) with U.S. Bank National Association, as trustee.

The net proceeds from the sale of the 2019 Convertible Notes were approximately $212.9 million after deducting the initial purchasers’ discounts and commissions of $6.6 million and offering expenses of $0.5 million by the Company. The Company used $28.4 million of the net proceeds from the sale of the 2019 Convertible Notes to pay the cost of the capped call transactions in September 2019 described below.

On May 12, 2020, the Company issued the 2020 Convertible Notes with an aggregate principal amount of $300.0 million. The net proceeds from the sale of the 2020 Convertible Notes were approximately $322.9 million after deducting the purchasers’ discounts and commission of $5.7 million and offering expenses of $0.3 million. The Company used $43.1 million of the net proceeds from the sale to pay the cost of the additional capped call transactions in May 2020 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 converted earlier, redeemed or repurchased in accordance with their terms.

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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 $39.4625 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.

Prior to the adoption of ASU 2020-06 effective January 1, 2021, the Company used an effective interest rate of 10.5% to determine the liability component of the 2019 and 2020 Convertible Notes. This resulted in the recognition of $145.1 million and $204.5 million as the liability component of the 2019 and 2020 Convertible Notes, respectively and the recognition of the residual amount of $74.9 million and $95.5 million as the debt discount with a corresponding increase to additional paid in capital for the equity component of the 2019 and 2020 Convertible Notes, respectively. The 2020 Convertible Notes aggregate debt issuance costs of $6.0 million were allocated to the liability and equity components in the amounts of $3.7 and $2.3 million, respectively. The 2019 Convertible Notes aggregate debt issuance costs of $7.1 million were allocated to the liability and equity components in the amounts of $4.7 million and $2.4 million, respectively.  

Effective January 1, 2021, the Company adopted ASU 2020-06 using the modified retrospective method. Upon adoption, the Company increased net debt and reduced net equity by $149.7 million. The $149.7 million consisted of several items. The first item is the reclassification from equity to debt of the residual amounts originally identified as the equity components of the 2019 and 2020 Convertible Notes of $74.9 million and $95.5 million, respectively. The equity component reclassification was offset by the adjustment to retained earnings for the reversal of previous non-cash interest expense recorded for the amortization of the equity components of $17.1 million. The second item is the reclassification from equity to debt of the debt issuance costs originally allocated to equity for the 2019 and 2020 Convertible Notes of $2.4 million and $2.3 million, respectively. The debt issuance costs reclassification was offset by the adjustment to retained earnings for previous amortization of the debt issuance costs recorded of $1.1 million.  

In January 2021, the Company entered into separate, privately negotiated exchange agreements to modify the conversion terms with certain holders of its 2019 Convertible Notes. Under the terms of these exchange agreements, the holders exchanged approximately $126.1 million in aggregate principal amount of 2019 Convertible Notes held by them for an aggregate of 3,906,869 shares of common stock issued by the Company. In accordance with ASC topic 470-20, “Debt,– Debt with Conversion and Other Options,” the Company accounted for the exchange as an induced conversion based on the short period of time the conversion offer was open and the substantive conversion feature offer. The Company accounted for the conversion of the debt as an inducement by expensing the fair value of the shares that were issued in excess of the original terms of the Convertible Notes. The Company reduced net debt outstanding and increased net equity on the consolidated balance sheet by $122.8 million, consisting of the par value of the 2019 Convertible Notes exchanged of $126.1 million less the $3.3 million of remaining debt issuance costs associated with the exchanged notes. The Company also increased shares outstanding by 3,906,869 shares consisting of 3,196,172 shares issued at the initial conversion rate in the Indenture of 25.3405 plus an additional 710,697 shares. Additionally, the Company issued 69,491 shares as settlement of debt issuance costs paid to the Company’s advisor in connection with the conversion transaction. The Company recorded a loss on conversion of debt of $39.5 million comprised of $36.4 million related to the value of the shares issued in excess of the original conversion terms at the fair market value and $3.1 million for the value of the 69,491 shares issued in payment of issuance

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costs. Upon exchange of the 2019 Convertible Notes, the holders forfeited accrued interest through the date of the exchange of $1.7 million, which the Company charged to interest expense and to equity. As of March 31, 2021, the Company held as treasury Convertible Notes the $126.1 million principal amounts of exchanged notes and such notes had not been cancelled.  

Interest expense for the Convertible Notes was $4.2 million and $3.9 million for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, interest expense included accrued semi-annual coupon payable of $3.8 million and amortization of debt issuance costs of $0.4 million. For the three months ended March 31, 2020 interest expense included the amortization of the discount on the Convertible Notes of $1.9 million, an accrued semi-annual coupon payable of $1.9 million and amortization of debt issuance costs of $0.1 million. As of March 31, 2021, $7.7 million of debt issuance costs was recorded on the unaudited condensed consolidated balance sheet as a reduction to the carrying amount of the Convertible Notes.

The aggregate principal balance of the Convertible Notes, net of unamortized debt issuance costs, as of March 31, 2021 and December 31, 2020 was $386.2 million and $358.8 million respectively.

Capped Call Transactions

On September 11, 2019, and May 6, 2020 concurrently with the pricing of the 2019 Convertible Notes and the 2020 Convertible Notes, respectively, 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, 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 $28.4 million and $43.1 million were recorded as reductions to additional paid-in capital at March 31, 2021 for the 2019 and 2020 Convertible Notes, respectively.

6. Leases

On January 1, 2019, the Company adopted ASU 2016-02 Leases (Topic 842) using a modified retrospective method. 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.

As a practical expedient permitted under Topic 842, the Company 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 of these 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 March 31, 2021 and December 31, 2020, all leases were classified as operating lease assets and liabilities. Additional information related to the operating lease assets and liabilities is as follows (in thousands):

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For the three months ended March 31, 2021 and 2020, the total lease cost for operating lease expense was $1.3 million and $1.0 million, respectively.

Supplemental cash flow information related to operating leases for the three months ended March 31 is as follows (in thousands):

The maturities of the Company’s operating lease liabilities as of March 31, 2021 are as follows (in thousands):

7. Marketable Securities

The amortized cost, gross unrealized holding losses and fair value of available-for-sale debt securities by type of security as of March 31, 2021 and December 31, 2020 were as follows (in thousands):

All available-for-sale securities mature in one year or less.

