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DURATA THERAPEUTICS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the notes to those financial statements appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2013 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 14, 2014. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth in Part II, Item 1A. Risk Factors of this Quarterly Report on Form 10-Q, our actual results may differ materially from those anticipated in these forward-looking statements. Overview We are a pharmaceutical company focused on the development and commercialization of new therapeutics for patients with infectious diseases and acute illnesses. We submitted a new drug application, or NDA, to the U.S. Food and Drug Administration, or FDA, on September 26, 2013 for dalbavancin for the treatment of acute bacterial skin and skin structure infections (ABSSSI) caused by certain susceptible bacteria. On November 25, 2013, the FDA accepted our NDA for priority review with an action date of May 26, 2014. On May 23, 2014, the U.S. Food and Drug Administration (FDA) approved Dalvance™ (dalbavancin) for injection for the treatment of adult patients with acute bacterial skin and skin structure infections (ABSSSI) caused by susceptible Gram-positive bacteria, including methicillin-resistant Staphylococcus aureus (MRSA). Dalvance is the first and only IV antibiotic approved for the treatment of ABSSSI with a two-dose regimen of 1000 mg followed one week later by 500 mg, each administered over 30 minutes. Sales of dalbavancin in the United States commenced in late July 2014. Dalbavancin is designated as a Qualified Infectious Disease Product (QIDP) by the FDA. Dalbavancin's QIDP designation qualifies it for an additional five years of marketing exclusivity to be added to certain exclusivity periods already provided by the Food, Drug and Cosmetic Act. We have completed two global Phase 3 clinical trials with dalbavancin for the treatment of patients with ABSSSI. We announced the preliminary top line results of our first Phase 3 clinical trial, which we refer to as DISCOVER 1, in December 2012, and our second Phase 3 clinical trial, which we refer to as DISCOVER 2, in February 2013. Based on final data from DISCOVER 1 and DISCOVER 2, or the DISCOVER trials, dalbavancin achieved its primary efficacy endpoint of non-inferiority, which was clinical response at 48 to 72 hours after initiation of therapy, as determined by the cessation of spread of the lesion, as well as the resolution of fever. Dalbavancin also achieved its secondary efficacy endpoint in the DISCOVER trials, which was clinical success at the end of treatment. We expect that this secondary endpoint will be the primary measure of efficacy for regulatory review in Europe. We submitted a marketing authorization application, or MAA, to the European Medicines Agency, or EMA, on November 27, 2013. On December 20, 2013, the EMA accepted our MAA for review. We are directly commercializing dalbavancin in the United States and, if approved in the European Union, we may also directly commercialize dalbavancin in Western Europe with a targeted hospital sales force and may use a variety of types of collaboration arrangements for commercialization in other markets. On July 29, 2014 we entered into a license agreement and a supply agreement with Angelini (A.C.R.A.F. S.p.A.) for the purpose of allowing Angelini to commercialize dalbavancin in certain European markets. In April 2014, we initiated enrollment in a Phase 3b clinical trial to evaluate the efficacy and safety of a single 1500 mg dose of dalbavancin infused over 30 minutes in adult patients with ABSSSI caused by susceptible Gram-positive bacteria, which we refer to as our single dose study. This Phase 3b multicenter, double-blind, randomized, controlled clinical trial is designed to compare a single dose of dalbavancin with the same two dose, once weekly regimen of dalbavancin that was used in each of the previously conducted Phase 3 clinical trials for dalbavancin. We plan to enroll approximately 410 adult patients with ABSSSI known or suspected to be caused by susceptible Gram-positive bacteria, including methicillin-resistant Staphylococcus aureus, commonly referred to as MRSA. We are randomizing adult patients in the single dose study to receive either one 1500 mg single dose of dalbavancin on day 1 or two doses of dalbavancin, with a 1000 mg dose on day 1 followed by a 500 mg dose on day 8. All doses will be administered over 30 minutes through a peripheral intravenous line. The primary outcome measure for efficacy evaluation will be the percentage of patients in each treatment group who demonstrate a clinical response at 48 to 72 hours after the initiation of therapy with study medication. The study was designed to meet the new standards required by regulatory authorities for antibiotic development in the United States. We are also currently developing protocols for two additional Phase 3 clinical trials to evaluate efficacy and safety of dalbavancin in patients with pediatric osteomyelitis and with community-acquired pneumonia. We expect both of these trials to begin enrollment in late 2014 to early 2015. We acquired our rights to dalbavancin through our acquisition of all of the outstanding shares of capital stock of Vicuron Pharmaceuticals Inc., or Vicuron, from Pfizer Inc., or Pfizer, in December 2009. We paid total up-front consideration of $10.0 million for the Vicuron shares and dalbavancin inventory to be used in research. In March 2011, Pfizer refunded to us $6.0 million of the initial purchase price under the terms of our stock purchase agreement, or Pfizer Agreement, based on documentation we provided that supported the position that marketing approval for dalbavancin required more than one new Phase 3 clinical trial. Following the first commercial sale of dalbavancin for the treatment of adult patients with ABSSSI in the United States, which occurred in late July 2014, we became obligated to pay