UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)s

For the quarterly period ended September 30, 2017

OR

For the transition period from              to             

Commission File Number: 001-38112

 

ATHENEX, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Registrant’s telephone number, including area code:

(716) 427-2950

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. 

 

 

Emerging growth company ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 27, 2017, the registrant had 57,995,264 shares of common stock, $0.001 par value per share, outstanding.

 

 

 

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Table of Contents

 

 

 

 

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PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

ATHENEX, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited)

(In thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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ATHENEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Loss

(unaudited)

(In thousands, except share and per share data)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

.

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ATHENEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity

(unaudited)

(In thousands, except share data)

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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ATHENEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited)

(In thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Athenex, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Company and Nature of Business

Organization and Description of Business

Athenex, Inc. (the “Company” or “Athenex”), originally known as Kinex Pharmaceuticals LLC, formed in November 2003, commenced operations on February 5, 2004, and operated as a limited liability company until it was incorporated in the State of Delaware under the name Kinex Pharmaceuticals, Inc. on December 31, 2012. The Company changed its name to Athenex, Inc. on August 26, 2015.  

Athenex is a global biopharmaceutical company dedicated to the discovery, development and commercialization of novel therapies for the treatment of cancer. The Company’s mission is to improve the lives of cancer patients by creating more effective, safer and tolerable treatments. The Company has generated its clinical product candidates through its Orascovery and Src Kinase Inhibition research platforms, which are based on its understanding of human absorption biology and novel approaches to inhibiting kinase activity, respectively. The Company has assembled a leadership team and has established operations in the U.S. and China across the pharmaceutical value chain to execute its mission to become a global leader in bringing innovative cancer treatments to the market and improving health outcomes. The Company’s primary activities since commencement have been conducting research and development internally and through corporate collaborators, in-licensing and out-licensing pharmaceutical compounds and technology, and conducting clinical trials.

Significant Risks and Uncertainties

The Company has incurred operating losses since its inception and, as a result, as of December 31, 2016 and September 30, 2017 had an accumulated deficit of $195.1 million and $298.0 million, respectively. Operations have been funded primarily through the sale of common stock and convertible bonds and, to a lesser extent, through revenue generated from our Global Supply Chain Platform and Commercial Platform. The Company will require significant additional funds in order to conduct clinical trials and to fund its operations. There can be no assurances, however, that additional funding will be available on favorable terms, or at all. If adequate funds are not available, the Company may be required to delay, modify, or terminate its research and development programs or reduce its planned commercialization efforts. The Company believes that it will be able to obtain additional working capital through equity financings or other arrangements to fund operations. If the Company is unable to obtain such additional financing, the Company will need to reevaluate future operating plans. Accordingly, there is substantial doubt regarding the Company’s ability to continue as a going concern.

These consolidated financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of the business. The Company’s recurring losses from operations and negative cash flows from operations have raised substantial doubt regarding its ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.

Athenex is subject to a number of risks similar to other biopharmaceutical companies, including, but not limited to, the lack of available capital, possible failure of preclinical testing or clinical trials, inability to obtain marketing approval of product candidates, competitors developing new technological innovations, market acceptance of the Company’s products, and protection of proprietary technology. If the Company does not successfully commercialize or partner any of its product candidates, it will be unable to generate sufficient product revenue to achieve profitability.

Initial Public Offering

On June 13, 2017, the Company’s Registration Statement on Form S-1 (File No. 333-217928) relating to the initial public offering (“IPO”) of its common stock was declared effective by the Securities and Exchange Commission (“SEC”). Pursuant to such Registration Statement, the Company sold an aggregate of 6,900,000 shares of its common stock at a price of $11.00 per share for cash proceeds of $64.2 million, net of underwriting discounts and commissions of $6.1 million and offering costs of $5.6 million.

On June 14, 2017, the day of the IPO, convertible bonds with an aggregate principal value of $68.0 million, and a carrying value of $55.8 million, were converted into 7,727,273 shares of common stock. The IPO closed on June 19, 2017. On September 29, 2017, the remaining convertible bond with a principal value of $7.0 million was converted into 795,455 shares of common stock, at a 20% discount from the IPO price of $11 per share.

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2. Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information (Accounting Standards Codification (“ASC”) 270, Interim Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these financial statements do not include all of the information necessary for a full presentation of financial position, results of operations, and cash flows in conformity with GAAP. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of the Company for the periods presented. These condensed consolidated financial statements reflect the accounts and operations of the Company and those of its subsidiaries in which the Company has a controlling financial interest. Intercompany transactions and balances have been fully eliminated in consolidation.

Results of the operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results expected for the full fiscal year or for any future annual or interim period. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes for the years ended December 31, 2015 and 2016 included in the prospectus dated June 15, 2017, filed with the SEC pursuant to Rule 424 promulgated under the Securities Act of 1933, as amended.

Use of Estimates

These condensed consolidated financial statements have been prepared in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the condensed consolidated financial statements and the reported amount of revenue and expenses during the reporting period. Such management estimates include those relating to assumptions used in contract research accruals, allowance for doubtful accounts, chargebacks, inventory reserves, income taxes, the estimated useful life and recoverability of long-lived assets, and the valuation of stock-based awards. Actual results could differ from those estimates.

Revenue Recognition

Product Sales, Chargebacks, Returns, and Discounts

The Company recognizes product revenue when there is persuasive evidence of an arrangement, the price is fixed or determinable, collectability is reasonably assured, and upon shipment to or delivery and acceptance by customers. Service revenue is recognized in the period such services have been rendered.

The Company’s specialty products sold through its Commercial Platform are distributed through independent pharmaceutical wholesalers. The wholesalers then generally sell to an end-user, normally a hospital, alternative healthcare facility, or an independent pharmacy, at a lower price previously established by the end-user and the Company. Sales are initially recorded at the list price sold to the wholesaler. Because these prices will be reduced for the end-user, the Company records a contra asset in accounts receivable and a reduction to revenue at the time of the sale, using the difference between the list price and the estimated end-user contract price. Upon the sale by the wholesaler to the end-user, the wholesaler will chargeback the difference between the original list price and price at which the product was sold to the end-user and such chargeback is offset against the initial estimated contra asset. As of September 30, 2017, the Company’s chargeback provision totaled $2.6 million.

The Company offers cash discounts, which approximate 2% of the gross sales price as an incentive for prompt customer payment, and, consistent with industry practice, the Company’s return policy permits customers to return products within a window of time before and after the expiration of product dating, most often 2% of gross purchases. The Company expects that its wholesale customers will make timely payments and take advantage of the cash discounts, and expects customers to use their right of return. Therefore, at the time of sale, product revenue and accounts receivable are reduced by the full amount of the discount offered and the return expected. The Company considers payment performance and historical return rates and adjusts the accrual to reflect actual experience. As of September 30, 2017, the Company’s accrual for cash discounts and return accrual were not material to the financial statements.

