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CNDO > SEC Filings for CNDO > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto and other financial information appearing elsewhere in this Form 10-K.


We are a clinical stage biopharmaceutical company focused on the development of novel immunotherapy biologic agents for the treatment of autoimmune diseases and cancer. Our two principal pharmaceutical product candidates in clinical development are:

TSO, or CNDO-201, the microscopic eggs of the porcine whipworm, for the treatment of autoimmune diseases, such as Crohn's disease, ulcerative colitis, multiple sclerosis, autism, psoriasis, type 1 diabetes and rheumatoid arthritis; and

CNDO-109, a biologic that activates natural killer, or NK, cells of the immune system to seek and destroy cancer cells, for the treatment of acute myeloid leukemia.

We acquired exclusive rights to TSO in January 2011 from Asphelia Pharmaceuticals, Inc., or Asphelia, for an aggregate purchase price of $20.7 million, consisting of 2,525,677 shares of our Series B Convertible Preferred Stock, or Series B Shares, valued at $6.38 per share, the assumption of a promissory note due to PCP in the aggregate principal amount of $750,000, which was prepaid in September 2012 and the assumption of Asphelia's obligation to reimburse Ovamed for certain development costs. Of this purchase price, $3.8 million has been paid in cash, including $3.4 million to Ovamed and $0.4 million for repayment of Asphelia's debt, including $61,000 to a related party. Under the terms of a sublicense agreement with Ovamed that we acquired from Asphelia, we are required to make annual license payments to Ovamed of $250,000, reimburse patent expenses, make payments totaling up to $5.4 million, of which $3.0 million was paid, contingent upon the achievement of various milestones related to regulatory events for the first product to be approved for marketing, and make additional milestone payments, contingent upon the achievement of regulatory events related to subsequent indications for TSO. In the event that TSO is commercialized, we will be obligated to pay annual royalties based upon net sales of the product. If we sublicense TSO, we must pay Ovamed a portion of sublicense revenues we receive, if any. We have been required to purchase our clinical requirements of TSO from Ovamed at pre-determined prices.

In December 2012, we and Ovamed entered into the Second Amendment amending certain provisions of our Exclusive Sublicense Agreement and our Manufacturing and Supply Agreement, between us and Ovamed, and providing for certain additional agreements between the parties. Pursuant to the Second Amendment, our exclusive license from Ovamed in the North America, South America and Japan known as the "Coronado Territory" was amended to include an exclusive license to make and have made product containing TSO in the Coronado Territory and Ovamed's exclusive supply rights in the Coronado Territory will terminate once we establish an operational manufacturing facility in the United States. The Ovamed License, as amended, terminates 15 years from the first commercial sale of TSO in the United States, subject to earlier termination under certain circumstances.

In exchange, we agreed to pay Ovamed a total of $1,500,000 in three equal installments of $500,000 in each of December 2014, 2015, and 2016. Additionally, in lieu of product supply payments that would have been payable to Ovamed as the exclusive supplier, we will pay Ovamed a manufacturing fee for product manufactured and sold by us. The manufacturing fee will be the greater of (i) a royalty on net sales of product we manufacture or (ii) a specified amount per unit, the Transfer Fee Component. The manufacturing fee is subject to certain adjustments and credits and we have a right to reduce the Transfer Fee Component by paying Ovamed an agreed amount within 10 business days following FDA approval of a Biologics License Application authorizing the manufacturing, marketing and commercial sale of product containing TSO in the United States and an additional amount within ninety days after the end of the first calendar year in which net sales in the Coronado Territory exceed an agreed amount.

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Simultaneously with the execution of the Second Amendment, Ovamed assigned to us a five-year property lease for space in Woburn, Massachusetts, where we intend to establish a TSO manufacturing facility. Build out of the manufacturing facility are planned to commence in 2013 and continue throughout the year to enable production of supplies of TSO, for use in Phase 3 clinical trials. Ovamed agreed to assist us in establishing this facility and the Second Amendment contemplates that we and Ovamed may act as second source suppliers to each other at agreed transfer prices pursuant to a Second Source Agreement to be negotiated between the parties.

