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CEMP > SEC Filings for CEMP > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for CEMPRA, INC.

Form 10-K for CEMPRA, INC.


28-Feb-2014

Annual Report


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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this report, including those set forth under "Item 1A. Risk Factors."

Overview

We are a clinical-stage pharmaceutical company focused on developing differentiated antibiotics for the acute care and community settings to meet critical medical needs in the treatment of bacterial infectious diseases, particularly respiratory tract infections and chronic staphylococcal infections. Our lead product, solithromycin (CEM-101), is in Phase 3 clinical trials. We are developing solithromycin in oral capsules, intravenous, or IV, and suspension formulations, initially for the treatment of community acquired bacterial pneumonia, or CABP, one of the most serious infections of the respiratory tract. Solithromycin is a potent new


fourth generation macrolide and the first fluoroketolide in clinical development. We have also completed a Phase 2 study of solithromycin in uncomplicated gonorrhea. Our second program is Taksta, which we are developing exclusively in the U.S. as a long term oral treatment for prosthetic joint infections caused by staphylococci, including S. aureus and MRSA. We are conducting a Phase 2 trial for Taksta in patients with prosthetic joint infections and have submitted a proposal for a Phase 3 trial for Tasksta as a treatment for PJI, which could lead to an NDA. If we receive concurrence from the FDA on the planned Phase 3 trial, we plan to stop the Phase 2 trial and roll into the Phase 3 trial.

We acquired worldwide rights (exclusive of ASEAN countries) to a library of over 500 macrolide compounds, including solithromycin, from Optimer Pharmaceuticals, Inc., or Optimer, in March 2006. We entered into a long-term supply arrangement with Ercros, S.A. in March 2011, pursuant to which we have the exclusive right to acquire fusidic acid for the production of Taksta. We believe Ercros is one of only two currently known manufacturers that can produce fusidic acid compliant with the purity required for human use. The United States Patent and Trademark Office (USPTO) issued our patent, entitled "Fusidic Acid Dosing Regimens for Treatment of Bacterial Infections," on May 28, 2013 with claims directed to the company's novel loading dose regimen for Taksta. This patent provides protection until 2029, excluding possible patent term extensions.

Our Board of Directors approved a 1-for-9.5 reverse stock split of our common and preferred shares on January 12, 2012, which became effective on January 29, 2012. All references to common stock, common shares outstanding, average number of common shares outstanding and per share amounts in our consolidated financial statements and notes to consolidated financial statements have been restated to reflect the 1-for-9.5 reverse stock split on a retroactive basis.

Financial Overview

Revenue

To date, we have not generated revenue from the sale of any products. All of our revenue to date has been derived from (1) a government contract and (2) the receipt of up-front proceeds under our license agreement with Toyama, a portion of which has been recognized in accordance with US GAAP.

In May 2013, we entered into an agreement with the Biomedical Advanced Research and Development Authority of the U.S. Department of Health and Human Services, or BARDA, for the evaluation and development of solithromycin for the treatment of bacterial infections in pediatric populations and infections caused by bioterror threat pathogens, specifically anthrax and tularemia.

The BARDA agreement is a cost plus fixed fee development contract, with a base performance segment valued at approximately $17.7 million, and four option work segments that BARDA may request in its sole discretion pursuant to the agreement. If all four option segments are requested, the cumulative value of the agreement would be approximately $58 million. Three of the options are cost plus fixed fee arrangements and one option is a cost sharing arrangement for which we would be responsible for a designated portion of the costs associated with that work segment. The estimated period of performance for the base performance segment is May 24, 2013 through May 23, 2015. If all option segments are requested, this estimated period of performance would be extended until approximately May 23, 2018.

Under the contract, we are reimbursed and recognize revenue as allowable costs are incurred plus a portion of the fixed-fee earned. We consider fixed-fees under cost reimbursable contracts to be earned in proportion to the allowable costs incurred in performance of the work as compared to total estimated contract costs, with such costs incurred representing a reasonable measurement of the proportional performance of the work completed. Through December 31, 2013, we recognized $3.5 million in revenue under this agreement.

In May 2013, Cempra Pharmaceuticals, Inc., our wholly owned subsidiary, entered into a license agreement with Toyama, whereby we licensed to Toyama the exclusive right, with the right to sublicense, to make, use and sell any product in Japan that incorporates solithromycin as its sole active pharmaceutical ingredient, or API, for human therapeutic uses, other than for ophthalmic indications or any condition, disease or affliction of the ophthalmic tissues. Toyama also has a nonexclusive license in Japan and certain other countries, with the right to sublicense, to manufacture or have manufactured API for solithromycin for use in manufacturing such products, subject to limitations and obligations of the concurrently executed supply agreement discussed below. Toyama has granted us certain rights to intellectual property generated by Toyama under the license agreement with respect to solithromycin or licensed products for use with such products outside Japan or with other solithromycin-based products inside or outside Japan.


