ENANTA PHARMACEUTICALS INC - Quarter Report: 2017 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended December 31, 2017

OR

Commission File Number 001-35839

ENANTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

500 Arsenal Street

Watertown, Massachusetts 02472

(617) 607-0800

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

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.

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 February 1, 2018, the registrant had 19,160,667 shares of common stock, $0.01 par value per share, outstanding.

ENANTA PHARMACEUTICALS, INC.

FORM 10-Q — Quarterly Report

For the Quarterly Period Ended December 31, 2017

TABLE OF CONTENTS

NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, or Form 10-Q, contains forward-looking statements concerning our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business operations and financial performance and condition. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “potential,” “positioned,” “seek,” “should,” “target,” “will,” “would,” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements about overall trends, royalty revenue trends, research and clinical development plans, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends and similar expressions. These forward-looking statements are based on our management’s current expectations, estimates, forecasts and projections about our business and the industry in which we operate and our management’s beliefs and assumptions. These forward-looking statements are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. As a result, any or all of our forward-looking statements in this Form 10-Q may turn out to be inaccurate. Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” and discussed elsewhere in this Form 10-Q. These forward-looking statements speak only as of the date of this Form 10-Q. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future. You should, however, review the factors and risks we describe in the reports we will file from time to time with the Securities and Exchange Commission (SEC) after the date of this Form 10-Q.

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PART I—FINANCIAL INFORMATION

ENANTA PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands, except per share amounts)

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

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ENANTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share amounts)

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

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ENANTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited)

(in thousands)

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

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ENANTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

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

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ENANTA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(Amounts in thousands, except per share data)

Enanta Pharmaceuticals, Inc. (the “Company”), incorporated in Delaware in 1995, is a biotechnology company that uses its robust, chemistry-driven approach and drug discovery capabilities to create small molecule drugs primarily for the treatment of viral infections and liver diseases. The Company discovered glecaprevir, the second of two protease inhibitors discovered and developed through its collaboration with AbbVie and marketed as part of AbbVie’s new direct-acting antiviral (DAA) regimen under the tradenames MAVYRET™ (U.S.) or MAVIRET™ (ex-U.S.) (glecaprevir/pibrentasvir) for the treatment of chronic hepatitis C virus, or HCV. The other protease inhibitor under its HCV collaboration is part of AbbVie’s initial DAA regimens for the treatment of chronic HCV marketed under the tradenames VIEKIRA PAK^® (paritaprevir/ritonavir/ombitasvir/dasabuvir) (U.S.) or VIEKIRAX^®(paritaprevir/ritonavir/ombitasvir) (ex-U.S.). Royalties from the Company’s AbbVie collaboration and its existing financial resources provide funding to support its wholly owned research and development efforts, which are currently focused on the following disease targets: non-alcoholic steatohepatitis (“NASH”); primary biliary cholangitis (“PBC”); respiratory syncytial virus (“RSV”) and hepatitis B virus (“HBV”).

The Company is subject to risks common to companies in the biotechnology industry including, but not limited to, the uncertainties of research and development, competition from technological innovations of others, dependence on collaborative arrangements, protection of proprietary technology, dependence on key personnel and compliance with government regulations and the need to obtain additional financing. Product candidates currently under development will require significant additional research and development efforts, including extensive preclinical and clinical testing and regulatory approvals, prior to commercialization. These efforts require significant amounts of capital, adequate personnel infrastructure, and extensive compliance reporting capabilities.

Unaudited Interim Financial Information

The consolidated balance sheet at September 30, 2017 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). The accompanying unaudited consolidated financial statements as of December 31, 2017 and for the three months ended December 31, 2017 and 2016 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017.

In the opinion of management, all adjustments, consisting of normal recurring adjustments necessary for a fair statement of the Company’s financial position as of December 31, 2017 and results of operations for the three months ended December 31, 2017 and 2016 and cash flows for the three months ended December 31, 2017 and 2016, have been made. The results of operations for the three months ended December 31, 2017 are not necessarily indicative of the results of operations that may be expected for subsequent quarters or the year ending September 30, 2018.

The accompanying consolidated financial statements have been prepared in conformity with GAAP. All dollar amounts in the consolidated financial statements and in the notes to the consolidated financial statements, except per share amounts, are in thousands unless otherwise indicated.

For the Company’s Significant Accounting Policies, please refer to its Annual Report on Form 10-K for the fiscal year ended September 30, 2017. Other than the adoption of ASU 2016-09 as of October 1, 2017, there were no other significant changes to the Company’s Significant Accounting Policies during the quarter.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the

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consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions reflected in these consolidated financial statements include, but are not limited to, management’s judgments of separate units of accounting and best estimate of selling price of those units of accounting within its revenue arrangements; valuation of stock-based awards; and the accounting for income taxes, including uncertain tax positions and the valuation of net deferred tax assets. Estimates are periodically reviewed in light of changes in circumstances, facts and experience. Actual results could differ from the Company’s estimates.

