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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2016

OR

For the transition period from                      to                    

Commission File Number: 001-37926

RA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

617-401-4060

(Registrant’s telephone number, including area code)

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  o    No  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

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

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

The number of shares outstanding of the registrant’s common stock as of November 29, 2016: 22,546,165 shares.

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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve substantial risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, strategy and plans and our expectations for future operations, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “anticipate,” “believe,” “contemplates,” “continue,” “could,” “design,” “estimate,” “expect,” “intend,” “likely,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “will,” “would,” “seek,” “should,” “target,” or the negative version of these words and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, strategy, short- and long-term business operations and objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, assumptions and other important factors, including those described in the section titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Quarterly Report on Form 10-Q and our final prospectus dated October 25, 2016, filed pursuant to Rule 424(b)(4) under the Securities Act of 1933 on October 26, 2016. In light of these risks, uncertainties, assumptions and other factors, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q or our final prospectus dated October 25, 2016, filed pursuant to Rule 424(b)(4) under the Securities Act of 1933 on October 26, 2016 may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking statements.

Forward-looking statements include, but are not limited to, statements about:

·                  the initiation, timing, progress and results of our research and development programs and future preclinical and clinical studies;

·                  our ability to advance any product candidates into, and successfully complete, clinical studies and obtain regulatory approval for them;

·                  our ability to identify additional product candidates using our Extreme Diversity platform;

·                  the timing or likelihood of regulatory filings and approvals;

·                  the commercialization, marketing and manufacturing of our product candidates, if approved;

·                  the pricing and reimbursement of our product candidates, if approved;

·                  the rate and degree of market acceptance and clinical utility of any products for which we receive marketing approval;

·                  the implementation of our strategic plans for our business, product candidates and technology;

·                  the scope of protection we are able to establish and maintain for intellectual property rights covering our product candidates and technology;

·                  our expectations related to the use of proceeds from our initial public offering, and estimates of our expenses, future revenues, capital requirements and our needs for additional financing;

·                  our ability to maintain and establish collaborations;

·                  our financial performance;

·                  developments relating to our competitors and our industry, including the impact of government regulation; and

·                  other risks and uncertainties, including those listed under the caption “Risk Factors.”

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RA PHARMACEUTICALS, INC. 

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except share and per share data)

See accompanying notes to these unaudited condensed consolidated financial statements.

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RA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(in thousands, except share and per share data)

See accompanying notes to these unaudited condensed consolidated financial statements

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RA PHARMACEUTICALS, INC. 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)
(in thousands)

See accompanying notes to these unaudited condensed consolidated financial statements.

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RA PHARMACEUTICALS, INC. 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.              Nature of Business

Ra Pharmaceuticals, Inc. (the “Company”) is a clinical-stage biopharmaceutical company using its proprietary peptide chemistry platform to create novel therapeutics to treat life-threatening diseases that are caused by excessive or uncontrolled activation of the complement system, an essential component of the body’s innate immune system. The Company’s lead product candidate, RA101495, is being developed as a convenient self-administered subcutaneous, or SC, injection, which is an injection into the tissue under the skin for the treatment of paroxysmal nocturnal hemoglobinuria, or PNH, a rare, chronic, life-threatening, blood disorder where red blood cells are mistakenly attacked and destroyed by the complement system. The Company is also developing RA101495, administered SC, to treat other debilitating complement-mediated diseases such as myasthenia gravis, or MG, and lupus nephritis, or LN. The Company is also pursuing discovery and preclinical programs targeting selective inhibition of other uncontrolled complement pathway factors to treat a variety of ophthalmologic, renal and inflammatory diseases. In addition to its focus on developing novel therapeutics to treat complement-mediated diseases, the Company has a collaboration with Merck & Co., Inc., or Merck, for a non-complement cardiovascular target.

The Company was incorporated in Delaware on June 27, 2008 and is located in Cambridge, Massachusetts. During 2011, the Company acquired Cosmix Verwaltungs GmbH (“Cosmix”), organized in Germany. The condensed consolidated financial statements include the assets and liabilities and operating results of the Company and its wholly-owned subsidiary, Cosmix. In January 2016, the Company formed a wholly-owned subsidiary organized in the United Kingdom (“UK”), Ra Europe Limited for the purpose of conducting clinical trials in Europe and the UK. Since inception, the Company has devoted substantially all of its efforts to research and development, business planning, acquiring operating assets, seeking protection for its technology and product candidates, and raising capital.

On October 31, 2016, we completed an initial public offering (“IPO”), in which we issued and sold 7,049,230 shares of our common stock at a public offering price of $13.00 per share, resulting in net proceeds to us of $82.9 million after deducting $6.4 million of underwriting discounts and commissions and offering costs of $2.3 million. On November 29, 2016, we completed the sale of an additional 1,057,385 shares of common stock to the underwriters under the underwriters’ option in the IPO to purchase additional shares of common stock at the public offering price of $13.00 per share, resulting in net proceeds to us of $12.8 million after deducting underwriting discounts and commissions. The shares began trading on the NASDAQ Global Market on October 26, 2016. Upon the closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into 13,623,933 shares of common stock at the applicable conversion ratio then in effect and the outstanding warrants to purchase 222,775 shares of common stock net exercised, in accordance with their terms, into 221,573 shares of common stock.

2.        Summary of Significant Accounting Policies

Unaudited Interim Financial Information

The condensed consolidated financial statements of the Company included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from this report, as is permitted by such rules and regulations. Accordingly, these financial statements should be read in conjunction with the financial statements as of and for the year ended December 31, 2015, and notes thereto, included in the Company’s final prospectus for the IPO filed with the Securities and Exchange Commission pursuant to Rule 424(b)(4) on October 26, 2016 (the “Prospectus”).

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Basis of Presentation and Use of Estimates

The accompanying condensed consolidated financial statements are unaudited. The Company’s unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). Any reference in these notes to applicable guidance is meant to refer to the authoritative United States generally accepted accounting principles as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASU”) of the Financial Accounting Standards Board (“FASB”).

