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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-38630

Aridis Pharmaceuticals, Inc.

(Exact Name of Registrant as Specified in its Charter)

(408) 385-1742

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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 x No o

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 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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 7(a)(2)(B) of the Securities Act. o

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

The number of shares of the registrant’s common stock, $0.0001 par value per share, outstanding at November 13, 2018 was 8,104,757.

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Aridis Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

See accompanying notes to the unaudited condensed consolidated financial statements.

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Aridis Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except share and per share amounts)

See accompanying notes to the unaudited condensed consolidated financial statements.

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Aridis Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

See accompanying notes to the unaudited condensed consolidated financial statements.

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Aridis Pharmaceuticals. Inc.

Notes to Condensed Consolidated Financial Statements

1. Description of Business and Basis of Presentation

Organization

Aridis Pharmaceuticals, Inc. (the “Company” or “we” or “our”) was established as a California limited liability corporation in 2003. The Company converted to a Delaware C corporation on May 21, 2014. Aridis’ principal place of business is in San Jose, California. It is a clinical-stage company focused on developing new breakthrough therapies for infectious diseases and addressing the growing problem of antibiotic resistance. The Company has a diversified portfolio of clinical and pre-clinical stage anti-infective product candidates that are complimented by a fully human monoclonal antibody discovery platform technology. The Company’s two most mature clinical candidates AR-301 and AR-105 are at Phase 3 and Phase 2 clinical trial stage, respectively. The Company’s suite of anti-infective monoclonal antibodies offers opportunities to profoundly alter the current trajectory of increasing antibiotic resistance and improve the health outcome of many of the most serious life-threatening infections particularly in hospital settings.

Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements include the amounts of the Company and our wholly-owned subsidiaries and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the preceding fiscal year contained in the Company’s final prospectus for its initial public offering filed pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, on August 15, 2018 with the United States Securities and Exchange Commission (“SEC”).

The consolidated financial statements include the accounts of the Company and its two wholly-owned subsidiaries, Aridis Biopharmaceuticals, Inc. and Aridis Pharmaceuticals, C.V. All intercompany balances and transactions have been eliminated in consolidation. The Company operates in one segment. Management uses one measurement of profitability and does not segregate its business for internal reporting.

Reverse Stock Split

On August 3, 2018, the Company effected a 1 for 6.417896 reverse stock split of the Company’s common stock. The par value and the number of authorized shares of the common and convertible preferred stock were not adjusted as a result of the reverse stock split. All common stock share and per-share amounts for all periods presented in this Quarterly Report on Form 10-Q have been adjusted retroactively to reflect the reverse stock split.

Liquidity and Capital Resources

On August 13, 2018, the Company’s registration statement on Form S-1 relating to its initial public offering of its common shares (the “IPO”) was declared effective by the SEC. The IPO closed on August 16, 2018 and the Company issued and sold 2,000,000 common shares at a public offering price of $13.00 per share. Gross proceeds totaled $26.0 million and net proceeds totaled $22.8 million after deducting underwriting discounts and commissions of $1.8 million and other offering expenses of approximately $1.4 million. The underwriters of the IPO partially exercised their over-allotment option, and on August 30, 2018, the Company issued and sold 192,824 common shares at a public offering price of $13.00 per share for gross proceeds totaling approximately $2.5 million and net proceeds of approximately $2.3 million after deducting underwriting discounts and commissions of approximately $0.2 million.

Management expects to continue to incur additional substantial losses in the foreseeable future as a result of the Company’s research and development activities. Management plans to finance operations through equity or debt financings or other capital sources, including potential collaborations or other strategic transactions. There can be no assurances that, in the event that the Company requires additional financing, such financing will be available on terms which are favorable to the Company, or at all. If the Company is unable to raise additional funding to meet its working capital needs in the future, it will be forced to delay or reduce the scope of its research programs and/or limit or cease its operations.

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The Company believes that its existing cash and cash equivalents will provide sufficient funds to enable it to meet its obligations for at least the next 12 months.

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of expenses during the reporting period. Such estimates include those related to the evaluation of our ability to continue as a going concern, revenue recognition, long-lived assets, income taxes, assumptions used in the Black-Scholes-Merton (“BSM”) model to calculate the fair value of stock-based compensation, Monte Carlo Simulation (“MSM”) model to calculate the fair value of warrants, deferred tax asset valuation allowances, valuation of the Company’s common and convertible preferred stock, fair value assumptions used in the valuation of warrants, preclinical study and clinical trial accruals and various accrued liabilities. Actual results could differ from those estimates.

Concentration of Risk

The Company’s cash and cash equivalents are maintained at financial institutions in the United States of America. Deposits held by these institutions may exceed the amount of insurance provided on such deposits.

For the three and nine months ended September 30, 2018 and 2017, one customer accounted for 100% of total revenue. As of September 30, 2018, one customer accounted for 100% of accounts receivable. There were no accounts receivable as of December 31, 2017.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of checking account and money market account balances.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded at the invoiced amount and do not bear interest. The Company considers the credit worthiness of its customers, but does not require collateral in advance of a sale. The Company evaluates collectability and maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio when necessary. The allowance is based on the Company’s best estimate of the amount of losses in the Company’s existing accounts receivable, which is based on customer creditworthiness, facts and circumstances specific to outstanding balances, and payment terms. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of September 30, 2018 and December 31, 2017, there were $800,000 and $0 accounts receivable, respectively. As of September 30, 2018 and December 31, 2017, there were no allowances for doubtful accounts.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally between three and five years. Maintenance and repairs are charged to expense as incurred. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the balance sheet and any resulting gain or loss is reflected in the consolidated statement of operations and comprehensive loss in the period realized.

Intangible Assets

Intangible assets are recorded at cost and amortized over the estimated useful life of the asset. Intangible assets consist of licenses with various institutions whereby the Company has rights to use intangible property obtained from such institutions.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparison of the carrying amount to the future net cash flows which the assets are expected to generate. If such assets are considered to be impaired, the impairment is measured by

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the excess of the carrying amount of the assets over fair value less the costs to sell the assets, generally determined using the projected discounted future net cash flows arising from the asset. There have been no such impairments of long-lived assets as of September 30, 2018 and December 31, 2017.

Revenue Recognition

Revenue is recognized in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

During the three and nine months ended September 30, 2018 and 2017, revenue consisted of grant revenue. We recognize revenue under such awards under the milestone method, up to the limit of the prior approval funding amounts, and when we have determined that we have earned the right to receive the recognized portion according to the terms of the original grant awarded.

In December 2016, the Company received an award from the Cystic Fibrosis Foundation (“CF Foundation”) for approximately $2,902,000. The agreement contains an upfront payment of $200,000 which is being recognized straight-line over the term of the contract as we believe the upfront fee relates to services performed throughout the contract period and the upfront fee does not represent a substantive milestone within the agreement. Recognition of revenue for the remaining payments under the agreement will be recognized under the milestone method as substantive milestones are met. The milestones relate to pre-clinical research activities. The agreement also specifies that we are obligated to cumulatively spend on the development program at least an equal amount as it receives from the non-profit organization. In the event that we do not spend as much as we received under the agreement, we are obligated to return any overage to the non-profit organization.

For the three months ended September 30, 2018 and 2017, the Company had grant revenue of $1,022,000 and $22,000, respectively. For the nine months ended September 30, 2018 and 2017, the Company had grant revenue of $1,367,000 and $67,000, respectively. All grant revenue was derived from our award agreement with the CF Foundation. As of September 30, 2018, there was approximately $44,000 in deferred revenue related to the CF Foundation grant award. As of December 31, 2017, there was approximately $111,000 in deferred revenue related to the CF Foundation grant award.

In 2017, the Company entered into a collaborative research and development agreement with GlaxoSmithKline plc (“GSK”). In accordance with the agreement, we received an upfront fee and are due annual fees and amounts for development work to be performed as specifically outlined under the agreement. The work to be performed was delineated into three specific research projects. In assessing the appropriate revenue recognition related to a collaboration agreement, we first determined whether the arrangement includes multiple elements, such as the delivery of intellectual property rights and research and development services. The multiple elements were analyzed to determine whether the deliverables could be separated or whether they must be accounted for as a single unit of accounting. Amounts received prior to satisfying the revenue recognition criteria are recorded as deferred revenue in our balance sheet. Recognition of revenue under the contract will be based on the terms of the contract and will be recognized under the proportional performance method derived from the completion of certain stages as defined within the contract.

For the three and nine months ended September 30, 2018 and 2017, no collaboration revenue was recorded under the Company’s agreement with GSK. As of September 30, 2018, there was approximately $509,000 in deferred revenue related to the Company’s agreement with GSK. As of December 31, 2017, there was approximately $9,000 in deferred revenue related to the Company’s agreement with GSK.

Costs for Collaborative Arrangements

Costs incurred under collaborative arrangements include personnel costs, laboratory supplies and fees paid to third parties. These amounts are included in research and development in the accompanying consolidated statement of operations. For the three months ended September 30, 2018 and 2017, the Company incurred expenses of $170,000 and $179,000, respectively. For the nine months ended September 30, 2018 and 2017, the Company incurred expenses of $488,000 and $480,000, respectively, related to its collaborative arrangement.

Research and Development

Research and development costs are charged to operations as incurred. Research and development expenses consist of salaries and benefits, laboratory supplies, consulting fees and fees paid to third parties.

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Stock-Based Compensation

The Company recognizes compensation expense for all stock-based awards to employees and directors based on the grant-date estimated fair values, net of an estimated forfeiture rate. The Company recognizes stock-based compensation cost for employees and directors on a straight-line basis over the requisite service period for the award. Stock-based compensation expense is recognized only for those awards that are ultimately expected to vest. The Company estimates forfeitures based on an analysis of historical employee turnover and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. The Company will revise the forfeiture estimate, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Changes in forfeiture estimates impact stock-based compensation cost in the period in which the change in estimate occurs.

The BSM option pricing model incorporates various highly sensitive assumptions, including the fair value of the Company’s common stock, expected volatility, expected term and risk-free interest rates. The weighted-average expected life of options was calculated using the simplified method as prescribed by the SEC’s Staff Accounting Bulletin No. 107 (“SAB No. 107”). This decision was based on the lack of relevant historical data due to the Company’s limited historical experience. In addition, due to the Company’s limited historical data, the estimated volatility also reflects the application of SAB No. 107, incorporating the historical volatility of comparable companies whose stock prices are publicly available. The risk-free interest rate for the periods within the expected term of the option is based on the U.S. Treasury yield in effect at the time of grant. The dividend yield was zero, as the Company has never declared or paid dividends and has no plans to do so in the foreseeable future.

The Company accounts for stock-based compensation arrangements with non-employees by recording the expense of such services based on the estimated fair value of the common stock at the measurement date. The value of the equity instrument, including adjustment to fair value at each balance sheet date, is charged to net loss over the term of the service agreement.

Prior to the completion of the Company’s initial public offering of common stock on August 16, 2018, due to the absence of a public market trading for the Company’s common stock, it was necessary to estimate the fair value of the common stock underlying the Company’s stock-based awards when performing fair value calculations.

Income Taxes

The Company accounts for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

The Company assesses all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by the relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the positions sustainability and is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. At each balance sheet date, unresolved uncertain tax positions must be reassessed, and the Company will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

Comprehensive Loss

The Company has no items of comprehensive income or loss other than net loss.

Loss Per Share

Basic loss per common share is calculated by dividing net loss available to common shareholders for the period by the weighted-average number of common shares outstanding during the period. For diluted loss per share calculation purposes, the net loss available to commons shareholders is adjusted to add back any preferred stock dividends and any interest on convertible debt reflected in the consolidated statement of operations for the respective periods.

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The following potentially dilutive securities were excluded from the computation of diluted net loss per share attributable to common stockholders for the periods presented because including them would have been antidilutive:

The convertible preferred stock and preferred stock warrants in the previous table reflect the conversion of these instruments into their common stock equivalents as of the dates reported.

JOBS Act Accounting Election

The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We are choosing to take advantage of this provision and, as a result, we will adopt the extended transition period available under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided under the JOBS Act.