Following execution of the agreement, we received a $10.0 million upfront payment from Toyama. Toyama is also obligated to pay us up to an aggregate of $60.0 million in milestone payments, depending on the achievement of various regulatory, patent, development and commercial milestones. Under the terms of the license agreement, Toyama must also pay us a royalty equal to a low-to-high first double decimal digit percentage of net sales, subject to downward adjustment in certain circumstances. Through December 31, 2013, we recognized $4.3 million in revenue under this agreement and the remainder, which is deferred, will be recognized when earned.

As part of the license agreement, we also entered into a supply agreement with Toyama, whereby we will be the exclusive supplier (with certain limitations) to Toyama and its sublicensees of API for solithromycin for use in licensed products in Japan, as well as the exclusive supplier to Toyama and its sublicensees of finished forms of solithromycin to be used in its clinical trials in Japan. Pursuant to the supply agreement, Toyama will pay us for such clinical supply of finished product and all supplies of API for solithromycin for any purpose, other than the manufacture of products for commercial sale in Japan, at prices equal to our costs. All API for solithromycin supplied by us to Toyama for use in the manufacture of finished product for commercial sale in Japan will be ordered from us at prices determined by our manufacturing costs, and which may, depending on such costs, equal, exceed, or be less than such costs. Either party may terminate the supply agreement for uncured material breach or insolvency of the other party, with Toyama's right to terminate for our breach subject to certain further conditions in the case of our failure to supply API for solithromycin or clinical supply, but otherwise the supply agreement will continue until the expiration or termination of the license agreement.

In the future, we anticipate generating revenue from a combination of sales of our products, if approved, whether through our own or a third-party sales force, and license fees, milestone payments and royalties in connection with strategic collaborations regarding any of our product candidates. We expect that any revenue we generate will fluctuate from quarter to quarter. If we or our strategic partners fail to complete the development of solithromycin or Taksta in a timely manner or obtain regulatory approval for them, or if we fail to develop our own sales force or find one or more strategic partners for the commercialization of approved products, our ability to generate future revenue, and our financial condition and results of operations would be materially adversely affected.

Research and Development Expenses

Since our inception, we have focused our resources on our research and development activities, including conducting pre-clinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings for our product candidates. We recognize our research and development expenses as they are incurred. Our research and development expenses consist primarily of:

employee-related expenses, which include salaries, benefits and share compensation expense, for personnel in research and development functions;

fees paid to consultants and clinical research organizations, or CROs, in connection with our clinical trials, and other related clinical trial costs, such as for investigator grants, patient screening, laboratory work and statistical compilation and analysis;

costs related to acquiring and manufacturing clinical trial materials;

costs related to compliance with regulatory requirements;

consulting fees paid to third parties related to non-clinical research and development;

research supplies; and

license fees and milestone payments related to in-licensed technologies.

Our direct research and development expenses consist principally of external costs, such as fees paid to investigators, consultants, central laboratories and CROs in connection with our clinical trials, and related clinical trial fees. Our internal resources, employees and infrastructure are not directly tied to any individual research project and are typically deployed across multiple projects. Through our clinical development programs, we are advancing solithromycin and Taksta in parallel primarily for the treatment of CABP and prosthetic joint infections, respectively, as well as for other indications. Through our pre-clinical development programs, we are seeking to develop macrolide product candidates for non-antibacterial indications.


The following table sets forth costs incurred on a program-specific basis for solithromycin and Taksta, excluding personnel-related costs. Macrolide research includes costs for discovery programs. All employee-related expenses for those employees working in research and development functions are included in "Research and development personnel cost" in the table, including salary, bonus, employee benefits and share-based compensation. We do not allocate insurance or other indirect costs related to our research and development function to specific product candidates. Those expenses are included in "Indirect research and development expense" in the table.

                                                          Year Ended December 31,
                                                       2011         2012         2013
                                                               (in thousands)
 Direct research and development expense by program:
 Solithromycin                                       $ 14,129     $ 12,786     $ 34,155
 Taksta                                                   282        1,079        1,459
 Macrolide research                                       162           46           61
 Research and development personnel cost                1,865        2,657        4,887
 Total direct research and development expense         16,438       16,568       40,562
 Indirect research and development expense                434          301          738
 Total research and development expense              $ 16,872     $ 16,869     $ 41,300

The successful development of our clinical and pre-clinical product candidates is highly uncertain. At this time, we cannot reasonably estimate the nature, timing or costs of the efforts that will be necessary to complete the remainder of the development of any of our clinical or pre-clinical product candidates or the period, if any, in which material net cash inflows from these product candidates may commence. This is due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

the scope, rate of progress and expense of our ongoing, as well as any additional clinical trials required and other research and development activities;

future clinical trial results; and

the timing of regulatory approvals.