Recently Issued Accounting Pronouncements

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which intends to simplify several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, a choice to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. This amendment is effective for the Company in the fiscal year beginning October 1, 2017. As a result of the adoption this quarter, the Company changed its forfeiture rate policy to recognize forfeitures as they occur. Upon adoption, the cumulative impact of this change in policy on retained earnings and deferred tax assets in the consolidated balance sheet was not material. In addition, the consolidated statements of cash flows will present excess tax benefits, if any, as part of cash flows from operating activities. The Company elected to adopt this change on a prospective basis and, therefore, excess tax benefits from prior periods in the statement of cash flow were not restated. The adoption of the standard is also expected to create variability in the consolidated statements of operations in years in which the Company is expected to have taxable income, as the tax consequences of settled share-based payments will be recognized in income tax expense when share-based payment awards are settled.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”) which supersedes all existing revenue recognition requirements, including most industry-specific guidance. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The FASB has continued to issue accounting standards updates to clarify and provide implementation guidance related to Revenue from Contracts with Customers, including ASU 2016-08, Revenue from Contract with Customers: Principal versus Agent Considerations, ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, and ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients. These amendments address a number of areas, including an entity’s identification of its performance obligations in a contract, collectibility, non-cash consideration, presentation of sales tax and an entity’s evaluation of the nature of its promise to grant a license of intellectual property and whether or not that revenue is recognized over time or at a point in time. The new guidance must be adopted using either a modified retrospective approach or a full retrospective approach for all periods presented. Under the modified retrospective method, the cumulative effect of applying the new standard would be recognized at the adoption date in retained earnings on the consolidated balance sheet. Under the full retrospective approach, the new standard would be applied to each prior reporting period presented. These new standards will be effective for the Company beginning October 1, 2018. Currently, the Company has only one revenue-generating contract – the AbbVie Agreement. The Company has completed its substantial performance obligations under the contract and is eligible to earn annually tiered per-product royalties on the portion of AbbVie’s net sales of HCV regimens allocable to the protease inhibitor in the regimen. The Company is in process of determining the method of adoption but under either method, the impact of adoption is not expected to have a material impact on the Company’s consolidated financial statements as presently, the AbbVie Agreement is the only revenue-generating arrangement outstanding, and all performance obligations under the agreement have been achieved.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”) that changes the presentation of restricted cash and cash equivalents on the statement of cash flows. Restricted cash and restricted cash equivalents will 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 amendment is effective for the Company in the fiscal year beginning October 1, 2018, but early adoption is permissible. Upon adoption, the Company will adjust the presentation of the statement of cash flows to include restricted cash related to an outstanding letter of credit collateralized by a money market fund of $608 so that it is included in the beginning balance of cash and cash equivalents.

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718) (“ASU 2017-09”) which provides updated guidance about changes to the terms or conditions of a share-based payment award that requires companies to apply modification accounting under Topic 718. This amendment is effective for the Company in the fiscal year beginning October 1, 2018, but early adoption is permissible. The Company does not expect the adoption of ASU 2017-09 to have a material impact on its consolidated financial statements.

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In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”), which will replace the existing guidance in ASC 840, “Leases.” The updated standard aims to increase transparency and comparability among organizations by requiring lessees to recognize leased assets and leased liabilities on the consolidated balance sheets and requiring disclosure of key information about leasing arrangements. This amendment is effective for the Company in the fiscal year beginning October 1, 2019, but early adoption is permissible. The Company is currently evaluating the potential impact that ASU 2016-02 may have on its financial position and results of operations.

In March 2017, the FASB issued ASU No. 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”) which requires companies to amend the amortization period for premiums on debt securities with explicit call features to be the earliest call date rather than through the contractual life of the debt instrument. This amendment aims to more closely align the recognition of interest income with the manner in which market participants price such instruments. This amendment is effective for the Company in the fiscal year beginning October 1, 2019, but early adoption is permissible. The Company is currently evaluating the potential impact that ASU 2017-08 may have on its financial position and results of operations.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (“ASU 2016-13”), which introduces a new methodology for accounting for credit losses on financial instruments, including available-for-sale debt securities. The guidance establishes a new “expected loss model” that requires entities to estimate current expected credit losses on financial instruments by using all practical and relevant information. Any expected credit losses are to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. This amendment is effective for the Company in the fiscal year beginning October 1, 2020. The Company is currently evaluating the potential impact that ASU 2016-13 may have on its financial position and results of operations.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

The following tables present information about the Company’s financial assets and liabilities that were subject to fair value measurement on a recurring basis as of December 31, 2017 and September 30, 2017 and indicate the fair value hierarchy of the valuation inputs utilized to determine such fair value:

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During the three months ended December 31, 2017 and 2016, there were no transfers between Level 1, Level 2 and Level 3.

