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ZFGN > SEC Filings for ZFGN > Form 10-K on 15-Mar-2016All Recent SEC Filings

Show all filings for ZAFGEN, INC.

Form 10-K for ZAFGEN, INC.


15-Mar-2016

Annual Report


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

The following discussion and analysis of our financial condition and results of operations should be read together with our "Selected Financial Data" and our consolidated financial statements, related notes, and other financial information included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those described in, or implied by, the forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed above in the section entitled "Risk Factors."

Overview

We are a biopharmaceutical company dedicated to significantly improving the health and well-being of patients affected by obesity and complex metabolic disorders. Beloranib, our lead product candidate, is a novel, first-in-class, twice-weekly subcutaneous injection being developed for the treatment of multiple indications, including severe obesity in two rare diseases, Prader-Willi syndrome, or PWS, and hypothalamic injury-associated obesity, or HIAO, including craniopharyngioma-associated obesity. We are also developing ZGN-839, a liver-targeted methionine aminopeptidase 2, or MetAP2, inhibitor, for the treatment of nonalcoholic steatohepatitis, or NASH, and abdominal obesity, as well as other second-generation methionine aminopeptidase 2, or MetAP2, inhibitors for the treatment of severe obesity. In December 2015, the U.S. Food and Drug Administration, or FDA, placed a full clinical hold on our Investigational New Drug Application, or IND, for beloranib, as a result of the number of thrombotic events observed in patients treated with beloranib in our clinical trials. We plan to present to the FDA data from our recently completed Phase 3 clinical trial evaluating beloranib as a treatment for PWS and our recently completed Phase 2b clinical trial evaluating beloranib in severe obesity complicated by type 2 diabetes, a proposal for a risk mitigation strategy for beloranib in PWS, and other requested data, in an effort to resolve the full clinical hold.

Obesity is a complex medical disorder involving appetite dysregulation and altered lipid and energy metabolism that results in excessive accumulation of fat tissue. Weight loss and hunger control are urgently needed for certain subpopulations of obese patients, in which obesity is life-threatening and a co-morbidity of an underlying condition such as PWS and HIAO that, while rare, occurs most commonly as a consequence of treatment for craniopharyngioma and other mid-brain tumors. PWS and HIAO are characterized by severe and intractable obesity resulting from damage to or impaired functioning of the hypothalamus, an area of the brain responsible for many functions including the neurophysiological drive to eat.

Since our inception in November 2005, we have devoted substantially all of our resources to developing beloranib, ZGN-839, and our second-generation molecules, building our intellectual property portfolio, developing our supply chain, business planning, raising capital, and providing general and administrative support for these operations. Prior to our initial public offering, or IPO, in June 2014, we funded our operations primarily through sales of redeemable convertible preferred stock and, to a lesser extent, through the issuances of convertible promissory notes. From our inception through our IPO in June 2014, we have received gross proceeds of $104.0 million from such transactions. During June 2014, we completed our IPO with net proceeds of $102.7 million after deducting underwriting discounts and commissions paid by us. We also incurred offering costs of $2.5 million related to the IPO. On January 28, 2015, we completed a follow-on offering of our common stock, which resulted in the sale of 3,942,200 shares at a price of $35.00 per share. We received net proceeds from the follow-on offering of approximately $129.6 million based upon the price of $35.00 per share and after deducting underwriting discounts and commissions, and offering expenses.

We have never generated any revenue and have incurred net losses in each year since our inception. We have an accumulated deficit of $179.7 million as of December 31, 2015. Our net loss was $74.3 million, $36.5 million and $14.0 million for the years ended December 31, 2015, 2014 and 2013, respectively. These losses have resulted principally from costs incurred in connection with in-licensing our product candidates, research and


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development activities and general and administrative costs associated with our operations. We expect to incur significant expenses and increasing operating losses for the foreseeable future.

We expect that our expenses will continue to increase in connection with our ongoing activities, as we:

advance the clinical development of beloranib as a treatment for obesity and hyperphagia in patients with PWS following resolution of the full clinical hold on the beloranib IND;

advance the clinical development of beloranib as a treatment for patients with HIAO following resolution of the full clinical hold on the beloranib IND;

conduct IND enabling studies and clinical development of ZGN-839 and our second-generation MetAP2 inhibitors;

seek to identify additional indications for our product candidates;

seek to obtain regulatory approvals for our product candidates;

add operational, financial and management information systems;

add personnel, including personnel to support our product development and future commercialization; and

maintain, leverage and expand our intellectual property portfolio.

As a result, we will need additional financing to support our continuing operations. Until such time that we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of public or private equity or debt financings or other sources, which may include collaborations with third parties. Arrangements with collaborators or others may require us to relinquish rights to certain of our technologies or product candidates. In addition, we may never successfully complete development of any of our product candidates, obtain adequate patent protection for our technology, obtain necessary regulatory approval for our product candidates or achieve commercial viability for any approved product candidates. Adequate additional financing may not be available to us on acceptable terms, or at all. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategy. We will need to generate significant revenue to achieve profitability, and we may never do so.

