REATA PHARMACEUTICALS INC - Quarter Report: 2018 September (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2018

OR

For the transition period from         to         

Commission File Number: 001-37785

 

Reata Pharmaceuticals, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

Registrant’s telephone number, including area code: (972) 865-2219

 

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 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 such files).    Yes ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, an emerging growth company, or a smaller reporting 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.

 

 

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 November 2, 2018, the registrant had 23,990,922 shares of Class A common stock, $0.001 par value per share, and 5,727,108 shares of Class B common stock, $0.001 par value per share, outstanding.

 

TABLE OF CONTENTS

 

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties.  We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws.  All statements, other than statements of historical or present facts, including statements regarding our future financial condition, future revenues, projected costs, prospects, business strategy, and plans and objectives of management for future operations, are forward-looking statements.  In some cases, you can identify forward-looking statements by terminology such as “believe,” “will,” “may,” “might,” “estimate,” “continue,”  “anticipate,” “intend,” “target,” “project,” “model,” “should,” “would,” “plan,” “expect,” “predict,” “could,” “seek,” “goals,” “potential,”  and similar terms or expressions that concern our expectations, strategy, plans, or intentions.  These forward-looking statements include, but are not limited to, statements about:

Any forward-looking statements in this Quarterly Report on Form 10-Q reflect our current views with respect to future events or to our future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by these forward-looking statements.  Factors that may cause actual results to differ materially from current expectations include, among other things, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017.  Given these uncertainties, you should not place undue reliance on these forward-looking statements.

You should read this Quarterly Report on Form 10-Q and the documents that we have filed as exhibits to this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect.  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.

 

PART I - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements.

Reata Pharmaceuticals, Inc.

Consolidated Balance Sheets

(in thousands, except share data)

 

 

 

See accompanying notes.

 

 

Reata Pharmaceuticals, Inc.

Unaudited Consolidated Statements of Operations

(in thousands, except share and per share data)

 

 

 

See accompanying notes.

 

 

Reata Pharmaceuticals, Inc.

Unaudited Consolidated Statements of Cash Flows

(in thousands)

 

 

 

 

See accompanying notes.

 

 

 

 

Reata Pharmaceuticals, Inc.

Notes to Unaudited Consolidated Financial Statements

 

 

1. Description of Business

Reata Pharmaceuticals, Inc. (the Company) is a clinical stage biopharmaceutical company focused on identifying, developing, and commercializing therapeutics to address serious and life-threatening diseases with few or no approved therapies by targeting molecular pathways that regulate cellular metabolism and inflammation.  The Company is currently conducting three registrational trials with its lead product candidates, bardoxolone methyl and omaveloxolone, which activate the transcription factor Nrf2 to restore mitochondrial function, reduce oxidative stress, and resolve inflammation.  The Company’s lead registrational programs are evaluating its product candidates for the treatment of a rare form of chronic kidney disease (CKD) caused by Alport syndrome, a rare form of degenerative neuromuscular disease called Friedreich’s ataxia (FA), and a rare and severe form of pulmonary arterial hypertension associated with connective tissue disease (CTD-PAH).  The Company has received orphan drug designation from the FDA and the European Medicines Agency (EMA) for bardoxolone methyl for the treatment of Alport syndrome and for omaveloxolone for the treatment of FA and from the FDA for bardoxolone methyl for the treatment of PAH.

In addition to its three registrational programs, the Company is developing plans to advance bardoxolone methyl into a Phase 3 trial in 2019 for the treatment of autosomal dominant polycystic kidney disease (ADPKD) and to also pursue IgA nephropathy (IgAN) and type 1 diabetic CKD (T1D CKD) as commercial indications.  The Company is also currently conducting additional clinical and preclinical programs in serious and life-threatening diseases that may provide additional opportunities for its drug candidates and plans to evaluate data from the remaining earlier stage programs to determine which indications to advance into later stage trials.

The Company’s consolidated financial statements include the accounts of all majority-owned subsidiaries.  Accordingly, the Company’s share of net earnings and losses from these subsidiaries is included in the consolidated statements of operations.  Intercompany profits, transactions, and balances have been eliminated in consolidation.

On July 27, 2018, the Company closed a follow-on underwritten public offering of 3,450,000 shares of its Class A common stock for gross proceeds of $248,400,000.  The Company received net proceeds from the offering of $232,846,000, after deducting underwriting discounts and commissions and offering expenses.

 

 

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the nine months ended September 30, 2018, are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.  The consolidated balance sheet at December 31, 2017, has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  For further information, refer to the annual consolidated financial statements and footnotes thereto of the Company.

The Company’s significant accounting policies are described in Note 2 of Notes to Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2017 (2017 Annual Report on Form 10-K).  During the first quarter of 2018, the Company adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606).  As a result of the adoption of Topic 606, the Company has updated its Revenue Recognition policies.  There were no other changes to its significant accounting policies from those disclosed in its 2017 Annual Report on Form 10-K.

 

Revenue Recognition

The Company’s revenue to date has been generated primarily from licensing fees received under its collaborative licensing agreements with AbbVie Ltd. (AbbVie) and Kyowa Hakko Kirin Co., Ltd. (KHK) and reimbursements for expenses from KHK.  The terms of the agreements include non-refundable upfront fees, funding of research and development activities, payments based upon achievement of milestones, and royalties on net product sales.

Under Topic 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.  To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the entity performs the following five steps: (i) identify the promised goods or services in the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price, including the constraint on variable consideration; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when or as the entity satisfies a performance obligation.  