As of September 30, 2017, the Company’s warrant liability was comprised of the value of warrants for the purchase of its Series 1 nonconvertible preferred stock. These warrants were financial instruments that might have required a transfer of assets because of the liquidation features and were therefore recorded as liabilities and measured at fair value. These warrants expired on October 4, 2017, and are therefore no longer outstanding. The outstanding shares of Series 1 nonconvertible preferred stock are also measured at fair value. The fair value of these instruments was based on significant inputs not observable in the market, which represented a Level 3 measurement within the fair value hierarchy. The Company utilized a probability-weighted valuation model which takes into consideration various outcomes that may require the Company to transfer assets upon exercise. Changes in the fair value of the warrant liability and Series 1 nonconvertible preferred stock are recognized in other income (expense), net in the consolidated statements of operations.

The recurring Level 3 fair value measurements of the Company’s outstanding warrant liability and Series 1 nonconvertible preferred stock using probability-weighted discounted cash flow include the following significant unobservable inputs:

The following table provides a rollforward of the aggregate fair values of the Company’s warrants for the purchase of Series 1 nonconvertible preferred stock and the outstanding Series 1 nonconvertible preferred stock for which fair value is determined by Level 3 inputs:

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As of December 31, 2017 and September 30, 2017, the fair value of available-for-sale marketable securities, by type of security, was as follows:

As of December 31, 2017, marketable securities consisted of short-term marketable securities, which are investments that mature within one year, and long-term marketable securities, with an aggregate fair value of $77,047, which consist of certain U.S. Treasury notes and corporate bonds that have maturities of more than one year but not more than three years.

Accrued expenses and other current liabilities as well as other long-term liabilities consisted of the following as of December 31, 2017 and September 30, 2017:

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AbbVie Collaboration

The Company has a Collaborative Development and License Agreement (as amended, the “AbbVie Agreement”), with AbbVie to identify, develop and commercialize HCV NS3 and NS3/4A protease inhibitor compounds, including paritaprevir and glecaprevir, under which the Company has received license payments, proceeds from a sale of preferred stock, research funding payments, milestone payments and royalties totaling approximately $525,000 through December 31, 2017. Since the Company completed all its performance obligations under the AbbVie Agreement by the end of fiscal 2011, all milestone payments received since then have been recognized as revenue when the milestones were achieved by AbbVie.

The Company is also receiving annually tiered royalties per Company protease product ranging from the low double digits up to twenty percent, or on a blended basis from the low double digits up to the high teens, on the portion of AbbVie’s calendar year net sales of each HCV regimen that is allocated to the protease inhibitor in the regimen. Beginning with each January 1, the cumulative net sales of a given royalty-bearing protease inhibitor product start at zero for purposes of calculating the tiered royalties on a product-by-product basis.

During the three months ended December 31, 2017, the Company earned and recognized milestone revenue of $15,000 upon AbbVie’s achievement of commercialization regulatory approval in Japan for MAVIRET™.

In October and November 2010, the Company issued warrants to purchase up to a total of 2,000 shares of Series 1 nonconvertible preferred stock. As these warrants were financial instruments that might have required the Company to transfer assets, these instruments are classified as liabilities. The following table summarizes the activity of the warrants to purchase Series 1 nonconvertible preferred stock:

As of December 31, 2017, 1,931 shares of Series 1 nonconvertible preferred stock were issued and outstanding. As this preferred stock may require the Company to transfer a fixed amount of assets, these shares are classified as liabilities.

The Company has granted stock-based awards, including stock options, restricted stock units, and performance share units, under its existing 2012 Equity Incentive Plan (the “2012 Plan”). The Company also has outstanding stock-based awards under its 1995 Equity Incentive Plan (the “1995 Plan”), but is no longer granting awards under this plan.

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The following table summarizes stock option activity, including performance-based options, for the year-to-date period ending December 31, 2017:

Market and Performance-Based Stock Unit Awards

The Company awards both performance share units, or PSUs, and relative total stockholder return units, or rTSRUs, to its executive officers. The number of units represents the target number of shares of common stock that may be earned; however, the actual number of shares that may be earned ranges from 0% to 200% of the target number. The following table summarizes PSU and rTSRU activity for the year-to-date period ending December 31, 2017:

Restricted Stock Units

During the three months ended December 31, 2016, the Company awarded restricted stock units to its employees, which vest 50% in three years and 50% in four years, provided the employee remains employed with the Company at the time of vesting. The fair value of these awards is determined based on the intrinsic value of the stock on the date of grant and will be recognized as stock-based compensation expense over the requisite service period. The following table summarizes the restricted stock unit activity for the year-to-date period ending December 31, 2017:

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Stock-Based Compensation Expense

During the three months ended December 31, 2017 and 2016, the Company recognized the following stock-based compensation expense:

During the three months ended December 31, 2017 and 2016, the Company recognized stock-based compensation expense for PSUs and performance-based options upon achievement of performance-based targets that occurred during their respective periods.