Pfizer an additional milestone payment of $25.0 million. However, pursuant to the Pfizer Agreement, we will elect to defer the milestone payment for a period of up to five years by delivering to Pfizer a promissory note, in late August 2014, for the full amount of such milestone payment. Interest on the outstanding principal amount of the promissory note will accrue at a rate of 10% per annum, compounded -15- -------------------------------------------------------------------------------- Table of Contents annually. Under our credit agreement with PDL BioPharma, Inc., or PDL, discussed in note 5 to our financial statements, Long-term Debt, we are prohibited from making any payment to Pfizer as long as amounts are outstanding under the credit agreement, which we refer to as the PDL credit agreement. We were incorporated and commenced active operations in the fourth quarter of 2009. Our operations to date have been limited to organizing and staffing our company, business planning, raising capital, acquiring and developing dalbavancin and building our commercialization and marketing infrastructure. Through June 30, 2014, we have not generated any revenues. We have financed our operations primarily with net proceeds from private placements of our preferred stock, our initial public offering of common stock, which we closed in July 2012, a secured debt financing, which we completed in March 2013 and refinanced with a new lender in October 2013, and a public offering of our common stock, which we closed in April 2013. As of June 30, 2014, we had a deficit accumulated during the development stage of $207.3 million. Our net loss was $37.9 million for the six month period ended June 30, 2014. In March 2013, we and certain of our subsidiaries entered into a loan and security agreement, or loan agreement, with Oxford Finance LLC, or Oxford, pursuant to which our wholly-owned Dutch subsidiaries borrowed an aggregate principal amount of $20.0 million. On October 31, 2013, we and certain of our subsidiaries entered into the PDL credit agreement, pursuant to which our wholly-owned Dutch subsidiaries borrowed an aggregate principal amount of $25.0 million, and upon marketing approval of dalbavancin on May 23, 2014 we borrowed, as required, an additional aggregate principal amount of $15 million. Upon the satisfaction of certain conditions to funding set forth in the PDL credit agreement, and for up to nine months following regulatory approval in May 2014, we have the option to borrow an additional aggregate principal amount of up to $30.0 million. Amounts borrowed under the PDL credit agreement are guaranteed by us and certain of our subsidiaries. The loans are secured by a lien on all or substantially all of our assets and all or substantially all of the assets of our subsidiaries (other than Durata Therapeutics Limited), including the pledge of the equity interests in each of our subsidiaries. Pursuant to the PDL credit agreement, in October 2013 we repaid in full amounts outstanding under the Oxford loan agreement, including prepayment penalties and fees, and our arrangement with Oxford was terminated. In April 2013, we closed a public offering of 8,222,500 shares of common stock at a public offering price of $7.00 per share, including 1,072,500 shares pursuant to the exercise by the underwriters of an over-allotment option. Net proceeds were approximately $54.1 million, after deducting underwriting discounts and commissions but prior to the payment of offering expenses payable by us. We expect to continue to incur significant expenses particularly as we commercialize dalbavancin, seek marketing approval for product candidates, build our commercial organization, conduct clinical trials for additional indications for dalbavancin, including osteomyelitis, diabetic foot infection and pneumonia, as well as new dosing strategies and formulations, and manufacture product. In addition, based upon the marketing approval of dalbavancin, and if we obtain marketing approval of any other product candidate that we develop, we expect to incur significant sales, marketing, distribution and outsourced manufacturing expenses, as well as ongoing research and development expenses. Furthermore, we are incurring additional costs associated with operating as a public company. These costs include significant legal, accounting, investor relations and other expenses that we did not incur as a private company. Moreover, additional rules and regulations applicable to public companies will continue to increase our legal and financial compliance costs and make some activities more time-consuming and costly. Accordingly, we may need to obtain substantial additional funding in connection with our continuing operations. Adequate additional financing may not be available to us on acceptable terms, or at all. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or any future commercialization efforts. We will need to generate significant revenues to achieve profitability, and we may never do so. Financial Operations Overview Revenue Through June 30, 2014, we have not generated any revenues. Our ability to generate product revenues, will depend heavily on our ability to successfully commercialize dalbavancin. Research and Development Expenses Research and development expenses consist of costs associated with our research activities, and the development and clinical testing of dalbavancin. Our research and development expenses consist of: • employee-related expenses, including salaries, benefits, travel and share-based compensation expense; -16- -------------------------------------------------------------------------------- Table of Contents • external research and development expenses incurred under arrangements with third parties, such as contract research organizations, or CROs, manufacturing organizations and consultants, including our scientific advisory board; and • facilities and laboratory and other supplies. We expense research and development costs to operations as incurred. We