A change in the outcome of any of these variables with respect to the development of a product candidate could mean a significant change in the costs and timing associated with the development of that product candidate. For example, if the FDA or another regulatory authority were to require us to conduct clinical trials beyond those which we currently anticipate or if we experience significant delays in enrollment in any of our clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development.

We are conducting our pivotal trial program for solithromycin, including one trial with oral solithromycin and one trial with IV solithromycin progressing to oral solithromycin. Both of these trials are randomized, double-blinded studies conducted against a comparator drug agreed upon with the FDA, for which we will have to show non-inferiority from an efficacy perspective and acceptable safety and tolerability. Using feedback received from the FDA, we began the Phase 3 trial with oral solithromycin in December 2012. We finalized the overall development program for solithromycin for CABP with the FDA at our end of Phase 2 meeting for solithromycin, which occurred in May 2013, and initiated the IV-to-oral trial in the December 2013. In 2010, we successfully completed a Phase 2 clinical trial with Taksta in ABSSSI patients. In this trial, the Taksta loading dose regimen demonstrated efficacy, safety and tolerability that was comparable to linezolid. Like ABSSSI, prosthetic joint infections are often caused by S. aureus, including MRSA. At this time, however, we do not intend to pursue Taksta as a treatment for ABSSSI. In December 2012, we initiated a Phase 2 trial of Taksta in patients with prosthetic joint infections.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related costs, including share-based compensation, for employees in executive, operational, finance and human resources functions. Other significant general and administrative expenses include professional fees for accounting, legal, and information technology services, facilities costs, and expenses associated with obtaining and maintaining patents.

We expect that our general and administrative expenses will increase with the continued development and potential commercialization of our product candidates. We believe that these increases will likely include increased costs related to the hiring of additional personnel and increased fees for outside consultants, lawyers and accountants. We also expect to incur significant costs to comply with corporate governance, internal controls and similar requirements applicable to public companies.


Other Income (Expense), Net

Interest income consists of interest earned on our cash and equivalents as well as changes in fair value of warrants issued in connection with the August 2011 Notes and the Hercules loan as described below. We expect our interest income to decrease as our cash resources are used to fund the development of our programs.

Interest expense in 2011 consists of interest accrued under the August 2011 Notes and the Hercules loan as described below. Interest expense in 2012 and 2013 consists of interest accrued and paid under the Hercules loan as described below as well as changes in fair value of warrants issued in connection with the Hercules warrant agreement as described below.

In August 2011, we issued unsecured convertible notes, referred to as the August 2011 Notes, in the original aggregate principal amount of $5.0 million. The August 2011 Notes bore interest at a rate of 10.0% per annum, originally were to mature on August 4, 2012 and precluded us from incurring any other debt in excess of $0.5 million or granting a security interest in any of our assets without the consent of the noteholders. This restriction was revised by our shareholders in connection with the Hercules loan (discussed below) in December 2011. Also in connection with the Hercules loan, in December 2011, we and the holders of the August 2011 Notes agreed to extend the maturity dates of the August 2011 Notes to May 29, 2016. We did not record any gain or loss in connection with the extension of the maturity date of the August 2011 Notes because we determined that the extension of the maturity date of the August 2011 Notes met the criteria of a troubled debt restructuring outlined in ASC Topic 470-60, Troubled Debt Restructurings. The August 2011 Notes converted into shares of common stock in connection with the IPO completed in February 2012. Additionally, we granted warrants to the holders of the August 2011 Notes, which, after completion of the IPO in February 2012, became exercisable for shares of common stock with an exercise price equal to the IPO price of $6.00.

In December 2011, we entered into a $20,000,000 loan and security agreement (the "December 2011 Note") with Hercules Technology Growth Capital, Inc. ("Hercules") and borrowed $10,000,000 upon closing. The principal amount outstanding under the $10,000,000 borrowing bears interest at the greater of (i) 9.55%, or
(ii) the sum of 9.55% plus the prime lending rate, as published by the Wall Street Journal, minus 3.25% per annum. The terms of the December 2011 Note agreement provided that we could, at any time prior to October 1, 2012, request another borrowing in the aggregate amount of $10,000,000. We elected not to request the additional borrowing and let the option expire on September 30, 2012. In May 2013, we amended the December 2011 Note, increasing the initial loan amount to $15,000,000, receiving an additional $5,238,327 upon closing. We also extended the date by which it could request the additional $10,000,000 to September 30, 2013. We elected not to request the additional borrowing and let the option expire on September 30, 2013. This amendment also provides for us to make interest only payments through June 2014. Principal and interest payments will start July 1, 2014 over a 36-month amortization period. The principal balance outstanding on the loan agreement and all accrued but unpaid interest thereunder will be due and payable on June 1, 2017. In addition, we are required to pay Hercules the following fees:

$400,000 on the earliest to occur of (i) December 1, 2015, (ii) the date that we prepay all of the outstanding advances and accrued interest, or (iii) the date that all of the advances and interest become due and payable.

