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KBIO > SEC Filings for KBIO > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for KALOBIOS PHARMACEUTICALS INC


1-Apr-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 together with our financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. We use words such as "may," "will," "expect," "anticipate," "estimate," "intend," "plan," "predict," "potential," "believe," "should" and similar expressions to identify forward-looking statements, including statements related to the scope, progress, expansion, and costs of developing and commercializing our product candidates, our anticipated financial results and condition, our expected future contract revenue from Sanofi and our anticipated expenses related to development activities, our clinical trials and the development and potential commercialization of our product candidates. These statements appearing throughout this Annual Report on Form 10-K are statements regarding our intent, belief, or current expectations, primarily regarding our operations. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. As a result of many factors, such as those set forth under "Risk Factors" and elsewhere in this Annual Report on Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Annual Report on Form 10-K.

Overview

We are a biopharmaceutical company focused on monoclonal antibody therapeutics for diseases that are a significant burden to society and patients and their families. We have a portfolio of patient-targeted, first-in-class antibodies using our Humaneered ® antibody technology to treat serious medical conditions with a primary clinical focus on respiratory diseases and cancer. Our principal pharmaceutical product candidates at the clinical development stage are:

• KB001-A, a Humaneered®, PEGylated, anti-PcrV Fab' antibody that is being developed for the prevention and treatment of Pa infections in mechanically ventilated patients and CF patients with chronic Pa infections;

• KB003, a Humaneered® anti-GM-CSF monoclonal antibody that is being developed for the treatment of severe asthma inadequately controlled by corticosteroids; and

• KB004, a Humaneered® monoclonal antibody directed against EphA3 which has the potential to offer a novel approach to treating both hematologic malignancies and solid cancer tumors.

In January 2010, we entered into an agreement with Sanofi pursuant to which we granted to Sanofi an exclusive worldwide license to develop, manufacture, and commercialize antibodies directed against the PcrV protein of Pa (including KB001-A) for all indications, and Sanofi is solely responsible for research, development, manufacturing, and commercialization. As part of this agreement, we retain the right to develop and promote KB001-A for Pa in CF or bronchiectasis patients. Sanofi is focusing its clinical development on prevention of Pa VAP. Pursuant to the agreement, we received an initial upfront payment of $35 million and an additional $5 million payment in August 2011 that were recognized as revenue through June 30, 2012. We have the potential to receive additional contingent payments aggregating up to $250 million upon achievement by Sanofi of certain clinical, regulatory and commercial events, together with tiered royalties based upon global net sales of licensed products. However, there can be no assurances that Sanofi will continue to further develop KB001-A or achieve the events that will trigger the contingent payments. As a result, we may not recognize any additional revenue from this arrangement. We are conducting a Phase 2 clinical trial in CF patients infected with Pa. As part of Sanofi's clinical development plan for Pa VAP, Sanofi is conducting a Phase 1 clinical study in healthy volunteers to evaluate higher doses than those that we previously tested. We understand that the Phase 1 study will be followed, after completion of manufacturing process development and scale-up, by a Phase 2b intravenous study in late 2014 to determine the safety and efficacy of KB001-A in preventing Pa VAP and then Sanofi plans a subsequent Phase 3 study. We also


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understand that the Phase 2b and Phase 3 trials are being designed as pivotal studies and are intended to serve as a basis for registration of KB001-A for the prevention of Pa VAP.

We initiated a 180 patient randomized, double-blind, placebo-controlled Phase 2 clinical trial for KB001-A in CF patients with chronic Pa infections in January 2013. In August 2012, we initiated a 150 patient, randomized, double-blind, placebo-controlled, monthly-dose, intravenous Phase 2 clinical trial for KB003 in patients with severe asthma inadequately controlled by corticosteroids. KB004 is in Phase 1 clinical testing for hematological malignancies. We believe the net proceeds from our initial public offering, together with our cash, cash equivalents, and marketable securities, and our borrowing capacity pursuant to the loan and security agreement we entered into with MidCap Financial in September 2012, will be sufficient to complete our KB001-A and KB003 Phase 2 clinical trials as currently projected. If the KB001-A and KB003 Phase 2 clinical trials are successful, we will need to raise additional capital in order to further advance our product candidates towards regulatory approval.

