Spero Therapeutics, Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2018

OR

Commission File Number 001-38266

SPERO THERAPEUTICS, INC.

(Exact name of registrant as specified in its Charter)

Registrant’s telephone number, including area code: (857) 242-1600

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 November 5, 2018, the registrant had 18,187,488 shares of common stock, $0.001 par value per share, outstanding.

Forward-Looking STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements about:

Any forward-looking statements in this Quarterly Report on Form 10-Q reflect our current views with respect to future events or to our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under Part II, Item 1A. “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain diseases, including data regarding the estimated size of those markets, and the incidence and prevalence of certain medical conditions. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market and other data from reports, research surveys, studies and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data and similar sources.

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Spero Therapeutics, Inc.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

SPERO THERAPEUTICS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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SPERO THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share data)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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SPERO THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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SPERO THERAPEUTICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Spero Therapeutics, Inc., together with its consolidated subsidiaries (the “Company”), is a multi-asset, clinical-stage biopharmaceutical company focused on identifying, developing and commercializing novel treatments for multi-drug resistant (“MDR”) bacterial infections. The Company’s most advanced product candidate, SPR994, is designed to be the first broad-spectrum oral carbapenem-class antibiotic for use in adults to treat MDR Gram-negative infections. Treatment with effective orally administrable antibiotics may prevent hospitalizations for serious infections and enable earlier, more convenient and cost-effective treatment of patients after hospitalization. The Company also has a platform technology known as its Potentiator Platform that it believes will enable it to develop drugs that will expand the spectrum and potency of existing antibiotics, including formerly inactive antibiotics, against Gram-negative bacteria. The Company’s lead product candidates generated from its Potentiator Platform are two intravenous, or IV,-administered agents, SPR741 and SPR206, designed to treat MDR Gram-negative infections in the hospital setting. In addition, the Company is developing SPR720, an oral antibiotic designed for the treatment of pulmonary non-tuberculous mycobacterial infections. The Company believes that its novel product candidates, if successfully developed and approved, would have a meaningful patient impact and significant commercial applications for the treatment of MDR infections in both the community and hospital settings.

The Company was formed as Spero Therapeutics, LLC in December 2013 under the laws of the State of Delaware. On June 30, 2017, through a series of transactions, Spero Therapeutics, LLC merged with and into Spero Therapeutics, Inc. (formerly known as Spero OpCo, Inc.), a Delaware corporation. As part of the transactions, holders of preferred units and common units of Spero Therapeutics, LLC exchanged their units for shares of Spero Therapeutics, Inc. on a one-for-one basis. These transactions are collectively referred to as the Reorganization. Upon completion of the Reorganization, the historical consolidated financial statements of Spero Therapeutics, LLC became the historical consolidated financial statements of Spero Therapeutics, Inc. because the Reorganization was accounted for as a reorganization of entities under common control.

The Company is subject to risks and uncertainties common to early-stage companies in the biotechnology industry, including, but not limited to, development by competitors of new technological innovations, dependence on key personnel, protection of proprietary technology, compliance with government regulations and the ability to secure additional capital to fund operations. Product candidates currently under development will require significant additional research and development efforts, including preclinical and clinical testing and regulatory approval prior to commercialization. These efforts require significant amounts of additional capital, adequate personnel and infrastructure and extensive compliance-reporting capabilities. Even if the Company’s product development efforts are successful, it is uncertain when, if ever, the Company will realize significant revenue from product sales.

On October 20, 2017, the Company effected a one-for-6.0774 reverse stock split of its issued and outstanding shares of common stock and a proportional adjustment to the existing conversion ratios for each series of the Company’s then outstanding Preferred Stock. Accordingly, all share and per share amounts for all periods presented in the accompanying consolidated financial statements and notes thereto have been adjusted retroactively, where applicable, to reflect this reverse stock split and adjustment of the preferred stock conversion ratios. In addition, all common units and incentive units as well as the conversion ratios of preferred units of Spero Therapeutics, LLC have been presented as if the reverse stock split of the common stock of Spero Therapeutics, Inc. had been applied to such units and ratios of Spero Therapeutics, LLC.

On November 6, 2017, the Company completed an initial public offering (“IPO”) of its common stock, and issued and sold 5,500,000 shares of common stock at a public offering price of $14.00 per share, resulting in net proceeds of $71.6 million after deducting underwriting discounts and commissions but before deducting offering costs. On November 14, 2017, Spero Therapeutics, Inc., issued and sold an additional 471,498 shares of its common stock at the IPO price of $14.00 per share pursuant to the underwriters’ partial exercise of their option to purchase additional shares of common stock, resulting in additional net proceeds of $6.1 million after deducting underwriting discounts and commissions. Aggregate net proceeds from the IPO totaled $74.2 million after deducting underwriting discounts, commissions and offering costs.

On July 17, 2018, the Company completed an underwritten public offering of its common and preferred stock, which resulted in the sale of 3,780,000 shares of common stock at a price of $12.50 per share, and 2,220 shares of Series A Convertible Preferred Stock at a price of $12,500 per share. Each share of Series A Convertible Preferred Stock sold in the offering is convertible into 1,000 shares of the Company’s common stock. The Company received net proceeds from the offering of approximately $70.5 million after deducting underwriting discounts and commissions but before deducting $1.0 million of offering expenses payable by the Company.    

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In accordance with Accounting Standards Update (“ASU”) 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40), the Company has evaluated whether there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are issued. Since inception, the Company has funded its operations with proceeds from sales of preferred units (including bridge units, which converted into preferred units), payments received in connection with a concluded collaboration agreement and funding from government contracts, and most recently, with proceeds from the IPO completed in November 2017 and the underwritten public offering of common and Series A Convertible Preferred Stock completed in July 2018. The Company has incurred recurring losses since inception, including net losses attributable to Spero Therapeutics, Inc. of $31.1 million for the nine months ended September 30, 2018, and $38.7 million and $25.5 million for the years ended December 31, 2017 and 2016, respectively. In addition, as of September 30, 2018, the Company had an accumulated deficit of $127.9 million. The Company expects to continue to generate operating losses for the foreseeable future. As of the issuance date of the quarterly consolidated financial statements, or November 8, 2018, the Company expects that its cash, cash equivalents and marketable securities will be sufficient to fund its operating expenses, capital expenditure requirements through at least 12 months from the issuance date of these quarterly consolidated financial statements. However, the future viability of the Company beyond that point is dependent on its ability to raise additional capital to finance its future operations. The Company will seek additional funding through public or private financings, debt financing, collaboration agreements or government grants. The inability to obtain funding, as and when needed, would have a negative impact on the Company’s financial condition and ability to pursue its business strategies. If the Company is unable to obtain funding, the Company could be forced to delay, reduce or eliminate some or all of its research and development programs, product portfolio expansion or commercialization efforts, which could adversely affect its business prospects, or the Company may be unable to continue operations. Although management intends to pursue plans to obtain additional funding to finance its operations, there is no assurance that the Company will be successful in obtaining sufficient funding on terms acceptable to the Company to fund continuing operations, if at all.

The accompanying consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company and its consolidated subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Interim Financial Information

The consolidated balance sheet at December 31, 2017 was derived from audited financial statements, but does not include all disclosures required by GAAP. The accompanying unaudited consolidated financial statements as of September 30, 2018, and for the three and nine months ended September 30, 2018 and 2017, have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, on file with SEC. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the Company’s financial position as of September 30, 2018, and results of operations for the three and nine months ended September 30, 2018 and 2017, and cash flows for the nine months ended September 30, 2018 and 2017 have been made. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2018.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting periods. Significant estimates and assumptions reflected in these consolidated financial statements include, but are not limited to, revenue recognition, the accrual for research and development expenses, the valuation of common shares prior to the Company’s completion of its IPO, the valuation of share-based awards and the valuation of derivative liabilities. The Company bases its estimates on historical experience, known trends and other market-specific or other relevant factors that it believes to be reasonable under the circumstances. On an ongoing basis, management evaluates its estimates, as there are changes in circumstances, facts and experience. Actual results may differ from those estimates or assumptions.

Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.

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Marketable Securities

Marketable securities consist of investments with original maturities greater than 90 days. The Company considers its investment portfolio of investments to be available-for-sale. Accordingly, these investments are recorded at fair value, which is based on quoted market prices. Investments with maturities beyond one year are generally classified as short term, based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. Unrealized gains and losses are reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary are included as a component of other income (expense), net based on the specific identification method. When determining whether a decline in value is other than temporary, the Company considers various factors, including whether the Company has the intent to sell the security, and whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis.

Fair Value Measurements

Certain assets and liabilities are carried at fair value under GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:

The Company’s cash equivalents and derivative liabilities are carried at fair value, determined according to the fair value hierarchy described above (see Note 3). The carrying values of the Company’s accounts payable and accrued expenses approximate their fair values due to the short-term nature of these liabilities.

Derivative Liabilities

In connection with certain equity financings, licensing transactions and research collaborations, the Company has identified certain embedded and freestanding derivatives, which are recorded as liabilities on the Company’s consolidated balance sheet and are remeasured to fair value at each reporting date until the derivative is settled. Changes in the fair value of the derivative liabilities are recognized as other income (expense) in the consolidated statement of operations and comprehensive loss.

Net Income (Loss) per Share Attributable to Spero Therapeutics, Inc.

The Company follows the two-class method when computing net income (loss) per share, as the Company has issued shares that meet the definition of participating securities. The two-class method determines net income (loss) per share for each class of common and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. The two-class method requires income available to common stockholders for the period to be allocated between common and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed. Net income (loss) per share attributable to common stockholders is calculated based on net income (loss) attributable to Spero Therapeutics, Inc. and excludes net income (loss) attributable to non-controlling interests.