Concentration of Credit Risk, Other Risks and Uncertainties

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and investments. The Company deposits its cash equivalents in interest-bearing money market accounts and certificates of deposit. Although the Company deposits the cash with multiple financial institutions, cash balances may occasionally be in excess of

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the amounts insured by the Federal Deposit Insurance Corporation. The primary focus of the Company’s investment strategy is to preserve capital and meet liquidity requirements. The Company’s investment policy addresses the level of credit exposure by limiting the concentration in any one corporate issuer and establishing a minimum allowable credit rating. The Company also has significant assets and liabilities held in its overseas manufacturing facility in China, Taihao, and therefore is subject to foreign currency fluctuation. Also, due to government restrictions on transferring funds out of China, the total restricted net assets of the Company’s consolidated subsidiaries was $12.7 million and  $15.7 million as of September 30, 2017 and December 31, 2016, respectively.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”, and subsequent clarifying guidance, which will supersede most current revenue recognition guidance, including industry-specific guidance. The underlying principle is that an entity will recognize revenue based on the transfer of goods or services to customers in an amount that the entity expects to be entitled to in exchange for those goods or services. The new guidance sets forth a five-step revenue recognition model that will need to be applied consistently to all contracts with customers to determine the amount and timing of revenue to be recognized. Also required are new disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. The new standard is required to be applied either retrospectively to each prior reporting period presented (“full retrospective approach”) or retrospectively with the cumulative effect of initial application recognized at the date of initial application (“modified retrospective approach”). The Company has established an implementation team focused on evaluating the effects of the new standard on the Company’s operations and made progress in its evaluation of the guidance. Based on our preliminary assessment, we expect the most significant impact be the expanded disclosure requirements. We are continuing to work on the plan for implementation of the new guidance, including reviewing accounting policies and evaluating updates to our control environment where applicable. We will adopt the requirements of the new standard on January 1, 2018 using the modified retrospective method. The modified retrospective method requires companies to recognize the cumulative effect of initially applying the new standard as an adjustment to opening retained earnings. We currently do not anticipate such adjustment to be material.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” which requires that lessees distinguish between finance and operating leases and recognize the assets and liabilities that arise from the leases on the balance sheet. This ASU is required to be adopted retrospectively and is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and is required to be applied on a modified retrospective basis. The Company is evaluating the effect of this standard on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which modifies the measurement of expected credit losses of certain financial instruments. ASU 2016-13 is required to be adopted retrospectively and is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. The Company is evaluating the effect of this standard on its consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-entity Transfers of Assets Other Than Inventory,” which requires entities to recognize the income tax consequences of intra-entity transfers of assets other than inventory when the transfers occur. This ASU is effective for the Company for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The primary purpose of this ASU is to reduce the diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. This ASU will require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017. This ASU is required to be applied retrospectively. Early adoption is permitted, including adoption in an interim period. The Company does not anticipate the effect of this standard on its consolidated financial statements to be material.

In May 2017, the FASB issued ASU 2017-09, “Stock Compensation - Scope of Modification Accounting,” which provides guidance as to when a modification of a share-based award must be accounted for. In general, if a modification of the terms and conditions of an award does not change the fair value of the award (or calculated value or intrinsic value, if used instead of fair value), does not change the vesting conditions of the award, and does not change the classification of the award as an equity instrument or a liability instrument, then an entity need not account for the modification. This guidance is effective in the first quarter of fiscal year

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2018. The new rules are applied prospectively to awards modified after the adoption date. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.

Recently Adopted Accounting Pronouncements

In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory.” This ASU requires inventory to be measured at the lower of cost or net realizable value. The amendment is required to be applied prospectively. The Company adopted ASU 2015-11 effective January 1, 2017. Adoption of ASU 2015-11 did not have a significant impact on the consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” which simplifies the accounting for share-based payment award transactions including: income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows.  Effective January 1, 2017, the Company adopted ASU 2016-09. The standard eliminated the requirement to defer recognition of excess tax benefits related to employee share-based awards until they are realized through a reduction to income taxes payable. The Company applied the modified retrospective method and there was no net cumulative effect adjustment to retained earnings on January 1, 2017 because the increase in deferred income tax assets for previously unrecognized excess tax benefits was fully offset by a valuation allowance. As permitted by the ASU, the Company will continue to use an estimated forfeiture rate in determining stock-based compensation expense.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which addresses the classification of certain cash transactions on the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company early adopted ASU 2016-15 as of January 1, 2016 and applied its provisions retrospectively through the earliest period presented, which did not have a significant impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The primary purpose of the ASU is to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The ASU also applies the same test of goodwill to all reporting units, now including those with a zero or negative carrying amount of net assets. This ASU is required to be adopted on a prospective basis and is effective for any goodwill impairment tests in fiscal years beginning after December 15, 2019, although early adoption is permitted for any impairment tests performed after January 1, 2017. The Company adopted the new guidance on a prospective basis during the first quarter of 2017. The adoption of this ASU has not impacted the Company’s consolidated financial statements.

3. Inventories

Inventories consist of the following (in thousands):

 

 

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4. Intangible Assets, net

 

The Company’s identifiable intangible assets, net, consist of the following (in thousands):

 

 

 

As of December 31, 2016, licenses at cost include an Orascovery license of $0.4 million and a license purchased from Gland Pharma Ltd (“Gland”) of $2.7 million. The Orascovery license with Hanmi Pharmaceuticals Co. Ltd. (“Hanmi”) was purchased directly from Hanmi and is being amortized on a straight-line basis over a period of 12.75 years, the remaining life of the license agreement at the time of purchase. The license purchased from Gland is being amortized on a straight-line basis over a period of 5 years, the remaining life of the license agreement at the time of purchase. During the nine months ended September 30, 2017, the Company purchased additional licenses from Gland for $1.6 million which are being amortized over a period of 5 years.

The remaining intangible assets were acquired in connection with the acquisitions of Athenex Pharma Solutions (formerly referred to as QuaDPharma), Polymed, and CDE. Intangible assets are amortized using an economic consumption model over their useful lives. The Athenex Pharma Solutions customer list was being amortized on a straight-line basis over 7 years. The Polymed customer list and technology are amortized on a straight-line basis over 6 and 12 years, respectively. The CDE in-process research and development, or IPR&D, will not be amortized until the related projects are completed. IPR&D will be tested annually for impairment, unless conditions exist causing an earlier impairment test (i.e. abandonment of project).  During the nine months ended September 30, 2017, the Company abandoned a project within IPR&D and therefore, the related balance of $0.1 million was written-off as impaired and is included within research and development expenses in the condensed consolidated statement of operations and comprehensive loss for the nine months ended September 30, 2017. The weighted-average useful life for all intangible assets was 7.91 years as of September 30, 2017.

The Company recorded $0.4 million and $0.2 million of amortization expense for the three months ended September 30, 2017 and 2016, respectively, and $1.2 million and $0.5 million of amortization expense for the nine months ended September 30, 2017 and 2016, respectively.