account for non-refundable advance payments for goods and services that will be used in future research and development activities as expenses when the service has been performed or when the goods have been received, rather than when the payment is made. We intend in the future to use our employee and infrastructure resources across multiple research and development projects. We do not allocate employee-related expenses or depreciation to any particular project. To date, the large majority of our research and development work has related to dalbavancin and completing clinical testing to support approval to market dalbavancin for the treatment of adult patients with ABSSSI, which was received in May 2014. We anticipate that we will continue to incur significant research and development expenses in connection with clinical trials for additional indications and new dosing strategies and formulations for dalbavancin, manufacturing product candidates and with seeking marketing approval for possible other product candidates. The successful development of dalbavancin and future product candidates is highly uncertain. This is due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of: • the scope, rate of progress and expense of our research and development activities; • our ability to market, commercialize and achieve market acceptance for dalbavancin or any other product candidate that we may develop in the future; • clinical trial results; • the terms and timing of regulatory approvals; and • the expense of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights. A change in the outcome of any of these variables with respect to the development of dalbavancin or any other product candidate that we may develop could mean a significant change in the costs and timing associated with the development of dalbavancin or such product candidate. For example, if the FDA or other regulatory authority were to require us to conduct clinical trials beyond those which we currently anticipate will be required for the completion of clinical development of product candidates or if we experience significant delays in enrollment in any clinical trials of product candidates, we could be required to expend significant additional financial resources and time on the completion of the clinical development. General and Administrative Expenses General and administrative expenses consist primarily of salaries and related costs for personnel, including share-based compensation expense, in our executive, finance, medical affairs, marketing and business development functions. Other general and administrative expenses include facility costs and professional fees for legal, patent, consulting and accounting services. We anticipate that our general and administrative expenses will increase in future periods to support increases in our commercialization activities and research and development and as a result of increased headcount, expanded infrastructure, increased legal, compliance, accounting and investor and public relations expenses associated with being a public company and increased insurance premiums, among other factors. Acquisition Related Charges, Net In connection with our acquisition of Vicuron in December 2009, we were required to fair value two contingent payment streams on the closing date of the acquisition. The first related to the $25.0 million milestone payment owed to Pfizer in connection with the first commercial sale of dalbavancin and the other related to the potential refund of $6.0 million of the initial purchase price. We completed an assessment of the probability of the successful clinical development, regulatory approval and commercial sale of dalbavancin in future periods and determined that a liability of $5.8 million should be recorded at December 11, 2009 to reflect the best estimate of additional cash consideration likely to be paid related to the potential $25.0 million milestone payment. We also recorded the fair value of a contingent asset of $0.6 million at December 11, 2009 based on the probability of receiving the potential refund from Pfizer of $6.0 million of the initial purchase price. -17- -------------------------------------------------------------------------------- Table of Contents Subsequent to the closing date of the acquisition, we measure the contingent consideration arrangements at fair value for each period with changes in fair value recognized in our statement of operations under acquisition related charges, net. Changes in fair value reflect new information about the acquired in-process research and development asset and its progress toward approval, and the passage of time, and therefore ultimately the probability of achieving regulatory approval for dalbavancin. Separately, the possibility of receiving the $6.0 million contingent asset was also reassessed as development efforts continued. We received the $6.0 million contingent receivable in March 2011. In the absence of new information, changes in fair value reflect only the passage of time as development work towards the achievement of the milestones progresses. The balance of the contingent liability consideration, which reflects the fair value of the contingent milestone payment, was $25.0 million as of June 30, 2014 and $20.9 million as of December 31, 2013. We have classified this liability as noncurrent in our consolidated balance sheets, as payment is not expected to occur within twelve months because we intend to take advantage of our right under our arrangement with Pfizer to defer the payment and we are prohibited from making any payment to Pfizer as long as amounts are outstanding under our credit agreement with PDL. Interest Income Our cash and cash equivalents are invested primarily in money market accounts and other short-term investments, which generate a modest amount of interest income. We expect to continue that investment philosophy as we obtain more financing proceeds. Critical Accounting Policies and Significant Judgments and