As discussed in Note 2, the Company adopted ASU 2016-09 during the three months ended December 31, 2017. ASU 2016-09 intends to simplify several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, a choice to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. As a result of the adoption, the Company changed its forfeiture rate policy to recognize forfeitures as they occur. Upon adoption, the cumulative impact of this change in policy on retained earnings and deferred tax assets in the consolidated balance sheet was not material. In addition, the consolidated statements of cash flows will present excess tax benefits, if any, as part of cash flows from operating activities. The Company elected to adopt this change on a prospective basis and, therefore, excess tax benefits from prior periods in the statement of cash flow were not retroactively restated. The adoption of the standard is also expected to create variability in the consolidated statements of operations in years in which the Company is expected to have taxable income, as the tax consequences of settled share-based payments will be recognized in income tax expense when share-based payment awards are settled.

As of December 31, 2017, the Company had an aggregate of $32,132 of unrecognized stock-based compensation cost, which is expected to be recognized over a weighted average period of 2.7 years.

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Basic and diluted net income (loss) per share attributable to common stockholders was calculated as follows for three months ended December 31, 2017 and 2016 (in thousands, except per share data):

The impact of certain common stock equivalents was excluded from the computation of diluted net loss per share for the periods in which the Company was in a net loss position since the impact of such common stock equivalents would have been anti-dilutive.

For the three months ended December 31, 2017 and 2016, the Company recorded an income tax (expense) benefit of $(3,644) and $1,542, respectively, which was attributable to the Company’s domestic operations. During the three months ended December 31, 2017, income tax expense included a revaluation adjustment against deferred tax assets of $(3,859) due to a decrease in the federal corporate income tax rate as enacted under the U.S. Tax Cuts and Jobs Act (the “Tax Act”). The Company also recorded an income tax benefit of $215 during the three months ended December 31, 2017, primarily related to excess tax benefits for stock option activity which is now recorded in income tax expense (benefit) due to the adoption of ASU 2016-09 during the three months ended December 31, 2017.  

Estimates used to prepare our income tax expense are based on the Company’s initial analysis of the Tax Act enacted in December 2017. Given the complexity of the act, anticipated guidance from the U. S. Treasury regarding implementation of the act, and potential for additional guidance from the SEC and the Financial Accounting Standards Board related to the act, these estimates may be adjusted during fiscal 2018 to reflect any such guidance provided.

During the three months ended December 31, 2016, the Company recorded an income tax benefit due to the Company’s loss before income taxes for the quarter as well as federal research and development tax credits which reduced taxes payable and were reflected in the Company’s annual effective tax rate.

The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal and state jurisdictions, where applicable. The Company’s tax years are still open under statute from 2013 to the present. Earlier years may be examined to the extent that tax credit or net operating loss carryforwards are used in future periods. The Company is currently under examination by the Internal Revenue Service for the year ending September 30, 2016. No adjustments have been proposed to date. The Company has not received notice of examination by any other jurisdictions for any other tax year open under statute.

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The Company had an unrecognized tax benefit of $1,188 and $1,175 as of December 31, 2017 and September 30, 2017, respectively. Unrecognized tax benefits represent tax positions for which reserves have been established. The Company’s policy is to record interest and penalties related to uncertain tax positions as part of its income tax provision.

Leases

The Company has an office and laboratory lease that expires in September 2022. Payment escalation as specified in the lease agreement is accrued such that rent expense is recognized on a straight-line basis over the term of occupancy. The Company recorded rent expense of $506 for both the three months ended December 31, 2017 and 2016.

In connection with the lease, the Company has outstanding a $608 letter of credit, collateralized by a money market account. As of December 31, 2017 and September 30, 2017, the Company classified the $608 related to the letter of credit as restricted cash. Additionally, the lease, as amended, included a $598 tenant improvement allowance from the landlord, which is accounted for as a capital lease obligation.

Litigation and Contingencies Related to Use of Intellectual Property

From time to time, the Company may become subject to legal proceedings, claims and litigation arising in the ordinary course of business. The Company currently is not a party to any threatened or pending litigation. However, third parties might allege that the Company or its collaborators are infringing their patent rights or that the Company is otherwise violating their intellectual property rights. Such third parties may resort to litigation against the Company or its collaborators, which the Company has agreed to indemnify. With respect to some of these patents, the Company expects that it could be required to obtain licenses and could be required to pay license fees or royalties, or both. These licenses may not be available on acceptable terms, or at all. A costly license, or inability to obtain a necessary license, would have a material adverse effect on the Company’s financial condition, results of operations or cash flows. The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

Indemnification Agreements

In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters including, but not limited to, losses arising out of breach of such agreements or from services to be provided to the Company, or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with members of its board of directors and its executive officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is, in many cases, unlimited. To date, the Company has not incurred any material costs as a result of such indemnifications. In addition, the Company maintains officers and directors insurance coverage. The Company does not believe that the outcome of any claims under indemnification arrangements will have a material effect on its financial position, results of operations or cash flows, and it has not accrued any liabilities related to such obligations in its financial statements as of December 31, 2017.

