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AFFY > SEC Filings for AFFY > Form 10-K on 2-Apr-2013All Recent SEC Filings

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Form 10-K for AFFYMAX INC


2-Apr-2013

Annual Report


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

Overview
We are a biopharmaceutical company committed to discovering, developing and delivering innovative therapies that improve the lives of patients with kidney disease and other serious and often life-threatening illnesses. In March 2012, the U.S. Food and Drug Administration, or FDA, approved our first product, OMONTYS® (peginesatide) Injection for the treatment of anemia due to chronic kidney disease in adult patients on dialysis. OMONTYS is a synthetic, peptide-based erythropoiesis stimulating agent, or ESA, designed to stimulate production of red blood cells. Our product is the only once-monthly ESA that has been available to the adult dialysis patient population in the U.S. In 2012, we co-commercialized OMONTYS in the U.S. with our collaboration partner, Takeda Pharmaceutical Company Limited, or Takeda, the largest pharmaceutical company in Japan.

In early 2013 and in consultation with the FDA, we and Takeda voluntarily recalled OMONTYS nationwide from the market as a result of post-marketing reports regarding serious hypersensitivity reactions, including anaphylaxis, which can be life-threatening or fatal. In connection with the recall, we and Takeda suspended all promotional and marketing activities for OMONTYS. While we continue to investigate the potential cause of the safety concerns at this time, we face significant challenges to our business. We are unable to estimate the scope or timelines associated with the investigation, which may be costly and time-consuming, and with our limited funds and resources, we may not be able to complete the investigation or ever identify the causes of the safety concerns.

In March 2013, we undertook plans to reorganize our operations in order to reduce operating costs and focus on the OMONTYS safety and other related FDA issues associated with the recall of the product. In addition to transitioning many of the ongoing activities to our collaborator, Takeda, our plans include a significant reduction in force of approximately 230 employees (75% of our workforce), including our commercial and medical affairs field forces as well as other employees throughout the organization. We expect to incur between $8.0 million and $10.0 million in restructuring charges related to the workforce reduction during the first quarter of 2013. As a result of this restructuring and the recall, we may also incur additional charges depending on further review and additional reductions in operations and may also experience impairment changes with respect to our property and equipment and long lived assets in the first quarter of 2013.

We will continue to review our operations as we discuss with Takeda the roles and responsibilities of the parties in addressing our regulatory and other obligations resulting from the OMONTYS recall. In any event, we plan to continue to make efforts to substantially reduce our operating costs, which will likely include further reductions in force as we endeavor to conserve our cash resources. We have been in discussions with, and are planning to seek further assistance and support from Takeda as we transition from a commercial operating company to a company potentially without any product. We are undertaking steps to reduce all of our outstanding obligations to third parties and are dependent on those efforts to continue operations even in the near term, however, we may not be successful. We are particularly dependent on Takeda's willingness to continue the collaboration in a modified form that reduces our operating expenses and responsibilities under the collaboration, but we may also be required to reduce our share of OMONTYS profits if and when the product may be re-introduced in the future. Even if Takeda is willing to assume additional responsibilities under the collaboration, including the conduct of most or all of the ongoing investigation, the loss of critical personnel and functions means that we may not be able to maintain our operations, support the New Drug Application or NDA, continue as a going concern or ever re-introduce OMONTYS.

In view of our limited resources and funds, we plan to explore various strategic alternatives, including a sale of the company or its assets or a corporate merger. We are considering all possible alternatives, including further restructuring activities, wind-down of operations or even bankruptcy proceedings.

If we and Takeda are unable to rapidly identify and rectify the causes of the safety concerns to the satisfaction of the FDA, which is highly uncertain, OMONTYS may be permanently withdrawn from the market. The recall of OMONTYS has severely harmed our business, financial condition and prospects as a going concern. The recall has also limited our access to funds and the resources that may be required in order to address the safety concerns. As a result, we may be unable to continue our operations. In order to reintroduce OMONTYS, we would have to complete our ongoing thorough investigation, identify the causes of the safety concerns and provide a suitable plan to the FDA for approval. Accordingly, there can be no assurance that we can address the safety concerns and meet the requirements of the FDA for reintroduction. Moreover, even if


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OMONTYS could be reintroduced, the commercial prospects for this product may be permanently diminished and the product may no longer be commercially viable.

