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TSRX > SEC Filings for TSRX > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Form 10-K for TRIUS THERAPEUTICS INC


13-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with "Item 8. Financial Statements and Supplementary Data" included below in this Annual Report on Form 10-K. Operating results are not necessarily indicative of results that may occur in future periods.

This discussion and analysis contains forward-looking statements that involve a number of risks, uncertainties and assumptions. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, those set forth in "Item 1A. Risk Factors" in this Annual Report on Form 10-K. All forward-looking statements included in this Annual Report on Form 10-K are based on information available to us as of the time we file this Annual Report on Form 10-K and, except as required by law, we undertake no obligation to update publicly or revise any forward-looking statements.

Overview

We are a biopharmaceutical company focused on the discovery, development and commercialization of innovative antibiotics for serious infections. We are developing tedizolid phosphate, a new, novel antibiotic, for the treatment of serious Gram-positive bacterial infections, including those caused by methicillin-resistant staphylococcus aureus, or MRSA. Tedizolid phosphate is being developed for acute bacterial skin and skin structure infections, or ABSSSI, and pneumonia, and potentially for other indications. ABSSSI is the current classification for complicated skin and skin structure infections. In addition, we are discovering antibiotics for infections caused by Gram-negative bacteria using our structure based discovery platform.

In December 2011, we reported top line data from our first Phase 3 clinical trial, the ESTABLISH 1 (TR701-112) study, of the oral dosage form of tedizolid phosphate for the treatment of ABSSSI. All primary and secondary endpoints for the ESTABLISH 1 study were achieved. In December 2012, we completed enrollment in our second Phase 3 clinical trial, the ESTABLISH 2 (TR701-113) study, of the intravenous to oral transition therapy for the treatment of ABSSSI. We expect to report top line data from this second Phase 3 clinical trial near the end of the first quarter in 2013. We currently expect to submit a New Drug Application, or NDA, to the Food and Drug Administration, or FDA, for tedizolid phosphate for the treatment of ABSSSI during the second half of 2013.

We also expect to initiate a Phase 3 program of tedizolid phosphate for the treatment of pneumonia using the same 200 mg, once daily dose of tedizolid phosphate that we are testing for ABSSSI. We are currently working with the FDA and the European Medicines Agency, or EMA to develop the protocol for the Phase 3 study and, pending agreement from the regulatory agencies, we plan to initiate it in the second half of 2013.

The FDA has designated tedizolid phosphate as a Qualified Infectious Disease Product, or QIDP, for the treatment of ABSSSI as well as for the treatment of pneumonia, which designation enables us to benefit from certain incentives for the development of new antibiotics, including priority review and eligibility for fast-track status. The QIDP designations were granted for both the intravenous, or IV, and oral dosage forms of tedizolid phosphate.

In July 2011, we signed collaboration and license agreement with Bayer Pharma AG, or Bayer, under which we granted Bayer exclusive rights to develop and commercialize tedizolid phosphate in China, Japan and substantially all other countries in Asia, Africa, Latin America and the Middle East, excluding North and South Korea, which we refer to as the Bayer Licensed Territory. We intend to continue to evaluate potential strategic alliances for tedizolid phosphate in Europe.

We acquired worldwide rights to tedizolid phosphate outside of South and North Korea, or Korea, from Dong-A ST Co., Ltd., as successor-in-interest to Dong-A Pharmaceutical Co., Ltd., or Dong-A, in January 2007.


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Since then we have progressed tedizolid phosphate from submitting an Investigational New Drug Application, or IND, through two Phase 3 clinical trials. In addition, we have substantially lowered the manufacturing costs of tedizolid phosphate.

In September 2008, we entered into a five-year contract with NIAID under which we may receive up to $27.7 million to support our development of novel dual-target antibacterial agents as therapeutics for the treatment of gram-negative biodefense pathogens. The scope of the contract includes preclinical, nonclinical and clinical IND and NDA-enabling development activities. Pursuant to our NIAID contract, subject to our compliance with applicable regulations, we may elect to obtain ownership of each patentable invention that arises from the performance of the research and development funded by our NIAID contract, subject to the United States government's march-in rights with respect to such inventions. We have recognized $25.2 million in revenues through December 31, 2012 related to research performed under the NIAID contract. In February 2013, we were notified by NIAID that they would not be extending the contract beyond March 31, 2013 and that we will not be eligible to drawdown against the remaining amount available under the contract after that date.

