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ENTA > SEC Filings for ENTA > Form 10-K on 18-Dec-2013All Recent SEC Filings

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Form 10-K for ENANTA PHARMACEUTICALS INC


18-Dec-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 of financial condition and results of operations together with the section entitled "Selected Financial Data" and our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and other parts of this prospectus contain forward-looking statements that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the "Risk Factors" section of this Annual Report on Form 10-K.

Overview

We are a research and development-focused biotechnology company that uses its robust chemistry-driven approach and drug discovery capabilities to create small molecule drugs in the infectious disease field. We are discovering and developing inhibitors designed for use against the hepatitis C virus, referred to as HCV. We believe that a successful approach to a complete cure for HCV in most patients will likely require treatment with a combination of drugs that attack different mechanisms necessary for replication and survival of HCV. Further, as there are many variants of HCV, we are developing inhibitors that may be used in multiple combination therapies, each designed and tested for effectiveness against one or more of those variants. Our development of inhibitors for validated HCV target mechanisms, as well as our collaborations with AbbVie (which name refers to Abbott Laboratories for all periods before January 1, 2013) and Novartis, should allow us to participate in multiple unique drug combinations as we and our collaboration partners seek the best combination therapies for HCV in its various forms. We estimate that total worldwide sales of HCV therapies were over $4 billion in 2012. We believe that annual worldwide sales of these therapies and future approved therapies could increase sales in this market to $10 to $20 billion within the next ten years. In addition to our HCV programs, we have used our internal research capabilities to discover a new class of antibiotics which we are developing for the treatment of multi-drug resistant bacteria, including methicillin-resistant Staphylococcus aureus bacteria, also referred to as MRSA. We have utilized our internal chemistry and drug discovery capabilities and our collaborations to generate all of our development-stage programs, and we have active research efforts to broaden our infectious disease drug pipeline.


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The following table summarizes our product development pipeline in HCV antivirals as well as MRSA antibiotics:

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Our HCV portfolio includes five compounds, each of which is an inhibitor of one of four fundamental, validated HCV targets:

NS3 Protease Inhibitors: ABT-450 and ABT-493. Our lead product candidate, ABT-450, is a protease inhibitor being developed by AbbVie in several combination regimens; AbbVie is completing several Phase 3 trials for the most advanced regimen, the first of which reported top-line results in November 2013, with the results of the other trials expected later in 2013 or the first quarter of calendar 2014. ABT-493, our next-generation protease inhibitor, is being developed also through our collaboration with AbbVie.

NS5A Inhibitor: EDP-239. Our lead NS5A product candidate, EDP-239, is being developed through our collaboration with Novartis.

Cyclophilin Inhibitors. Our independent research activities are focused on our lead cyclophilin inhibitor candidates, which are in preclinical development.

Nucleotide Polymerase Inhibitor. We also have a small-molecule drug discovery effort underway for nucleotide polymerase inhibitors.

In our HCV programs, AbbVie has funded all research and development of our protease inhibitors since we entered into the collaboration in November 2006, and is responsible for obtaining regulatory approvals and


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commercializing ABT-450, ABT-493 and any follow-on products worldwide. We received $57.2 million from AbbVie upon signing the collaboration agreement and its simultaneous purchase of preferred stock from us in 2006. We also received a $40.0 million milestone payment in December 2010 following AbbVie's successful completion of a Phase 2a clinical trial and a $15.0 million milestone payment in December 2012 following AbbVie's initiation of dosing in a Phase 3 clinical trial that includes ABT-450. Assuming AbbVie's successful development of the first protease inhibitor product, we will also be eligible to receive $195.0 million of additional pre-commercialization milestone payments. We are also eligible to receive additional milestone payments totaling up to $80.0 million upon AbbVie's achievement of similar commercial regulatory approval milestones for each additional collaboration product containing a protease inhibitor, as well as tiered royalties per product ranging from the low double digits up to twenty percent, or on a blended basis from the low double digits up to the high teens, on net sales, if any, by AbbVie allocable to the collaboration's protease inhibitors.

Under our collaboration with Novartis, which we entered into in February 2012, Novartis is responsible for all further development of our NS5A inhibitors. Novartis was also responsible for funding further research that we conducted through August 2013 to discover additional NS5A compounds. We received an upfront payment of $34.4 million in March 2012 and an $11.0 million milestone payment in January 2013 based on Novartis' initiation of dosing in a Phase 1 clinical trial that included EDP-239. We are eligible to receive up to $395 million of additional milestone payments for the first NS5A inhibitor product for which the specified milestones are achieved.

Our independent research activities are focused on our lead cyclophilin candidates, which are in preclinical development. We also have a small-molecule drug discovery effort underway for nucleotide polymerase inhibitors. We are currently funding all research and development for these two programs, and we expect to incur substantially greater expenses as we seek to advance these programs into clinical development.

