Conatus Pharmaceuticals Inc. (CNAT)

[Theo]

10K

Form 10-K for CONATUS PHARMACEUTICALS INC.

16-Mar-2017

Annual Report


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

Overview

We are a biotechnology company focused on the development and commercialization of novel medicines to treat liver disease. We are developing emricasan, a first-in-class, orally active pan-caspase protease inhibitor, for the treatment of patients with chronic liver disease. Emricasan is designed to reduce the activities of human caspases, which are enzymes that mediate inflammation and apoptosis. We believe that by reducing the activity of these enzymes, emricasan has the potential to interrupt the progression of liver disease and potentially provide treatment options in multiple areas of liver disease. Preclinical studies and clinical trials have yielded compelling results that suggest emricasan may have clinical utility in slowing progression of liver disease regardless of the original cause of the disease. To date, emricasan has been studied in over 650 subjects in 16 clinical trials across a broad range of liver disease etiologies and stages of progression. We plan to focus on advancing toward initial registration of emricasan for patients with cirrhosis due to NASH, with parallel development toward registration of emricasan for patients with NASH fibrosis.

We plan to conduct three EmricasaN, a Caspase inhibitOR, for Evaluation clinical trials, or the ENCORE trials, designed to provide further information on doses leading to clinically relevant efficacy, including improvement in biopsy-proven fibrosis and inflammation in patients with NASH fibrosis, and improvement in severe portal hypertension and hepatic function in patients with NASH cirrhosis. The ENCORE trials are also designed to provide safety data to support the initial registration of emricasan for chronic administration in patients with NASH cirrhosis. We expect the ENCORE trials to build on the data from our recently completed clinical trials, which have demonstrated emricasan's ability to provide improvements in validated functional surrogate endpoints of portal hypertension and liver function.

Two of the ENCORE trials are ongoing, the Phase 2b ENCORE-NF trial evaluating emricasan's potential long-term benefits for patients with liver fibrosis resulting from NASH, which we initiated in January 2016 and expect results from in 2018, and the Phase 2b ENCORE-PH trial evaluating the effect of emricasan in reducing hepatic venous pressure gradient, or HVPG, in compensated or early decompensated NASH cirrhosis patients with severe portal hypertension, which we initiated in November 2016 and expect results from in 2018. The third planned ENCORE trial is the Phase 2b ENCORE-LF trial to evaluate emricasan in patients with decompensated NASH cirrhosis, which we plan to initiate in the second quarter of 2017. We have another Phase 2 trial ongoing in post-orthotopic liver transplant, or POLT, recipients with reestablished liver fibrosis post-transplant as a result of recurrent hepatitis C virus, or HCV, infection who have successfully achieved a sustained viral response, or SVR, following HCV antiviral therapy, or POLT-HCV-SVR, patients with residual fibrosis or cirrhosis, which was initiated in May 2014.

In December 2016, we entered into an Option, Collaboration and License Agreement, or the Collaboration Agreement, with Novartis Pharma AG, or Novartis, pursuant to which we granted Novartis an exclusive option to collaborate with us for the global development and commercialization of emricasan. If Novartis exercises its option under the Collaboration Agreement, we will grant Novartis an exclusive, worldwide license to our intellectual property rights relating to emricasan to develop and commercialize products containing emricasan either as a single active ingredient or in combination with other Novartis compounds for liver cirrhosis or liver fibrosis, including but not limited to Farnesoid X receptor agonists that Novartis is currently developing for the treatment of chronic liver diseases for the treatment, diagnosis and prevention of disease in all indications in humans. The option, which expires on October 31, 2017, is exercisable upon, among other things, our providing notice to Novartis of the initiation of the planned Phase 2b ENCORE-LF trial, which we expect to initiate in the second quarter of 2017.