In March 2012, we entered into a loan and security agreement, or the Loan Agreement, with Oxford Finance LLC and Silicon Valley Bank, or, collectively, the Lenders, under which we may borrow up to a total of $30.0 million in two tranches. The first tranche of $10.0 million was borrowed in March 2012. The second tranche of $20.0 million was available for drawdown until March 31, 2013; however, it may no longer be available due to our recent recall of OMONTYS. In connection with the Loan Agreement, we issued the Lenders warrants to purchase 132,855 shares of our common stock, or the Warrants, which are exercisable at $11.855 per share. In September 2012, SVB Financial Group, the parent group of Silicon Valley Bank, exercised its Warrant for a net exercise of 23,453 shares of our common stock. In October 2012, Oxford Finance LLC exercised the remaining Warrants for a net exercise of 36,660 shares of common stock. Both of these Warrants were net exercised on a cashless basis. Since we suspended the marketing activities of OMONTYS and voluntarily recalled OMONTYS, we may be in breach under our Loan Agreement. The voluntary recall may be considered a material adverse event under the Loan Agreement. As a result, we have classified our loan balance as a current liability. Events of default under the Loan Agreement provide the Lenders with various rights, including the right to require immediate repayment of the outstanding principal plus accrued and unpaid interest through the prepayment date, the final payment of $0.5 million and the prepayment fee of $0.5 million. We have not received a notice of default. If we receive a notice of default from the Lenders, in addition to repaying the outstanding balance of our loan. we will also accrue the remaining final interest charge and the full amount of the final payment and the prepayment fee. In 2012, we co-commercialized OMONTYS with Takeda. The commercial launch of the product occurred in April 2012. To commercialize OMONTYS, we established commercial and medical affairs infrastructures in 2012. The functions of our commercial and medical affairs infrastructures include marketing and sales, medical education, coverage and reimbursement and account management. In 2012, we marketed our product primarily to dialysis organizations. Associated costs are included in selling, general and administrative costs or SG&A, in our accompanying financial statements.

In 2012, Takeda was responsible for account management, pricing and contracting. Specifically, Takeda had sole responsibility for invoicing and collection of receivables with regard to sales of OMONTYS. Takeda also has the rights and responsibility for establishing and modifying terms and conditions with customers with respect to the sale of OMONTYS in the U.S., including pricing discounts available to third-party payors, price adjustments and other allowable discounts and allowances. Both parties also have shared responsibilities such as joint marketing activities, business analytics and account management allocated by customer segments.
Outside of the U.S., Takeda holds an exclusive license to develop and commercialize OMONTYS and has primary responsibility for filing regulatory submissions and obtaining product approvals in those territories. Revenues in 2012, 2011 and 2010 were derived almost exclusively from collaboration revenue from Takeda. Collaboration revenue consists of milestone payments, profit equalization revenue related to our share of product profit or loss on OMONTYS, reimbursement of development and commercialization expenses, and revenue for active pharmaceutical ingredient or API, under our agreements with Takeda or collectively, the Arrangement. We derived most of our collaboration revenue in 2012 from milestone payments and profit equalization revenue. From inception to December 31, 2012, we have received $122.0 million of upfront license fees, $115.3 million in milestone payments and $297.2 million related to the profit equalization revenue, the reimbursement of development and commercialization expenses and purchase of API under our Arrangement with Takeda. We are eligible to receive an aggregate of $357.0 million in additional milestone payments from Takeda upon successful achievement of as yet unmet clinical development and regulatory milestones and sales-based milestones. However, timing and amounts are extremely uncertain, due to the recall.

We have experienced significant operating losses since inception. We have funded our operations primarily through the sale of equity securities, reimbursement for development expenses and API production, license fees, milestone payments and profit equalization revenue from Takeda, issuance of notes payable, capital lease financings, interest earned on investments and limited license fees and royalties from licensing intellectual property. As of December 31, 2012, we had an accumulated deficit of $543.7 million. However, due to the recent recall of OMONTYS described under the caption "OMONTYS Voluntary Recall" under "Item 1. Business" of this Annual Report on Form 10-K, we anticipate that we will incur substantial losses in future periods and may continue to incur substantial losses in the long term depending on our success in reintroducing and commercializing OMONTYS. Our operations have consumed substantial amounts of cash since our inception. If we are unable to identify quickly the causes of the OMONTYS safety concerns or raise additional funds when required or on acceptable terms, we may have to:


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• abandon the plan to reintroduce OMONTYS;

• assume greater risks and significantly delay, scale back, or discontinue operations;

• relinquish some or all of our existing rights to OMONTYS;

• eliminate or defer manufacturing efforts that may negatively impact OMONTYS; or

• pursue alternatives such as a restructuring or winddown of operations.