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited financial statements. The unaudited condensed consolidated financial statements include the accounts of Ra Pharmaceuticals, Inc. and its wholly owned subsidiary. All intercompany transactions and balances of the subsidiary have been eliminated in consolidation. In the opinion of the Company’s management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments which are necessary to present fairly the Company’s financial position as of September 30, 2016, the results of its operations for the three and nine months ended September 30, 2016 and 2015 and cash flows for the nine months ended September 30, 2016 and 2015. Such adjustments are of a normal and recurring nature. The results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results for the year ending December 31, 2016, or for any future period.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Management considers many factors in selecting appropriate financial accounting policies and in developing the estimates and assumptions that are used in the preparation of the financial statements. Management must apply significant judgment in this process. In addition, other factors may affect estimates, which include, but are not limited to, expected business and operational changes, sensitivity and volatility associated with the assumptions used in developing estimates and whether historical trends are expected to be representative of future trends. Management’s estimation process often may yield a range of potentially reasonable estimates and management must select an amount that falls within that range of reasonable estimates. On an ongoing basis, the Company’s management evaluates its estimates related to, but not limited to, estimates related to convertible notes (“Convertible Notes”), bifurcated features embedded in the Convertible Notes, preferred stock tranche rights, stock-based compensation expense, clinical and pre-clinical trial accruals, and reported amounts of revenues and expenses during the period. The Company bases its estimates on historical experience and other market-specific or other relevant assumptions that it believes to be reasonable under the circumstances. Actual results may differ from those estimates or assumptions.

Reverse Stock Split

In connection with preparing for its IPO, the Company effected a one-for-seven reverse stock split of the Company’s common stock. The reverse stock split became effective on October 14, 2016. The par value and authorized shares of common stock and convertible preferred stock were not adjusted as a result of the reverse stock split. All share and per share amounts within the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this reverse stock split, including reclassifying an amount equal to the reduction in par value of common stock to additional paid-in capital.

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Summary of Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” in the Prospectus. There have been no material changes to the significant accounting policies during the period ended September 30, 2016.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes existing revenue recognition guidance. 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 defines 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 April 2016, the FASB issued ASU 2016-10, Revenue From Contracts With Customers: Identifying Performance Obligations and Licensing (“ASU 2016-10”), which addresses certain implementation issues and clarifies certain core revenue recognition principles of ASU 2014-09. In July 2015, the FASB voted to delay the effective date of this standard such that ASU 2014-09, as amended by ASU 2016-10, will be effective for the Company for annual periods beginning after December 15, 2017 and for interim periods within those fiscal years. Early adoption of the standard is permitted for annual periods beginning after December 15, 2016. The Company is evaluating the impact that the adoption of these ASUs will have on its financial statements.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s ability to Continue as a Going Concern (“ASU 2014-15”), which provides guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The amendments in ASU 2014-15 are effective for the annual reporting period ending after December 15, 2016 and for annual and interim periods thereafter. Early adoption is permitted. The Company is currently evaluating the potential impact of ASU 2014-15 on its financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which changes the presentation of debt issuance costs in financial statements. Under this authoritative guidance, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. The new guidance was effective for the Company beginning January 1, 2016. Early adoption was permitted. ASU 2015-03 did not have a significant impact on the Company’s financial statements.

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which changes the classification of deferred taxes in financial statements. This update requires that deferred tax liabilities and assets be classified as noncurrent on the balance sheet. The current requirement that deferred tax liabilities and assets of each jurisdiction of an entity be offset and presented as a single amount is not affected by the amendments in this update. The amendments in ASU 2015-17 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. The Company does not expect ASU 2015-17 to have an impact on its financial statements.

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In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which changes the presentation of assets and liabilities relating to leases.  The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. The provisions of this guidance are effective for annual periods beginning after December 15, 2018, and for interim periods therein. The Company has not yet assessed the impact of this new standard on its financial statements.

In March 2016, the FASB issued ASU 2016-09, Stock Compensation (Topic 718) (“ASU 2016-09”), which is intended to simplify several aspects of the accounting for share-based payment award transactions. The guidance will be effective for the fiscal year beginning after December 15, 2016, including interim periods within that year. The Company is currently evaluating the potential impact ASU 2016-09 may have on its financial position

3.              Fair Value Measurements

Below is a summary of assets and liabilities measured at fair value as of September 30, 2016 and December 31, 2015 (in thousands):

The Company’s cash equivalents consist principally of money market funds. Cash equivalents are stated at fair value and consist of Level 1 financial instruments in the fair value hierarchy.

Preferred Stock Tranche Rights are stated at fair value and are considered Level 3 inputs because their fair value measurement is based, in part, on significant inputs not observed in the market. The Company determined the fair value of Preferred Stock Tranche Rights as described in Note 9.

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4.              Property and Equipment, net

Property and equipment, net, consists of the following (in thousands):

Depreciation expense was $0.3 million and $0.2 million for the three months ended September 30, 2016 and 2015, respectively, and $1.0 million and $0.6 million for the nine months ended September 30, 2016 and 2015, respectively.

5.              Accrued Expenses

Accrued expenses consist of the following (in thousands):

6.              Convertible Notes

On April 1, 2015, the Company entered into a Convertible Note Purchase Agreement (the “Note Agreement”) with the holders of its existing Series A Preferred Stock. Upon entering the Note Agreement, the Company issued Convertible Notes and warrants to purchase 221,521 shares of the Company’s common shares.  In connection with the issuance, the Company received gross proceeds of $5.0 million and incurred issuance costs of $6,000.  The Convertible Notes bore interest at a rate of 8% per annum and were payable in full at the earliest of March 2018 (“Maturity Date”), an event of default as defined in the Note Agreement, or the sale of the Company. As discussed in more detail below, the notes and accrued interest thereon converted into shares of Series B-1 Preferred Stock on July 10, 2015.

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The Convertible Notes included certain features resulting in automatic conversion or possible early redemption. In the event the Company sold or issued shares (“Equity Securities”) resulting in cash proceeds to the Company of no less than $5 million (“Qualified Financing”), the Convertible Notes would automatically convert into the Equity Securities at a conversion price equal to the price per share paid by the investors purchasing the Equity Securities.  In the event of the Company undergoing a change in control prior to the Maturity Date, the Convertible Notes would automatically convert into the right to receive 3 times the outstanding principal, plus accrued interest. Lastly, the Convertible Notes included a put feature, at the option of the holders, whereby upon an event of default, repayment of the Convertible Notes could be accelerated in the amount of outstanding principal, plus accrued interest. Each of these three features were embedded derivatives that required bifurcation and accounting as liabilities to be measured at fair value at each reporting date.