$495,245 on the earliest to occur of (i) June 1, 2017, (ii) the date that we prepay all of the outstanding advances and accrued interest, or (iii) the date that all of the advances and interest become due and payable.

We granted Hercules a security interest in all of its assets, except intellectual property. Our obligations to Hercules include restrictions on borrowing, asset transfers, placing liens or security interests on our assets including our intellectual property, mergers and acquisitions and distributions to stockholders.

In connection with the initial closing of the December 2011 note, we entered into a warrant agreement with Hercules (the "First Hercules Warrant"), under which Hercules has the right to purchase 39,038 shares of our common stock. The exercise price of the First Hercules Warrant was initially $10.25 per share, subject to adjustment in the event of a merger, reclassification, subdivision or combination of shares or stock dividend and subject also to antidilution protection. In connection with the amendment to the loan agreement, the exercise price of the First Hercules Warrant was reduced to the lower of (a) $6.11, and
(b) the effective price per share of our common stock issued or issuable in any offering of our equity or equity-linked securities that occurs prior to June 1, 2014, provided that such offering is effected principally for equity or debt-financing purposes. The First Hercules Warrant expires on December 20, 2021. Proceeds equal to the fair value of the First Hercules Warrant were recorded as a liability at the date of issuance and the borrowings under the December 2011 Note will be increased to equal the face amount of the borrowings plus interest through interest expense over the term of the loan using the effective interest method. Upon completion of IPO, the warrant liability was reclassified to additional paid-in capital. Since the amendment to the warrant resulted in a variable exercise price, the fair value of the warrant as of the date of the amendment was reclassified from additional paid-in capital to a warrant liability.

Additionally, in connection with the amendment of the December 2011 note, we entered into a warrant agreement with Hercules (the "Second Hercules Warrant"), under which Hercules has the right to purchase an aggregate number of shares of our common stock equal to the quotient derived by dividing $609,533 by the exercise price then in effect, which is defined as the lower of (a) $6.11, and


(b) the effective price per share of our common stock issued or issuable in any offering of our equity or equity-linked securities that occurs prior to June 1, 2014, provided that such offering is effected principally for equity or debt-financing purposes. The exercise price is subject to adjustment in the event of a merger, reclassification, subdivision or combination of shares or stock dividend and subject also to antidilution protection. The Second Hercules Warrant expires on May 31, 2023. Proceeds equal to the fair value of the Second Hercules Warrant were recorded as a liability at the date of issuance and the borrowings under the December 2011 Note will be increased to equal the face amount of the borrowings plus interest through interest expense over the term of the loan using the effective interest method.

Critical Accounting Policies and 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. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities in our financial statements. We evaluate our estimates and judgments, including those related to accrued expenses and share-based compensation, on an ongoing basis. 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.

Our significant accounting policies are described in more detail in the notes to our audited consolidated financial statements included in this report. We believe the following accounting policies to be most critical to the judgments and estimates used in preparation of our financial statements and such policies have been reviewed and discussed with our audit committee.

Accrued Expenses

As part of the process of preparing our financial statements, we are required to estimate accrued expenses. This process involves reviewing open contracts and purchase orders, communicating with applicable vendor 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 financial statements based on facts and circumstances known to us. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued expenses include:

fees paid to CROs in connection with pre-clinical or clinical trials;

fees paid to investigative sites in connection with clinical trials;

milestone payments; and

unpaid salaries, wages and benefits.

We accrue our expenses related to clinical trials based on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials 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. 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 will adjust the accrual accordingly. If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. We do not currently anticipate the future settlement of existing accruals to differ materially from our estimates.

Revenue Recognition

Our revenue generally consists of research related revenue under federal contracts and licensing revenue related to non-refundable upfront fees, milestone payments and royalties earned under license agreements. Revenue is recognized when the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery of the products and/or services has occurred;
(3) the selling price is fixed or determinable; and (4) collectability is reasonably assured.

For arrangements that involve the delivery of more than one element, each product, service and/or right to use assets is evaluated to determine whether it qualifies as a separate unit of accounting. This determination is based on whether the deliverable has "stand-alone value" to the customer. The consideration that is fixed or determinable is then allocated to each separate unit of accounting based on the relative selling prices of each deliverable. The consideration allocated to each unit of accounting is recognized as the related . . .

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