Under the Collaboration Agreement, Novartis paid us an upfront payment of $50.0 million. Following Novartis' exercise of the option under the Collaboration Agreement, Conatus will receive $7.0 million. Pursuant to the Collaboration Agreement, we are responsible for completing the four Phase 2b clinical trials described above, but we will share the costs of these trials equally with Novartis following Novartis' exercise of its option. Novartis will also be responsible for 100% of certain expenses for required registration-supportive nonclinical activities. Novartis will be responsible for development of emricasan beyond the Phase 2b trials described above, including the Phase 3 development of emricasan single agent products and all development of emricasan combination products. If Novartis exercises its option under the Collaboration Agreement, we expect the upfront and option exercise payments and the cost-sharing under the Collaboration Agreement to fund our current ongoing operations, including conducting the Phase 2b trials described above, through 2019.

We also plan to explore opportunities to expand our development pipeline by developing our existing preclinical product candidates or acquiring or in-licensing product candidates.

Since our inception, our primary activities have been organizational activities, including recruiting personnel, conducting research and development, including clinical trials, and raising capital. We have no products approved for sale, and we have not generated any revenues from product sales to date. We have funded our operations since inception primarily through sales of equity securities and convertible promissory notes and collaboration agreements, and we have incurred significant operating losses since our inception. We have never been profitable and have incurred net losses of $29.7 million, $24.1 million and $22.3 million in the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, we had an accumulated deficit of $150.6 million.

We expect to continue to incur significant operating losses and negative cash flows from operating activities for the foreseeable future as we continue the clinical development of emricasan and seek regulatory approval for and, if approved, pursue commercialization of emricasan.

As of December 31, 2016, we had cash, cash equivalents and marketable securities of $77.0 million. Although it is difficult to predict future liquidity requirements, we believe that our existing cash, cash equivalents and marketable securities will be sufficient to fund our operations for at least the next 12 months from the date of the filing of this Form 10-K. We will need to raise additional capital to fund further operations, which are expected to include completion of additional clinical trials of emricasan, regulatory filings for emricasan in the United States and the European Union, the potential commercialization of emricasan and the development of other product candidates. We may obtain additional financing in the future through the issuance of our common stock in future public offerings, through other equity or debt financings or through collaborations or partnerships with other companies.

Successful transition to profitability is dependent upon achieving a level of revenues adequate to support our cost structure. We cannot assure you that we will ever be profitable or generate sustained positive cash flow from operating activities and, unless and until we do, we will need to raise substantial additional capital through equity or debt financings or through collaborations or partnerships with other companies. We may not be able to raise additional capital on terms acceptable to us, or at all, and any failure to raise capital as and when needed could have a material adverse effect on our results of operations, financial condition and our ability to execute on our business plan.

JOBS Act

In April 2012, the Jumpstart Our Business Startups Act of 2012, or 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. In addition, we are in the process of evaluating the benefits of relying on the other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, if as an "emerging growth company" we choose to rely on such exemptions, we may not be required to, among other things, (i) provide an auditor's attestation report on our system of internal control over financial reporting pursuant to
Section 404 of the Sarbanes-Oxley Act of 2002, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act,
(iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor's report providing additional information about the audit and the financial statements (auditor discussion and analysis) and
(iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer's compensation to median employee compensation. These exemptions will apply for a period of five years following the completion of our initial public offering, or IPO, or until we no longer meet the requirements of being an "emerging growth company," whichever is earlier.

Financial Overview

Revenues

Our revenues to date have been generated primarily from the Collaboration Agreement with Novartis. Under the terms of the Collaboration Agreement, we received an upfront payment of $50.0 million. If Novartis exercises the option, we will receive $7.0 million and are eligible to receive up to approximately $650.0 million in additional payments for development, regulatory and commercial sales milestones, as well as royalties or profit and loss sharing on future product sales, if any.

We currently have no products approved for sale, and we have not generated any revenues from product sales to date. We have not submitted any product candidate for regulatory approval. If we fail to achieve clinical success in the development of emricasan in a timely manner and/or obtain regulatory approval for this product candidate, our ability to generate future revenues would be materially adversely affected.