Recent Accounting Pronouncements

In November 2018, the FASB issued Accounting Standards Update (“ASU”) No. 2018-18, “Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606,” which provides guidance on whether certain transactions between collaborative arrangement participants should be accounted for with revenue under Topic 606. It provides more comparability in the presentation of revenue for certain transactions between collaborative arrangement participants. Before the issuance of Topic 606, stakeholders indicated that revenue from collaborative arrangements may have included: (1) revenue that was recognized in accordance with Topic 605, Revenue Recognition, (2) revenue that was recognized through analogy to the guidance in Topic 605 and (3) revenue that was recognized through the application of a policy election. The amendments improve comparability by allowing the presentation of the units of account in collaborative arrangements that are within the scope of Topic 606 together with revenue accounted for under Topic 606. ASU 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation — Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting,” which aligns the measurement and classification guidance for share-based payments to nonemployees with that for employees, with certain exceptions. It expands the scope of ASC 718 to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in the entity’s own operations and supersedes the guidance in ASC 505-50. The ASU retains the existing cost attribution guidance, which requires entities to recognize compensation cost for nonemployee awards in the same period and in the same manner (i.e., capitalize or expense) they would if they paid cash for the goods or services, but it moves the guidance to ASC 718. The guidance also allows nonpublic entities to account for nonemployee awards using certain practical expedients that are already available for employee awards, but the same accounting policies must be used for awards to both employees and nonemployees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.

In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part 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 (“ASU 2017-11”). ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity-classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round

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provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 can be applied using a full or modified retrospective approach. The Company is currently evaluating the impact of adopting this guidance.

In May 2017, the FASB issued ASU 2017-09, “Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting,” to provide clarity and reduce both diversity in practice and cost complexity when applying the guidance in Topic 718 to a change to the terms and conditions of a stock-based payment award. ASU 2017-09 also provides guidance about the types of changes to the terms or conditions of a share-based payment award that require an entity to apply modification accounting in accordance with Topic 718. For all entities, including emerging growth companies, the standard is effective for annual periods beginning after December 15, 2017, and for interim periods therein. The adoption of this standard did not have a material effect.

In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing.” This clarifies the principle for determining whether a good or service is “separately identifiable” from other promises in the contract and, therefore, should be accounted for as a separate performance obligation. In that regard, ASU 2016-10 requires that an entity determine whether its promise is to transfer individual goods or services to the customer, or a combined item (or items) to which the individual goods and services are inputs. In addition, ASU 2016-10 categorizes intellectual property, or IP, into two categories: “functional” and “symbolic.” Functional IP has significant standalone functionality. All other IP is considered symbolic IP. Revenue from licenses of functional IP is generally recognized at a point in time, while revenue from licenses of symbolic IP is recognized over time. The new standard is effective for the Company on January 1, 2019. The Company is currently evaluating the impact of adopting this guidance.

3. Fair Value Disclosure

The carrying value of the Company’s cash and cash equivalents, prepaid expenses and other current assets, other assets, accounts payable, accrued liabilities, and convertible notes payable approximate fair value due to the short-term nature of these items.

Fair value is defined as the exchange price that would be received for an asset or an exit price paid to transfer a liability 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.

The fair value hierarchy defines a three-level valuation hierarchy for disclosure of fair value measurements as follows:

The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

There were no fair value measurements as of September 30, 2018.

Financial assets or liabilities are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. The preferred stock warrants are measured using the Monte Carlo valuation model which is based, in part, upon inputs for which there is little or no observable market data, requiring the Company to develop its own assumptions. The assumptions used in calculating the estimated fair value of the warrants represent the Company’s best estimates; however, these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and different assumptions are used, the warrant liability and the change in estimated fair value of the warrants could be materially different.

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4. Balance Sheet Components

Property and Equipment, net

Property and equipment, net consist of the following as of September 30, 2018 and December 31, 2017 (in thousands):

Depreciation expense was approximately $73,000 and $12,000 for the three months ended September 30, 2018 and 2017, respectively. Depreciation expense was approximately $195,000 and $20,000 for the nine months ended September 30, 2018 and 2017, respectively.

Intangible Assets, net

Intangible assets, net consist of the following as of September 30, 2018 and December 31, 2017 (in thousands):

Amortization expense was approximately $1,000 and $1,000 for the three months ended September 30, 2018 and 2017, respectively. Amortization expense was approximately $4,000 and $4,000 for the nine months ended September 30, 2018 and 2017, respectively.

Accrued Liabilities

Accrued liabilities consist of the following at September 30, 2018 and December 31, 2017 (in thousands):

5. Equity Method Investment

On February 11, 2018, the Company entered into a joint venture agreement (the “JV Agreement”) with Shenzen Hepalink Pharmaceutical Group Co., Ltd., a related party, shareholder of the Company, and a Chinese entity (“Hepalink”), for developing and commercializing products for infectious diseases. Under the terms of the JV Agreement, the Company is obligated to contribute $1 million and the license of its technology relating to the Company’s AR-101 and AR-301 product candidates for use in the joint venture entity (the “JV Entity”) in the territories of the Republic of China, Hong Kong, Macau and Taiwan (the “Territory”) and initially owns 49% of the JV Entity. On July 2, 2018, the JV Entity received final approval from the government of the Peoples Republic of China.

On August 6, 2018, the Company entered into an amendment to the JV Agreement with Hepalink whereby the Company agreed to additionally contribute an exclusive, revocable, and royalty-free right and license to its AR-105 product candidate in the Territory. Pursuant to the JV Agreement and the amendment, Hepalink initially owns 51% of the JV Entity and is obligated to contribute the equivalent of $7.2 million to the JV Entity. Additionally, Hepalink is obligated to make an additional equity investment of $10,800,000 or more at the time of the JV Entity’s first future financing.

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The Company evaluated the accounting for the JV Agreement entered into noting that it did not meet the accounting definition of a joint venture and instead meets the definition of a variable interest entity. The Company concluded that it is not the primary beneficiary of the JV Entity and therefore is not required to consolidate the entity. This conclusion was based on the fact that the equity-at-risk is insufficient to support operations without additional investment and that the Company does not hold decision-making power over activities that significantly impact the JV Entity’s operations. The Company accounted for its investment in the JV Entity as an equity method investment. The Company recorded the equity method investment at $1 million which represents the Company’s contribution into the JV Entity which as of September 30, 2018, was not paid and is included in accrued liabilities. The Company’s license contributed to the JV Entity was recorded at its carryover basis of $0. For the nine months ended September 30, 2018 and 2017, the Company recognized $20,000 and $0 losses from the operations of the JV Entity, respectively. As of September 30, 2018 and December 31, 2017, the Company’s equity method investment in the JV Entity was $980,000 and $0, respectively.

6. Warrants

Common Stock Warrant Expense

In November 2015, an engagement letter was effectuated with the Company’s current Vice Chairman of the Board of Directors. Under the terms of the engagement, upon being appointed the Company’s Vice Chairman and the closing of a minimum of $25 million in gross proceeds from sales of its Series A convertible preferred stock under a private placement memorandum, the Vice Chairman would receive 234,860 common stock warrants. On December 12, 2016, both of the aforementioned conditions had been met and the Company issued 234,860 common stock warrants at an exercise price of $14.50 per share.

The fair value of the warrants was determined using a Monte Carlo simulation method which calculates the estimated value based on running numerous simulations and analyzing the various outcomes. The total fair value of award was approximately $661,000 and is being amortized over the five-year vesting period. For each of the three months ended September 30, 2018 and 2017, the Company recorded stock-based compensation expense of approximately $33,000 related to these warrants. For each of the nine months ended September 30, 2018 and 2017, the Company recorded stock-based compensation expense of approximately $99,000 related to these warrants.

Warrant Liability

The following table (in thousands) summarizes the Company’s activity and fair value calculations of its derivative warrants for nine months ended September 30, 2018:

7. Convertible Preferred Stock

In connection with the IPO, the holders of a majority of the Series A Preferred Stock approved the mandatory conversion of the Series A Preferred Stock into one share of common stock for every 6.417896 shares of Series A Preferred Stock which converted immediately prior to the consummation of the IPO. Upon conversion, a total of 5,744,586 shares of common stock were issued for the converted Series A Preferred Stock which includes accrued dividends upon conversion.  All warrants to purchase Series A Preferred Stock became warrants to purchase common stock, adjusted for the 1 for 6.417896 shares reverse stock split.

All holders of Series A convertible preferred stock as of June 30, 2016 began accruing a 3% stock dividend beginning on July 1, 2016. Subsequent acquirers began accruing on the date they acquired their respective shares. Accrued dividends were payable annually on December 31. Dividends stopped accruing on August 13, 2018 when all outstanding preferred stock converted into common shares. On August 13, 2018, the Company issued 669,489 dividend shares to its preferred stockholders with a fair value of approximately $1,357,000.

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During June 2017, 2,033,898 shares of our Series A convertible preferred stock sold at $2.95 per share which contain price based anti-dilution protection rights. Unless agreed to otherwise, if the Company issues additional securities at a purchase price less than the purchase price paid by these respective holders, the Company shall issue additional preferred shares equal to the difference of the number of preferred shares that each respective shareholder would have received if they paid the subsequent lower price, and the number of share each respective shareholder originally received. The Company reviewed the embedded anti-dilution protection feature included in the Series A convertible preferred stock sold during 2016 pursuant to ASC 480, Distinguishing Liabilities From Equity, and ASC 815, Derivatives and Hedging, and determined that the provisions of ASC 480 did not result in liability classification, the embedded anti-dilution protection feature did not meet the definition of a derivative as there was no market for the Series A convertible preferred stock to be converted into cash and that the embedded anti-dilution protection feature did not require bifurcation.

The liquidation preference provisions of the Series A convertible preferred stock were considered contingent redemption provisions because there are certain elements that are not solely within the control of the Company, such as a change in control of the Company. Accordingly, the Company presented the Series A convertible preferred stock within the mezzanine portion of the accompanying consolidated balance sheets at the full liquidation value.

On December 30, 2016, the Company completed a private placement memorandum and sold 2,439,024 shares of its Series A convertible preferred stock at a price of $2.05 per share though a private offering memorandum for total gross proceeds of $5.0 million and net proceeds of approximately $4.5 million. The net proceeds of $4.5 million was received in January 2017.

From June through August of 2017, the Company sold 6,516,135 shares of Series A convertible preferred stock to various investors at prices ranging from $2.70 to $2.95 per share for total gross proceeds of $18.3 million and net proceeds of $16.6 million after financing costs. On July 12 2017, in conjunction with the sale of its Series A convertible preferred stock to one of the investors, the Company issued 370,370 warrants to purchase its Series A convertible preferred stock. The warrant has a term of five years from the issuance date.

8. Common Stock

As of September 30, 2018, the Company had reserved the following common stock for future issuance:

As of December 31, 2017, the Company had reserved the following common stock for future issuance:

9. Stock-Based Compensation

In May 2014, the Company adopted and the shareholders approved the 2014 Equity Incentive Plan (the 2014 Plan). Under the 2014 Plan, 233,722 shares of the Company’s common stock have been reserved for the issuance of stock options to employees, directors, and consultants, under terms and provisions established by the Board of Directors. Under the terms of the 2014 Plan, options may be granted at an exercise price not less than fair market value. For employees holding more than 10% of the voting rights of all classes of stock, the exercise prices for incentive and nonstatutory stock options may not be less than 110% of fair market value, as determined by the Board of Directors. The terms of options granted under the 2014 Plan may not exceed ten years.

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In addition, the 2014 Plan contains an “evergreen” provision allowing for an annual increase in the number of shares of our common stock available for issuance under the 2014 Plan on the first day of each fiscal year beginning in fiscal year 2015. The annual increase in the number of shares shall be equal to the greater of:

·                  77,908 shares of our common stock; or

·                  such number of shares as is equal to the number of shares sufficient to cause the option pool to equal 20% of the issued and outstanding common stock of the Company, provided, however, that if on any calculation date the number of shares equal to 20% of the total issued and outstanding shares of common stock is less than the number of shares of common stock available for issuance under the 2014 Plan, no change will be made to the aggregate number of shares of common stock issuable under the 2014 Plan for that year (such that the aggregate number of shares of common stock available for issuance under the 2014 Plan will never decrease).

