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ASTX > SEC Filings for ASTX > Form 10-Q on 9-Nov-2012All Recent SEC Filings




Quarterly Report

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

You should read the following discussion together with our consolidated financial statements and related notes included elsewhere in this report. The results discussed below are not necessarily indicative of the results to be expected in any future periods. Our disclosure and analysis in this section of the report also contain forward-looking statements. When we use the words "anticipate," "estimate," "project," "intend," "expect," "plan," "believe," "should," "likely" and similar expressions, we are making forward-looking statements. Forward-looking statements provide our current expectations or forecasts of future events. In particular, these statements include statements such as: our estimates about profitability or losses; the percentage and amount of royalties we expect to earn on Dacogen sales under our agreement with Eisai; our forecasts regarding our operating expenses; our expectations about the timing of regulatory reviews; and our statements regarding the sufficiency of our cash to meet our operating needs. Our actual results could differ materially from those predicted in the forward-looking statements as a result of risks and uncertainties including, but not limited to: the commercial success of Dacogen; the approval by regulatory agencies of expanded applications for Dacogen; delays and risks associated with conducting and managing our clinical trials; developing products and obtaining regulatory approval; our ability to launch and commercialize products; the stability of our stock price for purposes of measuring impairment of goodwill; our ability to establish and maintain collaborative relationships; competition; our ability to obtain funding; our ability to protect our intellectual property; our dependence on third party suppliers; risks associated with the hiring and loss of key personnel; and adverse changes in the specific markets for our products. Certain unknown or immaterial risks and uncertainties can also affect our forward-looking statements. Consequently, no forward-looking statement can be guaranteed and you should not rely on these forward-looking statements. For a discussion of the known and material risks that could affect our actual results, please see the "Risk Factors" section of this report. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Readers should carefully review the Risk Factors section as well as other reports or documents we file from time to time with the Securities and Exchange Commission.


We are a pharmaceutical company dedicated primarily to the discovery and development of novel small molecule therapeutics with a focus on oncology. We believe we are developing a proprietary pipeline of novel medicines for partnership with leading pharmaceutical companies. We believe we are a leader in the application of fragment-based drug discovery and development of small-molecule therapeutics. Fragment-based drug discovery is considered by many in our sector to be one of the most important advances in discovery chemistry in the last 20 years.

On July 20, 2011, we completed the acquisition of all of the outstanding shares of Astex Therapeutics Limited ("ATL"), a privately held UK-based biotechnology company with particular expertise in fragment-based drug discovery. We agreed to pay deferred consideration of $30 million in stock, cash, or a combination of stock and cash, to be determined at the discretion of the Company, no later than 30 months after the closing of the acquisition (January 2014). We made the first payment of $10 million in cash in February 2012 and paid the second installment of $2.2 million in cash in August 2012.

ATL discovers and develops novel small molecule therapeutics. Using its fragment-based drug discovery platform, Pyramid™, ATL has built a pipeline of molecularly-targeted drugs for large pharmaceutical partners and internal development that are at various stages of clinical, pre-clinical and early discovery development.

Our founding strategy was to in-license late-stage clinical products and commercialize these products by executing selective developmental and commercialization strategies that might allow these products to come into the market and be utilized by the widest possible patient populations. However,

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the competition for late-stage compounds that can be obtained through licensure or acquisition, that have shown initial efficacy in humans, has increased significantly with most major pharmaceutical companies and emerging biotechnology companies taking positions in this market. We believe that our current strategy attempts to mitigate the competitive risk of in-licensure and positions us to out-license selective products to our licensing competitors or other pharmaceutical companies. Our primary objective is to become a leading developer and seller or licensor of medicines for patients suffering from cancer.

We currently receive development and license revenue from partnered programs and royalty revenues relating to sales of Dacogen® (decitabine) for Injection, a product approved by the FDA for the treatment of patients with myelodysplastic syndrome ("MDS"), which is licensed to Eisai. We are entitled to receive a royalty on worldwide net sales of Dacogen starting at 20% and escalating to a maximum of 30%. We recognize royalty revenue when the royalty statement is received from Eisai because we do not have sufficient ability to accurately estimate Dacogen sales prior to that time. In 2006, Eisai executed an agreement to sublicense Dacogen to Cilag Gmbh International ("Cilag"), a Johnson & Johnson company, granting exclusive development and commercialization rights in all territories outside North America. Cilag is responsible for conducting regulatory and commercial activities related to Dacogen in all territories outside North America, while Eisai retains all commercialization rights and responsibility for all activities in the United States, Canada and Mexico. As a result of both the original agreement with Eisai and the sublicense with Cilag, we may receive up to $17.5 million in future contingent payments dependent upon achievements for Dacogen globally. In September 2012, the European Commission approved the marketing authorization for Dacogen for the treatment of adult patients (age 65 years and above) with newly diagnosed de novo or secondary Acute Myeloid Leukemia ("AML"), according to the World Health Organization classification, who are not candidates for standard induction chemotherapy. Dacogen was also granted a 10-year Orphan Drug designation in Europe for the treatment of elderly AML. In early October 2012, we received a $5 million payment from Eisai for the first commercial sale of Dacogen in the EU, which will be reflected as revenue during the fourth quarter of 2012.