In April 2010, we entered into a four and one-half year contract with DTRA under which we were eligible to receive up to $29.5 million to support a preclinical program to identify targets of antibacterial compounds from marine natural product libraries from The Regents of the University of California, or UCSD, and to apply our structure based drug design and development capabilities to optimize promising antibacterial compounds for activity against gram-negative bacteria, including multiple biodefense pathogens. Pursuant to the DTRA contract, subject to our compliance with applicable regulations, we may elect to obtain ownership of each patentable invention that arises from the performance of the research and development funded by our DTRA contract, subject to the United States government's march-in rights with respect to such inventions. In May 2012, DTRA notified us that, due to programmatic priorities toward later stage programs, it elected not to exercise its option to extend funding under its contract with us and the contract was not extended beyond July 20, 2012. As a result, we discontinued our marine natural products discovery program, which was solely funded by the DTRA contract. We recognized $7.3 million in revenues through the expiration of the DTRA contract.

In April 2011, we entered into a three year research contract with Lawrence Livermore National Laboratory, or LLNL, for the development of novel antibiotics directed against gram negative multi-drug resistant bacterial pathogens. We may receive up to $3.0 million over three years in support of its development efforts. LLNL can terminate the contract upon delivering notice to us for default or convenience. Upon receipt of a notice of termination, we must discontinue contract activities and LLNL must pay the Company a final settlement based on eligible expenses incurred under the contract. From contract inception through December 31, 2012, we have recognized $1.8 million in revenues related to the research performed under the LLNL contract.

In January 2012, we raised approximately $48.4 million in net proceeds from the public offering of our common stock in which we sold 9,890,000 shares of common stock at an offering price of $5.25 per share.

In January 2013, we raised approximately $31.6 million in net proceeds from the public offering of our common stock in which we sold 7,169,135 shares of common stock at an offering price of $4.75 per share.

We were originally incorporated in California in June 2004 and reincorporated in Delaware in December 2007. Our principal offices are in San Diego, California. We have never been profitable and have incurred significant net losses since our inception. As of December 31, 2012, we had an accumulated deficit of $149.3 million. These losses have resulted principally from costs incurred in connection with research and development activities, including the costs of clinical trial activities associated with tedizolid phosphate, license fees and general and administrative expenses. We expect to continue to incur operating losses for the next several years as we pursue the clinical development and commercialization of tedizolid phosphate and work to discover and develop additional product candidates through our research and discovery program. As a result, we will seek to fund our operations through public or private equity or debt financings or other sources, such as collaborations and government contracts. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategies.


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Financial Obligations Related to the License of Tedizolid Phosphate

In January 2007, we entered into a license agreement with Dong-A, pursuant to which we acquired an exclusive license to certain patent applications and other intellectual property related to the oral and injectable forms of tedizolid phosphate to develop and commercialize licensed products, including tedizolid phosphate, outside of Korea. We have the right to grant sublicenses to third parties.

Upon entering into the license agreement, we paid a $500,000 upfront-fee and have made subsequent milestone payments of $5.7 million. In addition, we may be required to make up to an aggregate of $11.5 million in additional payments, upon the achievement of specified development and regulatory approval milestones. We are also obligated to pay Dong-A mid-single digit tiered royalties on net sales of tedizolid phosphate.

Financial Overview

We have recognized $87.2 million of revenues from inception through December 31, 2012. We have derived substantially all of our revenues from our Bayer Agreement and government contracts, small business innovation research, or SBIR, grants funded by the NIH, and collaborations with other third parties for the research and development of certain preclinical programs. We have no products approved for sale, and we have not generated any revenues from product sales. We expect to recognize revenues from our government contracts as well as through our license and collaboration agreement with Bayer. We continue to pursue government contract funding for our nonclinical, preclinical and clinical programs. If our development efforts for any of our product candidates result in clinical success and regulatory approval, or other collaboration agreements with third parties, we may generate revenues from those product candidates.

Research and Development Expenses

The majority of our operating expenses to date have been for research and development activities related to tedizolid phosphate and our preclinical and non-clinical programs. Research and development expenses consist of:
(1) expenses incurred under agreements with contract research organizations, or CROs, and investigative sites, which conduct a substantial portion of our nonclinical and preclinical studies, and all of our clinical trials;
(2) employee-related expenses, which include salaries, benefits and share-based compensation; (3) payments to third-party manufacturers, which produce our active pharmaceutical ingredient and finished product; (4) license fees paid to third parties for use of their intellectual property; (5) facilities, depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities and equipment, depreciation of leasehold improvements and equipment and laboratory and other supplies; and
(6) payments to consultants.