8. Other Comprehensive Income and Accumulated Other Comprehensive Income

The following tables summarize the changes in accumulated other comprehensive income/(loss), by component for the three months ended March 31, 2021 and 2020 (in thousands):

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9. 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 table presents the fair value of financial instruments recorded originally at amortized cost or fair value and not remeasured on a recurring basis (in thousands):

The Company’s Convertible Notes are Level 1 category within the fair value level hierarchy at March 31, 2021 due to the adoption of ASU 2020-06. The fair value of the Convertible Notes was $547.3 million at March 31, 2021. At December 31, 2020, the Company’s Convertible Notes were Level 2 category within the fair value level hierarchy. At December 31, 2020, the fair value of debt was determined using broker quotes in a non-active market for valuation. As of December 31, 2020, the debt component of the Company's Convertible Notes was $676.2 million. 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 sheets at March 31, 2021 and December 31, 2020.

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The following table presents the fair value of financial instruments recorded at fair value at inception and remeasured on a recurring basis (in thousands):

The fair value of the SFJ Agreement is presented as a development 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 (11.76%).

SFJ’s implied cost of borrowing was 8.0% and the Company’s implied cost of borrowing was 11.76% as of the reporting date. These implied costs of borrowing were determined assuming the SFJ Agreement was initially executed with arm’s-length terms.

10. Income Taxes

Deferred tax assets and deferred tax liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is recorded against deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has recorded a full valuation allowance against its deferred tax assets for the period ended on March 31, 2021.

The Company does not recognize a tax benefit for uncertain tax positions unless it is more likely than not that the position will be sustained upon examination by tax authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit that is recorded for these positions is measured at the largest amount of cumulative benefit that has greater than a 50 percent likelihood of being realized upon ultimate settlement. Deferred tax assets that do not meet these recognition criteria are not recorded and the Company recognizes a liability for uncertain tax positions that may result in tax payments. If such unrecognized tax benefits were realized and not subject to valuation allowances, the entire amount would impact the tax provision. The Company has not recorded any amounts for unrecognized tax positions for the period ended on March 31, 2021.

For the three months ended on March 31, 2021 and 2020, the Company did not record any current or deferred income tax expense or benefit.

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11. License and Collaboration Agreements

Sobi Transaction

On October 27, 2020, the Company and its subsidiaries Apellis Switzerland GmbH and APL DEL Holdings, LLC entered into a Collaboration and License Agreement with Sobi, concerning the development and commercialization of pegcetacoplan and specified other structurally and functionally similar compstatin analogues or derivatives for use systemically or for local non-ophthalmological administration (collectively referred to as the “Licensed Products”).

Under the collaboration agreement, the Company granted Sobi an exclusive (subject to certain retained rights of the Company), sublicensable license of certain patent rights and know-how to develop and commercialize Licensed Products in all countries outside of the United States. The Company retains the right to commercialize Licensed Products in the United States, and, subject to specified limitations, to develop Licensed Products worldwide for commercialization in the United States.  

Under the collaboration agreement, the Company and Sobi have agreed to collaborate to develop Licensed Products for the treatment of paroxysmal nocturnal hemoglobinuria, cold agglutinin disease, hematopoietic stem cell transplantation-associated thrombotic microangiopathy, C3 glomerulopathy and immune complex membranoproliferative glomerulonephritis, and amyotrophic lateral sclerosis, and any other indications subsequently agreed upon by the parties, for commercialization by or on behalf of the Company in the United States and by or on behalf of Sobi outside of the United States. If the parties do not agree to jointly pursue any development activities for the Licensed Products (whether for an Initial Indication or otherwise), the party proposing to pursue such activities may conduct such activities at its sole expense (with the non-proposing party having the right to obtain rights to the data generated by such development activities by paying a specified percentage of that expense), subject to agreed-upon exceptions that limit each party’s unilateral development rights.

The initial development plan sets forth the initial development activities to be conducted by each of the Company and Sobi, with the Company bearing all costs incurred in conducting the activities set forth in such initial development plan, as well as certain specified additional costs that are not included in the initial development plan that may be incurred by the parties in developing Licensed Products for paroxysmal nocturnal hemoglobinuria in the European Union and the United Kingdom. The Company and Sobi will form several governance committees to oversee the development and manufacture, and to review and discuss the commercialization, of Licensed Products.

The Company shall supply Licensed Products to Sobi for development and for commercialization outside of the United States in accordance with a supply agreement to be negotiated by the parties. The collaboration agreement grants Sobi the right to perform or have performed drug product manufacturing of Licensed Products for development and for commercialization outside the United States and to manufacture or have manufactured drug substance under certain circumstances.

Sobi paid the Company an upfront payment of $250.0 million in November 2020 and has agreed to pay up to an aggregate of $915.0 million upon the achievement of specified one-time regulatory and commercial milestone events, and to reimburse the Company for up to $80.0 million in development costs. The Company will also be entitled to receive tiered, double-digit royalties (ranging from high teens to high twenties) on sales of Licensed Products outside of the United States, subject to customary deductions and third-party payment obligations, until the latest to occur of: (i) expiration of the last-to-expire of specified licensed patent rights; (ii) expiration of regulatory exclusivity; and (iii) ten (10) years after the first commercial sale of the applicable Licensed Product, in each case on a Licensed Product-by-Licensed Product and country-by-country basis. Under the collaboration agreement, the Company remains responsible for its license fee obligations (including royalty obligations) to the University of Pennsylvania as a licensor of the Company and for its payment obligations to SFJ Pharmaceuticals.

Accounting Analysis

The Company has determined that the agreement is within the scope of ASC 808 as a contractual arrangement that involves a joint operating activity whereby both parties are (i) active participants in the activity and (ii) exposed to certain significant risks and rewards dependent on the commercial success of the activity. ASC Topic 808 does not address measurement or recognition matters but allows for analogizing to ASC 606. Pursuant to ASC 606, the Company performed the following five steps: (i) identified the contract(s) with a customer; (ii) identified the performance obligations in the contract; (iii) determined the transaction price; (iv) allocated the transaction price to the performance obligations in the contract; and (v) recognized revenue when (or as) the entity satisfies a performance obligation.  

The Company identified the following material distinct promises under the Sobi Agreement: (1) licenses to develop and commercialize pegcetacoplan or, Licenses to IP, and (2) performance of research and development services. The Company determined the promises to be distinct because Sobi can benefit from each of the license and the development services on their own or with readily available services. The Company could have provided the license without any development services and Sobi would have been

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able to benefit from it by obtaining development services from another provider as the Licensed Products are at a more mature stage in their life cycle.     

Under the agreement, Sobi agreed to pay the Company

At contract inception, the $250.0 million non-refundable payment and the $80.0 million reimbursements were fixed proceeds.  The Company evaluated whether Sobi is a customer for either of the distinct promises in the agreement. Under the Licenses to IP, the Company determined that Sobi is a customer as the know-how provided and the right granted by the Company to Sobi are outputs of the Company’s business activities for which the Company will receive consideration. With respect to research and development activity, management determined that there is no vendor relationship as performing research and development activities for others is not a part of the Company’s ongoing central operations. Based upon the evaluation of the relative fair values, the Company allocated the purchase price of $250.0 million and the related milestones and royalties to the license of IP and $80.0 million to performance of research and development activities.