All of our current products, other than Dacogen, are in the development or clinical trial stage, and will require substantial additional investments in research and development, clinical trials, regulatory and sales and marketing activities to commercialize these product candidates. Conducting clinical trials is a lengthy, time-consuming, and expensive process involving inherent uncertainties and risks, and our studies may be insufficient to demonstrate safety and efficacy to support FDA approval of any of our product candidates.

As a result of our substantial research and development expenditures and minimal product revenues, we have incurred cumulative losses of $331.1 million through September 30, 2012, and have not consistently generated enough funds through our operations to support our business. Although we were profitable in the years ended December 31, 2011 and 2010, as a result of our acquisition of ATL we expect to have operating losses over the next few years and we may never achieve sustained profitability.

Ultimately, our ability to sustain profitability will depend upon a variety of factors, including seeking and receiving regulatory approvals of our products, the timing of the introduction and market acceptance of our products and competing products, Eisai's success in selling Dacogen, the success of our various collaborative, research and license arrangements, the launch of new products and our ability to control our ongoing costs and operating expenses. If our drug discovery and research efforts are not successful, or if the results from our clinical trials are not positive and do not support further development or approval, we may not be able to get sufficient funding to continue our trials or conduct new trials, and we would be forced to scale down or cease our business operations. Moreover, if our products are not approved or commercially accepted we will remain unprofitable for longer than we

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currently anticipate. As a result, we might be forced to substantially scale down our operations or sell certain of our assets, and it is likely the price of our stock would decline precipitously.

Critical Accounting Policies

Our management discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and reported disclosures. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, valuation of investments and stock-based compensation. We base our estimates on historical experience and on various other assumptions 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 more fully disclosed in Note 1 to our consolidated financial statements included in our 2011 Annual Report on Form 10-K. However, some of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management. We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.

Stock-Based Compensation

We account for stock-based compensation at the fair value estimated on the measurement date using the Black-Scholes option-pricing model based on assumptions for volatility, risk-free interest rates, expected life of the option, and dividends (if any). Expected volatility is determined based on a blend of historical volatility and implied volatility of our common stock based on the period of time corresponding to the expected life of the stock options. The expected life of our stock options is based on our historical data and represents the period of time that stock options granted are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant commensurate with the expected life assumption.

We are using the straight-line attribution method to recognize stock-based compensation expense. The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest, including awards that vest based on certain performance criteria. We estimate forfeitures at the time of grant and revise them, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the unvested portion of the surrendered option. This analysis is re-evaluated quarterly and the forfeiture rate is adjusted as necessary based upon historical data. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest.

As of September 30, 2012, there was $4.3 million of total unrecognized compensation cost related to unvested stock-based awards that vest based upon service conditions or vest based upon performance conditions and are probable of vesting. This cost is expected to be recognized over a weighted average period of 2.51 years.

Revenue Recognition

Eisai is required to pay us royalties starting at 20% and escalating to a maximum of 30% of net worldwide Dacogen sales within 45 days after the end of each calendar quarter. During the nine month period ended September 30, 2012, we recorded royalty revenue of $52.0 million. Because we do not

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have sufficient ability to accurately estimate Dacogen sales, we recognize royalty revenue when we receive the royalty statement from Eisai. In accordance with our license agreement with Eisai, we are entitled to receive 50% of any payments Eisai receives as a result of any sublicenses.

In January 2012, we entered into an Asset Transfer Agreement with GSK. Under the terms of the Transfer Agreement, we terminated our license agreement and transferred certain existing research work and assets generated under the epigenetic collaboration and grant licensing rights to GSK. We have no further obligation to conduct additional research work on the program. GSK will make one-time, non-refundable payments to us upon the achievement of the first transferred licensed compound to reach defined milestones as described in the Transfer Agreement and will also pay us royalties upon certain sales from the transferred assets, if any. We recognized the remaining balance of deferred revenue of $1.4 million at December 31, 2011 related to this agreement as development and license revenue in the nine months ended September 30, 2012.