At contract inception, the Company assesses the goods or services promised within each contract, determines those that are performance obligations, and assesses whether each promised good or service is distinct.  The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when or as the performance obligation is satisfied.

Licenses of intellectual property: If a license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer, and the customer can use and benefit from the license.  For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees.  The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

Milestone payments: At the inception of each arrangement that includes milestone payments, the Company evaluates whether the milestones are considered probable of being achieved and estimates the amount to be included in the transaction price using the most likely amount method.  If it is probable that a significant revenue reversal would not occur, the value of the associated milestone (such as a regulatory submission by the Company) is included in the transaction price, which is then allocated to each performance obligation.  Milestone payments that are not within the control of the Company, such as approvals from regulators, are not considered probable of being achieved until those approvals are received.  At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such development milestones and, if necessary, adjusts its estimate of the overall transaction price.  Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration, and other revenues and earnings in the period of adjustment and in future periods through the end of the performance obligation period.

Royalties: For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and where the license is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue at the later of (a) when the related sales occur, or (b) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).  To date, the Company has not recognized any royalty revenue resulting from any of its licensing arrangements.

Manufacturing Supply Services: Arrangements that include a promise for future supply of drug substance or drug product for either clinical development or commercial supply at the customer’s discretion are generally considered options.  The Company assesses if these options provide a material right to the licensee and, if so, they are accounted for as separate performance obligations.  If the Company is entitled to additional payments when the customer exercises these options, any additional payments are recorded when the customer obtains control of the goods, which is upon delivery.

 

For a complete discussion of accounting for collaborative licensing agreements, see Note 3, Collaboration Agreements.

The Recent Accounting Pronouncements

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the JOBS Act).  Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies.  The Company has irrevocably elected not to avail itself of this exemption from new or revised accounting standards, and, therefore, will be subject to the same new or revised accounting standards as public companies that are not emerging growth companies.

In May 2014, the Financial Accounting Standards Board (FASB) issued Topic 606, which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition (Topic 605).  The FASB has subsequently issued a number of amendments to Topic 606.  The Company adopted this new standard on January 1, 2018 using the modified retrospective transition method.  As of January 1, 2018, upon adoption of Topic 606, the Company recorded a cumulative adjustment of $2,634,000 to increase accumulated deficit and increase deferred revenue.  This adjustment was the remainder of the transaction price related to the $15,000,000 received milestones that were recognized under the prior milestone recognition methodology when the milestones were achieved in 2010 and 2012.  For a complete discussion of accounting for collaborative licensing agreements, see Note 3, Collaboration Agreements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02), which supersedes ASC 840, Leases.  ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for those leases previously classified as operating leases.  The standard is effective for public companies for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted.

The Company has not yet completed its final evaluation of the impact of this guidance, but it believes the primary change to the financial statements will relate to the recognition of right-of-use assets and offsetting lease liabilities in the consolidated balance sheet for operating leases.  The Company will adopt ASU 2016–02 as of January 1, 2019 and will apply certain practical expedients offered in the guidance, such as those that state that the Company need not reassess whether expired or existing contracts contain leases, reevaluate the classification of expired or existing leases, or reassess initial direct costs for existing leases.

 

 

3. Collaboration Agreements

On January 1, 2018, the Company adopted Topic 606 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historical accounting under Topic 605.

AbbVie

In December 2011, the Company entered into the AbbVie collaboration agreement to jointly research, develop, and commercialize the Company’s portfolio of second and later generation oral Nrf2 activators.  The terms of the agreement include payment to the Company of a nonrefundable, up-front payment of $400,000,000 and development cost sharing for jointly developing indications after certain initial early development costs were incurred by the Company.  

The Company evaluated the AbbVie collaboration agreement under Topic 606 and determined that the upfront payment constituted the transaction price.  The Company identified three performance obligations at contract inception: (1) the exclusive license rights to research, develop, and commercialize Nrf2 activators outside the United States, (2) the obligation to participate in Joint Steering Committees (JSCs), and (3) cost sharing for jointly developed indications.  The transaction price was allocated to the exclusive license rights and the obligation to participate on JSCs, which are accounted for as a single performance obligation, and is being recognized as revenue

 

ratably through December 2026, which is the estimated minimum period that is needed to complete the deliverables under the terms of the AbbVie Collaboration Agreement.  The Company records shared development cost payments from AbbVie as reductions of research and development expense.  As the Company is currently unilaterally developing its lead Nrf2 activator omaveloxolone, no amounts were recognized during the nine months ended September 30, 2018.  The adoption of Topic 606 did not result in a significant change in revenue recognition for this agreement.

As of January 1, 2018, the Company’s deferred revenue balance was $238,292,000, which represents the contract liability for the unsatisfied performance obligations as well as the variable consideration paid in advance that is being recognized ratably through December 2026.  The Company began recognizing revenue related to the up-front payment upon execution of the agreement and, accordingly, recognized approximately $6,717,000 and $19,931,000 as collaboration revenue during the three and nine months ended September 30, 2018, respectively.  As of September 30, 2018, the Company has a remaining deferred revenue balance totaling approximately $218,361,000.

KHK

In December 2009, the Company entered into the KHK agreement, which granted KHK an exclusive license to develop and commercialize bardoxolone methyl in the licensed territory.  The Company received a nonrefundable, up-front license fee of $35,000,000 in 2009 and regulatory milestones totaling $45,000,000 in 2010, 2012, and 2018 and could receive additional regulatory milestones of $52,000,000 and commercial milestones of $140,000,000, as well as tiered royalties ranging from the low teens to the low 20 percent range, depending on the country of sale and the amount of annual net sales, on net sales by KHK in the licensed territory.  