Basic net income (loss) per share attributable to common stockholders is computed by dividing the net income (loss) attributable to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted net income (loss) attributable to common stockholders is computed by adjusting net income (loss) attributable to common stockholders to reallocate undistributed earnings based on the potential impact of dilutive securities. Diluted net income (loss) per share attributable to common stockholders is computed by dividing the diluted net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period, including potential dilutive common shares assuming the dilutive effect of common stock equivalents.

The Company’s preferred stock contractually entitles the holders of such shares to participate in dividends but does not contractually require the holders of such shares to participate in losses of the Company. Accordingly, in periods in which the

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Company reports a net loss, such losses are not allocated to such participating securities. In periods in which the Company reports a net loss attributable to common stockholders of Spero Therapeutics, Inc., diluted net loss per share attributable to common stockholders of Spero Therapeutics, Inc. is the same as basic net loss per share attributable to common stockholders of Spero Therapeutics, Inc., since dilutive common shares are not assumed to have been issued if their effect is anti-dilutive. The Company reported a net loss attributable to common stockholders of Spero Therapeutics, Inc. for the three and nine months ended September 30, 2018 and 2017.

Recently Issued and Adopted Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which supersedes existing revenue recognition guidance under GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard outlines a five-step process to achieve this principle, and will require companies to use more judgment and make more estimates than under the current guidance. The Company expects that these judgments and estimates will include identifying performance obligations in the customer contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delays the effective date of ASU 2014-09 such that the standard is effective for public entities for annual periods beginning after December 15, 2017 and for interim periods within those fiscal years. In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (“ASU 2016-08”), which further clarifies the implementation guidance on principal versus agent considerations in ASU 2014-09. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, clarifying the implementation guidance on identifying performance obligations and licensing. Specifically, the amendments in this update reduce the cost and complexity of identifying promised goods or services and improve the guidance for determining whether promises are separately identifiable. The amendments in this update also provide implementation guidance on determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”), which clarifies the objective of the collectability criterion, presentation of taxes collected from customers, non-cash consideration, contract modifications at transition, completed contracts at transition and how guidance in ASU 2014-09 is retrospectively applied. ASU 2016-08, ASU 2016-10 and ASU 2016-12 have the same effective dates and transition requirements as ASU 2014-09. The Company adopted this standard using the modified retrospective approach, however the Company determined that government grant revenue is outside the scope of ASC 606. Therefore, the adoption of ASC 606 did not impact the Company’s financial position, results of operations or cash flows as its only existing revenue source as of September 30, 2018 is government grants.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use (“ROU”) asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The guidance is effective for public entities for annual reporting periods beginning after December 15, 2018 and for interim periods within those fiscal years, and early adoption is permitted. The FASB subsequently issued amendments to ASU 2016-02, which have the same effective date and transition date of January 1, 2019: (i) ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which amends certain narrow aspects of the guidance issued in ASU 2016-02; and (ii) ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which allows for a transition approach to initially apply ASU 2016-02 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption as well as an additional practical expedient for lessors to not separate non-lease components from the associated lease component. The Company is in the process of reviewing its existing lease contracts and evaluating the impact that these adoption of these new leasing standards may have on its consolidated statements of operations. The Company expects that the adoption of the new leasing standards will result in the recognition of material ROU assets and liabilities in its consolidated balance sheets. The Company does not expect the adoption of the new leasing standards will have a material impact to its consolidated statement of operations. The Company will adopt the new leasing standards using a modified retrospective transition approach to be applied to leases existing as of, or entered into after, January 1, 2019.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), to address diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for annual periods beginning after December 15, 2017, including

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interim periods within those fiscal years. The Company’s adoption of ASU 2016-15 did not have a material impact on the Company’s consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18 Statement of Cash Flows (Topic 230) (“ASU 2016-18”), which requires that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years and should be applied using a retrospective transition method to each period presented. The adoption of ASU 2016-18 did not have a material impact on the Company’s consolidated financial statements. The inclusion of restricted cash increased the beginning and ending balances of the unaudited condensed consolidated statement of cash flows by $50,000 for the nine months ended September 30, 2017.

In January 2017, FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”). The amendments in this update clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. The standard is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of ASU 2017-01 did not materially impact the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”), which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The standard is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The adoption of ASU 2017-09 did not materially impact the Company’s consolidated financial statements.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) I. Accounting for Certain Financial Instruments with Down Round Features II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Part I applies to entities that issue financial instruments such as warrants, convertible debt or convertible preferred stock that contain down-round features. Part II replaces the indefinite deferral for certain mandatorily redeemable non-controlling interests and mandatorily redeemable financial instruments of nonpublic entities contained within ASC Topic 480 with a scope exception and does not impact the accounting for these mandatorily redeemable instruments. ASU 2017-11 is required to be adopted for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact that the adoption of ASU 2017-11 will have on its consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which aligns the accounting for share-based payment awards issued to employees and nonemployees. Under the new guidance, the existing employee guidance will apply to nonemployee share-based transactions (as long as the transaction is not effectively a form of financing), with the exception of specific guidance related to the attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an expected term in the option-pricing model for nonemployee awards. The amendments in the new guidance are effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, including in interim periods, but no earlier than an entity’s adoption of ASC 606. The Company does not expect the adoption of ASU 2018-07 to have a material impact on its consolidated financial statements.

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The following tables present information about the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):

During the three and nine months ended September 30, 2018 and 2017, there were no transfers between Level 1, Level 2 and Level 3 categories.

Marketable Securities

The Company’s marketable securities are classified as Level 2 assets under the fair value hierarchy as these assets were primarily determined from independent pricing sources, which generally derive security prices from recently reported trades for identical or similar securities. 

The following table summarizes the gross unrealized gains and losses of the Company’s marketable securities as of September 30, 2018 (in thousands):

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As of September 30, 2018, all of the Company’s marketable securities had remaining contractual maturity dates of one year or less from the consolidated balance sheet date. The Company did not own any marketable securities as of December 31, 2017.

Anti-Dilution Rights

In connection with the issuance of non-controlling interests in certain of the Company’s subsidiaries (see Note 8), specifically Spero Potentiator, Inc., Spero Europe, Ltd. and Spero Gyrase, Inc., the Company granted anti-dilution rights to the minority investors. The Company classifies the anti-dilution rights as a derivative liability on its consolidated balance sheet because they are freestanding instruments that represent a conditional obligation to issue a variable number of shares. The Company remeasures the derivative liability associated with the anti-dilution rights to fair value at each reporting date, and recognizes changes in the fair value of the derivative liability as a component of other income (expense) in the consolidated statement of operations and comprehensive loss. The fair value of these derivative liabilities was determined using a discounted cash flow model. As of September 30, 2018 and December 31, 2017, the Company’s fair value of the anti-dilution rights relates only to the anti-dilution rights held by the minority investor in Spero Gyrase, Inc., as detailed below.

Spero Gyrase, Inc.

In March 2016, in connection with the issuance of a non-controlling interest in its subsidiary, Spero Gyrase, Inc. (“Spero Gyrase”), to Biota Pharmaceuticals, Inc. (now Aviragen Therapeutics, Inc.) (“Aviragen”), the Company granted to Aviragen certain anti-dilution rights (see Note 8). The fair value of the derivative liability related to the anti-dilution rights upon issuance in March 2016 was $1.6 million.

The most significant assumption impacting the fair value of the anti-dilution rights was the probability that the Company would fund the maximum amount of investment providing anti-dilution protection. Upon issuance of the rights and through December 31, 2016, the probability of such funding was determined to be 100%. During 2017, the probability of such funding was reduced to 0% due to the Company’s decision to no longer pursue development of the acquired technology. The fair value of the derivative liability decreased accordingly by $1.4 million to $0.2 million by June 30, 2017. As of September 30, 2018 and December 31, 2017, the value of the derivative liability of $0.2 million represents amounts funded to the entity that could be settled by the issuance of equity.

5.Convertible Preferred Shares

Series A Convertible Preferred Shares

The Company’s amended and restated certificate of incorporation authorizes its Board of Directors to issue up to 10,000,000 shares of preferred stock, par value $0.001 per share. As part of the Company’s July 2018 underwritten public offering, 2,220 shares were designated as Series A Convertible Preferred Stock and issued at a price of $12,500 per share.

Each share of Series A Convertible Preferred Stock is convertible into 1,000 shares of the Company’s common stock at any time at the option of the holder, provided that the holder will be prohibited from converting the Series A Convertible Preferred Stock into shares of common stock if, as a result of such conversion, the holder, together with its affiliates, would own more than 9.99% of the total number of shares of the Company’s common stock then issued and outstanding. In the event of the Company’s liquidation, dissolution, or winding up, holders of Series A Convertible Preferred Stock will receive a payment equal to $0.001 per share of Series A Convertible Preferred Stock, plus an additional amount equal to any dividends declared but unpaid on such shares, before any proceeds are distributed to the holders of common stock or any of our securities that by their terms are junior to the Series A Convertible Preferred Stock. The Series A Convertible Preferred Stock has no voting rights, except as required by law and except that the consent of the outstanding Series A Convertible Preferred Stock holders will be required to amend the terms of the Series A

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Convertible Preferred Stock. The Series A Convertible Preferred Stock does not have any mandatory redemption rights or other redemption rights that would be outside of the Company’s control. As such, the Company has classified the Series A Convertible Preferred Stock within permanent equity in its consolidated balance sheet.