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto for our fiscal year ended September 30, 2017 included in our Annual Report on Form 10-K for that fiscal year which is referred to as our 2017 Form 10-K. Please refer to our note regarding forward-looking statements on page 2 of this Form 10-Q, which is incorporated herein by this reference.

The Enanta name and logo are our trademarks. This Quarterly Report also includes trademarks, trade names and service marks of other persons. All other trademarks, trade names and service marks appearing in this Quarterly Report are the property of their respective owners.

Overview

We are a biotechnology company that uses our robust, chemistry-driven approach and drug discovery capabilities to create small molecule drugs primarily for the treatment of viral infections and liver diseases. We discovered glecaprevir, the second of two protease inhibitors discovered and developed through our collaboration with AbbVie and marketed as part of AbbVie’s new direct-acting antiviral (DAA) regimen under the tradenames MAVYRET™ (U.S.) or MAVIRET™ (ex-U.S.) (glecaprevir/pibrentasvir) for the treatment of chronic hepatitis C virus, or HCV. The other protease inhibitor under our HCV collaboration is part of AbbVie’s initial DAA regimens for the treatment of chronic HCV marketed under the tradenames VIEKIRA PAK^® (paritaprevir/ritonavir/

ombitasvir/dasabuvir) (U.S.) or VIEKIRAX^® (paritaprevir/ritonavir/ombitasvir) (ex-U.S.). Our royalties from our AbbVie collaboration and our existing financial resources provide us funding to support our wholly owned research and development efforts, which are currently focused on the following disease targets:

We had $297.5 million in cash and marketable securities at December 31, 2017. In the first quarter of our fiscal year 2018, we earned $23.1 million in royalties on the portion of AbbVie’s net sales of its HCV regimens allocated to glecaprevir or paritaprevir and earned our remaining $15.0 million milestone under our collaboration with AbbVie as a result of commercialization regulatory approval of MAVIRET™ in Japan. We expect our existing financial resources and cash flows will allow us to continue to fund our wholly owned research and development programs for the foreseeable future.

Our Wholly Owned Programs

Our wholly owned research and development programs are in liver disease (non-virology), namely NASH and PBC, and in virology, namely RSV and HBV:

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We have utilized our internal chemistry and drug discovery capabilities to generate all of our development-stage programs.

Licensed Products

Through our Collaborative Development and License Agreement with AbbVie, we have developed and licensed to AbbVie two protease inhibitor compounds that have been clinically tested, manufactured, and commercialized by AbbVie. To date, we have earned a total of $330.0 million in milestone payments related to clinical development and commercialization regulatory approvals of these regimens in major markets:

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Our economics from AbbVie’s MAVYRET/MAVIRET consist of two components:

The U.S., EU and Japan authorizations for the MAVYRET/MAVIRET combination of glecaprevir and pibrentasvir, and AbbVie’s applications for approval of MAVYRET/MAVIRET in other jurisdictions, are supported by the following studies:

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The following table summarizes our product development pipeline in our liver disease and virology programs: 

Financial Operations Overview

We are currently funding all research and development for our wholly owned programs. We expect to incur substantially greater expenses as we continue to advance our FXR agonist program for NASH and PBC. We have completed a Phase 1 study and initiated a Phase 2 study in PBC patients in calendar 2017 and have recently initiated recruitment of a Phase 2 study in NASH patients. We also initiated a Phase 1 clinical study of our lead RSV candidate, EDP-938, in the fourth quarter of calendar 2017 and plan to initiate a Phase 2a challenge study in RSV in the second half of 2018. We expect to increase expenses in fiscal 2018 as we conduct these clinical studies and advance other compounds into substantial preclinical development.

Since going public in 2013, we have devoted substantially all of our resources to the discovery and development of novel compounds for the treatment of viral infections and liver diseases. For the periods included in this report we have funded our operations primarily through payments received under our collaboration agreement with AbbVie. Our revenue in the near term will continue to be dependent on our royalty payments from our collaboration with AbbVie.

For its new MAVYRET/MAVIRET regimen, which in the majority of chronic HCV patients only requires 8 weeks of treatment compared to 12 weeks with VIEKIRA PAK, AbbVie has initially set a lower list price compared to its original HCV regimens and

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other HCV products on the market. As MAVYRET/MAVIRET replaces AbbVie’s paritaprevir-containing regimens over the next several quarters, AbbVie is seeking to increase its HCV market share through this pricing and the favorable treatment characteristics of the new regimen. It is still too early to know how successful AbbVie’s efforts will be.