The number of shares, terms, and vesting periods are determined by the Company’s Board of Directors or a committee thereof on an option by option basis. Options generally vest ratably over service periods of up to four years and expire ten years from the date of grant.

The fair value of the employee options granted during the three and nine months ended September 30, 2018 and 2017 were estimated using the following assumptions:

Stock option activity for the nine months ended September 30, 2018 is represented in the following table:

The Company recognized stock compensation as follows (in thousands):

As of September 30, 2018, the Company had unrecognized stock-based compensation of approximately $3.0 million. As of September 30, 2018, the intrinsic value of all vested and outstanding options was approximately $1.6 and $1.8 million, respectively.

10. Commitments and Contingencies

Leases

The Company leases office and lab space in San Jose, California under an operating lease arrangement which can be terminated at any time with 90 days’ notice. The Company recognizes rent expense as incurred. For the three months ended September 30, 2018 and 2017, the Company incurred expenses of $78,000 and $75,000, respectively. For the nine months ended September 30, 2018 and 2017, the Company incurred expenses of $233,000 and $222,000, respectively.

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Indemnification

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may incur charges in the future as a result of these indemnification obligations.

Contingencies

From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

From time to time, the Company may be involved in various legal proceedings, claims and litigation arising in the ordinary course of business. As of September 30, 2018 and December 31, 2017, there were no pending legal proceedings.

Grant Income

The Company receives various grants that are subject to audit by the grantors or their representatives. Such audits could result in requests for reimbursement for expenditures disallowed under the terms of the grant; however, management believes that these disallowances, if any, would be immaterial.

Cystic Fibrosis Foundation Agreement

In December 2016, the Company received an award for up to $2,902,097 from the Cystic Fibrosis Foundation to advance research on potential drugs utilizing inhaled gallium citrate anti-infective. Under the award agreement, the Cystic Fibrosis Foundation will make payments to the Company as certain milestones are met. The award agreement also contains a provision whereby if the Company spends less on developing a potential drug utilizing inhaled gallium citrate anti-infective than the Company actually receives under this award agreement, the Company will be required to return the excess portion of the award to the Cystic Fibrosis Foundation. At the end of any reporting period, if the Company determines that the cumulative amount spent on this program is less than the cumulative cash received from the Cystic Fibrosis Foundation, the Company will record the excess amount received as a liability.

In the event that development efforts are successful and the Company commercialized a drug from these related development efforts, the Company may be subject to pay to Cystic Fibrosis Foundation a one-time amount equal to the awarded amount. Such amount shall be paid in as few as three but not more than five annual installments, as follows: within ninety days of the end of the calendar year in which the First Commercial Sale occurs, and within ninety days of the end of each subsequent calendar year until the amount is paid, Aridis shall pay up to one-third of the amount but not more than 5% of net sales from compounds containing gallium citrate or gallium nitrate citrate as an active ingredient for that calendar year (except that in the fifth installment, if any, the Company shall pay the remaining unpaid portion of the awarded amount).

In addition to the amount payable above, the Company will pay to Cystic Fibrosis Foundation a one-time amount equal to the amount of funding from Cystic Fibrosis Foundation under the agreement, within sixty days after the end of the first calendar year during which aggregate net sales of compounds containing gallium citrate or gallium nitrate citrate as an active ingredient exceed $100 million.

In the event that Aridis licenses rights to the product in the field to a third party, sells the product, or consummates a change of control transaction prior to the first commercial sale, Aridis shall pay to Cystic Fibrosis Foundation an amount equal to two times the actual awarded amount under the agreement, if the change of control transaction occurs prior to the completion of the first Phase IIb (or equivalent) clinical study with respect to the product; and four times the actual awarded amount if the change of control transaction occurs after the completion of the Phase IIb clinical trial specified above. The payment shall be made within sixty days after the closing of such a transaction.

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, or this Quarterly Report, 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 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. Our operations and business prospects are always subject to risks and uncertainties including, among others:

·            the timing of regulatory submissions;

·            our ability to obtain and maintain regulatory approval of our existing product candidates and any other product candidates we may develop, and the labeling under any approval we may obtain;

·            approvals for clinical trials may be delayed or withheld by regulatory agencies;

·            preclinical and clinical studies will not be successful or confirm earlier results or meet expectations or meet regulatory requirements or meet performance thresholds for commercial success;

·            risks relating to the timing and costs of clinical trials, the timing and costs of other expenses;

·            risks associated with obtaining funding from third parties;

·            management and employee operations and execution risks;

·            loss of key personnel;

·            competition;

·            risks related to market acceptance of products;

·            intellectual property risks;

·            assumptions regarding the size of the available market, benefits of our products, product pricing and timing of product launches;

·            risks associated with the uncertainty of future financial results;

·            our ability to attract collaborators and partners; and

·            risks associated with our reliance on third party organizations.

Any forward-looking statements in this Quarterly Report 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. 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 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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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 our financial statements and related notes appearing elsewhere in this Quarterly Report and our final prospectus for our initial public offering filed pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, or the Securities Act, with the Securities and Exchange Commission, or the SEC, on August 15, 2018. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, 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, 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.

All dollar amounts in this discussion and analysis are to the nearest thousand unless otherwise noted.

Overview

We are a late-stage biopharmaceutical company focused on the discovery and development of targeted immunotherapy using fully human monoclonal antibodies, or mAbs, to treat life-threatening infections. mAbs represent an innovative treatment approach that harnesses the human immune system to fight infections and are designed to overcome the deficiencies associated with current therapies, such as rise in drug resistance, short duration of response, negative impact on the human microbiome, and lack of differentiation among the treatment alternatives. The majority of our product candidates are derived by employing our differentiated antibody discovery platform called MabIgX. Our proprietary product pipeline is comprised of fully human mAbs targeting specific pathogens associated with life-threatening bacterial infections, primarily hospital-acquired pneumonia, or HAP, and ventilator-associated pneumonia, or VAP. Two of our product candidates have exhibited promising preclinical data and clinical data are available from two completed studies. Our lead product candidate, AR-301, also referred to as Salvecin, targets the alpha toxin produced by gram-positive bacteria Staphylococcus aureus, or S. aureus, a common pathogen associated with HAP and VAP. We have conducted an end-of-Phase 2 meeting with the US Food and Drug Administration, or FDA, and expect to initiate a Phase 3 pivotal trial for AR-301 in the second half of 2018.

To date, we have devoted substantially all of our resources to research and development efforts relating to our therapeutic candidates, including conducting clinical trials and developing manufacturing capabilities, in-licensing related intellectual property, protecting our intellectual property and providing general and administrative support for these operations. We have generated revenue from our payments under our collaboration strategic research and development contracts and federal awards and grants, as well as awards and grants from not-for-profit entities and fee for service to third party entities. Since our inception, we have funded our operations primarily through these sources and the issuance of convertible preferred stock and debt securities.

We have incurred losses in most years since our inception. Our net losses were approximately $24.7 million for the year ended December 31, 2017 and $7.9 million and $16.7 million for the three and nine months ended September 30, 2018, respectively. As of September 30, 2018, we had an accumulated deficit of approximately $65.6 million. As of September 30, 2018, we had $34.1 million of cash and cash equivalents, respectively. Substantially all our net losses have resulted from costs incurred in connection with our research and development programs, clinical trials, intellectual property matters, building our manufacturing capabilities, and from general and administrative costs associated with our operations.

On August 13, 2018, we completed an initial public offering of our common stock, in which we sold and issued 2,000,000 shares, plus 192,824 shares sold pursuant to the partial exercise by the underwriters of their over-allotment option, at an issuance price of $13.00 per share, less underwriting discounts and commissions. As a result of the IPO and the exercise of the underwriters’ over-allotment option, we received total net proceeds of approximately $25.1 million, net of underwriting and other offering expenses. We believe that our existing cash and cash equivalents will provide sufficient funds to enable us to meet our obligations for at least the next 12 months.

We have not yet achieved commercialization of our products and have a cumulative net loss from our operations. We will continue to incur net losses for the foreseeable future. Our consolidated financial statements have been prepared assuming that we will continue as a going concern. We will require additional capital to meet our long-term operating requirements. We expect to raise additional capital through the sale of equity and/or debt securities. Historically, our principal sources of cash have included proceeds from grant funding, fees for services performed, issuances of convertible debt and the sale of our preferred stock. Our principal uses of cash have included cash used in operations, specifically related to research and development. We expect that the principal uses of cash in the future will be for continuing operations, funding of research and development including our clinical trials and general working capital requirements.

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We anticipate that our expenses will increase substantially if and as we:

·            continue enrollment in our ongoing clinical trials;

·            initiate new clinical trials;

·            seek to identify, assess, acquire and develop other products, therapeutic candidates and technologies;

·            seek regulatory and marketing approvals in multiple jurisdictions for our therapeutic candidates that successfully complete clinical studies;

·            establish collaborations with third parties for the development and commercialization of our products and therapeutic candidates;

·            make milestone or other payments under our agreements pursuant to which we have licensed or acquired rights to intellectual property and technology;

·            seek to maintain, protect, and expand our intellectual property portfolio;

·            seek to attract and retain skilled personnel;

·            incur the administrative costs associated with being a public company and related costs of compliance;

·            create additional infrastructure to support our operations as a commercial stage public company and our planned future commercialization efforts; and

·            experience any delays or encounter issues with any of the above.

We expect to continue to incur significant expenses and increasing losses for at least the next several years. Accordingly, we anticipate that we will need to raise additional capital in order to obtain regulatory approval for, and the commercialization of our therapeutic candidates. Until such time that we can generate meaningful revenue from product sales, if ever, we expect to finance our operating activities through public or private equity or debt financings, government or other third-party funding and other collaborations, strategic alliances and licensing arrangements or a combination of these approaches. If we are unable to obtain funding on a timely basis, we may be required to significantly curtail, delay or discontinue one or more of our research or development programs or the commercialization of any approved therapies or products or be unable to expand our operations or otherwise capitalize on our business opportunities, as desired, which could materially adversely affect our business, financial condition and results of operations.

Financial Overview

Reverse Stock Split

On August 3, 2018, we effected a 1 for 6.417896 reverse stock split of our common stock. The par value and the number of authorized shares of the common and convertible preferred stock were not adjusted as a result of the reverse stock split. All common stock share and per-share amounts for all periods presented in this Quarterly Report on Form 10-Q have been adjusted retroactively to reflect the reverse stock split.

Initial Public Offering

On August 13, 2018, our registration statement on Form S-1 relating to our initial public offering of our common shares (the “IPO”) was declared effective by the Securities and Exchange Commission (“SEC”). The IPO closed on August 16, 2018 and we issued and sold 2,000,000 common shares at a public offering price of $13.00 per share. Gross proceeds totaled $26.0 million and net proceeds totaled $22.8 million after deducting underwriting discounts and commissions of $1.8 million and other offering expenses of approximately $1.4 million. The underwriters of the IPO partially exercised their over-allotment option, and on August 30, 2018 we issued and sold 192,824 common shares at a public offering price of $13.00 per share for gross proceeds totaling approximately $2.5 million and net proceeds of approximately $2.3 million after deducting underwriting discounts and commissions of approximately $0.2 million.

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In connection with the IPO, the holders of a majority of the Series A Preferred Stock approved the mandatory conversion of the Series A Preferred Stock into one share of common stock for every 6.417896 shares of Series A Preferred Stock which converted immediately prior to the consummation of the IPO. Upon conversion, a total of 5,744,586 shares of common stock were issued for the converted Series A Preferred Stock which includes the accrued dividends upon conversion.  All warrants to purchase Series A Preferred Stock became warrants to purchase common stock, adjusted for the 1 for 6.417896 shares reverse stock split.

Revenue

Our sources of revenue are grants and contract services provided to third party entities related to research and development activities under specific agreements with such granting authorities and third parties. As there is a contractually agreed upon price, and collectability from the granting authorities or other entities is reasonably assured, revenue for these services are earned according to the terms of the respective agreements, usually as progress is made throughout the term of the agreement or as certain material milestones are met.