In March 2012, we signed a Collaboration Agreement with Falk and Ovamed for the development of TSO for treatment of Crohn's disease. Under the Collaboration Agreement, Falk granted us exclusive rights and licenses under certain Falk patent rights, pre-clinical data and clinical data from Falk's clinical trials of TSO as a treatment for Crohn's disease, including Falk's ongoing Phase 2 clinical trial, for use in the Coronado Territory. We granted Falk exclusive rights and licenses to data from our clinical trials of TSO in Crohn's disease for use in Europe. Under the agreement, we agreed to pay Falk (i) a total of 5 million (approximately $6.5 million) after receipt of certain pre-clinical and clinical data, of which 2.5 million (approximately $3.4 million) was paid in 2012 and the remaining 2.5 million is expected to be paid in the first half of 2014, and (ii) a royalty of 1% of net sales of TSO in North America, South America and Japan. A steering committee comprised of our representatives and representatives of Falk and Ovamed is overseeing the clinical development program of TSO as a treatment for Crohn's disease, under which we and Falk will each be responsible for clinical testing on approximately 50% of the total number of patients required for regulatory approval of TSO for treatment of Crohn's disease in the United States and Europe and will share in certain pre-clinical development costs.

We acquired an exclusive worldwide license to CNDO-109 in November 2007 from University College of London Business PLC, or UCLB. In consideration for the license, we paid UCLB initial license fees totaling $0.1 million and are required to make milestone payments totaling up to $22 million upon the achievement of various milestones related to regulatory events for the first three indications. In March 2012, we recognized our $250,000 milestone obligation to UCLB related to our IND filed in February 2012 and in April 2012 we paid UCLB for this milestone. In June 2012, we were notified by the FDA that CNDO-109 was granted orphan drug designation and in September 2012, the U.S. Patent and Trademark Office issued the first U.S. patent covering CNDO-109. If CNDO-109 is commercialized, we will be obligated to pay to UCLB annual royalties based upon net sales of the product or if we sublicense CNDO-109, a portion of sublicensing revenues we receive, if any.

In June 2012, we completed an underwritten public offering of 5,750,000 shares of our common stock, including 750,000 shares subject to an over-allotment option exercised by the underwriters, at a price of $5.00 per share for proceeds, net of underwriting commissions and other offering expenses, of approximately $26.4 million. In August 2012, we received net proceeds of $14.7 million from a $15 million term loan with Hercules.

In September 2012, the Company filed a shelf registration statement on Form S-3 pursuant to which the Company may sell up to $75.0 million of common stock over the next three years. In October 2012, the Company entered into an At Market Issuance Sales Agreement, or ATM with MLV & Co. LLC, or MLV, to issue and sell up to $30.0 million of common stock. Under the terms of the ATM we pay directly to MLV fees equal to 3% of the gross proceeds. Through December 31, 2012, the Company sold 3,361 shares of common stock for net proceeds of $19,000. From January 1, 2013 through March 11, 2013, the Company issued 1,426,250 shares of common stock pursuant to the ATM and received net proceeds of $10.5 million.

On December 28, 2012, the Company's Board of Directors appointed current director Dr. Harlan F. Weisman, as Chairman and Chief Executive Officer. At that time, the Company's Executive Chairman, Dr. Glenn L. Cooper, resigned his position as Executive Chairman and as a director of the Company. In addition, on December 28, 2012, Dr. Bobby W. Sandage, Jr.'s status as Chief Executive Officer and President of the Company changed to President of the Company. Dr. Sandage remains a member of the Board of Directors. (See note 15 of Notes to Consolidated Financial Statements.)

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Critical Accounting Policies and Use of Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. 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 the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses and stock-based compensation. We base our estimates on historical experience, known trends and events and various other factors that are believed to be 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 consolidated financial statements appearing elsewhere in this Form 10-K. We believe the following accounting policies to be most critical to the judgments and estimates used in the preparation of our consolidated financial statements.

Research and Development Expenses

As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contracts and purchase orders, reviewing the terms of our license agreements, communicating with our applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual cost. The majority of our service providers invoice us monthly in arrears for services performed. We make estimates of our accrued expenses as of each balance sheet date in our consolidated financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued research and development expenses as of December 31, 2012 include fees to:

Contract Research Organizations, or CROs, and other service providers in connection with clinical studies;

Investigative sites in connection with clinical studies;

Contract manufacturers in connection with production of clinical trial materials;

Vendors in connection with the preclinical development activities; and

Licensors for the achievement of milestone-related events.

We base our expenses related to clinical studies on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical studies on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows and expense recognition. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual accordingly. Our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in our reporting changes in estimates in any particular period. To date, our estimates have not materially differed from actual costs. Expenses related to annual license fees are accrued on a pro rata basis throughout the year.