The embedded features requiring separate accounting were combined and valued upon issuance using a single income valuation approach. The Company estimated the fair value of the combined embedded derivative identified above using a “with and without” income valuation approach. Under this approach, the Company estimated the present value of the fixed interest rate debt based on the fair value of similar debt instruments excluding the embedded features. This amount was then compared to the fair value of the debt instrument including the embedded features using a probability weighted approach by assigning each embedded derivative feature a probability of occurrence, with consideration provided for the settlement amount including conversion terms, prepayment penalties, the expected life of the liability and the applicable discount rate.

The Company recorded approximately $0.1 million as the fair value of the combined embedded derivative liability on April 1, 2015, resulting in a debt discount. The debt discount was being amortized as interest expense over the life of the Convertible Notes under the effective interest method prior to conversion. Changes in the estimated fair value of the embedded features were recorded as a component of other income (expense) in the condensed consolidated statement of operations.

As of July 10, 2015 and April 1, 2015, the Company ascribed a probability to the mandatory conversion feature upon a Qualified Financing of approximately 100% and 98%, respectively. As of July 10, 2015 and April 1, 2015, the Company ascribed a probability to the redemption feature upon a change in control of approximately 0% and 1%, respectively. For all other features included in the combined embedded derivative, the Company estimated a 0% and 1% probability of occurrence as of July 10, 2015 and April 1, 2015, respectively. The Company classified the liability within Level 3 of the fair value hierarchy as the probability factors are unobservable inputs and significant to the valuation model.

On July 10, 2015, the Company received gross proceeds of approximately $24.1 million from the issuance of Series B-1 Preferred Stock to new and existing investors at a price per share of $0.92667. This transaction was a Qualified Financing and resulted in the automatic conversion of the notes into 5,512,743 shares of Series B-1 Preferred Stock at a conversion price of $0.92667 per share. Upon conversion, the Company recorded the difference between the fair value of the Series B-1 Preferred Stock issued and the carrying value of the Convertible Notes plus accrued interest as a $0.6 million loss on debt extinguishment in its condensed consolidated statement of operations.

The warrants issued in connection with the Convertible Notes may be exercised at any time for shares of common stock at an exercise price of $0.01 per share. The warrants expire in March 2022. The Company estimated the fair value of these warrants as of the issuance date using a Black-Scholes option pricing model with the following assumptions:

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The proceeds from the Convertible Notes and warrants issuance were allocated between the notes and the warrants on a relative fair value basis. The Company allocated $0.5 million of the proceeds from the Convertible Notes to the common stock warrants and recognized this amount as additional paid-in capital with a corresponding debt discount upon issuance. As of September 30, 2016, the common stock warrants issued in connection with the Convertible Notes had not been exercised and remained outstanding. In October 2016, upon the closing of the IPO, all of the outstanding warrants net exercised, in accordance with their terms, into shares of common stock. See Note 9 for further details.

7.              Commitments and Contingencies

Significant contracts and agreements

In April 2013, the Company entered into a collaboration and license agreement with Merck under which the Company granted Merck an exclusive license to develop, manufacture, and commercialize the Company’s cyclomimetrics compounds. See Note 11 for further details.

Lease commitments

In September 2010, the Company entered into a lease for approximately 6,500 square feet of research and development laboratories and general office space in One Kendall Square, Cambridge, Massachusetts. In September 2012, the Company amended the original lease to provide for additional space of approximately 4,000 square feet in the same facility. The Company’s lease expired on April 30, 2016.

In September 2015, the Company entered into a new lease for approximately 27,000 square feet of research and development laboratories and general office space in 87 Cambridge Park Drive, Cambridge, Massachusetts. The lease commenced in September 2015 and expires in April 2023. The Company moved its operations to the space in April 2016.

In connection with the new lease, the Company recorded a lease incentive obligation for reimbursable costs under a tenant improvement allowance provided by the landlord. As of September 30, 2016 and December 31, 2015, the Company has recorded a lease incentive obligation of $2.7 million and $0.4 million in deferred rent in the condensed consolidated balance sheet.

The Company has accounted for all facility leases as operating leases. Rent expense was $0.2 million and $0.1 million for the three months ended September 30, 2016 and 2015, respectively, and $0.8 million and $0.2 million for the nine months ended September 30, 2016 and 2015, respectively.

Future minimum commitments due under these non-cancelable operating lease agreements as of September 30, 2016 are as follows (in thousands):

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Restricted cash

As of September 30, 2016 and December 31, 2015, the Company had restricted cash of $1.3 million and $1.5 million, respectively. During the nine months ended September 30, 2016, restricted cash decreased pursuant to the return of $0.1 million letter of credit for the Company’s facility lease at One Kendall Square that expired during the period. During the year ended December 31, 2015, restricted cash increased pursuant to a letter of credit of $1.4 million for the Company’s facility lease at 87 Cambridge Park Drive in Cambridge, Massachusetts. Letters of credit are secured by cash equivalents held in a money market fund.

Litigation

The Company is not a party to any litigation and does not have contingency reserves established for any litigation liabilities.

8.              Redeemable Convertible Preferred Stock

Series A Preferred Stock

In February 2010, the Company issued 12,887,999 shares of Series A Preferred Stock pursuant to the Series A Preferred Stock agreement at a price of $0.80176 per share, for gross proceeds of $9.7 million, and the conversion of the principal and accrued interest totaling $0.6 million related to convertible notes and incurred issuance costs of $0.2 million, (the “First Tranche”). Additionally, in accordance with the terms of the Series A Preferred Stock agreement, investors were granted the right to purchase up to an additional 21,552,566 shares of the Company’s Series A Preferred Stock at a price of $0.80176, in two subsequent closings (the “Second Tranche” and “Third Tranche,” respectively), upon the Company meeting certain milestone criteria by approval of the Board of Directors and approval of investors holding a majority of the Series A Preferred Stock (the “Series A Preferred Stock Tranche Rights”).

In February 2012, the Board of Directors waived certain Second Tranche milestone events provided for in the Series A Preferred Stock agreement and the Company issued 10,776,283 shares of Series A Preferred Stock at a price of $0.80176 for gross proceeds of $8.6 million and incurred issuance costs of $6,000.

In March 2014, the Board of Directors waived certain Third Tranche milestone events provided for in the Series A Preferred Stock agreement and the Company issued 10,776,283 shares of Series A Preferred Stock at a price of $0.80176 for gross proceeds of $8.6 million and incurred issuance costs of $9,000.

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As of September 30, 2016 and December 31, 2015, the total authorized, outstanding and issued Series A Preferred Stock of the Company was 34,440,565 shares. In October 2016, upon the closing of the Company’s IPO, all outstanding shares of Series A Preferred Stock converted into 4,920,074 shares of the Company’s common stock.