Research and Development Expenses

The majority of our operating expenses to date have been incurred in research and development activities. Starting in late 2011, research and development expenses have been focused on the development of emricasan. Since acquiring emricasan in 2010, we have incurred $67.4 million in the development of emricasan through December 31, 2016. Our business model is currently focused on the development of emricasan in various liver diseases and is dependent upon our continuing to conduct research and a significant amount of clinical development. Our research and development expenses consist primarily of:

? expenses incurred under agreements with contract research organizations, or CROs, investigative sites and consultants that conduct our clinical trials and our preclinical studies;

? employee-related expenses, which include salaries and benefits;

? the cost of finalizing our chemistry, manufacturing and controls, or CMC, capabilities and providing clinical trial materials; and

? costs associated with other research activities and regulatory approvals.

Research and development costs are expensed as incurred.

At this time, due to the inherently unpredictable nature of preclinical and clinical development, we are unable to estimate with any certainty the costs we will incur in the continued development of emricasan. Clinical development timelines, the probability of success and development costs can differ materially from expectations.

The costs of clinical trials may vary significantly over the life of a project owing to factors that include but are not limited to the following:

? per patient trial costs;

? the number of patients that participate in the clinical trials;

? the number of sites included in the clinical trials;

? the countries in which the clinical trials are conducted;

? the length of time required to enroll eligible patients;

? the number of doses that patients receive;

? the drop-out or discontinuation rates of patients;

? potential additional safety monitoring or other studies requested by regulatory agencies;

? the duration of patient follow-up; and

? the efficacy and safety profile of the product candidate.

We are currently focused on advancing emricasan in multiple indications, and our future research and development expenses will depend on its clinical success. In addition, we cannot forecast with any degree of certainty if Novartis will exercise its option under the Collaboration Agreement and to what extent Novartis will develop and commercialize emricasan.

Research and development expenditures will continue to be significant and will increase as we continue clinical development of emricasan over at least the next several years. We expect to incur significant development costs as we conduct our ongoing and future Phase 2b trials of emricasan.

We do not expect emricasan to be commercially available, if at all, for at least the next several years.
General and Administrative Expenses

General and administrative expenses consist principally of salaries and related costs for personnel in executive, finance, business development and administrative functions. Other general and administrative expenses include costs related to being a public company, as well as insurance, facilities, travel, patent filing and maintenance, legal and consulting expenses.

If emricasan receives regulatory approval, we may incur expenses associated with activities related to commercializing emricasan. Some expenses may be incurred prior to receiving regulatory approval of emricasan. We do not expect to receive any such regulatory approval for at least the next several years.

Interest Income

Interest income consists primarily of interest income earned on our cash, cash equivalents and marketable securities.

Interest Expense

Interest expense consists of coupon interest on our $1.0 million promissory note payable to Pfizer Inc.

Other Income (Expense)

Other income (expense) includes non-operating transactions such as those caused by currency fluctuations between transaction dates and settlement dates and the conversion of account balances held in foreign currencies to U.S. dollars.

Critical Accounting Policies and Significant Judgments and Estimates

Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these 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 the financial statements, as well as the reported revenues and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. 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. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in the notes to our audited financial statements appearing elsewhere in this annual report, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements and understanding and evaluating our reported financial results.

Revenue Recognition

We recognize revenue when each of the following four criteria is met: (i) persuasive evidence of an arrangement exists; (ii) products are delivered or as services are rendered; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured.

Multiple-element arrangements, such as the Collaboration Agreement, may include
(i) grants of licenses, or options to obtain licenses, to intellectual property,
(ii) research and development services, (iii) participation on joint research and/or joint development committees, and/or (iv) manufacturing or supply services. The payments we may receive under these arrangements typically include one or more of the following: non-refundable, upfront license fees; option exercise fees; funding of research and/or development efforts; amounts due upon the achievement of specified objectives; and/or royalties on future product sales.