Revenue

Since our inception, our revenue has been derived from two primary sources: collaboration agreements with pharmaceutical companies and one government research and development contract. We have entered into three significant collaboration agreements and contracts since 2006, the most significant of which is our continuing collaboration agreement with AbbVie.

Beginning in our fiscal year ended September 30, 2015, we have generated royalty revenue from AbbVie’s net sales allocable to our protease inhibitors, including paritaprevir, which is part of AbbVie’s initial treatment regimens for HCV approved in the U.S. in December 2014 and in the EU and dozens of other countries since then. During the quarter ended September 30, 2017, AbbVie received approvals of its new HCV regimen containing glecaprevir in the U.S. and EU and began commercializing the combination under the tradenames MAVYRET™ in the U.S. and MAVIRET™ outside the U.S.

The following table is a summary of revenue recognized from our collaboration agreement for the three months ended December 31, 2017 and 2016:

AbbVie Agreement

Since all of our research obligations under the AbbVie agreement were concluded by June 30, 2011, all milestone payments received since then have been recognized as revenue upon achievement of each milestone by AbbVie. During the three months ended December 31, 2017, we earned and recognized as revenue the last milestone payment for glecaprevir, which was a $15.0 million milestone payment upon AbbVie’s achievement of commercialization regulatory approval of MAVIRET™ in Japan. We did not earn any milestones during the same period in 2016.

We also receive annually tiered, double-digit royalties per protease inhibitor product on AbbVie’s net sales allocable to either of our collaboration’s protease inhibitors. Under the terms of our AbbVie agreement, as amended in October 2014, 50% of AbbVie’s net sales of MAVYRET/MAVIRET are allocated to glecaprevir. In the case of regimens containing paritaprevir, 30% of net sales of 3-DAA regimens containing paritaprevir and 45% of net sales of 2-DAA regimens containing paritaprevir are allocated to paritaprevir for purposes of calculating our annually tiered royalties. Beginning with each January 1, the cumulative net sales of each royalty-bearing product start at zero for purposes of calculating the tiered royalties on a product-by-product basis.

Internal Programs

As our internal product candidates are currently in preclinical or early clinical development, we have not generated any revenue from our own product sales and do not expect to generate any revenue from product sales derived from these product candidates for at least the next several years. We expect that our revenue for 2018 and the next several years will be derived from royalties under our current collaboration agreement with AbbVie, as well as any additional collaboration that we may enter into in the future.

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Operating Expenses

The following table summarizes our operating expenses for the three months ended December 31, 2017 and 2016:

Research and Development Expenses

Research and development expenses consist of costs incurred to conduct basic research, such as the discovery and development of novel small molecules as therapeutics, as well as any external expenses of preclinical and clinical development activities. We expense all costs of research and development as incurred. These expenses consist primarily of:

Project-specific expenses reflect costs directly attributable to our clinical development candidates and preclinical candidates nominated and selected for further development. Remaining research and development expenses are reflected in research and drug discovery, which represents early-stage drug discovery programs. At any given time, we typically have several active early stage research and drug discovery projects. Our internal resources, employees and infrastructure are not directly tied to any individual research or drug discovery project and are typically deployed across multiple projects. As such, we do not report information regarding costs incurred for our early-stage research and drug discovery programs on a project-specific basis. We expect that our research and development expenses will continue to increase in the future as we advance our NASH, PBC, RSV and HBV programs.

Our research and drug discovery programs are at early stages; therefore, the successful development of our product candidates is highly uncertain and may not result in approved products. Completion dates and completion costs can vary significantly for each product candidate and are difficult to predict. Given the uncertainty associated with clinical trial enrollments and the risks inherent in the development process, we are unable to determine the duration and completion costs of the current or future clinical trials of our product candidates or if, or to what extent, we will generate revenue from the commercialization and sale of any of our product candidates. We anticipate that we will make determinations as to which development programs to pursue and how much funding to direct to each program on an ongoing basis in response to the preclinical and clinical success and prospects of each product candidate, as well as ongoing assessments of the commercial potential of each product candidate.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs, which include salaries, related benefits and stock-based compensation, of our executive, finance, business and corporate development and other administrative functions. General and administrative expenses also include travel expenses, allocated facility-related costs not otherwise included in research and development expenses, directors and officers liability insurance premiums, and professional fees for auditing, tax, and legal services and patent expenses.

We expect that general and administrative expenses will increase in the future primarily due to ongoing expansion of our operating activities in support of our own research and development programs, as well as potential additional costs associated with operating a growing public company.