Estimates Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on our limited historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are described in more detail in the notes to our financial statements. However, we believe that certain of those significant accounting policies are the most critical to aid you in fully understanding and evaluating our financial condition and results of operations. We refer to these policies as "critical" because these specific areas generally require us to make judgments and estimates about matters that are uncertain at the time we make the estimate, and different estimates, which also would have been reasonable, could have been used, which would have resulted in different financial results. The critical accounting policies we identified in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 related to accrued research and development expenses, share-based compensation and valuation of long-lived and intangible assets and goodwill. There have been no material changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. Comparison of Three Month Periods Ended June 30, 2014 and 2013 The following table summarizes selected operating expense data for the three month periods ended June 30, 2014 and 2013: Three Month Period Ended (In Thousands) June 30, 2014 June 30, 2013 Operating Expenses: Amortization of intangible assets $ 127 $ - Research and development expenses 6,186 13,179 General and administrative expenses 11,064 4,514 Acquisition related charges, net 1,413 289 -18- -------------------------------------------------------------------------------- Table of Contents Amortization of intangible assets We recorded $0.1 million of amortization of intangible assets for the three month period ended June 30, 2014. No amortization had been recorded for the three month period ended June 30, 2013 as the related acquired research and development was still in-process. Research and Development Expenses Our research and development work was principally related to the activities associated with seeking approval to market dalbavancin in the United States, which was obtained in May 2014, and to a lesser extent in certain international markets. Such activities also included clinical trial costs, trial product manufacturing and sourcing, manufacturing of product for the anticipated commercialization and regulatory activities related to our NDA and MAA submissions. Research and development expenses for the quarter ended June 30, 2014 were $6.2 million, compared to $13.2 million for the quarter ended June 30, 2013. The $7.0 million decrease was due primarily to the production of active pharmaceutical ingredient in the second quarter of 2013 versus none in the second quarter of 2014 and is partially offset by an increase in costs related to our single dose study and higher payroll expenses as a result of increased headcount to support ongoing development of dalbavancin. Research and development expenses during the three month periods ended June 30, 2014 and 2013 included the following: • CRO and other clinical trial related expenses were $2.3 million for the three month period ended June 30, 2014, representing 37% of total research and development expenses during the period, and were principally comprised of expenses for clinical trial activities, including costs related to our single dose study. CRO and other clinical trial expenses were $3.1 million for the three month period ended June 30, 2013. The decrease of $0.8 million is primarily due to the decrease in clinical trial activities following completion of our DISCOVER trials partially offset by the increase in costs related to our clinical trial activities for our single dose study. • Chemistry, manufacturing and control, or CMC, related expenses were $0.4 million for the three month period ended June 30, 2014, representing 7% of total research and development expenses during the period, and were principally comprised of costs related to the manufacturing of product for commercialization. CMC related expenses were $6.8 million for the three month period ended June 30, 2013, and were principally comprised of costs related to manufacture of product for eventual commercialization. • Consulting fees were approximately $1.0 million for the three month period ended June 30, 2014, representing 16% of total research and development expenses during the period, and were comprised of $0.3 million for clinical activity consultants, including database, microbiology, toxicology and pharmacology consultants, $0.3 million for regulatory consultants, $0.2 million for CMC consultants and $0.2 million for quality assurance consultants. Consulting fees were $2.0 million for the three month period ended June 30, 2013, and were comprised of $1.2 million for clinical activity consultants, including database, microbiology, toxicology and pharmacology consultants, $0.2 million for regulatory consultants, $0.4 million for CMC consultants and $0.2 million for quality assurance consultants. The decrease of $1.0 million is primarily due to the decrease in clinical trial activities following completion of the DISCOVER trials and the increase in headcount to support ongoing development of dalbavancin. • Payroll expenses were $2.5 million for the three month period ended June 30, 2014, representing 40% of total research and development expenses during the period, and were principally comprised of salaries, payroll taxes and benefits for our employees in research and development. We had 44 employees in research and development at June 30, 2014. Payroll expenses for the three month period ended June 30, 2014 also included share-based compensation expense for employees of approximately $0.2 million. We had 20 employees in research and development at June 30, 2013. Payroll expenses for the three month period ended June 30, 2013 were $1.3 million, which included $0.1 million of share-based compensation expense. The increase of $1.2 million is primarily related to increased headcount as we build out our clinical