Redeemable Convertible Preferred Shares

Prior to the Reorganization, the operating agreement of Spero Therapeutics, LLC, as amended and restated, provided for the issuance of Junior preferred units, Class A preferred units, Class B preferred units and bridge units, but did not specify an authorized number of each for issuance. Subsequent to the Company’s Reorganization on June 30, 2017 (see Note 1), the Company’s amended and restated certificate of incorporation authorized the issuance of 43,297,267 shares of preferred stock, par value $0.001 per share, and holders of outstanding preferred units of Spero Therapeutics, LLC exchanged their units for preferred stock of Spero Therapeutics, Inc. on a one-for-one basis. The rights and preferences of each class of stock were the same both before and after the Reorganization. On October 20, 2017, the Company effected a one-for-6.0774 reverse stock split of its issued and outstanding shares of common stock and a proportional adjustment to the existing conversion rations for each series or the Company’s Preferred Stock. Upon the closing of the Company’s IPO in November 2017, all of the then outstanding convertible preferred shares automatically converted into shares of common stock.

In March 2017, the Company issued and sold 24,326,470 Class C preferred units at a price of $1.7749 per unit for proceeds of $43.0 million, net of issuance costs of $0.2 million. The sale of Class C preferred units met the definition of a qualified financing under the 2016 bridge unit agreements.

The Company issued 5,321,112 Class C preferred units upon the conversion of the 2016 bridge units in the amount of $8.5 million, at a conversion price of $1.60 per unit, which represented a discount of 10% to the price per unit paid by other investors in the Class C preferred unit financing. The conversion was accounted for as an extinguishment for accounting purposes. Accordingly, the Company recorded the Class C preferred units issued upon conversion of the 2016 bridge units at their aggregate fair value of $9.4 million and recorded a corresponding adjustment to extinguish the then-current carrying value of the 2016 bridge units of $8.5 million and the then-current fair value of the derivative liability related to the contingent prepayment option associated with the 2016 bridge units of $0.9 million. There was no gain or loss recognized upon the extinguishment.

In July 2017 the Company sold to its Chief Financial Officer 61,880 shares of the Company’s Series C preferred stock at a price of $1.7749 per share, for proceeds of $0.1 million.

On July 17, 2018, the Company completed an underwritten public offering of its common and preferred stock, which resulted in the sale of 3,780,000 shares of common stock at a price of $12.50 per share, and 2,220 shares of Series A Convertible Preferred Stock at a price of $12,500 per share. The Company received net proceeds from the offering of approximately $70.5 million after deducting underwriting discounts and commissions but before deducting $1.0 million of offering expenses payable by the Company.

On June 28, 2017, the Company’s stockholders approved the 2017 Stock Incentive Plan (the “2017 Plan”). The 2017 Plan provides for the grant of incentive stock options, nonqualified stock options, stock grants and stock-based awards. The 2017 Plan is administered by the board of directors, or at the discretion of the board of directors, by a committee of the board. The exercise prices, vesting and other restrictions are determined at the discretion of the board of directors, or their committee if so delegated, except that the exercise price per share of stock options may not be less than 100% of the fair market value of the share of common stock on the date of grant and the term of stock option may not be greater than ten years. The number of shares initially reserved for issuance under the 2017 Plan was 1,785,416 shares of common stock. The shares of common stock underlying any awards that are forfeited, cancelled, repurchased or are otherwise terminated by the Company under the 2017 Plan will be added back to the shares of common stock available for issuance under the 2017 Plan.

On October 18, 2017, the Company’s stockholders approved an amendment to the 2017 Plan, which became effective upon the completion of the Company’s IPO, to increase the total number of shares reserved for issuance under the 2017 Plan from 1,785,416 to 2,696,401. Additionally, the number of shares of common stock that may be issued under the 2017 Plan will automatically increase on each January 1, beginning with the fiscal year ending December 31, 2019 and continuing for each fiscal year until, and including, the fiscal year ending December 31, 2027, equal to the lowest of (i) 607,324 shares of common stock, (ii) 4% of the outstanding shares of common stock on such date and (iii) an amount determined by the Company’s board of directors or compensation committee. There were 322,730 options granted during the nine months ended September 30, 2018. As of September 30, 2018, there were 2,186,378 options outstanding under the 2017 Plan and 476,711 shares remaining available to be issued under the 2017 Plan.

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The Company recorded share-based compensation expense in the following expense categories of its consolidated statements of operations and comprehensive loss (in thousands):

Spero Potentiator

In February 2015, the Company’s wholly owned subsidiary, Spero Potentiator, issued 996 shares of its common stock with an aggregate fair value of $1.1 million to Northern Antibiotics Oy Ltd. (“Northern”) in exchange for an exclusive license to develop and commercialize certain licensed compounds and licensed products.  

In connection with the acquisition of the license, Northern obtained anti-dilution rights to maintain its 49.9% ownership percentage in Spero Potentiator at no additional cost to Northern in the event that Spero Potentiator completed subsequent equity financings, subject to a maximum amount of such financings. The Company accounted for the anti-dilution rights as a derivative liability on its consolidated balance sheet. The fair value of the derivative liability associated with the anti-dilution rights upon issuance in February 2015 of $2.4 million was recorded as research and development expenses as it was deemed to represent additional consideration for the license.

In November 2015, Northern was issued an additional 2,736 common shares of Spero Potentiator for no additional cost as a result of the anti-dilution rights. The Company valued these shares at $1.5 million and recorded the amount as an increase in the non-controlling interest and a reduction in the carrying value of the derivative liability. In January and August 2016, Northern was issued an additional 2,160 common shares of Spero Potentiator for no additional cost. The Company valued these shares at $1.0 million and recorded the amount as an increase in the non-controlling interest and a reduction of the derivative liability. At that time, the anti-dilution rights issued to Northern were fully settled as Northern had received the maximum number of shares it was entitled to under the anti-dilution rights.

In June 2017, the Company repurchased all of the shares of Spero Potentiator held by Northern in exchange for a cash payment of $1.0 million and contingent consideration of $0.1 million. As a condition of the repurchase of the shares from Northern, the Company amended the license agreement with Northern such that the Company will be obligated to make milestone payments of up to $7.0 million upon the achievement of specified clinical, commercial and other milestones, including a payment of $2.5 million upon the closing of an IPO, which occurred and was paid in November 2017. As a result of this transaction, during the six months ended June 30, 2017, the Company reclassified the balance of the non-controlling interest of $6.4 million as of the date of the transaction to accumulated deficit as an increase to that account. Additionally, the cash payment of $1.0 million was recorded as an increase to accumulated deficit. The Company will record the contingent payments as research and development expense when it becomes probable that the payments will be due. For periods subsequent to the acquisition, the Company no longer reports a non-controlling interest related to Spero Potentiator.

Spero Europe

In January 2016, the Company entered into an agreement with Promiliad Biopharma Inc. (“Promiliad”), whereby Promiliad granted to Spero Europe certain know-how and a sublicense to research, develop, manufacture and sell certain compounds. In exchange for the know-how and sublicense, Spero Europe provided Promiliad with a 5% equity ownership interest in Spero Europe, with a fair value of $0.1 million. In addition, Spero Europe agreed to make payments to Promiliad upon the achievement of future regulatory and commercial milestones of $4.1 million and to pay to Promiliad royalties of a mid single-digit percentage on net sales of licensed products under the agreement. Spero had the right to terminate the agreement with thirty days’ notice. The Company recognized research and development expense of $0.1 million upon the acquisition of the license and recorded a non-controlling interest in Spero Europe in a corresponding amount.

In connection with the acquisition of the license, Promiliad obtained anti-dilution rights to maintain their 5% equity ownership in Spero Europe at no additional cost to Promiliad in the event that Spero Europe completed subsequent funding events, subject to a maximum amount of such funding of $5.0 million.

The Company accounted for the anti-dilution rights as a derivative liability on its consolidated balance sheet. The fair value of the derivative liability associated with the anti-dilution rights upon issuance in January 2016 of $0.2 million was recorded as research and development expenses as it was deemed to represent additional consideration for the license.

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In May 2017, the Company repurchased all of the shares of Spero Europe from Promiliad in exchange for the return of the license. As a result of the transaction, the Company reclassified the balance of the non-controlling interest in Spero Europe of less than $0.1 million as of the date of the transaction to accumulated deficit as an increase to that account. For periods subsequent to the repurchase, the Company no longer reports a non-controlling interest related to Spero Europe.

Spero Gyrase

In March 2016, the Company entered into an agreement with Aviragen and its affiliates in order to acquire certain intellectual property and know-how related to certain compounds. In connection with the transaction, the Company established Spero Gyrase, a Delaware corporation, and issued to Aviragen 200 common shares of Spero Gyrase with a fair value of $1.1 million, which represented a 20% equity ownership interest in Spero Gyrase. In addition, Spero Gyrase agreed to make future milestone and royalty payments in exchange for the intellectual property. The Company accounted for the acquisition of technology as an asset acquisition because it did not meet the definition of a business. The Company recorded the acquired technology as research and development expense in the consolidated statement of operations and comprehensive loss in the amount of $1.1 million, because the acquired technology had not reached commercial feasibility and had no alternative future use, and recorded a non-controlling interest in Spero Gyrase in a corresponding amount.

In connection with the agreement, Aviragen obtained anti-dilution rights to maintain their 20% equity ownership of Spero Gyrase at no additional cost to Aviragen in the event that Spero Gyrase completed subsequent funding events, subject to a maximum amount of such funding of $8.0 million.