In addition, we have an award agreement with the Cystic Fibrosis Foundation to support funding for the development of our Inhaled Gallium Citrate Anti-Infective program. Also, we have a collaborative and option agreement with GlaxoSmithKline Biologicals S.A., or GSK, aimed at evaluating improved formulations for a rotavirus vaccine. These agreements contain upfront payments. We recognize revenue from upfront payments ratably over the term of our estimated period of performance under the agreements or as certain milestones are met. In addition to receiving upfront payments, we may also be entitled to milestone and other contingent payments upon achieving predefined objectives or the exercise of options for specified programs by our strategic partners. Such payments are recorded as revenue when we achieve the underlying milestone if there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved. For each of the three months ended September 30, 2018 and 2017, we recognized approximately $1,022,000 and $22,000 in revenue pursuant to our Cystic Fibrosis Foundation agreement and no revenue pursuant to our GSK agreement.  For the nine months ended September 30, 2018 and 2017, we recognized approximately $1,367,000 and $67,000, respectively, in revenue pursuant to our Cystic Fibrosis Foundation agreement and no revenue pursuant to our GSK agreement.

We expect that any revenue we generate for the foreseeable future will fluctuate from period to period as a result of the timing and amount of milestones and other payments from our agreements.

Research and Development Expenses

We recognize research and development expenses as they are incurred. Our research and development expenses consist primarily of:

·            salaries and related overhead expenses, which include stock-based compensation and benefits for personnel in research and development functions;

·            fees paid to consultants and contract research organizations, or CROs, including in connection with our preclinical studies and clinical trials and other related clinical trial fees, such as for investigator grants, patient screening, laboratory work, clinical trial material management and statistical compilation and analyses;

·            costs related to acquiring and manufacturing clinical trial materials;

·            costs related to compliance with regulatory requirements; and

·            payments related to licensed products and technologies.

We expense all research and development costs in the periods in which they are incurred. Costs for certain development activities are recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors and clinical sites. Nonrefundable advance payments for goods or services to be received in future periods for use in research and development activities are deferred and capitalized. The capitalized amounts are then expensed as the related goods are delivered and the services are performed.

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From our inception through September 30, 2018, we have incurred approximately $64.1 million in research and development expenses.

We plan to increase our research and development expenses for the foreseeable future as we continue to develop our therapeutic programs, and subject to the availability of additional funding, further advance the development of our therapeutic candidates for additional indications and begin to conduct clinical trials. We typically use our employee and infrastructure resources across multiple research and development programs, and accordingly we have not historically allocated resources specifically to our individual clinical programs.

The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, and the successful development of our therapeutic candidates is highly uncertain. As a result, we are unable to determine the duration and completion costs of our research and development projects or when and to what extent we will generate revenue from the commercialization and sale of any of our therapeutic candidates.

General and Administrative Expenses

General and administrative expenses consist primarily of costs related to executive, finance, corporate development and administrative support functions, including stock-based compensation expenses and benefits for personnel in general and administrative functions. Other significant, general and administrative expenses include rent, accounting and legal services, obtaining and maintaining patents or other intellectual property rights, the cost of various consultants, occupancy costs, insurance premiums and information systems costs.

We expect that our general and administrative expenses will increase as we operate as a public company, continue to conduct our clinical trials and prepare for commercialization. We believe that these increases will likely include increased costs for director and officer liability insurance, costs related to the hiring of additional personnel to support product commercialization efforts and increased fees for outside consultants, attorneys and accountants. We also expect to incur increased costs to comply with corporate governance, internal controls, investor relations and disclosures, and similar requirements applicable to public companies.

Interest and Other Income (Expense), Net

Interest and other income (expense), net consists primarily of interest on our cash balances.

Critical Accounting Policies and Estimates

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

We define our critical accounting policies as those accounting principles generally accepted in the United States that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations as well as the specific manner in which we apply those principles. We believe the critical accounting policies used in the preparation of our financial statements that require significant estimates and judgments are as follows:

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Use of Estimates

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of expenses during the reporting period. Such estimates include those related to the evaluation of our ability to continue as a going concern, revenue recognition, long lived assets, income taxes, assumptions used in the Black Scholes Merton (“BSM”) model to calculate the fair value of stock based compensation, Monte Carlo Simulation (“MSM”) model to calculate the fair value of warrants, deferred tax asset valuation allowances, valuation of the Company’s common and convertible preferred stock, fair value assumptions used in the valuation of warrants, preclinical study and clinical trial accruals and various accrued liabilities. Actual results could differ from those estimates.

Revenue Recognition

Revenue is recognized in accordance with the Financial Accounting Standards Board, or FASB Accounting Standards Codification, or ASC 605, Revenue Recognition which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.

During the three and nine months ended September 30, 2018 and 2017, all grant revenue was derived from our award agreement with the Cystic Fibrosis Foundation.

In December 2016, we received an award from the Cystic Fibrosis Foundation for approximately $2,902,000. The agreement contains an upfront payment of $200,000 which is being recognized straight-line over the term of the contract as we believe the upfront fee relates to services performed throughout the contract period and the upfront fee does not represent a substantive milestone within the agreement. Recognition of revenue for the remaining payments under the agreement will be recognized using the milestone method as substantive milestones are met since there is uncertainty as to whether the milestones will be met and our performance will be responsible for achieving the respective milestones. The milestones relate to both preclinical development and regulatory related activities. The agreement also specifies that we are obligated to cumulatively spend on the development program at least an equal amount as it received from the non-profit organization. In the event that we do not spend as much as we received under the agreement, we are obligated to return any overage to the Cystic Fibrosis Foundation.

In 2017, we entered into a collaborative research and development agreement with GSK. In accordance with the agreement, we received an upfront fee and annual fees and amounts for development work to be performed as specifically outlined under the agreement. The work to be performed was delineated into three specific research projects. In assessing the appropriate revenue recognition related to a collaboration agreement, we first determined whether the arrangement includes multiple elements, such as the delivery of intellectual property rights and research and development services. The multiple elements were analyzed to determine whether the deliverables could be separated or whether they must be accounted for as a single unit of accounting. We determined that none of the elements had stand-alone value and that the agreement qualifies for treatment as a multiple element arrangement to be accounted for as a single unit of accounting. Amounts received prior to satisfying the revenue recognition criteria are recorded as deferred revenue in our balance sheet. Recognition of revenue under the contract will be based on the terms of the contract and will be recognized under the proportional performance method derived from the completion of certain stages as defined within the contract.

For the three and nine months ended September 30, 2018 and 2017, no collaboration revenue was recorded under our agreement with GSK.

Research and Development

Research and development costs are charged to operations as incurred.

Stock-Based Compensation

We recognize compensation expense for all stock-based awards to employees and directors based on the grant-date estimated fair values, net of an estimated forfeiture rate. We recognize stock-based compensation cost for employees and directors on a straight-line basis over the requisite service period for the award. Stock-based compensation expense is recognized only for those awards that are ultimately expected to vest. We estimate forfeitures based on an analysis of historical employee turnover and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. We will revise the forfeiture estimate, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Changes in forfeiture estimates impact stock-based compensation cost in the period in which the change in estimate occurs.

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The BSM option pricing model incorporates various highly sensitive assumptions, including the fair value of our common stock, expected volatility, expected term and risk-free interest rates. The weighted average expected life of options was calculated using the simplified method as prescribed by the SEC’s Staff Accounting Bulletin No. 107, or SAB No. 107. This decision was based on the lack of relevant historical data due to our limited historical experience. In addition, due to our limited historical data, the estimated volatility also reflects the application of SAB No. 107, incorporating the historical volatility of comparable companies whose stock prices are publicly available. The risk-free interest rate for the periods within the expected term of the option is based on the U.S. Treasury yield in effect at the time of grant. The dividend yield was zero, as we have never declared or paid dividends and have no plans to do so in the foreseeable future.

We account for stock-based compensation arrangements with nonemployees by recording the expense of such services based on the estimated fair value of the common stock at the measurement date. The value of the equity instrument, including adjustment to fair value at each balance sheet date, is charged to earnings over the term of the service agreement.

Due to the absence of a public market trading for our common stock prior to going public in August of 2018, it was necessary to estimate the fair value of the common stock underlying our stock-based awards when performing fair value calculations. The estimated fair value of our common stock was determined using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants, or AICPA, Practice Aid: Valuation of Privately-Held-Company Equity Securities Issued as Compensation.

We expect to utilize fair market values as determined by trades in the public markets at such time as our shares trade publicly and an observable market exists.

Fair Value of Common Stock

Prior to our public initial offering in August of 2018, to assist our board of directors with the determination of the exercise price of our stock options and the fair value of the common stock underlying the options, we obtained third-party valuations of our common stock as of various dates since we began granting options, with concluded fair values between $2.89 per share and $17.91 per share. Our board of directors considered the fair values of the common stock derived in the third-party valuations as one of the factors it considered when setting the exercise prices for options granted. The valuations were performed in accordance with applicable elements of the AICPA Practice Aid. The AICPA Practice Aid identifies various available methods for allocating enterprise value across classes and series of capital stock to determine the estimated fair value of common stock at each valuation date. In accordance with the AICPA Practice Aid, we considered the following methods:

·                  Option Pricing Method.  Under the option pricing method, or OPM, shares are valued by creating a series of call options with exercise prices based on the liquidation preferences and conversion terms of each equity class. The estimated fair values of the preferred and common stock are inferred by analyzing these options.

·                  Probability-Weighted Expected Return Method.  Under the probability-weighted expected return method, or PWERM, common equity value is based upon an analysis of various future outcomes, such as an initial public offering, or IPO, merger or sale, dissolution, or continued operation as a private enterprise until a later exit date. The future allocated value is based upon the probability-weighted present values of expected future investment returns, considering each of the possible outcomes available to the enterprise, as well as the rights of each security class.

Our board of directors also considered a range of objective and subjective factors and assumptions in estimating the fair value of our common stock on the date of grant, including: progress of our research and development efforts; our operating results and financial condition, including our levels of available capital resources; rights and preferences of our common stock compared to the rights and preferences of our other outstanding equity securities; our stage of development and material risks related to our business; our commercial success in regard to our catheter sales; the achievement of enterprise milestones; the valuation of publicly-traded companies in the life sciences and biotechnology sectors, as well as recently completed mergers and acquisitions of peer companies; equity market conditions affecting comparable public companies; the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering given prevailing market and biotechnology sector conditions; and that the grants involved illiquid securities in a private company. The fair value of our common stock as of December 31, 2017 and September 30, 2017 was $17.20 and $16.98, respectively.

Income Taxes

We account for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

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We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by the relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the positions sustainability and is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. At each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

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 (in thousands):

Grant Revenue.    Grant revenue increased by $1,000,000 from $22,000 for the three months ended September 30, 2017 to $1,022,000 for the three months ended September 30, 2018 due to recognizing certain milestones related to the grant award from the Cystic Fibrosis Foundation.

Research and Development Expenses.    Research and development expenses increased by approximately $2,048,000 from $4,859,000 for the three months ended September 30, 2017 to $6,907,000 for the three months ended September 30, 2018 due primarily to increasing enrollment for our AR-105 Phase 2 clinical trial and servicing the Cystic Fibrosis Foundation grant partially offset by a decrease in expenses for our AR-301 program.

General and Administrative Expenses.    General and administrative expenses increased by approximately $86,000 from $649,000 for the three months ended September 30, 2017 to $735,000 for the three months ended September 30, 2018 due primarily to an increase in directors and liabilities insurance costs and stock compensation expenses.

Interest and Other Income (Expense), net.    Interest and other income (expense), net increased by approximately $55,000 from $64,000 for the three months ended September 30, 2017 to $119,000 for the three months ended September 30, 2018 due primarily to a higher rate of return on our cash balance partially offset by a lower average cash balance.

Change in Fair Value of Warrant Liability.    Change in fair value of warrant liability decreased by approximately $1,392,000 from a gain of $4,000 for the three months ended September 30, 2017 to a loss of $1,388,000 for the three months ended September 30, 2018 due primarily to an increase in the fair value of our Series A convertible preferred stock during the third quarter of 2018.

Loss From Equity Method Investment.    Loss from equity method investment increased by $20,000 from $0 for the three months ended September 30, 2017 to a loss of $20,000 for the three months ended September 30, 2018 due to our share of loss from our minority interest calculated under the equity method during the third quarter of 2018. We had no equity method investment during 2017.