The Company evaluated the KHK agreement under Topic 606 and identified three performance obligations at contract inception: (1) the exclusive license rights to develop and commercialize bardoxolone methyl in Japan and licensed territory, (2) the obligation to participate in JSCs, and (3) the obligation to supply bardoxolone methyl for KHK’s clinical trial and commercial needs.  The transaction price was allocated to the exclusive license rights and the obligation to participate on JSCs, which are accounted for as a single performance obligation and is recognized as revenue ratably through December 2021, which is the estimated minimum period to complete the performance obligation under the KHK agreement.  Any consideration related to the Company’s obligation to supply KHK with drug product is recognized upon delivery.

Upon adoption of Topic 606, the Company determined that the transaction price for this agreement at contract inception includes the upfront fee of $35,000,000 and regulatory milestones of $15,000,000 received prior to 2013.  In May 2018, the Company achieved its regulatory milestone of $30,000,000.  The Company believes the remaining additional regulatory milestones of $52,000,000 and commercial milestones of $140,000,000 are fully constrained as they are not within the control of the Company or KHK and did not include these remaining milestones in the transaction price.  Any consideration related to royalties will be recognized when the related sales occur.

During the nine months ended September 30, 2018, the Company included the regulatory milestone of $30,000,000 as variable consideration to the transaction price.  For the nine months ended September 30, 2018, the Company received $30,000,000 and recognized $21,881,000 in collaboration revenue, including a cumulative catch-up for the portion of this milestone that was satisfied in prior periods.  The remainder of $8,119,000 was recorded in deferred revenue on the balance sheet and will be recognized over the remaining performance obligation period.  The Company also recognized related license fees and other expenses of approximately $3,600,000 related to achievement of this milestone.  The Company recognized approximately $(2,951,000) and $23,521,000 as collaboration revenue during the three and nine months ended September 30, 2018, respectively.  

Due to the adoption of Topic 606, collaboration revenue was decreased and net loss was increased by $3,337,000 and $7,626,000 for the three and nine months ended September 30, 2018, respectively.  Basic and diluted net loss per share increased by $0.12 and $0.28 for the three and nine months ended September 30, 2018, respectively.  

As of September 30, 2018, the Company’s deferred revenue balance was $15,259,000, which represents the contract liability for the unsatisfied performance obligations as well as the variable consideration paid in advance and achieved that is being recognized ratably through the remaining performance obligation period.

 

 

4. Term Loan

On June 14, 2018, the Company entered into an Amended and Restated Loan and Security Agreement (the Restated Agreement) with Oxford Finance LLC, as the collateral agent and a lender (Oxford), and Silicon Valley Bank (SVB), as a lender (collectively, the Lenders), which amended and restated the Loan and Security Agreement entered into among Reata and the Lenders on March 31, 2017, as amended on November 3, 2017 (the Loan Agreement).

Under the Restated Agreement, the Term A Loan was increased from $20,000,000 to $80,000,000 and the Term B Loan availability was increased to $45,000,000, upon the achievement of one of two milestones by the earlier of 30 days after the achievement of a milestone or December 31, 2019.  If the Company is entitled to draw the Term B Loan, but does not draw the Term B Loan by December 31, 2019, the Company is obligated to pay a non-utilization fee of $450,000.  On June 14, 2018, the Company borrowed the additional $60,000,000 under the Term A Loan and recorded a loss on extinguishment as a result of the debt modification of $1,007,000, which consisted primarily of lender fees and unamortized debt issuance costs.

All outstanding Term Loans will mature on June 1, 2023.  Under the Term A Loan, the Company will make interest-only payments for 24 months through June 1, 2020; however, if the Company draws the Term B Loan, the Company will make interest-only payments for 36 months through June 1, 2021.  The interest-only payment period will be followed by 36 equal monthly payments, or 24 equal monthly payments if the Company draws the Term B Loan, of principal and interest payments. The Term Loans will bear interest at a floating per annum rate calculated as 7.79% plus the greater of the 30-day U.S. Dollar LIBOR rate reported in The Wall Street Journal on the last business day of the month that immediately precedes the month in which the interest will accrue or 1.91%, with a minimum rate of 9.7% and maximum rate of 12.29%.

The Company has the option to prepay all, but not less than all, of the borrowed amounts, provided that the Company will be obligated to pay a prepayment fee equal to (a) the aggregate amount of interest that the Company would have paid through the maturity date if prepayment is made on or before the first anniversary of the applicable funding date of the Term Loan, (b) 4.0% of the outstanding principal balance of the applicable Term Loan if prepayment is made after the first anniversary of the applicable funding date of the Term Loan, (c) 3.0% of the outstanding principal balance of the applicable Term Loan if prepayment is made by the after second anniversary of the applicable funding date of the Term Loan, or (d) 1.5% of the outstanding principal balance of the applicable Term Loan if prepayment is made after the third anniversary of the applicable funding date of the Term Loan.  The Company will also be required to make a final exit fee payment of 6.5% of the principal balance of the Term A Loan and 4.0% of the Term B Loan, payable on the earliest of the prepayment of the Term Loans, acceleration of any Term Loan, or at maturity of the Term Loans.

The Company may use the proceeds from the Term Loans for working capital and to fund its general business requirements.  The Company’s obligations under the Restated Agreement are secured by substantially all of its current and future assets, including its owned intellectual property.