5. Fair Value Measurements

Financial instruments consist of cash and cash equivalents, short-term investments, an equity investment, accounts receivable, accounts payable, accrued liabilities, and debt. Short-term investments, the equity investment, and the embedded derivative liability are stated at fair value. Cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and debt, are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment date of such amounts.

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ASC 820, Fair Value Measurements, establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under the ASC 820 are described as follows:

Level 1—Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.

Level 2—Inputs to the valuation methodology include:

Level 3—Inputs to the valuation methodology are unobservable, supported by little or no market activity, and are significant to the fair value measurement.

Transfers between levels, if any, are recorded as of the beginning of the reporting period in which the transfer occurs. There were no transfers between Levels 1, 2 or 3 for any of the periods presented.

The following tables represent the fair value hierarchy for those assets and liabilities that the Company measures at fair value on a recurring basis (in thousands):

 

 

 

The Company classifies its certificates of deposit and money market funds within Level 1 because it uses quoted market prices to determine their fair value. The Company classifies its commercial paper, corporate notes, and U.S. government bonds within Level 2 because it uses quoted prices for similar assets or liabilities in active markets and each has a specified term and all level 2 inputs are observable for substantially the full term of each instrument.

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The Company owns 68,000 shares of PharmaEssentia, a company publicly traded on the Taiwan OTC Exchange (“TWO”). As of September 30, 2017 and December 31, 2016, the Company’s investment in PharmaEssentia is valued at the closing price reported on the TWO. This investment is classified as a level 1 investment.

The Company bifurcated the embedded derivative feature from its convertible bonds and recorded it as a long-term liability. The derivative liability was measured at fair value as of the issuance date and remeasured at fair value at the end of the reporting period. The liability is measured at fair value using level 3 inputs. The derivative liability is discussed further in Note 7—Debt.

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial instruments (in thousands):

 

 

6. Income Taxes

The Company did not record a provision for federal income taxes for the nine months ended September 30, 2017 because it expects to generate a loss for the year ending December 31, 2017 and the Company’s net deferred tax assets continue to be offset by a full valuation allowance. Tax benefit to date relates to foreign tax benefit on losses in the Peoples Republic of China (“PRC”) offset by state franchise taxes and amortization of long-lived intangible assets in the U.S. and PRC.

7. Debt

As of September 30, 2017 and December 31, 2016, the balances of this debt are as follows (in thousands):

 

 

The promissory notes have a 36-month term beginning on July 1, 2015 and ending on June 1, 2018 with a 6% stated interest rate. The mortgage payments extend through July 30, 2018. Future minimum principal payments on these promissory notes and mortgage consist of $1.1 million and $0.5 million due in the remaining three months in 2017 and 2018, respectively.

In 2016 and 2017, the Company issued convertible bonds with an aggregate principal value of $75.0 million and a maturity date of October 1, 2018. Of the convertible bonds issued, an aggregate principal of $24.0 million were issued to related parties. On June 14, 2017, the IPO date, $68.0 million of these bonds, which had a carrying value of $55.8 million, were converted into 7,727,273 shares of common stock.

In March 2017, the Company signed an amendment to its license agreement with Hanmi, under which the Company received the rights to develop and sell drugs under the Orascovery program in additional territories, including Japan. This license amendment required an upfront fee of $7.0 million payable to Hanmi upon the execution of the agreement. In lieu of the payment, the Company issued a convertible bond to Hanmi with a par value of $7.0 million. This bond carried an interest rate of 10% per annum and a maturity date of October 1, 2018. This amendment included additional regulatory milestone payments and royalties based on sales. The occurrence of any milestone triggering events have not been deemed to be probable and no sales have yet occurred. On September 29, 2017, Hanmi converted its bond with a principal value of $7.0 million into 795,455 shares of common stock, at a 20% discount

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from the IPO price of $11 per share, which resulted in a loss on the embedded derivative feature from the convertible bond of $6.5 million in the three months ended September 30, 2017.

8. Related Party Transactions

During the three and nine months ended September 30, 2017 and 2016, the Company entered into transactions with individuals and companies that have financial interests in the Company. Related party transactions included the following:

a. During 2014 and 2015, the Company issued promissory notes to two executives in the amount of $12.6 million to facilitate the executives’ purchase of the Company’s common stock. The notes were intended to be forgiven over a three-year period, as compensation to those executives. The Company accelerated the forgiveness of these promissory notes in 2016 and forgave the notes in full. Stock-based compensation expense related to these notes amounted to $0 and $1.0 million for the three months ended September 30, 2017 and 2016, respectively, and $0 and $3.1 million for the nine months ended September 30, 2017 and 2016, respectively.

Further, certain family members of executives perform consulting services for the Company. Such services were not significant to the condensed consolidated financial statements.  

b. In 2015, CDE signed an agreement with Avalon BioMedical (Management) (“Avalon”) under which Avalon will receive certain administrative services and will occupy space at CDE’s research location. Avalon reimburses CDE for these administrative services as incurred and pays CDE  a certain percentage of the total rent payment  based on its staff headcount occupying the Hong Kong research and development facility (See Note 14—Commitments and Contingencies). Certain members of the Company’s board and management collectively have a controlling interest in Avalon. The Company does not hold any interest in Avalon and does not have any obligations to absorb losses or any rights to receive benefits from Avalon. As of September 30, 2017 and December 31, 2016, Avalon held 678,880 shares of the Company’s common stock, which represented 1.1% and 1.7%, respectively of the Company’s total issued shares. Balances due from Avalon recorded on the condensed consolidated balance sheets were not significant.

c. The Company receives consulting and licensing revenue from PharmaEssentia, a company in which Athenex has an investment classified as available-for-sale (see Note 5—Fair Value Measurements). The Company recorded no revenue from PharmaEssentia for the three months ended September 30, 2017 or 2016, and $0.5 million and $0 for the nine months ended September 30, 2017 and 2016, respectively.

d. The Company previously purchased pharmaceutical ingredients from Chongqing Taisheng Biotechnology Co., Ltd. (“Taisheng”), a company which is owned by a member of Athenex’s management. The Company made no purchases from Taisheng  the three months ended September 30, 2017 or 2016  nor in the nine months ended September 30, 2017, but did purchase $0.2 million for the nine months ended September 30, 2016.

e. The Company receives clinical development services from ZenRx Limited and subsidiaries (“ZenRx”), a company for which one of our executive officers serves on the board of directors. In connection with such services, the Company made payments to ZenRx of $0.2 million and less than $0.1 million during the three months ended September 30, 2017 and 2016, respectively, and $0.5 million and less than $0.1 million during the nine months ended September 30, 2017 and 2016, respectively. As of each of September 30, 2017 and December 31, 2016, the Company owed ZenRx $0.1 million.

f. The Company receives consulting services from RSJ Consulting LLC (“RSJ”), a limited liability company for which one of our executive officers serves as the principal. Services incurred from RSJ amounted to less than $0.1 million and less than $0.1 million for the three months ended September 30, 2017 and 2016, respectively, and $0.1 million and $0.2 million for the nine months ended September 30, 2017 and 2016, respectively.

g. The Company issued and sold $24.0 million in convertible bonds in 2016 and 2017 to related parties. One of the holders of more than 5% of our outstanding common stock as of December 31, 2016, and an entity affiliated with one of our directors, each purchased $10.0 million in convertible bonds during 2016. Additionally, during the first quarter of 2017, the Company issued and sold $4.0 million in convertible bonds to two related parties. One of the holders of more than 5% of our outstanding common stock as of March 31, 2017 and a director of the Company each purchased $2.0 million in convertible bonds. On June 14, 2017, the IPO date, these bonds were converted into 2,727,273 shares of common stock.

