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KYTH > SEC Filings for KYTH > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for KYTHERA BIOPHARMACEUTICALS INC

Form 10-K for KYTHERA BIOPHARMACEUTICALS INC


17-Mar-2014

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 Annual Report contain forward-looking statements that involve risk and uncertainties, such as statements of our plans, objectives, expectations and intentions. 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 in Part I Item IA.

Overview

We are a clinical-stage biopharmaceutical company focused on the discovery, development and commercialization of novel prescription products for the aesthetic medicine market. Our objective is to develop first-in-class, prescription aesthetic products using an approach that relies on the scientific rigor of biotechnology to address unmet needs in the rapidly-growing market for aesthetic medicine. Our initial focus is on the facial aesthetics market, which comprises the majority of the aesthetic medicine market. Our product candidate, ATX-101, is a potential first-in-class, injectable drug in late stage clinical development for the reduction of submental fat, which commonly presents as an undesirable "double chin." Based on clinical trials conducted to date, ATX-101 has exhibited significant, meaningful and long-lasting results in the reduction of submental fat. These results correspond with patient satisfaction measures demonstrating meaningful improvement in perceived chin appearance. If approved by applicable regulatory authorities, we believe ATX-101 will be an attractive solution for the reduction of submental fat, representing a new product category within the rapidly growing facial aesthetics market. ATX-101 is our only product candidate in clinical development and we are substantially dependent on its regulatory approval and successful commercialization.

Since commencing operations in August 2005, we have devoted substantially all our efforts to identify and develop products for the aesthetics market, recruiting personnel and raising capital. We have devoted predominantly all of our resources to the preclinical and clinical development of ATX-101. In August 2010, we entered into a license agreement and related collaboration agreement with Bayer which provided Bayer the exclusive rights to develop and commercialize ATX-101 for all indications outside of the United States and Canada. In March 2014, we acquired these rights and now maintain all rights to develop and commercialize ATX-101 worldwide. We have not filed for approval with the FDA or any foreign regulatory agencies for the commercialization of ATX-101 and we have not generated any revenue from product sales. Historically we have funded substantially all of our operations through the sale and issuance of our common and preferred stock, convertible debt, amounts received from U.S. government grants and pursuant to our collaboration arrangement with Bayer and borrowings under our existing credit facility.

We have never been profitable and, as of December 31, 2013, we had an accumulated deficit of $172.2 million. We incurred net losses of $11.2 million, $36.8 million and $51.9 million for the years ended December 31, 2011, 2012 and 2013, respectively. We expect to continue to incur net operating losses for at least the next several years as we advance ATX-101 through clinical development, seek regulatory approval, prepare for and, if approved, proceed to commercialization. We have no manufacturing facilities and all of our manufacturing activities are contracted out to third parties. Additionally, we currently utilize third-party clinical research organizations, or CROs, to carry out our clinical development and we do not yet have a sales organization. We may need to seek additional funding to support our operating activities, especially as we approach anticipated regulatory approval and begin to establish our sales capabilities in the United States and internationally. Adequate funding may not be available to us on acceptable terms, or at all. Our failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, results of operations, and financial condition.


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On October 16, 2012, we completed our initial public offering ("IPO") of 5,060,000 shares of common stock at an offering price of $16.00 per share, which included the exercise in full by the underwriters of their option to purchase up to 660,000 additional shares of common stock. We received net proceeds of approximately $72.5 million, after deducting underwriting discounts, commissions and offering related expenses.

In September 2013, we announced positive topline results from our U.S. and Canadian Phase III clinical trials and in October 2013, we announced additional positive efficacy and patient satisfaction data from these trials.

In October 2013, we sold 2,622,950 shares of common stock in an underwritten public offering at a price to the public of $45.75 per share. In November 2013, the underwriters purchased an additional 297,042 shares of common stock pursuant to their option to purchase additional shares. We received aggregate net proceeds of approximately $125.0 million, after deducting the underwriting discount, commissions and offering related transaction costs.

Recent Development-Acquisition of Rights to ATX-101 Outside of the United States and Canada

In March 2014, we announced the acquisition of rights to develop and commercialize ATX-101 outside of the United States and Canada from Bayer. Under the new agreement, KYTHERA Holdings LTD, a wholly-owned Bermuda subsidiary of KYTHERA Biopharmaceuticals, Inc., purchased these rights for total consideration of $84.0 million comprised of $33.0 million in KYTHERA common stock based on a stock price of the average of 10 trading days before and after the transaction and a $51.0 million unsecured promissory note, which bears interest at 5% and is payable no later than 2024. Additionally, Bayer is eligible to receive up to $123.8 million upon the achievement of certain long-term sales milestone payments on annual sales of ATX-101 outside of the United States and Canada. The Company is in the process of completing its accounting for the acquisition of these rights and expects that it will incur a material charge for acquired in-process research and development in the quarter ending March 31, 2014.