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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 (in thousands):

Grant Revenue.    Grant revenue increased by $1,300,000 from $67,000 for the nine months ended September 30, 2017 to $1,367,000 for the nine months ended September 30, 2018 due primarily to recognizing certain milestones related to the grant award from the Cystic Fibrosis Foundation.

Research and Development Expenses.    Research and development expenses increased by approximately $4,582,000 from $12,836,000 for the nine months ended September 30, 2017 to $17,418,000 for the nine months ended September 30, 2018 due primarily to increasing enrollment for our AR-105 Phase 2 clinical trial and servicing the Cystic Fibrosis Foundation grant partially offset by a decrease in expenses for our AR-301 program.

General and Administrative Expenses.    General and administrative expenses decreased by approximately $27,000 from $2,516,000 for the nine months ended September 30, 2017 to $2,489,000 for the nine months ended September 30, 2018 due primarily to a decrease in stock-based compensation expenses.

Interest and Other Income (Expense), net.    Interest and other income (expense), net increased by approximately $100,000 from $162,000 for the nine months ended September 30, 2017 to $262,000 for the nine months ended September 30, 2018 due primarily to a higher rate of return on our cash balance partially offset by a lower average cash balance.

Change in Fair Value of Warrant Liability.    Change in fair value of warrant liability increased by approximately $6,221,000 from a loss of $4,589,000 for the nine months ended September 30, 2017 to a gain of $1,632,000 for the nine months ended September 30, 2018 due primarily to a decline in the fair value of the Company’s Series A convertible preferred stock during the first half of 2018 partially offset by a gain in the fair value of our Series A convertible preferred stock during the third quarter of 2018.

Loss From Equity Method Investment.    Loss from equity method investment increased by $20,000 from $0 for the nine months ended September 30, 2017 to a loss of $20,000 for the nine months ended September 30, 2018 due to our share of loss from our minority interest calculated under the equity method during the third quarter of 2018. We had no equity method investment during 2017.

Liquidity and Capital Resources

We anticipate that we will continue to generate operating losses and use cash in operations through the foreseeable future. Our IPO closed on August 16, 2018 and we issued and sold 2,000,000 common shares at a public offering price of $13.00 per share. Gross proceeds totaled $26.0 million and net proceeds totaled $22.8 million after deducting underwriting discounts and commissions of $1.8 million and other offering expenses of approximately $1.4 million. The underwriters of the IPO partially exercised their over-allotment option, and on August 30, 2018, we issued and sold 192,824 common shares at a public offering price of $13.00 per share for gross proceeds totaling approximately $2.5 million and net proceeds of approximately $2.3 million after deducting underwriting discounts and commissions of approximately $0.2 million.

Management expects to continue to incur additional substantial losses in the foreseeable future as a result of our research and development activities. Management plans to finance operations through equity or debt financings or other capital sources, including potential collaborations or other strategic transactions. There can be no assurances that, in the event that we require additional financing, such financing will be available on terms which are favorable to us, or at all. If we are unable to raise additional funding to

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meet our working capital needs in the future, we will be forced to delay or reduce the scope of our research programs and/or limit or cease our operations.

We believe that our existing cash and cash equivalents will provide sufficient funds to enable us to meet our obligations for at least the next 12 months.

Cash Flows

Our net cash flow from operating, investing and financing activities for the periods below were as follows (in thousands):

Cash Flows from Operating Activities.    Net cash used in operating activities was approximately $15,422,000 for the nine months ended September 30, 2018, which was primarily due to our net loss of approximately $16,666,000. The difference between our net loss and our net cash used in operating activities was due primarily to an increase in our accounts payable and accrued liabilities, a decrease in our other assets partially offset by an increase in accounts receivable and a decrease in deferred revenue, and non-cash expenses resulting from a gain in the fair value of preferred stock warrants and stock-based compensation expense. Net cash used in operating activities was approximately $13,394,000 for the nine months ended September 30, 2017, which was primarily due to our net loss of approximately $19,712,000.  The difference between our net loss and our net cash used in operating activities was due primarily to non-cash expenses and an increase in deferred revenue partially offset by an increase in prepaid expenses and other assets.

Cash Flows from Investing Activities.    Net cash used in investing activities of $677,000 during the nine months ended September 30, 2018 was due to the purchase of equipment, primarily for diagnostic use in our clinical trials. Net cash used in investing activities of $410,000 during the nine months ended September 30, 2017 was due to the purchase of equipment, primarily for diagnostic use in our clinical trials.

Cash Flows from Financing Activities.    Net cash provided by financing activities of $25,080,000 during the nine months ended September 30, 2018 was due to net proceeds received from our initial public offering (including over-allotment proceeds). Net cash provided by financing activities of $21,060,000 during the nine months ended September 30, 2017 was due to proceeds from a sale of our Series A convertible preferred stock, net of issuance costs, and the receipt of cash from a stock subscription agreement entered into during the previous year.

Future Funding Requirements

To date, we have generated revenue from grants and contract services performed and the issuance of convertible preferred stock. We do not know when, or if, we will generate any revenue from our development stage therapeutic programs. We do not expect to generate any revenue from sales of our therapeutic candidates unless and until we obtain regulatory approval. At the same time, we expect our expenses to increase in connection with our ongoing development activities, particularly as we continue the research, development and clinical trials of, and seek regulatory approval for, our therapeutic candidates. We expect to incur additional costs associated with operating as a public company. In addition, subject to obtaining regulatory approval of any of our therapeutic candidates, we expect to incur significant commercialization expenses for product sales, marketing, manufacturing and distribution. We anticipate that we will need additional funding in connection with our continuing operations. Additionally, if the Cystic Fibrosis Foundation does not continue to provide sufficient level of funding support, we may not be able to complete the Phase 1/2a clinical trial relating to AR-501.

Our future capital requirements will depend on many factors, including:

·            the progress, costs, results and timing of our clinical trials;

·            FDA acceptance, if any, of our therapies for infectious diseases and for other potential indications;

·            the outcome, costs and timing of seeking and obtaining FDA and any other regulatory approvals;

·            the number and characteristics of product candidates that we pursue, including our product candidates in preclinical development;

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·            the ability of our product candidates to progress through clinical development successfully;

·            our need to expand our research and development activities;

·            the costs of acquiring, licensing or investing in businesses, products, product candidates and technologies;

·            our ability to maintain, expand and defend the scope of our intellectual property portfolio, including the amount and timing of any payments we may be required to make, or that we may receive, in connection with the licensing, filing, prosecution, defense and enforcement of any patents or other intellectual property rights;

·            our need and ability to hire additional management and scientific, medical and administrative personnel;

·            the effect of competing technological and market developments; and

·            our need to implement additional internal systems and infrastructure, including financial and reporting systems.

Until such time that we can generate meaningful revenue from the sales of approved therapies and products, if ever, we expect to finance our operating activities through public or private equity or debt financings, government or other third-party funding, and other collaborations, strategic alliances and licensing arrangements or a combination of these approaches. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interests of our common stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing, if available, may involve agreements that include conversion discounts or covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through government or other third-party funding, marketing and distribution arrangements or other collaborations, or strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us.

Off-Balance Sheet Arrangements

During the periods presented we did not have, nor do we currently have, any off-balance sheet arrangements as defined under the rules of the SEC.

JOBS Act Accounting Election

The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We are choosing to take advantage of this provision and, as a result, we will adopt the extended transition period available under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided under the JOBS Act.

Recent Accounting Pronouncements

In November 2018, the FASB issued ASU No. 2018-18, “Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606,” which provides guidance on whether certain transactions between collaborative arrangement participants should be accounted for with revenue under Topic 606. It provides more comparability in the presentation of revenue for certain transactions between collaborative arrangement participants. Before the issuance of Topic 606, stakeholders indicated that revenue from collaborative arrangements may have included: (1) revenue that was recognized in accordance with Topic 605, Revenue Recognition, (2) revenue that was recognized through analogy to the guidance in Topic 605 and (3) revenue that was recognized through the application of a policy election. The amendments improve comparability by allowing the presentation of the units of account in collaborative arrangements that are within the scope of Topic 606 together with revenue accounted for under Topic 606. ASU 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of adopting this guidance.

In June 2018, the FASB issued ASU No. 2018 07, “Compensation — Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting,” which aligns the measurement and classification guidance for share-based payments to nonemployees with that for employees, with certain exceptions. It expands the scope of Accounting Standards Codification (“ASC”) 718 to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in the entity’s own operations and supersedes the guidance in ASC 505-50. The ASU retains the existing cost attribution guidance, which requires entities to recognize compensation cost for nonemployee awards in the same period and in the same manner (i.e., capitalize or expense) they would if they paid cash for the goods or services, but it moves the guidance to ASC 718. The

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guidance also allows nonpublic entities to account for nonemployee awards using certain practical expedients that are already available for employee awards, but the same accounting policies must be used for awards to both employees and nonemployees. ASU 2018 07 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of adopting this guidance.

In July 2017, FASB issued ASU No. 2017 11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part 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 (“ASU 2017 11”). ASU 2017 11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value of a down round feature only when it is triggered and the strike price has been adjusted downward. For equity classified freestanding financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be amortized to earnings. ASU 2017 11 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017 11 can be applied using a full or modified retrospective approach. We are currently evaluating the impact of adopting this guidance.

In May 2017, the FASB issued ASU 2017 09, “Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting,” to provide clarity and reduce both diversity in practice and cost complexity when applying the guidance in Topic 718 to a change to the terms and conditions of a stock based payment award. ASU 2017 09 also provides guidance about the types of changes to the terms or conditions of a share based payment award that require an entity to apply modification accounting in accordance with Topic 718. For all entities, including emerging growth companies, the standard is effective for annual periods beginning after December 15, 2017, and for interim periods therein. Early adoption is permitted. The adoption of this standard did not have a material effect.

In April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing.” This clarifies the principle for determining whether a good or service is “separately identifiable” from other promises in the contract and, therefore, should be accounted for as a separate performance obligation. In that regard, ASU 2016-10 requires that an entity determine whether its promise is to transfer individual goods or services to the customer, or a combined item (or items) to which the individual goods and services are inputs. In addition, ASU 2016-10 categorizes intellectual property, or IP, into two categories: “functional” and “symbolic.” Functional IP has significant standalone functionality. All other IP is considered symbolic IP. Revenue from licenses of functional IP is generally recognized at a point in time, while revenue from licenses of symbolic IP is recognized over time. In April 2016, the FASB issued ASU No. 2016 10, “Revenue from Contract with Customers: Identifying Performance Obligations and Licensing.” The amendments in this Update clarify the two following aspects (a) contracts with customers to transfer goods and services in exchange for consideration and (b) 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). The new standard is effective for the Company as of January 1, 2019. We are currently evaluating the impact of adopting this guidance.

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Item 3. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In connection with the audit of our financial statements for the years ended December 31, 2017, our management concluded that we had a material weakness in our internal controls resulting from one individual having almost complete responsibility for the processing of financial information and from our finance department not having adequate staff to process in a timely manner complex, non-routine transactions. While we have designed and implemented, or expect to implement, measures that we believe address or will address these control weaknesses, we continue to develop our internal controls, processes and reporting systems by, among other things, hiring qualified personnel with expertise to perform specific functions, implementing software systems to manage our revenue and expenses and to allow us to budget, undertaking multi-year financial planning and analyses and designing and implementing improved processes and internal controls, including ongoing senior management review and audit committee oversight. We plan to remediate the identified material weakness by hiring financial consultants and we expect to hire additional senior accounting staff to complete the remediation by the end of 2018. We expect to incur additional costs to remediate these weaknesses, primarily personnel costs and external consulting fees. We may not be successful in implementing these systems or in developing other internal controls, which may undermine our ability to provide accurate, timely and reliable reports on our financial and operating results. Further, we will not be able to fully assess whether the steps we are taking will remediate the material weaknesses in our internal control over financial reporting until we have completed our implementation efforts and sufficient time passes in order to evaluate their effectiveness. In addition, if we identify additional material weaknesses in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. Moreover, in the future we may engage in business transactions, such as acquisitions, reorganizations or implementation of new information systems that could negatively affect our internal control over financial reporting and result in material weaknesses.