The Company accounted for the anti-dilution rights as a derivative liability on its consolidated balance sheet (see Note 3). The fair value of the derivative liability associated with the anti-dilution rights upon issuance in March 2016 of $1.6 million was recorded as research and development expenses as it was deemed to represent additional consideration for the license.

Spero Cantab

In June 2016, the Company entered into a stock purchase agreement and related agreements (the “Cantab Agreements”) with Pro Bono Bio PLC, a corporation organized under the laws of England, and certain of its affiliates, including PBB Distributions Limited (“PBB”), Cantab Anti-Infectives Ltd. (“CAI”) and New Pharma License Holdings Limited (“NPLH”) in order to acquire NPLH and its intellectual property rights and assets relating to the Company’s Potentiator Platform.

Under the Cantab Agreements, CAI agreed to submit a request to NIAID to novate the CAI-held NIAID contract to the Company. The NIAID contract provides for development funding of up to $6.3 million over a base and three option periods. To date, funding for the base period and the first two option periods totaling $5.7 million had been committed to CAI. Novation of the NIAID contract to the Company was finalized in December 2017. The Company shall pay PBB a percentage of funds received from NIAID up to a maximum of $1.3 million.

Consideration under Cantab Agreements consisted of: (i) 125 shares of Spero Cantab, the Company’s subsidiary, which represented a 12.5% ownership interest in Spero Cantab, and anti-dilution rights (as described below) issued to PBB, with a combined fair value of $1.6 million, (ii) upfront consideration of $0.3 million (to be credited against future payments payable to CAI), (iii) contingent milestone payments due upon the achievement of certain clinical, regulatory and commercial milestones (see Note 11), (iv) royalty payments of low single-digit percentages based on net sales of products from the licensed technology, and (v) a specified portion of funding payments made by NIAID.

The Company accounted for the acquisition of NPLH as an asset acquisition because NPLH did not meet the definition of a business. The Company recognized research and development expense of $1.6 million upon the acquisition of NPLH because the acquired technology had not reached commercial feasibility and had no alternative future use. Upon the issuance of the shares and anti-dilution rights, the Company recorded a non-controlling interest in Spero Cantab of $1.6 million. The $0.3 million payment was recognized as research and development expenses as the services were performed by CAI. The Company records the contingent payments outlined in (iii), (iv) and (v) as research and development expense when it becomes probable that the payments will be due. Novation of the NIAID contract to Spero was finalized in December 2017. Prior to the contract novation, CAI performed research and development services at the Company’s direction and applied for reimbursement from NIAID. The Company paid CAI for such research and development services at an agreed-upon rate which took into consideration costs incurred by CAI, amounts reimbursed to CAI by NIAID and the portion of the NIAID reimbursement the Company paid to CAI.

In connection with the Cantab Agreements, PBB obtained anti-dilution rights to maintain a certain equity ownership, ranging from 5% to 12.5%, of Spero Cantab at no additional cost to PBB in the event that Spero Cantab completed subsequent funding events, subject to maximum amount of such funding of $8.0 million. These anti-dilution rights represent a conditional obligation to issue a variable number of shares but are not freestanding and, therefore, do not require bifurcation for accounting purposes from the 125 shares issued.

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In July 2017, the Company repurchased all of the outstanding shares of Spero Cantab owned by PBB in exchange for a cash payment of $0.2 million and an amendment to the licensing agreement to increase the first two contingent milestone payments by a total of $0.1 million. For periods subsequent to the repurchase, the Company no longer reports a non-controlling interest related to Spero Cantab.

As of September 30, 2018 and December 31, 2017, the Company’s only remaining non-controlling interest relates to Spero Gyrase, Inc., which totaled $0.4 million.

License Agreements

The Company has entered into license agreements with various parties under which it is obligated to make contingent and non-contingent payments (see Note 11).

Operating Leases

In August 2015, the Company entered into an operating lease agreement with U.S. REIF Central Plaza Massachusetts, LLC (the “Landlord”) with respect to its corporate headquarters located at 675 Massachusetts Avenue, Cambridge, Massachusetts (the “Original Lease”).The term of the Original Lease commenced in January 2016 and was scheduled to expire in December 2020. The Original Lease required annual payments of $0.4 million over the initial five-year term. The Original Lease provided for a renewal option to extend its term for an additional five years. Under the terms of the Original Lease, the Company provided a security deposit of $0.2 million to the Landlord, which is included in long-term assets in the accompanying consolidated balance sheets. The Original Lease provided for annual rent escalations as well as tenant incentives in the amount of $0.7 million, of which $0.3 million would be reimbursed to the Landlord over the initial term of the Original Lease.

In July 2016, the Company entered into an agreement to lease laboratory space through November 30, 2019 from a sublessor, which requires annual lease payments of $0.3 million, subject to certain escalations.

On January 17, 2018, the Company entered into an amendment (the “Amendment”) to the Original Lease. The Amendment makes certain changes to the Original Lease, including (i) the addition of approximately 7,800 square feet of office space in the same building (the “Expansion Premises”) and (ii) an extension of the expiration date of the Original Lease to seven years following the delivery date of the Expansion Premises (the “Lease Term”), which is estimated to be December 1, 2018.

Under the Amendment, the Company has two consecutive options to extend the Lease Term for an additional period of five years (the “Option Terms”), subject to certain conditions, upon notice to the Landlord. The Amendment provides for annual base rent for the Expansion Premises of approximately $0.5 million in the first year of the Lease Term, which increases on an annual basis to approximately $0.6 million in the final year of the Lease Term, and annual base rent during the Option Terms to be calculated based on the Landlord’s good faith determination of 100% of the fair market rate for such Option Terms. The Company is also obligated to pay the Landlord certain costs, taxes and operating expenses, subject to certain exclusions. The Amendment also includes a provision from the landlord of $0.4 million for leasehold improvements on the Expansion Premises.

Rent escalations and tenant incentives for operating leases are included in deferred rent in the consolidated balance sheet, and rent expense is recognized on a straight-line basis over the terms of occupancy.

The following table summarizes the future minimum payments due under the operating leases as of September 30, 2018 (in thousands):

Rent expense during the three months ended September 30, 2018 and 2017 was $0.2 million. Rent expense during the nine months ended September 30, 2018 and 2017 was $0.6 million.

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Indemnification Agreements

In the ordinary course of business, the Company may provide indemnification of varying scope and terms to vendors, lessors, business partners and other parties with respect to certain matters including, but not limited to, losses arising out of breach of such agreements or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with members of its board of directors that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is, in many cases, unlimited. To date, the Company has not incurred any material costs as a result of such indemnifications. The Company does not believe that the outcome of any claims under indemnification arrangements will have a material effect on its financial position, results of operations or cash flows, and it has not accrued any liabilities related to such obligations in its consolidated financial statements as of September 30, 2018 or December 31, 2017.

Legal Proceedings

The Company is not currently party to any material legal proceedings. At each reporting date, the Company evaluates whether or not a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. The Company expenses as incurred the costs related to such legal proceedings.

BARDA

In July 2018, the Company was awarded a contract from Biomedical Advanced Research and Development Authority (“BARDA”) of up to $44.2 million to develop SPR994 for the treatment of complicated urinary tract infections (“cUTIs”) caused by antibiotic resistant Gram-negative bacteria and for assessment against biodefense pathogens. The award commits initial funding of $15.7 million over a three-year base period from July 1, 2018 to June 30, 2021 for cUTI development activities. The balance of the award is subject to BARDA exercising two options. The exercise of the first option would entail funding of $13.6 million and is exercisable by BARDA subject to the Company achieving specified milestones related to, among other things, clinical progress and data. The exercise of the second option would entail funding of $14.9 million and is exercisable by BARDA subject to, among other things, satisfactory progress and results from the biodefense studies described below. The Company recognized $0.2 million of revenue under this award during the three and nine months ended September 30, 2018.

As part of an inter-agency collaboration between BARDA and the Defense Threat Reduction Agency (“DTRA”), a series of studies to assess the efficacy of SPR994 in the treatment of infections caused by biodefense threats such as anthrax, plague and melioidosis will be conducted by the U.S. Army Medical Research Institute of Infectious Diseases (“USAMRIID”) under the direction of Spero. Because the FDA requires data from a human pneumonic disease as supportive of use of an antibiotic to treat a biothreat infection, the scope of the BARDA award includes the assessment of SPR994 levels in the lung of healthy volunteers as well as a proof of concept clinical trial in pneumonia patients, an indication for which tebipenem, SPR994's active pharmaceutical ingredient, is currently approved in Japan for pediatric use.

U.S. Department of Defense

In September 2016, the Company was awarded a cooperative agreement with the DoD to further develop anti-infective agents to combat Gram-negative bacteria. The agreement is structured as a single, two-year $1.5 million award. The Company is eligible for the full funding from the DoD, and there are no options to be exercised at a later date. The DoD funding supports next-generation potentiator discovery and screening of SPR741 partners. The Company recognizes revenue under this agreement as qualifying expenses are incurred. The Company recognized less than $0.1 million and $0.2 million of revenue under this agreement during the three and nine months ended September 30, 2018, respectively, and $0.1 million and $0.4 million during the three and nine months ended September 30, 2017, respectively.

NIAID

In February 2017, the Company was awarded a grant from NIAID under its Small Business Innovation Research program, to conduct additional preclinical studies of SPR720, the Company’s novel oral bacterial gyrase inhibitor, for the treatment of non-tuberculous mycobacterial infections. The award is structured as a 12-month $0.6 million base period and a $0.4 million option period. Through December 31, 2017, only the base period funds had been committed. In February 2018, NIAID exercised the $0.4 million 12-month option period. The Company recognized less than $0.1 million and $0.3 million of revenue under this agreement during the

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three and nine months ended September 30, 2018. The Company recognized $0.1 million of revenue in the three and nine months ended September 30, 2017 under this agreement.