The following table presents our research and development expenses for the periods indicated (in thousands):

                                                           Year Ended December 31,
                                                        2012         2011         2010
  Clinical and nonclinical research and development   $ 57,968     $ 37,665     $ 15,787
  Preclinical research and development                  11,055       11,838        7,533

                                                      $ 69,023     $ 49,503     $ 23,320

At this time, due to the inherently unpredictable nature of preclinical, non-clinical and clinical development and given the early stage of our preclinical programs, we are unable to estimate with any certainty the costs we will incur in the continued development of tedizolid phosphate and our preclinical programs for potential commercialization. Clinical development timelines, the probability of success and development costs can differ materially from expectations. While we are currently focused on advancing tedizolid phosphate and our preclinical programs, our future research and development expenses will depend on the clinical success of each product candidate that we develop, as well as ongoing assessments of the commercial potential of such product


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candidates. In addition, other than our collaboration agreement with Bayer, we cannot forecast with any degree of certainty which product candidates may be subject to future collaborations or contracts, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. We expect to incur increased research and development expenses as we continue our Phase 3 clinical programs for tedizolid phosphate. In addition, we expect to incur significant research and development costs as we perform additional clinical trials necessary to obtain regulatory approval of tedizolid phosphate for additional indications, as well as to advance our preclinical programs.

The costs of clinical trials may vary significantly over the life of a project owing to but not limited to the following:

Per patient trial costs;

The number of sites included in the trials;

The countries in which the trials are conducted;

The length of time required to enroll eligible patients;

The number of patients that participate in the trials;

The number of doses that patients receive;

The cost of comparative agents used in trials;

The drop-out or discontinuation rates of patients;

Potential additional safety monitoring or other studies requested by regulatory agencies;

The duration of patient follow-up; and

The efficacy and safety profile of the product candidate.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related expenses for personnel in administration, finance, commercial strategy and business development. Other significant expenses include professional fees for general legal services, legal expenses to pursue patent protection of our intellectual property, accounting fees, director fees, directors' and officers' insurance premiums, fees for investor relations services, share-based compensation and allocated facility costs. We expect our general and administrative expense to increase as we continue to operate as a public company and build our corporate infrastructure, particularly our commercial group, as we pursue approval of our first commercial product and in support of continued development of tedizolid phosphate and our preclinical programs. These increases likely will include additional salaries and related expenses, consultant fees, and expenses related to enhanced business systems.

Interest Income

Interest income consists of interest earned on our cash, cash equivalents and short-term investments in marketable securities.

Interest Expense

There is no interest expense for the years ended December 31, 2012 and 2011. Interest expense for the year ended December 31, 2010 consisted primarily of a non-cash charge related to the conversion of the 2009 Convertible Notes Payable at a 12.5% discount to the price of our common stock sold in our initial public offering, or IPO, non-cash interest related to the amortization of debt discount costs associated with the capital leases and non-cash interest expense associated with the increase in fair value of the preferred stock warrants issued in connection with obtaining our capital leases and cash interest accrued or paid on our capital lease and convertible notes payable balances.


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Income Taxes

We assess income tax positions and record tax benefits for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where there is a greater than 50% likelihood that a tax benefit will be sustained, we have recorded the largest amount of tax benefit that may potentially be realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where there is less than 50% likelihood that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements.

As of December 31, 2012, we had federal and state net operating loss carryforwards of approximately $81.6 million and $82.4 million, respectively. If not utilized, the net operating loss carryforwards will begin expiring in 2025 for federal purposes and 2015 for state purposes. Additionally, we had both federal and state research and development tax credit carryforwards of approximately $4.0 million and $2.9 million, respectively. The federal tax credits will begin expiring in 2027 unless previously utilized and the state tax credits carryforward indefinitely. Under Section 382/383 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, substantial changes in our ownership may limit the amount of net operating loss carryforwards and development tax credit carryforwards that could be utilized annually in the future to offset taxable income. Any such annual limitation may significantly reduce the utilization of the net operating losses and tax credits before they expire. After a public offering of common stock in January 2012, we performed an analysis under Section 382 through January 31, 2012 and determined that an "ownership change" had occurred, but the resulting annual limitation does not have a material impact on our ability to use our net operating loss and tax credit carryforwards. After our public offering in January 2013, we updated our
Section 382 analysis and determined that it would not result in an additional "ownership change." In each period since our inception, we have recorded a valuation allowance for the full amount of our deferred tax asset, as the realization of the deferred tax asset is uncertain.