Multiple-element arrangements require the separability of deliverables included in an arrangement into different units of accounting and the allocation of arrangement consideration to the units of accounting. The evaluation of multiple-element arrangements requires management to make judgments about (i) the identification of deliverables, (ii) whether such deliverables are separable from the other aspects of the contractual relationship, (iii) the estimated selling price of each deliverable, and (iv) the expected period of performance for each deliverable.

To determine the units of accounting under a multiple-element arrangement, management evaluates certain separation criteria, including whether the deliverables have stand-alone value, based on the relevant facts and circumstances for each arrangement. Management then estimates the selling price for each unit of accounting and allocates the arrangement consideration to each unit using the relative selling price method. The allocated consideration for each unit of accounting is recognized based on the method most appropriate for that unit of account and in accordance with the revenue recognition criteria detailed above.

If there are deliverables in an arrangement that are not separable from other aspects of the contractual relationship, they are treated as a combined unit of accounting, with the allocated revenue for the combined unit recognized in a manner consistent with the revenue recognition applicable to the final deliverable in the combined unit. Payments received prior to satisfying the relevant revenue recognition criteria are recorded as deferred revenue in the accompanying balance sheets and recognized as revenue when the related revenue recognition criteria are met.

The Collaboration Agreement provides for non-refundable milestone payments. We recognize revenue that is contingent upon the achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. A milestone is considered substantive when the consideration payable to us for such milestone (i) is consistent with our performance necessary to achieve the milestone or the increase in value to the collaboration resulting from our performance, (ii) relates solely to our past performance and (iii) is reasonable relative to all of the other deliverables and payments within the arrangement. In making this assessment, we consider all facts and circumstances relevant to the arrangement, including factors such as the scientific, regulatory, commercial and other risks that must be overcome to achieve the milestone, the level of effort and investment required to achieve the milestone and whether any portion of the milestone consideration is related to future performance or deliverables.

We will periodically review the estimated performance periods under the Collaboration Agreement, which provides for non-refundable upfront payments and fees. We will adjust the periods over which revenue should be recognized when appropriate to reflect changes in assumptions relating to the estimated performance periods. We could accelerate revenue recognition in the event of early termination of programs or if our expectations change. Alternatively, we could decelerate revenue recognition if programs are extended or delayed. While such changes to our estimates have no impact on our reported cash flows, the amount of revenue recorded in future periods could be materially impacted.

We record revenues related to the reimbursement of costs incurred under the Collaboration Agreement where we act as a principal, control the research and development activities and bear credit risk. Under the Collaboration Agreement, we are reimbursed for associated out-of-pocket costs and for a certain amount of our full-time equivalent, or FTE, costs based on an agreed-upon FTE rate. The gross amount of these pass-through reimbursed costs are reported as revenue in the accompanying statements of operations and comprehensive loss, while the actual expenses for which we are reimbursed are reflected as research and development costs.

Accrued Research and Development Expenses

As part of the process of preparing our financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing contracts and purchase orders, reviewing the terms of our vendor agreements, communicating with our applicable 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 at that time.

Examples of estimated accrued research and development expenses include:

? fees paid to CROs in connection with clinical trials;

? fees paid to investigative sites in connection with clinical trials;

? fees paid to vendors in connection with preclinical development activities; and

? fees paid to vendors related to product manufacturing, development and distribution of clinical supplies.

We base our expenses related to clinical trials 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 and expense recognition. 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 adjust the accrual accordingly. 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 our reporting changes in estimates in any particular period. We have not experienced any significant adjustments to our estimates to date. In the years ended December 31, 2016, 2015 and 2014, we increased our clinical trial activities, and we expect our clinical trial activities to continue to increase as we initiate additional future clinical trials.