Stock-Based Compensation

We expense stock-based compensation to employees over the requisite service period based on the estimated grant-date fair value of the awards and considering estimated pre-vesting forfeiture rates. For stock-based

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compensation awards to non-employees, we re-measure the fair value of the non-employee awards at each reporting period prior to vesting and finally at the vesting date of the award. Changes in the estimated fair value of these non-employee awards are recognized as compensation expense in the period of change.

Determining the appropriate fair value of stock-based awards requires the use of subjective assumptions. Prior to November 17, 2011 in the absence of a public trading market for our common stock, we conducted periodic assessments of the valuation of our common stock. These valuations were performed concurrently with the achievement of significant milestones or with a significant financing. We use a Black-Scholes option-pricing model to determine the fair value of stock options. The determination of the grant date fair value of options using an option-pricing model is affected by our estimated common stock fair value as well as assumptions regarding a number of other subjective variables. These variables include the fair value of our common stock, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates, and expected dividends, which are estimated as follows:

Fair Value of our common stock. When our stock was not publicly traded, we estimated the fair value of common stock as discussed in "Common Stock Valuations Prior to Becoming a Publicly Traded Company" below. Since November 17, 2011, we have utilized the public trading price of our common stock.

Expected Term. Due to the limited exercise history of our own stock options, we determined the expected term based on the stratification of option holder groups. Our employee options meet the criteria for the Simplified Method under SAB 107 while the expected term for our non-employees is the remaining contractual life for both options and warrants.

Volatility. As we have a very limited trading history for our common stock, the expected stock price volatility for our common stock was estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers consist of several public companies in the biopharmaceutical industry similar in size, stage of life cycle and financial leverage. We did not rely on implied volatilities of traded options in our industry peers' common stock because the volume of activity was relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available, or unless circumstances change such that the identified companies are no longer similar to us, in which case, more suitable companies whose share prices are publicly available would be utilized in the calculation.

Risk-free Rate. The risk-free interest rate is based on the yields of United States Treasury securities with maturities similar to the expected term of the options for each option group.

Dividend Yield. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero.

The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period in which estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates.

For the years ended December 31, 2012, 2011, and 2010, stock-based compensation expense was $3.6 million, $1.5 million, and $2.3 million, respectively. As of December 31, 2012, we had approximately $4.5 million of total unrecognized compensation expense, related to unvested stock options and warrants granted to employees and non-employees, which we expect to recognize over a weighted-average period of approximately 1.4 years.

If any of the assumptions used in a Black-Scholes model changes significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.

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Common Stock Valuations Prior to Becoming a Publicly Traded Company

Prior to our becoming a publicly-traded company on November 17, 2011, the fair value of the common stock underlying our stock options, common stock warrants and restricted stock was determined by our board of directors, which intended all options granted to be exercisable at a price per share not less than the per share fair value of our common stock underlying those options on the date of grant. However, certain options granted on October 5, 2010 were granted with an exercise price that was below the fair value of our common stock as subsequently determined by an independent valuation as of that date. All other options previously granted or to be granted in the future are granted at the determined grant date fair value. The valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants, or AICPA, Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Guidelines. The assumptions we use in the valuation model are based on future expectations combined with management judgment. In the absence of a public trading market, our board of directors, with input from management, exercised significant judgment and considered numerous objective and subjective factors to determine the fair value of our common stock as of the date of each option, restricted stock and warrant grant, including the following factors:

arm's length private transactions involving our preferred stock, including the sale of our Series A Convertible Preferred Stock, or Series A Shares, at $8.39 per share in 2010 and our Series C Convertible Preferred Stock, or Series C Shares, at $5.59 per share in 2011;

independent valuations performed by knowledgeable experts in the field;

our operating and financial performance;

market conditions;

developmental milestones achieved;

business risks; and

management and board experience.

In valuing our common stock, we have used a variety of methodologies that have evolved as the life cycle of our company has progressed. For the underlying valuations of our common stock in periods prior to December 31, 2009, given the early stage of our company and its development programs, we used a cost approach to estimate the fair value of our common stock. The cost approach is based on the premise that an investor would pay no more for an asset than its replacement or reproduction cost. The cost to replace the asset would include the cost of constructing a similar asset of equivalent utility at prices applicable at the time of the valuation analysis. Under this methodology, a valuation analysis is performed for a company's identified fixed, financial, intangible and other assets. The derived aggregate fair value of the assets is then netted against the estimated fair value of all existing and potential liabilities, resulting in an indication of the fair value of total equity. This approach was considered an appropriate indication of value as the programs were still in early stages of the development cycle.