As of September 30, 2018, the Company had $80,000,000 outstanding under the Term A Loan, which was recorded at its initial carrying value of $80,000,000, less debt issuance costs totaling approximately $1,570,000.  In connection with the Term A Loan, the debt issuance costs were recorded as a reduction to debt on its balance sheet and are being accreted to interest expense over the life of the Term A Loan.  Additionally, the final exit fee of approximately $5,200,000 is being accrued over the life of the Term A Loan through interest expense.  The Term A Loan has a current effective interest rate of 10.8% before debt issuance costs and final exit fee and 13.4% including debt issuance costs and final exit fee.  The Company is in compliance with all covenants under the Loan Agreement as of September 30, 2018.

 

The future principal payments for the Company’s Term A Loan as of September 30, 2018 are as follows (in thousands):

 

 

 

5. Income Taxes

The Tax Cuts and Jobs Act of 2017 (the 2017 Tax Act), which was signed into law on December 22, 2017, resulted in significant changes to the U.S. corporate income tax system.  These changes include a federal statutory rate reduction from 35% to 21% and the elimination or reduction in the deductibility of certain credits and limitations, such as tax credits related to designated orphan drugs, net operating losses, interest expense, and executive compensation.  The federal statutory rate reduction took effect on January 1, 2018.  

The Company’s effective tax rate varies with the statutory rate due primarily to the impact of nondeductible stock-based compensation and the changes in valuation allowance related to certain deferred tax assets generated or utilized in the applicable period.  The Company’s deferred tax assets have been fully offset by a valuation allowance at September 30, 2018, and the Company expects to maintain this valuation allowance until there is sufficient evidence that future earnings can be achieved, which is uncertain at this time.

On December 22, 2017, Staff Accounting Bulletin No. 118 (SAB 118) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the 2017 Tax Act.  In accordance with SAB 118, the Company continues to evaluate the impact of the 2017 Tax Act, which may impact its current conclusions.  Any subsequent adjustment to those amounts will be recorded to current tax expense in the fourth quarter of 2018 when the analysis is expected to be complete.

The Internal Revenue Service (IRS) examination team has completed its examination of the Company’s 2013, 2014, and 2015 U.S. tax returns and proposed adjustments with respect to certain items that were reported by the Company for the 2013 tax year.  In June 2018, the Company received the Revenue Agent Report from the IRS.  The Company believes that it has accurately reported all amounts in its tax returns and has submitted an administrative protest with the IRS contesting the examination team’s proposed adjustments.  The Company intends to vigorously defend its reported positions and believes the ultimate resolution of the adjustments proposed by the IRS examination team will not have a material adverse effect on its consolidated financial statements.

 

 

6. Stock-Based Compensation

Stock Options

The following table summarizes stock-based compensation expense reflected in the consolidated statements of operations (in thousands):

 

 

 

The following table summarizes stock option activity as of September 30, 2018, and changes during the nine months ended September 30, 2018, under the 2007 Long Term Incentive Plan (the 2007 LTIP) and standalone option agreements:

 

 

The total intrinsic value of all outstanding options and exercisable options at September 30, 2018 was $202,793,000 and $87,708,000, respectively.

 

 

7. Net Loss per Share

The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders:

 

 

The number of weighted average options that were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive represented 3,337,262 and 2,396,878 shares for the nine months ended September 30, 2018 and 2017, respectively.

 

 

 

 

 

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 consolidated financial statements and related notes and other financial information appearing in this Quarterly Report on Form 10-Q.  Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business, operations, and product candidates, includes forward-looking statements that involve risks and uncertainties.  Factors that may cause actual results to differ materially from current expectations include, among other things, those described under the heading “Risk Factors” and discussed elsewhere in this Quarterly Report on Form 10-Q.

Overview

We are a clinical stage biopharmaceutical company focused on identifying, developing, and commercializing therapeutics with profound biological and clinical activity to address serious and life-threatening diseases with few or no approved therapies by targeting molecular pathways that regulate cellular metabolism and inflammation.  We are currently conducting three registrational trials with our lead product candidates, bardoxolone methyl and omaveloxolone, which activate the transcription factor Nrf2 to restore mitochondrial function, reduce oxidative stress, and resolve inflammation.  Our lead registrational programs are evaluating our product candidates for the treatment of three rare diseases: CKD caused by Alport syndrome, FA, and CTD-PAH.  We have received orphan drug designation from the FDA and the EMA for bardoxolone methyl for the treatment of Alport syndrome and for omaveloxolone for the treatment of FA and from the FDA for bardoxolone methyl for the treatment of PAH.

The chart below is a summary of our current registrational programs:

 

Bardoxolone Methyl in CKD Caused by Alport Syndrome and Additional Rare Forms of CKD

The clinical trial data for bardoxolone methyl demonstrate consistent, clinically meaningful improvement in kidney function across several disease states, as measured by various endpoints, including estimated glomerular filtration rate (eGFR) and GFR measured by inulin clearance.  Specifically, we have observed statistically significant increases in eGFR in all Phase 2 and Phase 3 clinical trials in six distinct patient populations treated with bardoxolone methyl, including patients with CKD caused by type 2 diabetes (T2D CKD), PAH, CKD caused by Alport syndrome, ADPKD, IgAN, and T1D CKD.  As discussed below, these data include sustained increases in eGFR up to two years in three patient populations and increases in retained eGFR, which is the eGFR change after a four-week withdrawal of drug, that was evaluated following 48 weeks of treatment in two patient populations.  We believe these data support the potential for bardoxolone methyl to delay or prevent dialysis, kidney transplant, and death in patients with Alport syndrome and other rare forms of CKD.  Further details on the clinical trials of bardoxolone methyl include the following:

 

We are developing bardoxolone methyl for the treatment of patients with CKD caused by Alport syndrome and four additional rare forms of CKD.  In addition, Kyowa Hakko Kirin Co., Ltd. (KHK), one of our strategic collaborators, is currently conducting its pivotal trial of bardoxolone methyl in diabetic (type 1 and 2) kidney disease in Japan, with data expected in the first half of 2022.