In addition to our HCV programs, we have used our internal research capabilities to discover a new class of antibiotics called Bicyclolides, which we are developing to overcome multi-drug resistant bacteria, including methicillin-resistant Staphulococcus aureus bacteria, also referred to as MRSA. Up to $23.5 million of the preclinical development of our lead antibiotic candidate, EDP-788, is funded under a September 2011 contract with the National Institute of Allergy and Infectious Diseases, a division of the National Institutes of Health, an agency of the United States Department of Health and Human Services, or NIAID, and there is potential for further NIAID funding of early clinical development. In August 2013 NIAID agreed to provide additional funding of $9.2 million under our contract, increasing total funding from NIAID to approximately $23.5 million.

Since commencing our operations in 1995, we have devoted substantially all of our resources to the discovery and development of novel compounds for the treatment of infectious diseases. We have historically funded our operations primarily through the sale of convertible preferred stock and payments received under our collaborations and a government contract. On March 26, 2013, we completed our IPO of 4,600,000 shares of our common stock at an offering price of $14.00 per share, which included the exercise in full by the underwriters of their option to purchase up to 600,000 additional shares of our common stock. We received net proceeds of approximately $59.9 million, after deducting underwriting discounts and commissions. As of September 30, 2013, we had $112.2 million in cash and investments. We are eligible to receive over the next several years an aggregate of $430 million based on potential future pre-commercialization milestones under our AbbVie and Novartis collaborations, assuming successful clinical trial results for the respective collaboration programs and our collaborators' continued development of our product candidates through successful regulatory and reimbursement approvals in the United States and other major markets. In addition, we are eligible to receive tiered royalties ranging on a blended basis from the low double digits up to the high teens on worldwide net sales of any products containing protease inhibitors or NS5A inhibitors developed pursuant to the collaborations, as well as up to $160 million of commercialization sales milestones under our Novartis collaboration.

Our revenue from our collaboration agreements has resulted in our reporting net income in fiscal 2013, 2012 and 2011. However, we had an accumulated deficit of $107.5 million as of September 30, 2013 and we have


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generated no royalties or other revenue from product sales. We expect that our revenue in the near term will continue to be substantially dependent on our collaborations with AbbVie and Novartis and their continued advancement of the related development programs. Given the schedule of potential milestone payments and the uncertain nature and timing of clinical development, we cannot predict when or whether we will receive further milestone payments under these collaborations or whether we will continue to report either revenue or net income in future years.

Financial Operations Overview

Revenue

Since our inception, our revenue has been derived from two primary sources:
collaboration agreements with pharmaceutical companies and one government research and development contract. We have not generated any revenue from product sales. We have entered into three significant collaboration agreements. In November 2006, we entered into a collaboration agreement with AbbVie and in February 2012 we entered into a collaboration agreement with Novartis. In September 2011, we entered into a contract with NIAID, which will fund us for the preclinical development of our lead product candidate in our new class of Bicyclolide antibiotics.

The following table is a summary of revenue recognized from our collaboration agreements and our government contract for the years ended September 30, 2013, 2012 and 2011:

                                                        Year Ended September 30,
                                                     2013         2012         2011
                                                             (in thousands)
    AbbVie agreement:
    Upfront license payment and research funding   $     -      $     -      $  1,882
    Milestone payments                               15,000           -        40,000
    Novartis agreement:
    Upfront license payment and research funding      1,675       35,567           -
    Milestone payments                               11,000           -            -
    NIAID contract                                    4,378        6,139           -

    Total revenue                                  $ 32,053     $ 41,706     $ 41,882

AbbVie Agreement

Under the terms of the AbbVie agreement, as amended, we received an upfront license payment of $44.7 million and a commitment for research funding through December 15, 2010, and we granted AbbVie an option to enter into a six-month evaluation period. We received a total of $8.1 million of research funding and expense reimbursement from AbbVie through June 15, 2011, the conclusion of the evaluation period. In December 2010, we received a $40.0 million milestone payment from AbbVie related to AbbVie's successful completion of a Phase 2a clinical study of an ABT-450-containing regimen. We recognized revenue from these payments, as well as from a $1.6 million premium above fair value paid for Series G-1 redeemable convertible preferred stock that AbbVie purchased concurrently with the execution of the original agreement, over the period from the date of the original agreement through the end of the evaluation period using the proportional performance model. Under this revenue recognition model, the revenue we recognized was limited to the amount of nonrefundable payments received or receivable to date. Related to these payments by AbbVie, we recognized revenue of $41.9 million during the year ended September 30, 2011. Since all of our research obligations under the agreement were concluded by June 30, 2011, any future milestone payments received will be recognized as revenue when each milestone is achieved by AbbVie. During the year ended September 30, 2013, we earned and recognized as revenue a $15.0 million milestone payment based on AbbVie's initiation of dosing in a Phase 3 clinical trial that included ABT-450. Under the terms of the AbbVie agreement, we are eligible to receive future milestone payments totaling up to $195 million related to the successful development of the first HCV treatment regimen