We expect that our existing cash and cash equivalents and marketable securities as of December 31, 2015, will enable us to fund our operating expenses and capital expenditure requirements for at least the next 18 months. See "-Liquidity and Capital Resources."

Financial Operations Overview

Revenue

We have not generated any revenue from product sales since our inception, and do not expect to generate any revenue from the sale of products in the near future. If our development efforts result in clinical success and regulatory approval or collaboration agreements with third parties for our product candidates, we may generate revenue from those product candidates or collaborations.

Operating Expenses

The majority of our operating expenses since inception have consisted primarily of in-licensing costs of our product candidate beloranib, research and development activities, and general and administrative costs.

Research and Development Expenses

Research and development expenses, which consist primarily of costs associated with our product research and development efforts, are expensed as incurred. Research and development expenses consist primarily of:

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


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

external costs of outside consultants;

payments made under our third-party licensing agreements;

laboratory consumables; and

allocated facility-related costs.

We have been developing beloranib, ZGN-839, and our second-generation MetAP2 inhibitors, and typically use our employee, consultant and infrastructure resources across our development programs. We track outsourced development costs by product candidate or development program, but we do not allocate personnel costs, external consultant costs, payments made under our licensing agreements or other internal costs to specific development programs or product candidates unless the payments are specifically identifiable to a development program or product candidate. We record our research and development expenses net of any research and development tax incentives we are entitled to receive from government authorities.

The following table summarizes our research and development expenses by program:

                                                      Year Ended December 31,
                                                   2015         2014        2013
                                                          (in thousands)
       Beloranib                                 $ 29,569     $ 19,738     $ 5,881
       ZGN-839                                      4,854        1,086         295
       Second-generation MetAP2 inhibitors          5,842          476          -
       Unallocated expenses                        14,353        6,091       3,385

       Total research and development expenses   $ 54,618     $ 27,391     $ 9,561

Research and development activities are central to our business. 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 that our research and development expenses will continue to increase in the foreseeable future as we pursue later stages of clinical development of our product candidates.

We cannot determine with certainty the duration and completion costs of the current or future clinical trials of our product candidates or if, when, or to what extent we will generate revenue from the commercialization and sale of any of our product candidates that obtain regulatory approval. We may never succeed in achieving regulatory approval for any 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 scope, rate of progress, and expense of our ongoing as well as any additional clinical trials and other research and development activities;

future clinical trial results;

uncertainties in clinical trial enrollment rate or design;

our ability to remove the full clinical hold imposed by the FDA on the beloranib IND;

significant and changing government regulation;

the timing and receipt of any regulatory approvals; and

the FDA's or other regulatory authority's influence on trial design.


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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 that we currently anticipate will be required for the completion of clinical development of a product candidate, 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.

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 administrative functions. General and administrative expenses also include travel expenses, allocated facility-related costs not otherwise included in research and development expenses, insurance expenses, 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 additional costs related to personnel; legal, accounting and audit services; directors' and officers' liability insurance premiums and deductibles to these policies; and investor relations. In addition, if we obtain marketing approval for beloranib or our other product candidates, we will incur significant sales and marketing expenses.

Other Income (Expense)

Interest income. Interest income consists of interest earned on our cash equivalents and marketable securities. Our interest income has not been significant due to low interest earned on invested balances. We anticipate that our interest income will decrease as we incur operating losses.

Interest expense. Interest expense relates to outstanding borrowings under a credit facility that we entered into on March 31, 2014, consisting of the stated interest of 8.1% per year due on outstanding borrowings, a final payment of 6% of amounts drawn down that is being recorded as interest expense over the term through the maturity date using the effective-interest method, the amortization of deferred financing costs, the accretion of debt discount relating to the credit facility, and a fee which was paid to the lender upon the completion of our IPO.

Foreign currency transaction gains (losses), net. Foreign currency transaction gains (losses), net consists of the realized and unrealized gains and losses from foreign currency-denominated cash balances, vendor payables and tax-related receivables from the Australian government. We currently do not engage in hedging activities related to our foreign currency-denominated receivables and payables; as such, we cannot predict the impact of future foreign currency transaction gains and losses on our operating results. See "-Quantitative and Qualitative Disclosures about Market Risk."

Income Taxes

Since our inception in 2005, we have not recorded any U.S. federal or state income tax benefits for the net losses we have incurred in each year or our earned tax credits, due to our uncertainty of realizing a benefit from those items. As of December 31, 2015, we had net operating loss carryforwards for federal and state income tax purposes of $42.5 million and $31.2 million, respectively, which begin to expire in 2026 and 2030, respectively. Included within these net operating loss carryforwards are amounts of $12.8 million and $10.6 million, respectively, that were attributable to stock option exercises, which will be recorded as an increase in additional paid-in capital once they are realized in accordance with accounting for stock-based compensation awards. As of December 31, 2015, we also had available tax credit carryforwards for federal and state income tax purposes of $10.6 million and $1.5 million, respectively, which begin to expire in 2026 and 2021, respectively.