We licensed our proprietary Humaneered® antibody technology to Novartis in 2007 on a non-exclusive basis and received a license fee of $30 million. We are not currently actively pursuing the license of our Humaneered® technology to third parties and we are not expecting to receive future revenue from additional licenses to this technology.

From the date we commenced our operations through 2006, our efforts focused primarily on research, development, and the advancement of our Humaneered® antibody technology. In 2006, we commenced our first clinical trial. We have incurred significant losses to date and, as of December 31, 2012, we had an accumulated deficit of $98.3 million. We have funded our operations primarily through private placements of our equity securities, contract revenue in connection with our collaborations, and grants and borrowings under equipment financing arrangements and our loan and security agreement. As of December 31, 2012, we had cash, cash equivalents, and marketable securities of $20.3 million. On February 5, 2013, we closed our initial public offering of 8,750,000 shares of common stock at an offering price of $8.00 per share, resulting in net proceeds of approximately $61.5 million, after deducting underwriting discounts, commissions and offering expenses. We expect to continue to incur net losses as we develop our drug candidates, expand clinical trials for our drug candidates currently in clinical development, expand our research and development activities, expand our systems and facilities, seek regulatory approvals, and engage in commercialization preparation activities in anticipation of FDA approval of our drug candidates. Specifically, we have incurred, and we expect to continue to incur, substantial expenses in connection with our Phase 2 clinical trials for KB003 in severe asthma patients inadequately controlled by cortiscosteroids and for KB001-A in CF patients with chronic Pa infections. In addition, if a product is approved for commercialization, we will need to expand our organization. Significant capital is required to launch a product and many expenses are incurred before revenue is received. We are unable to predict the extent of any future losses or when we will become profitable, if at all. In December 2012, our board of directors approved a 1-for-3.56147 reverse split of our issued and outstanding capital stock which became effective on January 15, 2013. Upon the effectiveness of the reverse stock split, (i) every 3.56147 shares of issued and outstanding common stock and convertible preferred stock was decreased to one share of common stock or convertible preferred stock, as applicable, (ii) the number of shares of common stock into which each outstanding option to purchase common stock is exercisable was proportionally decreased on a 1-for-3.56147 basis and the number of shares of convertible preferred stock into which each outstanding warrant is exercisable was proportionally decreased on a 1-for-3.56147 basis and, (iii) the exercise price of each outstanding option to purchase common stock and warrant to purchase convertible preferred stock was proportionately increased. All of the share numbers, share prices, exercise prices and other per share information have been adjusted within this Annual Report on Form 10-K, on a retroactive basis, to reflect this 1-for-3.56147 reverse stock split

Critical Accounting Policies and Use of Estimates

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


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generally accepted in the United States (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances and review our estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

We are an emerging growth company under the JOBS Act. Emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to avail ourselves of this exemption from new or revised accounting standards and, therefore, we may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

While our significant accounting policies are described in more detail in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Our contract revenue is generated primarily through research and development collaboration agreements, which may include nonrefundable, non-creditable upfront fees, funding for research and development efforts, and milestone or other contingent payments for achievements with regards to our licensed products. We have not materially modified any previous collaboration agreements or entered into any new agreements in 2012 or 2011, nor have we received any milestone payments in 2012 or 2011. Therefore, all collaboration agreements have been accounted for in accordance with the accounting guidance applicable to such arrangements prior to our adoption of Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements, and ASU 2010-17, Revenue Recognition-Milestone Method.

We recognize revenue when persuasive evidence of an arrangement exists; transfer of technology has been completed, services have been performed or products have been delivered; the fee is fixed and determinable; and collection is reasonably assured.

For multiple element arrangements, we evaluate whether the components of each arrangement are to be accounted for as separate units of accounting based on certain criteria. Upfront payments for licensing our intellectual property to date have not been separable from the activity of providing research and development services because the license has not been assessed to have stand-alone value separate from the research and development services provided. Such upfront payments are recorded as deferred revenue in the balance sheet and are recognized as contract revenue over the contractual or estimated substantive performance period, which is consistent with the term of the research and development obligations contained in the research and development collaboration agreement.