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9. Business and Economic Collaborative Agreements

New York State

On May 1, 2015, the Company executed an agreement for a medical technology research, development, innovation, and commercialization alliance with Fort Schuyler Management Corporation (“FSMC”), a not-for-profit corporation existing under the laws of the State of New York (the “State”). The Company has been granted $25 million by the State to build new corporate offices including a formulation lab with related equipment for the Company.

The Company, through its partnership with FSMC, Empire State Development (“ESD”), and The State University of New York (“SUNY”) Polytechnic, plans to execute a major expansion and establish a 315,000 square foot, ISO Class 5 high potency oral and sterile injectable pharmaceutical manufacturing facility in Dunkirk, New York. On September 4, 2017, the Company entered into a Grant Disbursement Agreement whereby the State will grant up to $200 million, plus any additional funds available from the previous $25 million ESD Grant for the Company’s corporate offices, to fund the construction of the new pharmaceutical manufacturing facility. The Company is entitled to lease the facility and all equipment purchased with grant funds at a rate of $1.00 per year for an initial 10-year term, and for the same rate if the Company elects to extend the lease for an additional 10-year term. In exchange, the Company committed to spending $1.52 billion on operational expenses in the facility in its first 10-year term, and an additional $1.50 billion on operational expenses if the Company elects to extend the lease for a second 10-year term. The Company does not have significant construction period risks and the State will fund a majority of the construction costs and hold ownership of the manufacturing and office facilities. As of September 30, 2017, construction on these facilities had not yet been completed.

10. Stockholders’ Equity

Common Stock

As of September 30, 2017 and 2016, 250 million common shares, par value $0.001, were authorized by the Company’s Board of Directors. The common shares are entitled to one vote per share and to receive dividends as declared.

On June 14, 2017, the Company completed an IPO of its common stock (refer to Note 1 – Company and Nature of Business for additional information). During the nine months ended September 30, 2017, the Company issued 6,900,000 shares of common stock at $11.00 per share in connection with the IPO, 8,522,728 shares of common stock from the conversion of the convertible bonds into common stock, 568,182 shares of common stock upon the IPO in connection with a licensing agreements, 512,586  shares from the exercise of warrants and options, and 821,982 shares from the vesting of restricted stock units and the grant of shares in connection with an executive’s employment agreement for cumulative increase to equity of $182.3 million.

Cost of Equity Raise

Costs incurred in raising equity, whether paid with cash or through the issuance of securities, are charged against the equity raised. These costs include underwriting discounts and commissions, legal fees, accounting services and amounts paid to consultants and amounted to $11.7 million, cumulatively, as of the IPO date. $1.8 million of these costs were deferred and included within other long-term assets on the consolidated balance sheet as of December 31, 2016. The total amount of $11.7 million was charged against the capital raised through the IPO.

Common Stock Option Plans

The Company has three common stock option plans adopted in 2013, 2007 and 2004 (the “Plans”) which authorize the grant of up to 11,800,000 common stock options to employees, directors, and consultants. Additionally, on June 14, 2017, the Company adopted its 2017 Omnibus Incentive Plan and 2017 Employee Stock Purchase Plan (the “2017 Plans”). Under the 2017 Plans, 5,200,000 shares of common stock are reserved for future issuance to employees, directors, and consultants, including 1,000,000 reserved for an Employee Stock Purchase Plan, which was established at IPO but no shares have as yet been issued.  Management has valued the options at their grant date using the Black-Scholes option pricing model. See Note 11—Stock-Based Compensation for more information.

11. Stock-Based Compensation

Stock Options

The total fair-value of stock options vested and recorded as compensation expense during the three months ended September 30, 2017 and 2016 and the nine months ended September 30, 2017 and 2016 was $2.3 million, $2.3 million, $5.7 million, and $6.2 million, respectively. As of September 30, 2017 and December 31, 2016, $15.8 million and $11.0 million of unrecognized cost related to non-vested stock options was expected to be recognized over a weighted-average period of approximately 1.9 years and 1.6 years,

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respectively. The total intrinsic value of options exercised was approximately $1.6 million and less than $0.1 million for the nine months ended September 30, 2017 and 2016, respectively.

The following table summarizes the status of the Company’s stock option activity granted under the Plans to employees, directors, and consultants (in thousands, except stock option amounts):

 

 

The Company determines the fair value of stock-based awards on the grant date using the Black-Scholes option pricing model, which is impacted by assumptions regarding a number of highly subjective variables. The following table summarizes the weighted-average assumptions used as inputs to the Black-Scholes model during the periods indicated:

 

 

Stock Grants

The Company grants common stock to key officers and directors as additional compensation in certain circumstances. The fair value of these grants is recorded as compensation expense throughout the requisite service period. Compensation cost recorded for the stock grants amounted to $0.5 million and $1.8 million for the three months ended September 30, 2017 and 2016, respectively, and $6.0 million and $4.0 million for the nine months ended September 30, 2017 and 2016, respectively.

Awards granted to non-employees

The Company has accounted for equity instruments issued to non-employees in accordance with the provisions of ASC 718, Compensation—Stock Compensation, and ASC 505, Equity. All transactions in which goods or services are received in exchange for equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The expense is recognized in the same manner as if the Company had paid cash for the services provided by the non-employees.

Restricted Stock

The following table summarizes restricted stock activity:

 

 

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Warrants

The Company has granted warrants to purchase common stock. The Company determined the fair value of the warrants on the grant date using the Black-Scholes option pricing model, consistent with the valuations of stock options described above. All warrants were fully vested and 344,000 were outstanding as of December 31, 2016. During June 2017, the holder exercised their warrants and as of September 30, 2017, there were no outstanding warrants.

Stock-Based Compensation Cost

The components of stock-based compensation and the amounts recorded within research and development expenses and selling, general, and administrative expenses in the Company’s consolidated statements of operations and comprehensive loss consisted of the following for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

 

12. Net Loss Per Share Attributable to Athenex, Inc. Common Stockholders

Basic net loss per share is calculated by dividing net loss attributable to common stockholders by the weighted-average number of common shares issued, outstanding, and vested during the period. Diluted net loss per share is computed by dividing net loss attributable to common stockholders by the weighted-average number of common share and common shares equivalents for the period using the treasury-stock method. For the purposes of this calculation, warrants for common stock and stock options are considered common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive.