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by AbbVie incorporating one of our collaboration's protease inhibitors. We are also eligible to receive additional milestone payments totaling up to $80.0 million upon AbbVie's achievement of similar commercial regulatory approval milestones for each additional collaboration product containing a protease inhibitor. We are also eligible to receive royalties on AbbVie's net sales, if any, allocable to any one of our collaboration's protease inhibitors.

Novartis Agreement

Under the terms of the Novartis agreement, we received an upfront payment of $34.4 million and a commitment to fund research at an agreed amount for one year. We recognized the upfront license payment upon receipt as we determined that the license to which the payment related and the research services were separable elements under the agreement that could be accounted for as each was delivered or provided. During the year ended September 30, 2012, revenue recognized under this agreement was $35.6 million, which consisted of the upfront license payment and research funding earned during that period. Our agreement with Novartis initially provided that we would receive up to $1.8 million in research funding during the first year of the agreement, which ended in February 2013, and was amended to extend the funding period for an additional six months through August 2013 at the same reimbursement rate. Additionally, our collaboration with Novartis provides for future milestone payments totaling of up to $406 million if certain goals related to drug development and net product sales are achieved by Novartis. In January 2013, we received an $11.0 million milestone payment based on Novartis' November 2012 initiation of dosing in a Phase 1 clinical trial that included EDP-239. During the year ended September 30, 2013, we recognized $12.7 million of revenue under the Novartis agreement, of which $11.0 million was attributed to license fees and $1.7 million was attributed to the performance of research services. An additional milestone payment of $15.0 million will be due upon Novartis' initiation of a subsequent Phase 2 trial using a combination treatment regimen containing an NS5A inhibitor. We are also eligible to receive royalties on Novartis' net sales, if any, allocable to our collaboration's NS5A inhibitors.

NIAID Contract

Under the terms of the NIAID contract, NIAID will pay us research and development funding of up to $14.3 million over an initial period of 30 months. The award also contains six option periods, which in aggregate could extend the contract at the option of NIAID up to an additional 30 months and provide us additional funding of up to $28.4 million. In August 2013 NIAID agreed to provide additional funding of $9.2 million under our contract, which will bring total funding from NIAID to approximately $23.5 million. We recognize revenue under this contract as the research and development services are performed. We recognized revenue of $4.4 million and $6.1 million under this agreement during the years ended September 30, 2013 and 2012, respectively.

As our internal product candidates are currently in preclinical development, we have not generated any revenue from product sales and do not expect to generate any revenue from product sales for at least the next several years. We expect that our revenue for the next several years will be derived primarily from payments under our current collaboration agreements with AbbVie and Novartis, payments under our NIAID contract, and any additional collaborations or government contracts that we may enter into in the future. We cannot provide assurance as to the timing of future milestone or royalty payments or that we will receive any of these payments at all.


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Operating Expenses

The following table summarizes our operating expenses for the years ended
September 30, 2013, 2012 and 2011:



                                               Year Ended September 30,
                                            2013         2012         2011
                                                    (in thousands)
             Research and development     $ 16,841     $ 15,115     $ 11,547
             General and administrative      6,183        5,302        5,036

             Total operating expenses     $ 23,024     $ 20,417     $ 16,583

Research and Development Expenses

Research and development expenses consist of costs incurred to conduct basic research, such as the discovery and development of novel small molecules as therapeutics. We expense all costs of research and development as incurred. These expenses consist primarily of:

personnel costs, including salaries, related benefits and stock-based compensation for employees engaged in scientific research and development functions;

third-party contract costs relating to research, formulation, manufacturing, preclinical study and clinical trial activities;

third-party license fees;

laboratory consumables; and

allocated facility-related costs.

Project-specific expenses reflect costs directly attributable to our clinical development candidates and preclinical candidates nominated and selected for further development. Remaining research and development expenses are reflected in research and drug discovery, which represents early-stage drug discovery programs. At any given time, we typically have several active early stage research and drug discovery projects. Our internal resources, employees and infrastructure are not directly tied to any individual research or drug discovery project and are typically deployed across multiple projects. As such, we do not maintain information regarding costs incurred for our early-stage research and drug discovery programs on a project-specific basis.

We expect that our research and development expenses will increase in the future as we advance our two independent HCV programs and our antibiotic program for MRSA into clinical development.