CARDINAL, a Study in Patients with CKD Caused by Alport Syndrome

Alport syndrome is a rare and serious hereditary disease that manifests as early as the first decade of life and causes average annual declines in eGFR of approximately 3 to 4 mL/min/1.73 m².  In patients with the most severe forms of the disease, approximately 50% progress to dialysis by age 25, 90% by age 40, and nearly 100% by age 60.  There are no approved therapies for Alport syndrome anywhere in the world.  

In July 2018, we announced positive interim safety and efficacy data for the ongoing open-label Phase 2 portion of CARDINAL.  The Phase 2 portion of the trial enrolled 30 patients, and 25 patients were available for analysis through one year.  No patients discontinued due to drug-related adverse events.  Data demonstrate that bardoxolone methyl significantly improved kidney function in Alport syndrome patients as measured by eGFR.  In the Phase 2 portion of CARDINAL, we achieved the following:

 

The Phase 3 portion of CARDINAL is an international, multi-center, randomized, double-blind, placebo-controlled trial that is studying the safety and efficacy of bardoxolone methyl in patients with CKD caused by Alport syndrome.  We are currently conducting the Phase 3 portion of CARDINAL. The protocol allows for enrollment of approximately 150 patients randomized evenly to either bardoxolone methyl or placebo, and the trial has been fully enrolled with 157 patients.  The FDA has provided us with guidance that an analysis of retained eGFR, demonstrating an improvement versus placebo after one year of bardoxolone methyl treatment, may support a New Drug Application (NDA) submission for accelerated approval of bardoxolone methyl for the treatment of CKD caused by Alport syndrome, and data demonstrating an improvement versus placebo in retained eGFR after two years of treatment may support full approval.  We expect to have one year top-line results available in the second half of 2019.  Based on retained eGFR benefit observed in CARDINAL Phase 2 patients at Week 52, we believe the Phase 3 portion of CARDINAL is conservatively powered.  No safety concerns have been reported by the DMC.

PHOENIX, a Study in Patients with Other Rare Forms of CKD

We are currently conducting our Phase 2 PHOENIX trial to assess whether bardoxolone methyl treatment can improve kidney function, as assessed by eGFR, in patients with four additional rare forms of CKD.  PHOENIX is an open-label, multi-center Phase 2 trial to evaluate the safety and efficacy of bardoxolone methyl in patients with ADPKD, IgAN, T1D CKD, and focal segmental glomerulosclerosis (FSGS).  In aggregate, the prevalence of these diseases exceeds 700,000 patients in the United States, representing a meaningful market for bardoxolone methyl in rare forms of CKD.  The protocol includes 25 patients with each of these rare forms of CKD in separate cohorts analyzed independently in PHOENIX.  In each cohort, we will evaluate the effect of bardoxolone methyl treatment on eGFR at 12 weeks.  

In July 2018, we announced positive final results for the Phase 2 ADPKD cohort of PHOENIX.  We enrolled 31 patients in this cohort and observed a statistically significant, mean increase from baseline in eGFR of 9.3 mL/min/1.73 m² (p<0.0001) at Week 12.  In addition:  

 

In September 2018, we announced positive final results for the Phase 2 IgAN cohort of PHOENIX.  We enrolled 26 patients in this cohort and observed a statistically significant, mean increase from baseline in eGFR of 8.0 mL/min/1.73 m² (p<0.0001) at Week 12.  In addition:  

In September 2018, we announced positive final results for the Phase 2 T1D CKD cohort of PHOENIX.  We enrolled 28 patients in this cohort and observed a statistically significant, mean increase from baseline in eGFR of 5.5 mL/min/1.73 m² (p=0.02) at Week 12.  In addition:  

The statistically significant, mean increases in eGFR observed in the ADPKD, IgAN, and T1D CKD cohorts of PHOENIX support our belief that bardoxolone methyl’s anti-inflammatory activity targets a common pathway of kidney function loss relevant to many forms of CKD.  Data suggest that the long-term eGFR improvements and retained eGFR benefits observed in trials in other forms of CKD may translate to ADPKD, IgAN, and T1D CKD patients.  No treatment-related serious adverse events (SAEs) were reported.  

We are developing plans to advance bardoxolone methyl into a Phase 3 trial in 2019 for the treatment of ADPKD and are also planning to pursue IgAN and T1D CKD as commercial indications.  Full primary endpoint data from the FSGS cohort are expected to be available in the first half of 2019.

Omaveloxolone in FA

We are developing omaveloxolone for the treatment of patients with FA, an inherited, debilitating, and degenerative neuromuscular disorder, which can begin as early as age five but more commonly begins by approximately ages 13 to 15.  Patients with FA typically become dependent on wheelchairs 10 to 15 years after disease onset, with a median age of death in the mid-30s.  Patients with FA experience an average annual worsening, or increase, in modified Friedreich’s Ataxia Rating Scale (mFARS) scores of one to two points.  There are no currently approved therapies for the treatment of FA anywhere in the world.  