The following outstanding shares of common stock equivalents were excluded from the calculation of diluted net loss per share attributable to common stockholders for the periods presented because including them would have been antidilutive:

 

 

 

13. Business Segment, Geographic, and Concentration Risk Information

The Company has three operating segments, which are organized based mainly on the nature of the business activities performed and regulatory environments in which they operate. The Company also considers the types of products from which the reportable segments derive their revenue (only applicable to two reportable segments). Each operating segment has a segment manager who is held accountable for operations and has discrete financial information that is regularly reviewed by the Company’s chief operating decision-maker. The Company’s operating segments are as follows:

Oncology Innovation Platform—This operating segment performs research and development on certain of the Company’s proprietary drugs, from the preclinical development of its chemical compounds, to the execution and analysis of its several clinical trials. This segment focuses specifically on the oral absorption cancer drug platform, the Src Kinase inhibitors, and the transmucosal drug delivery system. This segment performs research in the United States, Taiwan, Hong Kong, and mainland China.

Global Supply Chain Platform—This operating segment includes Athenex Pharma Solutions and Polymed. Athenex Pharma Solutions is a contract manufacturing company that provides small to mid-scale cGMP manufacturing of clinical and commercial products for pharmaceutical and biotech companies. Athenex Pharma Solutions also performs microbiological and analytical testing

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for raw material and formulated products and is expanding to manufacture and sell pharmaceutical products under 503B regulations set forth by the U.S. Food and Drug Administration (“FDA”). Polymed markets and sells API and medical devices in North America, Europe, and Asia from its locations in Texas and China. Polymed also develops new compounds, processing techniques, and manufactures API at Taihao, a cGMP facility in Chongqing, China. Currently, a majority of the Company’s revenue is generated by this segment.

Commercial Platform—This operating segment includes Athenex Pharmaceutical Division, a newly-formed component that is focused on the manufacturing, distribution, and sales of generic pharmaceuticals. This segment provides services and products to external customers based mainly in the United States.

The segments operate in North America and Asia. The Company’s Oncology Innovation Platform segment operates and holds long-lived assets located in the United States, Taiwan, Hong Kong, and mainland China. The Commercial Platform segment operates and holds long-lived assets located in the United States. The Global Supply Chain Platform segment operates and holds long-lived assets located in the United States and China. For geographic segment reporting, product sales have been attributed to countries based on the location of the customer.

Segment information is as follows (in thousands):

 

 

 

 

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Intersegment revenue is recorded by the selling segment when it is realized or realizable and all revenue recognition criteria are met. Upon consolidation, all intersegment revenue and related cost of sales are eliminated from the selling segment’s ledger.

 

 

 

 

 

Customer revenue and accounts receivable concentration amounted to the following for the identified periods. These customers relate to the Commercial Platform segment and the Global Supply Chain Platform segment.

 

 

 

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14. Commitments and Contingencies

Future minimum payments under the non-cancelable leases consisted of the following as of September 30, 2017 (in thousands):

 

 

Legal Proceedings

The Company is not a party to any pending or known threatened legal proceedings that, in the opinion of the Company, would have a material impact on the Company’s condensed consolidated financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes included in Part I, item I of this report and with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2016, included in our final prospectus dated June 13, 2017, filed with the Securities and Exchange Commission pursuant to Rule 424(b) under the Securities Act of 1933, as amended, or the Prospectus. This discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties, such as our plans, objectives, expectations, intentions and beliefs. 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 identified below and those discussed in the section entitled “Risk Factors” beginning on page 30 in this report.

NOTE ABOUT FORWARD-LOOKING STATEMENTS

This quarterly report contains forward-looking statements. All statements other than statements of historical fact are “forward-looking statements” for purposes of this Quarterly Report on Form 10-Q. These forward-looking statements may include, but are not limited to, statements regarding our future results of operations and financial position, business strategy, market size, potential growth opportunities, clinical development activities, the timing and results of clinical trials and potential regulatory approval and commercialization of product candidates. In some cases, forward-looking statements may be identified by terminology such as “believe,” “may,” “will,” “should,” “predict,” “goal,” “strategy,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect,” “seek” and similar expressions and variations thereof. These words are intended to identify forward-looking statements.

We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations, except as required by law.

As used in this Quarterly Report on Form 10-Q, the terms “Athenex,” “the Company,” “we,” “us,” and “our” refer to Athenex, Inc. and, where appropriate, its consolidated subsidiaries, unless the context indicates otherwise.

Overview

We are a global biopharmaceutical company dedicated to the discovery, development and commercialization of novel therapies for the treatment of cancer. Our mission is to improve the lives of cancer patients by creating more effective, safer and tolerable treatments. We have generated our clinical product candidates through our Orascovery and Src Kinase Inhibition research platforms, which are based on our understanding of human absorption biology and novel approaches to inhibiting kinase activity, respectively. We believe that our ability to overcome the challenges of oral delivery of chemotherapy and limitations associated with IV delivery, via our P-gp inhibitor, offers significant potential benefits to patient outcomes by allowing patients to stay on therapy longer and extending the potential opportunities to combine with other agents, including targeted therapies and immunotherapies that would otherwise be too toxic in combination with IV chemotherapy. We have assembled a leadership team and have established operations in the U.S. and China across the pharmaceutical value chain to execute our mission to become a global leader in bringing innovative cancer treatments to the market and improve health outcomes.

We have three segments operating in North America and Asia: our Oncology Innovation Platform, our Commercial Platform and our Global Supply Chain Platform. Our Oncology Innovation Platform include two core research and development centers, one in Hong Kong, China and one in the U.S.

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Since inception, we have devoted substantially all of our resources to research and development of our lead product candidates under our Orascovery and Src Kinase Inhibition platforms. We have incurred significant net losses since inception. As of September 30, 2017, we had an accumulated deficit of approximately $298.0 million. Our recurring losses from operations and negative cash flows from operations have raised substantial doubt regarding our ability to continue as a going concern, and as a result, our independent registered public accounting firm has noted this in their opinion on our consolidated financial statements for the year ended December 31, 2016, which was issued prior to our raising $64.2 million of net proceeds in our June 2017 IPO described below. As a result of the acquisitions of Athenex Pharma Solutions in 2014 and Polymed in 2015, we started to generate revenue from those businesses. Our Commercial Platform launched sales of generic injectable products in 2017. Product sales totaled $22.0 million and $14.5 million for the nine months ended September 30, 2017 and 2016, respectively. We expect to continue to incur significant expenses and operating losses for the foreseeable future. We anticipate that our expenses will increase significantly in connection with our ongoing activities, as we:

We have funded our operations to date primarily from the issuance and sale of our common stock and convertible bonds and, to a lesser extent, through revenue generated from our Global Supply Chain Platform and Commercial Platform. Cash used in operations for the nine months ended September 30, 2017 was $63.6 million compared with cash used in operations of $35.2 million for the nine months ended September 30, 2016. As of September 30, 2017, we had cash and cash equivalents of $19.3 million and short-term investments of $49.8 million.