Our research and drug discovery programs are at an early stage; therefore, the successful development of our product candidates is highly uncertain and may not result in approved products. Completion dates and completion costs can vary significantly for each product candidate and are difficult to predict. Given the uncertainty associated with clinical trial enrollments and the risks inherent in the development process, we are unable to determine the duration and completion costs of the current or future clinical trials of our product candidates or if, or to what extent, we will generate revenue from the commercialization and sale of any of our product candidates. We anticipate that we will make determinations as to which development programs to pursue and how much funding to direct to each program on an ongoing basis in response to the preclinical and clinical success of each product candidate, as well as ongoing assessments of the commercial potential of each product candidate.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs, consisting of salaries, related benefits and stock-based compensation, of our executive, finance, business and corporate development and other


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administrative functions. General and administrative expenses also include travel expenses, allocated facility-related costs not otherwise included in research and development expenses, directors' and officers' liability insurance premiums, and professional fees for auditing, tax and legal services, including legal expenses to pursue patent protection of our intellectual property.

We expect that general and administrative expenses will increase in the future as we expand our operating activities and incur additional costs associated with operating as a public company. These public company related increases will likely include costs of additional personnel; additional legal fees, accounting and audit fees and directors' and officers' liability insurance premiums; and costs related to investor relations.

Other Income (Expense)

Interest income. Interest income consists of interest earned on our cash and investment balances. In the past our interest income has not been significant due to nominal cash and investment balances and low interest earned on invested balances. We anticipate that our interest income will increase in the future due to our higher cash and investment balances now existing as a result of the $34.4 million upfront payment we received from Novartis in March 2012, the $15.0 million milestone payment we received from AbbVie in December 2012 and the $11.0 million milestone payment we received from Novartis in January 2013, as well as our receipt of $59.9 million of cash proceeds, net of underwriting discounts and commissions, from our IPO in March 2013.

Interest expense. Interest expense consisted of cash interest paid on our bridge notes and non-cash interest expense related to the accretion of debt issuance costs and debt discounts associated with our issuance of bridge notes in the first quarter of fiscal 2011. We anticipate that we will have little or no interest expense in the future related to debt as our outstanding bridge notes were fully repaid in the first quarter of fiscal 2011 and we no longer have any debt outstanding. Presently interest expense consists of non-cash interest expense which is being accreted to the value of accrued third-party license fees over the term of the obligation.

Change in fair value of warrant liability. We have outstanding warrants for the purchase of our nonconvertible preferred stock that we believe are financial instruments that may require a transfer of assets because of the redemption features of the underlying stock. Therefore, we have classified these warrants as liabilities that we remeasure to fair value at each reporting period and we record the changes in the fair value of the warrants as a component of other income (expense).

Therapeutic tax credit. We recorded other income for the year ended September 30, 2011 related to the Qualifying Therapeutic Discovery Project, or QTDP, reimbursement program of the United States government, which provided for reimbursement in calendar year 2010 of certain costs paid or incurred during calendar years 2009 and 2010 that were directly related to the conduct of a QTDP. We do not anticipate any further income related to the QTDP program.

Gain on embedded derivative. In connection with the repayment of our bridge financing that we entered into and fully repaid in the first quarter of fiscal 2011, we settled an embedded derivative at no cost to us and recorded a gain on settlement consisting of the value of the embedded derivative.

Other income (expense), net. Other income (expense), net consisted primarily of miscellaneous service income unrelated to our core operations. We do not expect to generate this income in the future as we do not anticipate providing these services in the future.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, costs and expenses, and


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related disclosures. We believe that the estimates and assumptions involved in the accounting policies described below may have the greatest potential impact on our financial statements and, therefore, consider these to be our critical accounting policies. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. See also Note 2 of our financial statements included elsewhere in this Annual Report on Form 10-K for information about these critical accounting policies as well as a description of our other significant accounting policies.

JOBS Act

On April 5, 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an "emerging growth company." As an "emerging growth company," we are electing not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.
Section 107 of the JOBS Act provides that our decision not to take advantage of the extended transition period is irrevocable. Subject to certain conditions set forth in the JOBS Act, as an "emerging growth company", we are not required to, among other things, (i) provide an auditor's attestation report on our system of internal controls over financial reporting pursuant to Section 404, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act, (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor's report providing additional information about the audit and the financial statements (auditor discussion and analysis), and
(iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer's compensation to median employee compensation. These exemptions will apply for a period of five years following the completion of our initial public offering in March 2013 or until we no longer meet the requirements of being an "emerging growth company," whichever is earlier.

Revenue Recognition

Our revenue is generated primarily through collaborative research and license agreements. The terms of these agreements contain multiple deliverables which may include (i) licenses, (ii) research and development activities, and . . .

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