Revenues associated with substantive, at-risk milestones pursuant to ATL's collaborative agreements will be recognized upon achievement of the milestones through option exercise by the collaboration partner. We consider a milestone to be substantive at the inception of the arrangement if it is (a) commensurate with either our performance to achieve the milestone or the enhancement of the value of the delivered item as a result of a specific outcome resulting from our performance to achieve the milestone, (b) it relates solely to past performance, and (c) it is reasonable relative to all of the deliverables and payment terms within the arrangement. Non-refundable contingent future amounts receivable in connection with future events specified in the collaboration agreement that are not considered milestones will be recognized as revenue when payments are earned from our collaborators through completion of any underlying performance obligations, the amounts are fixed or determinable, and collectibility is reasonably assured. In June 2012, Janssen Pharmaceutica NV received clearance to commence a Phase I clinical trial of a Fibroblast Growth Factor Receptor ("FGFR") kinase inhibitor from a collaborative, cancer drug discovery program with ATL. The regulatory clearance required to take the compound into Phase I triggered a payment to us of £3.5 million (US$5.4 million). We are also eligible to receive further payments during clinical development and royalties on commercialization of products derived from the collaboration.

Intangible Assets and Goodwill

The fair value of the identified intangible assets recorded in the acquisition of ATL was estimated by using income or cost replacement approaches. The acquisition of ATL also created goodwill as the purchase price exceeded the fair value of the identifiable assets acquired net of the liabilities assumed. The value assigned to developed technology is being amortized over seven years and the value assigned to the non-active collaboration agreements is being amortized over five years, the estimated useful lives of the assets. The in-process research and development and trademark intangibles, as well as the goodwill, are deemed to have indefinite lives. The indefinite lived intangible assets will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present) until the completion or abandonment of the associated research and development efforts. During the quarter ended September 30, 2012, one of our collaboration partners ceased development of three research and development projects, which resulted in the recording of an impairment charge of $7.4 million.

Impairment of Investments in Financial Instruments

Investments in financial instruments are carried at fair value based on quoted market prices, with unrealized gains and losses included in accumulated other comprehensive income or loss in stockholders' equity. Our investment portfolio includes equity securities that could subject us to material equity market risk and corporate and U.S. government (or U.S. governmental agency) obligations that subject us to varying levels of credit risk. An other-than-temporary decline in fair value

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of a financial instrument will be subject to a write-down resulting in a charge against earnings. The determination of whether a decline in fair value is other-than-temporary requires significant judgment, and could have a material impact on our balance sheet and results of operations. Our management reviews the securities within our portfolio for other than temporary declines in value on a regular basis. The prices of some of our marketable equity securities are subject to considerable volatility.

Equity investments in securities without readily determinable fair value, which consist of investments in privately held companies, are carried at cost. As of December 31, 2011, we held one such non-marketable security with a carrying amount of $500,000, which has been included in other assets in the condensed consolidated balance sheets. We periodically review this investment and evaluate whether an impairment has occurred. We monitor the liquidity and financing activities of the issuer of this security and evaluate, among other factors, the financial condition and business outlook of the issuer, including key operational and cash flow metrics and current market conditions, as well as our intent and ability to retain the investment. During the quarter ended September 30, 2012, based on the current financial status and information received from the issuer, we determined that the value of our investment was impaired, and recorded an other than temporary decline in value of $485,000.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-04 relating to fair value measurements. This guidance clarifies the application of existing fair value measurements and disclosures, and changes certain principles or requirements for fair value measurements and disclosures. The amendment is effective for interim and annual periods beginning after December 15, 2011. We adopted this ASU on January 1, 2012. The adoption of this amendment did not have a material impact on our results of operations, cash flows, or financial position.

In June 2011, the FASB issued ASU 2011-05 on the presentation of comprehensive income, which amends current comprehensive income guidance. This amendment requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amended guidance, which must be applied retroactively, is effective for interim and annual periods beginning after December 15, 2011. We adopted this ASU on January 1, 2012. The adoption of the provisions of this guidance did not have a material impact on our results of operations, cash flows, and financial position.

In September 2011, the FASB issued ASU 2011-08 on testing goodwill for impairment. Under the amendment, an entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. If determined to be necessary, the two-step impairment test shall be used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any. The amendment is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of the provisions of this guidance is not expected to have a material impact on our results of operations, cash flows, and financial position.