MOXIe, a Study in Patients with FA

Our Phase 2 trial, called MOXIe, is a two-part, international, multi-center, randomized, double-blind, placebo-controlled registrational trial that studies the safety and efficacy of omaveloxolone in patients with FA.  In part 1 of MOXIe, at the optimal dose level of omaveloxolone, we achieved the following:

 

We are currently conducting the registrational part 2 of MOXIe.  The protocol allows for enrollment of approximately 100 patients randomized evenly to either 150 mg of omaveloxolone or placebo, and the trial has been fully enrolled with 103 patients.  The FDA has provided us with guidance that an analysis of mFARS scores demonstrating an improvement versus placebo after 48 weeks of omaveloxolone treatment may support an NDA submission for accelerated or full approval of omaveloxolone for the treatment of FA.  Based on the findings from part 1, the pivotal part 2 of MOXIe was designed to optimize the likelihood of a clinically meaningful and statistically-significant outcome that could support approval by the FDA.  The protocol sample size is larger, with 50 patients on placebo and 50 patients on omaveloxolone versus 17 on placebo and 12 on 160 mg of omaveloxolone in part 1.  Additionally, the duration of the trial is 48 weeks, versus 12 weeks in part 1, potentially allowing more time for omaveloxolone to achieve its maximal effect, and for any placebo effect to normalize.  Finally, the proportion of patients with a foot deformity called pes cavus, in whom greater variability in mFARS was observed in part 1, was capped at 20% versus the 66% enrolled in the 160 mg cohort of part 1.  We expect to have top-line data from MOXIe available in the second half of 2019.  No safety concerns have been reported by the DSMB.

Bardoxolone Methyl in Pulmonary Hypertension

CATALYST, a Study in Patients with CTD-PAH

We are studying bardoxolone methyl in CTD-PAH, which is a serious and progressive disease that leads to heart failure and death.  CTD-PAH patients are less responsive to existing vasodilator therapies than patients with the idiopathic form of PAH (I-PAH) and have a worse prognosis, with a five-year survival rate of approximately 44% compared to 68% for I-PAH patients.  Currently approved therapies, all systemic vasodilators, are used to treat all etiologies of PAH.  By a meta-analysis of 11 registrational trials comprised of more than 2,700 patients, the currently approved therapies were shown to be less beneficial for CTD-PAH patients compared to I-PAH patients as measured by 6-minute walk distance (6MWD) responses in CTD-PAH patients of 9.6 meters, or approximately one-third, compared to the responses in I-PAH patients of 30 meters.  Bardoxolone methyl is an Nrf2 activator, not a systemic vasodilator, and directly targets the bioenergetic and inflammatory components of PAH.  Additionally, because bardoxolone methyl does not have systemic hemodynamic effects or cause drug-drug interactions in PAH patients, it may be used in combination with other therapies to a greater incremental effect than an additional vasodilator.

Initial results from our Phase 2 LARIAT trial in PAH patients showed that bardoxolone methyl provided the greatest improvement in 6MWD to CTD-PAH patients.  CTD-PAH patients treated with bardoxolone methyl demonstrated a statistically significant, mean increase in 6MWD compared to baseline of 38.2 meters (p<0.001) and a placebo-corrected change in 6MWD of 28.4 meters (p=0.07).  Further analysis of data from CTD-PAH patients who would be eligible for inclusion in our Phase 3 trial, CATALYST, demonstrated a statistically significant, mean increase in 6MWD compared to baseline of 42.7 m (p<0.001) and a placebo-corrected change in 6MWD of 48.5 meters (p=0.005).

We are currently conducting CATALYST, an international, multi-center, randomized, double-blind, placebo-controlled Phase 3 trial that studies the safety and efficacy of bardoxolone methyl in patients with CTD-PAH when added to standard-of-care therapy.  The protocol includes 200 patients, and we expect to have top-line data from the CATALYST trial in the first half of 2020.  Data from CATALYST demonstrating an improvement in 6MWD versus placebo may support an NDA submission for approval of bardoxolone methyl for the treatment of CTD-PAH.  No safety concerns have been reported by the DSMB that oversees the trial and reviews all data.

Additionally, similar large and clinically meaningful treatment effects have been observed in patients with other forms of pulmonary hypertension (PH).  For example, in our Phase 2 LARIAT trial, we observed statistically significant increases in 6MWD, not only in patients with CTD-PAH and I-PAH, but also in patients with PH due to interstitial lung disease (PH-ILD), specifically, PH-ILD caused by sarcoidosis and idiopathic pulmonary fibrosis.  

 

Other Programs

RTA 901 is the lead product candidate from our Hsp90 modulator program, which includes highly potent and selective C-terminal modulators of Hsp90.  We have observed favorable activity of RTA 901 in a range of preclinical models of neurodegeneration and neuroprotection, including models of diabetic neuropathy, neural inflammation, and neuropathic pain.  RTA 901, administered orally once-daily, has been observed to rescue existing nerve function, restore thermal and mechanical sensitivity, and improve nerve conductance velocity and mitochondrial function in rodent disease models.  We have completed a Phase 1 trial to evaluate the safety, tolerability, and pharmacokinetic profile of RTA 901 in healthy adult volunteers.  No safety or tolerability concerns were reported.  We are the exclusive licensee of RTA 901 and have worldwide commercial rights.

RTA 1701 is the lead product candidate from our proprietary series of RORγt inhibitors for the potential treatment of a broad range of autoimmune, inflammatory, and fibrotic diseases.  RTA 1701 is an orally-bioavailable, RORγt-selective allosteric inhibitor that suppresses Th17 differentiation in vitro and demonstrates strong efficacy in rodent disease models of autoimmune disease.  RTA 1701 also potently suppresses production of IL-17A, a clinically important cytokine, in human immune cells and when dosed orally to non-human primates.  We are currently conducting a Phase 1 trial to evaluate the safety, tolerability, and pharmacokinetic profile of RTA 1701 in healthy adult volunteers, with initial results expected in the first half of 2019.  We retain all rights to our RORγt inhibitors, which are not subject to any existing commercial collaborations.