On June 14, 2017, we completed the initial public offering (IPO) of our common stock pursuant to a registration statement on Form S-1. In the IPO, we sold an aggregate of 6,900,000 shares of our common stock, which included 900,000 shares of common stock purchased by the underwriters upon the full exercise of their options to purchase additional common stock, at a price to the public of $11.00 per share. We received aggregate cash proceeds of approximately $64.2 million from the IPO, net of underwriting discounts and commissions and offering expenses. Upon the IPO, convertible bonds with an aggregate principal value of $68.0 million, and a carrying value of $55.8 million, were converted into 7,727,273 shares of common stock. On September 29, 2017, the remaining convertible bond with a principal value of $7.0 million was converted into 795,455 shares of common stock, at a 20% discount from the IPO price of $11 per share.

Key Components of Results of Operations

Revenue

We derive our consolidated revenue primarily from (i) the sales of API and medical devices by our Global Supply Chain Platform; (ii) the sales of generic injectable products by our Commercial Platform; (iii) licensing and collaboration projects conducted by our Oncology Innovation Platform, which generates revenue in the form of upfront payments, milestone payments and payments received for providing research and development services for our collaboration projects and for other third parties; and (iv) grant awards from government agencies and universities for our continuing research and development efforts.

We do not anticipate revenue being generated from sales of our product candidates under development in our Oncology Innovation Platform until we have obtained regulatory approval. We cannot assure you that we will succeed in achieving regulatory approval for our drug candidates as planned, or at all.

Cost of Product Sales

Along with sourcing from third party manufacturers, we manufacture clinical products in our cGMP facility in New York and APIs at our cGMP facility in China. Cost of product sales primarily includes the cost of finished products, raw materials, labor costs, manufacturing overhead expenses and reserves for expected scrap, as well as transportation costs. Cost of product sales also includes depreciation expense for production equipment, amortization of certain licenses, changes to our excess and obsolete inventory reserves, and certain direct costs such as shipping costs, net of costs charged to customers.

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Research and Development Expenses

Research and development expenses consist of the costs associated with in licensing of product candidates, conducting preclinical studies and clinical trials, activities related to regulatory filings and other research and development activities. Our current research and development activities mainly relate to the clinical development of the following programs:

Orascovery platform—Comprised of our in-licensed and novel P-gp inhibitor, HM30181A, that is combined with various chemotherapeutic agents and enables them to be absorbed into the blood when given orally:

Src Kinase Inhibition platform—Targets the tyrosine kinase protein in regulating cell growth that leads to blockade of metastasis:

We expense research and development costs as incurred. We record costs for certain development activities, such as clinical trials, based on an evaluation of the progress to completion of specific tasks using data such as patient enrollment or clinical site activations. We do not allocate employee-related costs, depreciation, rental and other indirect costs to specific research and development programs because these costs are deployed across multiple product programs under research and development.

We cannot determine with certainty the duration, costs and timing of the current or future preclinical or clinical studies of our drug candidates. The duration, costs, and timing of clinical studies and development of our drug candidates will depend on a variety of factors, including:

A change in the outcome of any of these variables with respect to the development of a drug candidate could mean a significant change in the costs and timing associated with the development of that drug candidate.

Research and development activities are central to our business model. We expect our research and development expenses to continue to increase for the foreseeable future as we continue to support the clinical trials of Oraxol, Oratecan, Oradoxel, Oratopo, KX-01 ointment, KX-01 oral and KX-02, as well as initiate and prepare for additional clinical and preclinical studies. We also expect spending to increase in the research and development for API, 503B and specialty products. There are numerous factors associated with the successful commercialization of any of our drug candidates, including future trial design and various regulatory requirements, many of which cannot be determined with accuracy at this time based on our stage of development. Additionally, future commercial and regulatory factors beyond our control will likely impact our clinical development programs and plans.

Selling, General and Administrative Expenses

Selling, general and administrative, or SG&A, expenses primarily consist of compensation, including salary, employee benefits and stock-based compensation expenses for sales and marketing personnel, and for administrative personnel that support our general operations such as executive management, legal counsel, financial accounting, information technology, and human resources personnel. SG&A expenses also includes professional fees for legal, patents, consulting, auditing and tax services, as well as other direct and allocated expenses for rent and maintenance of facilities, insurance and other supplies used in the selling, marketing, general and administrative activities. We expect to incur additional SG&A expenses in connection with our becoming a public company, which may increase further when we are no longer able to rely on the “emerging growth company” exemption pursuant to the JOBS Act.

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We anticipate that our SG&A expenses will increase in future periods to support increases in our research and development and commercialization activities. We expect these increases will likely result in increased headcount, increased share compensation charges, expanded infrastructure and increased costs for insurance. We also anticipate increases to legal, compliance, accounting and investor and public relations expenses associated with being a public company.

Results of Operations

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

The following table sets forth a summary of our condensed consolidated results of operations for the three months ended September 30, 2017 and 2016, together with the changes in those items in dollars and percentage. This information should be read together with our consolidated financial statements and related notes included elsewhere in this document. Our operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

 

Revenue

Revenue for the three months ended September 30, 2017 was $14.0 million, an increase of $8.4 million, or 149%, as compared to $5.6 million for the three months ended September 30, 2016. The increase was primarily attributable to the 2017 launch of specialty products sold through our Commercial Platform, which contributed revenue of $7.4 million during the period. API sales increased by $1.3 million. This was offset by $0.3 million decrease in contract manufacturing revenue.

Cost of Product Sales

Cost of product sales for the three months ended September 30, 2017 totaled $8.1 million, an increase of $2.7 million, or 49%, as compared to $5.4 million for the three months ended September 30, 2016. This was primarily due to the increase of $3.8 million cost of product sales in the recently launched specialty products, offset by the decrease of $1.1 million cost of product sales in the contract manufacturing and API. The increase in gross profit was driven primarily by the sale of Sodium Bicarbonate, of which there was a shortage during the period. Changes in availability of products could increase or decrease our revenue and gross profit in the future.  

Research and Development Expenses

Research and development expenses for the three months ended September 30, 2017 totaled $11.9 million, a decrease of $6.1 million, or 34%, as compared to $18.1 million for the three months ended September 30, 2016. This was primarily due to decreased licensing fees and decreased preclinical program expenses, and included the following:

These decreases were partially offset by a $1.4 million increase related to the research and development of our clinical studies, 503B products and API products.

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Selling, General, and Administrative Expenses

Selling, general and administrative expenses for the three months ended September 30, 2017, totaled $10.4 million, an increase of $3.6 million, or 53%, as compared to $6.8 million for the three months ended September 30, 2016. This was primarily due to the establishment of our Commercial Platform in the third quarter of 2016, as well as additional costs associated with being a public company beginning in June 2017, and included the following:

Interest Expenses

Interest expense for the three months ended September 30, 2017 totaled $0.4 million, an increase of $0.3 million as compared to $0.1 million for the three months ended September 30, 2016. The increase was due to the interest incurred on convertible bonds we issued between the third quarter of 2016 and the second quarter of 2017, which had all been converted into common stock as of September 30, 2017.