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Critical Accounting Policies and Significant Judgments and Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of our consolidated 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 related disclosures. We believe that the estimates and assumptions involved in the accounting policies described below may have the greatest potential impact on our consolidated 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 consolidated financial statements included elsewhere in this Annual Report 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 Jumpstart Our Business Startups Act, or 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.

As an "emerging growth company" we are relying on other exemptions and reduced reporting requirements provided by the JOBS Act. As such, we have elected not to
(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 apply for a period of five years following the completion of our IPO in June 2014 or until we no longer meet the requirements of being an "emerging growth company," whichever is earlier.

Research and Development Expenses

As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contracts and purchase orders, communicating with our personnel and outside vendors to identify services that have been performed on our behalf and estimating the level of service performed and the associated costs incurred for the services when we have not yet been invoiced or otherwise notified of the actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met; however, some require advance payments. We make estimates of our accrued expenses as of each balance sheet date in our consolidated financial statements based on facts and circumstances known to us at that time. Examples of estimated accrued research and development expenses include fees paid to:

contract research organizations, or CROs, in connection with clinical trials;

investigative sites or other providers in connection with clinical trials;

vendors in connection with pre-clinical development activities; and

vendors related to product candidate manufacturing, development and distribution of clinical supplies.


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We base our expenses related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple 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. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the clinical expense, pre-clinical expense, or manufacturing activities. 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, enrollment of patients, number of sites activated 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 adjust the accrual or prepaid accordingly. 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 in any particular period. To date, we have not made any material adjustments to our prior estimates of accrued research and development expenses.

Stock-Based Compensation

We have historically issued equity awards to employees, directors and consultants, generally in the form of options to purchase shares of our common stock and, to a lesser extent, shares of restricted common stock. We measure stock-based awards granted to employees and directors at fair value on the date of grant and recognize the corresponding compensation expense of those awards, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the respective award. Generally, we issue stock options and restricted stock awards with only service-based vesting conditions and record the expense for these awards using the straight-line method. We measure stock-based awards granted to consultants and nonemployees at the fair value of the award on the date at which the related service is complete. Compensation expense is recognized over the period during which services are rendered by such consultants and nonemployees until completed. At the end of each financial reporting period prior to completion of the service, the fair value of these awards is re-measured using the then-current fair value of our common stock and updated assumption inputs in the Black-Scholes option-pricing model.

We estimate the fair value of each stock option grant using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our stock options, the risk-free interest rate for a period that approximates the expected term of our stock options and our expected dividend yield. Until completion of our IPO in June 2014, we were a private company and lacked company-specific historical and implied volatility information. Therefore, we estimated our expected volatility based on the historical volatility of our publicly traded peer companies and expect to continue to do so until such time as we have adequate historical data regarding the volatility of our traded stock price. The expected term of our options has been determined utilizing the "simplified" method for awards that qualify as "plain-vanilla" options, while the expected term of our options granted to consultants and nonemployees has been determined based on the contractual term of the options. The risk-free interest rate is determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award. Expected dividend yield is based on the fact that we have never paid cash dividends and do not expect to pay any cash dividends in the foreseeable future.

The assumptions we used to determine the fair value of stock options granted to employees and directors are as follows, presented on a weighted average basis:

                                            2015        2014        2013
                Risk-free interest rate      1.75 %      1.90 %      1.12 %
                Expected term (in years)     6.25        6.25        6.25
                Expected volatility            87 %        90 %        85 %
                Expected dividend yield         0 %         0 %         0 %


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These assumptions represented our best estimates, but the estimates involve inherent uncertainties and the application of our judgment. As a result, if factors change and we use significantly different assumptions or estimates, our stock-based compensation expense could be materially different. We recognize compensation expense for only the portion of awards that are expected to vest. In developing a forfeiture rate estimate for pre-vesting forfeitures, we have considered our historical experience of actual forfeitures. If our future actual forfeiture rate is materially different from our estimate, our stock-based compensation expense could be significantly different from what we have recorded in the current period.

The following table summarizes the classification of our stock-based compensation expenses recognized in our consolidated statements of operations and comprehensive loss:

                                               Year Ended December 31,
                                             2015          2014       2013
              Research and development     $   2,930      $   490     $ 176
              General and administrative       5,652        1,063       219

                                           $   8,582      $ 1,553     $ 395

As of December 31, 2015, we had an aggregate of $27.5 million of unrecognized stock-based compensation cost, which is expected to be recognized over a weighted average period of 2.6 years.

Results of Operations

Comparison of Years Ended December 31, 2015 and 2014

The following table summarizes our results of operations for the years ended
December 31, 2015 and 2014:



                                                                  Year Ended December 31,
                                                                                            Increase
                                                        2015               2014            (Decrease)
                                                           (in thousands, except per share data)
Statement of Operations Data:
Revenue                                              $        -          $      -         $         -

Operating expenses:
. . .
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