Financial Operations Overview

To date, we have focused most of our efforts and resources on developing our product candidates and conducting preclinical studies and clinical trials.  We have historically financed our operations primarily through revenue generated from our collaborations with AbbVie and KHK, from sales of our securities, and from secured loans.  We have not received any payments or revenue from collaborations other than nonrefundable upfront, milestone, and cost sharing payments from our collaborations with AbbVie and KHK and reimbursements of expenses under the terms of our agreement with KHK.  We have incurred losses in each year since our inception, other than in 2014.  As of September 30, 2018, we had approximately $375.2 million of cash and cash equivalents and an accumulated deficit of $394.8 million.  We continue to incur significant research and development and other expenses related to our ongoing operations.  Despite the potential to receive future payments from our collaborators, we anticipate that, without taking into account deferred revenue, we will continue to incur losses for the foreseeable future, and we anticipate that our losses will increase as we continue our development of, and seek regulatory approval for, our product candidates.  If we do not successfully develop and obtain regulatory approval of our existing product candidates or any future product candidates and effectively manufacture, market, and sell any products that are approved, we may never generate revenue from product sales.  Furthermore, even if we do generate revenue from product sales, we may never again achieve or sustain profitability on a quarterly or annual basis.  Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity and working capital.  Our failure to become and remain profitable could depress the market price of our Class A common stock and could impair our ability to raise capital, expand our business, diversify our product offerings, or continue our operations.

Revenue

Beginning January 1, 2018, we have followed the provisions of Topic 606.  Our revenue to date has been generated primarily from licensing fees received under our collaborative license agreements and reimbursements for expenses.  We currently have no approved products and have not generated any revenue from the sale of products to date.  In the future, we may generate revenue from product sales, royalties on product sales, reimbursements for collaboration services under our current collaboration agreements, or license fees, milestones, or other upfront payments if we enter into any new collaborations or license agreements.  We expect that our future revenue will fluctuate from quarter to quarter for many reasons, including the uncertain timing and amount of any such payments and sales.

Our license and milestone revenue has been generated primarily from our license agreement with KHK, our license agreement with AbbVie, and our collaboration agreement with AbbVie and consists of upfront payments and milestone payments.  Under our revenue recognition policy, license revenue associated with upfront, non-refundable

 

license payments received under the license and collaboration agreements with AbbVie and KHK are deferred and recognized ratably over the expected term of the performance obligations under the agreements, which extend through 2017, 2021, and 2026 for the AbbVie license agreement, the KHK license agreement, and the AbbVie collaboration agreement, respectively.  Milestones and other variable consideration are evaluated and recorded when they are no longer constrained over the expected term of the performance obligations under the agreements.  As of November 2017, the deferred revenue related to the AbbVie license agreement has been fully recognized, which resulted in a decrease in license revenue recognized in 2018.

During the nine months ended September 30, 2018, we adopted Topic 606 and recorded an adjustment of $2.6 million to increase accumulated deficit and increase deferred revenue.  During the nine months ended September 30, 2018, we included the regulatory milestone of $30 million as variable consideration to the transaction price.  For the nine months ended September 30, 2018, we received $30 million and recognized $21.9 million in collaboration revenue, including a cumulative catch-up for the portion of this milestone that was satisfied in prior periods.  The remainder of $8.1 million was recorded in deferred revenue on the balance sheet and will be recognized over the remaining performance obligation period.  Additionally, we recognized approximately $3.6 million in related license fees and other expenses related to achievement of this regulatory milestone.

Due to the adoption of Topic 606, collaboration revenue was decreased and net loss was increased by $3.3 million and $7.6 million for the three and nine months ended September 30, 2018, respectively.  Basic and diluted net loss per share increased by $0.12 and $0.28 for the three and nine months ended September 30, 2018, respectively.  

We also have other license revenue, which consists of milestone payments from a disease advocacy organization in 2017, and other revenue, which consists of reimbursements from KHK for expenses incurred to obtain drug supplies.

Research and Development Expenses

The largest component of our total operating expenses has historically been our investment in research and development activities, including the clinical development of our product candidates.  From our inception through September 30, 2018, we have incurred a total of $621.4 million in research and development expense, the majority of which relates to the development of bardoxolone methyl and omaveloxolone.  We expect our research and development expense to continue to increase in the future as we advance bardoxolone methyl and omaveloxolone through ongoing and future clinical trials, scale manufacturing for registrational and validation purposes, advance other product candidates into mid and later stage clinical trials, and expand our product candidate portfolio.  The process of conducting the necessary clinical research to obtain regulatory approval is costly and time-consuming, and we consider the active management and development of our clinical pipeline to be crucial to our long-term success.  The actual probability of success for each product candidate and preclinical program may be affected by a variety of factors, including the safety and efficacy data for product candidates, investment in the program, competition, manufacturing capability, and commercial viability.

Research and development expenses include:

 

Research and development costs are expensed as incurred.  Costs for certain development activities such as clinical trials are recognized based on an evaluation of the progress to completion of specific tasks using information and data provided to us by our vendors and our clinical sites.

We base our expense accruals related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and contract research organizations (CROs) that conduct and manage clinical trials on our behalf.  The financial terms of these agreements vary from contract to contract and may result in uneven payment flows.  Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones.  In accruing costs, we estimate the time period over which services will be performed and the level of effort to be expended in each period.  If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates.