Loss on Derivative Liability

Loss on derivative liability for the three months ended September 30, 2017 increased by $6.5 million. This increase was due to the increase in our stock price changing the fair value of the derivatives embedded within the convertible bonds we issued between the third quarter of 2016 and the second quarter of 2017.  

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

The following table sets forth a summary of our condensed consolidated results of operations for the nine months ended September 30, 2017 and 2016, together with the changes in those items in dollars and percentage. This information should be read together with our consolidated financial statements and related notes included elsewhere in this document. Our operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

 

Revenue

Revenue for the nine months ended September 30, 2017 was $23.2 million, an increase of $7.7 million, or 50%, as compared to $15.4 million for the nine months ended September 30, 2016. The increase was primarily attributable to the launch of 11 specialty products sold through our Commercial Platform since March 2017, which contributed $9.3 million of the revenue increase in the current year. Revenue from licensing fees and proprietary products sales increased by $0.5 million and $0.2 million, respectively. These were offset by the decreases of $1.4 million in API sales, $0.4 million in medical devices sales, $0.3 million in contract manufacturing revenue and $0.2 million in grant revenue.

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Cost of Product Sales

Cost of product sales totaled $15.1 million for the nine months ended September 30, 2017, an increase of $0.7 million, or 5%, from the nine months ended September 30, 2016. The launch of our specialty products from the Commercial Platform in 2017 resulted in an increase of $5.1 million cost of product sales, offset by a $4.4 million decrease in API, medical device and contract manufacturing cost of product sales. The increase in gross profit was driven primarily by the sale of Sodium Bicarbonate, of which there was a shortage in the third quarter of 2017.

Research and Development Expenses

Our research and development expenses increased by $22.5 million, or 67%, to $55.9 million for the nine months ended September 30, 2017 from $33.4 million for the nine months ended September 30, 2016, primarily due to the increased costs of drug licensing fees and the advancement of our clinical pipeline, and included the following:

These increases were partially offset by a $3.5 million decrease in compensation expenses due to a shift in focus of certain personnel to supporting selling, general and administrative functions and a $2.1 million decrease in the preclinical study costs as our proprietary drugs entered the clinical stages.

Selling, General, and Administrative Expenses

Our selling, general and administrative expenses increased by $18.1 million, or 115%, from $15.7 million for the nine months ended September 30, 2016 to $33.8 million for the nine months ended September 30, 2017 primarily due to an increase in employee compensation, and included the following:

 

Interest Expenses

Interest expenses increased by $6.0 million for the nine months ended September 30, 2017. This was primarily due to the interest incurred on the convertible bonds issued between the third quarter of 2016 and the second quarter of 2017, which had all been converted into common stock as of September 30, 2017.

Loss on Derivative Liability

Loss on derivative liability increased by $15.4 for the nine months ended September 30, 2017. This was primarily due to the increase in our stock price changing the fair value of the derivatives embedded within the convertible bonds we issued between the third quarter of 2016 and the second quarter of 2017.

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Liquidity and Capital Resources

Capital Resources

Since our inception, we have incurred net losses and negative cash flows from our operations. Substantially all of our losses have resulted from funding our research and development programs and selling, general and administrative costs associated with our operations. We incurred net losses of $103.0 million and $47.8 million for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, we had an accumulated deficit of $298.0 million. Our primary use of cash is to fund research and development costs. Our operating activities used $63.6 million and $35.2 million of cash during the nine months ended September 30, 2017 and 2016, respectively. Our principal sources of liquidity as of September 30, 2017 were cash and cash equivalents totaling of $19.3 million and short-term investments totaling $49.8 million, which are generally U.S. government or high quality investment grade corporate debt securities.

Pursuant to our IPO in June 2017, the Company sold an aggregate of 6,900,000 shares of its common stock at a price of $11.00 per share for cash proceeds of $64.2 million, net of underwriting discounts and commissions of $6.1 million and offering costs of $5.6 million.

 

Based on our current operating plan, we expect that our existing cash, cash equivalents and short-term investments as of September 30, 2017, will enable us to fund our operating expenses and capital expenditures requirements through March 2018. We expect that our expenses will increase substantially as we continue to fund clinical development of our Orascovery and Src Kinase Inhibition research programs, fund new and ongoing research and development activities and working capital and other general corporate purposes. We have based our estimates on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect. Because of the numerous risks and uncertainties associated with the development and commercialization of our drug candidates, we are unable to accurately estimate the amounts of increased capital outlays and operating expenditures necessary to complete the development and commercialization of our drug candidates.

 

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed elsewhere in this “Risk Factors” section.

Our future capital requirements will depend on many factors, including:

Until such time, if ever, as we can generate substantial product revenue, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements and government grants. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our shareholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect rights of holders of common stock. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends and may require the issuance of warrants, which could potentially dilute the ownership interest of holders of common stock. If we raise additional funds through collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams or research programs or to grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts or grant rights to develop and market products or drug candidates that we would otherwise prefer to develop and market ourselves.

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We believe that the existing cash and cash equivalents and short term investments will not be sufficient to enable us to complete all necessary development or commercially launch our proprietary drug candidates. If we are unable to raise capital when needed or on attractive terms, we will be forced to delay, reduce or eliminate our research and development programs or future commercialization efforts. Our inability to obtain additional funding when needed could seriously harm our business.

 

Cash Flows

The following table provides information regarding our cash flows for the nine months ended September 30, 2017 and 2016:

 

 

Net Cash Used in Operating Activities

The use of cash was primarily resulted from our net loss adjusted for non-cash charges and changes in components of working capital. The primary use of our cash in the periods presented was to fund our research and development, regulatory and other clinical trial costs, drug licensing costs, inventory purchase, and other expenditures related to sales, marketing and administration.

Net cash used in operating activities was $63.6 million for the nine months ended September 30, 2017. This resulted principally from our net loss of $103.0 million, adjusted for non-cash charges of $49.7 million, and by cash used in our operating assets and liabilities of $10.3 million. Our net non-cash charges during the nine months ended September 30, 2017 primarily consisted of $15.4 million of fair value change in derivative liabilities, $13.3 million of licensing fees settled by bonds and equity, $11.7 million of stock-based compensation expense, $3.7 million of convertible bonds interest, $3.3 million amortization of debt discount, and $2.6 million depreciation and amortization expense.

Net cash used in operating activities was $35.1 million for the nine months ended September 30, 2016. The resulted principally from our net loss of $47.8 million, adjusted for non-cash charges of $12.1 million, and by cash provided from our operating assets and liabilities of $0.5 million. Our non-cash charges during the nine months ended September 30, 2016 primarily consisted of $10.0 million of stock-based compensation expense.

Net Cash Used in Investing Activities

Net cash used in investing activities was $47.0 million for the nine months ended September 30, 2017, compared to $2.2 million used in investing activities for the nine months ended September 30, 2016. The increased use in cash from investing activities was primarily due to cash used in purchasing short-term investments, including commercial paper, corporate notes, and U.S. government bonds.