As our business and programs evolved, beginning in 2010, we migrated away from the cost approach to a market approach to incorporate the indication of value established through our development efforts and reflected in our Series A Share issuances during 2010. Under this approach, the business enterprise value was established based on the contemporaneous equity offerings. Pursuant to the AICPA Guidelines, an option pricing method was used to value the shares using a contingent claims analysis, which applies a series of call options whose inputs reflect the liquidation preferences and conversion behavior of the different classes of equity. The value of our common stock was then derived by analyzing the fair value of these options. After the equity value of the business enterprise was determined, the total equity value of any equity instruments such as preferred stock, stock options, restricted stock and warrants outstanding and the concluded common stock value on a converted basis is allocated. Next, the option pricing method was used to allocate the residual equity value (inclusive of any infusion of cash from in-the-money options and warrants) to our common stock. Since our shares were not publicly traded, a discount for lack of marketability was applied. This lack of marketability discount was estimated to be 10% prior to becoming a publicly-traded company. A theoretical put option model was used to capture the cost to ensure stock could be sold at the price prevailing at the valuation date after the time required

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to finding a market, or the time until an expected liquidity event. The put option model considers the expected time to a liquidity event, estimated volatility based on peer company data, risk free interest rates and management judgment. The ultimate fair values of our common stock were used as an input in determining the fair value of the warrants, restricted stock and stock options at various periods of time. As our development programs continue we expect to incur an increase in research and development expenses.

Results of Operations


To date, we have not generated any revenues from operations and, at December 31, 2012, we had an accumulated deficit of $84.2 million primarily as a result of research and development expenses, purchases of in-process research and development and general and administrative expenses. While we may in the future generate revenue from a variety of sources, including license fees, milestone payments, research and development payments in connection with strategic partnerships and/or product sales, our product candidates are at an early stage of development and may never be successfully developed or commercialized. Accordingly, we expect to continue to incur substantial losses from operations from our operations for the foreseeable future and there can be no assurance that we will ever generate significant revenues.

Research & Development Expenses

Conducting research and development is central to our business. For the years ended December 31, 2010, 2011 and 2012 research and development expenses were $8.3 million, $8.6 million and $17.5 million, respectively, and such expenses were $42.0 million for the period from inception (June 28, 2006) to December 31, 2012. Noncash, stock-based compensation expense included in research and development in 2012 and from inception through 2012 was $3.6 million and $7.5 million, respectively. Research and development expenses consist primarily of:

employee-related expenses, which include salaries and benefits, and rent expense;

non cash stock-based compensation expense;

license fees and milestone payments related to in-licensed products and intellectual property;

expenses incurred under agreements with CROs, investigative sites and consultants that conduct or provide other services relating to our clinical trials and our preclinical activities;

the cost of acquiring clinical trial materials from third party manufacturers; and

costs associated with non-clinical activities, patent filings and regulatory filings.

We expect to continue to incur substantial expenses related to our research and development activities for the foreseeable future as we continue product development. Since product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later stage clinical trials, we expect that our research and development expenses will increase in the future. In addition, if our product development efforts are successful, we expect to incur substantial costs to prepare for potential commercialization of any late-stage product candidates and, in the event one or more of these product candidates receive regulatory approval, to fund the launch of the product. From inception through December 31, 2012, direct, external development costs incurred for our TSO product development program were $13.8 million, including $0.2 million, $2.7 million and $10.9 million for the years ended December 31, 2010, 2011 and 2012, respectively. Excluded from these costs is $21.7 million of in-process research and development costs, consisting of $20.7 million related to our acquisition of certain rights to TSO in 2011 and $1.0 million related to our domestic manufacturing rights for TSO. From inception through December 31, 2012, direct, external development costs incurred for our CNDO-109 product development program were $6.2 million, including $2.1 million, $1.9 million and $1.9 million, for the years ended December 31, 2010, 2011 and 2012, respectively. Our results of operations for the years ended

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December 31, 2010 and 2011 include direct, external development costs incurred in connection with two product development programs that have been discontinued. From inception through December 31, 2012, such expenses totaled $5.2 million. No costs were incurred for these programs in 2012.

General and Administrative Expenses

General and administrative expenses consist principally of personnel-related costs, professional fees for legal, consulting, audit and tax services, rent and other general operating expenses not otherwise included in research and development expenses. From inception to December 31, 2012, G&A expenses were $16.3 million, including $0.9 million, $5.8 million, and $8.7 million for the years ended December 31, 2010, 2011 and 2012, respectively. Non cash, stock-based compensation expense included in general and administrative in 2012 . . .

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