The milestone and royalty payments are subject to activities outside the control of the Company. Per ASC 606, the Company considers this to be a customer/ vendor relationship, therefore, the Company will include the regulatory milestone payments in the total transaction price when it is probable that a significant reversal of revenue would not occur in a future period. The Company will recognize commercial milestone and royalty revenue at the later of (i) when the related sales occur or (ii) when the performance obligation to which the commercial milestone or royalty has been allocated has been satisfied. In case of commercial milestone or royalty payments, the Company will recognize revenue in the same period that the sales are completed for which the Company is contractually entitled to the milestone or percentage-based royalty payment. To date, the Company has not recognized any commercial milestone or royalty revenue resulting from any of our licensing arrangements. Management will periodically assess the elements of the contract and re-evaluate revenue recognition as necessary.

Pursuant to ASC 606, for the year ended December 31, 2020 the Company recognized the $250.0 million in revenue as this is the amount allocated to the license. The $80.0 million reimbursement for research and development activities does not constitute a customer/vendor relationship and thus is not in the scope of ASC 606. As ASC 808 does not include recognition guidance, the Company has established an accounting policy to recognize the payments under the reimbursement as a receivable on the balance sheet in an amount that is to be reimbursed based upon expense incurred by the Company, with a contra- research and development expense recognized in the statement of operations, over time as the expenses are incurred.

Under the Sobi collaboration agreement, for the three months ended March 31, 2021, the Company did not recognize licensing revenue. As of March 31, 2021, the Company recognized $8.1 million for contra-research and development expense in the unaudited condensed consolidated statement of operations related to the $80.0 million reimbursement from Sobi. As of December 31, 2020, the Company had recorded a $43.0 million receivable for contra-research and development reimbursement on the consolidated balance sheet, with $25.0 million and $18.0 million in current and long-term assets, respectively. The Company received a $25.0 million payment from Sobi in January 2021. As of March 31, 2021, the Company has a receivable of $26.1 million for contra-research and development reimbursement from Sobi recognized on the unaudited condensed consolidated balance sheet with $20.0 million recognized in current assets and $6.1 million recognized in other assets.

12. License Agreements

In connection with its purchase of assets from Potentia in September 2014, the Company became party to a license agreement with the Trustees of the University of Pennsylvania (“Penn”) as a result of an agreement to purchase substantially all the assets of Potentia Pharmaceuticals, Inc, for an exclusive, worldwide license to specified patent rights. The Company is required to pay annual maintenance fees of $0.1 million until the first sale of a licensed product. The Company is also required to make milestone payments aggregating up to $3.2 million based upon the achievement of specified development and regulatory milestones and up to $5.0 million based upon the achievement of specified annual sales milestones with respect to each licensed product, and to pay low single-digit royalties based on net sales of each licensed product and with minimum quarterly royalty thresholds. In addition, the Company is obligated to pay a specified portion of income it receives from sublicensees.

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In addition, the Company is also party to a license agreement with Penn for an exclusive, worldwide license to specified patent rights for the development and commercialization of products in fields of use, as defined therein. The Company is required to pay annual maintenance fees of $0.1 million until the first sale of a licensed product. The Company is required to make milestone payments aggregating up to $1.7 million, based upon the achievement of development and regulatory approval milestones, and up to $2.5 million, based upon the achievement of annual sales milestones with respect to each of the first two licensed products. The license agreement also requires the Company to pay low single digit royalties based on net sales of each licensed product, subject to minimum quarterly royalty thresholds. In addition, the Company is obligated to pay a specified portion of income it receives from sublicensees.

In January 2021, the Company paid $25.0 million for royalty expense owed to Penn related to the Sobi Agreement and another licensing transaction. As of December 31, 2020 the $25.0 million was recognized in accrued expenses on the consolidated balance sheet and recognized in license fees on the consolidated income statement.

In addition to the license agreement with Penn, 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 $15.0 million or to pay royalty fees ranging from 3-6% if any of the research results in regulatory approval or commercial revenue for a product.

13. Commitments and Contingencies

The Company contracts to conduct research and development activities with third parties. 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 March 31, 2021, the Company would be required to pay certain termination costs and other fees of approximately $3.2 million that would be incurred in future periods.

The Company has certain non-cancellable purchase obligations related to the manufacturing of drug substance and drug product, primarily with Bachem Americas, Inc., and Bachem AG, collectively (“Bachem”) for the drug substance for the finished dosage form of pegcetacoplan and with NOF Corporation and NOF America Corporation, collectively, (“NOF”) for a component of pegcetacoplan. As of March 31, 2021, the Company has non-cancellable purchase commitments for 2021 with Bachem and NOF in the amount of approximately $16.4 million and $32.4 million, respectively. Subsequent to March 31, 2021, the Company became obligated for additional non-cancellable purchase commitments to Bachem and NOF for 2021 of approximately $2.9 million and $6.4 million, respectively.

Following regulatory approval by the FDA or EMA of pegcetacoplan for the treatment of PNH, the Company has certain payment and other obligations under the SFJ Agreement, which are discussed above in Note 4.

Indemnifications—In the ordinary course of business, the Company enters into agreements that may include indemnification provisions. Pursuant to such agreements, the Company may indemnify, hold harmless and defend indemnified parties for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third-party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. The Company has not incurred any cost to defend lawsuits or settle claims related to these indemnification provisions.

Legal—During the normal course of business, the Company may be a party to legal claims that may not be covered by insurance. Management does not believe that any such claims would have a material impact on the Company’s consolidated financial statements.

14. 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 (in thousands):

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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, 2020 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2021, which we refer to as the 2020 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 programs targeting C3 with Phase 3 clinical trials of our lead product candidate, pegcetacoplan, in multiple indications. We believe that pegcetacoplan 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. Pegcetacoplan 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; cold agglutinin disease, or CAD; and C3 glomerulopathy, or C3G. We are developing pegcetacoplan and other product candidates, including APL-9, targeting C3 through various routes of administration and plan to conduct clinical trials of these compounds in additional complement-dependent indications.