development team to support ongoing development of dalbavancin. General and Administrative Expenses Our general and administrative expenses in the three month period ended June 30, 2014 increased $6.6 million to $11.1 million from $4.5 million in the three month period ended June 30, 2013. The increase related to our continued expansion efforts in preparation for the anticipated commercial launch of dalbavancin, which occurred in late July 2014. General and administrative expenses during three month periods ended June 30, 2014 and 2013 included the following: • Payroll expenses for the three month period ended June 30, 2014 were $7.1 million, representing 64% of total general and administrative expenses during the period, and were principally comprised of salaries, payroll taxes and benefits for our general and administrative employees. We had 156 employees in general and administrative functions at June 30, 2014 and 38 employees as of June 30, 2013. Payroll expense of a similar nature was $3.0 million for the three month period ended June 30, 2013. Payroll expense for the three month periods ended June 30, 2014 and 2013 included share-based compensation expense for employees of $0.7 million and $0.5 million, respectively. The increase of $4.1 million is primarily due to increased headcount as we progressed toward commercialization. -19- -------------------------------------------------------------------------------- Table of Contents • Professional fee expenses for the three month period ended June 30, 2014 were $0.3 million, representing 3% of total general and administrative expenses during the period, and were principally comprised of fees for legal services. Professional fee expense of a similar nature was $0.2 million for the three month period ended June 30, 2013. • Consulting fees for the three month period ended June 30, 2014 were $2.5 million, representing 22% of total general and administrative expenses during the period, and were principally comprised of activities related to the anticipated commercialization of dalbavancin. Consulting fees also included expenses related to tax services, business development, public relations, audit and public reporting fees, and research projects for our medical affairs and commercial departments. Consulting fees were $0.7 million for the three month period ended June 30, 2013. The increase of $1.8 million is due to costs associated with the advancement of our commercial planning activities. • Occupancy and other operating expenses for the three month period ended June 30, 2014 were $1.0 million, representing 9% of total general and administrative expenses during the period, and were principally comprised of rent, utilities, insurance, office and other expenses. Occupancy and other operating expense of a similar nature was $0.5 million for the three month period ended June 30, 2013. • Non-employee compensation expense for the three month period ended June 30, 2014 was $0.2 million, representing 2% of total general and administrative expense during the period, and included board of director fees and expense related to non-employee director stock option awards. Non-employee compensation expense for the three month period ended June 30, 2013 was approximately $0.1 million and included board of director fees and expense related to non-employee director stock option awards. Acquisition Related Charges, Net For the three month period ended June 30, 2014, acquisition related charges, net principally consisted of the change in probability of the contingent liability related to the $25.0 million milestone payment that became due upon the first commercial sale of dalbavancin. However, under our credit agreement with PDL discussed in note 5 to our financial statements, Long-term Debt, we are prohibited from making any payment to Pfizer as long as amounts are outstanding under our credit agreement with PDL. Pursuant to the terms of the Pfizer Agreement, we will deliver to Pfizer a promissory note in an aggregate principal amount of $25.0 million representing the amount of such milestone payment during August 2014. The contingent liability increased by $1.4 million for the three month period ended June 30, 2014 and $0.3 million for the three month period ended June 30, 2013, which was recorded as a charge to acquisition related charges, net. The increase during the three month period ended June 30, 2014 is due to the FDA's approval of dalbavancin for the treatment of adult patients with ABSSSI on May 23, 2014. Income Taxes We have historically computed interim period tax expense by applying the forecasted effective tax rate to year-to-date earnings. However, for the three month period ended June 30, 2014 we determined we were unable to reliably estimate our annual effective tax rate due to the effective tax rate being highly sensitive to minor fluctuations in forecasted income. As such, we have computed the U.S. and foreign tax expense for the three month period ended June 30, 2014 using the actual year-to-date effective tax rate. The effective tax rate for the three month period ended June 30, 2014 was 9.1%. This effective tax rates differ from the federal tax rate of 35% primarily due to the effects of foreign losses that are not benefited, state taxes, foreign rate differential, as well as items that are deductible for books and not U.S. tax. We recorded income benefit of $1.8 million in the three month period ended June 30, 2014, and income tax expense of $0.2 million in the three month period ended June 30, 2013. Interest Expense Interest expense recorded in the three month period ended June 30, 2014 consisted of interest incurred and amortization of fees related to our credit agreement with PDL. For the three month period ended June 30, 2013, interest expense consisted of interest incurred and amortization of debt discount and debt financing fees related to the debt financing completed in March 2013. -20- -------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of Six Month Periods Ended June 30, 