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AERI > SEC Filings for AERI > Form 10-K on 26-Mar-2014All Recent SEC Filings

Show all filings for AERIE PHARMACEUTICALS INC

Form 10-K for AERIE PHARMACEUTICALS INC


26-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management's discussion and analysis should be read in conjunction with our audited financial statements and related notes that appear elsewhere in this Annual Report on Form 10-K. This management's discussion and analysis contains forward-looking statements that involve risks and uncertainties. Please see "Special Note Regarding Forward-Looking Statements" for additional factors relating to such statements, and see "Risk Factors" in Part I, Item 1A of this report for a discussion of certain risk factors applicable to our business, financial condition and results of operations. Past operating results are not necessarily indicative of operating results in any future periods.

Overview

We are a clinical-stage pharmaceutical company focused on the discovery, development and commercialization of first-in-class therapies for the treatment of patients with glaucoma and other diseases of the eye. Our lead product candidate, once-daily, triple-action RhopressaTM, completed a Phase 2b clinical trial in patients with open-angle glaucoma and ocular hypertension in May 2013. We plan to commence two Phase 3 registration trials of RhopressaTM in early third quarter 2014. We are also developing a second product candidate, once-daily, quadruple-action RoclatanTM, which is a fixed-dose combination of RhopressaTM and latanoprost, the most commonly prescribed drug for the treatment of patients with glaucoma. The first patients enrolled in our Phase 2b trial of RoclatanTM were dosed in January 2014. We are focused on glaucoma because we believe our product candidates provide important new opportunities to improve the treatment of the disease.

We are developing RhopressaTM as the first of a new class of compounds that is designed to lower intraocular pressure, or IOP, in patients through novel mechanisms of action, or MOAs. RoclatanTM is designed to lower IOP through all currently known MOAs: increasing fluid outflow through the trabecular meshwork, or the TM, the eye's primary drain, reducing fluid production in the eye, lowering episcleral venous pressure, or EVP, and, through the MOA of latanoprost, increasing fluid outflow through the uveoscleral pathway, the eye's secondary drain.

We are a development stage company and have incurred net losses since our inception in June 2005. Our operations to date have been limited to research and development and raising capital. As of December 31, 2013, we had a deficit accumulated during the development stage of $95.1 million. We recorded net losses of $31.1 million, $15.0 million and $13.0 million for the years ended December 31, 2013, 2012 and 2011, respectively. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on completing the development and obtaining regulatory approval and preparing for potential commercialization of our product candidates.

On October 30, 2013, we completed our IPO and issued 7,728,000 shares of our common stock at an IPO price of $10.00 per share, including 1,008,000 shares of common stock issued upon the exercise in full by the underwriters of their option to purchase additional shares to cover over-allotments. Our shares began trading on the NASDAQ Global Market on October 25, 2013. We received net proceeds from the IPO of approximately $68.3 million, after deducting underwriting discounts and commissions of $5.4 million and expenses of $3.6 million.

Prior to our IPO, substantially all of our operations were funded through the private placement of our equity securities and issuance of convertible promissory notes. We have raised net cash proceeds of $78.6 million from the sale of $43.8 million of convertible preferred stock and $34.8 million of convertible notes. Subsequent to their issuance, we paid $0.5 million in cash payments on the convertible notes, $16.2 million of the convertible notes were converted into shares of convertible preferred stock, which were subsequently converted into shares of common stock in connection with our IPO, and $18.0 million of the convertible notes were converted into shares of common stock in connection with our IPO. In connection with our IPO, all outstanding shares of convertible preferred stock were converted into shares of common stock. Refer to Note 9 to our audited financial statements appearing elsewhere in this report. To date, we have not generated any revenue.


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We expect our research and development expenses to increase if and when we initiate additional clinical trials for our RhopressaTM and RoclatanTM product candidates and pursue regulatory approval. As we prepare for commercialization, we will likely incur significant commercial, sales, marketing and outsourced manufacturing expenses. Since our IPO in October 2013, we are also incurring additional expenses associated with operating as a public company. As a result, we expect to continue to incur significant and increasing operating losses at least for the next several years. We do not expect to generate product revenue unless and until we successfully complete development and obtain regulatory approval for one or more of our product candidates.