In June 2016, the Company entered into agreements with Pro Bono Bio PLC (“PBB”), a corporation organized under the laws of England, and certain of its affiliates, including PBB Distributions Limited and Cantab Anti-Infectives Limited (“CAI”), in order to acquire certain intellectual property and government funding arrangements relating to SPR206 (see Note 11). Under these agreements, CAI agreed to submit a request to NIAID to assign the CAI-held NIAID contract to Spero, which was finalized in December 2017. The NIAID contract provides for total development funding of up to $6.3 million, including a base period and three option periods. To date, funding for the base period and the first two option periods totaling $5.7 million have been committed. Spero shall pay PBB a percentage of funds received from NIAID up to a maximum of $1.3 million, of which $0.3 million was paid upfront to PBB as part of this agreement. The Company recognized $0.4 million and $1.1 million of revenue under this agreement during the three and nine months ended September 30, 2018. During the three and nine months ended September 30, 2018, the Company recorded approximately $0.1 million and $0.4 million, respectively, in expense associated with amounts payable to PBB under this agreement, which has been included within research and development expenses within the consolidated statement of operations and comprehensive loss. 

CARB-X

In April 2017, the Company was awarded a grant from CARB-X, a public-private partnership funded by BARDA within the U.S. Department of Health and Human Services to be used to screen, identify and complete Phase 1 trials with at least one partner compound for SPR741, one of the Company’s Potentiator Platform product candidates. The award committed to funding of $1.5 million over a 12-month period. On March 12, 2018, CARB-X committed an additional $0.4 million related to the first option for a period from December 1, 2017 to March 31, 2018. There will be no additional options exercised under the CARB-X award. The Company recognized zero and $0.5 million of revenue during the three and nine months ended September 30, 2018, respectively, under this agreement. The Company recognized $0.4 million and $0.5 million of revenue during the three and nine months ended September 30, 2017, respectively, under this agreement.

The Company has certain obligations under license agreements with third parties that include annual maintenance fees and payments that are contingent upon achieving various development, regulatory and commercial milestones. Pursuant to these license agreements, the Company is required to make milestone payments if certain development, regulatory and commercial milestones are achieved, and may have certain additional research funding obligations. Also, pursuant to the terms of each of these license agreements, when and if commercial sales of a product commence, the Company will pay royalties to its licensors on net sales of the respective products.

Aviragen Agreement

Under the Company’s agreement with Aviragen (see Note 8) for certain intellectual property and know-how relating to developing a gyrase inhibitor to develop therapies for Gram-negative infections, the Company is obligated to make milestone payments of up to an aggregate of $12.0 million upon the achievement of specified clinical, regulatory and commercial milestones and to pay royalties of low single-digit percentages based on net sales of products the Company acquired under the agreement.

Cantab License Agreement

Under the Cantab Agreements (see Note 8), the Company is obligated to make milestone payments of up to $5.8 million upon the achievement of specified clinical and regulatory milestones and a payment of £5.0 million ($6.5 million and $6.7 million as of September 30, 2018 and December 31, 2017, respectively) upon the achievement of a specified commercial milestone. In addition, the Company has agreed to pay to PBB royalties, on a product-by-product and country-by-country basis, of a low single-digit percentage based on net sales of products licensed under the agreement.

The Cantab Agreements continue indefinitely, with royalty payment obligations thereunder continuing on a product-by-product and country-by-country basis until the later of ten years after the first commercial sale of such product in such country or the expiration in such country of the last to expire valid claim of any of the applicable patents.

Vertex License Agreement

In May 2016, the Company entered into an agreement with Vertex Pharmaceuticals Incorporated (“Vertex”) whereby Vertex granted the Company certain know-how and a sublicense to research, develop, manufacture and sell products for a proprietary compound, as well as a transfer of materials. In exchange for the know-how, sublicense and materials, Spero paid Vertex an upfront, one-time, nonrefundable, non-creditable fee of $0.5 million, which was recognized as research and development expense. As part of the agreement, the Company is obligated to make future milestone payments of up to $81.1 million upon the achievement of specified

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clinical, regulatory and commercial milestones and to pay Vertex tiered royalties, on a product-by-product and country-by-country basis, of a mid single-digit to low double-digit percentage based on net sales of products licensed under the agreement.

The agreement continues in effect until the expiration of all payment obligations thereunder, with royalty payment obligations continuing on a product-by-product and country-by-country basis until the later of ten years after the first commercial sale of such product in such country or the date of expiration in such country of the last to expire applicable patent. Further, Vertex has the right to terminate the agreement if provided with notification from the Company of intent to cease all development or if no material development or commercialization efforts occur for one year.

Meiji License Agreement

In June 2017, the Company entered into agreements with Meiji Seika Pharma Co. Ltd. (“Meiji”), a Japanese corporation, whereby Meiji granted to the Company certain know-how and a license to research, develop, manufacture and sell products for a proprietary compound in the licensed territory. In exchange for the know-how and license, the Company paid Meiji an upfront, one-time, nonrefundable, non-creditable fee of $0.6 million, which was recognized as research and development expense. As part of the agreement, the Company is obligated to make milestone payments of up to $3.0 million upon the achievement of specified clinical and regulatory milestones, to pay royalties, on a product-by-product and country-by-country basis, of a low single-digit percentage based on net sales of products licensed under the agreement and to pay Meiji a low double-digit percentage of any sublicense fees received by the Company up to $7.5 million. In October 2017, the Company paid a $1.0 million milestone payment to Meiji upon the enrollment of the first patient in the Company’s Phase 1 clinical trial of SPR994. The payment was recorded as research and development expense in the statement of operations and comprehensive loss for the year ended December 31, 2017. Additionally, the Company will pay Meiji approximately $1.6 million during the fourth quarter of 2018 related to fixed assets which will be used in manufacturing related activities at Meiji. This equipment has been capitalized as property and equipment in the consolidated balance sheet as of September 30, 2018.

The agreement continues in effect until the expiration of all payment obligations thereunder (including royalty payments and licensee revenue) on a product-by-product and country-by-country basis, unless earlier terminated by the parties. Pursuant to the terms of the agreement, in addition to each party’s right to terminate the agreement upon the other party’s material breach (if not cured within a specified period after receipt of notice) or insolvency, the Company also has unilateral termination rights (i) in the event that the Company abandons the development and commercialization of SPR994 for efficacy, safety, legal or business factors, and (ii) under certain circumstances arising out of the head license with a global pharmaceutical company.

Northern License Agreement

In June 2017, in connection with the repurchase of all of the outstanding shares of Spero Potentiator (see Note 8), the Company amended its license agreement with Northern such that the Company agreed to pay Northern up to $7.0 million upon the achievement of specified clinical, regulatory and other milestones, including a total payment of $2.5 million upon the closing of an initial public offering. In addition, under an exchange agreement the Company entered into with Northern, the Company is obligated to make a payment to Northern of $0.1 million upon the closing of an initial public offering. The agreement has a perpetual term and no express termination rights. Upon the closing of the Company’s IPO in November 2017, the Company paid $2.6 million to Northern in connection with both the license and exchange agreements. This payment was recorded as research and development expense in the Company’s statement of operations and comprehensive loss for the year ended December 31, 2017.

The Australian government has established a research and development tax incentive to encourage industry investment in research and development, which is available to companies incorporated under Australian law that have core research and development activities. In September 2016, the Company established Spero Potentiator Australia Pty Limited to carry out certain research and development activities. As this subsidiary meets the eligibility requirements of the Australian tax law, it is eligible to receive a 43.5% tax incentive for qualified research and development activities. The Company recorded $0.3 million and $0.7 million as a reduction to research and development expenses in the consolidated statements of operations and comprehensive loss during both the three and nine months ended September 30, 2018, respectively, associated with this tax incentive, representing 43.5% of the Company’s qualified research and development spending in Australia. The Company recorded $0.1 million and $0.8 million as a reduction to research and development expenses in the consolidated statements of operations and comprehensive loss associated with this tax incentive during the three and nine months ended September 30, 2017, respectively. The tax incentive refund is denominated in Australian dollars and, therefore, the associated tax incentive receivable is re-measured to U.S. dollars as of each reporting date. The Company’s tax incentive receivables from the Australian government totaled $0.7 million as of September 30, 2018 and $1.9 million as of December 31, 2017.      

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Basic and diluted net loss per share attributable to common stockholders of Spero Therapeutics, Inc. was calculated as follows (in thousands, except share and per share amounts):

The Company excluded potentially dilutive securities from the computation of diluted net loss per share as the effect would be to reduce the net loss per share. Therefore, the weighted average number of common shares outstanding used to calculate both basic and diluted net loss per share attributable to common stockholders of Spero Therapeutics, Inc. is the same. The Company excluded the following potential common shares, presented based on amounts outstanding at each period end, from the computation of diluted net loss per share attributable to common stockholders for the periods indicated because including them would have had an anti-dilutive effect:

14.Subsequent Events

The Company has evaluated, for potential recognition and disclosure, events that occurred prior to the date at which the condensed consolidated financial statements were available to be issued. There were no material subsequent events.

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

You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited financial information and the notes thereto included appearing elsewhere in this Quarterly Report on Form 10-Q, and the audited financial information and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the “Risk Factors” section of this Quarterly Report on Form 10-Q, our actual results could differ materially from the results described in, or implied by, the forward-looking statements contained in the following discussion and analysis.