Series A Preferred Stock Tranche Rights

The Company determined the right of the investors to purchase shares of Series A Preferred Stock in two future tranches met the definition of a freestanding financial instrument and was recognized as a liability at fair value upon the initial issuance of the First Tranche of Series A Preferred Stock in February 2010. The Company adjusted the carrying value of the Series A Preferred Stock Tranche Rights liability to its estimated fair value at each subsequent reporting date and immediately prior to the issuance of the Second and Third Tranche of Series A Preferred Stock through charges to other income (expense) in the condensed consolidated statement of operations. Upon the closing of each tranche, the marked-to-market fair value of the liability was included in the carrying value of Series A Preferred Stock issued.

Immediately prior to the issuance of the Third Tranche of Series A Preferred Stock in March 2014, the Company adjusted the carrying value of the liability to its estimated fair value of $3.4 million and recorded the adjustment of $1.6 million within other income on the condensed consolidated statements of operations. The fair value of the Third Tranche obligation was determined using the fair value of the Series A Preferred Stock under the guideline public company option-pricing method on the date of the issuance.

Series B Preferred Stock

In July 2015, the Company issued 31,564,630 shares of Series B-1 Preferred Stock pursuant to the Series B Preferred Stock agreement at a price of $0.92667 per share for gross proceeds of $24.1 million and the conversion of the principal and accrued interest totaling $5.1 million related to the April 2015 Convertible Notes (Note 7) and incurred issuance costs of $0.2 million (the “Series B-1 Closing”).

Additionally, in accordance with the terms of the Series B Preferred Stock agreement, investors were granted the right to purchase up to an additional 29,362,452 shares of the Company’s Series B-2 Preferred Stock (“Series B-2 Preferred Stock”) at a price of $0.99617 (the “Series B-2 Preferred Stock Tranche Rights”), in any number of subsequent closings upon the request of each investor (the “Subsequent Closings”) or in a mandatory closing upon the Company meeting certain milestone criteria by approval of the Board of Directors and certain investors (the “Mandatory Closing”). Upon consummation of a Mandatory Closing, if an investor fails to purchase the full amount of Series B-2 Preferred Stock allocated to the investor in the Series B Preferred Stock agreement at the Mandatory Closing, then all shares of Series A Preferred Stock and Series B Preferred Stock held by such investor will automatically be converted into shares of common stock of the Company initially on a one for one basis. In June 2016, the Board of Directors and required certain investors waived the milestone criteria and triggered the Mandatory Closing of the Series B-2 Preferred Stock.

In June 2016, the Company issued 29,362,452 shares of Series B-2 Preferred Stock pursuant to the Series B Preferred Stock Agreement at a price of $0.99617 per share, for gross proceeds of $29.2 million and incurred issuance costs of $22,000 (“the Series B-2 Closing”).

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The Company incurred $0.2 million of costs related to the issuance of the Series B-1 Preferred Stock. $17,000 of the Series B-1 Preferred Stock issuance costs were allocated to Preferred Stock Tranche Rights relating to the Series B-2 Preferred Stock upon issuance. The amount allocated to the Series B-1 Preferred Stock was offset against the proceeds upon closing of the issuance of the first tranche of Series B Preferred Stock. The amount allocated to the future tranche rights was recorded as an offset to the tranche right liability at issuance. The Company incurred $22,000 of costs related to the issuance of the Series B-2 Preferred Stock.

As of September 30, 2016 and December 31, 2015, the total authorized, outstanding and issued Series B-1 Preferred Stock of the Company was 31,564,630 shares. As of September 30, 2016, the total authorized, outstanding and issued Series B-2 Preferred Stock of the Company was 29,362,452 shares. As of December 31, 2015, the total authorized Series B-2 Preferred Stock of the Company was 29,362,452 shares, and no shares were outstanding and issued. In October 2016, upon the closing of the Company’s IPO, all outstanding shares of Series B-1 and B-2 Preferred Stock converted into 8,703,859 shares of the Company’s common stock.

Series B-2 Preferred Stock Tranche Rights

The Company determined the right of the investors to purchase shares of Series B-2 Preferred Stock in a Subsequent Closing or in a Mandatory Closing met the definition of a freestanding financial instrument and was recognized as a liability at fair value upon the initial issuance of the Series B-1 Preferred Stock in July 2015.

As of June 14, 2016, December 31, 2015 and July 10, 2015, the Series B-2 Preferred Stock Tranche Rights liability had a fair value of $3.6 million, $2.6 million and $2.7 million, respectively. The fair value of the Series B-2 Preferred Stock Tranche Rights liability was determined using the probability-weighted present value of the benefit of the investment with the following assumptions:

The Company adjusted the carrying value of the Series B-2 Preferred Stock Tranche Rights liability to its estimated fair value at each reporting date subsequent to issuance and immediately prior to the issuance of the Series B-2 Preferred Stock on June 14, 2016 through charges to other income (expense) in the condensed consolidated statement of operations. During the three and nine months ended September 30, 2016, the Company recognized total other expense of $0 and $1.0 million, respectively, related to changes in the fair value of the Series B-2 Preferred Stock Tranche Rights.

The change in the carrying value of the Series A Preferred Stock Tranche Rights liability and the Series B-2 Preferred Stock Tranche Rights liability (collectively, the “Preferred Stock Tranche Rights”) on the condensed consolidated balance sheets during the nine months ended September 30, 2016 and the year ended December 31, 2015 was as follows:

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The Series B-2 Preferred Stock Tranche Rights liability was extinguished in June 2016 upon the issuance of the Series B-2 Preferred Stock. Immediately prior to the issuance of the Series B-2 Preferred Stock in June 2016, the Company adjusted the carrying value of the liability to its estimated fair value of $3.6 million.

The rights, preferences, and privileges of the Series A, Series B-1 and Series B-2 (collectively the “Preferred Stock”) are included in the Prospectus. There were no changes to the rights, preferences, and privileges of the Preferred Stock during the nine months ended September 30, 2016.

9.              Common Stock

The Company was authorized to issue up to 125,000,000 shares of common stock with a $0.001 par value per share as of September 30, 2016 and December 31, 2015. As of September 30, 2016 and December 31, 2015, the Company had 594,044 and 536,690 shares, respectively, of common stock issued and outstanding.