2014 and 2013 The following table summarizes selected operating expense data for the six month periods ended June 30, 2014 and 2013: Six Month Period Ended (In Thousands) June 30, 2014 June 30, 2013 Operating Expenses: Amortization of intangible assets $ 127 $ - Research and development expenses 15,194 24,271 General and administrative expenses 18,302 8,565 Acquisition related charges, net 4,111 573 Amortization of intangible assets We recorded $0.1 million of amortization of intangible assets for the six month period ended June 30, 2014. No amortization had been recorded for the six month period ended June 30, 2013 as the related acquired research and development was still in process. Research and Development Expenses Our research and development work was principally related to the activities associated with seeking approval to market dalbavancin in the United States, which was obtained in May 2014, and to a lesser extent in certain international markets. Such activities include clinical trial costs, trial product manufacturing and sourcing, manufacturing of product for the anticipated commercialization and regulatory activities related to our NDA and MAA submissions. Research and development expenses for the six month period ended June 30, 2014 were $15.2 million, compared to $24.3 million for the six month period ended June 30, 2013. The $9.1 million decrease was due primarily to the production of active pharmaceutical ingredient in the second quarter of 2013 versus none in the second quarter of 2014 and is partially offset by an increase in costs related to our single dose study and higher payroll expenses as a result of increased headcount to support ongoing development of dalbavancin. Research and development expenses during the six month periods ended June 30, 2014 and 2013 included the following: • CRO and other clinical trial related expenses were $4.6 million for the six month period ended June 30, 2014, representing 30% of total research and development expenses during the period, and were principally comprised of expenses for clinical trial activities, including costs related to our single dose study. CRO and other clinical trial expenses were $7.9 million for the six month period ended June 30, 2013. The decrease of $3.3 million is primarily due to the decrease in clinical trial activities following completion of our DISCOVER trials, partially offset by the increase in costs related to our clinical trial activities for our single dose study. • Chemistry, manufacturing and control, or CMC, related expenses were $3.4 million for the six month period ended June 30, 2014, representing 22% of total research and development expenses during the period, and were principally comprised of costs related to the manufacturing of product for commercialization. CMC related expenses were $9.9 million for the six month period ended June 30, 2013, and were principally comprised of costs related to the production of API in anticipation of commercialization. • Consulting fees were approximately $2.4 million for the six month period ended June 30, 2014, representing 16% of total research and development expenses during the period, and were comprised of $0.8 million for clinical activity consultants, including database, microbiology, toxicology and pharmacology consultants, $0.8 million for regulatory consultants, $0.3 million for CMC consultants and $0.5 million for quality assurance consultants. Consulting fees were $3.8 million for the six month period ended June 30, 2013, and were comprised of $2.3 million for clinical activity consultants, including database, microbiology, toxicology and pharmacology consultants, $0.4 million for regulatory consultants, $0.7 million for CMC consultants and $0.4 million for quality assurance consultants. The decrease of $1.4 million is primarily due to the decrease in clinical trial activities following completion of the DISCOVER trials and the increase in headcount to support ongoing development of dalbavancin. • Payroll expenses were approximately $4.8 million for the six month period ended June 30, 2014, representing 32% of total research and development expenses during the period, and were principally comprised of salaries, payroll taxes and benefits for our employees in research and development. Payroll expenses for the six month period ended June 30, 2014 also included share-based compensation expense for employees of approximately $0.4 million. Payroll expenses for the six month period ended June 30, 2013 were $2.7 million, which included $0.2 million of share-based compensation expense. The increase of $2.1 million is primarily related to increased headcount as we build out our clinical development team to support ongoing development of dalbavancin. -21- -------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses Our general and administrative expenses in the six month period ended June 30, 2014 increased $9.7 million to $18.3 million from $8.6 million in the six month period ended June 30, 2013. The increase related to our continued expansion efforts in preparation for the anticipated commercial launch of dalbavancin. General and administrative expenses during the six month periods ended June 30, 2014 and 2013 included the following: • Payroll expenses for the six month period ended June 30, 2014 were $11.6 million, representing 64% of total general and administrative expenses during the period, and were principally comprised of salaries, payroll taxes and benefits for our general and administrative employees. Payroll expense of a similar nature was $5.3 million for the six month period ended June 30, 2013. Payroll expense for the six month periods ended June 30, 2014 and 2013 included share-based compensation expense for employees of $1.2 million and $0.9 million, respectively. The increase of $6.3 million is primarily due to increased headcount as we progressed toward commercialization. • Professional fee expenses for the six month period ended June 30, 2014 was $0.6 million, representing 