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $96.1 million for the nine months ended September 30, 2017, including $75.9 million from the issuance of common stock, which resulted in net proceeds of $65.7 million from the IPO due to $6.1 million of underwriting discounts and commissions and $4.1 million of certain offering costs, and $30.0 million from the issuance of convertible bonds, compared with $37.6 million for the nine months ended September 30, 2016, which included $35.0 million from the issuance of convertible bonds, $8.5 million from the issuance of common stock, offset by $3.1 million payment of contingent consideration and $2.3 million purchase of treasury stock.

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Contractual Obligations

A summary of our contractual obligations as of September 30, 2017 is as follows:

 

 

The operating leases include (1) the rental of our global headquarters in the Conventus Center for Collaborative Medicine in Buffalo, NY, (2) the rental of our research and development facility in the Integrated Circuit Development Centre in Hong Kong, (3) the rental of the Commercial Platform headquarters in Chicago, IL, and (4) the rental of our clinical research and development facility in Cranford, NJ. Of the total amounts committed, $9.4 million are committed for the rental of our Buffalo, NY global headquarters, $0.2 million are committed for our Hong Kong research and development facility, $2.6 million are committed for our Commercial Platform headquarters in Schaumburg, IL, and  $0.5 million are committed for our research and development center in New Jersey. The above amounts do not include the interest that will be incurred on our debt.

Off Balance Sheet Arrangements

We do not maintain any off balance sheet partnerships, arrangements, or other relationships with unconsolidated entities or others, often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Significant Judgments and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenue and expenses during the periods. We evaluate our estimates and judgments on an ongoing basis, including but not limited to, estimating the useful lives of long-lived assets, assessing the impairment of long-lived assets, stock-based compensation expenses, and the realizability of deferred income tax assets. We base our estimates on historical experience, known trends and events, contractual milestones and other various factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Changes in the accounting estimates are likely to occur from period to period. Actual results could be significantly different from these estimates. There have been no significant changes in our critical accounting policies and estimates as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Operations included in our prospectus filed on June 15, 2017 with the SEC, except for the determination of the fair value of our common stock, which was used in estimating the fair value of stock-based awards at grant date. Prior to IPO, our stock was not publicly traded, therefore we estimated the fair value of our common stock as discussed in the prospectus. Following our IPO, we established a policy, using the closing sale price per share of our common stock as quoted on the NASDAQ Global Market on the date of grant for purposes of determining the exercise price per share of our share-based awards to purchase common stock.

Recent Accounting Pronouncements

In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission, or other authoritative accounting bodies to determine the potential impact they may have on our condensed consolidated financial statements. See Note 2 of the Notes to Condensed Consolidated Financial Statements contained in Item 1 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations.

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JOBS Act

Under Section 107(b) of the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, an “emerging growth company” can delay the adoption of new or revised accounting standards until such time as those standards would apply to private companies. We have irrevocably elected not to avail ourselves of this exemption and, as a result, we will adopt new or revised accounting standards at the same time as other public companies that are not emerging growth companies. There are other exemptions and reduced reporting requirements provided by the JOBS Act that we are currently evaluating. For example, as an emerging growth company, we are exempt from Sections 14A(a) and (b) of the Exchange Act which would otherwise require us to (1) submit certain executive compensation matters to shareholder advisory votes, such as “say-on-pay,” “say-on-frequency” and “say-on-golden parachutes;” and (2) disclose certain executive compensation related matters. We also rely on an exemption from the rule requiring us to provide an auditor’s attestation report on our internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and the rule requiring us to 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, known as the auditor discussion and analysis. We will continue to remain an “emerging growth company” until the earliest of the following: (1) the last day of the fiscal year following the fifth anniversary of the date of the completion of our initial public offering, (2) the last day of the fiscal year in which our total annual gross revenue is equal to or more than $1 billion, (3) the date on which we have issued more than $1 billion in nonconvertible debt during the previous three years, or (4) the date on which we are deemed to be a large accelerated filer under the rules of the SEC.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Foreign Currency Exchange Risk

A significant portion of our business is located outside the United States and, as a result, we generate revenue and incur expenses denominated in currencies other than the U.S. dollar, a majority of which is denominated in Renminbi, or RMB. In the nine months ended September 30, 2017 and 2016, approximately 5% and 6%, respectively, of our sales, excluding intercompany sales, were denominated in foreign currencies. As a result, our revenue can be significantly impacted by fluctuations in foreign currency exchange rates. We expect that foreign currencies will represent a lower percentage of our sales in the future due to the anticipated growth of our U.S. business. Our international selling, marketing, and administrative costs related to these sales are largely denominated in the same foreign currencies, which somewhat mitigates our foreign currency exchange risk rate exposure.

Currency Convertibility Risk

A portion of our revenues and expenses, and a portion of our assets and liabilities are denominated in RMB. On January 1, 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted daily by the People’s Bank of China, or PBOC. However, the unification of exchange rates does not imply that the RMB may be readily convertible into U.S. dollars or other foreign currencies. All foreign exchange transactions continue to take place either through the PBOC or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the PBOC. Approvals of foreign currency payments by the PBOC or other institutions require submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.

Additionally, the value of the RMB is subject to changes in central government policies and international economic and political developments affecting supply and demand in the PRC foreign exchange trading system market.

Interest Rate Sensitivity

We had cash and cash equivalents of $19.3 million as of September 30, 2017, which consisted primarily of bank deposits and money market funds. In addition, we also had short term investments of $49.8 million as of September 30, 2017. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates. However, because of the short-term nature of the instruments in our portfolio, a sudden change in market interest rates would not be expected to have a material impact on our condensed consolidated financial condition or results of operations. We do not believe that our cash or cash equivalents have significant risk of default or illiquidity.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2017. The term “disclosure controls and procedures,” as defined in Rule 13a15(e) under the Exchange Act means controls and other procedures of a company that are designed to ensure that

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information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well-designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2017, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a15(d) and 15d15( d) of the Exchange Act that occurred during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, results of operations, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

Item 1A. Risk Factors.

There have been no material changes to the risk factors set forth in our Quarterly Report on Form 10-Q filed for the quarter ended June 30, 2017.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Unregistered Sales of Equity Securities

On September 29, 2017, we issued 795,455 shares of common stock through the conversion of our convertible bond with a principal value of $7.0 million. These transactions were exempt from the registration requirements of the Securities act in reliance upon Section 4(a)(2) of the Securities Act.

Use of Proceeds

On June 13, 2017, our Registration Statement on Form S-1(File no.333-217928) relating to the IPO of our common stock was declared effective by the SEC.

There has been no material change in the expected use of the net proceeds from our IPO, as described in our final prospectus filed with the SEC on June 15, 2017 pursuant to Rule 424(b)

Item 3. Defaults upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable

Item 5. Other Information.

Not applicable

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Item 6. Exhibits.

The exhibits filed or furnished as part of this Quarterly Report on Form 10Q are set forth below.

 

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on  its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

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