Financial Overview

Revenue

To date, all of our revenue has been derived from license fees we received pursuant to our collaboration arrangement with Bayer. We have not generated any revenue from product sales.

In the future, if ATX-101 is approved for commercial sale, we may generate revenue from product sales. In May 2012, we received a $15.8 million payment from Bayer triggered by Bayer's decision to pursue continued development and regulatory approval for ATX-101 after receipt of positive results from the European Phase III clinical trials for ATX-101. In addition, we also received $17.4 million from Bayer to fund certain further global development activities of ATX-101 under the terms of the collaboration arrangement. As of March 2014, we acquired rights to ATX-101 outside of the United States and Canada from Bayer and no longer expect future revenues from our license agreement.

Even if ATX-101 is approved for commercial sale, we do not expect to generate revenue from product sales until at least 2015, if at all. If we fail to complete the development of ATX-101, or other product candidates, in a timely manner or to obtain regulatory approval, our ability to generate future revenue, and our results of operations and financial position, would be materially adversely affected.

Research and Development Expenses

Major components of our research and development costs include cash compensation, stock-based compensation expense, pre-clinical studies, clinical trials and related clinical manufacturing, materials and supplies, and fees paid to consultants and other entities that conduct certain research and


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development activities on our behalf. We expense all research and development costs in the periods in which they are incurred. To date, our research and development expenses have related predominately to the development of ATX-101. In the years ended December 31, 2011, 2012 and 2013 we spent $15.8 million, $43.2 million and $34.0 million, respectively, on research and development expenses. Since inception through December 31, 2013, we have spent approximately $95.8 million on research and development expenses related to the development of ATX-101, excluding cash and stock-based compensation expenses. We do not allocate cash and stock-based compensation expense to individual product candidates, as we are organized and record expense by functional department and our employees may allocate time to more than one development project. We do not utilize a formal time allocation system to capture expenses on a project-by-project basis.

Conducting significant research and development is central to our business and strategy. 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 greater duration of late stage clinical trials as compared to earlier clinical and preclinical development. We expect our research and development expenses will increase as we prepare for submission for approval in the United States and other territories throughout the world and as a result of the acquisition of rights to ATX-101 outside of the United States and Canada.

General and Administrative Expenses

Our general and administrative costs primarily consist of personnel costs, including cash compensation and stock-based compensation expense, associated with our executive, accounting and finance, legal, marketing and human resources departments. Other general and administrative expenses include costs in connection with patent filing, prosecution and defense, facility costs and professional fees for legal, consulting, marketing, audit and tax services. For the years ended December 31, 2011, 2012 and 2013, our general and administrative expenses totaled approximately $6.9 million, $10.5 million and $16.1 million, respectively. We expect our general and administrative costs will rise as we increase our headcount and expand our staffing, occupy larger facility space, establish commercial infrastructure and other activities to support our company growth as we prepare for a potential commercial launch of ATX-101, both in the United States and internationally.

Former Collaboration Arrangement with Bayer

In August 2010, we entered into a license agreement with Bayer Consumer Care AG and a related collaboration agreement with Bayer's affiliate, Intendis GmbH. We refer to these agreements jointly as our collaboration arrangement with Bayer, and we refer to Bayer Consumer Care AG and Intendis GmbH jointly as Bayer. Pursuant to our collaboration arrangement, we licensed to Bayer all of the development and commercial rights to ATX-101 outside the United States and Canada. In connection with establishing the collaboration arrangement, we received upfront payments of $43.6 million in 2010 comprised of license fees and amounts to fund certain further global development activities of ATX-101. In May 2012, we received a $15.8 million payment from Bayer triggered by Bayer's decision to pursue continued development and regulatory approval for ATX-101 after receipt of positive results from the European Phase III clinical trials for ATX-101. In addition, in May 2012, we also received $17.4 million from Bayer to fund certain further Bayer global development activities of ATX-101 under the terms of the collaboration arrangement. In March 2014, we announced that we acquired the rights to develop and commercialize ATX-101 outside of the United States and Canada from Bayer. Please see "Recent Development-Acquisition of Rights to ATX-101 Outside of the United States and Canada" for additional details.


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License Fees

License fees received in 2010 of approximately $21.3 million were deferred and recognized on a straight-line basis over the expected period of substantial involvement in the collaboration activities that were required to be conducted relative to the upfront license fee and development funds received from Bayer and completion of which was a condition to Bayer's decision to pursue continued development and regulatory approval for ATX-101. These activities were completed as of May 31, 2012, and pursuant to the acquisition of rights from Bayer to ATX-101 outside the U.S. and Canada we will not receive future license fees from Bayer.