Overview

We are a multi-asset, clinical-stage biopharmaceutical company focused on identifying, developing and commercializing novel treatments for multi-drug resistant, or MDR, bacterial infections. Our most advanced product candidate, SPR994, is designed to be the first broad-spectrum oral carbapenem-class antibiotic for use in adults to treat MDR Gram-negative infections. Treatment with effective orally administrable antibiotics may prevent hospitalizations for serious infections and enable earlier, more convenient and cost-effective treatment of patients after hospitalization. We also have a platform technology known as our Potentiator Platform that we believe will enable us to develop drugs that will expand the spectrum and potency of existing antibiotics, including formerly inactive antibiotics, against Gram-negative bacteria. Our lead product candidates generated from our Potentiator Platform are two intravenous, or IV,-administered agents, SPR741 and SPR206, designed to treat MDR Gram-negative infections in the hospital setting. In addition, we are developing SPR720, an oral antibiotic designed for the treatment of pulmonary non-tuberculous mycobacterial infections. We believe that our novel product candidates, if successfully developed and approved, would have a meaningful patient impact and significant commercial applications for the treatment of MDR infections in both the community and hospital settings. Since our inception in 2013, we have focused substantially all of our efforts and financial resources on organizing and staffing our company, business planning, raising capital, acquiring and developing product and technology rights, building our intellectual property portfolio and conducting research and development activities for our product candidates. We do not have any products approved for sale and have not generated any revenue from product sales.

On November 6, 2017, we completed an initial public offering, or IPO, of our common stock, and issued and sold 5,500,000 shares of common stock at a public offering price of $14.00 per share, resulting in net proceeds of $71.6 million after deducting underwriting discounts and commissions but before deducting offering costs. On November 14, 2017, we issued and sold an additional 471,498 shares of our common stock at the IPO price of $14.00 per share pursuant to the underwriters’ partial exercise of their option to purchase additional shares of common stock, resulting in additional net proceeds of $6.1 million after deducting underwriting discounts. Aggregate net proceeds from the IPO totaled $74.2 million after deducting underwriting discounts, commissions and offering costs.

On July 17, 2018, we completed an underwritten public offering of 3,780,000 shares of our common stock at a price of $12.50 per share, and 2,220 shares of our Series A Convertible Preferred Stock at a price of $12,500 per share. We received net proceeds from the offering of approximately $70.5 million after deducting underwriting discounts and commissions but before deducting $1.0 million of offering expenses payable by us.

Each share of Series A Convertible Preferred Stock is convertible into 1,000 shares of our common stock at any time at the option of the holder, provided that the holder will be prohibited from converting the Series A Convertible Preferred Stock into shares of our common stock if, as a result of such conversion, the holder, together with its affiliates, would own more than 9.99% of the total number of shares of our common stock then issued and outstanding. In the event of our liquidation, dissolution, or winding up, holders of our Series A Convertible Preferred Stock will receive a payment equal to $0.001 per share of Series A Convertible Preferred Stock before any proceeds are distributed to the holders of our common stock. The Series A Convertible Preferred Stock has no voting rights, except as required by law and except that the consent of the Series A Convertible Preferred Stock holders will be required to amend the terms of the Series A Convertible Preferred Stock.

Prior to the IPO and our July 2018 equity offering, we funded our operations with proceeds from the sale of preferred units and bridge units and payments received under a concluded collaboration agreement and funding from government contracts. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our product candidates. As of September 30, 2018, we had an accumulated deficit of $127.9 million. We expect to continue to incur significant expenses and increasing operating losses for at least the next several years.

We will not generate revenue from product sales unless and until we successfully complete clinical development and obtain regulatory approval for our product candidates. If we obtain regulatory approval for any of our product candidates and do not enter into a commercialization partnership, we expect to incur significant expenses related to developing our internal commercialization capability to support product sales, marketing and distribution. Further, we expect to incur additional costs associated with operating as a public company.

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As a result, we will need substantial additional funding to support our continuing operations and pursue our growth strategy. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of equity offerings, debt financings, government funding arrangements, collaborations, strategic alliances and marketing, distribution or licensing arrangements. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. If we fail to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more of our product candidates.

Because of the numerous risks and uncertainties associated with pharmaceutical product development, we are unable to accurately predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations.

As of September 30, 2018, we had cash, cash equivalents and marketable securities of $131.2 million. We believe that our existing cash, cash equivalents and marketable securities, together with the initial funding committed under our BARDA award in July 2018, will enable us to fund our operating expenses and capital expenditure requirements into the second half of 2020, including through top-line data readout of our planned pivotal Phase 3 clinical trial of SPR994. As described elsewhere, a portion of the funding from our BARDA award supporting the development of SPR994 is scheduled to occur in periods after 2020, provided we achieve specified milestones under the award agreement and BARDA exercises all of its options under the agreement.

Recent Developments

SPR994 Phase 1 Final Results and Dose Selection Data Supporting Planned Pivotal Phase 3 Clinical Trial

In September 2018, we announced positive results from the final analysis of our Phase 1 clinical trial of SPR994 in healthy volunteers. The final data expand on the interim data announced in July 2018, and the Company anticipates the data will support the advancement of SPR994 at a dose of 600 mg administered three times per day, or TID, into a pivotal Phase 3 clinical trial, which we expect to initiate around year-end 2018, subject to our discussions with the FDA. Dose escalation within the multiple ascending dose, or MAD, portion of the trial demonstrated that 600 mg of SPR994 provides greater drug exposure than was observed in the first dosing cohort of 300 mg while maintaining a favorable safety, tolerability and pharmacokinetic profile.

The Phase 1 single ascending dose, or SAD, and MAD clinical trial assessed the safety, tolerability and pharmacokinetics of orally administered SPR994. The Phase 1 clinical trial enrolled 124 healthy adult volunteers into 14 SAD cohorts with SPR994 given orally as single doses ranging from 100 mg to 900 mg daily and 2 MAD cohorts with SPR994 given orally at doses of 300 mg and 600 mg every 8 hours for 14 days. Repeated dose administration of both 300mg and 600mg of SPR994 was well tolerated, with a safety profile consistent with the carbapenem class of antibiotics. Final results demonstrated a linear and proportional increase in plasma exposure over the dose range tested, with no accumulation over 14 days of repeated dosing. Furthermore, the administration of SPR994 in the fed or fasting state did not substantially alter the plasma drug exposure, indicating that SPR994 can likely be administered without regard to meals. Consistent with the predominantly renal elimination of SPR994, peak urine concentrations were approximately 50 to 100-fold higher than maximum concentrations in plasma, supporting SPR994’s potential utility as treatment for patients with complicated urinary tract infections, or cUTI. Following completion of the Phase 1 trial, we have scheduled a pre-Phase 3 meeting with the U.S. Food and Drug Administration, or FDA, in the fourth quarter of 2018. Subject to our discussions with the FDA, we expect to submit an investigational new drug application, or IND, and initiate a pivotal Phase 3 clinical trial of SPR994 around year-end 2018. The Phase 3 clinical trial will assess the activity of SPR994 in cUTI.

SPR720 preclinical data supports advancement into Phase 1 clinical trials

In early November 2018 we announced positive results from preclinical IND-enabling studies of SPR720, our oral antimicrobial agent being developed for the treatment of pulmonary non-tuberculous mycobacterial, or NTM, infections. SPR720 was assessed in a series of non-clinical studies, including IND-enabling 28- and 31-day GLP toxicology studies in non-human primates and rats, respectively, and safety pharmacology studies. Results from in vitro minimum inhibitory concentration, or MIC, studies demonstrated potent activity for SPR720 against prevalent NTM pathogens, including Mycobacterium avium complex and Mycobacterium abscessus. Furthermore, in vivo studies in murine models of pneumonia demonstrated favorable efficacy relative to standard-of-care comparator agents. The data suggest that SPR720 has an acceptable safety profile, encouraging target pathogen efficacy, and a wide therapeutic margin. These results, in conjunction with recent regulatory interactions, support the further development of SPR720. Following regulatory acceptance of our clinical trial authorization application in the United Kingdom, we plan to initiate a First-in-Human Phase 1 clinical trial of SPR720 in early 2019.

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Potentiator Platform Developments

In May 2018, we announced data from our completed Phase 1b drug-drug interaction clinical trial of SPR741. The Phase 1b trial was designed to assess the impact, if any, on the pharmacokinetics or tolerability of either SPR741 or beta-lactam drugs when the two are dosed together. The single-dose data indicated that the administration of three different beta-lactam antibiotics (ceftazidime, piperacillin/tazobactam, and aztreonam) had no impact on the pharmacokinetics or tolerability of SPR741. Such results, together with previously-reported date on the in vitro activity of SPR741 in combination with beta-lactam drugs, provide support for the further development of SPR741 as a combination agent for the treatment of MDR Gram-negative infections.