In October 2020, we entered into a collaboration and license agreement, or the collaboration agreement, with Swedish Orphan Biovitrum AB (Publ), or Sobi. Under the collaboration agreement, we agreed to co-develop pegcetacoplan for systemic indications, including PNH, CAD and hematopoietic stem cell transplantation-associated thrombotic microangiopathy, or HSCT-TMA, in hematology; C3G and immune complex membranoproliferative glomerulonephritis, or IC-MPGN in nephrology; and amyotrophic lateral sclerosis, or ALS in neurology. Sobi has exclusive ex-U.S. commercialization rights for systemic pegcetacoplan. We retain commercialization rights for systemic pegcetacoplan in the United States and worldwide commercial rights for ophthalmological pegcetacoplan, which includes our GA program in addition to worldwide commercialization rights for APL-9 and other novel compounds targeting C3.

GA. We initiated a Phase 3 clinical program consisting of two Phase 3 clinical trials evaluating pegcetacoplan in patients with GA in September 2018. We refer to these trials as the DERBY and OAKS trials. Both trials are fully enrolled and we expect to announce top-line data from these trials in the third quarter of 2021. In our Phase 2 clinical trial of pegcetacoplan in patients with GA, treatment with pegcetacoplan resulted in a significant reduction in the rate of GA lesion growth over 12 months. Additionally, data released in April 2021 from a post hoc analysis of seven patients in our Phase 1b trial of pegcetacoplan in patients with advanced GA and low vision demonstrated a trend in reduced lesion growth in eyes treated with pegcetacoplan versus untreated fellow eyes after 24 months of treatment.

Systemic Pegcetacoplan. We are developing pegcetacoplan for systemic administration in several indications, including PNH, C3G, IC-MPGN, ALS, CAD and HSCT-TMA.

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PNH. In June 2018, we initiated a Phase 3 clinical trial evaluating pegcetacoplan in 80 patients with PNH who exhibited signs of moderate to severe anemia, specifically with an inclusion criterion of hemoglobin level of less than 10.5 g/dL, while being treated with eculizumab, an approved therapy for PNH that is marketed as Soliris. We refer to this trial as the PEGASUS trial.

In January 2020, we announced top-line data from the PEGASUS trial that showed that pegcetacoplan met the trial’s primary efficacy endpoint, demonstrating superiority to eculizumab, with a statistically significant improvement in adjusted means of 3.8 g/dL of hemoglobin at week 16 (p < 0.0001), and promising results in key secondary endpoints. Additional data from the PEGASUS trial presented in June 2020 and December 2020 demonstrated increased hemoglobin levels, reduced transfusion requirements and improved key markers of hemolysis across the patient population, both in patients with high transfusion requirements and in patients with low or no transfusion requirements, which improvements were sustained through 48 weeks of treatment. In the PEGASUS trial, the safety profile of pegcetacoplan was comparable to that of eculizumab.  

In September 2019, we initiated a second Phase 3 clinical trial in patients with PNH who have not been treated with eculizumab within three months before entering the trial. This trial is fully enrolled and we intend to present top-line data in the second quarter of 2021. We refer to this trial as the PRINCE trial.

We submitted an NDA to the FDA, and an MAA to the EMA, for pegcetacoplan for the treatment of PNH in September 2020. The FDA accepted the NDA and set the Prescription Drug User Fee Act, or PDUFA, target action date for May 14, 2021. The EMA validated the MAA in October 2020, with the potential for a European Commission decision on the MAA in the second half of 2021.  

C3G/IC-MPGN. We have initiated and will continue to lead our registrational program in C3G / IC-MPGN. We initiated the Phase 2 NOBLE trial in up to 12 patients with post-kidney transplant recurrence of C3G or IC-MPGN in October 2020. We expect to dose the first patient in the NOBLE trial in the first half of 2021. We also plan to begin a Phase 3 clinical trial in patients with native kidney or post-transplant recurrence of C3G or IC-MPGN, having reduction of proteinuria as its primary endpoint, in the second half of 2021.

ALS. We have initiated a randomized, placebo-controlled Phase 2 clinical trial of pegcetacoplan in approximately 200 adults with sporadic ALS. We refer to this trial as the MERIDIAN trial. We treated the first patient in MERIDIAN in November 2020 and expect to complete enrollment in MERIDIAN in the second half of 2021.

CAD and HSCT-TMA. Sobi will lead development activities for a Phase 3 clinical trial in CAD and a Phase 2 clinical trial in HSCT-TMA, both planned to begin in 2021. In our Phase 2 clinical trial of pegcetacoplan in patients with CAD, patients achieved increased hemoglobin levels, reduced reticulocytes and bilirubin levels, and reduced LDH levels compared to baseline.

Pipeline. We are developing pegcetacoplan and other product candidates, including APL-9, targeting C3 through various routes of administration. We plan to conduct clinical trials of these compounds in additional complement-dependent indications. APL-9 is a C3 modulator designed to be intravenously administered for acute use. In May 2020 we initiated a Phase 1/2 randomized, placebo-controlled clinical trial for APL-9 in 66 patients with respiratory failure including acute respiratory distress syndrome (ARDS) secondary to COVID-19. In March 2021 we announced that we will not pursue additional development of APL-9 for the treatment of severe COVID-19 after an interim review of data from the Phase 1/2 trial by an independent data monitoring committee found no meaningful reduction in the overall mortality rate in patients treated with APL-9 in combination with standard of care therapy compared to the standard of care alone. No safety signals were observed by the data monitoring committee. We expect to report results from this trial in the second quarter of 2021. We are also developing APL-9 for the prevention of complement immune system activation coincident with adeno-associated virus, or AAV, vector administration for gene therapies and other indications. We plan to advance three new product candidates into clinical development by the end of 2022.

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 pegcetacoplan, 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.

To date, we have financed our operations primarily through $772.1 million in net proceeds from public offerings of our common stock, including our initial public offering, or IPO, $535.8 million in net proceeds from the private offerings of Convertible Notes, a $250.0 million upfront payment and a $25.0 million as a development reimbursement payment from Sobi each pursuant to the Sobi collaboration agreement, $112.6 million in proceeds from the private placement of shares of our convertible preferred stock prior to our IPO, $140.0 million under 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. We have repaid the term loan facility and the promissory note in full, and we exchanged $126.1 million of aggregate principal amount of 2019 Convertible Notes for shares of our common stock in January 2021.

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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 $183.7 million and $168.8 million for the three months ended March 31, 2021 and March 31, 2020, respectively. As of March 31, 2021, we had an accumulated deficit of $1.1 billion. 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 our ongoing and planned clinical trials of pegcetacoplan and APL-9; initiate and continue research and preclinical and clinical development efforts for any future product candidates; 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 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 March 31, 2021 we had cash, cash equivalents and marketable securities of $723.7 million. We believe that our existing cash, cash equivalents and marketable securities as of March 31, 2021, along with the committed development reimbursement payments from Sobi, will enable us to fund our operating and capital expenditure requirements at least into the second half of 2022. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect. See “Liquidity and Capital Resources.”