On February 27, 2013, a securities class action complaint was filed in the United States District Court for the Northern District of California, naming as defendants Affymax, Inc. or the Company, certain of its officers, Takeda Pharmaceutical Company Limited, Takeda Pharmaceuticals U.S.A., Inc. and Takeda Global Research & Development Center, Inc. A second complaint naming the same defendants was filed on March 6, 2013. The complaints, filed on behalf of purported stockholders of the Company, allege violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, in connection with allegedly false and misleading statements made by the defendants regarding the Company's business practices, financial projections and other disclosures between December 8, 2011 and February 22, 2013, or the Class Period. The plaintiff seeks to represent a class comprised of purchasers of the Company's common stock during the Class Period and seeks damages, costs and expenses and such other relief as determined by the Court. On March 19, 2013, a derivative lawsuit was filed purportedly on behalf of the Company in California Superior Court for the County of Santa Clara naming certain of our officers and directors as defendants. The lawsuit alleges that certain of the Company's officers and directors breached their fiduciary duties related to the clinical trials for OMONTYS and for representations regarding the Company's business health, which was tied to the success of OMONTYS. The lawsuits also asserts claims for unjust enrichment and corporate waste. Additional complaints may be filed against us and our directors and officers related to our recall of OMONTYS. Our management believes that we have meritorious defenses and intends to defend these lawsuits vigorously. However, these lawsuits are subject to inherent uncertainties, the actual cost may be significant, and we may not prevail. We believe we are entitled to coverage under our relevant insurance policies, subject to a retention, but coverage could be denied or prove to be insufficient.

We expect to continue to incur substantial operating losses as we investigate the cause of these safety concerns to OMONTYS, search for and implement solutions to address it and prepare for the potential reintroduction of OMONTYS as well as share in those efforts of Takeda's. When and if we reintroduce OMONTYS, we expect to incur additional operating losses as we add infrastructure and operations to support commercialization of OMONTYS, and potentially begin new R&D programs. Our ability to generate product sales and become profitable depends heavily on our ability to successfully reintroduce and commercialize OMONTYS. OMONTYS will require significant marketing efforts and substantial investment before it can provide us or our partners with any meaningful revenue. Accordingly, we may never generate significant revenues and, even if we do generate revenue in the future, we may never achieve or sustain profitability.

As a result of the February 23, 2013 nationwide voluntary recall of OMONTYS and the suspension of all marketing activities, there is significant uncertainty as to whether we will have sufficient existing cash, cash equivalents and investments to fund our operations for the next 12 months. If we were to reduce cash outflows, there is no assurance that we will be able to reduce our operating expenses enough to meet our existing obligations. If we are not able to reintroduce the product or obtain additional funding in the near future, our cash resources will rapidly be depleted and we will be required to materially reduce or suspend operations, which would likely have a material adverse effect on our business, stock price and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained. If we do not have sufficient funds to continue operations, we could be required to liquidate our assets, seek bankruptcy protection or other alternatives that would likely result in receiving less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or some of their investment in us. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into collaborative relationships with business partners, make it more difficult to obtain required financing on favorable terms or at all, negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.

If the recall is not lifted and we are not able to reintroduce OMONTYS, this will result in a severe decrease to our profit equalization revenue in future periods. Even if we are successful in reintroducing and commercializing OMONTYS in the future, there can be no assurance that revenues will ramp up rapidly enough to offset operating losses and repayment of debts. Further challenges or delays to potential reintroduction and commercialization of OMONTYS may require us to raise additional funding to successfully reintroduce and commercialize OMONTYS. We may seek to raise additional funds through public or private financing, strategic partnerships or other arrangements. Any additional equity financing would be dilutive to


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stockholders and debt financing, if available, may involve restrictive covenants that may limit our ability to conduct our business and increase our risk of defaults. The market may take into consideration of the recent recall of OMONTYS, which recall is described under the caption "OMONTYS Voluntary Recall" in "Item 1. Business" of this Annual Report on Form 10-K which may negatively affect our ability to obtain additional funding. Market conditions may significantly limit our ability to raise funds such that there can be no assurance we can raise the additional funds to support our continuing operations, and successfully reintroduce and commercialize OMONTYS, and funding may not be available to us on acceptable terms, or at all.