3% of total general and administrative expenses during the period, and was principally comprised of fees for legal services. Professional fee expense of a similar nature was $0.6 million for the six month period ended June 30, 2013. • Consulting fees for the six month period ended June 30, 2014 were $3.9 million, representing 21% of total general and administrative expenses during the period, and were principally comprised of activities related to the anticipated commercialization of dalbavancin. Consulting fees also included expenses related to tax services, business development, public relations, audit and public reporting fees, and research projects for our medical affairs and commercial departments. Consulting fees were $1.4 million for the six month period ended June 30, 2013. The increase of $2.5 million is due to costs associated with the advancement of our commercial planning activities. • Occupancy and other operating expenses for the six month period ended June 30, 2014 were $1.8 million, representing 10% of total general and administrative expenses during the period, and were principally comprised of rent, utilities, insurance, office and other expenses. Occupancy and other operating expense of a similar nature was $1.1 million for the six month period ended June 30, 2013. • Non-employee compensation expense for the six month period ended June 30, 2014 was $0.4 million, representing 2% of total general and administrative expense during the period, and included board of director fees and expense related to non-employee director stock option awards. Non-employee compensation expense for the six month period ended June 30, 2013 was approximately $0.2 million and included board of director fees and expense related to non-employee director stock option awards. Acquisition Related Charges, Net For the six month period ended June 30, 2014, acquisition related charges, net principally consisted of the change in probability of the contingent liability related to the $25.0 million milestone payment that became due upon the first commercial sale of dalbavancin. However, under our credit agreement with PDL discussed in note 5 to our financial statements, Long-term Debt, we are prohibited from making any payment to Pfizer as long as amounts are outstanding under our credit agreement with PDL. Pursuant to the terms of the Pfizer Agreement, we will deliver to Pfizer a promissory note in an aggregate principal amount of $25.0 million representing the amount of such milestone payment during August 2014. The contingent liability increased by $4.1 million for the six month period ended June 30, 2014 and $0.6 million for the six month period ended June 30, 2013, which was recorded as a charge to acquisition related charges, net. The increase during the six month period ended June 30, 2014 is due to the FDA's approval of dalbavancin for the treatment of adult patients with ABSSSI on May 23, 2014. Income Taxes We have historically computed interim period tax expense by applying the forecasted effective tax rate to year-to-date earnings. However, for the six month period ended June 30, 2014, we determined we were unable to reliably estimate our annual effective tax rate due to the effective tax rate being highly sensitive to minor fluctuations in forecasted income. As such, we have computed the U.S. and foreign tax expense for the six month period ended June 30, 2014, using the actual year-to-date effective tax rate. The effective tax rate for the six month period ended June 30, 2014 was 4.2%. This effective tax rates differ from the federal tax rate of 35% primarily due to the effects of foreign losses that are not benefited, state taxes, foreign rate differential, as well as items that are deductible for books and not U.S. tax. We recorded income tax benefit of $1.7 million for the six month period ended June 30, 2014, and income tax expense of $0.5 million in the six month period ended June 30, 2013. -22- -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Sources of Liquidity Through June 30, 2014, we have not generated any revenues and have financed our operations primarily with proceeds from private placements of our preferred stock, our initial public offering of common stock, which we closed in July 2012, a secured debt financing, which we completed in March 2013 and refinanced with a new lender in October 2013, and a public offering of our common stock, which we closed in April 2013. As of June 30, 2014, we had cash and cash equivalents totaling $20.9 million and short-term investments of $13.8 million. We primarily invest our cash and cash equivalents in money market funds. The following table summarizes our cash flow activity for the six month periods ended June 30, 2014 and 2013: Six Month Period Ended (In Thousands) June 30, 2014 June 30, 2013 Net cash used in operating activities $ (39,031 ) $ (34,274 ) Net cash provided by (used in) investing activities $ 7,902 $ (9,761 ) Net cash provided by financing activities $ 15,176 $ 73,162 Operating Activities The use of cash in all periods resulted primarily from our net losses adjusted for non-cash charges and changes in the components of working capital. The increase in net cash used in operating activities in the six month period ended June 30, 2014 was primarily related to the increase in general and administrative costs as we continued expansion efforts in preparation for the anticipated commercial launch of dalbavancin, partially offset by a decrease in research and development expenses following the completion of the DISCOVER trials, as discussed above under results of operations. Investing Activities Net cash provided by investing activities during the six month period ended June 30, 2014 was primarily related to proceeds from the sale of short-term investments, partially offset by the addition of a certificate of deposit held by our bank as collateral for an irrevocable standby letter of credit issued in connection with one of our office leases. Net cash used by investing activities