In May 2018, we announced results from IND-enabling studies of SPR206. SPR206 was assessed in a suite of preclinical, IND-enabling studies, including 14-day, two species, good laboratory practice, or GLP, toxicology experiments, and in vitro and in vivo GLP safety pharmacology, and absorption, distribution, metabolism and excretion studies. The data, combined with earlier microbiological and in vivo efficacy testing of SPR206, support SPR206’s advancement as a clinical candidate for the treatment of MDR and extensively drug-resistant, or XDR, Gram-negative bacterial strains, including carbapenem-resistant Pseudomonas aeruginosa, Acinetobacter baumannii and Enterobacteriaceae. We believe the composite data suggest that SPR206 has the potential for wide therapeutic margins in the setting of serious Gram-negative infections in the hospital. Moreover, data from these studies suggest a potency and safety profile for SPR206 that may be superior to SPR741, and we believe SPR206 may have a potentially faster path to pivotal clinical trials when compared with SPR741, because SPR206 is being developed as a single agent. In October 2018, we announced that SPR206 has been granted Qualified Infectious Disease Product, or QIDP designation by the FDA for the treatment of cUTIs and hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia. The QIDP designation was created by the Generating Antibiotic Incentives Now, or GAIN, Act and creates incentives for the development of certain antibiotics that treat serious or life-threatening infections. The primary incentives are an additional five-year extension of Hatch-Waxman Act exclusivity, the opportunity for a priority review of the marketing application and the opportunity to request Fast Track designation for SPR206.

As previously disclosed, we expect to select either SPR741 or SPR206 to bring forward as our lead Potentiator Platform product candidate, based on our evaluation of available clinical data for each candidate and other factors, and we expect to seek partnering opportunities or other non-dilutive funding for further clinical development of the Potentiator Platform candidate we elect to deprioritize. In light of the positive data from our preclinical toxicology studies of SPR206, subject to regulatory approval, we plan to initiate a Phase 1 clinical trial of SPR206 around year-end 2018. We expect that data from this Phase 1 clinical trial of SPR206, together with the data from our completed Phase 1b clinical trial of SPR741, will enable us to select a lead Potentiator Platform product candidate to advance into late-stage development. Our current view is that a prioritization decision can best be made after each of our Potentiator Platform candidates has achieved a similar clinical development stage. Until such time, we expect to continue to assess clinical development strategies, partnering opportunities and non-dilutive funding for both of our Potentiator Platform product candidates. 

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Non-Dilutive Government Funding for SPR994

In July 2018, we were awarded initial funding of $15.7 million from the Biomedical Advanced Research and Development Authority, or BARDA, with the potential for up to an additional $28.5 million over 5 years, if BARDA exercises all of its options under the award. This funding will support the further clinical development of SPR994. As part of an inter-agency collaboration between BARDA and the Defense Threat Reduction Agency, or DTRA, a series of studies to assess the efficacy of SPR994 in the treatment of infections caused by biodefense threats such as anthrax, plague and melioidosis will be conducted by the U.S. Army Medical Research Institute of Infectious Diseases, or USAMRIID, under the direction of Spero. Because the FDA requires data from a human pneumonic disease as supportive of use of an antibiotic to treat a biothreat infection, the scope of the BARDA award includes the assessment of SPR994 levels in the lung of healthy volunteers as well as a proof of concept clinical trial in community-acquired bacterial pneumonia patients. Tebipenem, SPR994's active pharmaceutical ingredient, is currently approved in Japan for common bacterial respiratory tract infections in the pediatric population.

In addition, as part of the collaboration described above, DTRA will provide support of up to $10.0 million to cover the cost of certain nonclinical biodefense studies contemplated by the collaboration, if specified milestones are achieved. While such funding would be for the purpose of developing SPR994 in these areas, we will not receive any funds directly from DTRA for these nonclinical studies.

Components of Our Results of Operations

Grant Revenue

To date, we have not generated any revenue from product sales and do not expect to generate any revenue from the sale of products in the foreseeable future. If our development efforts for our product candidates are successful and result in regulatory approval, we may generate revenue in the future from product sales. We cannot predict if, when, or to what extent we will generate revenue from the commercialization and sale of our product candidates. We may never succeed in obtaining regulatory approval for any of our product candidates.

To date, all of our revenue has been derived from government awards. We expect that our revenue for the next several years will be derived primarily from payments under our government awards that we that we have entered or may look to enter into in the future.

BARDA

In July 2018, we were awarded a contract from BARDA of up to $44.2 million to develop SPR994 for the treatment of cUTIs caused by antibiotic resistant Gram-negative bacteria and for assessment against biodefense pathogens. The award commits initial funding of $15.7 million over a three-year base period from July 1, 2018 to June 30, 2021 for cUTI development activities. The balance of the award is subject to BARDA exercising two options. The exercise of the first option would entail funding of $13.6 million and is exercisable by BARDA subject to our achieving specified milestones related to, among other things, clinical progress and data. The exercise of the second option would entail funding of $14.9 million and is exercisable by BARDA subject to, among other things, satisfactory progress and results from certain biodefense studies. We receive funding under the BARDA award as we incur qualifying expenses.

U.S. Department of Defense

In September 2016, we were awarded a cooperative agreement with the U.S. Department of Defense to further develop anti-infective agents to combat Gram-negative bacteria. The agreement is structured as a single, two-year $1.5 million award. We are eligible for the full funding from DoD and there are no options to be exercised at a later date. The DoD funding supports next-generation potentiator discovery and screening of SPR741 partner antibiotics. We receive funding under the DoD award as we incur qualifying expenses.

NIAID

In February 2017, we received an award from the U.S. National Institute of Allergy and Infectious Diseases under its Small Business Innovation Research, or SBIR program, to conduct additional preclinical studies of SPR720. The award is structured as a 12-month $0.6 million base period, which has already been committed, and a $0.4 million option period. In February 2018 NIAID exercised the $0.4 million 12-month option period. We receive funding under the NIAID award as we incur qualifying expenses.

In June 2016, we entered into agreements with Pro Bono Bio PLC, a corporation organized under the laws of England, and certain of its affiliates, including PBB Distributions Limited and Cantab Anti-Infectives Limited, in order to acquire certain

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intellectual property and government funding arrangements relating to SPR206. Under these agreements, CAI agreed to submit a request to NIAID to assign the CAI-held NIAID contract to us. The NIAID contract provides for total development funding of up to $6.3 million over a base period and three option periods. To date, funding for the base period and the first two option periods totaling $5.7 million have been committed. Novation of the NIAID contract was finalized in December 2017. We will pay PBB a percentage of funds received from NIAID up to a maximum of $1.3 million, of which $0.3 million was paid upfront to PBB as part of this agreement. During the three and nine months ended September 30, 2018, we recorded approximately $0.1 million and $0.4 million, respectively, in expense related to amounts payable to PBB under this agreement.  

CARB-X

In April 2017, we received an award from the Combating Antibiotic Resistant Bacteria Biopharmaceutical Accelerator, a public-private partnership funded by the Biomedical Advanced Research and Development Authority within the U.S. Department of Health and Human Services, to be used to screen, identify and complete Phase 1 clinical trials with at least one partner compound for SPR741, one of our lead potentiator product candidates. The award committed funding of $1.5 million over a 12-month period. In March 2018, CARB-X committed an additional $0.4 million related to the first option for a period from December 1, 2017 to March 31, 2018. There will be no additional options exercised under the CARB-X award.

Operating Expenses

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:

Prior to novation of the NIAID contract to us, under our agreements with PBB and certain of its affiliates, CAI continued to perform research and development at our direction. We paid CAI for such research and development services at an agreed-upon rate that took into consideration costs incurred by CAI, net of amounts reimbursed to CAI by NIAID. Thus, prior to novation of the NIAID contract to us, the amount we record as research and development expenses is net of the NIAID reimbursement amount that CAI received. We also paid CAI a portion of the NIAID reimbursement received at rates specified in the agreement, which we also recorded as research and development expense.

Since the fourth quarter of 2016, we have recorded research and development expenses conducted by our Australian subsidiary net of a 43.5% research and development tax incentive we expect to receive for qualified expenses from the Australian government.

We expense research and development costs as incurred. Nonrefundable advance payments we make for goods or services to be received in the future for use in research and development activities are recorded as prepaid expenses. The prepaid amounts are expensed as the related goods are delivered or the services are performed.

Our direct research and development expenses are tracked on a program-by-program basis and consist primarily of external costs, such as fees paid to consultants, contractors, CMOs and CROs in connection with our preclinical and clinical development activities. License fees and other costs incurred after a product candidate has been designated and that are directly related to the product candidate are included in direct research and development expenses for that program. License fees and other costs incurred prior to designating a product candidate are included in early stage research programs. We do not allocate employee costs, costs associated with our preclinical programs or facility expenses, including depreciation or other indirect costs, to specific product development programs because these costs are deployed across multiple product development programs and, as such, are not separately classified. The table below summarizes our research and development expenses incurred by development program:

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Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect that our research and development expenses will increase substantially in connection with our planned clinical development activities in the near term and in the future as we initiate additional clinical trials and other studies of SPR994, SPR206 and our other product candidates, continue to discover and develop additional product candidates, hire additional clinical and scientific personnel and acquire or in-license other product candidates and technologies.

At this time, we cannot reasonably estimate or know the nature, timing and costs of the efforts that will be necessary to complete the preclinical and clinical development of any of our product candidates. The successful development and commercialization of our product candidates is highly uncertain. This is due to the numerous risks and uncertainties, including the following:

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. We may never succeed in obtaining regulatory approval for any of our product candidates.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related costs, including share-based compensation, for personnel in executive, finance and administrative functions. General and administrative expenses also include direct and allocated facility-related costs as well as professional fees for legal, patent, consulting, investor and public relations, accounting and audit services. We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our continued research, development, and commercialization of our product candidates. We also anticipate that we will incur

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increased accounting, audit, legal, regulatory, compliance, and director and officer insurance costs as well as investor and public relations expenses associated with operating as a public company.