Results of Operations

Revenue

During the commercialization period, which commenced in June 2011, we receive reimbursement for certain collaboration expenses. Takeda bears responsibility for 70% of third-party expenses related to U.S. development and 50% of third party expenses related to the commercialization of OMONTYS in the U.S. incurred by us and we are responsible for the reciprocal amount of development and commercialization expenses. Certain employee-related expenses supporting preparation for commercialization of OMONTYS in the U.S. are also shared equally. Such employee-related costs include the cost of certain employees that are required to commercialize OMONTYS such as field sales representatives, sales operations, medical science liaisons, nurse educators, conversion specialists, national accounts managers and reimbursement specialists. In addition, costs of employees in clinical, regulatory and other development functions supporting any post-marketing development activity required by the FDA or separately agreed to by the parties in the U.S. are generally shared equally.

During the development period under the Arrangement with Takeda, which ended in May 2011 upon the submission of our NDA to the FDA for review, collaboration revenue was recognized using the Contingency Adjusted Performance Model, or CAPM. As a result, any payments from Takeda under the Arrangement were recorded as deferred revenue and recognized ratably over the estimated development period. Prior to the approval of OMONTYS, collaboration revenue had consisted of reimbursement of development and commercial expenses, net of Takeda's own eligible expenses, and milestone payments.

OMONTYS sales by Takeda commenced in September 2012. Subsequent to the launch of OMONTYS and recognition of product revenue by Takeda, our collaboration revenue consisted of profit equalization revenue generated from our collaboration agreement with Takeda, milestone payments, reimbursements of certain eligible development and commercial expenses, net of Takeda's own eligible expenses, and revenue previously deferred related to payments we received associated with previously expensed API, which have been sold by Takeda. Revenue from profit equalization is calculated on a quarterly basis as the amount required so that the profit or loss realized by both Affymax and Takeda on OMONTYS equates to 50% of the total product profit or loss. Total product profit or loss on OMONTYS is calculated as gross product sales recorded by Takeda, less the following deductions recorded by Takeda: rebates and discounts, cost of goods and other gross-to-net adjustments incurred by Takeda, royalty expense incurred by us, commercialization expenses (full-time equivalents or FTE, related and out of pocket costs) incurred by both Takeda and us, and certain development costs associated with post-marketing development activities (FTE related and out of pocket costs) incurred by both Takeda and us.

Revenue as compared to prior years is as follows (in thousands):

                                 Year ended December 31,              Percent Change
                              2012        2011         2010      2012/2011      2011/2010
Collaboration revenue       $ 94,358    $ 47,703    $ 112,503        98  %        (58 )%
License and royalty revenue       12          17           18       (29 )%         (6 )%
Total revenue               $ 94,370    $ 47,720    $ 112,521        98  %        (58 )%

Revenue increased $46.7 million from $47.7 million in 2011 to $94.4 million in 2012. The increase in collaboration revenue for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily due to the recognition of $60.3 million in milestone payments from Takeda related to FDA approval of OMONTYS, the European Medicines Agency, or EMA's acceptance for review of the Marketing Authorization Application or MAA submitted by Takeda, and commercial progress on the OMONTYS product launch and our profit equalization revenue(1) related to the commencement of OMONTYS sales, and revenue previously deferred related to previously expensed API, which is partially offset by a decrease in amounts eligible for reimbursement under our Arrangement with Takeda.