during the six month period ended June 30, 2013 was primarily related to cash invested in short-term investments, the purchase of property and equipment and an increase in our certificate of deposit held by the bank as collateral for an irrevocable standby letter of credit issued in connection with one of our office leases. Financing Activities Net cash provided by financing activities for the six month period ended June 30, 2014 was principally the result of cash received from the receipt of the obligatory Second Tranche Milestone funding as part of our credit agreement with PDL, and cash received from stock option exercises. Net cash provided by financing activities for the six month period ended June 30, 2013 was principally the result of the $54.1 million of net proceeds from the public offering that we closed in April 2013 and the proceeds from the $20.0 million secured debt financing that we closed in March 2013, partially offset by financing fees and expenses of $1.0 million that we paid in connection with these two financings. Funding Requirements We anticipate that we will continue to incur significant expenses in connection with marketing our products, seeking marketing approval for product candidates, developing our commercial organization, conducting clinical trials for additional indications for dalbavancin, including osteomyelitis, diabetic foot infection and pneumonia, as well as new dosing strategies and formulations, and manufacturing product. In addition, in connection with obtaining regulatory approval and commercializing dalbavancin, we expect to incur significant sales, marketing, distribution and outsourced manufacturing expenses, as well as ongoing research and development expenses. Our expenses also will increase if and as we: • maintain, expand and protect our intellectual property portfolio; • in-license or acquire other products and technologies; • hire additional clinical, quality control and scientific personnel; and • add operational, financial and management information systems and personnel, including personnel to support our product development and planned future commercialization efforts. We estimate that our existing cash and cash equivalents and short-term investments and other sources of liquidity discussed will be sufficient to support our current and projected funding requirements for at least the next twelve months. We estimate that such funds will be sufficient to enable us to commercially launch dalbavancin for the treatment of patients with ABSSSI in the United States and to seek marketing approval for dalbavancin in the European Union. Additionally, we estimate the funds will be sufficient to explore the development of dalbavancin for additional indications and new dosing strategies and formulations. We have based this estimate on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. This estimate is based on a number of assumptions and gives effect to our election to defer for a period of up to five years payment of the $25.0 million milestone that we became obligated to pay to Pfizer upon the first commercial sale of dalbavancin by delivering to Pfizer a promissory note for such amount, which we intend to do during August 2014. We also are prohibited from paying the $25.0 million milestone payment to Pfizer as long as amounts are outstanding under our current credit agreement with PDL. Interest on the outstanding principal amount of the promissory note will accrue at a rate of 10% per annum, compounded annually. Our future capital requirements will depend on many factors, including: • the costs of commercialization activities for dalbavancin, including the costs and timing of establishing product sales, marketing, distribution and manufacturing capabilities; -23- -------------------------------------------------------------------------------- Table of Contents • revenue received from commercial sales of dalbavancin; • the costs of developing dalbavancin for additional indications and new dosing strategies and formulations; • the costs, timing and outcome of regulatory review of dalbavancin; • our ability to establish collaborations on favorable terms, if at all; • the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims; • the extent to which we in-license or acquire other products and technologies; and • the scope, progress, results and costs of product development for our product candidates. Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Additional debt financing, 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. If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams or product candidates or grant licenses on terms that may not be favorable to us. As of June 30, 2014, we do not have any committed external source of funds other than our credit agreement with PDL, which includes a $30.0 million delayed draw, receipt of which funds is subject to the satisfaction of certain conditions set forth in the PDL credit agreement. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market product candidates that we would otherwise prefer to develop and market ourselves. Contractual Obligations and Commitments Pursuant to the PDL credit agreement, upon marketing approval of dalbavancin in the United States on May 23, 2014, the Company borrowed, as required, an aggregate principal amount of $15.0 million from PDL. Pursuant to the Pfizer Agreement, we will deliver to Pfizer a promissory note in an aggregate principal amount of $25.0 million representing the amount of the milestone payment owed to Pfizer as a result of the first commercial sale of dalbavancin for the treatment of ABSSSI. There have been no other material changes to our contractual obligations and commitments outside the ordinary course of business from those disclosed under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations and Commitments" in our Annual Report on Form 10-K for the year ended December 31, 2013. Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under Securities and Exchange Commission rules. |