We temporarily closed our facilities in March 2020 in respect to the COVID-19 pandemic. We have since reopened our facilities on a limited basis, subject to compliance with strict safety guidelines, but most of our employees continue to work remotely. We do not believe that the COVID-19 pandemic has had a significant impact upon our operations, including our ongoing clinical trials and the manufacture and supply of our product candidates.

SFJ Agreement

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 pegcetacoplan 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 pegcetacoplan in PNH and subject to our having cash resources at the time sufficient to fund at least 10 months of our operations.

On June 7, 2019, we amended the SFJ 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 pegcetacoplan for the treatment of patients with PNH.

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.

In September 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 in January 2020 received the remaining $20.0 million installment of the additional $60.0 million upon the announcement of the results of the PEGASUS phase 3 trial.

Under the SFJ Agreement, following regulatory approval by the FDA or EMA under the SFJ Agreement for the use of pegcetacoplan 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.

Convertible Notes

In September 2019, we issued and sold $220.0 million aggregate principal amount of 3.5% convertible senior notes due 2026, or the 2019 Convertible Notes, in a private offering. The net proceeds from the sale of the 2019 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 in September 2019 described below.

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In May 2020, we issued and sold an additional $300.0 million aggregate principal amount of 3.5% convertible senior notes due 2026, or the 2020 Convertible Notes, in a private offering. The aggregate purchase price of the 2020 Convertible Notes was $328.9 million, which amount included accrued interest from March 15, 2020 to, but not including, May 12, 2020. The net proceeds from the sale of the 2020 Convertible Notes were approximately $322.9 million after deducting the initial purchasers’ discounts and commissions and offering expenses payable by us. We used $43.1 million of the net proceeds from the offering to pay the cost of the capped call transactions in May 2020 described below. The 2020 Convertible Notes were issued as additional notes under the Indenture and form a single series with, and have the same terms as, the 2019 Convertible Notes, but have a different issue date, issue price, CUSIP number and different restrictions on transfer. We refer to the 2019 Convertible Notes and the 2020 Convertible Notes together as the Convertible Notes.

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 $39.4625 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 governing the Convertible Notes, or 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 our 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 January 6, 2021, we entered into separate, privately negotiated exchange agreements with certain holders of our 2019 Convertible Notes. Under the terms of these exchange agreements, the holders exchanged approximately $126.1 million in aggregate principal amount of 2019 Convertible Notes held by them for an aggregate of 3,906,869 shares of our common stock. The exchange transactions closed in January 2021.

Capped Call Transactions

In September 2019 and May 2020, concurrently with the pricing of the 2019 Convertible Notes and 2020 Convertible Notes, respectively, 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, 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.

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Collaboration Agreement with Sobi

On October 27, 2020, we entered into the collaboration agreement with Sobi, concerning the development and commercialization of pegcetacoplan and specified other structurally and functionally similar compstatin analogues or derivatives for use systemically or for local non-ophthalmological administration, collectively referred to as the licensed products. See “Business—Collaboration and License Agreement with Sobi” for a description of the key terms of our collaboration agreement with Sobi. We granted Sobi an exclusive (subject to certain rights retained by us), sublicensable license of certain patent rights and know-how to develop and commercialize licensed products in all countries outside of the United States. We retained the right to commercialize licensed products in the United States, and, subject to specified limitations, to develop licensed products worldwide for commercialization in the United States. Under the agreement, Sobi made an upfront payment of $250.0 million in November 2020, and agreed to pay up to an aggregate of $915.0 million upon the achievement of specified one-time regulatory and commercial milestone events, and to reimburse us for up to $80.0 million in development costs. In January 2021 we received a $25.0 million development reimbursement payment from Sobi and expect to receive the balance in installments over the next three years, subject to certain conditions. We are also entitled to receive tiered, double-digit royalties (ranging from high teens to high twenties) on sales of licensed products outside of the United States, subject to customary deductions and third-party payment obligations, until the latest to occur of: (i) expiration of the last-to-expire of specified licensed patent rights; (ii) expiration of regulatory exclusivity; and (iii) ten (10) years after the first commercial sale of the applicable licensed product, in each case on a licensed product-by-licensed product and country-by-country basis. We remain responsible for our license fee obligations (including royalty obligations) to the University of Pennsylvania and for our payment obligations to SFJ Pharmaceuticals.

Financial Operations Overview

Revenue 

We have not generated any revenue from product sales. If we are able to obtain regulatory approval for pegcetacoplan for the treatment of PNH in the United States, we will expect to generate revenue from the sale of products within the next twelve months.  

Licensing and Collaboration Revenue

We enter into licensing agreements from time to time in which we receive upfront payments, milestone payments and royalties. In 2020 we entered into a collaboration agreement with Sobi for the development and commercialization of systemic pegcetacoplan, described below, and two license agreements with third parties to use APL-9 in certain research projects.

We analyze our license and collaboration arrangements pursuant to FASB ASC Topic 808, Collaborative Arrangement Guidance and Considerations to assess whether such arrangements, or transactions between arrangement participants, involve joint operating activities performed by parties that are both active participants in the activities and exposed to significant risks and rewards dependent on the commercial success of such activities or are more akin to a vendor-customer relationship. In making this evaluation, we consider whether the activities of the collaboration are considered to be distinct and deemed to be within the scope of the collaborative arrangement guidance and those that are more reflective of a vendor-customer relationship and, therefore, within the scope of the revenue with contracts with customers guidance. This assessment is performed throughout the life of the arrangement based on changes in the responsibilities of all parties in the arrangement.

For elements of collaboration arrangements that are not accounted for pursuant to the revenue from contracts with customers guidance, an appropriate recognition method is determined and applied consistently, generally by analogy to the revenue from contracts with customers guidance. Amounts related to transactions with a counterparty in a collaborative arrangement that is not a customer are presented as collaboration revenue and on a separate line item from revenue recognized from contracts with customers, if any, in our consolidated statements of operations.

Revenue is recognized when a customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that we determine are within the scope of ASC 606, Revenue from Contracts with Customers (“ASC 606”), we perform the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract, determine those that are performance obligations and assess whether each promised good or service is distinct. We then recognize as revenue the

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amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Pursuant to ASC 606, we recorded the $250.0 million non-refundable upfront payment in revenue as the payment was associated with the transfer of the good or services in the form of the license to Sobi. The $80.0 million reimbursement for research and development activities does not constitute a customer/vendor relationship and thus is not in the scope of ASC 606. As ASC 808 does not include recognition guidance, we established an accounting policy to recognize the payments under the reimbursement as a receivable on the balance sheet in an amount that is probable to be reimbursed based upon expense incurred by us, with a contra-research and development expense recognized in the statement of operations.