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Other Income (Expense), Net

Other income (expense), net, consists of interest income, interest expense and the change in fair value of our Series 1 nonconvertible preferred stock and the change in fair value of our outstanding warrant liability in 2017. Interest income consists of interest earned on our cash equivalents and short-term and long-term marketable securities balances as well as interest earned for refunds received from tax authorities. Interest expense consists of interest expense related to our capital lease obligation. The change in fair value of our outstanding warrant liability and Series 1 nonconvertible preferred stock relates to the remeasurement of these financial instruments from period to period as these instruments may require a transfer of assets because of the liquidation preference features of the underlying stock. The change in fair value also includes any forfeiture of unexercised warrants which expired on October 4, 2017.

Income Tax (Expense) Benefit

Income tax (expense) benefit is based on our best estimate of applicable income tax rates for the entire fiscal year applied to pre-tax profit or loss reported for the year-to-date period.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our consolidated financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. We believe that the estimates and assumptions involved in the accounting policies described below may have the greatest potential impact on our consolidated financial statements and, therefore, consider these to be our critical accounting policies. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. See also our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 (referred to as our 2017 Form 10-K) for information about these accounting policies as well as a description of our other significant accounting policies. We believe that of our significant accounting policies, the following accounting policies involve the most judgment and complexity:

Accordingly, we believe the policies set forth above are critical to fully understanding and evaluating our financial condition and results of operations. If actual results or events differ materially from the estimates, judgments and assumptions used by us in applying these policies, our reported financial condition and results of operations could be materially affected.

There have been no material changes in our critical accounting policies since September 30, 2017 aside from the adoption of ASU 2016-09 in the first quarter of fiscal 2018. For further information, please see the discussion of critical accounting policies included in our 2017 Form 10-K.

Results of Operations

Comparison of Three Months Ended December 31, 2017 and 2016

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Revenue

We recognized revenue of $38.1 million during the three months ended December 31, 2017 as compared to $10.4 million during the three months ended December 31, 2016. During the three months ended December 31, 2017, revenue consisted of a $15.0 million milestone earned upon AbbVie’s achievement of commercialization regulatory approval of MAVIRET™ in Japan, as well as royalties earned on the portion of AbbVie’s net sales of its HCV treatment regimens allocable to glecaprevir or paritaprevir. During the three months ended December 31, 2016, our revenue consisted of royalties earned on the portion of AbbVie’s net sales of its HCV treatment regimens allocable to paritaprevir.

Our revenue is generated through our collaboration with AbbVie. Our collaboration’s new MAVYRET/MAVIRET regimen, a pan-genotypic treatment combining two DAAs, began commercialization in the third calendar quarter of 2017, following its approval in the EU and the U.S. We are entitled to annually tiered, double-digit, per-product royalties on 50% of all net sales of MAVYRET/MAVIRET. Our royalty revenues eligible to be earned in the future will potentially fluctuate depending on AbbVie’s HCV market share, the pricing of the MAVYRET/MAVIRET regimen and number of patients treated.

Research and development expenses

Research and development expenses increased $5.4 million for the three months ended December 31, 2017 as compared to the same period in 2016. The increase was primarily due to progression of preclinical and clinical activities in our liver disease and virology programs. Increases were driven by an increase in headcount to support our preclinical activities and an increase in external costs for clinical and preclinical activities.

General and administrative expenses

General and administrative expenses increased by $0.8 million for the three months ended December 31, 2017 as compared to the same period in 2016. The increase was primarily due to an increase in compensation expense due to increased headcount.

Other income (expense), net

Other income (expense), net, increased $0.4 million for the three months ended December 31, 2017 as compared to the same period in 2016 due to an increase in interest income due to higher average investment balances and changes in interest rates for the period ended December 31, 2017 as compared to the same period in 2016. In addition, we recognized an increase to other income (expense), net, of less than $0.1 million as a result of the expiration of unexercised warrants during the three months ended December 31, 2017.  

Income tax (expense) benefit

For the three months ended December 31, 2017 and 2016, we recorded an income tax (expense) benefit of $(3.6) million and $1.5 million, respectively. During the three months ended December 31, 2017, our income tax expense included a revaluation adjustment against deferred tax assets of $(3.8) million due to a decrease in the federal corporate income tax rate as enacted under the U.S. Tax

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Cuts and Jobs Act (the “Tax Act”). We also recorded an income tax benefit of $0.2 million primarily related to tax deductions for stock option activity which is now recorded in income tax expense (benefit) due to the adoption of ASU 2016-09 during the first quarter of fiscal 2018. For the three months ended December 31, 2016, we recorded an income tax benefit due to the Company’s loss before income taxes for the quarter as well as federal research and development tax credits which reduced taxes payable and were reflected in the Company’s annual effective tax rate.