We anticipate that we will use approximately $25.0 million and $12.4 million of the cash and cash equivalents on our balance sheet as of December 31, 2013 for direct clinical and non-clinical costs, respectively, associated with the completion of Phase 3 registration trials for our product candidate RhopressaTM. We expect to use approximately $2.5 million and $1.0 million of the cash and cash equivalents on our balance sheet as of December 31, 2013 for direct clinical and non-clinical costs, respectively, associated with the completion of the Phase 2b clinical trial for our product candidate RoclatanTM. We expect to use approximately $6.3 million for Phase 3 enabling activities for RoclatanTM. We intend to use the remainder of our cash and cash equivalents for working capital and general corporate purposes. We expect that these funds will not be sufficient to enable us to complete all necessary development or commercially launch these product candidates. Accordingly, we will be required to obtain further funding through public or private offerings, debt financing, collaboration and licensing arrangements or other sources. Adequate additional funding may not be available to us on acceptable terms, or at all. If we are unable to raise capital when needed or on acceptable terms, we would be forced to delay, reduce or eliminate our research and development programs or commercialization efforts.

Financial Overview

Revenue

We have not generated any revenue from the sale of any products, and we do not expect to generate any revenue unless or until we obtain regulatory approval of and commercialize our products.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries, benefits and stock-based compensation for all officers and employees in general management, finance and administration. Other significant expenses include facilities expenses and professional fees for accounting and legal services.

We expect that our general and administrative expenses will increase with the continued advancement of our product candidates and with our increased management, legal, compliance, accounting and investor relations expenses as we continue to grow. We expect these increases will likely include increased expenses for insurance, expenses related to the hiring of additional personnel and payments to outside service providers, lawyers and accountants.

Research and Development Expenses

Since our inception, we have focused on our development programs. Research and development expenses consist primarily of costs incurred for the research and development of our preclinical and clinical candidates, which include:

• employee-related expenses, including salaries, benefits, travel and stock-based compensation expense for research and development personnel;

• expenses incurred under agreements with contract research organizations ("CROs"), contract manufacturing organizations and service providers that conduct clinical trials and preclinical studies;

• costs associated with preclinical activities and development activities;


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• costs associated with regulatory operations; and

• depreciation expense for assets used in research and development activities.

We expense research and development costs to operations as incurred. The costs for certain development activities, such as clinical trials, are recognized based on the terms of underlying agreements as well as an evaluation of the progress to completion of specific tasks using data such as patient enrollment, clinical site activations along with additional information provided to us by our vendors.

Expenses relating to activities, such as manufacturing and stability and toxicology studies, that are supportive of the product candidate itself, are classified as direct non-clinical. Expenses relating to clinical trials and similar activities, including costs associated with CROs, are classified as direct clinical. Expenses relating to activities that support more than one development program or activity such as personnel costs, stock-based compensation and depreciation are not allocated to direct clinical or non-clinical expenses and are separately classified as "unallocated."

The following table shows our research and development expenses by type of activity for the years ended December 31, 2013, 2012 and 2011:

                                                            YEAR ENDED
                                                           DECEMBER 31,
                                                   2013        2012         2011
        (in thousands)
        Rhopressa™
        Direct non-clinical                      $  3,410     $ 2,318     $  2,809
        Direct clinical                             1,607         993           -

        Total                                    $  5,017     $ 3,311     $  2,809
        Roclatan™
        Direct non-clinical                      $    481     $    -      $     -
        Direct clinical                               234          -            -

        Total                                    $    715     $    -      $     -
        Discontinued product candidates:
        Direct non-clinical                      $    596     $ 2,312     $  4,675
        Direct clinical                             2,965       1,475        1,023

        Total                                    $  3,561     $ 3,787     $  5,698
        Unallocated                                 2,590       2,175        2,188

        Total research and development expense   $ 11,883     $ 9,273     $ 10,695

From inception through December 31, 2013, we did not incur any direct non-clinical or direct clinical costs for AR-13533. Costs for this product candidate were primarily comprised of internal personnel costs and were included in unallocated costs. Discontinued product candidates relate to previously developed AR-12286 and related compounds, which did not meet their primary endpoints in clinical trials. We incurred direct non-clinical and direct clinical expenses for these discontinued product candidates in all periods presented.

From inception through December 31, 2013, we have incurred approximately $55.0 million in research and development expenses.

Research and development activities associated with the discovery and development of new drugs and products for the treatment of diseases of the eye are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. We expect our research and development expenses to increase as we initiate Phase 3 and Phase 2b clinical trials for our product candidates, or if the FDA requires us to conduct additional trials for approval.