For the three months ended March 31, 2021 we did not recognize licensing revenue. As of March 31, 2021, we recognized $8.1 million in contra-research and development expense in the unaudited condensed consolidated statement of operations related to the $80.0 million reimbursement from Sobi. As of December 31, 2020, we had recorded a $43.0 million receivable for contra-research and development reimbursement, with $25.0 million and $18.0 million recorded in current and long-term assets, respectively. In January 2021, we received a $25.0 million development reimbursement payment from Sobi. As of March 31, 2021, we have a receivable of $26.1 million for contra-research and development reimbursement from Sobi recognized on the unaudited condensed consolidated balance sheet, with $20.0 million of the receivable in current assets and $6.1 million in other assets.

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 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 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 pegcetacoplan 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

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increased size and duration of later-stage clinical trials. We expect research and development costs to increase for the 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 2020 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:  

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Results of Operations

Comparison of Three Months Ended March 31, 2021 and 2020

The following table summarizes our results of operations for the three months ended March 31, 2021 and 2020, together with the dollar increase or decrease and percentage change in those items (in thousands):

Research and Development Expenses

The following table summarizes our research and development expenses incurred during the three months ended March 31, 2021 and 2020, together with the dollar increase or decrease and percentage change in those items (in thousands):

Research and development expenses increased by $14.7 million to $84.0 million for the three months ended March 31, 2021 from $69.3 million for the three months ended March 31, 2020, an increase of 21%. The increase in research and development expenses was primarily attributable to an increase of $10.1 million in clinical trial costs associated the on-going Phase 3 trials and the preparation for and commencement of our clinical trials in other indications, an increase of $7.8 million in personnel related costs primarily due to the hiring of additional personnel, an increase of $9.5 million in research and development supporting activities caused primarily by increased quality and medical affairs expenses. The increases were offset by a decrease of $8.1 million in contra research and development expense related to the Sobi transaction, $4.4 million in contract manufacturing expenses due to timing of drug supply and analytical activity and $0.2 million in device development expenses. 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 $11.1 million to $40.6 million for the three months ended March 31, 2021, from $29.5 million for the three months ended March 31, 2020, an increase of 38%. The increase in general and administrative expenses was primarily attributable to an increase in employee related costs of $7.8 million, an increase in professional and consulting

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fees and general commercial preparation activities of $3.2 million, an increase of $0.6 million in director stock compensation expense, and an increase in $0.1 million in insurance, offset by a decrease in general office costs and conference and travel related expenses of $0.6 million. The increase in employee related costs of $7.8 million consisted of a $4.7 million increase in salaries and benefits primarily due to the increase in the number of employees, $4.1 million related to stock expense associated with the grant of stock options and restricted stock units to employees offset by a decrease of $1.0 million in recruitment expense. The increase in other professional and consulting fees and general commercial preparation activities of $3.2 million primarily related to an increase in commercial related activity of $4.8 million, offset by a decrease in general professional fees of $1.3 million and a decrease in communication and public relations fees of $0.3 million.

Loss on Conversion of Debt

In January 2021, we entered into separate, privately negotiated exchange agreements to modify the conversion terms with certain holders of our 2019 Convertible Notes. Under the terms of these exchange agreements, the holders exchanged approximately $126.1 million in aggregate principal amount of 2019 Convertible Notes held by them for an aggregate of 3,906,869 shares of common stock issued by us. In accordance with ASC topic 470-20, “Debt,– Debt with Conversion and Other Options,” we accounted for the exchange as an induced conversion based on the short period of time the conversion offer was open and the substantive conversion feature offer. We accounted for the conversion of the debt as an inducement by expensing the fair value of the shares that were issued in excess of the original terms of the Convertible Notes. We reduced net debt outstanding and increased equity on the consolidated balance sheet by $122.8 million, consisting of the par value of the 2019 Convertible Notes exchanged of $126.1 million less the $3.3 million of remaining debt issuance costs associated with the exchange notes. We also increased shares outstanding by 3,906,869 shares consisting of 3,196,172 shares issued at the initial conversion rate in the Indenture of 25.3405 plus an additional 710,697 shares.  Additionally, we issued 69,491 shares as settlement of debt issuance costs paid to our advisor in connection with the conversion transaction. Upon exchange of the 2019 Convertible Notes, the holders forfeited accrued interest through the date of the exchange of $1.7 million, which we charged to interest expense and to equity. We recorded a loss on conversion of debt of $39.5 million comprised of $36.4 million related to the value of the shares issued in excess of the original conversion terms at the fair market value and $3.1 million for the value of the 69,491 shares issued in payment of issuance costs.  As of March 31, 2021, we held as treasury Convertible Notes the $126.1 million principal amount of exchanged notes and such notes have not been cancelled.

Gain/Loss from Remeasurement of Development Derivative Liability

On February 28, 2019, we entered into the SFJ agreement under which SFJ agreed to provide funding to us to support the development of pegcetacoplan for the treatment of patients with PNH. The development derivative liability was initially recorded at the value of the $60.0 million aggregate cash received pursuant to the contractual terms.  

The SFJ 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 and in each of September 2019 and January 2020, we achieved a $20.0 million development milestone under the terms of the agreement, resulting in the receipt of an aggregate of $60.0 million of additional funding from SFJ.

We remeasure the fair value of the liability as a level 3 derivative at the end of each quarter. The remeasurement as of March 31, 2021 and March 31, 2020 resulted in a change in fair value recorded as a loss in the unaudited condensed consolidated statements of operations of $17.1 million and $68.4 million for the three months ended March 31, 2021 and March 31, 2020, respectively.

Interest Expense

Interest expense was $4.2 million for the three months ended March 31, 2021 and $3.9 million for the three months ended March 31, 2020 primarily related to the 2019 and 2020 Convertible Notes. The increase in interest was primarily due to the increase in the Convertible Notes outstanding offset by the adoption of ASU 2020-06 which reduced the amount of non-cash interest recognized on the debt discount.

Interest Income

Interest income was $0.1 million for the three months ended March 31, 2021, a decrease of $2.1 million, compared to $2.2 million for the three months ended March 31, 2020. The decrease in interest income was primarily attributable to a decline in investment yields and interest rates.

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Other Income, Net

Other income, net during the three months ended March 31, 2021, decreased $1.5 million compared to the three months ended March 31, 2020.