The rights, preferences, and privileges of the Company’s common stock are included in the Prospectus. There were no changes to the rights, preferences, and privileges of the common stock during the nine months ended September 30, 2016.

As of September 30, 2016 and December 31, 2015, the Company had warrants to purchase 222,775 shares of common stock issued and outstanding. In October 2016, upon the closing of the IPO, all of the outstanding warrants to purchase 222,775 shares of common stock net exercised, in accordance with their terms, into 221,573 shares of common stock.

Reserve for future issuance

The Company has reserved for future issuances the following number of shares of common stock:

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10.       Revenue Recognition

Merck Collaboration and License Agreement

In April 2013, the Company entered into a multi-target collaboration and license agreement with Merck to use its proprietary drug discovery technology platform to identify orally available cyclic peptides for non-complement program targets nominated by Merck and provide specific research and development services. Under the agreement, the Company granted Merck licenses under certain of its intellectual property rights to manufacture, develop and commercialize compounds and products directed to selected program targets. The agreement consists of a research phase, where the Company and Merck collaborated on identifying and pre-clinically developing orally available cyclic peptides suitable for further development by Merck, and a development and commercialization phase pursuant to which Merck has sole discretion and responsibility, including financial responsibility, for further development and commercialization of these peptides, on a program-by-program basis, from the collaboration. In April 2015, the Merck Agreement was amended to extend the research term of the collaboration to April 2016.

At the signing of the Merck Agreement, Merck made an upfront non-refundable, technology license fee of $4.5 million to the Company. In addition, during the research term, which ended in April 2016, the Merck Agreement provided for reimbursement of research and development services provided by the Company in accordance with pre-specified limits for the number of the Company’s full-time equivalent employees (“FTEs”) working under the Merck Agreement. At the conclusion of the research term, Merck elected to continue the development of a non-complement cardiovascular target, for which the Company had received $3.5 million in preclinical milestone payments as of September 30, 2016.

The Company has identified two deliverables in connection with the Merck Agreement: (1) rights to access the Company’s technology platform for each program target, and (2) the research & development services provided during the research term. The Company has determined that none of the deliverables have standalone value. Since the separability criteria have not been met for any of the deliverables, the deliverables are being accounted for as a single combined unit of accounting at the outset of the arrangement.

The Company has recognized revenue in connection with the upfront non-refundable license fee ratably over the research term of the Merck Agreement. Payments for research and development services and reimbursement for certain lab supplies and reagents have been recognized as services are performed, and milestone payments are recognized as these milestones are achieved, assuming all other revenue recognition criteria are met.

The Company has determined that the $3.5 million in milestone payments received through September 30, 2016 were substantive in nature as they were commensurate with the enhancement of value under the Merck Agreement and because the Company concluded at the start of the collaboration that there was no certainty that these milestones would be successful. Accordingly, the Company has accounted for these milestone payments under the milestone method. The Company is entitled to receive future aggregate milestone payments of up to $61.5 million for the non-complement cardiovascular target selected, consisting of remaining preclinical and clinical milestones of $16.5 million, regulatory milestones of $19.0 million, and commercial milestones of $26.0 million, and low-to-mid single digit percentage royalties on future sales, if any. Following the end of the research term, any future milestone payments will be recognized as revenue upon achievement as no further performance obligations exist for the Company under the Merck Agreement.

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The Company recognized revenue of $0 and $0.2 million during the three months ended September 30, 2016 and 2015, respectively, and $4.2 million and $0.8 million during the nine months ended September 30, 2016 and 2015, respectively, related to upfront, non-refundable payments. The Company recognized revenue of $0 and $0.8 million during the three months ended September 30, 2016 and 2015, respectively, and $0.6 million and $2.3 million during the nine months ended September 30, 2016 and 2015, respectively, related to research and development services performed under the agreement. In addition, the Company also recognized approximately $0 and $0.1 million during the three months ended September 30, 2016 and 2015, respectively, and $0.1 million and $0.2 million during the nine months ended September 30, 2016 and 2015, respectively, in revenue related to reimbursable expenses under the terms of the Merck Agreement.

As of September 30, 2016 and December 31, 2015, the Company had $0 and $1.9 million, respectively, of deferred revenue, and, $0 and $6,000, respectively, of billed and unbilled accounts receivable pursuant to the agreement with Merck.

11.       Stock Incentive Plan

The Company maintains the 2010 Stock Incentive Plan (the “2010 Plan”) for employees, consultants, advisors, and directors. The 2010 Plan provides for the grant of incentive, non-qualified stock options and restricted stock grants as determined by the Board of Directors. The Company has reserved 2,495,607 shares of common stock under the 2010 Plan. As of September 30, 2016 and December 31, 2015, the Company has 101,109, and 678,781, respectively, of shares available for future issuance under the 2010 Plan. Shares of common stock issued upon exercise of stock options are generally issued from new shares of the Company. The 2010 Plan provides that the exercise price of incentive stock options cannot be less than 100% of the fair market value of the common stock on the date of the award for participants who own less than 10% of the total combined voting power of stock of the Company, and not less than 110% for participants who own more than 10% of the Company’s voting power. Options and restricted stock granted under the 2010 Plan vest over periods as determined by the Board of Directors, which generally are equal to four years. Options generally expire ten years from the date of grant.

Total stock-based compensation expense recorded in research and development and general and administrative expenses, respectively, for employees, directors and non-employees during the three and nine months ended September 30, 2016 and 2015 is as follows (in thousands):

As of September 30, 2016 and December 31, 2015, the total unrecognized compensation expense related to non-vested, employee and non-employee director stock options, net of related forfeiture estimates, was $4.8 million and $1.2 million, respectively. As of September 30, 2016 and December 31, 2015, the total unrecognized compensation cost related to non-vested, non-employee stock options, net of related forfeiture estimates, was $0.1 million and $0, respectively. The Company expects to recognize its remaining unrecognized stock-based compensation expense over a weighted-average period of approximately three years. The weighted-average grant date fair value per share for awards granted was $0.58 during the three months ended September 30, 2016, and was $0.48 and $0.26 during the nine months ended September 30, 2016 and 2015, respectively. The Company did not grant any awards to employee and non-employee directors during the three months ended September 30, 2015.