Changes in Internal Control over Financial Reporting

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting other than that describes above.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be subject to litigation and claims arising in the ordinary course of business. We are not currently a party to any material legal proceedings and we are not aware of any pending or threatened legal proceeding against us that we believe could have a material adverse effect on our business, operating results, cash flows or financial condition.

Item 1A. Risk Factors

You should carefully consider the risks described below, as well as general economic and business risks and the other information in this Quarterly Report on Form 10-Q. The occurrence of any of the events or circumstances described below or other adverse events could have a material adverse effect on our business, results of operations and financial condition and could cause the trading price of our common stock to decline. Additional risks or uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

Risks Relating to Our Financial Position and Need for Additional Capital

We expect to continue to incur increasing net losses for the foreseeable future, and we may never achieve or maintain profitability.

We are a clinical-stage biopharmaceutical company with a limited operating history. Investment in biopharmaceutical product development is highly speculative because it entails substantial upfront capital expenditures and significant risk that any potential product candidate will fail to demonstrate adequate effect or an acceptable safety profile, gain regulatory approval and become commercially viable. We have no products approved for commercial sale and have not generated any revenue from product sales to date, and we continue to incur significant research and development and other expenses related to our ongoing operations. As a result, we are not profitable and have incurred losses in each period since our inception. For the year ended December 31, 2017, we reported a net loss of approximately $24.7 million. For the three and nine months ended September 30, 2018, we reported a net loss of approximately $7.9 million and $16.7 million, respectively. As of September 30, 2018, we had an accumulated deficit of $65.6 million.

To become and remain profitable, we or our partners must succeed in developing our product candidates, obtaining regulatory approval for them, and manufacturing, marketing and selling those products for which we or our partners may obtain regulatory approval. We or they may not succeed in these activities, and we may never generate revenue from product sales that is significant enough to achieve profitability. Because of the numerous risks and uncertainties associated with biopharmaceutical product development and commercialization, we are unable to accurately predict the timing or amount of future expenses or when, or if, we will be able to achieve or maintain profitability. Currently, we have no products approved for commercial sale, and to date we have not generated any product revenue. We have financed our operations primarily through the sale of equity securities, upfront payments pursuant to collaboration agreements, government grants and capital lease and equipment financing. The size of our future net losses will depend, in part, on the rate of growth or contraction of our expenses and the level and rate of growth, if any, of our revenues. Our ability to achieve profitability is dependent on our ability, alone or with others, to complete the development of our products successfully, obtain the required regulatory approvals, manufacture and market our proposed products successfully or have such products manufactured and marketed by others, and gain market acceptance for such products. There can be no assurance as to whether or when we will achieve profitability.

Available cash resources may be insufficient to provide for our working capital needs beyond the next twelve months.

The accompanying consolidated interim financial statements have been prepared on a going concern basis that contemplates the realization of assets and discharge of liabilities in their normal course of business. We have suffered recurring losses from operations since inception and negative cash flows from operating activities during the three and nine months ended September 30, 2018 and year ended December 31, 2017. As of September 30, 2018, we had $34.1 million of cash and cash equivalents. In August 2018, we effected an initial public offering in which we sold 2,000,000 shares of our common stock at $13.00 per share, which generated net cash proceeds of $22.8 million and sold 192,824 over-allotment shares which generated net cash proceeds of $2.3 million.

We believe our existing cash and cash equivalents will be sufficient to fund our projected operating requirements, including operations related to the continued development and potential commercialization of our products, for at least the next 12 months. However, it is possible that we will not achieve the progress that we expect, because the actual costs and timing of drug development, particularly clinical studies, and regulatory approvals are difficult to predict, subject to substantial risks and delays, and often vary depending on the particular indication and development strategy.

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We expect to continue significant spending in connection with the development and commercialization of our product candidates. In order to continue these activities, we may decide to raise additional funds through a combination of public or private equity offerings, debt financings, royalty financings, collaborations, strategic alliances, licensing arrangements, asset sales, and other marketing and distribution arrangements. Sufficient additional funding may not be available on acceptable terms, or at all. If adequate funds are not available in the future, we may need to delay, reduce the scope of, or put on hold our clinical studies, research and development programs, or commercialization efforts.

We will require substantial additional capital in the future. If additional capital is not available, we will have to delay, reduce or cease operations.

Developing pharmaceutical products, including conducting preclinical studies and clinical trials, is expensive. Development of our product candidates will require substantial additional funds to conduct research, development and clinical trials necessary to bring such product candidates to market and to establish manufacturing, marketing and distribution capabilities. We expect our development expenses to substantially increase in connection with our ongoing activities, particularly as we advance our clinical programs. Our future capital requirements will depend on many factors, including, among others:

·            the scope, rate of progress, results and costs of our preclinical and non-clinical studies, clinical trials and other research and development activities;

·            the scope, rate of progress and costs of our manufacturing development and commercial manufacturing activities;

·            the cost, timing and outcomes of regulatory proceedings, including FDA review of any Biologics License Application, or BLA, or New Drug Application, or NDA, that we file;

·            payments required with respect to development milestones we achieve under our in-licensing agreements, including any such payments to University of Chicago, University of Iowa, Brigham and Women’s Hospital, Inc., Brigham Young University, Public Health Service and Kenta Biotech Ltd.;

·            the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims;

·            the costs associated with commercializing our product candidates, if they receive regulatory approval;

·            the cost and timing of establishing sales and marketing capabilities;

·            competing technological efforts and market developments;

·            changes in our existing research relationships;

·            our ability to establish collaborative arrangements to the extent necessary;

·            revenues received from any future products;

·            the ability to achieve and receive milestone payments for products licensed to collaborators; and

·            payments received under any future strategic collaborations.

We anticipate that we will continue to generate significant losses for the next several years as we incur expenses to complete our clinical trial programs for our product candidates, build commercial capabilities, develop our pipeline and expand our corporate infrastructure. We believe that the net proceeds from this offering, together with our existing cash and cash equivalents, will allow us to fund our operating plan for at least the next twelve months from the date of this prospectus. However, our operating plan may change as a result of factors currently unknown to us. Changing circumstances may cause us to consume capital faster or slower than we currently anticipate or to alter our operations. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available financial resources sooner than we currently expect.

There can be no assurance that our revenue and expense forecasts will prove to be accurate, and any change in the foregoing assumptions could require us to obtain additional financing earlier than anticipated. There is a risk of delay or failure at any stage of developing a product candidate, and the time required and costs involved in successfully accomplishing our objectives cannot be accurately predicted. Actual drug research and development costs could substantially exceed budgeted amounts, which could force us to delay, reduce the scope of or eliminate one or more of our research or development programs. Additionally, if the Cystic Fibrosis Foundation does not continue to provide sufficient level of funding support, we may not be able to complete the Phase 1/2a clinical trial relating to AR-501.

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We may never be able to generate a sufficient amount of product revenue to cover our expenses. Until we do, we expect to seek additional funding through public or private equity or debt financings, collaborative relationships, capital lease transactions or other available financing transactions. However, there can be no assurance that additional financing will be available on acceptable terms, if at all, and such financings could be dilutive to existing security holders. Moreover, in the event that additional funds are obtained through arrangements with collaborators, such arrangements may require us to relinquish rights to certain of our technologies, product candidates or products that we would otherwise seek to develop or commercialize ourselves.

If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our research or development programs. Our failure to obtain adequate financing when needed and on acceptable terms would have a material adverse effect on our business, financial condition and results of operations.

Risks Relating to Clinical Development and Commercialization of Our Product Candidates

If we fail to successfully complete clinical trials, fail to obtain regulatory approval or fail to successfully commercialize our product candidates, our business would be harmed and the value of our securities would decline.

We must be evaluated in light of the uncertainties and complexities affecting a pre-commercial biopharmaceutical company. We have not completed clinical development for any of our product candidates. Our three lead product candidates are AR-301, AR-105 and AR-101. We expect to initiate a Phase 3 pivotal trial of AR-301 in VAP patients in the second half of 2018, while AR-105 is currently in Phase 2 clinical testing, and AR-101 is ready for phase 2/3 pivotal testing. We are clinically testing AR-105 as a well-controlled Phase 2 trial; however, we have not yet had discussions with the FDA and the EMA regarding the status, and they may not agree. We cannot assure you that our planned clinical development for our product candidates will be completed in a timely manner, or at all, or that we, or any future partner, will be able to obtain approval for our product candidates from the FDA or any foreign regulatory authority.

Regulatory agencies, including the FDA must approve our product candidates before they can be marketed or sold. The approval process is lengthy, requires significant capital expenditures, and is uncertain as to outcome. Our ability to obtain regulatory approval of any product candidate depends on, among other things, completion of additional clinical trials, whether our clinical trials demonstrate statistically significant efficacy with safety issues that do not potentially outweigh the therapeutic benefit of the product candidates, and whether the regulatory agencies agree that the data from our future clinical trials are sufficient to support approval for any of our product candidates. The final results of our current and future clinical trials may not meet FDA or other regulatory agencies’ requirements to approve a product candidate for marketing, and the regulatory agencies may otherwise determine that our manufacturing processes or facilities are insufficient to support approval. We, and our current and potential future collaborators, may need to conduct more clinical trials than we currently anticipate. Even if we do receive FDA or other regulatory agency approval, we or our collaborators may not be successful in commercializing approved product candidates. If any of these events occur, our business could be materially harmed and the value of our securities would decline.

We, or our collaborators, may face delays in completing our clinical trials, and may not be able to complete them at all.

Clinical trials necessary to support an application for approval to market any of our product candidates have not been completed. Our, or our collaborators’, current and future clinical trials may be delayed, unsuccessful, or terminated as a result of many factors, including, but not limited to:

·            delays in reaching agreement on trial design and clinical study protocol with investigators and regulatory authorities in various countries where our clinical trials are being conducted;

·            governmental or regulatory delays, failure to obtain regulatory approval or changes in regulatory requirements, policy or guidelines;

·            adding new clinical trial sites;

·            reaching agreement on acceptable terms with prospective contract research organizations, or CROs, and clinical trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;

·            the actual performance of CROs and clinical trial sites in ensuring the proper and timely conduct of our clinical trials;

·            developing and validating companion diagnostics on a timely basis;

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·            adverse effects experienced by subjects in clinical trials;

·            manufacturing sufficient quantities of product candidates for use in clinical trials;

·            delay or failure in achieving study efficacy endpoints and completing data analysis for a trial;

·            regulators or institutional review boards, or IRBs, may not authorize us to commence a clinical trial;

·            regulators or IRBs may suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements or concerns about patient safety;

·            we may suspend or terminate our clinical trials if we believe that they expose the participating patients to unacceptable health risks;

·            patients may not complete clinical trials due to safety issues, side effects, such as injection site discomfort, a belief that they are receiving placebo instead of our product candidates, or other reasons;

·            patients with serious diseases included in our clinical trials may die or suffer other adverse medical events for reasons that may not be related to our product candidates;

·            in those trials where our product candidate is being tested in combination with one or more other therapies, deaths may occur that may be attributable to the other therapies;

·            we may have difficulty in maintaining contact with patients after treatment, preventing us from collecting the data required by our study protocol;

·            product candidates may demonstrate a lack of efficacy during clinical trials;

·            personnel conducting clinical trials may fail to properly administer our product candidates; and

·            our collaborators may decide not to pursue further clinical trials.

If our planned AR-301 Phase 3 pivotal trial remains an 80% power study rather than 90% power study, the probability that we reach statistical significance would be reduced, which may negatively affect the approval process for AR-301. If the Cystic Fibrosis Foundation does not continue to provide sufficient level of funding support, we may not be able to complete the Phase 1/2a clinical trial relating to AR-501.

In addition, we rely on academic institutions, medical institutions, physician practices and CROs to conduct, supervise or monitor some or all aspects of clinical trials involving our product candidates. We have less control over the timing and other aspects of these clinical trials than if we conducted the monitoring and supervision entirely on our own. Third parties may not perform their responsibilities for our clinical trials on our anticipated schedule or consistent with a clinical trial protocol or applicable regulations. We also may rely on CROs to perform our data management and analysis. They may not provide these services as required or in a timely or compliant manner, and we may be held legally responsible for any or all of their performance failures or inadequacies.

If we or our collaborators experience delays in the completion of, or termination of, any clinical trial of our product candidates, the commercial prospects of our product candidates will be harmed, and our ability to generate product revenues from any of these product candidates will be delayed or eliminated. In addition, any delays in completing our clinical trials will increase our costs, slow our product candidate development and approval process, and jeopardize our ability to commence product sales and generate revenues. Any of these occurrences may harm our business, financial condition and prospects. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also lead to the denial of regulatory approval of our product candidates.

If we encounter difficulties enrolling patients in our clinical trials, our clinical trials could be delayed or otherwise adversely affected.

Clinical trials for our product candidates require us to identify and enroll a large number of patients with the disease under investigation. We may not be able to enroll a sufficient number of patients with required or desired characteristics to conduct our clinical trials in a timely manner, if at all. Patient enrollment is affected by factors including, but not limited to:

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·            severity of the disease under investigation;

·            design of the trial protocol;

·            the size and nature of the patient population;

·            eligibility criteria for the study in question;

·            lack of a sufficient number of patients who meet the enrollment criteria for our clinical trials;

·            delays in characterizing a patient’s infection to allow us to select a product candidate, which may lead patients to seek to enroll in other clinical trials or seek alternative treatments;

·            perceived risks and benefits of the product candidate under study;

·            availability of competing therapies and clinical trials;

·            efforts to facilitate timely enrollment in clinical trials;

·            scheduling conflicts with participating clinicians;

·            patient referral practices of physicians;

·            the ability to monitor patients adequately during and after treatment; and

·            proximity and availability of clinical trial sites for prospective patients.

We have experienced slower enrollment of patients in our smaller clinical trials due to the pace in which clinical sites were being initiated for enrollment and may experience similar difficulties in the future. In addition, AR-301 and AR-101 have been granted orphan drug designation for the treatment of P. aeruginosa and S. aureus in the EU respectively, and the low prevalence of such diseases relative to the total population may make it harder to identify patients to enroll. If we have difficulty enrolling a sufficient number or diversity of patients to conduct our clinical trials as planned, we may need to delay or terminate ongoing or planned clinical trials, either of which would have an adverse effect on our business.

Our product candidates are based on a novel technology, which may raise development issues we may not be able to resolve, regulatory issues that could delay or prevent approval, or personnel issues that may keep us from being able to develop our product candidates.

Our product candidates are based on our mAb technology and gallium-based anti-infective platforms. There can be no assurance that development problems related to our novel technologies will not arise in the future that will cause significant delays or that we will not able to resolve.

Regulatory approval of novel product candidates such as ours can be more expensive and take longer than for other, more well-known or extensively studied pharmaceutical or biopharmaceutical product candidates due to our and regulatory agencies’ lack of experience with them. Only two mAbs have been approved by the FDA. Synagis which stimulates the immune system to target a viral infection and ZINPLAVA to reduce recurrence of Clostridium difficile infections. The novelty of our platform may lengthen the regulatory review process, require us to conduct additional studies or clinical trials, increase our development costs, lead to changes in regulatory positions and interpretations, delay or prevent approval and commercialization of our product candidates or lead to significant post-approval limitations or restrictions. For example, the FDA could require additional studies that may be difficult or impossible to perform.

The novel nature of our product candidates also means that fewer people are trained in or experienced with product candidates of this type, which may make it difficult to find, hire and retain capable personnel, particularly for research, development, commercialization and manufacturing positions. For example, study personnel may administer the wrong version of our product candidates or assign study therapy to the wrong treatment group, resulting in potential disqualification of subjects from data analysis. These factors could potentially cause a trial to fail for a reason unrelated to the efficacy of our product candidates. If we are unable to hire and retain the necessary personnel, the rate and success at which we can develop and commercialize product candidates will be limited. Any such events would increase our costs and could delay or prevent our ability to commercialize our product candidates, which could adversely impact our business, financial condition and results of operations.

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If we are unable to successfully develop companion diagnostics for our therapeutic product candidates, or experience significant delays in doing so, we may not realize the full commercial potential of our product candidates.

We intend to use rapid diagnostic tests of patients’ respiratory samples to target our mAb product candidates to those patients we believe are infected with the bacterial agents which our mAb will act against. However, currently there is no commercially available companion diagnostic for AR-101 and AR-401. Therefore, there is a risk that a companion diagnostic for these products are not developed or available to support product launch. The FDA and similar regulatory authorities outside the United States regulate companion diagnostics. Companion diagnostics require separate or coordinated regulatory approval prior to commercialization of the therapeutic product. Changes to applicable regulations could delay our development programs or delay or prevent eventual marketing approval for our product candidates that may have otherwise been approved.

The FDA’s evolving position on the topic of companion diagnostics could affect our clinical development programs that utilize companion diagnostics. In particular, the FDA may limit our ability to use retrospective data, otherwise disagree with our approaches to trial design, biomarker qualification, clinical and analytical validity, and clinical utility, or make us repeat aspects of a trial or initiate new trials.

Assays that can be used as companion diagnostics are commercially available, but in some cases such as for AR-101, they do not yet have regulatory approval for use as companion diagnostic. We have limited experience in the development of diagnostics and may not be successful in developing necessary diagnostics to pair with those product candidates that require a companion diagnostic.

Given our limited experience in developing diagnostics, we expect to rely in part on third parties for their design and manufacture. If we, or any third parties that we engage to assist us, are unable to successfully develop companion diagnostics for our product candidates that require such diagnostics, or experience delays in doing so, the development of our product candidates may be adversely affected, our product candidates may not receive marketing approval and we may not realize the full commercial potential of any products that receive marketing approval. As a result, our business could be materially harmed.

Clinical development is a lengthy and expensive process with an uncertain outcome, and results of earlier studies and clinical trials may not be predictive of future trial results.

Clinical testing is expensive and can take many years to complete, and its outcome is inherently uncertain. Failure can occur at any time during the clinical trial process. The results of preclinical studies and early clinical trials of our product candidates may not be predictive of the design or results of later-stage clinical trials. The results regarding initial tolerability and clinical activity generated to date in clinical trials for our AR-301 and AR-101 product candidates in HAP and VAP patients do not ensure that later clinical trials will demonstrate similar results. While we have observed in exploratory analysis statistically significant improvements in the outcomes of some of our clinical trials, many of the improvements we have seen have not reached statistical significance. Statistical significance is a statistical term that means that an effect is unlikely to have occurred by chance. In order to be approved by the FDA, European Medicines Agency, or other drug approving authorities, product candidates must demonstrate that their effect on patients’ diseases in the trial is statistically significant and clinically meaningful. Product candidates in later stages of clinical trials may fail to show the desired safety and efficacy traits despite having progressed through preclinical studies and initial clinical trials. Early clinical trials frequently enroll patient populations that are different from the patient populations in later trials, resulting in different outcomes in later clinical trials from those in earlier stage clinical trials. In addition, adverse events may not occur in early clinical trials and only emerge in larger, late-stage clinical trials or after commercialization. Companies in the biopharmaceutical industry have suffered significant setbacks in advanced clinical trials due to lack of efficacy or adverse safety profiles, notwithstanding promising results in earlier clinical trials. If later stage clinical trials do not demonstrate efficacy and safety of our product candidates we will not be able to market them and our business will be materially harmed.

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We may seek a breakthrough therapy designation for our existing and future product candidates, but we might not receive such designation, and even if we do, such designation may not lead to a faster development or regulatory review or approval process.

We may seek a breakthrough therapy designation for our existing and future product candidates; however, we cannot assure you our product candidates will meet the criteria for that designation. A breakthrough therapy is defined as a therapy that is intended, alone or in combination with one or more other therapies, to treat a serious condition, and preliminary clinical evidence indicates that the therapy may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints, such as substantial treatment effects observed early in clinical development. For therapies and biologics that have been designated as breakthrough therapies, interaction and communication between the FDA and the sponsor of the trial can help to identify the most efficient path for clinical development while minimizing the number of patients placed in ineffective control regimens. Therapies designated as breakthrough therapies by the FDA may also be eligible for priority review if supported by clinical data at the time the new drug application is submitted to the FDA.

Designation as a breakthrough therapy is within the discretion of the FDA. Accordingly, even if we believe that one of our product candidates meets the criteria for designation as a breakthrough therapy, the FDA may disagree and instead determine not to make such designation. Even if we receive breakthrough therapy designation, the receipt of such designation for a product candidate may not result in a faster development or regulatory review or approval process compared to drugs considered for approval under conventional FDA procedures and does not assure ultimate approval by the FDA. In addition, even if one or more of our product candidates qualify as breakthrough therapies, the FDA may later decide that the product candidate no longer meets the conditions for qualification or decide that the time period for FDA review or approval will not be shortened.

Designation of our product candidates as qualified infectious disease products is not assured and, in any event, even if granted, may not actually lead to a faster development or regulatory review, and would not assure FDA approval of our product candidates.

We may seek designation of our existing and future product candidates as qualified infectious disease products, or QIDP. A QIDP is an antibacterial or antifungal drug intended to treat serious or life- threatening infections, including those caused by an antibacterial or antifungal resistant pathogen, including novel or emerging infectious pathogens or certain “qualifying pathogens.” A product designated as a QIDP for a particular indication will also be granted priority review by the FDA and can qualify for fast track status. Upon the approval of an NDA for a drug product designated by the FDA as a QIDP, the product is granted a period of five years of regulatory exclusivity that is in addition to any other period of regulatory exclusivity for which the product is eligible. The FDA has broad discretion whether or not to grant these designations, so even if we believe a particular product candidate is eligible for such designation or status, the FDA could decide not to grant it. Moreover, even if we do receive such a designation, we may not experience a faster development process, review or approval compared to conventional FDA procedures and there is no assurance that our product candidate, even if determined to be a QIDP, will be approved by the FDA.

Regulatory authorities may not approve our product candidates even if they meet safety and efficacy endpoints in clinical trials.

The time required to obtain approval by the FDA and comparable foreign authorities is unpredictable but typically takes many years following the commencement of clinical trials and depends upon numerous factors, including the substantial discretion of regulatory authorities. In addition, approval policies, regulations, or the type and amount of clinical data necessary to gain approval may change during the course of a product candidate’s clinical development and may vary among jurisdictions. We have discussions with and obtain guidance from regulatory authorities regarding certain aspects of our clinical development activities. These discussions are not binding commitments on the part of regulatory authorities. Under certain circumstances, regulatory authorities may revise or retract previous guidance during the course of our clinical activities or after the completion of our clinical trials. A regulatory authority may also disqualify a clinical trial in whole or in part from consideration in support of approval of a potential product for commercial sale or otherwise deny approval of that product. Prior to regulatory approval, a regulatory authority may elect to obtain advice from outside experts regarding scientific issues and/or marketing applications under a regulatory authority review. In the United States, these outside experts are convened through the FDA’s Advisory Committee process, which would report to the FDA and make recommendations that may differ from the views of the FDA. Should an Advisory Committee be convened, it would be expected to lengthen the time for obtaining regulatory approval, if such approval is obtained at all.

The FDA and foreign regulatory agencies may delay, limit or deny marketing approval for many reasons, including, but not limited to:

·            a product candidate may not be considered safe or effective;

·            our manufacturing processes or facilities may not meet the applicable requirements;

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·            changes in the agencies’ approval policies or adoption of new regulations may require additional work on our part, for example, the FDA may require us to change or expand the endpoints in our clinical trials;

·            different divisions of the FDA are reviewing different product candidates and those divisions may have different requirements for approval; and

·            changes in regulatory law, FDA or foreign regulatory agency organization, or personnel may result in different requirements for approval than anticipated.

Our product candidates may not be approved even if they achieve their endpoints in clinical trials. Regulatory agencies, including the FDA, or their advisors may disagree with our trial design and our interpretations of data from preclinical studies and clinical trials. Regulatory agencies also may approve a product candidate for fewer or more limited indications than requested or may grant approval subject to the performance of post-marketing studies. In addition, regulatory agencies may not approve the labeling claims that are necessary or desirable for the successful commercialization of our product candidates. We have not obtained regulatory approval for any product candidate, and it is possible that none of our existing product candidates or any product candidates we may seek to develop in the future will ever obtain regulatory approval.

Any delay in or failure to receive or maintain approval for any of our product candidates could prevent us from ever generating revenues or achieving profitability.

We may be required to suspend, repeat or terminate our clinical trials if they are not conducted in accordance with regulatory requirements, the results are negative or inconclusive, or the trials are not well designed.

Clinical trials must be conducted in accordance with FDA regulations governing clinical studies, or other applicable foreign government guidelines, and are subject to oversight by the FDA, other foreign governmental agencies and IRBs/Ethic Committees at the medical institutions where the clinical trials are conducted. In addition, clinical trials must be conducted with product candidates produced under current Good Manufacturing Practices, or cGMP, and may require large numbers of test subjects. Clinical trials may be suspended by the FDA, other foreign governmental agencies or us for various reasons, including, but not limited to:

·            deficiencies in the conduct of the clinical trials, including failure to conduct the clinical trial in accordance with regulatory requirements or clinical protocols;

·            deficiencies in the clinical trial operations or trial sites;

·            the product candidate may have unforeseen adverse side effects;

·            the time required to determine whether the product candidate is effective may be longer than expected;

·            deaths or other adverse events arising during a clinical trial due to medical problems that may not be related to clinical trial treatments;

·            the product candidate may not appear to be more effective than current therapies;

·            the quality or stability of the product candidate may fall below acceptable standards; and

·            insufficient quantities of the product candidate might be available to complete the trials.

In addition, changes in regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect these changes. Amendments may require us to resubmit our clinical trial protocols to IRBs for reexamination, which may impact the costs, timing or successful completion of a clinical trial. Due to these and other factors, our product candidates could take longer to gain regulatory approval than we expect or we may never gain approval for any product candidates, which could reduce or eliminate our revenue by delaying or terminating the commercialization of our product candidates.

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A Fast Track product designation or other designation to facilitate product candidate development may not lead to faster development or regulatory review or approval process, and it does not increase the likelihood that our product candidates will receive marketing approval.

We have received a Fast Track product designation for AR-301 and AR-101 and we may seek Fast Track designation for other of our current or future product candidates. Receipt of a designation to facilitate product candidate development is within the discretion of the FDA. Accordingly, even if we believe one of our product candidates meets the criteria for a designation, the FDA may disagree. In any event, the receipt of such a designation for a product candidate may not result in a faster development process, review, or approval compared to drugs considered for approval under conventional FDA procedures and does not assure ultimate marketing approval by the FDA. In addition, the FDA may later decide that the products no longer meet the designation conditions.

We may not be able to maintain orphan drug marketing exclusivity for our AR-101 product candidate in the United States and/or the European Union, and orphan drug marketing exclusivity may not be available for any of our other product candidates.

Under the Orphan Drug Act, the FDA may grant orphan drug designation to a drug or biologic intended to treat a rare disease or condition (with a population of less than 200,000), which is defined as one occurring in a patient population of fewer than 200,000 in the United States, or a patient population greater than 200,000 in the U.S. where there is no reasonable expectation that the cost of developing the drug or biologic will be recovered from sales in the United States. In the EU, following the opinion of the EMA’s Committee for Orphan Medicinal Products, the European Commission grants orphan drug designation to a product if (1) it is intended for the diagnosis, prevention or treatment of a life-threatening or chronically debilitating condition; (2) either (a) such condition affects no more than five in 10,000 persons in the EU when the application is made, or (b) the product, without the incentives derived from orphan medicinal product status, would not generate sufficient return in the EU to justify investment; and (3) there exists no satisfactory method of diagnosis, prevention or treatment of such condition authorized for marketing in the EU, or if such a method exists, the product will be of significant benefit to those affected by the condition.

Generally, if a drug with an orphan drug designation subsequently receives the first marketing approval for the indication for which it has such designation, the drug is entitled to a period of marketing exclusivity, which precludes the FDA or the European Commission and the competent authorities in the EU Member States from approving another marketing application for the same drug (or similar medicinal product in the European Union) for that time period, except in limited circumstances. The applicable period is seven years in the U.S. and 10 years in the EU. The EU exclusivity period can be reduced to six years if a drug no longer meets the criteria for orphan drug designation or if the drug is sufficiently profitable that market exclusivity is no longer justified. Orphan drug exclusivity may be lost if the FDA determines that the request for designation was materially defective or if the manufacturer is unable to assure sufficient quantity of the drug to meet the needs of patients with the rare disease or condition.

We have been granted orphan drug designation for our AR-101 and AR-301 drug candidates in the European Union, as well as orphan drug designation for our AR-101 drug candidate in the U.S. The AR-301 drug candidate has not been approved for orphan drug designation in the U.S. Although we may apply for orphan drug designation for other product candidates we may develop in both the U.S. and EU, applicable regulatory authorities may not grant us this designation. In addition, even if such status is obtained for any other product candidate that we may develop, that exclusivity may not effectively protect the candidate from competition because other drugs, such as those with different active ingredients or molecular structures, can be approved for the same condition. Furthermore, even after an orphan drug is approved, the FDA can subsequently approve another drug for the same condition if the FDA concludes that the later drug is clinically superior, in that it is shown to be safer, more effective or makes a major contribution to patient care. In the EU, a marketing authorization may be granted to a similar product during the 10-year period of market exclusivity for the same therapeutic indication at any time if:

·            the second applicant can establish in its application that its product, although similar to the orphan medicinal product already authorized, is safer, more effective or otherwise clinically superior;

·            the holder of the marketing authorization for the original orphan medicinal product consents to a second orphan medicinal product application; or

·            the holder of the marketing authorization for the original orphan medicinal product cannot supply enough orphan medicinal product.

Any inability to secure orphan drug designation or to maintain the exclusivity benefits of this designation could have an adverse impact on our ability to develop and commercialize our product candidates, depending on the extent to which we would be protected by other patents and regulatory exclusivities, and may adversely affect our business, prospects, financial condition and results of operations.

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Any product candidate for which we, or our collaborators, obtain marketing approval could be subject to restrictions or withdrawal from the market, and we may be subject to penalties if we fail to comply with regulatory requirements or if we experience unanticipated problems with our products, when and if any of them are approved.

Any product candidate that we, or our collaborators, obtain marketing approval for, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for such product, will be subject to continuing requirements of the FDA and other regulatory authorities. These requirements include submissions of safety and other post-marketing information, reports, facility registration and product listing requirements, cGMP requirements relating to quality control, quality assurance and corresponding maintenance of records and documents, requirements regarding the distribution of samples to physicians and recordkeeping. Even if marketing approval of a product candidate is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to conditions of approval, or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product. The FDA closely regulates the post-approval marketing and promotion of drugs to ensure drugs are marketed only for the approved indications and in accordance with the provisions of the approved labeling. The FDA imposes stringent restrictions on manufacturers’ communications regarding off-label use. If we market our products outside of their approved indications, we will be subject to enforcement action for off-label marketing.

In addition, later discovery of previously unknown problems with these products, manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may yield various results, including, but not limited to:

·            restrictions on such products, manufacturers or manufacturing processes;

·            restrictions on the labeling or marketing of a product;

·            restrictions on product distribution or use;

·            requirements to conduct post-marketing clinical trials;

·            warning or untitled letters;

·            withdrawal of the products from the market;

·            refusal to approve pending applications or supplements to approved applications that we submit;

·            recall of products, fines, restitution or disgorgement of profits or revenue;

·            suspension or withdrawal of marketing approvals;

·            refusal to permit the import or export of our products;

·            product seizure; and

·            injunctions or the imposition of civil or criminal penalties.

The FDA’s policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of our product candidates. If we, or our collaborators, are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we, or our collaborators, are not able to maintain regulatory compliance, any marketing approval that was obtained could be lost, which would adversely affect our business, prospects and ability to achieve or sustain profitability.

If we, or our collaborators, are unable to comply with foreign regulatory requirements or obtain foreign regulatory approvals, our ability to develop foreign markets for our products could be impaired.

Sales of our products outside the U.S. will be subject to foreign regulatory requirements governing clinical trials, marketing approval, manufacturing, product licensing, pricing and reimbursement. These regulatory requirements vary greatly from country to country. As a result, the time required to obtain approvals outside the U.S. may differ from that required to obtain FDA approval and we may not be able to obtain foreign regulatory approvals on a timely basis or at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other countries or by the FDA and foreign regulatory authorities could require additional testing. Failure to comply with these regulatory requirements or obtain required approvals could impair our ability to develop foreign markets for our products.

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We are subject to U.S. and certain foreign export and import controls, sanctions, embargoes, anti-corruption laws, and anti-money laundering laws and regulations. Compliance with these legal standards could impair our ability to compete in domestic and international markets. We can face criminal liability and other serious consequences for violations, which can harm our business.

We are subject to export control and import laws and regulations, including the U.S. Export Administration Regulations, U.S. Customs regulations, various economic and trade sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Controls, the U.S. Foreign Corrupt Practices Act of 1977, as amended, or FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the USA PATRIOT Act, and other state and national anti-bribery and anti-money laundering laws in the countries in which we conduct activities. Anti-corruption laws are interpreted broadly and prohibit companies and their employees, agents, contractors, and other collaborators from authorizing, promising, offering, or providing, directly or indirectly, improper payments or anything else of value to recipients in the public or private sector. We may engage third parties for clinical trials outside of the United States, to sell our products abroad once we enter a commercialization phase, and/or to obtain necessary permits, licenses, patent registrations, and other regulatory approvals. We have direct or indirect interactions with officials and employees of government agencies or government-affiliated hospitals, universities, and other organizations. We can be held liable for the corrupt or other illegal activities of our employees, agents, contractors, and other collaborators, even if we do not explicitly authorize or have actual knowledge of such activities. Any violations of the laws and regulations described above may result in substantial civil and criminal fines and penalties, imprisonment, the loss of export or import privileges, debarment, tax reassessments, breach of contract and fraud litigation, reputational harm, and other consequences.

Developing product candidates in combination with other therapies may lead to unforeseen side effects or failures in our clinical trials.

We, and our collaborators, are studying our product candidates in clinical trials in combination with approved therapies, including antibiotics, and we anticipate that if any product candidates are approved for marketing, they will be approved to be used only in combination with other therapies. Our development programs and planned studies carry all the risks inherent in drug development activities, including the risk that they will fail to demonstrate meaningful efficacy or acceptable safety. In addition, our development programs are subject to additional regulatory, commercial, manufacturing and other risks because of the use of other therapies in combination with our product candidates. For example, the other therapies may lead to toxicities that are improperly attributed to our product candidates or the combination of our product candidates with other therapies may result in toxicities that the product candidate or other therapy does not produce when used alone. The other therapies we are using in combination with our product candidates may be removed from the market or become prohibitively expensive and thus be unavailable for testing or commercial use with any of our approved products. Testing product candidates in combination with other therapies may increase the risk of significant adverse effects or test failures. The timing, outcome and cost of developing products to be used in combination with other therapies is difficult to predict and dependent on a number of factors that are outside our reasonable control. If any safety or toxicity issues arise in these clinical trials or with any approved products, or if the other therapies are removed from the market, the products may not be approved, which could prevent us from ever generating revenues or achieving profitability.

We will need to develop or acquire additional manufacturing and distribution capabilities, or outsource the same to third parties, in order to commercialize any product candidates that obtain marketing approval, and we may encounter unexpected costs or difficulties in doing so.

If we independently develop and commercialize one or more of our product candidates, we will need to invest in acquiring or building additional capabilities and effectively manage our operations and facilities to successfully pursue and complete future research, development and commercialization efforts. We will require additional investment and validation process development in order to qualify our commercial-scale manufacturing process to manufacture clinical trial materials and commercial material if any of our products are approved for marketing. This investment and validation process development may be expensive and time-consuming. We will require additional personnel with experience in commercial-scale manufacturing, managing of large-scale information technology systems and managing a large-scale distribution system. We will need to add personnel and expand our capabilities, which may strain our existing managerial, operational, regulatory compliance, financial and other resources. To do this effectively, we must:

·            recruit, hire, train, manage and motivate a growing employee base;

·            accurately forecast demand for our products;

·            assemble and manage the supply chain to ensure our ability to meet demand; and

·            expand existing operational, manufacturing, financial and management information systems.