Liquidity and Capital Resources 

Sources of Liquidity

To date, we have financed our operations primarily through $772.1 million in net proceeds from public offerings of our common stock, including our IPO, $535.8 million in net proceeds from offerings of Convertible Notes, a $250.0 million upfront payment and a $25.0 million development reimbursement payment from Sobi each pursuant to the Sobi collaboration agreement, $112.6 million in proceeds from the private placement of shares of our convertible preferred stock prior to our IPO, $140.0 million under 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. We have repaid the term loan facility and the promissory note in full, and we exchanged $126.1 million of aggregate principal amount of 2019 Convertible Notes for shares of our common stock in January 2021.

On April 23, 2018, we issued and sold 5,500,000 shares of our common stock in a follow-on public offering at a public offering price of $25.50 per share for net proceeds of $131.2 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.

On January 13, 2020, we issued and sold 10,925,000 shares of our common stock in a follow-on offering at a public offering price of $37.00, including 1,425,000 shares sold pursuant to the underwriters’ exercise in full of their option to purchase additional shares of common stock. We received total net proceeds of $381.4 million after deducting underwriting discounts and commissions of $22.2 million and offering costs of $0.5 million.

On May 12, 2020, we completed a private offering of $300.0 million aggregate principal amount of 2020 Convertible Notes. We received net proceeds of approximately $322.9 million, which included accrued interest March 15, 2020 to, but not including May 12, 2020, and the initial purchasers’ discounts and commissions and offering costs of $6.0 million.

On January 6, 2021, we entered into separate, privately negotiated exchange agreements with certain holders of our 2019 Convertible Notes. Under the terms of these exchange agreements, the holders exchanged approximately $126.1 million in aggregate principal amount of 2019 Convertible Notes held by them for an aggregate of 3,906,869 shares of our common stock. The exchange transactions closed in January 2021.

In addition to our existing cash, cash equivalents and marketable securities, we expect to receive research and development reimbursements and are eligible to earn development and commercial milestone payments and royalties under our collaboration agreement with Sobi. Our ability to earn these milestone payments and the timing of earning these payments is dependent upon the outcome of our research and development and commercialization activities and is uncertain at this time.

The capped call transactions that we entered into concurrently with the issuance of the Convertible Notes 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.

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Cash Flows

The following table provides information regarding our cash flows for the three months ended March 31, 2021 and 2020 (in thousands):

Net Cash Used in Operating Activities 

Net cash used in operating activities was $153.3 million for the three months ended March 31, 2021 and consisted primarily of a net loss of $183.7 million adjusted for $75.4 million of non-cash items, including a loss on early conversion of debt of $39.5 million and a loss from remeasurement of development derivative liability of $17.1 million, share-based compensation expense of $16.4 million, and the forfeiture of accrued interest in the exchange of the 2019 Convertible Notes of $1.7 million, a net increase in operating assets of $1.9 million, an decrease in accounts payable of $4.1 million and an decrease in accrued expenses of $42.8 million.

Net cash used in operating activities was $108.3 million for the three months ended March 31, 2020 and consisted primarily of a net loss of $168.8 million adjusted for $79.8 million of non-cash items, including a loss from remeasurement of development derivative liability of $68.4 million and share-based compensation expense of $9.3 million, a net increase in accounts payable, accrued expenses and other liabilities of $15.2 million and a net decrease in operating assets of $4.1 million.

Net Cash Used in Investing Activities

Net cash used in investing activities during the three months ended March 31, 2021 was $146.8 million due primarily to the purchase of marketable securities.

Net cash used in investing activities during the three months ended March 31, 2020 was $227.9 million due primarily to the purchase of marketable securities with proceeds from the January 2020 follow-on offering.

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $1.6 million during the three months ended March 31, 2021 and consisted primarily of $2.6 million upon the exercise of stock options offset by $1.0 million for the payment of employee tax withholding related to equity-based compensation.

Net cash provided by financing activities was $403.3 million during the three months ended March 31, 2020 and consisted primarily of proceeds from the follow-on offering in January 2020 of $381.6 million, the receipt of $20.0 million from the SFJ agreement and $1.7 million upon the exercise of stock options.

Funding Requirements

We expect our expenses to increase in connection with our ongoing activities, particularly as we continue the research and development of, and seek marketing approval for, our product candidates. In addition, if we obtain marketing approval for any of our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. Furthermore, we expect to continue to incur additional costs associated with operating as a public company. Accordingly, we will need to obtain substantial additional funding in connection with our continuing operations. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or future commercialization efforts.

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We believe that our cash, cash equivalents and marketable securities as of March 31, 2021, along with the committed development reimbursement payments from Sobi, will enable us to fund our operating expenses and capital expenditure requirements at least into the second half of 2022. We have based this estimate on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect. Although we expect that our cash, cash equivalents and marketable securities will be sufficient to allow us to complete the DERBY and OAKS clinical trials, we do not believe they will be sufficient to allow us to support both the systemic and ophthalmological pegcetacoplan programs through commercial launch. Because of the numerous risks and uncertainties associated with the development of pegcetacoplan and other potential product candidates, and because the extent to which we may enter into collaborations with third parties for the development of these product candidates is unknown, we are unable to estimate the amounts of increased capital outlays and operating expenses associated with completing the research and development of our product candidates. Our future funding requirements will depend on many factors, including:

Identifying potential product candidates and conducting preclinical testing and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain marketing approval and achieve product sales. In addition, our product candidates, if approved, may not achieve commercial success. Our commercial revenues, if any, will be derived from sales of medicines that we do not expect to be commercially available for many years, if at all. Accordingly, we will need to continue to rely on additional financing to achieve our business objectives. Adequate additional financing may not be available to us on acceptable terms, or at all.

Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and licensing arrangements. We currently do not have any committed external source of funds. To the extent that we raise additional capital through the sale of equity or convertible debt securities, our stockholders’ ownership interests will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. Debt financing, if available, would result in fixed payment obligations and may involve agreements that include restrictive covenants that limit our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends, that could adversely impact our ability to conduct our business.

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If we raise funds through collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves.

Contractual Obligations

The disclosure of our contractual obligations and commitments is set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations” in our 2020 Annual Report on Form 10-K. See Note 12 to our unaudited condensed financial statements included in Item 1, “Financial Statements,” of this Quarterly Report on Form 10-Q for a discussion of obligations and commitments.

During the three months ended March 31, 2021, there were no material changes to our contractual obligations and commitments as of December 31, 2020 as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations” in our 2020 Annual Report on Form 10-K.

Off-Balance Sheet Arrangements 

We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under applicable SEC rules.

We are exposed to market risk related to changes in interest rates. As of March 31, 2021, we had cash, cash equivalents and marketable securities of $723.7 million, consisting primarily of money market funds and U.S. Government obligations and marketable securities. Our primary exposure to market risk is interest rate sensitivity, which is affected by changes in the general level of U.S. interest rates. Due to the short-term duration of our investment portfolio and the low risk profile of our investments, an immediate 10% change in interest rates would not have a material effect on the fair market value of our investment portfolio. We have the ability to hold our marketable securities until maturity, and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a change in market interest rates on our investments.