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Our research and development expenditures are subject to numerous uncertainties in timing and cost to completion. Development timelines, the probability of success and development expenses can differ materially from expectations. The cost of clinical trials may vary significantly over the life of a project as a result of differences arising during clinical development, including, among others, the following:

• number of trials required for approval;

• number of sites included in the trials;

• length of time required to enroll suitable patients;

• number of patients that participate in the trials;

• drop-out or discontinuation rates of patients;

• duration of patient follow-up;

• costs related to compliance with regulatory requirements;

• number and complexity of analyses and tests performed during the trial;

• phase of development of the product candidate; and

• efficacy and safety profile of the product candidate.

Our expenses related to clinical trials are based on estimates of patient enrollment and related expenses at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with research institutions, consultants and CROs that conduct and manage clinical trials on our behalf. We generally accrue expenses related to clinical trials based on contracted amounts applied to the level of patient enrollment and activity according to the protocol. If future timelines or contracts are modified based upon changes in the clinical trial protocol or scope of work to be performed, we modify our estimates of accrued expenses accordingly on a prospective basis. Historically, such modifications have not been material.

As a result of the uncertainties discussed above, we are unable to determine with certainty the duration and completion costs of our development programs or precisely when and to what extent we will receive revenue from the commercialization and sale of our products. We may never succeed in achieving regulatory approval for one or more of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future preclinical studies and clinical trials, uncertainties in the clinical trial enrollment rate and changing government regulation. In addition, the probability of success for each product candidate will depend on numerous factors, including efficacy and tolerability profiles, manufacturing capability, competition, and commercial viability.

Other Income (Expense), Net

Other income consists of interest earned on our cash and cash equivalents as well as the net proceeds from the sale of our net operating loss tax benefits for the state of New Jersey. Interest income is not considered significant to our historical financial statements and consists of interest earned on our cash and cash equivalents. Refer to Note 3 to our audited financial statements appearing elsewhere in this report for further information.

Other expense consists of interest accrued under convertible notes, amortization of debt discounts and non-cash expense related to the conversion of convertible notes to common stock in connection with our IPO and to changes in the fair value of our warrants liability arising from the stock purchase warrants as described in Note 6 and Note 10, respectively, to our audited financial statements appearing elsewhere in this report.

Accretion of Convertible Preferred Stock

Shares of our convertible preferred stock were initially recorded on our balance sheet at their cost, less associated issuance costs. Series A-1, A-2 and A-3 of our convertible preferred stock were fully accreted as of December 31, 2012.


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Our Series A-4 Convertible Preferred Stock issued on February 23, 2011, resulting from the conversion of the notes issued in 2010, was recorded at fair value. The difference between stated and fair value of $1.3 million was being accreted on a straight-line basis over the period from February 23, 2011 until the earliest redemption date, which was August 17, 2015. We determined that the straight-line method approximates the effective interest method. Accretion was recognized through the completion of our IPO.

Our Series B Convertible Preferred Stock issued on February 23, 2011 was recorded at fair value net of $1.2 million of issuance costs, which was being ratably accreted over the period from February 23, 2011 until the earliest redemption date, which was August 17, 2015. We determined that the straight-line method approximates the effective interest method. Accretion was recognized through the completion of our IPO.

Debt Discounts

Our notes payable were issued with warrant coverage. We recorded notes payable on our balance sheet net of a discount equal to the estimated fair value of the associated warrant instrument. The discount is amortized using the effective interest method over the term of the associated notes. In connection with the completion of our IPO, we recognized a loss representing the remaining unamortized discount associated with the warrant instrument.

Critical Accounting Policies and Use of Estimates

Our management's discussion and analysis of financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, costs and expenses and related disclosures. We evaluate our estimates and judgments on an ongoing basis. Significant estimates include assumptions used in the determination of the fair value measurement of stock purchase warrants, stock-based compensation and certain research and development expenses. 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 readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are more fully described in Note 2 to our audited financial statements included elsewhere in this report. The following accounting policies are the most critical in fully understanding and evaluating our reported financial results and affect significant judgments and estimates that we use in the preparation of our financial statements.

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. 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 clinical trials; and

• fees paid to investigative sites in connection with clinical trials.

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 research activities and/or manage clinical trials on our behalf. The financial terms of these agreements are subject to negotiation, vary


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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 level of effort varies from our estimate, we will adjust the accrual accordingly.