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The fair value of each stock option granted to employees and directors was estimated on the date of grant using the Black-Scholes option-pricing model, with the following range of assumptions for the three and nine months ended September 30, 2016 and 2015 is as follows (in thousands):

The following table summarizes the activity of the Company’s stock option plan for the nine months ended September 30, 2016, (intrinsic values in thousands):

The total intrinsic value of options exercised was $47,000 and $36,000 during the three months ended September 30, 2016 and 2015, respectively, and $0.1 million and $36,000 during the nine months ended September 30, 2016 and 2015, respectively.

Stock Option Grants to Non-Employees

During the nine months ended September 30, 2016 and 2015, the Company granted 28,571 and 14,285, respectively, of non-qualified stock options to non-employees, excluding grants to non-employee directors. The Company did not grant any non-qualified stock options to non-employees during the three months ended September 30, 2016 and 2015. The unvested shares held by non-employees are revalued using the Company’s estimate of fair value at each reporting period through the remaining vesting period. Stock-based compensation expense related to stock option grants to non-employees was $22,000 and $7,000 during three months ended September 30, 2016 and 2015, respectively, and was $0.1 million and $0.1 million during the nine months ended September 30, 2016 and 2015, respectively. The fair value of each non-qualified stock option granted to non-employees was estimated on the date of grant and at each revaluation date using the Black-Scholes option-pricing model, with the following range of assumptions, excluding performance-based awards, during the nine months ended September 30, 2016 and 2015 is as follows (in thousands):

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Performance-based Stock Options

In December 2015, the Company granted 5,714 non-qualified stock options to a non-employee consultant of the Company, which contain performance-based vesting criteria. Milestone events are specific to the Company’s development and progression in clinical trial studies. Stock-based compensation expense associated with this performance-based stock options is recognized if the achievement of the performance condition is considered probable using management’s best estimates. As of December 31, 2015, management determined that it was not probable these conditions would be met, and therefore no stock-based compensation expense relating to performance-based awards was recorded. As of September 30, 2016, management determined these conditions were met, and therefore stock-based compensation expense relating to this performance-based award was recorded during the nine months ended September 30, 2016.

In February 2016, the Company granted 29,285 shares of qualified stock options to an employee of the Company. Vesting of the stock option award only commences upon the occurrence of a Trigger Event, which is defined in the employee’s equity agreement as the consummation of either (i) an initial public offering of the Company’s common stock and (ii) a private placement financing, in one or a series of related closings, resulting in gross proceeds to the Company of at least $20 million (the “Trigger Event”). Stock-based compensation expense associated with this performance-based stock options is recognized if the achievement of the performance condition is considered probable using management’s best estimates. As of September 30, 2016, management determined that it was not probable the Trigger Event would be met, and therefore stock-based compensation expense relating to this performance-based award was not recorded during the nine months ended September 30, 2016. In October 2016, upon the closing of the initial public offering, the vesting of this stock option award commenced.

12.       Income Taxes

Deferred tax assets and deferred tax liabilities are recognized based on temporary differences between the financial reporting and tax basis of assets and liabilities using statutory rates. A valuation allowance is recorded against deferred tax assets if it is more likely than not that some or all of the deferred tax asset will not be realized. There were no significant income tax provisions or benefits for the three and nine months ended September 30, 2016 and 2015. Due to uncertainty surrounding the realization of its favorable tax attributes in future tax returns, the Company has recorded a full valuation allowance against the Company’s otherwise recognizable net deferred tax assets.

13.       Net loss Per Share Attributable to Common Stockholders

The Company computes basic and diluted earnings (loss) per share using a methodology that gives effect to the impact of outstanding participating securities (the “two-class method”). As the three and nine months ended September 30, 2016 and 2015 resulted in net losses, there is no income allocation required under the two-class method or dilution attributed to weighted average shares outstanding in the calculation of diluted loss per share.

Basic and diluted net loss per common share are calculated as follows:

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The following Common Stock equivalents, presented on an as converted basis, were excluded from the calculation of net loss per share for the periods presented, due to their anti-dilutive effect:

14.       Subsequent Events:

On October 14, 2016, the Company’s stockholders approved the 2016 Stock Award and Incentive Plan (the “2016 Plan”), which became effective on October 25, 2016. A total of 1,300,000 shares of common stock were reserved for issuance under the 2016 Plan, plus 101,109 shares originally available for future issuance under the 2010 Plan. In addition, the number of shares of common stock that may be issued under the 2016 Plan will automatically increase on each January 1, beginning on January 1, 2017 and ending on January 1, 2026, equal to the lesser of (i) 2,000,000 shares of common stock, (ii) 4% of the Company’s shares of common stock outstanding on the immediately preceding December 31 or (iii) an amount determined by the administrator of the 2016 Plan appointed by the Company’s board of directors.

On October 14, 2016, the Company’s stockholders approved the 2016 Employee Stock Purchase Plan (the “ESPP”), which became effective on October 25, 2016. A total of 175,000 shares of common stock were reserved for issuance under the ESPP. In addition, the number of shares of common stock that may be issued under the ESPP will automatically increase on each January 1, beginning on January 1, 2017 and ending on January 1, 2026, equal to the lesser of (i) 300,000 shares of common stock, (ii) 1% of the Company’s shares of common stock outstanding on the immediately preceding December 31 or (iii) an amount determined by the administrator of the ESPP appointed by the Company’s board of directors.

On October 14, 2016, the Company amended its certificate of incorporation to effect a one-for-seven 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 convertible preferred stock. Accordingly, all share and per share amounts for all periods presented in the accompanying interim condensed 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.

On October 31, 2016, we completed an IPO, in which we issued and sold 7,049,230 shares of our common stock at a public offering price of $13.00 per share, resulting in net proceeds to us of $82.9 million after deducting $6.4 million of underwriting discounts and commissions and offering costs of $2.3 million. On November 29, 2016, we completed the sale of an additional 1,057,385 shares of common stock to the underwriters under the underwriters’ option in the IPO to purchase additional shares of common stock at the public offering price of $13.00 per share, resulting in additional net proceeds to us of $12.8 million after deducting discounts and commissions.

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The shares began trading on the NASDAQ Global  Market on October 26, 2016. Upon the closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into 13,623,933 shares of common stock at the applicable conversion ratio then in effect and the outstanding warrants to purchase 222,775 shares of common stock net exercised, in accordance with their terms, into 221,573 shares of common stock.

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and the audited financial information and the notes thereto included in our final prospectus for our initial public offering filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Securities Act, with the Securities and Exchange Commission, or the SEC on October 26, 2016, or the Prospectus.