Limitations on Effectiveness of Controls and Procedures

The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934 as amended, or the Exchange Act, refers to controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

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

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated, as of the end of the period covered by this Quarterly Report on Form 10-Q, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2021.

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Changes in Internal Control Over Financial Reporting

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended March 31, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

As a result of the COVID-19 pandemic, beginning in March 2020 certain of our employees began working remotely. We have not identified any material changes in the Company’s internal control over financial reporting as a result of these changes to the working environment. We are continually monitoring and assessing the COVID-19 situation to determine any potential impacts on the design and operating effectiveness of our internal controls over financial reporting.

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PART II—OTHER INFORMATION

We are not currently subject to any material legal proceedings.

Careful consideration should be given to the following risk factors, in addition to the other information set forth in this Quarterly Report on Form 10-Q and in other documents that we file with the SEC, in evaluating our company and our business. Investing in our common stock involves a high degree of risk. If any of the following risks actually occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected.

RISK FACTOR SUMMARY

Our business is subject to a number of risks that if realized could materially affect our business, financial condition, results of operations, cash flows and access to liquidity. These risks are discussed more fully in the “Risk Factors” section of this Annual Report on Form 10-K. Our principal risks include the following:

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Risks Related to Our Financial Position and Need for Additional Capital

We have incurred significant losses since inception, expect to incur significant and increasing losses for at least the next several years, and may never achieve or maintain profitability.

We have incurred significant annual net operating losses in every year since our inception. We expect to continue to incur significant and increasing net operating losses for at least the next several years. Our net losses were $183.7 million for the three months ended March 31, 2021 and $344.9 million for the year ended December 31, 2020. As of March 31, 2021, we had an accumulated deficit of $1.1 billion. We have not generated any revenues from product sales, have not completed the development of any product candidate and may never have a product candidate approved for commercialization. We have financed our operations to date primarily through the sale of our common stock in our initial public offering and subsequent follow-on offerings, the sale of convertible notes, private placements of our preferred stock prior to our initial public offering, the development funding agreement with SFJ Pharmaceuticals Group, or SFJ, the collaboration agreement with Swedish Orphan Biovitrum AB (Publ), or Sobi, borrowings under a term loan facility and the issuance and sale of a promissory note. We have devoted substantially all of our financial resources and efforts to research and development, including preclinical studies and our clinical trials. Our net losses may fluctuate significantly from quarter to quarter and year to year. Net losses and negative cash flows have had, and will continue to have, an adverse effect on our stockholders’ equity and working capital.

We expect to continue to incur significant expenses and increasing operating losses for the foreseeable future. We anticipate that our expenses will increase substantially if and as we:

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Our ability to become and remain profitable depends on our ability to generate revenue. We do not expect to generate significant revenue unless and until we are, or our collaborators, including Sobi, are able to obtain marketing approval for, and successfully commercialize, one or more of our product candidates. Successful commercialization will require achievement of key milestones, including completing clinical trials of our product candidates, obtaining marketing approval for these product candidates, manufacturing, marketing and selling those products for which we, or any of our collaborators, may obtain marketing approval, satisfying any post-marketing requirements and obtaining reimbursement for our products from private insurance or government payors. Because of the uncertainties and risks associated with these activities, we are unable to accurately predict the timing and amount of revenues, and if or when we might achieve profitability. We and any collaborators may never succeed in these activities and, even if we do, or any collaborators do, we may never generate revenues that are large enough for us to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would decrease the value of our company and could impair our ability to raise capital, expand our business, maintain our research and development efforts, diversify our pipeline of product candidates or continue our operations. A decline in the value of our company could cause our stockholders to lose all or part of their investment.

We have not yet successfully obtained marketing approvals nor commercialized pharmaceutical products, which may make it difficult to evaluate our future prospects.  

Our operations to date have been limited to financing and staffing our company, developing our technology and conducting preclinical research and Phase 1, Phase 2 and Phase 3 clinical trials for our product candidates. However, although we have begun planning commercial activities, we have not yet demonstrated an ability to successfully obtain marketing approvals, manufacture a commercial-scale product, or arrange for a third party to do so on our behalf, or conduct sales and marketing activities necessary for successful product commercialization. Accordingly, our stockholders should consider our prospects in light of the costs, uncertainties, delays and difficulties frequently encountered by clinical-stage biopharmaceutical companies such as ours. Any predictions made about our future success or viability may not be as accurate as they could be if we had a longer operating history or a history of successfully developing and commercializing pharmaceutical products.

We may encounter unforeseen expenses, difficulties, complications, delays and other known or unknown factors in achieving our business objectives. We will need to transition from a company with a development focus to a company capable of supporting commercial activities. We may not be successful in such a transition.

We expect our financial condition and operating results to continue to fluctuate significantly from quarter to quarter and year to year due to a variety of factors, many of which are beyond our control. Accordingly, our stockholders should not rely upon the results of any quarterly or annual periods as indications of future operating performance.

We will need substantial additional funding to allow us to support both the systemic and ophthalmological programs through commercial launch, and if we are unable to raise capital when needed, we could be forced to delay, reduce or eliminate our product development programs or commercialization efforts.

Developing pharmaceutical products, including conducting preclinical studies and clinical trials, is a very time-consuming, expensive and uncertain process that takes years to complete. We have consumed substantial amounts of cash since our inception. For example, in the three months ended March 31, 2021, and in the years ended December 31, 2020, 2019 and 2018, we used net cash of $153.3 million, $160.5 million, $211.1 million and $131.2 million respectively, in our operating activities substantially all of which related to research and development activities. As of March 31, 2021, our cash, cash equivalents and marketable securities were $723.7 million. We expect our expenses to increase in connection with our ongoing activities, particularly as we initiate new clinical trials of, initiate new research and preclinical development efforts for, seek marketing approval for and prepare for commercialization of, our product candidates. In addition, if we obtain marketing approval for pegcetacoplan or any of our other product candidates, we may incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution to the extent that such sales, marketing, manufacturing and distribution are not the responsibility of the collaborator. Furthermore, we continue to incur significant costs associated with operating as a public company. Accordingly, we will need to obtain substantial additional funding in connection with our continuing operations, particularly if we commercialize the ophthalmological program outside the United States without a collaborator or if we fail to establish substantial commercial sales of systemic pegcetacoplan. If we are unable to raise capital when needed or on attractive terms, we may be forced to delay, reduce or eliminate our research and development programs or any future commercialization efforts.

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