Revenues decreased $64.8 million from $112.5 million in 2010 to $47.7 million in 2011. The decrease in collaboration revenue for the year ended December 31, 2011 compared to the year ended December 31, 2010 was due to a reduction in overall research and development or R&D costs eligible for reimbursement under our collaboration with Takeda as we completed our


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Phase 3 clinical trials in early 2010. Collaboration revenue for the year ended December 31, 2010 was also impacted by our change in estimate adjustment recorded in the fourth quarter of 2010 related to our clinical trial expense which reduced revenue by $7.8 million. These decreases were partially offset by milestone payments received from Takeda in 2011 and 2010. During the year ended December 31, 2011, we received a $10.0 million cash milestone payment from Takeda for acceptance for review of our NDA by the FDA in the third quarter of 2011. For the year ended December 31, 2010, we received a $5.0 million milestone payment from Takeda for the initiation of Phase 3 renal indication in Japan in March 2010 and $30.0 million in milestone payments for the database lock of our non-dialysis and dialysis Phase 3 trials in the second quarter of 2010. Both of these milestones were accounted for under CAPM.

The following table presents our collaboration revenue, by revenue type, for the periods presented (in thousands):

                                                Year ended December 31,
                                             2012        2011         2010
Profit equalization revenue (1)            $ 26,544    $      -    $       -
Milestone payments                           60,250      10,000            -
Revenue previously deferred related to API      936           -            -
Revenue recognized under CAPM                     -      26,606      112,503
Net expense reimbursement after CAPM          6,628      11,097            -
Total collaboration revenue                $ 94,358    $ 47,703    $ 112,503



(1) Revenue from profit equalization is calculated on a quarterly basis as the amount required such that the profit or loss realized by both Affymax and Takeda on the product equates to 50% of the total product profit or loss. Total product profit or loss on OMONTYS is calculated as gross product sales recorded by Takeda, less the following deductions also recorded by Takeda: rebates and discounts, cost of goods, and other gross-to-net adjustments incurred by Takeda; royalty expense incurred by us, commercialization expenses (FTE related and out of pocket costs) incurred by both Takeda and us, and certain development costs associated with post-marketing development activities (FTE related and out of pocket costs) incurred by both Takeda and us. Profit equalization revenue is recognized as revenue in the period product revenue is recognized by Takeda.

On February 23, 2013, we and Takeda announced a nationwide voluntary recall of OMONTYS as a result of postmarketing reports regarding safety concerns, including anaphylaxis, which can be life-threatening or fatal. We and Takeda are actively investigating the cause of these reactions but there can be no assurance that a solution will be found. As a result of the voluntary recall of OMONTYS, all marketing activities have been suspended and there is significant uncertainty as to when or if we will be able to reintroduce OMONTYS. Although we still maintain a license and are actively exploring a cause for the allergic reactions, we do not know when this reintroduction will occur, if at all. If the recall is not lifted and we are not able to reintroduce OMONTYS, this will result in a severe decrease to our profit equalization revenue or potentially profit equalization losses in future periods. The total estimated product returned in the recall all relates to product shipped subsequent to December 31, 2012; as a result there was no impact to the 2012 profit equalization revenue resulting from the recall. Given the uncertainty of any profit equalization revenue in future periods, we have recharacterized our deferred revenue as an Advance from Takeda, which is reflected as a current liability in our December 31, 2012 financial statements. Additionally, although we are eligible to receive future milestones from Takeda, timing and amounts of future milestone payments, if any, are extremely uncertain due to the recall.

Operating expenses incurred by us which have been subject to reimbursement by Takeda under the Arrangement, excluding API manufacturing costs are as follows (in thousands):

                                       Year ended December 31,
                                    2012        2011        2010
Research & development            $ 15,480    $ 22,412    $ 35,305
Selling, general & administrative   43,748       8,471       8,241
Total                             $ 59,228    $ 30,883    $ 43,546

The change in the mix of costs subject to reimbursement in 2012 compared to 2011 was primarily due to our company shifting from being a R&D company to now becoming a commercial company. In 2012, we commercially launched OMONTYS which resulted in much larger commercial-related reimbursements. In 2011, our primary focus was obtaining FDA approval which was more R&D-related. We expect collaboration revenue to fluctuate with changes in revenue related to the profit equalization of the collaboration and with changes in the amount of reimbursable expenses for our direct development. Revenue/


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loss from profit equalization is influenced by a number of factors, some of which may impact the sales of OMONTYS and reimbursement of collaboration expenses more significantly than others, including, but not necessarily limited to, our ability to reintroduce OMONTYS following the February 2013 recall and the level of reimbursable costs incurred by us versus those incurred by Takeda including costs associated with the recall, costs of the investigation and . . .

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