Our actual results and timing of certain events may differ materially from the results discussed, projected, anticipated, or indicated in any forward-looking statements. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Quarterly Report, they may not be predictive of results or developments in future periods.

The following information and any forward-looking statements should be considered in light of factors discussed elsewhere in the Quarterly Report on Form 10-Q, including those risks identified under Part II, Item 1A. Risk Factors.

We caution readers not to place undue reliance on any forward-looking statements made by us, which speak only as of the date they are made. We disclaim any obligation, except as specifically required by law and the rules of the SEC, to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

Overview

We are a clinical-stage biopharmaceutical company using our proprietary peptide chemistry platform to develop novel therapeutics for the treatment of serious diseases that are caused by excessive or uncontrolled activation of the complement system, a critical component of the immune system. The complement system, which consists of approximately 30 interacting proteins, offers a target-rich opportunity for us to leverage our proprietary peptide chemistry platform, which was pioneered by Nobel Laureate Dr. Jack Szostak and allows us to inhibit certain uncontrolled complement pathway factors involved in complement-mediated diseases. Known as our Extreme Diversity platform, our proprietary macrocyclic peptide chemistry technology allows us to produce synthetic macrocyclic peptides that combine the diversity and specificity of antibodies with the pharmacological properties of small molecules. We believe this chemistry technology will allow us to pursue challenging targets for which only monoclonal antibodies have been developed.

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We are developing our lead product candidate, RA101495, a convenient self-administered subcutaneous, or SC, injection, which is an injection into the tissue under the skin, for the treatment of paroxysmal nocturnal hemoglobinuria, or PNH. PNH is a rare, chronic, life-threatening, blood disorder where red blood cells are mistakenly attacked and destroyed by the complement system. We expect to initiate our Phase 2 clinical program for RA101495 in PNH patients in the first quarter of 2017 and release data in the second half of 2017. We are also developing RA101495, administered SC, to treat other debilitating complement-mediated diseases such as refractory generalized myasthenia gravis, or rMG, and lupus nephritis, or LN. We expect to initiate a Phase 2 clinical trial with RA101495 for rMG and a Phase 1b clinical trial in LN in the second half of 2017. We also have preclinical programs targeting selective inhibition of other complement factors for diseases with no approved therapies, including a Factor D program for ophthalmologic and renal diseases, an oral, small molecule C5 inhibitor and a C1s program for certain autoimmune and central nervous system, or CNS, diseases. In addition to our focus on developing novel therapeutics to treat complement-mediated diseases, we have validated our Extreme Diversity platform by successfully identifying and delivering orally-available cyclic peptides for a non-complement cardiovascular target with a large market opportunity in a collaboration with Merck & Co., Inc., or Merck.

Since our inception in June 2008, we have devoted substantially all of our resources to organizing and staffing our company, business planning, raising capital, acquiring and developing our proprietary chemistry technology, identifying potential product candidates and conducting preclinical studies of our product candidates and a clinical trial of our lead product candidate, RA101495. To date, we have not generated any product revenue and have financed our operations primarily through the private placement of our securities and revenue from our collaboration with Merck. As of September 30, 2016, we had raised an aggregate of $103.5 million comprised of $86.0 million gross proceeds from private placements of our securities and $17.5 million in payments in connection with our collaboration and license agreement with Merck, or the Merck Agreement.

On October 31, 2016, we completed an initial public offering (“IPO”), in which we issued and sold 7,049,230 shares of our common stock at a public offering price of $13.00 per share, resulting in net proceeds to us of $82.9 million after deducting $6.4 million of underwriting discounts and commissions and offering costs of $2.3 million. On November 29, 2016, we completed the sale of an additional 1,057,385 shares of common stock to the underwriters under the underwriters’ option in the IPO to purchase additional shares of common stock at the public offering price of $13.00 per share, resulting in additional net proceeds to us of $12.8 million after deducting discounts and commissions.

As of September 30, 2016, we had an accumulated deficit of $57.9 million. Our net losses were $8.1 million and $3.9 million for the three months ended September 30, 2016 and 2015, respectively, and $18.0 million and $9.4 million for the nine months ended September 30, 2016 and 2015, respectively. We have incurred significant net operating losses in every year since our inception and expect to continue to incur increasing net operating losses and significant expenses for the foreseeable future. Our net losses may fluctuate significantly from quarter to quarter and year to year. We anticipate that our expenses will increase significantly as we:

·                  continue to advance our lead program, RA101495, through clinical development by establishing clinical proof-of-concept activity using convenient SC administration in PNH patients;

·                  continue our current research programs and development activities;

·                  seek to identify additional research programs and additional product candidates;

·                  initiate preclinical testing and clinical trials for any product candidates we identify and develop, maintain, expand and protect our intellectual property portfolio;

·                  hire additional research, clinical and scientific personnel; and

·                  incur additional costs associated with operating as a public company, including expanding our operational, finance and management teams.

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Because of the numerous risks and uncertainties associated with product development, we are unable to 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.

Financial Overview

Revenue

We have derived all of our revenue to date from our collaboration and license agreement with Merck, or the Merck Agreement, which we entered into in April 2013. Under the Merck Agreement, we collaborated with Merck and used our proprietary drug discovery technology platform to identify orally available cyclic peptides for non-complement targets nominated by Merck and provided specific research and development services. At the signing, Merck paid us an upfront, non-refundable, license fee payment of $4.5 million. In addition, during the research term, which ended in April 2016, Merck reimbursed us for research and development services provided by us in accordance with a pre-specified number of our full-time equivalent employees, or FTEs, working under the Merck Agreement. At the conclusion of the research term, Merck elected to continue the development of a non-complement cardiovascular program target with a large market opportunity, for which we had received $3.5 million in preclinical milestone payments as of September 30, 2016. We are also entitled to receive future aggregate milestone payments of up to $61.5 million and low-to-mid single digit percentage royalties on any future sales for this program target. For additional information about the Merck Agreement, see the section entitled “—Revenue Recognition—Merck Collaboration and License Agreement” within the Prospectus. For additional information about our revenue recognition policy, see the section entitled “—Critical Accounting Policies and Significant Judgments and Estimates—Revenue” within the Prospectus.

To date, we have not generated any revenue from product sales and do not expect to do so in the near future. We expect that our revenue will be less than our expenses for the foreseeable future and that we will experience increasing losses as we continue our development of, and seek regulatory approvals for, our product candidates and begin to commercialize any approved products. Our ability to generate revenue for each product candidate for which we receive regulatory approval will depend on numerous factors, including competition, commercial manufacturing capability and market acceptance of our products.