Payments resulting from our research and development efforts under license agreements are recognized as the activities are performed and are presented on a gross basis. Revenue is recorded gross because we act as a principal, with discretion to choose suppliers, bear credit risk, and perform part of the services.

Substantive, at-risk milestone payments are recognized as revenue when the milestone is achieved and collectability is reasonably assured. When contingent payments are not for substantive and at-risk milestones, revenue is recognized over the estimated remaining term of the related service period or, if there are no continuing performance obligations under the arrangement, upon receipt provided that collection is reasonably assured and other revenue recognition criteria have been satisfied.


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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 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 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 include fees to:

• contract research organizations and other service providers in connection with clinical studies;

• contract manufacturers in connection with the production of clinical trial materials; and

• vendors in connection with preclinical development activities.

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 contract research organizations 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. Adjustments to prior period estimates have not been material for each of the years ended December 31, 2011 and 2010. In the fourth quarter of 2012, adjustments to increase clinical trial expenses by $657,000 were recorded due to the material weakness in our internal control over financial reporting discussed in Part II, Item 9A, Controls and Procedures, "Material Weakness in Internal Control Over Financial Reporting" of this Annual Report on Form 10-K.

Stock-Based Compensation

Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employee's requisite service period on a straight line basis. We recorded non-cash stock-based compensation expense of $0.8 million, $0.2 million, and $0.3 million, the years ended December 31, 2012, 2011, and 2010, respectively. As of December 31, 2012, we had approximately $2.8 million of total unrecognized compensation expense, net of related forfeiture estimates, which we expect to recognize over a weighted-average period of approximately 3.3 years. We expect to continue to grant stock options in the future, and to the extent that we do, our actual stock-based compensation expense recognized in future periods will likely increase.

Prior to our IPO, our board of directors, with the assistance of management and independent consultants, performed fair value analyses to determine the valuation of our common stock. For grants made on dates for which there was no contemporaneous valuation to utilize in setting the exercise price of our common stock, and given the absence of an active market for our common stock prior to our IPO in January 2013, our board of directors determined the fair value of our common stock on the date of grant based on several factors, including:

• important developments in our operations, most significantly related to the clinical development of our lead drug candidates, KB001-A, KB003, and KB004;

• equity market conditions affecting comparable public companies;


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• the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or an acquisition of us, given prevailing market conditions; and

• that the grants involved illiquid securities in a private company.

Results of Operations

General

We have not generated net income from operations, except for the year ended December 31, 2007 during which we recognized a one-time license payment from Novartis, and, at December 31, 2012, we had an accumulated deficit of $98.3 million primarily as a result of 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, and research and development payments in connection with strategic partnerships, 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 for the foreseeable future, and there can be no assurance that we will ever generate significant revenue or profits.

Contract Revenue

Our recent revenue is comprised primarily of collaboration agreement-related revenue. Collaboration agreement-related revenue includes license fees, payments for research and development services, and milestone and other contingent payments.

Research and Development Expenses

Conducting research and development is central to our business model. For the years ended December 31, 2012, 2011, and 2010, research and development expenses were $24.5 million, $18.5 million, $18.9 million, respectively. We expense both internal and external research and development costs as incurred. We currently track the external research and development costs incurred for each of our KB001-A, KB003, and KB004 projects. We have not tracked our external costs by project since inception. We began tracking our external costs by project beginning January 1, 2008. Our external research and development expenses consist primarily of:

• expenses incurred under agreements with contract research organizations, investigative sites, and consultants that conduct our clinical trials and a substantial portion of our preclinical activities;

• the cost of acquiring and manufacturing clinical trial and other materials; and

• other costs associated with development activities, including additional studies.

Internal research and development costs consist primarily of salaries and related fringe benefit costs for our employees (such as workers compensation and health insurance premiums), stock-based compensation charges, travel costs, lab supplies, and overhead expenses. Internal costs generally benefit multiple projects and are not separately tracked per project.