If we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. Although we do not currently anticipate the future settlement of existing accruals to differ materially from our estimates, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and could result in us reporting amounts that are too high or too low for any period. There have been no material changes in estimates for the periods presented.

Fair Value Measurements

We record certain financial assets and liabilities at fair value in accordance with the provisions of ASC Topic 820 on fair value measurements. As defined in the guidance, fair value, defined as an exit price, represents the amount that would be received to sell an asset or pay to transfer a liability in an orderly transaction between market participants. As a result, fair value is a market-based approach that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering these assumptions, the guidance defines a three-tier value hierarchy that prioritizes the inputs used in the valuation methodologies in measuring fair value.

• Level 1-Unadjusted quoted prices in active, accessible markets for identical assets or liabilities.

• Level 2-Other inputs that are directly or indirectly observable in the marketplace.

• Level 3-Unobservable inputs that are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Our material financial instruments consist primarily of cash and cash equivalents, other current assets, accounts payable, accrued expenses, long-term debt and stock purchase warrant liabilities. The fair value of cash and cash equivalents, other current assets, accounts payable and accrued expenses approximate their respective carrying values due to the short-term nature of these instruments. We have historically determined the stock purchase warrants liability to be Level 3 fair value measurement.

Stock-Based Compensation

We recognize compensation costs related to stock options granted to employees ratably over the requisite service period, which in most cases is the vesting period of the award for employees, based on the estimated fair value of the awards on the date of grant. Compensation expense for options granted to non-employees is determined as the fair value of consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The fair value of the awards granted to non-employees is re-measured each period until the related service is complete. Compensation expense related to restricted stock awards is based on the market value of our common stock on the grant date and is expensed ratably over the vesting period. Compensation expense for stock purchase rights under our employee stock purchase plan is measured and recognized on the date that we become contingently obligated to issue shares of our common stock and is based on the difference between the fair value of our common stock and the purchase price on such date.

Stock-based compensation expense was $2.9 million, $0.4 million and $0.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, we had $14.3 million of unrecognized compensation expense.


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Significant Factors, Assumptions and Methodologies Used in Determining Fair Value

Determining the appropriate fair value measurement of stock-based awards requires the use of subjective assumptions. In the absence of a public trading market for our common stock prior to the completion of our IPO, we conducted periodic assessments of the valuation of our common stock. These assessments were completed on an annual basis for all periods prior to December 31, 2012 and on a quarterly basis beginning in 2013 through September 30, 2013. In connection with our December 31, 2012 valuation of our common stock and in preparation of the IPO, we completed a retrospective valuation for the first three quarters in 2012, as described below in "-Common Stock Valuation." The determination of the fair value measurement of options using the Black-Scholes option pricing model is affected by our estimated common stock fair values as well as assumptions regarding a number of other subjective variables. These other variables include the expected term of the options, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates and expected dividends.

We estimated the fair value of stock options at the grant date using the following assumptions:

• Fair Value of our Common Stock. For all stock options granted after the completion of our IPO, the fair value for our underlying common stock is determined using the closing price on the date of grant as reported on the NASDAQ Global Market. For all stock options granted prior to the completion of our IPO, the fair value for our underlying common stock was estimated as discussed in "-Common Stock Valuations" below.

• Volatility. We calculate expected volatility based on reported data for a selected group of similar publicly traded companies, or guideline peer group, for which the relevant historical information is available. We selected representative companies from the pharmaceutical industry with similar characteristics to us, including stage of product development and therapeutic focus. We will continue to use the guideline peer group volatility information until relevant historical volatility data for our common stock is available to measure expected volatility for future option grants.

• Expected Term. We used the simplified method as prescribed by the SEC Staff Accounting Bulletin No. 107, Share-Based Payment, as we do not have sufficient historical exercise and post-vesting termination data to provide a reasonable basis upon which to estimate the expected term of stock options granted to employees.

• Risk-free Rate. The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected time to exercise.

• Forfeiture. Forfeitures are estimated such that we only recognize expense for the shares expected to vest, and adjustments are made if actual forfeitures differ from those estimates. We estimate our annual forfeiture rates based on our historical analysis of actual stock option forfeitures and our future expectations.

• Dividend Yield. Except for a one-time cash dividend related to the spin-off of certain non-core intellectual property (further described in Note 13 to our audited financial statements appearing elsewhere in this . . .

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