In July 2012, the FASB modified existing rules to allow entities to use a qualitative approach to test indefinite-lived intangible asset for impairment. The revised standard allows an entity the option to first assess qualitatively whether it is more likely than not (that is, a likelihood of more than 50 percent) that an indefinite-lived intangible asset is impaired. An entity is not required to calculate the fair value of an indefinite-lived intangible asset and perform the quantitative impairment test unless the entity determines that it is more likely than not that the asset is impaired. This guidance will be effective in 2013, but early adoption is permitted. Adoption of this standard will not have a material impact on our results of operations, cash flows, or financial position.

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Results of Operations

Three months ended September 30, 2012 compared to three months ended
September 30, 2011:

    Operating results for the three months ended September 30, 2011 include the
consolidated results of ATL since the acquisition date of July 20, 2011.

                                           Three months ended
                                             September 30,              Change
       Revenues                             2012         2011     Dollar    Percent
                                              (Dollars in thousands)
       Royalty revenue                    $   16,995   $ 16,638    $  357       2.15 %
       Development and license revenue           199        308      (109 )   (35.39 )

The increase in royalty revenue from 2011 to 2012 is due to higher Dacogen product sales as reported by Eisai. Eisai is required to pay us royalties starting at 20% and escalating to a maximum of 30% of net worldwide Dacogen sales within 45 days after the end of each calendar quarter. Because we do not have sufficient ability to accurately estimate Dacogen sales, we recognize royalty revenue when we receive the royalty statements from Eisai. Therefore, royalty revenues recognized in the third quarters of 2011 and 2012 relate to worldwide Dacogen sales for the second quarters of 2011 and 2012, respectively.

Development and license revenue in 2011 related to the recognition of upfront payments received in connection with collaboration agreements with GSK. The upfront payment received was being recognized ratably over five years. Development and license revenue in 2012 represents recognition of revenue from a collaboration agreement relating to achievement of a defined patient enrollment threshold.

                                                 Three months ended
                                                   September 30,              Change
Operating expenses                                2012         2011     Dollar    Percent
                                                    (Dollars in thousands)
Research and development                        $   13,633   $ 13,546   $    87       0.64 %
General and administrative                           4,188      5,095      (907 )   (17.80 )
Amortization of intangibles                          1,938      1,485       453      30.51
Impairment of intangibles                            7,402          -     7,402          -
Gain on disposition of assets and sale of
products                                              (576 )        -      (576 )        -

The increase in research and development expenses was primarily due to higher drug discovery, product development, and clinical trial programs costs associated with SGI-110 and AT13387, offset by declines in costs due to the closure of our Pleasanton and Utah laboratories. We expect that research and development expenses for 2012 will continue to increase over the prior year reflecting the operational impact of the acquisition of ATL and increased clinical trial activity related to our various clinical trial programs.

The decline in general and administrative expenses from 2011 to 2012 relates primarily to transaction costs recorded in 2011 related to the acquisition of ATL in July 2011.

Amortization of intangibles relates to the intangible assets that were part of the acquisition of ATL in July 2011. Definite-lived intangible assets are being amortized over their estimated useful lives. The value assigned to developed technology is being amortized over seven years and the value assigned to the non-active collaboration agreements is being amortized over five years.

Our indefinite lived intangible assets are not amortized but instead are tested for impairment at least annually (or more frequently if certain indicators are present) until the completion or

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abandonment of the associated research and development efforts. During the quarter ended September 30, 2012, one of our collaboration partners ceased development of three research and development projects, which resulted in the recording of an impairment charge of $7,402,000.

During the three months ended September 30, 2012 we acquired an investment of 681,632 shares of Series A preferred stock, representing less than 20% ownership, of a privately held company valued at $2.20 per share, for a total investment of $1,500,000. In exchange for acquisition of these shares, we contributed fixed assets and other intellectual property from our Utah laboratory location with a net book value of $924,000, resulting in the recording of a gain on disposition of assets of $576,000.

                                                 Three months ended
                                                   September 30,              Change
Other income (expense)                            2012         2011     Dollar    Percent
                                                    (Dollars in thousands)
Interest income                                 $      50     $    48   $     2       4.17 %
Gain on sale of investments and fixed assets        2,591           -     2,591          -
Other than temporary decline in value of
investments                                          (485 )         -      (485 )        -
Other expense                                          (4 )      (291 )     287     (98.63 )
Income tax benefit                                  5,479       2,352     3,127     132.95

Gain on sale of investments and fixed assets primarily represents the net . . .

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