Research and Development Expenses

Research and development expenses consist primarily of costs incurred for our research activities, including development of our proprietary chemistry technology platform, and our preclinical and clinical candidates, which include:

·                  employee-related expenses, including salaries, benefits, and stock-based compensation expense;

·                  expenses incurred under agreements with contract research organizations (CROs), contract manufacturing organizations (CMOs), and independent contractors that conduct research and development, preclinical and clinical activities on our behalf;

·                  costs of purchasing lab supplies and non-capital equipment used in our preclinical activities and in manufacturing preclinical study and clinical trial materials;

·                  consulting, licensing and professional fees related to research and development activities: and;

·                  facility costs, depreciation, and other expenses, which include direct and allocated expenses for rent and maintenance of facilities, insurance, and other supplies.

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We expense research and development costs as incurred. We recognize costs for certain development activities, such as preclinical studies and clinical trials, based on an evaluation of the progress to completion of specific tasks using information provided to us by our vendors such as patient enrollment or clinical site activations for services received and efforts expended.

Research and development activities are central to our business model. We expect research and development costs to increase significantly for the foreseeable future as our current development programs progress and new programs are added.

We have not provided program costs since inception because historically we have not tracked or recorded our research and development expenses on a program-by-program basis. We use our employee and infrastructure resources across multiple research and development programs directed toward developing our Extreme Diversity platform and for identifying and developing product candidates. We manage certain activities such as contract research and manufacturing of RA101495 and our discovery programs through our third-party vendors, and do not track the costs of these activities on a program-by-program basis.

Because of the numerous risks and uncertainties associated with product development, we cannot determine with certainty the duration and completion costs of the current or future preclinical studies and clinical trials or if, when, or to what extent we will generate revenues from the commercialization and sale of our product candidates. We may never succeed in achieving regulatory approval for our product candidates. The duration, costs and timing of preclinical studies and clinical trials and development of our product candidates will depend on a variety of factors, including:

·                  successful completion of preclinical studies and Investigational New Drug-enabling studies;

·                  successful enrollment in, and completion of, clinical trials;

·                  receipt of marketing approvals from applicable regulatory authorities;

·                  establishing commercial manufacturing capabilities or making arrangements with third-party manufacturers;

·                  obtaining and maintaining patent and trade secret protection and non-patent exclusivity;

·                  launching commercial sales of the product, if and when approved, whether alone or in collaboration with others;

·                  acceptance of the product, if and when approved, by patients, the medical community and third-party payors;

·                  effectively competing with other therapies and treatment options;

·                  a continued acceptable safety profile following approval;

·                  enforcing and defending intellectual property and proprietary rights and claims; and

·                  achieving desirable medicinal properties for the intended indications.

A change in the outcome of any of these factors could mean a significant change in the costs and timing associated with the development of our current and future preclinical and clinical product candidates. For example, if the FDA, or another regulatory authority were to require us to conduct clinical trials beyond those that we currently anticipate will be required for the completion of clinical development, or if we experience significant delays in enrollment in any of our preclinical or clinical trials, we could be required to expend significant additional financial resources and time on the completion of preclinical and clinical development. We expect our research and development expenses to increase for the foreseeable future as we continue the development of product candidates.

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General and Administrative Expenses

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

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

Other Income (Expense), Net

Other income (expense), net primarily consists of interest expense incurred on debt instruments, amortized debt discount, interest income earned on our cash and cash equivalents, non-cash changes in fair value of the derivative liability associated with the Convertible Notes, loss on debt extinguishment and the increase in fair value of preferred stock tranche rights, or Preferred Stock Tranche Rights. The debt discount primarily resulted from recording the relative fair value of warrants and the fair value of bifurcated features embedded in the Convertible Notes issued in April 2015. The debt discount has been amortized to interest expense over the life of the Convertible Note.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. We believe that several accounting policies are important to understanding our historical and future performance. We refer to these policies as critical because these specific areas generally require us to make judgments and estimates about matters that are uncertain at the time we make the estimate, and different estimates—which also would have been reasonable—could have been used. On an ongoing basis, we evaluate our estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and other market-specific or other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that our most critical accounting policies are those relating to revenue recognition, accrued research and development expenses and stock-based compensation. There have been no significant changes to our accounting policies discussed in our Prospectus.

Result of Operations

Comparison of the Three Months Ended September 30, 2016 and 2015

The following table summarizes our results of operations for the three months ended September 30, 2016 and 2015, together with the dollar change in those items:

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Revenue

Revenue decreased by $1.1 million to $0 for the three months ended September 30, 2016, from $1.1 million for the three months ended September 30, 2015. This decrease is primarily attributable to the expiration of the research term of the Merck Agreement in April, 2016.

Research and Development Expenses

Research and development expenses increased by $3.1 million to $7.1 million for the three months ended September 30, 2016, from $4.0 million for the three months ended September 30, 2015. This increase is primarily attributable to $1.4 million increase in CRO and CMO expenses in connection with our pre-clinical studies and clinical trials for RA101495, $0.9 million increase in employee-related costs associated with salaries, bonus, benefits and non-cash stock-based compensation, including costs for additional personnel to support our increased research and development activities, $0.4 million increase in facilities costs including rent, moving expenses related to our new facility, and depreciation expense, $0.3 million increase in consulting expenses and $0.1 million increase in lab-supply and reagent expenses.

General and Administrative Expenses

General and administrative expenses increased by $0.5 million to $1.0 million for the three months ended September 30, 2016, from $0.5 million for the three months ended September 30, 2015. The increase in general and administrative expenses was primarily attributable to $0.3 million increase in employee-related costs, including salary, bonus, benefits and non-cash stock-based compensation for executive and administrative personnel including for additional personnel to support our increased activities, $0.1 million increase in consulting and professional fees, including increased market research, accounting and audit fees, and approximately $0.1 million in increased facilities related costs.

Other Income (Expense), Net

Other income (expense), net increased by $0.5 million to $7,000 in other income, net during the three months ended September 30, 2016 from $0.5 million in other expense, net for the three months ended September 30, 2015. This increase was primarily attributable to $0.6 million in other expense related to the loss upon debt extinguishment of the Convertible Notes recognized in the three months ended September 30, 2015, partially offset by the increase in the fair value of the Series B-2 Preferred Stock Tranche Rights of approximately $0.1 million, recognized in the three months ended September 30, 2015.

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