Other Income (Expense)

Change in Fair Value of Derivative Liabilities

Contingent Prepayment Options. Bridge units issued to our investors in 2016 were automatically convertible into equity units sold in a subsequent round of qualified financing at a discounted rate. We refer to these automatic conversion features as contingent prepayment options. We classified the contingent prepayment options as a derivative liability on our consolidated balance sheet that we remeasured to fair value at each reporting date, and we recognized changes in the fair value of the derivative liability associated with the contingent prepayment options as a component of other income (expense) in our consolidated statement of operations and comprehensive loss. The contingent prepayment options were settled in the first quarter of 2017 upon the issuance of Class C preferred units.

Anti-Dilution Rights. In connection with the issuance of non-controlling interests in certain of our subsidiaries, specifically Spero Potentiator, Inc., Spero Europe, Ltd. and Spero Gyrase, Inc., we granted the minority investors the right to maintain ownership interests at no additional cost, subject to a maximum ownership percentage, which rights we refer to collectively as anti-dilution rights. We classified the anti-dilution rights as derivative liabilities on our consolidated balance sheet that we remeasured to fair value at each reporting date, and we recognized changes in the fair value of the derivative liabilities associated with the anti-dilution rights as a component of other income (expense) in our consolidated statement of operations and comprehensive loss. As of December 31, 2016, anti-dilution rights related to Spero Potentiator, Inc. were fully settled as the maximum number of shares to be issued to the minority investor had been reached in August 2016. In May 2017, we repurchased 100% of the minority investor’s outstanding shares in Spero Europe, Ltd. and settled the anti-dilution rights associated with the shares.

As of September 30, 2018 and December 31, 2017, the derivative liability of $0.2 million recorded on our consolidated balance sheet relates only to the anti-dilution rights held by the minority investor in Spero Gyrase, Inc.

Interest Income and Other Income (Expense), Net

Interest income consists of interest earned on our cash equivalents, which are primarily invested in money market accounts, as well as interest earned on our investments in marketable securities that we held during the nine months ended September 30, 2018. Other income (expense), net, consists of insignificant amounts of miscellaneous income, as well as realized and unrealized gains and losses from foreign currency-denominated cash balances, vendor payables and receivables from the Australian research and development tax incentive.

Income Taxes

Since our inception, we have not recorded any income tax benefits for the net losses we have incurred in each year or for our earned research and development tax credits, as we believe, based upon the weight of available evidence, that it is more likely than not that all of our net operating loss carryforwards and tax credits will not be realized. As of December 31, 2017, we had federal and state net operating loss carryforwards of $76.4 million and $76.0 million, respectively, which may be available to offset future income tax liabilities and begin to expire in 2033. In addition, as of December 31, 2017, we had foreign net operating loss carryforwards of $4.3 million, which may be available to offset future income tax liabilities and do not expire. As of December 31, 2017, we also had federal and state research and development tax credit carryforwards of $1.7 million and $0.4 million, respectively, which begin to expire in 2033 and 2028, respectively. We have recorded a full valuation allowance against our net deferred tax assets at each balance sheet date.

Prior to the Reorganization, our former parent company, Spero Therapeutics, LLC, was treated as a partnership for federal income tax purposes and, therefore, its owners, and not itself, were subject to U.S. federal or state income taxation on the income of Spero Therapeutics, LLC. Prior to the Reorganization, all of Spero Therapeutics, LLC’s directly held subsidiaries (including Spero Therapeutics, Inc.) were treated as corporations for U.S. federal income tax purposes and were subject to taxation in the United States or in other countries. Upon the Reorganization, Spero Therapeutics, Inc., whose consolidated financial statements are presented in this Quarterly Report on Form 10-Q, became the parent company for Spero Therapeutics, LLC’s former subsidiaries and these entities continue to be subject to taxation in the United States or in other countries.

Net Income (Loss) Attributable to Non-Controlling Interests

Net income (loss) attributable to non-controlling interests in our consolidated statement of operations and comprehensive loss is a result of minority investments in our subsidiaries, Spero Europe, Ltd., Spero Potentiator, Inc., Spero Cantab, Inc. and Spero Gyrase, Inc., and consists of the portion of the net income or loss of these subsidiaries that is not allocated to us. Changes in the amount of net

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income (loss) attributable to non-controlling interests are directly impacted by changes in the net income or loss of our consolidated subsidiaries and by the ownership percentage of the minority investors.

In May 2017, we repurchased 100% of the issued and outstanding shares of Spero Europe, Ltd. held by the minority investor. In June 2017, we repurchased 100% of the issued and outstanding shares of Spero Potentiator, Inc. held by the minority investor. In July 2017, we repurchased 100% of the issued and outstanding shares of Spero Cantab, Inc. held by the minority investor. As a result of these repurchases of the non-controlling interests, for periods subsequent to each repurchase, we no longer attribute net income (loss) to the non-controlling interest. As of September 30, 2018, the remaining non-controlling interest relates only to Spero Gyrase, Inc.

Results of Operations

Comparison of the Three Months Ended September 30, 2018 and 2017

The following table summarizes our results of operations for the three months ended September 30, 2018 and 2017:

Grant Revenue

Grant revenue recognized during the three months ended September 30, 2018 consisted of the reimbursement of qualifying expenses incurred in connection with our various government awards, including $0.4 million under our award with NIAID related to our SPR206 program, and $0.2 million under our award with BARDA related to our SPR994 program. Revenue recognized during the three months ended September 30, 2017 was primarily due to the reimbursement of qualifying expenses incurred in connection with our CARB-X award related to our SPR741 program of $0.4 million. We also recognized $0.1 million each under our awards from DoD and NIAID related to our SPR741 program and SPR720 program, respectively. 

Research and Development Expenses

Direct costs related to our SPR994 program increased during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 primarily due to an increase in formulation development, manufacturing process and

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manufacturing of Phase 3 clinical trial material, as well as an increase in clinical trial expenses related to closing our Phase 1 clinical trial and costs incurred to prepare for our planned pivotal Phase 3 clinical trial, which we expect to initiate around year-end 2018. These increases were partially offset by a decrease in preclinical costs due to costs incurred during the three months ended September 30, 2017 in preparation for the Phase 1 clinical trial which commenced in October 2017. Research and development expenses for our SPR994 program conducted by our Australian subsidiary were recorded net of a 43.5% research and development tax incentive for qualified expenses from the Australian government of $0.3 million during the three months ended September 30, 2018.

Direct costs related to our Potentiator Platform includes costs related to our SPR206 and SPR741 programs. We designated SPR206 as a product candidate in July 2017, prior to which time it was included within our preclinical program efforts. Direct costs related to our SPR206 program increased by $1.0 million during the three months ended September 30, 2018, primarily due to manufacturing efforts to support our planned Phase 1 clinical trial. We expect direct costs related to our SPR206 program to continue to increase as we prepare to initiate a Phase 1 clinical trial for SPR206 around year-end 2018. Direct costs related to our SPR741 program decreased by $2.4 million during the three months ended September 30, 2018 primarily due to higher costs during the three months ended September 30, 2017 in connection with preparing for our Phase 1b drug-drug interaction clinical trial of SPR741 in the United Kingdom, which was initiated in November 2017 and completed during the first half of 2018. Research and development expenses for our SPR741 program conducted by our Australian subsidiary were recorded net of a 43.5% research and development tax incentive for qualified expenses from the Australian government of $0.1 million during the three months ended September 30, 2017. Because our Phase 1b clinical trial of SPR741 is complete, we anticipate that our direct costs related to our SPR741 program will continue at a reduced level pending our prioritization of our Potentiator Platform product candidates.

Direct costs related to our SPR720 program increased during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, primarily due to costs incurred during the three months ended September 30, 2018 related to formulation development and manufacturing process of clinical trial material, as well as clinical trial costs as we prepare to initiate a Phase 1 clinical trial of SPR720. We expect direct costs related to our SPR720 program to continue to increase as we prepare to initiate a Phase 1 clinical trial for SPR720 in early 2019.

Direct costs related to our preclinical programs decreased slightly during the three months ended September 30, 2018 compared to the three months ended September 30, 2017 due primarily to lower spending on preclinical programs as we focused development efforts on our more advanced product candidates.

The increase in personnel-related costs included in unallocated expenses was due to an increase in headcount in our research and development function. Personnel-related costs for the three months ended September 30, 2018 and 2017 included share-based compensation expense of $0.3 million and $0.2 million, respectively. The increase in facility-related and other costs was due to higher costs of supporting a larger group of research and development personnel and their research efforts, as well as expense related to the write-off of certain leasehold improvements and laboratory equipment as a result of the closure of our Watertown, MA laboratory facility during the three months ended September 30, 2018.

General and Administrative Expenses

Personnel-related increased slightly due to higher salary and benefit costs resulting from an increase in headcount in our general and administrative function, offset by lower share-based compensation expense. The decrease in share-based compensation expense is due to higher expense recorded during the three months ended September 30, 2017, related to the Reorganization. Personnel-related costs for the three months ended September 30, 2018 and 2017 included share-based compensation expense of $0.5 million and $0.7 million, respectively.

The decrease in professional and consultant fees is primarily related to higher expenses incurred during the three months ended September 30, 2017 in connection with the Reorganization as well as our preparations to operate as a public company.

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Other Income (Expense), Net

Other income, net was $0.5 million for the three months ended September 30, 2018, compared to $0.1 million for the three months ended September 30, 2017. Other income, net for the three months ended September 30, 2018 primarily consisted of $0.6 million of interest income related to interest earned on our invested cash balances, partially offset by $0.1 million of other expenses. Other income, net consisted almost entirely of interest income for the three months ended September 30, 2017 related to interest earned on invested cash balances.  

Comparison of the Nine Months Ended September 30, 2018 and 2017

The following table summarizes our results of operations for the nine months ended September 30, 2018 and 2017: