Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-38473
 
 Evelo Biosciences, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
46-5594527
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
620 Memorial Drive
Cambridge, Massachusetts
 
02139
(Address of principal executive offices)
 
(Zip Code)
(617) 577-0300
(Registrant's telephone number, including area code)

N/A

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

 
 

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock,
$0.001 par value per share
 
EVLO
 
Nasdaq Global Select Market

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
o
  
Accelerated filer
 
o
 
 
 
 
 
 
 
Non-accelerated filer
 
x
  
Smaller reporting company
 
x
 
 
 
 
 
 
 
 
 
 
  
Emerging growth company
 
x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  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
As of October 31, 2019, the registrant had 32,085,829 shares of common stock, $0.001 par value per share, outstanding.




FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy, prospective products, product approvals, research and development costs, timing and plans for clinical trials, expected timing of the release of clinical trial data, new formulations and product candidates, plans and objectives of management for future operations and future results of anticipated products, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important 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 the forward-looking statements.
In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this Quarterly Report on Form 10-Q are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described under the sections in this Quarterly Report on Form 10-Q entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q. These forward-looking statements are subject to numerous risks, including, without limitation, the following:
 
our status as a development-stage company and our expectation to incur losses in the future;
our future capital needs and our need to raise additional funds;
our ability to build a pipeline of product candidates and develop and commercialize drugs;
our unproven approach to therapeutic intervention;
our ability to enroll patients and volunteers in clinical trials, timely and successfully complete those trials and receive necessary regulatory approvals;
our ability to establish our own manufacturing facilities and to receive or manufacture sufficient quantities of our product candidates;
our ability to protect and enforce our intellectual property rights;
federal, state, and foreign regulatory requirements, including FDA regulation of our product candidates;
the timing of clinical trials and the likelihood of regulatory filings and approvals;
our ability to obtain and retain key executives and attract and retain qualified personnel; and
our ability to successfully manage our growth.
Moreover, we operate in an evolving environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties.
As forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified and some of which are beyond our control, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not occur or be achieved, and actual results could differ materially from those projected in the forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.




Evelo Biosciences, Inc.
Form 10-Q for the Quarterly Period Ended September 30, 2019
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 




PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
Evelo Biosciences, Inc.
Condensed Consolidated Balance Sheets
(Unaudited, in thousands, except per share and share amounts)
 
 
September 30,
2019
 
December 31,
2018
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
97,061

 
$
93,101

Short-term investments
 

 
54,818

Prepaid expenses and other current assets
 
4,170

 
3,703

Total current assets
 
101,231

 
151,622

Property and equipment, net
 
8,339

 
6,925

Other assets
 
1,570

 
1,320

Total assets
 
$
111,140

 
$
159,867

Liabilities and stockholders’ equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
1,358

 
$
1,519

Accrued expenses
 
7,919

 
4,965

Other current liabilities
 
398

 
2,751

Total current liabilities
 
9,675

 
9,235

Noncurrent liabilities:
 
 
 
 
Long-term debt, net of current portion
 
19,549

 
12,305

Deferred rent, net of current portion
 
1,146

 
1,071

Other noncurrent liabilities
 
224

 
307

Total liabilities
 
30,594

 
22,918

Commitments and contingencies
 

 

Stockholder’s equity:
 
 
 
 
Preferred stock, $0.001 par value; 10,000,000 shares authorized; no shares issued or outstanding at September 30, 2019 and December 31, 2018, respectively
 

 

Common stock, $0.001 par value; 200,000,000 shares authorized; 32,147,073 and 31,951,540 shares issued and 32,072,030 and 31,825,769 shares outstanding at September 30, 2019 and December 31, 2018, respectively
 
32

 
32

Additional paid-in capital
 
256,768

 
250,316

Accumulated other comprehensive loss
 

 
(18
)
Accumulated deficit
 
(176,254
)
 
(113,381
)
Total stockholders’ equity
 
80,546

 
136,949

Total liabilities and stockholders’ equity
 
$
111,140

 
$
159,867

See accompanying notes to condensed consolidated financial statements.

1


Evelo Biosciences, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Unaudited, in thousands, except share and per share data)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2019
 
2018
 
2019
 
2018
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
$
15,610

 
$
11,227

 
$
46,751

 
$
28,542

General and administrative
 
5,886

 
5,230

 
16,936

 
13,568

Total operating expenses
 
21,496

 
16,457

 
63,687

 
42,110

Loss from operations
 
(21,496
)
 
(16,457
)
 
(63,687
)
 
(42,110
)
Other income (expense):
 
 
 
 
 
 
 
 
Interest income, net
 
81

 
600

 
1,032

 
1,013

Other expenses
 
(218
)
 

 
(218
)
 
(406
)
Other income (expense), net
 
(137
)
 
600

 
814

 
607

Net loss
 
$
(21,633
)
 
$
(15,857
)
 
$
(62,873
)
 
$
(41,503
)
Convertible preferred stock dividends
 

 

 

 
(3,937
)
Net loss attributable to common stockholders
 
$
(21,633
)
 
$
(15,857
)
 
$
(62,873
)
 
$
(45,440
)
 
 
 
 
 
 
 
 
 
Net loss per share attributable to common stockholders, basic and diluted
 
$
(0.67
)
 
$
(0.50
)
 
$
(1.96
)
 
$
(2.45
)
Weighted-average number of common shares outstanding, basic and diluted
 
32,060,747

 
31,741,683

 
32,009,571

 
18,532,408

 
 
 
 
 
 
 
 
 
Comprehensive loss:
 
 
 
 
 
 
 
 
Net loss
 
$
(21,633
)
 
$
(15,857
)
 
$
(62,873
)
 
$
(41,503
)
Other comprehensive loss:
 
 
 
 
 
 
 
 
Unrealized gain (loss) on investments, net of tax of $0
 
(1
)
 
(38
)
 
18

 
(38
)
Comprehensive loss
 
$
(21,634
)
 
$
(15,895
)
 
$
(62,855
)
 
$
(41,541
)
See accompanying notes to condensed consolidated financial statements.


2


Evelo Biosciences, Inc.
Condensed Consolidated Statements of Preferred Stock and Stockholders’ Equity
(Unaudited, in thousands, except share amounts)
 
Nine Month Periods Ended September 30, 2019
 
Preferred Stock
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
 
Balance-December 31, 2018

 
$

 
 
31,825,769

 
$
32

 
$
250,316

 
$
(18
)
 
$
(113,381
)
 
$
136,949

Vesting of restricted common stock

 

 
 
23,345

 

 
7

 

 

 
7

Exercise of stock options and warrants

 

 
 
181,521

 

 
257

 

 

 
257

Stock-based compensation expense

 

 
 

 

 
1,953

 

 

 
1,953

Unrealized gain on investments

 

 
 

 

 

 
16

 

 
16

Net loss

 

 
 

 

 

 

 
(20,299
)
 
(20,299
)
Balance-March 31, 2019

 
$

 
 
32,030,635

 
$
32

 
$
252,533

 
$
(2
)
 
$
(133,680
)
 
$
118,883

Vesting of restricted common stock

 

 
 
13,692

 

 
7

 

 

 
7

Exercise of stock options

 

 
 
1,379

 

 
1

 

 

 
1

Stock-based compensation expense

 

 
 

 

 
2,135

 

 

 
2,135

Unrealized gain on investments

 

 
 

 

 

 
3

 

 
3

Net loss

 

 
 

 

 

 

 
(20,941
)
 
(20,941
)
Balance-June 30, 2019

 
$

 
 
32,045,706

 
$
32

 
$
254,676

 
$
1

 
$
(154,621
)
 
$
100,088

Vesting of restricted common stock

 

 
 
13,691

 

 
7

 

 

 
7

Exercise of stock options

 

 
 
12,633

 

 
23

 

 

 
23

Stock-based compensation expense

 

 
 

 

 
2,062

 

 

 
2,062

Unrealized gain on investments

 

 
 

 

 
 
 
(1
)
 

 
(1
)
Net loss

 

 
 

 

 

 

 
(21,633
)
 
(21,633
)
Balance-September 30, 2019

 
$

 
 
32,072,030

 
$
32

 
$
256,768

 
$

 
$
(176,254
)
 
$
80,546














See accompanying notes to condensed consolidated financial statements.

3



Evelo Biosciences, Inc.
Condensed Consolidated Statements of Convertible Preferred Stock, Preferred Stock and Stockholders’ Equity (Deficit)
(Unaudited, in thousands, except share amounts)

 
Nine Month Periods Ended September 30, 2018
 
Convertible Preferred
Stock
 
 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Loss
 
Accumulated Deficit
 
Total
 
Shares
 
Amount
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance-December 31, 2017
65,833,096

 
$
83,702

 
 

 
$

 
3,880,607

 
$
4

 
$
1,708

 
$

 
$
(56,435
)
 
$
(54,723
)
Issuance of Series B and Series C Preferred Stock, net of issuance costs
25,482,199

 
82,076

 
 

 

 

 

 

 

 

 

Vesting of restricted common stock

 

 
 

 

 
31,557

 

 
11

 

 

 
11

Exercise of stock options and warrants

 

 
 

 

 
31,765

 

 
35

 

 

 
35

Stock-based compensation expense

 

 
 

 

 

 

 
652

 

 

 
652

Net loss

 

 
 

 

 

 

 

 

 
(10,500
)
 
(10,500
)
Balance-March 31, 2018
91,315,295

 
$
165,778

 
 

 
$

 
3,943,929

 
$
4

 
$
2,406

 
$

 
$
(66,935
)
 
$
(64,525
)
Proceeds from Initial Public Offering, net of underwriting costs and commissions

 

 
 

 

 
5,312,500

 
5

 
75,793

 

 

 
75,798

Conversion of preferred stock into common stock
(91,315,295
)
 
(165,778
)
 
 

 

 
22,386,677

 
22

 
165,756

 

 

 
165,778

Reclassification of warrant liability

 

 
 

 

 

 

 
879

 

 

 
879

Vesting of restricted common stock

 

 
 

 

 
31,572

 

 
11

 

 

 
11

Exercise of stock options and warrants

 

 
 

 

 
51,408

 
1

 
4

 

 

 
5

Stock-based compensation expense

 

 
 

 

 

 

 
2,247

 

 

 
2,247

Unrealized gain on investments

 

 
 

 

 

 

 

 

 

 

Net loss

 

 
 

 

 

 

 

 

 
$
(15,146
)
 
$
(15,146
)
Balance-June 30, 2018

 
$

 
 

 
$

 
31,726,086

 
$
32

 
$
247,096

 
$

 
$
(82,081
)
 
$
165,047

Vesting of restricted common stock

 

 
 

 

 
25,816

 

 
7

 

 

 
7

Exercise of stock options

 

 
 

 

 
5,805

 

 
5

 

 

 
5

Stock-based compensation expense

 

 
 

 

 

 

 
1,595

 

 

 
1,595

Unrealized gain on investments

 

 
 

 

 

 

 

 
(38
)
 

 
(38
)
Net loss

 

 
 

 

 

 

 

 

 
$
(15,857
)
 
$
(15,857
)
Balance-September 30, 2018

 
$

 
 

 
$

 
31,757,707

 
$
32

 
$
248,703

 
$
(38
)
 
$
(97,938
)
 
$
150,759




See accompanying notes to condensed consolidated financial statements.

4


Evelo Biosciences, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
 
 
Nine Months Ended
September 30,
 
 
2019
 
2018
Operating activities
 
 
 
 
Net loss
 
$
(62,873
)
 
$
(41,503
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Stock-based compensation expense
 
6,150

 
4,494

Depreciation expense
 
1,264

 
1,575

Change in fair value of warrant and debt derivative liability
 

 
406

 Net (accretion of discount)/amortization of premium on marketable securities
 
(164
)
 

Non-cash interest expense
 
263

 
78

Gain on sale of fixed assets
 
(2
)
 

Changes in assets and liabilities:
 
 
 
 
Prepaid expenses and other current assets
 
(633
)
 
(3,180
)
Accounts payable
 
90

 
1,375

Accrued expenses and other current liabilities
 
2,907

 
4,314

Other liabilities
 
12

 
618

Net cash used in operating activities
 
(52,986
)
 
(31,823
)
Investing activities
 
 
 
 
Purchase of investments
 

 
(84,653
)
Proceeds from sales and maturities of investments
 
55,000

 

Purchases of property and equipment
 
(2,569
)
 
(4,227
)
Proceeds from the sale of fixed assets
 
2

 
171

Net cash provided by/(used in) investing activities
 
52,433

 
(88,709
)
Financing activities
 
 
 
 
Proceeds from the issuance of common stock upon completion of initial public offering
 

 
85,000

Net proceeds from the issuance of convertible preferred stock
 

 
81,336

Net proceeds from the issuance of long-term debt
 
19,481

 
4,975

Repayment of long-term debt
 
(15,000
)
 

Cash payment of initial public offering issuance costs
 

 
(9,171
)
Settlement of derivative liability
 

 
(250
)
Proceeds from the exercise of stock options, restricted common stock and warrants
 
282

 
104

Net cash provided by financing activities
 
4,763

 
161,994

Net increase in cash, cash equivalents and restricted cash
 
4,210

 
41,462

Cash, cash equivalents and restricted cash – beginning of period
 
94,351

 
39,746

Cash, cash equivalents and restricted cash – end of period
 
$
98,561

 
$
81,208

Supplemental disclosure of cash flow information
 
 
 
 
Cash paid for interest
 
$
728

 
$
535

Noncash investing and financing activities
 
 
 
 
Conversion of convertible preferred stock into common stock upon closing of initial public offering
 
$

 
$
165,778

Property and equipment additions in accounts payable and accrued expenses
 
$
290

 
$
176

Conversion of convertible preferred stock warrants into common stock warrants
 
$

 
$
819

Issuance of debt derivative liability in connection with long-term debt facility
 
$

 
$
150

Issuance of warrants in connection with long-term debt facility
 
$

 
$
89


See accompanying notes to the condensed consolidated financial statements.

5


EVELO BIOSCIENCES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. Organization
Evelo Biosciences, Inc. ("Evelo" or the "Company”) is a biotechnology company which was incorporated in Delaware on May 6, 2014. The Company is discovering and developing oral biologics designed to engage immune cells in the small intestine and drive therapeutic effects throughout the body. The Company is advancing these monoclonal microbials with the aim of treating a broad range of immune mediated diseases with an initial focus on inflammatory diseases and oncology. The Company is headquartered in Cambridge, Massachusetts.
Since inception, the Company has devoted substantially all of its efforts to research and development and raising capital. The Company has not generated any revenue related to its primary business purpose to date. The Company is subject to a number of risks similar to those of other development stage companies, including dependence on key individuals, the need to develop commercially viable products, competition from other companies, many of whom are larger and better capitalized, and the need to obtain adequate additional financing to fund the development of its products.
The Company has funded its operations from the issuance of convertible notes, convertible preferred stock, common stock and debt financing. At September 30, 2019, the Company had cash and cash equivalents of $97.1 million and an accumulated deficit of $176.3 million.
The Company has incurred operating losses since inception and expects such losses and negative operating cash flows to continue for the foreseeable future. The transition to profitability is dependent upon the successful development, approval, and commercialization of its products and product candidates and the achievement of a level of revenues adequate to support its cost structure. Based on the Company’s current operating plan, the Company believes that its cash and cash equivalents at September 30, 2019, along with the capacity to borrow an additional $10.0 million under the 2019 Credit Facility (see note 6), will be sufficient to fund operations and capital expenditures for at least the twelve months following the filing of this Quarterly Report on Form 10-Q. Management’s belief with respect to its ability to fund operations is based on estimates that are subject to risks and uncertainties. If actual results are different from management’s estimates, the Company may need to seek additional funding sooner than would otherwise be expected. There can be no assurance that the Company will be able to obtain additional funding on acceptable terms, if at all.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Any reference in these notes to applicable guidance is meant to refer to the authoritative United States generally accepted accounting principles as found in the Accounting Standard Codification (“ASC”) and Accounting Standards Updates (“ASU”) of the Financial Accounting Standards Board (“FASB”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from this report, as is permitted by such rules and regulations. Accordingly, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and notes thereto. The unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements. In the opinion of the Company’s management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments which are necessary to present fairly the Company’s financial position as of September 30, 2019, the results of its operations and stockholders' equity for the three and nine months ended September 30, 2019 and 2018 and cash flows for the nine months ended September 30, 2019 and 2018. Such adjustments are of a normal and recurring nature. The results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019, or for any future period.

6


Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant estimates and assumptions reflected in these condensed consolidated financial statements include, but are not limited to, the accrual of research and development expenses and the valuation of stock-based awards. The Company bases its estimates on historical experience and other market-specific or other relevant assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned, controlled subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Subsequent Event Considerations
The Company considers events or transactions that occur after the balance sheet date but prior to the issuance of the consolidated financial statements to provide additional evidence for certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated as required. The Company has evaluated all subsequent events and determined that there are no material recognized or unrecognized subsequent events requiring disclosure, other than those disclosed in this Quarterly Report on Form 10-Q.
Emerging Growth Company Status
Evelo is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"), and it may take advantage of reduced reporting requirements that are otherwise applicable to public companies. Evelo may take advantage of these exemptions until it is no longer an emerging growth company. Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. Evelo has elected to use the extended transition period for complying with new or revised accounting standards, and, as a result of this election, its consolidated financial statements may not be comparable to companies that comply with public company effective dates. Evelo may take advantage of these exemptions up until the last day of the fiscal year following the fifth anniversary of its IPO or such earlier time that it is no longer an emerging growth company. Evelo would cease to be an emerging growth company if it has more than $1.07 billion in annual revenue, it has more than $700.0 million in market value of its stock held by non-affiliates (and has been a public company for at least 12 months and has filed one annual report on Form 10-K), or it has issued more than $1.0 billion of non-convertible debt securities over a three-year period.
Comprehensive Loss
Comprehensive loss includes net loss and certain changes in stockholders’ equity that are excluded from net loss. The Company's only element of other comprehensive income (loss) is unrealized gains and losses on available-for-sale investments. Comprehensive loss totaled $21.6 million and $62.9 million for the three and nine months ended September 30, 2019, respectively, and $15.9 million and $41.5 million for the three and nine months ended September 30, 2018, and was not significantly different than net loss in any period. For the nine months ended September 30, 2018 comprehensive loss was equal to net loss.
Cash, Cash Equivalents, and Restricted Cash
Cash equivalents are comprised of highly liquid investments that are readily convertible into cash with original maturities of three months or less. Cash and cash equivalents include cash held in banks and amounts held in money market funds and U.S. treasuries with original maturities of three months or less. Cash equivalents are stated at cost, which approximates market value. The Company’s restricted cash consists of restricted cash in connection with building leases for the Company’s office and laboratory premises and deposits held in relation to the company's credit card facility. Restricted cash totaled approximately $1.5 million and $1.3 million at September 30, 2019 and December 31, 2018, respectively, and is classified within other assets on the accompanying condensed consolidated balance sheet. The following reconciles cash, cash equivalents and restricted cash as of September 30, 2019 and December 31, 2018, as presented on the Company's statements of cash flows, to its related balance sheet accounts (in thousands):

7


 
 
September 30,
2019
 
December 31,
2018
Cash and cash equivalents:
 
 
 
 
Cash
 
$
1,304

 
$
1,300

Money market funds
 
95,757

 
91,801

Total cash and cash equivalents
 
97,061

 
93,101

Restricted cash
 
1,500

 
1,250

Cash, cash equivalents and restricted cash
 
$
98,561

 
$
94,351

Investments
The Company accounts for and classifies its investments as either “available-for-sale,” “trading,” or “held-to-maturity,” in accordance with the accounting guidance related to the accounting and classification of certain investments in debt and equity securities. The determination of the appropriate classification is based primarily on management’s intent to sell the investment at the time of purchase. The Company did not have any investments at September 30, 2019. As of December 31, 2018 all of the Company's investments were classified as available‑for‑sale securities.
Available‑for‑sale securities are those securities which the Company views as available for use in current operations, if needed. The Company generally classifies its available‑for‑sale securities as short‑term investments, even though the stated maturity date may be one year or more beyond the current balance sheet date. Available‑for‑sale investments are stated at fair value with their unrealized gains and losses included in accumulated other comprehensive loss within stockholders’ (deficit) equity, until such gains and losses are realized in other income (expense) within the condensed consolidated statements of operations and comprehensive loss or until an unrealized loss is considered other‑than‑temporary.
The Company recognizes other‑than‑temporary impairments of its investments in debt securities when there is a decline in fair value below the amortized cost basis and if (a) it has the intent to sell the security or (b) it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. If either of these conditions is met, the Company recognizes the difference between the amortized cost of the security and its fair value at the impairment measurement date in the condensed consolidated statements of operations and comprehensive loss. If neither of these conditions is met, the Company must perform an additional analysis to evaluate whether the unrealized loss is associated with the creditworthiness of the issuer of the security rather than other factors, such as interest rates or market factors. If the Company determines from this analysis that it does not expect to receive cash flows sufficient to recover the entire amortized cost of the security, a credit loss exists, the impairment is considered other-than-temporary and is recognized in its condensed consolidated statements of operations and comprehensive loss.
Fair Value of Financial Instruments
ASC 820, Fair Value Measurement (“ASC 820”), establishes a fair value hierarchy for instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s own assumptions (unobservable inputs). Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset or liability and are developed based on the best information available in the circumstances.
ASC 820 identifies fair value as the exchange price, or exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a three-tier fair value hierarchy that distinguishes between the following:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
Level 3 inputs are unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability.

8


To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
An entity may choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The Company did not elect to measure any additional financial instruments or other items at fair value.
Research and Development Costs
Research and development costs are expensed in the period incurred. Research and development expenses consist of both internal and external costs such as payroll, consulting, and manufacturing costs associated with the development of the Company’s product candidates. Costs for certain development activities, such as clinical trials and manufacturing development activities, are recognized based on an evaluation of the progress to completion of specific tasks using data such as patient enrollment, clinical site activations, and information provided to the Company by its vendors on their actual costs incurred or level of effort expended.  Payments for these activities are based on the terms of the individual arrangements, which may differ from the pattern of costs incurred, and are reflected on the consolidated balance sheets as prepaid or accrued research and development expenses.
Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized. The capitalized amounts are expensed as the related goods are delivered or the services are performed.
The Company has and may continue to acquire the rights to develop and commercialize new product candidates from third parties. The upfront payments to acquire license, product or rights, as well as any future milestone payments, are immediately recognized as research and development expense provided that there is no alternative future use of the rights in other research and development projects. Any milestone payments made for Intellectual Property after regulatory approval, or that have alternative future use, are capitalized and amortized.
Stock-Based Compensation
The Company records stock-based compensation for options granted to employees and directors based on the grant date fair value of awards issued. The expense is recorded over the requisite service period, which is the vesting period, on a straight-line basis. The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options. The determination of the fair value of stock options on the date of grant using an option-pricing model is affected by the Company’s common stock price, as well as a number of other assumptions. The Company records forfeitures as they occur.
The Company accounts for stock-based compensation arrangements with non-employees based upon the fair value of the consideration received or the equity instruments issued, whichever is more reliably measurable. The measurement date for non-employee awards is generally the date performance of services required from the non-employee is complete. Stock-based compensation costs for non-employee awards are recognized as services are provided, which is generally the vesting period, on a straight-line basis. The unvested portion of the stock options is subject to re-measurement over the vesting period and forfeitures are recorded as they occur.
Segments
The Company has one operating segment. The Company's chief operating decision maker, its Chief Executive Officer, manages the Company's operations on a consolidated basis for the purposes of allocating resources.

9


Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), and further updated through ASU 2016-12 (“ASU 2016-12”), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is based on principles that govern the recognition of revenue at an amount to which an entity expects to be entitled when products are transferred to customers. This guidance is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2017, for public entities and no later than for annual reporting periods beginning after December 15, 2018, for non-public entities. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company adopted ASU 2014-09 on January 1, 2019 and has concluded that the adoption did not have a material impact on its consolidated financial statements as the Company is not yet generating revenues.
In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangements (Topic 808)-Clarifying the Interaction between Topic 808 and Topic 606 ("ASU 2018-18"). The amendments in ASU 2018-18 make targeted improvements to U.S. GAAP for collaborative arrangements by clarifying that certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account. In those situations, all the guidance in Topic 606 should be applied, including recognition, measurement, presentation, and disclosure requirements. In addition, unit-of-account guidance in Topic 808 was aligned with the guidance in Topic 606 (that is, a distinct good or service) when an entity is assessing whether the collaborative arrangement or a part of the arrangement is within the scope of 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, including adoption in any interim period. The amendments in this Update should be applied retrospectively to the date of initial application of Topic 606. The Company adopted ASU 2018-18 on January 1, 2019 and has concluded the adoption did not have a material impact on its consolidated financial statements as the Company does not have any collaborative agreements under which any participant is considered a customer of the Company.
Accounting Pronouncements Issued and Not Adopted as of September 30, 2019
In February 2016, the FASB issued ASU 2016-2, Leases (Topic 842) (“ASU 2016-2”), which supersedes the guidance in former ASC 840, Leases. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to the historical guidance for operating leases. This guidance is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2018 for most public entities. Early adoption is permitted for all entities. Although its assessment is not complete, the Company currently expects the adoption of this guidance to result in the addition of material balances of leased assets and corresponding lease liabilities to its consolidated balance sheets, primarily relating to leases of office space.
In June 2018, the FASB issued ASU No. 2018-07, Stock-based Compensation: Improvements to Nonemployee Share-based Payment Accounting (Topic 718) ("ASU 2018-07"), which amends the existing accounting standards for share-based payments to nonemployees. This ASU aligns much of the guidance on measuring and classifying nonemployee awards with that of awards to employees. Under the new guidance, the measurement of nonemployee equity awards is fixed on the grant date. This ASU becomes effective in the first quarter of fiscal year 2020 and early adoption is permitted but no earlier than the Company's adoption date of Topic 606. Entities will apply the ASU by recognizing a cumulative-effect adjustment to retained earnings as of the beginning of the annual period of adoption. The Company is currently evaluating the impact that ASU 2018-07 will have on its consolidated financial statements.

10


3. Investments
As of September 30, 2019 the Company did not hold any short-term investments. As of December 31, 2018, the Company had short-term investments, consisting entirely of U.S. treasury securities, of $54.8 million, respectively.
The following tables summarize the Company's investments held at December 31, 2018, which are all classified as available-for-sale (in thousands):
Description
 
Amortized cost
 
Unrealized Gain
 
Unrealized Loss
 
Fair Value
December 31, 2018:
 
 
 
 
 
 
 
 
U.S. treasury securities
 
$
54,836

 
$

 
$
(18
)
 
$
54,818

Total
 
$
54,836

 
$

 
$
(18
)
 
$
54,818

The amortized cost of available-for-sale securities is adjusted for amortization of premiums and accretion of discounts to maturity. At September 30, 2019 the Company had no accumulated other comprehensive loss. There were no material realized gains or losses recognized on the sale or maturity of available-for-sale securities during the three and nine months ended September 30, 2019 or 2018, and as a result, the Company did not reclassify any amounts out of accumulated other comprehensive loss for the same periods.
As of December 31, 2018, the aggregate fair value of securities held by the Company in an unrealized loss position for less than twelve months was $54.8 million, and none of these securities had remaining maturities of greater than three years. The Company has the intent and ability to hold such securities until recovery. The Company determined that there has been no material change in the credit risk of the above investments. As a result, the Company determined it did not hold any investments with any other-than-temporary impairment as of December 31, 2018.
4. Fair Value Measurements
The following tables present information about the Company’s financial assets and liabilities that have been measured at fair value as of September 30, 2019 and December 31, 2018 (in thousands):
Description
 
September 30,
2019
 
Active
Markets
(Level 1)
 
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Money market funds included within cash and cash equivalents
 
$
95,757

 
$
95,757

 
$

 
$

Total
 
$
95,757

 
$
95,757

 
$

 
$

Description
 
December 31,
2018
 
Active
Markets
(Level 1)
 
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Money market funds included within cash and cash equivalents
 
$
91,801

 
$
91,801

 
$

 
$

U.S. treasury securities included within short-term investments
 
54,818

 

 
54,818

 

Total
 
$
146,619

 
$
91,801

 
$
54,818

 
$

As of September 30, 2019 and December 31, 2018, the Company's cash equivalents and short-term investments have been initially valued at the transaction price and subsequently valued utilizing a third party pricing service. The Company validates the prices provided by its third-party pricing service by understanding the models used and obtaining market values from other pricing sources.

11


5. Property and Equipment, Net
Property and equipment consists of the following (in thousands):
 
 
September 30,
2019
 
December 31,
2018
Property and equipment:
 
 
 
 
Lab equipment
 
$
7,300

 
$
5,393

Leasehold improvements
 
1,944

 
1,824

Furniture and fixtures
 
701

 
525

Computers and software
 
200

 
115

Office equipment
 
9

 
9

Construction-in-process
 
1,394

 
1,011

Property and equipment
 
11,548

 
8,877

Less: accumulated depreciation
 
(3,209
)
 
(1,952
)
Property and equipment, net
 
$
8,339

 
$
6,925

The Company recognized $0.5 million and $1.3 million of depreciation expense for the three and nine months ended September 30, 2019, respectively, and $0.3 million and $1.6 million for the three and nine months ended September 30, 2018, respectively.
6. Loan and Security Agreements
2016 Credit Facility
In 2016, the Company entered into a credit facility (the “2016 Credit Facility”) with a bank that allowed the Company to borrow up to $15.0 million. Borrowings under the 2016 Credit Facility were secured by a lien on all Company assets, excluding intellectual property.
Prior to 2018, a total of $10.0 million was drawn under the 2016 Credit Facility, and in February 2018, the Company drew the remaining $5.0 million available. This resulted in an increase to the interest rate to the higher of (i) prime plus 0.25% or (ii) 4.50% per annum and extended the interest only payment period was extended through to August 15, 2019. Upon the expiration of the interest only period, amounts borrowed will be repaid over 24 equal monthly payments of principal plus interest accrued through August 15, 2021. The Company had the ability to prepay the outstanding balance of the 2016 Credit Facility at its option with a prepayment fee of 2% of principal amount if prepayment was made before August 15, 2018 or 0.5% if the prepayment was made between August 15, 2018 and August 15, 2019.
In conjunction with the February 2018 drawdown, the Company issued a warrant to purchase up to 34,722 shares of the Company’s Series B preferred stock at an exercise price of $1.80 per share. As part of the February 2018 drawdown, the loan and security agreement was amended to include the payment of a $0.3 million success fee to the financial institution in the event of a liquidation event, including an initial public offering. The success fee represented an embedded derivative which the Company bifurcated from the debt arrangement and carried at fair value. In May 2018, the Company completed its initial public offering (the "IPO") and paid the success fee of $0.3 million. In addition, the warrant issued in February 2018 was exercised in May 2018.
The 2016 Credit Facility contained negative covenants restricting the Company’s activities, including limitations on cash deposits, dispositions, mergers or acquisitions, incurring indebtedness or liens, paying dividends or making investments and certain other business transactions. There were no financial covenants associated with the agreement.
2019 Credit Facility
On July 19, 2019, the Company entered into a loan and security agreement (as amended, the "2019 Credit Facility") with K2 HealthVentures LLC ("K2HV") pursuant to which the K2HV agreed to make term loans in an aggregate principal amount of up to $45.0 million available to the Company in three tranches. The initial tranche of $20.0 million was funded upon closing on July 19, 2019. The second tranche of $10.0 million is available to be funded at the Company's election between December 1, 2019 and June 1, 2020, subject to certain customary conditions. The third tranche of

12


$15.0 million is available to be funded at the Company's election on or before January 15, 2021, subject to certain customary conditions and the achievement of certain clinical development milestones. Borrowings under the Loan Agreement are collateralized by substantially all of the Company's personal property, excluding intellectual property, and the Company pledged its equity interests in its subsidiaries, subject to certain limitations with respect to its foreign subsidiaries.

Interest on the outstanding loan balance will accrue at a variable annual rate equal to the greater of (i) 8.65% and (ii) the prime rate plus 3.15%. The Company is required to make interest-only payments on the loans on a monthly basis through February 28, 2022. If the Company elects to draw the third tranche, the interest-only period is extended through August 31, 2022. Subsequent to the interest only periods, the Company is required to make equal monthly payments of principal plus interest until the loans mature on August 1, 2024. Upon final payment or prepayment of the loans, the Company must pay a final payment equal to 4.3% of the loans borrowed, which is being accrued to interest expense over the term of the loan using the effective-interest method. The Company incurred fees associated with establishing the facility of $0.4 million. The Company has an option to prepay the loans in whole, subject to a prepayment fee of 2% of the amount prepaid or, if the prepayment occurs after the 18-month anniversary of the funding date of the loans, 1% of the amount prepaid.

The Loan Agreement contains customary representations, warranties and covenants and also includes customary events of default, including payment defaults, breaches of covenants, change of control and occurrence of a material adverse effect. The Company has determined that the risk of subjective acceleration under the material adverse events clause was remote and therefore has classified the long-term portion of the outstanding principal in non-current liabilities. Upon the occurrence and continuation of an event of default, a default interest rate of an additional 5% per annum may be applied to the outstanding loan balances, and the administrative agent, collateral agent, and lenders may declare all outstanding obligations immediately due and payable and exercise all of their rights and remedies as set forth in the Loan Agreement and under applicable law.

The Company used the proceeds from the initial $20.0 million tranche to prepay the full $15.0 million loan balance outstanding under the 2016 Credit Facility on July 19, 2019.
The Company has the following minimum aggregate future loan payments at September 30, 2019 (in thousands): 
Twelve month period ending September 30,
 
Amount
2020
 
$
1,759

2021
 
1,754

2022
 
6,318

2023
 
9,022

2024
 
8,515

Total minimum payments
 
$
27,368

Less amounts representing interest and discount
 
(7,819
)
Long-term debt
 
$
19,549

Interest expense related to the Company's 2016 Credit Facility was approximately $0.5 million for the nine months ended September 30, 2019 and $0.2 million and $0.6 million for the three and nine months ended September 30, 2018, respectively.
Interest expense related to the Company's 2019 Credit Facility was approximately $0.4 million for both the three and nine months ended September 30, 2019.

13


7. In-License Agreements
Mayo Foundation for Medical Education and Research
On June 10, 2016, the Company entered into a Research and License Agreement, (the “2016 Mayo License Agreement”) with Mayo Foundation for Medical Education and Research (“Mayo”). Under the Mayo License Agreement, Mayo was entitled to certain participation rights in connection with the issuance and sale of Series B Preferred Stock. The 2016 Mayo License Agreement allowed Mayo to purchase shares at the same price paid as other investors and is considered to be a fair value contract. In 2017, Mayo purchased 1,666,667 shares of Series B Preferred Stock at $1.80 per share. Also pursuant to the 2016 Mayo License Agreement, Mayo received 490 shares of common stock upon the completion of certain project milestones as well as warrants to purchase common stock (the “Mayo Warrants”) exercisable for 18 shares and 116 shares of common stock upon the completion of certain additional project milestones. The Mayo Warrants were fully vested and expensed in 2016. On April 9, 2018, Mayo Foundation exercised its warrant and was issued 134 shares of common stock.
On August 6, 2017, the Company and Mayo entered into a license agreement (“2017 Mayo License Agreement”). Under the 2017 Mayo License Agreement, Mayo granted the Company (i) an exclusive, worldwide, sublicensable license under Mayo’s rights to certain intellectual property and microbial strains (ii) a non-exclusive, worldwide, sublicensable license to certain related know-how, in each case, to develop and commercialize certain microbial strains and licensed products incorporating any such strains. As consideration, the Company paid a nonrefundable upfront fee of $0.2 million and annual license maintenance fees. Nonrefundable upfront fees were expensed in full to research and development expense in 2017. Annual maintenance fees will be expensed as incurred over the term of the agreement. The Company may owe Mayo milestone payments upon the achievement of certain development, regulatory, and commercial milestones, up to a maximum of $56.0 million in the aggregate, as well as royalties on net sales of licensed products in low single-digit percentages. As of September 30, 2019, the Company has incurred milestone payments to date totaling approximately $0.2 million under the agreement of which no amounts are currently due.
University of Chicago
On March 10, 2016, the Company and the University of Chicago entered into a patent license agreement (“2016 University of Chicago Agreement”). Under the 2016 University of Chicago Agreement, the University of Chicago granted the Company (i) an exclusive, royalty-bearing and sublicensable license under the Licensed Patents and (ii) a non-exclusive, royalty-bearing, sublicensable license to access the technical information to diligently develop and commercialize Licensed Products. As consideration, the Company paid a nonrefundable upfront fee of less than $0.5 million and will pay annual license maintenance fees. Nonrefundable upfront fees were expensed in full to research and development expense in 2016. Annual maintenance fees will be expensed as incurred over the term of the agreement. The Company may owe the University of Chicago milestone payments, totaling an aggregate of approximately $60.9 million upon the achievement of certain development, regulatory, and commercial milestones, as well as royalties on net sales of licensed products ranging from low to high single-digit percentages. As of September 30, 2019, the Company has incurred milestone payments to date totaling approximately $0.4 million.
In addition, the Company also agreed to pay the University of Chicago a share of sublicense revenue. The University of Chicago maintains control of patent prosecution, defense and maintenance on their patent rights. The Company has the first right, but not obligation, to control any post-grant proceedings and to take action in the prosecution or prevention of any infringement by a third party to patent rights. The Company is responsible for reimbursing the University of Chicago, or directly paying, for patent prosecution, defense and/or maintenance costs incurred. This includes any costs associated with defense activities related to one of the patents underlying the 2016 University of Chicago Agreement and to which in April 2019 the United States Patent and Trademark Office instituted a post-grant review based on a petition from a third party. For the nine months ended September 30, 2019, the Company has incurred expenses of $1.1 million related to the post grant review.

14


8. Commitments and Contingencies
Lease Obligations
In January 2018, the Company entered into an operating sublease arrangement to lease approximately 40,765 square feet for its office and research development space at 620 Memorial Drive, Cambridge, MA 02139 from February 2018 to September 2025. The Company maintains an additional separate operating lease for office and laboratory space that is scheduled to expire in 2020. The leases require security deposits, which the Company has primarily met with letters of credit from a financial institution that are secured with cash on deposit.
In June 2018, the Company entered into a sublease arrangement with a third party to lease space subject to an operating lease that is scheduled to expire in 2020. The future minimum rental payments to be received under this agreement total $0.3 million and are equivalent to the minimum payments due from the Company to the landlord.
The Company recorded rent expense of $0.7 million and $2.0 million for the three and nine months ended September 30, 2019, respectively. Rent expense for the three and nine months ended September 30, 2019 is net of sublease rental income of $0.1 million and $0.4 million, respectively. Rent expense totaled $0.8 million and $1.5 million for the three and nine months ended September 30, 2018, which is net of sublease rental income of $0.1 million in both periods.
The minimum aggregate future lease commitments, exclusive of any offsetting sublease rental payments, at September 30, 2019, are as follows (in thousands):
Twelve month period ending September 30,
 
Amount
2020
 
$
3,187

2021
 
2,951

2022
 
3,040

2023
 
3,131

2024
 
3,225

Thereafter
 
3,321

 
 
$
18,855


Collaboration Agreement with Sacco S.r.l.
In July 2019, the Company entered into a Collaboration Agreement with Sacco S.r.l. ("Sacco"), an affiliate of one of the Company’s existing contract manufacturing organizations, pursuant to which and subject to certain exceptions for pre-existing products for pre-existing customers, Sacco will manufacture and supply single strain, non-genetically modified microbes intended for oral delivery or oral use in pharmaceutical products exclusively for the Company for a period of five years. Sacco may terminate the agreement if the provision of manufacturing services has been, or is scheduled to be, inactive for a period of six consecutive months. The Company has agreed to pay Sacco an aggregate of €3.0 million, €0.6 million annually, during the exclusivity period. The Company recognized €0.6 million in expense associated with this agreement during the three months ended September 30, 2019.
Equipment Funding Arrangement
In July 2019, the Company entered into an arrangement with one of its external manufacturing partners providing the Company with priority access to future manufacturing services which will be rendered using certain dedicated equipment. In return for such access, the Company committed to provide funding for the purchase of the dedicated equipment in an aggregate amount of £0.8 million, £0.4 million of which to be paid upfront and, subject to the manufacturer's installation and qualification of the equipment, an additional two installments of £0.2 million will be paid in January and April 2020.

15


Biose Industrie
On February 15, 2018, the Company entered into an Exclusivity and Commitment Agreement with Biose Industrie (“Biose”), a French corporation, in which Biose has agreed to exclusively manufacture certain microbial biotherapeutic products for the Company and reserve agreed upon manufacturing resources to conduct manufacturing runs for such products. Under the terms of this agreement, the Company agreed to annual fees in the mid-six digits in consideration of both exclusivity for the manufacture of monoclonal microbials and for a set minimum number of manufacturing runs per year. Exclusivity fees paid and any minimum commitments are expensed as incurred. The Company has agreed to pay an exclusivity fee of $0.3 million per year.
Litigation and Other Proceedings
The Company may periodically become subject to legal proceedings and claims arising in connection with on-going business activities, including claims or disputes related to patents that have been issued or that are pending in the field of research on which the Company is focused. The Company is not a party to any material litigation and does not have contingency reserves established for any litigation liabilities.
In April 2019, the United States Patent and Trademark Office ("USPTO"), granted a third party petition to initiate a post-grant review of a patent issued to the University of Chicago, to which the Company has an exclusive license from the University of Chicago. Although the Company believes that the subject patent is valid, there is a possibility that the USPTO could invalidate the patent or require the University of Chicago to narrow the claims contained in the patent. Under the terms of the license agreement, the Company is responsible for reimbursing the University of Chicago for patent defense costs.
9. Stockholders’ Equity and Convertible Preferred Stock
Common Stock
On April 27, 2018, the Company filed an amendment to its certificate of incorporation with the Secretary of State of the State of Delaware, to effect a 1-for-4.079 reverse stock split of the Company’s common stock. All share and per share data shown in the accompanying condensed consolidated financial statements and related notes have been retroactively revised to reflect the reverse stock split.
On May 11, 2018, the Company completed an IPO of 5,312,500 shares of its common stock for aggregate gross proceeds of $85.0 million. The Company received approximately $75.8 million in net proceeds after deducting underwriting discounts and commissions and other estimated offering expenses payable by the Company. Upon closing of the IPO, all of the outstanding shares of convertible preferred stock automatically converted into 22,386,677 shares of common stock at the applicable conversion ratio then in effect
On May 11, 2018, the Company filed a restated certificate of incorporation with the Secretary of the State of Delaware, which became effective in connection with the closing of the IPO. Pursuant to the restated certificate of incorporation, the Company is authorized to issue 200,000,000 shares of common stock and 10,000,000 shares of preferred stock.
On June 3, 2019, the Company filed a Registration Statement on Form S-3 (File No. 333-231911) (the “Shelf”) with the SEC in relation to the registration of common stock, preferred stock, debt securities, warrants and/or units of any combination thereof in the aggregate amount of up to $200.0 million for a period up to three years from the date of the filing. The Company also simultaneously entered into a sales agreement with Cowen and Company, LLC, as sales agent, providing for the offering, issuance and sale by the Company of up to an aggregate $50.0 million of its common stock from time to time in “at-the-market” offerings under the Shelf. As of September 30, 2019, no securities have been issued pursuant to the sales agreement.
Convertible Preferred Stock
Upon closing of the IPO in May 2018, all 91,315,295 outstanding shares of the Series A, Series A-1, Series A-2, Series A-3, Series B and Series C Preferred Stock (collectively, the "Preferred Stock") automatically converted into 22,386,677 shares of the Company’s common stock at the applicable conversion ratio of 1-for-4.079. Prior to conversion, all shares of Preferred Stock accrued a cumulative dividend of 8% per annum. Dividends for the applicable periods are included in net loss attributable to common shareholders on the condensed consolidated statement of operations through the conversion date. All accrued dividends earned on Preferred Stock were forfeited as of the conversion.

16


In February and March 2018, the Company issued a total of 25,232,199 shares of Series C Preferred Stock at purchase price of $3.23 for gross proceeds of $81.5 million under the same terms as the Series B Preferred Stock.
10. Stock-Based Compensation
2018 Incentive Award Plan
The Company’s board of directors adopted on April 18, 2018, and the Company’s stockholders approved, the 2018 Incentive Award Plan (the “2018 Plan”), which became effective May 8, 2018 and under which the Company may grant cash and equity-based incentive awards to the Company’s employees, officers, directors, consultants and advisors. Following the effectiveness of the 2018 Plan, the Company ceased making grants under the 2015 Stock Incentive Plan (as amended the "2015 Plan"). The 2018 Plan allows the Company to grant awards for up to 1,344,692 shares of common stock plus that number of shares of common stock subject to awards outstanding under the 2015 Plan, that expire, lapse or become terminated or are exchanged for cash, surrendered, repurchased, canceled without having been fully exercised or forfeited. Each year starting with 2019 and ending in and including 2028, the, the number of shares available for grants of awards under the 2018 Plan will be increased automatically on January 1 by a number of shares of common stock equal to the lesser of 4% of the shares of common stock outstanding on the final day of the preceding calendar year or the number of shares determined by the Company’s board of directors. Accordingly, effective January 1, 2019, the number of shares authorized for issuance under the 2018 Plan was increased by 1,273,031 shares. The 2015 Plan continues to govern the terms and conditions of the outstanding awards granted under it. 
The exercise price of stock options granted under the 2018 Plan is not less than the fair market value of a share of the Company’s common stock on the grant date. Other terms of awards, including vesting requirements, are determined by the board of directors and are subject to the provisions of the 2018 Plan. Stock options granted to employees generally vest over a four-year period but may be granted with different vesting terms. Certain options provide for accelerated vesting in the event of a change in control. Awards granted to non-employee consultants generally vest monthly over a period of one to four years. Stock options granted under the 2018 Plan expire no more than 10 years from the date of grant. As of September 30, 2019, equity-based incentive awards for the purchase of up to 2,135,946 shares of the Company’s common stock have been issued under the 2018 Plan, of which 99,196 have been canceled and none have been exercised. As of September 30, 2019, 947,381 shares of common stock are available for future grant under the 2018 Plan, which includes 366,408 shares subject to awards that were originally granted, and have, since the effective date of the 2018 Plan, been canceled or repurchased under the 2015 Plan.
2015 Stock Incentive Plan
Prior to the approval of the 2018 Plan, the Company granted equity awards under the 2015 Plan, which originally provided for grant of incentive stock options, non-qualified stock options, restricted stock awards ("RSAs"), and other stock-based awards to the Company’s employees, officers, directors, consultants and advisors.
The terms of stock awards agreements, including vesting requirements, are determined by the board of directors and are subject to the provisions of the 2015 Plan. Stock options granted to employees generally vest over a four-year period but may be granted with different vesting terms. A limited number of awards contain performance-based vesting criteria and for such awards that are deemed probable of vesting, the Company records expense in the period in which such determination is made through any estimated remaining vesting period. Certain options provide for accelerated vesting in the event of a change in control. Awards granted to non-employee consultants generally vest monthly over a period of one to four years. Stock options issued under the 2015 Plan expire no more than 10 years from the date of grant. As of the adoption of the 2018 Plan, the Company ceased making awards under the 2015 Plan.
Under the 2015 Plan, the Company was authorized to grant equity awards up to an aggregate of 5,417,044 shares of common stock. As of September 30, 2019, an aggregate of 5,758,518 options and other equity awards had been granted under the 2015 Plan, of which 1,100,083 have been exercised and 802,417 have been canceled and 18,468 have been repurchased as of September 30, 2019. A total of 113,006 shares previously reserved under the 2015 Plan that had not been exercised or were otherwise subject to outstanding exercise awards were no longer authorized as of May 8, 2018.

17


Stock-Based Compensation Expense
Stock-based compensation expense included in the Company’s condensed consolidated statements of operations and comprehensive loss is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2019
 
2018
 
2019
 
2018
General and administrative
 
$
1,082

 
$
831

 
$
3,306

 
$
2,727

Research and development
 
980

 
764

 
2,844

 
1,767

Total stock-based compensation expense
 
$
2,062

 
$
1,595

 
$
6,150

 
$
4,494

Stock Options
A summary of the Company’s stock option activity and related information is as follows: 
 
 
Shares
 
Weighted-
Average
Exercise
Price
Options outstanding at December 31, 2018
 
4,917,811

 
$
5.64

Granted
 
1,431,970

 
11.35

Exercised
 
(195,533
)
 
1.44

Canceled
 
(261,467
)
 
8.38

Options outstanding at September 30, 2019
 
5,892,781

 
$
7.05

Exercisable as of September 30, 2019
 
2,230,234

 
$
4.00

The weighted-average fair value of options granted during the nine months ended September 30, 2019 and 2018 was $7.66 and $8.18, respectively.
On January 30, 2018, the Company issued 250,000 shares of Series B Preferred Stock to a non-employee consultant as part of the consideration for services performed and completed in 2017. The Company has recognized $0.7 million as general and administrative expense in the condensed consolidated statement of operations and comprehensive loss, of which $0.1 million was recorded in the nine months ended September 30, 2018.
As of September 30, 2019, total unrecognized stock-based compensation expense relating to unvested stock options was $21.6 million. This amount is subject to change as the unvested portion of the stock options granted to non-employees is subject to re-measurement over the vesting period. This amount is expected to be recognized over a weighted average period of 2.71 years.
2018 Employee Stock Purchase Plan

The Company's board of directors adopted on April 18, 2018, and the Company’s stockholders approved, the 2018 Employee Stock Purchase Plan (the “ESPP”), which became effective on May 8, 2018. A total of 336,356 shares of common stock were initially reserved for issuance under the ESPP. In addition, the number of shares of common stock that may be issued under the ESPP will automatically increase on the first day of each calendar year, beginning in 2020 and ending in and including 2028, by an amount equal to the lesser of (i) 1% of the number of shares of the Company’s common stock outstanding on the last day of the applicable preceding calendar year and (ii) an amount determined by the Company’s board of directors. The plan administrators have proposed, and the Company's board of directors has authorized, an initial offering period under the ESPP commencing on February 1, 2020.
11. Income Taxes
Deferred tax assets and deferred tax liabilities are recognized based on temporary differences between the financial reporting and tax basis of assets and liabilities using statutory rates. A valuation allowance is recorded against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized.

18


There were no significant income tax provisions or benefits for the three or nine months ended September 30, 2019.  Due to losses incurred since inception and the uncertainty surrounding the realization of the favorable tax attributes in future tax returns, the Company has recorded a full valuation allowance against the Company’s otherwise recognizable net deferred tax assets.
12. Net Loss Per Share
Basic and diluted net loss per common share is determined by dividing net loss attributable to common stockholders by the weighted-average common shares outstanding during the period. The Company has computed diluted net loss per common share after giving consideration to all potentially dilutive common shares, including options to purchase common stock, restricted common stock, convertible preferred stock and warrants to purchase convertible preferred stock, outstanding during the period determined using the if-converted and treasury stock methods, except where the effect of including such securities would be antidilutive. Because the Company has reported net losses since inception, these potential common shares have been anti-dilutive and therefore basic and diluted net loss per share have been equivalent.
The following table presents securities that have been excluded from the computations of diluted weighted-average shares outstanding as they would be anti-dilutive:
 
 
Nine Months Ended
September 30,
 
 
2019
 
2018
Unvested common stock from early exercise of options
 
75,043

 
168,947

Stock options to purchase common stock
 
5,892,781

 
4,912,281

Total
 
5,967,824

 
5,081,228

13. Related Party Transactions
The Company receives clinical advisory services from Weatherden Ltd. (“Weatherden”) under agreements that were entered into during 2017 and 2018. Duncan McHale, the Company’s Chief Medical Officer, is a part owner of Weatherden. During the nine months ended September 30, 2019 and 2018, the Company paid Weatherden $0.7 million and $0.5 million, respectively. As of September 30, 2019 and 2018, the amounts due to Weatherden under the supply of service agreement were $0.1 million in both periods.
In June 2018, the Company entered into a subleasing arrangement with Ring Therapeutics (formerly VL46), an affiliate of one of its stockholders, Flagship Venture Funds. Under the terms of the sublease, the Company will invoice Ring Therapeutics for an aggregate $0.9 million in rent payments which are due during the period from July 1, 2018 through May 31, 2020 plus any related taxes and lease operating costs. For the nine months ended September 30, 2019, $0.5 million related to this sublease agreement, inclusive of taxes and operating expenses, has been recorded as an offset to operating expense within the consolidated statements of operations and comprehensive loss.
The Company entered into a consulting agreement with David Epstein (the "Consulting Agreement"), the Company's Chairman of the Board, effective September 16, 2019 pursuant to which Mr. Epstein will provide strategic advisory and other consulting services to the Company. The Consulting Agreement has an one year term and may be earlier terminated by either Mr. Epstein or the Company upon 30 days’ notice, or 24 hours’ notice by the non-breaching party in the event of a breach. In accordance with the terms of the Consulting Agreement, Mr. Epstein was granted an option to purchase 75,000 shares of the Company’s common stock, which award vests in 36 equal monthly installments subject to his continued provision of consulting services to the Company pursuant to the Consulting Agreement on the applicable vesting date. Under the Consulting Agreement, Mr. Epstein also is entitled to receive (i) an annual equity award on each anniversary of the effective date of the Consulting Agreement in the form of an option to purchase shares of the Company’s common stock having an aggregate grant date fair market value equal to approximately $0.2 million, as determined by the Board in its discretion based on customary option pricing methodologies, which award vests in full on the first anniversary of the grant date, subject to his continued provision of consulting services to the Company pursuant to the Consulting Agreement on the applicable vesting date, and (ii) an aggregate annual cash consulting fee of $0.3 million for his consulting services. All of the foregoing options, to the extent then outstanding, will be subject to accelerated vesting upon the occurrence of a change in control of the Company.

19


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2018 (the "2018 Annual Report"), including the audited consolidated financial statements and notes thereto contained in our 2018 Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business, includes forward looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the ‘‘Risk Factors’’ section of this Quarterly Report on Form 10-Q, our actual results could differ materially from the results described, in or implied, by these forward-looking statements. In this Quarterly Report on Form 10-Q, unless otherwise stated or as the context otherwise requires, references to “Evelo,” “Evelo Biosciences,” the “Company,” “we,” “us,” “our” and similar references refer to Evelo Biosciences, Inc. and its consolidated subsidiaries.
Overview
Evelo Biosciences is discovering and developing oral biologics that act on cells in the small intestine with systemic therapeutic effects. These cells in the small intestine play a central role in governing the immune, metabolic and neurological systems. Our first product candidates are monoclonal microbials, single strains of microbes selected for defined pharmacological properties. They have been observed in preclinical models to have systemic dose-dependent effects, modulating multiple clinically-validated pathways. Our product candidates have the potential to be effective, safe and affordable medicines to improve the lives of people with chronic diseases and cancer.

We currently have three product candidates in clinical trials, EDP1066 and EDP1815 for the treatment of inflammatory diseases and EDP1503 for the treatment of cancer. We also are advancing additional oral biologics through preclinical development in other disease areas.
Recent Clinical Developments
EDP1815
EDP1815 is a monoclonal microbial candidate for inflammatory diseases. In November 2018 we initiated our ongoing Phase 1b placebo-controlled dose-escalating safety and tolerability study of EDP1815 in approximately 24 healthy volunteers and up to 108 individuals with mild to moderate psoriasis or atopic dermatitis. The primary endpoint of this trial is safety and tolerability. Prospectively defined secondary and exploratory endpoints include clinical measures of disease, cellular histological biomarkers and blood immune cell biomarkers taken from biopsies and blood samples, respectively, at the start and end of the 28-day dosing period. Safety and tolerability, and secondary clinical endpoints are also measured at day 42, 2 weeks after completion of dosing.

In August 2019, we reported positive interim data from this Phase 1b trial from an initial cohort of 12 individuals with mild to moderate psoriasis dosed once per day for 28 days with 550mg ("1x" or "low" dose) of the enteric capsule formulation of EDP1815. EDP1815 was well tolerated in this cohort with no overall difference reported from placebo.

At the end of the 28-day dosing period, individuals dosed with EDP1815 showed a statistically significant (p<0.05) reduction in mean lesion severity score ("LSS") at 28 days of 2 points, compared to a mean increase of 0.25 points in individuals who received placebo. LSS reductions over the dosing period of individuals dosed with EDP1815 ranged from 0-67 percent. LSS, a secondary endpoint, is a component of the Psoriasis Area and Severity Index ("PASI") score and measures redness, thickness, and scaling of an individual psoriatic lesion and is a sensitive clinical measure for individuals with mild to moderate disease. Trends consistent with the LSS reductions were observed in the reduction of the PASI scores in individuals treated with EDP1815 compared to individuals treated with placebo.

Analysis of the basal epithelium mitotic count, a secondary endpoint and cellular driver of psoriasis pathology, showed a mean reduction over the dosing period of 2.25 cells/mm2 in individuals who received EDP1815 compared to no change in individuals receiving placebo. Lower basal epithelium mitotic counts indicate a reduction of psoriasis pathology. In an analysis of the change over the dosing period of blood immune cell cytokine production following stimulation with lipopolysaccharide, an exploratory endpoint, the individuals dosed with EDP1815 showed a reduction in cytokine production indicative of a systemic anti-inflammatory response, compared to no reduction in the placebo group.


20


In November 2019, we reported additional positive interim clinical data from this ongoing Phase 1b trial in a cohort of eighteen individuals with mild to moderate psoriasis who were randomized 2:1 to receive a daily dose of 2.76g (5x or high dose) of the enteric capsule formulation of EDP1815 or placebo for 28 days.

EDP1815 continued to be well tolerated in this cohort, with no overall difference reported from placebo. At the end of the 28-day dosing period, the high dose cohort showed a mean reduction in LSS consistent with previously reported data from the low dose cohort.

Two weeks following the completion of the dosing period, at day 42, the high dose cohort showed continued reductions from baseline in both mean LSS and PASI, which may be indicative of a sustained clinical effect and dose response.

A summary of the LSS and PASI results are shown in the tables below.

Mean (+/-SE) Percentage Change in LSS vs. Start of Dosing Period (1)
 
n
At end of 28-day
dosing period
At day 42
Placebo (2)
10
0.6% (9.0%)
-7.2% (6.2%)
EDP1815 (high dose)
12
-15.1% (6.4%)
-24.1% (7.1%)
EDP1815 (low dose)
8
-22.8% (9.9%)
-9.0% (12.7%)

Mean (+/-SE) Percentage Change in PASI vs. Start of Dosing Period (1) 
 
n
At end of 28-day
dosing period
At day 42
Placebo (2)
10
-1.0% (13.2%)
-3.3% (14.8%)
EDP1815 (high dose)
12
-16.0% (8.1%)
-20.7% (8.2%)
Note:
(1) This study was not sufficiently powered to detect statistically significant differences in clinical effect between treatment groups.
(2) Represents the combination of placebo arms for the low dose (n=4) and high dose (n=6) cohorts

A range of histological and molecular biomarkers were measured in the high dose cohort, with trends in line with the clinical effects of EDP1815 at the cohort level.

Based on the psoriasis data from the ongoing Phase 1b clinical trial, we plan to advance EDP1815 into Phase 2 in early 2020. This placebo-controlled trial will investigate daily dosing of EDP1815 in individuals with mild to moderate psoriasis over 16 weeks, and the primary endpoint will be a reduction in PASI score. Part A of the trial is designed to select an optimal formulation and will test the high dose of the enteric capsule formulation versus the high dose of a new formulation of EDP1815 versus placebo in approximately 180 individuals. We expect to perform an interim analysis, and to report initial data from Part A of the trial, in late 2020, which will enable the selection of the optimal formulation and potential initiation of Part B. Part B is designed to test three doses of the optimal formulation determined in Part A against placebo in approximately 250 individuals.

Based on the positive results of the ongoing Phase 1b trial and the planned Phase 2 psoriasis study, we will not enroll any further cohorts of individuals with psoriasis in the ongoing Phase 1b trial.

We expect to report additional data from the Phase 1b trial in a cohort of individuals with atopic dermatitis to be dosed with a new formulation of EDP1815 in the second quarter of 2020.

We expect to advance EDP1815 into further inflammatory disease indications after the Phase 2 interim data analysis. Potential indications include psoriatic arthritis, axial spondylarthritis, rheumatoid arthritis atopic dermatitis and asthma.

21


EDP1066
EDP1066 is a monoclonal microbial candidate for inflammatory diseases. In April 2018 we initiated our ongoing Phase 1b placebo-controlled dose-escalating safety and tolerability study of EDP1066 in approximately 36 healthy volunteers and up to 96 subjects with mild to moderate psoriasis or atopic dermatitis. The primary endpoint of this trial is safety and tolerability. Prospectively defined secondary and exploratory endpoints include clinical measures of disease, cellular histological biomarkers and blood immune cell biomarkers taken from biopsies and blood samples, respectively, at the start and end of the 28-day dosing period.
In August 2019, we reported interim clinical data from two cohorts of mild to moderate psoriasis subjects from this Phase 1b trial. EDP1066 was well tolerated with no overall difference reported from placebo. In an analysis of the change over the dosing period of blood immune cell cytokine production following stimulation by lipopolysaccharide, an exploratory endpoint, subjects who received a 3.3g ("5x dose") of EDP1066 showed a reduction in cytokine production consistent with a pharmacodynamic effect. No reduction was observed in subjects receiving a 660mg ("1x dose") of EDP1066 or placebo. No effects were observed in the secondary endpoints of clinical measures of disease or cellular histological biomarkers at either the 660mg or 3.3g dose of EDP1066.
Based on this data and the EDP1815 psoriasis data reported in August 2019, we refocused the ongoing EDP1066 Phase 1b trial on the enrollment of a cohort of mild to moderate atopic dermatitis subjects to be dosed with a new formulation which demonstrated significantly higher potency in preclinical studies. We expect to report data from this cohort in the first quarter of 2020. There will be no further development of EDP1066 in psoriasis.
EDP1503
EDP1503 is a monoclonal microbial candidate for oncology. In December 2018, we initiated our ongoing Phase 1/2 open-label study of EDP1503 in combination with KEYTRUDA (pembrolizumab), Merck's anti-PD-1 therapy, in three groups of patients: microsatellite stable colorectal cancer; triple-negative breast cancer; and patients across multiple tumor types who have relapsed on prior PD-1/L1 inhibitor treatment. We estimate that we will enroll up to 120 subjects in this study which will assess the safety and tolerability, immune response markers and overall response rates achieved with EDP1503 in combination with KEYTRUDA.

In November 2019, we announced that the microsatellite stable colorectal cancer cohort is fully recruited. No clinical responses have been evident, however, several patients in this cohort have experienced extended stable disease. Cellular infiltration biomarker changes were also observed in tumor biopsies taken from those patients during the EDP1503 monotherapy period, which are consistent with preclinical observations for EDP1503. We continue to monitor patients in this cohort.

Given newly approved treatments for triple-negative breast cancer, we anticipate that the majority of triple negative breast cancer patients to be recruited will have relapsed following prior PD-1/L1 therapy, similarly to those in the PD-1 relapsed cohort. We expect to report further clinical data from this trial in the first half of 2020.
In January 2019, the University of Chicago initiated a Phase 2a investigator-sponsored clinical study of EDP1503 in combination with KEYTRUDA in melanoma patients. The University of Chicago will enroll up to 70 PD-1-naïve and PD-1-relapsed melanoma patients in this study which is assessing the safety, tolerability and overall response rates achieved with EDP1503 in combination with KEYTRUDA. Additionally, the University of Chicago will evaluate immune response markers from biopsies taken during the study. Evelo is not issuing guidance related to this investigator-sponsored trial.
In addition to these ongoing clinical trials, we expect to initiate future additional clinical trials related to these product candidates and potential new product candidates. For instance, we expect to continue to conduct immuno-pharmacology clinical trials in healthy volunteers with EDP1066 and EDP1815.
Recent Collaboration Activities
On July 9, 2019, we entered into a Collaboration Agreement with Sacco, an affiliate of one of our existing contract manufacturing partners. Pursuant to the Collaboration Agreement, and subject to certain exceptions for pre-existing products for pre-existing customers, Sacco will manufacture and supply single strain, non-genetically modified microbes intended for oral delivery or oral use in pharmaceutical products exclusively for us for a period of five years. Sacco may terminate the agreement if the provision of manufacturing services has been, or is scheduled to be, inactive for

22


a period of six consecutive months. We have agreed to pay Sacco an aggregate of 3.0 million, 0.6 million annually, during the exclusivity period.
Recent Financing Activities
On July 19, 2019 we entered into a Loan and Security Agreement, as amended with K2 HealthVentures LLC providing for up to $45.0 million in potential debt financing, the proceeds of which were used to prepay our entire existing outstanding loan balance, and additional amounts are intended for the advancement of our research and development activities related to our pipeline of oral biologics and for general corporate purposes. Under terms of the Loan Agreement, the aggregate principal amount of $45.0 million is available in three tranches of term loans of $20.0 million, $10.0 million, and $15.0 million, respectively. At closing on July 19, 2019, we borrowed $20.0 million, representing the first tranche under the 2019 Credit Facility. The second tranche will be available to us between December 1, 2019 and June 1, 2020. The third tranche will be available to us through January 15, 2021, subject to the achievement of certain clinical development milestones. Interest on the outstanding loan balance will accrue at a variable rate equal to the greater of (i) 8.65% and (ii) the prime rate as published in the Wall Street Journal, plus 3.15%. We are required to make monthly interest-only payments through February 2022. If we elect to draw the third tranche, the interest-only period is extended through August 2022. Subsequent to the interest-only period, we are required to make equal monthly principal payments plus any accrued interest until the loans mature in August 2024. Upon final payment or prepayment of the loans, we are required to pay a final payment equal to 4.3% of the loans borrowed.

Contemporaneous with the closing of the first tranche of funding described above, our $15.0 million loan balance outstanding under an existing credit facility, was repaid in full. In accordance with the agreement underlying the prior debt facility, we paid an additional 0.5% prepayment fee as additional expense.
Since our incorporation in 2014, we have devoted substantially all of our resources to developing our clinical and preclinical candidates, building our intellectual property portfolio and process development and manufacturing function, business planning, raising capital and providing general and administrative support for these operations. On May 11, 2018, we completed our IPO of 5,312,500 shares of our common stock at a public offering price of $16.00 per share. The net proceeds from the IPO were approximately $75.8 million. Prior to our IPO, we financed our operations primarily with proceeds from sales of convertible preferred stock to our equity investors and borrowings under a loan and security agreement, as amended, with a financial institution. Through September 30, 2019, we had received aggregate gross proceeds of $262.6 million from sales of common stock, convertible preferred stock and borrowings under our loan and security agreements.
We are a development stage company and have not generated any revenue. All of our product candidates are in early clinical or preclinical development. Our ability to generate product revenue sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our product candidates. Since our inception, we have incurred significant operating losses and we continue to incur significant research and development and other expenses related to our operations. For the nine months ended September 30, 2019, our net loss was $21.6 million. As of September 30, 2019, we had an accumulated deficit of $176.3 million. We do not expect to generate revenue from sales of any products for the foreseeable future, if at all.
We expect that our expenses will increase substantially in connection with our ongoing activities, particularly as we:
continue the ongoing proof of concept trials for EDP1066, EDP1815 and EDP1503;
potentially initiate additional clinical trials for EDP1066, EDP1815 and EDP1503;
initiate or advance the clinical development of additional product candidates;
conduct research and continue preclinical development of potential product candidates;
make strategic investments in manufacturing capabilities, including potentially planning and building our own manufacturing facility;
maintain our current intellectual property portfolio and opportunistically acquire complementary intellectual property;

23


increase employees and employee-related expenses including salaries, benefits, travel and stock-based compensation expense; and
seek to obtain regulatory approvals for our product candidates.
In addition, if we obtain marketing approval for any of our product candidates, we expect to incur significant commercialization expenses related to product manufacturing, marketing, sales and distribution.
As a result, we will need additional financing to support our continuing operations. Until such time as we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of public or private equity or debt financings or other sources, which may include collaborations with third parties. Adequate additional financing may not be available to us on acceptable terms, or at all. Our inability to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategy. We will need to generate significant revenue to achieve profitability, and we may never do so.
Because of the numerous risks and uncertainties associated with drug development, we are unable to predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate revenue from product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations.
As of September 30, 2019, our principal source of liquidity is cash and cash equivalents, which totaled approximately $97.1 million. We expect that our existing cash and cash equivalents, along with the potential to borrow, at Evelo's election between December 1, 2019 and June 1, 2020, the second tranche of $10.0 million under the 2019 Credit Facility, will enable us to fund our planned operating expenses and capital expenditure requirements to the end of 2020. We have based these estimates on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect. See “Liquidity and Capital Resources.”
Financial Operations Overview
Revenue
We have not generated any revenue since our inception and do not expect to generate any revenue from the sale of products in the near future, if at all. If our development efforts for our current product candidates or additional product candidates that we may develop in the future are successful and result in marketing approval or if we enter into collaboration or license agreements with third parties, we may generate revenue in the future from a combination of product sales or payments from such collaboration or license agreements.
Operating Expenses
Our operating expenses since inception have consisted primarily of research and development activities and general and administrative costs.
Research and Development Expenses
Research and development expenses consist primarily of costs incurred for our research activities, including our discovery efforts, and the development of our product candidates, which include:
expenses incurred under agreements with third parties, including investigative sites, external laboratories and contract research organizations ("CROs") that conduct research, preclinical activities and clinical trials on our behalf;
manufacturing process-development costs as well as technology transfer and other expenses incurred with CMOs that manufacture drug substance and drug product for use in our preclinical activities and any current or future clinical trials;
salaries, benefits and other related costs, including stock-based compensation expense, for personnel in our research and development functions;

24


expenses to acquire technologies to be used in research and development;
costs of outside consultants, including their fees, stock-based compensation and related travel expenses;
the cost of laboratory supplies and acquiring, developing and manufacturing preclinical study and clinical trial materials;
costs related to compliance with regulatory requirements; and
facility-related expenses, which include depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs.
We expense research and development costs as incurred. We recognize external development costs based on an evaluation of the progress to completion of specific tasks using information provided to us by our vendors and our clinical investigative sites. Payments for these activities are based on the terms of the individual agreements, which may differ from the pattern of costs incurred, and are reflected in our financial statements as prepaid or accrued research and development expenses. Nonrefundable advance payments for goods or services to be received in the future for use in research and development activities are deferred and capitalized, even when there is no alternative future use for the research and development. The capitalized amounts are expensed as the related goods are delivered or the services are performed.
Our primary focus of research and development since inception has been building a platform to enable us to develop medicines based on an understanding that cells in the small intestine play a central role in governing the immune, metabolic and neurological systems and to show potential clinical utility. Our platform and program expenses consist principally of costs, such as preclinical research, clinical and preclinical manufacturing activity costs, clinical development costs, licensing expense as well as an allocation of certain indirect costs, facility costs and depreciation expense. We do not allocate personnel costs, which primarily include salaries, discretionary bonus and stock-based compensation costs, as such costs are separately classified as research and development personnel costs.
Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect that our research and development expenses will continue to increase in the foreseeable future as we continue to implement our business strategy, continue our ongoing clinical trials for our product candidates, including EDP1066, EDP1815 and EDP1503, initiate additional clinical trials, continue to discover and develop additional product candidates, seek regulatory approvals for any products that successfully complete clinical trials, build manufacturing capabilities, hire additional research and development personnel, and expand into additional therapeutic areas.
At this time, we cannot reasonably estimate or know the nature, timing and estimated costs of the efforts that will be necessary to complete the development of, and obtain regulatory approval for, any of our product candidates. We are also unable to predict when, if ever, material net cash inflows will commence from sales or licensing of our product candidates. This is due to the numerous risks and uncertainties associated with drug development, including the uncertainty of:
our ability to add and retain key research and development personnel;
our ability to successfully develop, obtain regulatory approval for, and then successfully commercialize, our product candidates;
our successful enrollment in and completion of clinical trials;
the costs associated with the development of our current product candidates and/or any additional product candidates we identify in-house or acquire through collaborations;
our ability to discover, develop and utilize biomarkers to demonstrate target engagement, pathway engagement and the impact on disease progression of our product candidates;
our ability to establish an appropriate safety profile with Investigational New Drug-enabling toxicology studies;

25


our ability to establish and maintain agreements with third-party manufacturers and other entities for clinical trial supply and future commercial supply, if our product candidates are approved;
the terms and timing of any collaboration, license or other arrangement, including the terms and timing of any milestone payments thereunder;
our ability to obtain and maintain patent, trade secret and other intellectual property protection and regulatory exclusivity for our product candidates if and when approved;
our receipt of marketing approvals from applicable regulatory authorities;
our ability to commercialize products, if and when approved, whether alone or in collaboration with others; and
the continued acceptable safety profiles of the product candidates following approval.
A change in any of these variables with respect to the development of any of our product candidates would significantly change the costs, timing and viability associated with the development of that product candidate.
General and Administrative Expenses
General and administrative expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation, for personnel in our executive, finance, corporate and business development, and administrative functions. General and administrative expenses also include legal fees relating to patent and corporate matters; professional fees for accounting, auditing, tax and administrative consulting services; insurance costs; administrative travel expenses; and facility-related expenses, which include depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs.
We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support the expected growth in our research and development activities and the potential commercialization of our product candidates. We also expect to incur increased expenses associated with being a public company, including increased costs of accounting, audit, legal, regulatory and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, director and officer insurance costs and investor and public relations costs.
Interest Income (Expense), Net
Interest income (expense), net primarily consists of interest earned on our cash, cash equivalents and short-term investments balances offset by interest expense incurred on our debt. During each of the three and nine month periods ended September 30, 2019 and 2018, interest income (expense), net consisted primarily of interest earned on institutional money market instruments and U.S. treasury securities offset by interest at the stated rate on borrowings under our loan and security agreements and amortization of deferred financing costs and interest expense related to the accretion of debt discount.
Other Expenses
Other expenses for the three and nine months ended September 30, 2019 primarily consist of loss on extinguishment of debt related to unamortized debt discount and a prepayment penalty for the repayment of the prior debt facility. For the three and nine months ended September 30, 2018, other expenses consist of non-cash changes in the fair value of warrants issued in connection with our previous loan and security agreement with Pacific Western Bank, all of which were settled in 2018.
Income Taxes
Since our inception in 2014, we have not recorded any U.S. federal or state income tax benefits for the net losses we have incurred in each year or our earned research and development tax credits, due to our uncertainty of realizing a benefit from those items.

26


Results of Operations
Comparison of the Three Months Ended September 30, 2019 and 2018
The following table summarizes our results of operations for the three months ended September 30, 2019 and 2018 (in thousands):
 
 
Three Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
Operating expenses:
 
 
 
 
 
 
Research and development
 
$
15,610

 
$
11,227

 
$
4,383

General and administrative
 
5,886

 
5,230

 
656

Total operating expenses
 
21,496

 
16,457

 
5,039

Loss from operations
 
(21,496
)
 
(16,457
)
 
(5,039
)
Other (expense) income:
 
 
 
 
 

Interest income, net
 
81

 
600

 
(519
)
Other expense
 
(218
)
 

 
(218
)
Other income (expense), net
 
(137
)
 
600

 
(737
)
Net loss
 
$
(21,633
)
 
$
(15,857
)
 
$
(5,776
)
Research and Development Expenses (in thousands):
 
 
Three Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
Platform expenses
 
$
4,182

 
$
2,287

 
$
1,895

Inflammation programs
 
5,039

 
3,759

 
1,280

Oncology programs
 
1,697

 
1,976

 
(279
)
Research and development personnel costs (including stock-based compensation)
 
4,692

 
3,205

 
1,487

Total research and development expenses
 
$
15,610

 
$
11,227

 
$
4,383

Research and development expenses were $15.6 million for the three months ended September 30, 2019, compared to $11.2 million for the three months ended September 30, 2018. The increase of $4.4 million was due primarily to an increase of $1.3 million in costs for our inflammation programs, driven primarily by clinical trial expenses, as well as an increase of $1.9 million in platform expenses in line with our strategy to maximize the potential of our platform. Personnel costs increased $1.5 million due primarily to increases in research and development headcount and compensation, including an increase of $0.2 million in stock-based compensation expense. These increases were partially offset by a decrease of $0.3 million for our oncology program due to the timing of clinical activity. We expect that our research and development expenses will continue to increase in the foreseeable future as we continue our clinical trials for our product candidates, initiate new clinical trials, continue discovery and development efforts for additional product candidates, hire additional research and development personnel and seek to increase manufacturing capabilities and possibly expand into additional therapeutic areas.

27


General and Administrative Expenses (in thousands):
 
 
Three Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
General and administrative personnel costs (including stock-based compensation)
 
$
3,154

 
$
2,372

 
$
782

Professional fees
 
1,682

 
1,819

 
(137
)
Facility costs, office expense and other
 
1,050

 
1,039

 
11

Total general and administrative expenses
 
$
5,886

 
$
5,230

 
$
656

General and administrative expenses were $5.9 million for the three months ended September 30, 2019, compared to $5.2 million for the three months ended September 30, 2018. The increase of $0.7 million primarily reflects costs required to support our growing organization and public company status. Professional fees decreased $0.1 million, reflecting a decrease in consulting expenses offset by increases in legal and patent costs, including $0.6 million related to the ongoing post-grant review of a patent issued to the University of Chicago, as well as increases in other professional fees. Personnel costs increased by $0.8 million, due primarily to increases in general and administrative headcount and compensation. The increase in personnel costs includes an increase of $0.3 million in stock-based compensation expense. We expect general and administrative expenses to continue to increase due to higher personnel and related costs, professional fees, and consulting expenses in support of our continued growth.
Other Income (Expense), Net
Other income (expense), net for the three months ended September 30, 2019 was expense of $0.1 million compared to income of $0.6 million for the three months ended September 30, 2018. This change was primarily driven by an increase in interest expense due to a higher interest rate on a greater principal balance from our 2019 Credit Facility. Additionally, we recorded $0.2 million for extinguishment of debt due to the repayment of our prior debt facility in July 2019.
Net Loss
Net loss for the three months ended September 30, 2019 was $21.6 million, compared to $15.9 million for the three months ended September 30, 2018.
Comparison of the Nine Months Ended September 30, 2019 and 2018
The following table summarizes our results of operations for the nine months ended September 30, 2019 and 2018 (in thousands):
 
 
Nine Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
Operating expenses:
 
 
 
 
 
 
Research and development
 
$
46,751

 
$
28,542

 
$
18,209

General and administrative
 
16,936

 
13,568

 
3,368

Total operating expenses
 
63,687

 
42,110

 
21,577

Loss from operations
 
(63,687
)
 
(42,110
)
 
(21,577
)
Other (expense) income:
 
 
 
 
 

Interest income (expense), net
 
1,032

 
1,013

 
19

Other expense
 
(218
)
 
(406
)
 
188

Other income (expense), net
 
814

 
607

 
207

Net loss
 
$
(62,873
)
 
$
(41,503
)
 
$
(21,370
)

28


Research and Development Expenses (in thousands):
 
 
Nine Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
Platform expenses
 
$
9,228

 
$
6,117

 
$
3,111

Inflammation programs
 
17,191

 
9,821

 
7,370

Oncology programs
 
6,723

 
3,905

 
2,818

Other program expenses
 

 
43

 
(43
)
Research and development personnel costs (including stock-based compensation)
 
13,609

 
8,658

 
4,951

Total research and development expenses
 
$
46,751

 
$
28,544

 
$
18,207

Research and development expenses were $46.8 million for the nine months ended September 30, 2019, compared to $28.5 million for the nine months ended September 30, 2018. The increase of $18.2 million was due primarily to increases of $7.4 million in costs for our inflammation programs, driven primarily by clinical trial expenses and external manufacturing costs, an increase of $2.8 million for our oncology programs, related primarily to increased costs associated with clinical development activities, as well as an increase of $3.1 million in platform expenses in line with our strategy to maximize the potential of our platform. Personnel costs increased $5.0 million due primarily to increases in research and development headcount and compensation, including an increase of $1.1 million in stock-based compensation expense.
General and Administrative Expenses (in thousands):
 
 
Nine Months Ended
September 30,
 
 
 
 
2019
 
2018
 
Change
General and administrative personnel costs (including stock-based compensation)
 
$
9,087

 
$
6,474

 
$
2,613

Professional fees
 
4,524

 
4,116

 
408

Facility costs, office expense and other
 
3,325

 
2,978

 
347

Total general and administrative expenses
 
$
16,936

 
$
13,568

 
$
3,368

General and administrative expenses were $16.9 million for the nine months ended September 30, 2019, compared to $13.6 million for the nine months ended September 30, 2018. The increase of $3.4 million primarily reflects costs required to support our growing organization and public company status. Personnel costs increased by $2.6 million, due primarily to increases in general and administrative headcount and compensation, including an increase of $0.6 million in stock-based compensation expense. Professional fees increased $0.4 million, reflecting increases in legal and patent costs, including $1.1 million related to the ongoing post-grant review of a patent issued to the University of Chicago, as well as increases in other professional consulting fees. Facility, office and other costs increased $0.3 million, primarily due to increased costs to support corporate operational activities including the expansion of our leased space to support our continued growth.
Other Income (Expense), Net
Other income (expense), net for the nine months ended September 30, 2019 was income of $0.8 million, compared to $0.6 million for the nine months ended September 30, 2018. This change was primarily driven by a decrease in net other expense of approximately $0.2 million, driven by the prior period including expense associated with the change in fair value of our warrant liabilities which were settled in the prior year period, partially offset by debt extinguishment charges in the nine months ended September 30, 2019
Net Loss
Net loss for the nine months ended September 30, 2018 was $62.9 million, compared to $41.5 million for the nine months ended September 30, 2018.

29


Liquidity and Capital Resources
We have incurred losses and generated negative operating cash flows since our inception and anticipate that we will continue to incur losses for at least the next several years. We incurred net losses of approximately $21.6 million and $15.9 million for the three months ended September 30, 2019 and 2018, respectively. To date, we have financed our operations primarily with proceeds from the initial public offering of our common stock, sales of our convertible preferred stock to our equity investors and borrowings under our debt facilities. From our inception through September 30, 2019, we have received gross proceeds of $262.6 million from such transactions, including a net $20.0 million borrowed under our debt facilities. As of September 30, 2019, we had cash and cash equivalents of $97.1 million and an accumulated deficit of $176.3 million.
On June 3, 2019, we entered into a sales agreement with Cowen and Company, LLC, as sales agent, pursuant to which we may, from time to time, issue and sell up to an aggregate of $50.0 million of our common stock in “at-the-market” offerings. As of September 30, 2019, no securities had been issued pursuant to the sales agreement.
On May 11, 2018, we completed our IPO of 5,312,500 shares of common stock at a public offering price of $16.00 per share. The gross proceeds from the IPO were $85.0 million and the net proceeds were approximately $75.8 million, after deducting underwriting discounts and commissions and other estimated offering expenses payable by us.
On July 19, 2019 we entered into the 2019 Credit Facility with K2HV providing for up to $45.0 million of current and future potential debt financing. The aggregate principal amount is available in three tranches of term loans of $20.0 million, $10.0 million, and $15.0 million, respectively. At closing on July 19, 2019, we withdrew initial proceeds of $20.0 million representing the first tranche under the 2019 Credit Facility. The second tranche will be available to us between December 1, 2019 and June 1, 2020. The third tranche will be available to us through January 15, 2021, subject to the achievement of certain clinical development milestones.
Interest on the outstanding loan balance will accrue at a variable rate equal to the greater of (i) 8.65% and (ii) the prime rate as published in the Wall Street Journal, plus 3.15%. We are required to make monthly interest-only payments through February 2022. If we elect to draw the third tranche, the interest-only period is extended through August 2022. Subsequent to the interest-only period, we are required to make equal monthly principal payments plus any accrued interest until the loans mature in August 2024. Upon final payment or prepayment of the loans, we are required to pay a final payment equal to 4.3% of the loans borrowed. We have an option to prepay the loans in whole, subject to a prepayment fee of 2% of the amount prepaid or, if the prepayment occurs after the 18-month anniversary of the funding date of the loans, 1% of the amount prepaid.

Contemporaneous with the closing of the first tranche of funding described above, we repaid the entire $15.0 million loan balance outstanding under an existing loan and security agreement with a separate financial institution. In accordance with the agreement underlying the prior debt facility, we paid an additional 0.5% prepayment fee as additional expense.
We expect that our existing cash and cash equivalents, along with the capacity to borrow an additional $10.0 million under the 2019 Credit Facility, will enable us to fund our planned operating expenses and capital expenditure requirements to the end of 2020.
Until such time, if ever, as we can generate revenue from product sales, we expect to finance our cash needs through a combination of equity offerings, debt financings and potential collaborations, license and development agreements. To the extent that we raise additional capital through future equity offerings or debt financings, ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of the common stockholders. Debt and equity financings, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. There can be no assurance that such financings will be obtained on terms acceptable to us, if at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us we may have to significantly delay, scale back or discontinue our research and development programs or future commercialization efforts. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties for one or more of our current or future drug candidates, we may be required to relinquish valuable rights to our technologies, future revenue streams, research programs or drug candidates or to grant licenses on terms that may not be favorable to us. Our failure to raise capital as and when needed would have a material adverse effect on our financial condition and our ability to pursue our business strategy.

30


Cash Flows
The following table summarizes our sources and uses of cash for each of the periods presented (in thousands):
 
 
Nine Months Ended
September 30,
 
 
2019
 
2018
Cash used in operating activities
 
$
(52,986
)
 
$
(31,823
)
Cash provided by/(used in) investing activities
 
52,433

 
(88,709
)
Cash provided by financing activities
 
4,763

 
161,994

Net increase in cash, cash equivalents and restricted cash
 
$
4,210

 
$
41,462

Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2019 was $53.0 million driven primarily by our net loss of $62.9 million partially offset by non-cash charges including stock-based compensation expense of $6.2 million and depreciation expense of $1.3 million and changes in components of working capital.
Net cash used in operating activities for the nine months ended September 30, 2018 was $31.8 million driven primarily by our net loss of $41.5 million. This was partially offset by a net change in working capital of $3.1 million, non-cash charges including stock-based compensation expense of $4.5 million, depreciation expense of $1.6 million, and a change in fair value of warrant liability and debt derivative of $0.4 million.
Investing Activities
Net cash provided by investing activities for the nine months ended September 30, 2019 was $52.4 million, primarily consisting of the maturity of investments totaling $55.0 million. This was partially offset by the purchase of capital equipment which totaled $2.6 million during the period.
Net cash used in investing activities for the nine months ended September 30, 2018 was $88.7 million, primarily consisting of the purchase of investments totaling $84.7 million. Additionally, the purchase of capital equipment totaled $4.2 million during the period, which was slightly offset by $0.2 million of cash received for the sale of equipment.
Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2019 was $4.8 million, primarily due to proceeds from the issuance of long-term debt under our 2019 Credit Facility and proceeds from the issuance of common stock in connection with the exercise of option totaling $0.3 million, partially offset by the repayment of our prior debt facility.
Net cash provided by financing activities for the nine months ended September 30, 2018 was $162.0 million, primarily consisting of the net proceeds of $75.8 million from our IPO, net proceeds of $81.3 million from the issuance of our Series C Preferred Stock as well as net proceeds of approximately $5.0 million from the issuance of long-term debt, partially offset by a payment made for the settlement of a derivative liability of $0.3 million.
Contractual Obligations and Commitments
On July 19, 2019 we entered into the Loan Agreement with K2HV providing for up to $45.0 million of current and future potential debt financing in three tranches. At closing, we drew $20.0 million of proceeds which were available under the first tranche of this debt facility and contemporaneously repaid the entire $15.0 million outstanding under the 2016 Credit Facility, including a 0.5% prepayment fee. Under the Loan Agreement, a second tranche of $10.0 million will be available to us, at our election, between December 1, 2019 and June 1, 2020, subject to certain customary conditions, and a third tranche of $15.0 million will be available to us through January 15, 2021, subject to the achievement of certain clinical development milestones. Interest on the outstanding loan balance will accrue at a variable rate equal to the greater of (i) 8.65% and (ii) the prime rate as published in the Wall Street Journal, plus 3.15%. We are required to make monthly interest-only payments through February 2022 or, if the third tranche is drawn, August 2022. Subsequent to the interest-only period, principal payments will commence in March 2022 or September 2022, as

31


applicable, with equal payments plus accrued interest being made by us in consecutive monthly installments until the loans mature in August 2024. Upon final payment or prepayment of the loans, we are required to make a final payment equal to 4.3% of the loans borrowed. At our option, we may prepay the loans in whole, subject to a prepayment fee of 2% of the amount prepaid or, if the prepayment occurs after the 18-month anniversary of the funding date of the loans, 1% of the amount prepaid. Based on the above and using our initial interest rate of 8.65%, minimum contractual interest and principal payments due under our 2019 Credit Facility from December 31, 2018 will total approximately: $0.6 million within 1 year; $3.5 million between 1 to 3 years; $17.1 million between 4-5 years; and $6.4 million thereafter.
In July 2019, we entered into the Collaboration Agreement with a CMO. Pursuant to the agreement, the CMO has agreed that subject to certain exceptions, it will exclusively provide specified manufacturing services for us over a period of five years. We have committed to pay the CMO an aggregate of 3.0 million, 0.6 million annually, during the exclusivity period.
Also in July 2019, we entered into an arrangement with one of our external manufacturing partners to fund the purchase of certain dedicated equipment that will be used in manufacturing for an aggregate amount of £0.8 million, £0.4 million to be paid upfront and, subject to the manufacturer's installation and qualification of the equipment, the additional two equal installments of £0.2 million will be paid in January and April 2020.
Other than as described immediately above, there have been no material changes to our contractual obligations and commitments included in our Annual Report on Form 10-K for the year ended December 31, 2018.
Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.
Recent Accounting Pronouncements
For a discussion of recently adopted or issued accounting pronouncements please refer to Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Use of Estimates
Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities in our consolidated financial statements, as well as the reported revenues and expenses during the reporting periods. These items, including accrued research and development expenses and stock-based compensation, are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience, known trends and events, 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. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions. In making estimates and judgments, management employs critical accounting policies.
There have been no material changes to our critical accounting policies from those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K that was filed with the SEC on February 15, 2019.

32


Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Fluctuation Risk
We are exposed to market risk related to changes in interest rates. As of September 30, 2019, our cash and cash equivalents consisted of cash, money market accounts and U.S. treasury securities. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates. However, because of the short-term nature of the instruments in our portfolio, an immediate 10% change in market interest rates would not have a material impact on the fair market value of our investment portfolio or on our financial position or results of operations.
In July 2019, we received proceeds of $20.0 million under the 2019 Credit Facility. This term loan bears interest at a variable annual rate equal to the greater of (i) 8.65% and (ii) the prime rate plus 3.15%, thereby exposing us to interest rate risk. Based upon the prime rate at September 30, 2019 of 5.00% and considering the $20.0 million of borrowings described above, an immediate 10% change in the prime rate would have no impact on our interest to be paid annually and therefore would not have a material impact on our debt-related obligations, financial position or results of operations.
Foreign Currency Fluctuation Risk
We are not currently exposed to significant market risk related to changes in foreign currency exchange rates; however, we have contracted with and may continue to contract with foreign vendors that are located in Europe.
Our operations may be subject to fluctuations in foreign currency exchange rates in the future.
Inflation Fluctuation Risk
Inflation generally affects us by increasing our cost of labor and clinical trial costs. We do not believe that inflation had a material effect on our business, financial condition or results of operations during the three and nine months ended September 30, 2019 and 2018.
Item 4. Controls and Procedures.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated, as of the end of the period covered by this Quarterly Report on Form 10-Q, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2019.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

33


PART 2—OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time we may be involved in claims and proceedings arising in the course of our business. The outcome of any such claims or proceedings, regardless of the merits, is inherently uncertain. For example, in April 2019, the United States Patent and Trademark Office ("USPTO") granted Genome & Co.'s petition to initiate a post-grant review of a patent issued to the University of Chicago, to which we have an exclusive license from the University of Chicago. Although we believe that the subject patent is valid, there is a possibility that the USPTO could invalidate the patent or require the University of Chicago to narrow the claims contained in the patent. Under the terms of our license agreement we are responsible for reimbursing the University of Chicago for patent defense costs.
Item 1A. Risk Factors.
Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this Quarterly Report on Form 10-Q, including our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” before deciding whether to invest in our common stock. The occurrence of any of the events or developments described below could harm our business, financial condition, results of operations and growth prospects. In such an event, the market price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Financial Position and Need for Additional Capital
We are a development-stage company and have incurred significant losses since our inception. We expect to incur losses for the foreseeable future and may never achieve or maintain profitability.
Since inception, we have incurred significant operating losses. Our net loss was $21.6 million and $62.9 million for the three and nine months ended September 30, 2019, respectively, and $56.9 million, $28.0 million and $13.3 million for the years ended December 31, 2018, 2017 and 2016, respectively. As of September 30, 2019, we had an accumulated deficit of $176.3 million. Through September 30, 2019, we have financed our operations through private placements of our preferred stock, borrowings under our previous loan and security agreement with Pacific Western Bank and our current loan and security agreement with K2 HealthVentures LLC and other parties ("K2HV") and proceeds from our initial public offering which was completed in May 2018. We have devoted substantially all of our financial resources and efforts to developing our monoclonal microbial platform, identifying potential product candidates and conducting preclinical and clinical studies. We are in the early stages of developing our product candidates, and we have not completed the development of any monoclonal microbial therapies or other drugs or biologics. We expect to continue to incur significant expenses and operating losses for the foreseeable future. We anticipate that our expenses will increase substantially as we:
seek to enhance our monoclonal microbial platform and discover and develop additional product candidates;
seek regulatory approvals for any product candidates that successfully complete clinical trials;
seek to establish a sales, marketing and distribution infrastructure and scale-up manufacturing capabilities to commercialize any products for which we may obtain regulatory approval;
maintain, expand and protect our intellectual property portfolio; and
add clinical, scientific, operational, financial and management information systems and personnel, including personnel to support our product development and potential future commercialization efforts and to support our operations as a public company.
In addition, we anticipate that our expenses will increase substantially if we experience any delays or encounter any issues with any of the above, including but not limited to failed studies, complex results, safety issues or other regulatory challenges.
To become and remain profitable, we must succeed in developing and eventually commercializing products that generate significant revenue. This will require us to be successful in a range of challenging activities, including completing preclinical testing and clinical trials of our product candidates, discovering additional product candidates,

34


obtaining regulatory approval for these product candidates and manufacturing, marketing and selling any products for which we may obtain regulatory approval. We are only in the preliminary stages of most of these activities. We may never succeed in these activities and, even if we do, may never generate revenue that is significant enough to achieve profitability.
Because of the numerous risks and uncertainties associated with pharmaceutical product and biological product development, we are unable to accurately predict the timing or amount of increased expenses or when, or if, we will be able to achieve profitability. If we are required by the U.S. Food and Drug Administration ("FDA") or the European Medicines Agency ("EMA") or other regulatory authorities to perform preclinical or clinical studies in addition to those currently expected, or if there are any delays in completing our preclinical studies or clinical trials or the development of any of our product candidates, our expenses could increase and revenue could be further delayed.
Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would depress our value and could impair our ability to raise capital, expand our business, maintain our research and development efforts, diversify our product offerings or even continue our operations.
We will need additional funding in order to complete development of our product candidates and commercialize our products, if approved. If we are unable to raise capital when needed, we could be forced to delay, reduce or discontinue our product development programs or commercialization efforts.
We expect our expenses to increase in connection with our ongoing activities, particularly as we conduct clinical trials, build manufacturing capacity and expand into additional therapeutic areas.