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The following table shows our total research and development expenses for the years ended December 31, 2012, 2011, 2010, and for the period from January 1, 2008 to December 31, 2012:

                                      Year Ended December 31,            For the Period from
                                                                         January 1, 2008 to
                                   2012         2011         2010         December 31, 2012
External costs:
KB001-A                          $  4,996     $  2,209     $  1,667     $              20,295
KB003                               7,682        1,433        2,676                    22,825
KB004                               4,102        5,502        4,781                    19,555
Internal costs                      7,739        9,368        9,769                    46,571

Total research and development   $ 24,519     $ 18,512     $ 18,893     $             109,246

We expect to continue to incur substantial expenses related to our development activities for the foreseeable future as we continue the Phase 2 clinical trials for our KB001-A CF program and our KB003 severe asthma program and continue our Phase 1 clinical trial for our KB004 program. As 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 clinical trials and activities beyond the Phase 2 trials for KB001-A and KB003 and the Phase 1 trial for KB004.

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. For the years ended December 31, 2012, 2011, and 2010, general and administrative expenses were $5.1 million, $4.0 million, $4.9 million, respectively. Upon the effectiveness of our registration statement on Form 10 in August 2012, we became a public reporting company under the Exchange Act. We anticipate general and administrative expenses will increase in future periods, reflecting an expanding infrastructure and increased professional fees associated with being a public reporting company.

Comparison of Years Ended December 31, 2012 and 2011



                                          For the Year Ended
                                             December 31,            Variance
          (In thousands)                  2012           2011
          Contract revenue              $   6,098      $ 20,255      $  14,157
          Operating expenses:
          Research and development         24,519        18,512         (6,007 )
          General and administrative        5,061         4,010         (1,051 )

          Loss from operations            (23,482 )      (2,267 )       21,215
          Interest income (expense)          (140 )          43            183
          Other income (expense), net         113            (8 )         (121 )

          Net loss                      $ (23,509 )    $ (2,232 )    $  21,277

Contract revenue in each period related solely to our arrangement with Sanofi in which we licensed the KB001-A program to Sanofi in 2010. Contract revenue decreased $14.2 million in 2012 compared to 2011. This decrease was mainly attributable to the completion of our substantive performance obligations under our agreement with Sanofi. This decrease was partially offset by an additional $1.7 million of contract revenue recognized in 2012 related to the $5.0 million payment received from Sanofi in August 2011 that was being


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recognized ratably through the completion of our substantive performance obligations under the agreement. As we have completed all of our substantive performance obligations under our agreement with Sanofi, we expect future contract revenue from Sanofi to be minimal in future periods unless we receive contingent payments or royalties under our agreement.

Research and development expenses increased $6.0 million in 2012 compared to 2011. This was primarily due to a $8.6 million increase related to spending for clinical trial and development expenses, primarily for our KB003 severe asthma program, start up activities for our KB001-A CF program, and ongoing activities for our KB004 program for hematological malignancies, as well as an increase in consulting expenses of $1.3 million to support ongoing development and clinical activities. This was partially offset by a $3.4 million decrease in payroll related expenses, including travel and supplies, resulting from a headcount reduction of 19 employees in our research and development organization primarily during mid to late 2011, and a decrease of $0.5 million in sublicense fees, primarily related to a milestone payment to our sublicensee for KB001-A in 2011. We began enrollment of patients in a Phase 2 clinical trial of KB003 for severe asthma in the third quarter of 2012 and began enrollment of patients in a Phase 2 clinical trial for KB001-A in CF patients with chronic Pa infections in January 2013, and as a result, we expect these expenses to increase significantly.

General and administrative expenses increased $1.1 million in 2012 compared to 2011. The increase in general and administrative expenses was primarily due to an increase of $1.0 million in legal, accounting and consulting fees related to being a public reporting company. As we became a publicly traded company in January 2013 though our initial public offering, we expect these expenses to increase, including legal, accounting, investor relations, and director and officer's insurance expenses.

Interest income (expense), increased by $183,000 in 2012 compared to 2011. The increase was due to interest expense related to our loan and security agreement entered into in September 2012, partially offset by interest income of $45,000.

Other income (expense), increased by $121,000 in 2012 compared to 2011. The increase was due to a gain on sale of fixed assets of $146,000 and a gain of $39,000 related to the revaluation of our convertible preferred stock warrant liabilities. The increase was primarily offset by a foreign currency exchange loss of $64,000.

Comparison of Years Ended December 31, 2010 and 2011



                                          For the Year Ended
                                             December 31,            Variance
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