Estimates used to prepare our income tax expense during the three months ended December 31 2017 are based on our initial analysis of the Tax Act. Given the complexity of the Tax Act, anticipated guidance from the U.S. Treasury regarding implementation of the act, and potential for guidance from the Securities and Exchange Commission or the Financial Accounting Standards Board related to the act, these estimates may be adjusted during our fiscal 2018 to reflect any such guidance provided.

Liquidity and Capital Resources

At December 31, 2017, our principal sources of liquidity were cash, cash equivalents and short-term and long-term marketable securities totaling $297.5 million.

From our inception through December 31, 2017, we have financed our operations primarily through payments under our collaborations, government research and development contracts and grants, and the net proceeds from our initial public offering of our equity in March 2013. The following table shows a summary of our cash flows for the three months ended December 31, 2017 and 2016:

Net cash provided by operating activities

The increase in cash provided by operating activities of $1.3 million for the three months ended December 31, 2017 as compared to the same period in 2016 is driven primarily by timing of payments received under our collaboration with AbbVie year over year, which were substantially offset by increased expenditures in research and development in order to progress clinical development and preclinical research in our proprietary programs. We received $25.6 million during the three months ended December 31, 2017 from AbbVie, including royalties and a $15.0 million milestone payment, compared to $12.8 million in cash during three months ended December 31, 2016 which consisted exclusively of royalties. In addition, our cash taxes paid decreased by $1.0 million due to timing of estimated tax payments.

Net cash provided by (used in) investing activities

The decrease in cash provided by investing activities of $3.3 million for the three months ended December 31, 2017 as compared to the same period in 2016 was driven by the timing of purchases, sales and maturities of marketable securities.

Net cash provided by financing activities

The increase in net cash provided by financing activities of $0.4 million for the three months ended December 31, 2017 as compared to the same period in 2016 was driven by an increase in exercises of stock options during the three months ended December 31, 2017 as compared to the same period in 2016.

Funding requirements

As of December 31, 2017, we had $297.5 million in cash, cash equivalents and short-term and long-term marketable securities. We believe that our existing cash, cash equivalents and marketable securities as of December 31, 2017 will be sufficient to meet our anticipated cash requirements for the foreseeable future. However, our forecast of the period of time through which our financial

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resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially.

Our future capital requirements are difficult to forecast and will depend on many factors, including:

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financing activities. We do not have any interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance entities.

Contractual Obligations and Commitments

In our 2017 Form 10-K Part II, Item 7, Management’s Discussion and Analysis of Financial Conditions and Results of Operations, under the heading “Contractual Obligations and Commitments”, we have described our commitments and contingencies. There were no material changes in our commitments and contingencies during the three months ended December 31, 2017.

Recently Issued Accounting Pronouncements

A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is set forth in Note 2 to the consolidated financial statements included in this Quarterly Report on Form 10-Q.

Interest Rate Sensitivity

We had cash, cash equivalents and short-term and long-term marketable securities of $297.5 million at December 31, 2017 consisting of cash, money market funds, commercial paper, corporate bonds and government securities. Interest income is sensitive to changes in the general level of interest rates; however, due to the nature of these investments, a 1% change in market interest rates would not be expected to have a material impact on our financial condition or results of operations. Other than our capital lease obligation, we had no debt outstanding as of December 31, 2017.

a) Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures.

Our management, with the participation of the principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under

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the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on this evaluation, the principal executive officer and principal financial officer concluded that these disclosure controls and procedures are effective and designed to ensure that the information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods.

b) Changes in Internal Control Over Financial Reporting.

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in connection with the evaluation of our internal control performed during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II —OTHER INFORMATION

ITEM 1A.RISK FACTORS

RISK FACTORS

Our business faces significant risks and uncertainties, any of which, alone or in combination with others, may have a material adverse effect on our business prospects, financial condition and results of operations. Accordingly, in evaluating our business, we encourage you to consider the following summary of the risk factors and uncertainties that we believe are most relevant to our business. You should carefully consider the risks described below before making an investment decision, and understand that it is not possible to predict or identify all such factors. Other events that we do not currently anticipate or that we currently deem immaterial may also affect our business, prospects, financial condition and results of operations.  In addition, we operate in a competitive and rapidly changing environment.  New factors emerge from time to time and it is not possible to predict the impact of all of these factors on our business, financial condition or results of operations. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise.  

The statement of risk factors provided in this Item 1A includes any material changes to and supersedes the statement of risk factors associated with our business previously disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2017 filed on December 11, 2017 with the Securities and Exchange Commission (SEC). In assessing these risks, investors should also refer to the other information contained or incorporated by reference in this Form 10-Q and our other filings made from time to time with the SEC.

Risks Related to Our Business

Our financial prospects for the next several years are dependent upon the development and commercialization efforts of AbbVie for combination therapies incorporating our protease inhibitors paritaprevir or glecaprevir for the treatment of HCV. AbbVie may act in its best interest rather than in our best interest, which could adversely affect our business.