Change in Fair Value of Common Stock Warrants Liability

We have issued warrants to purchase our common stock that may require us to purchase unexercised warrants for a cash amount equal to their fair value following the announcement of specified events defined as Fundamental Transactions involving us (e.g., merger, sale of all or substantially all assets, tender offer, or share exchange) or a delisting, which is deemed to occur when the common stock is no longer listed on a national securities exchange. The cash settlement provisions require use of the Black-Scholes model in calculating the cash payment value in the event of a Fundamental Transaction or a delisting. As a consequence of these provisions, the warrants are classified as a liability on our balance sheets. The cash settlement value at the time of any future Fundamental Transaction or delisting will depend upon the value of the following inputs at that time: the price per share of our common stock, the volatility of our common stock, the expected term of the warrant, the risk-free interest rate based on U.S. Treasury security yields, and our dividend yield.

The fair value of the warrants is determined using a Black-Scholes model. The valuation of warrants is subjective and is affected by changes in inputs to the valuation model including the price per share of our common stock, the historical volatility of the stock prices of our peer group, risk-free rates based on U.S. Treasury security yields, the expected term of the warrants and our dividend yield. Changes in these assumptions can materially affect the fair value estimate. We could ultimately incur amounts to settle the warrant at a cash settlement value that is significantly different than the carrying value of the liability on our financial statements. We will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire, or are amended in a way that would no longer require these warrants to be classified as a liability. Changes in the fair value of the common stock warrants liability are recognized as a component of other income (expense) in the statement of operations.

Critical Accounting Policies and Significant Judgments and Estimates

Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in


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the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenues earned under our contracts, preclinical, nonclinical and clinical development costs and drug manufacturing costs (research and development expense), and share-based compensation. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 1 to our financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements.

Revenue Recognition

Our revenues historically have consisted of federal contract and grant revenues and fees for research services from license or collaboration agreements. We recognize revenues when all four of the following criteria are met:
(1) persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred; (3) the selling price is fixed or determinable; and (4) collectability is reasonably assured.

For arrangements that include multiple deliverables, we determine the deliverables and then identify separate units of accounting. The expected non-contingent arrangement consideration is then allocated to the separate units of accounting based on their relative fair values. Applicable revenue recognition criteria are considered separately for each unit of accounting. Upfront fees are allocated to the license and recorded immediately as license revenue as long as the payment is less than the value ascribed to the license. Any upfront payments in excess of the value ascribed to the license, are deferred and recognized as either license revenues or collaboration revenues, in proportion to the original percentages of estimated selling prices. For ongoing development and regulatory efforts, we record revenues as the development and regulatory efforts that are subject to reimbursement are incurred, throughout the expected development and regulatory period. Amounts received in advance of services performed are recorded as deferred revenue until earned.

We have made an election to utilize the milestone method for recognizing milestone payments into revenue, when the milestone is deemed substantive. In order for milestone consideration to be deemed substantive, it should:

1. Be commensurate with either the vendor's performance to achieve the milestone or the enhancement of value of the item delivered as a result of the specific outcome resulting from the vendor's performance to achieve the milestone;

2. Relate solely to past performance; and

3. Be reasonable relative to all deliverables and payment terms in the arrangement.

These milestones will be recorded as revenue, when achieved and will be recorded as license fees and collaboration revenues, in accordance with the initial ratios of the selling prices for the units of accounting.

For contract payments achieved during the period where we have material ongoing performance obligations, and the contract payment is deemed not to be substantive, we do not treat these payments as milestones for accounting purposes, and use the cumulative catch up approach for recording non-substantive contract payments. We update the remaining expected arrangement consideration by adding to it the amount to be received for achieving the payment. This payment amount is prorated, with a portion being applied to the allocated arrangement consideration for the license and a portion applied to the allocated arrangement consideration for the


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development services based upon the initial proration of the deemed selling prices for the license and development services at the inception of the agreement. We then calculate the amount of cumulative revenue recognizable for both the license and development services upon achievement of the event resulting in the payment. The amount recognizable as revenue for the development services is equal to the percentage calculated by dividing the cumulative costs completed as of the time of earning the payment divided by the total expected costs to be incurred by us during the development period and then multiplying this percentage by the new updated arrangement consideration for the development services. From this amount, we subtract the previous cumulative amount recognized for development service revenues to calculate the amount of development service revenues to record for the period. The revenue to be recorded is the lower of this amount or the actual amount of development service billings for the period. If the calculated amount is lower than the actual billings, then the difference will be recorded as deferred revenue until such time as the efforts are greater than or equal to the billings. The amount recognizable for the license is generally equal to the difference between the new allocated arrangement consideration for the license and the prior allocated arrangement consideration for the license, given that the earnings process for delivery of the license is typically complete.

For contract payments which are not deemed to be substantive milestones in accordance with U.S. generally accepted accounting principles, or GAAP, that are expected to be achieved after the completion of any material performance obligations required by us, since there are no material further performance . . .

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