Collaboration Development Funds

Additionally, we have received approximately $39.6 million to fund certain further global development activities of ATX-101, which were recorded as restricted cash and deferred development funds and are an offset to research and development expenses as the restricted cash is utilized to fund development activities. Amounts recognized as offsets to research and development expenses were $14.6 million, $10.1 million, and $11.7 million for the years ended December 31, 2011, 2012 and 2013, respectively. Pursuant to the acquisition of rights from Bayer to ATX-101 outside the U.S. and Canada, the amount of Collaboration Development Funds will be spent and not replenished.

Los Angeles Biomedical Research Institute

We entered into a license agreement with the Los Angeles Biomedical Research Institute, or LA Biomed, in August 2005, which granted us exclusive worldwide rights to key intellectual property for the active ingredient in ATX-101. As part of this license agreement, we incur sublicense fees equal to 10% of any non-royalty sublicense income, up to a total of an aggregate of $5.0 million. We are obligated to pay LA Biomed low- to mid-single digit royalties on net product sales of ATX-101. Additionally, we will incur a milestone payment of $0.5 million upon receipt of marketing approval.

In August 2010, due to the receipt of the license fee income from Bayer, we incurred non-royalty sublicense fees of $2.0 million, which was deferred and recorded as sublicense expense on a straight-line basis over the same period as the license income was recorded. During 2010, we made payments to LA Biomed in cash and stock totaling $0.4 million related to the non-royalty sublicense fee incurred and the remaining $1.6 million was paid upon our IPO in 50% cash and 50% stock. Due to the receipt of the $15.8 million contingent event-based payment from Bayer in May 2012, we incurred an additional non-royalty sublicense fee of $1.6 million due to LA Biomed which was paid in 50% cash and 50% stock.

Critical Accounting Policies and Significant Judgments and Estimates

The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our financial statements as well as the reported revenues and expenses during the reported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ materially from these estimates.

While our significant accounting policies are described in the notes to our financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe that the following critical accounting policies are most important to understanding and evaluating our reported financial results.


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Revenue Recognition

To date, we have only recognized revenue derived from license fees pursuant to our license agreement with Bayer executed in August 2010. In the future, we may receive revenue from the sale of our products, if approved. We recognize revenue when all of the following four criteria are present: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured. For arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets, the elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has "standalone value" to the collaborator and whether there is objective and reliable evidence of the fair value of the undelivered obligation(s). The estimated selling price of each deliverable is determined using the following hierarchy of values: (i) vendor-specific objective evidence of fair value, (ii) third-party evidence of selling price (TPE) and (iii) best estimate of selling price (BESP). The BESP reflects our best estimate of what the selling price would be if the deliverable was regularly sold by us on a standalone basis. In most cases we expect to use TPE or BESP for allocating consideration to each deliverable. The consideration received is allocated among the separate units either on the basis of each unit's fair value or using the residual method and the applicable revenue recognition criteria is applied to each of the separate units. Analyzing the arrangement to identify deliverables requires the use of judgment, and each deliverable may be an obligation to deliver services, a right or license to use an asset, or another performance obligation.

The non-refundable upfront license payment we received upon execution of our license agreement with Bayer had continuing performance obligations under the terms of our collaboration arrangement with Bayer, including development and clinical manufacturing supply obligations. Due to these ongoing performance obligations, we determined that the license did not have standalone value. We also did not have objective and reliable evidence of the fair value of these undelivered obligations. Accordingly, amounts received upfront under the license agreement were recorded as deferred revenue and revenue was recognized on a straight-line basis over the expected period of substantial involvement in the collaboration activities. The period over which these activities were to be performed was based upon management's estimate of the period to complete the development activities required to be conducted relative to the upfront license fee and development funds received from Bayer, and all revenue was recognized as of May 31, 2012.

We recognize revenue from milestone payments when earned; provided that
(i) the milestone event is substantive in that it can only be achieved based in whole or in part on either our performance or on the occurrence of a specific outcome resulting from our performance and its achievability was not reasonably assured at the inception of the agreement, (ii) we do not have ongoing performance obligations related to the achievement of the milestone and (iii) it would result in the receipt of additional payments. Milestone payments are considered substantive if all of the following conditions are met: the milestone payment is non-refundable; achievement of the milestone was not reasonably assured at the inception of the arrangement; substantive effort is involved to achieve the milestone; and the amount of the milestone payments appears reasonable in relation to the effort expended, the other milestones in the arrangement and the related risk associated with the achievement of the milestone. Any amounts received under the agreements in advance of performance, if deemed substantive, are recorded as deferred revenue and recognized as revenue as we complete our performance obligations.

Clinical Trial Accruals

As part of the process of preparing our financial statements, we are required to estimate our accrued expenses. Our clinical trial accrual process seeks to account for expenses resulting from our obligations under contract with vendors, consultants and clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations, which vary from contract to contract and may result in payment flows that do not match the periods over which


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materials or services are provided to us under such contracts. Our objective is to reflect the appropriate trial expense in our financial statements by matching the appropriate expenses with the period in which services and efforts are expended. We account for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. We determine accrual estimates through financial models that take into account discussion with applicable personnel and outside services providers as to the progress or state of completion of trials, or the services completed. During the course of a clinical trial, we adjust our rate of clinical expense recognition if actual results differ from our estimates. We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on the facts and circumstances known to us at that time. Although we do not expect our estimates to be materially different from amounts actually incurred, 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 us reporting amounts that are too high or too low for any particular period. Through December 31, 2013, there have been no material adjustments to our prior period estimates of accrued expenses for clinical trials. Our clinical trial accrual is dependent, in part, upon the receipt of timely and accurate reporting from clinical research organizations and other third-party vendors.

Stock-Based Compensation

We account for all stock-based compensation payments issued to employees and directors using an option pricing model for estimating fair value. Accordingly, stock-based compensation expense is measured based on the estimated fair value of the awards on the date of grant, net of forfeitures.

We estimate the fair value of our stock-based awards to employees and directors using the Black-Scholes option pricing model. The Black-Scholes model requires the input of various assumptions, including (a) the expected stock price volatility, (b) the calculation of the expected term of the award, (c) the risk free interest rate and (d) expected dividends. Due to our limited operating history and a lack of company specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies, which are publicly-traded. When selecting these public companies on which we have based our expected stock price volatility, we selected companies with comparable characteristics to us, including enterprise value, risk profiles, position within the industry, and with historical share price information sufficient to meet the expected life of our stock-based awards. The historical volatility data was computed using the daily closing prices for the selected companies' shares during the equivalent period of the calculated expected term of our stock-based awards. We will continue to apply this process until a sufficient amount of historical information regarding the volatility of our own stock price becomes available. We have estimated the expected life of our employee stock options using the "simplified" method, whereby, the expected life equals the arithmetic average of the vesting term and the original contractual term of the option. The risk-free interest rates for periods within the expected life of the option are based on the U.S. Treasury yield curve in effect during the period the options were granted. We have never paid, and do not expect to pay dividends in the foreseeable future. These inputs, which are complex and subjective, can significantly impact the estimated grant date fair value for our stock-based awards and the resulting compensation expense recognized.

We are also required to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from our estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. To the extent that actual forfeitures differ from our estimates, the difference is recorded as a cumulative adjustment in the period the estimates were revised. For the years ended December 31, 2011, 2012 and 2013 we applied a forfeiture rate, which was determined based on historical forfeitures. No forfeiture rate was applied for any period prior to January 1, 2011 as forfeitures prior to such date had been insignificant.


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Total compensation cost recorded in the statements of operations and comprehensive loss, includes stock-based compensation expense related to stock options and restricted stock units issued to employees and directors, and the value of stock options issued to non-employees for services is as follows for the years ended December 31, 2011, 2012 and 2013, respectively: $0.9 million, $1.9 million and $6.5 million.

As of December 31, 2013, there was $13.3 million of unrecognized compensation expense related to unvested employee stock award agreements, which is expected to be recognized over a weighted-average period of approximately 2.32 years.

Net Operating Loss Carryforwards

We recorded deferred tax assets of approximately $73.7 million as of December 31, 2013, which have been fully offset by a valuation allowance due to uncertainties surrounding our ability to realize these tax benefits. The deferred tax assets are primarily composed of federal and state tax net operating losses, or NOL carryforwards, research and development tax credit carryforwards, and start-up expenditures. As of December 31, 2013, we have federal NOL carryforwards of approximately $152.0 million available to reduce future taxable income, if any. These federal NOL carryforwards expire at various times through 2033. In general, if we experience a greater than 50 percentage point aggregate change in ownership of certain significant stockholders over a three-year period (a "Section 382 ownership change"), utilization of our pre-change NOL carryforwards are subject to an annual limitation under
Section 382 of the Internal Revenue Code (and similar state laws). Such limitations may result in expiration of a portion of the NOL carryforwards before utilization and may be substantial. We have determined that we have experienced ownership changes in the past. If we experience a Section 382 ownership change as a result of future changes in our stock ownership, including the issuance of common stock related to the acquisition of rights from Bayer, some of which changes are outside our control, the tax benefits related to the NOL carryforwards may be further limited or lost.

Asset Purchase Accounting

The accounting treatment for an acquisition of a "business" is substantially different from the accounting for an acquisition of an asset or a group of . . .

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