To date, we have not experienced significant changes in our estimates of accrued research and development expenses after a reporting period.  However, due to the nature of estimates, we cannot assure you that we will not make changes to our estimates in the future as we become aware of additional information about the status or conduct of our clinical trials and other research activities.

Currently, AbbVie is not participating in the development of bardoxolone methyl for the treatment of CKD caused by Alport syndrome, PH, or other rare kidney diseases, and they are therefore currently not incurring any costs for this program.  AbbVie has the right to opt-in to these programs at any time during development.  Upon opting-in, AbbVie would be required to pay an agreed upon amount of all development costs accumulated up to the point of exercising their opt-in right.  All development costs incurred after AbbVie’s opt-in would be split equally.

In September 2016, we and AbbVie mutually agreed that we would continue unilateral development of omaveloxolone.  Therefore, AbbVie no longer co-funds the exploratory development costs of this program, but retains the right to opt back in at certain points in development.  Depending upon what point, if any, AbbVie opts back into development, AbbVie may retain its right to commercialize a product outside the United States, or we may be responsible for commercializing the product on a worldwide basis.  Upon opting back in, AbbVie would be required to pay an agreed upon amount of all development costs accumulated up to the point of exercising their opt-in right, after which development costs incurred and product revenue worldwide would be split equally.  For the three and nine months ended September 30, 2018, no payments related to shared research and development costs were received.

The following table summarizes our research and development expenses incurred:

 

The program-specific expenses summarized in the table above include costs that we directly allocate to our product candidates.  Our other research and development expenses include research and development salaries, benefits, stock-based compensation, and preclinical, research, and discovery costs, which we do not allocate on a program-specific basis.

 

General and Administrative Expenses

General and administrative expenses consist primarily of employee-related expenses for executive, operational, finance, legal, compliance, and human resource functions.  Other general and administrative expenses include facility-related costs, professional fees, accounting and legal services, depreciation expense, other external services, and expenses associated with obtaining and maintaining our intellectual property rights.

We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our increased research and development efforts, expand facilities to accommodate growth, and plan for commercialization of our product candidates.  We have also incurred increased expenses associated with being a public company, including exchange listing and SEC requirements, director and officer insurance premiums, legal, audit, and tax fees, regulatory compliance programs, and investor relations costs.  Additionally, if and when we believe the first regulatory approval of one of our product candidates appears likely, we anticipate an increase in payroll and related expenses as a result of our preparation for commercial operations, especially for the sales and marketing of our product candidates.

Investment Income

Investment income represents interest and gains earned on our cash and cash equivalents, which include money market funds.

Interest Expense

Commencing in March 2017, interest expense is primarily attributable to interest charges associated with borrowings under our Loan Agreement.

Loss on Extinguishment of Debt

On June 14, 2018, we entered into the Restated Agreement with the Lenders.  The debt modification was considered substantial and resulted in a loss on extinguishment of debt from the difference between the amount paid to modify the debt and the net carrying amount of the extinguished debt.

Provision for Taxes on Income

Provision for taxes on income consists of net loss, taxed at federal tax rates and adjusted for certain permanent differences.  We maintain a valuation allowance against the majority of our net deferred tax assets.  Changes in this valuation allowance also affect the tax provision.

 

 

Results of Operations

Comparison of the Three Months Ended September 30, 2018 and 2017 (unaudited)

The following table sets forth our results of operations for the three months ended September 30:

 

 

Revenue

License and milestone revenue represented approximately 92% and 100% of total revenue for the three months ended September 30, 2018 and 2017, respectively.  License and milestone revenue decreased by $7.7 million, or 62%, for the three months ended September 30, 2018, compared to the three months ended September 30, 2017.  The decrease was primarily due to an adjustment in the calculation of revenue related to a regulatory milestone included as variable consideration in the transaction price under the KHK agreement and the full recognition of deferred revenue for the AbbVie license agreement in November 2017 offset by milestone revenue recognized from a disease advocacy organization in July 2018.

Under Topic 606, we recognize revenue over the expected term of the performance obligations under the agreements.  Following the nine months ended September 30, 2018, we anticipate quarterly recognition of revenue totaling approximately $7.8 million, composed of $6.6 million and $1.2 million from the AbbVie collaboration agreement and the KHK agreement, respectively.  These estimates do not include any potential adjustments that might be needed due to changes in the estimated performance obligation period or adjustments to the estimated transaction price resulting from our periodic re-evaluations of milestones.

Other revenue increased by $0.4 million, or 630%, during the three months ended September 30, 2018 compared to the three months ended September 30, 2017, primarily due to revenue recognized for reimbursements of expenses from KHK for expenses incurred.

 

Deferred revenue for the AbbVie license agreement was fully recognized in November 2017.  Deferred revenue for the AbbVie collaboration agreement and the KHK agreement are recognized ratably through December 2026 and December 2021, respectively.  The following table summarizes the sources of our revenue for the three months ended September 30:

 

 

Research and Development Expenses

Research and development expenses increased by $8.8 million, or 48%, for the three months ended September 30, 2018, compared to the three months ended September 30, 2017.  The increase was primarily due to $5.7 million in expanded clinical and manufacturing activities, primarily for CARDINAL, MOXIe, and PHOENIX, offset by decreased clinical activities for LARIAT, $1.2 million in increased medical affairs activities, $1.1 million in personnel expense to support expanded development activities, and $0.4 million in compensation expense.

Research and development expenses, as a percentage of total expenses, was 78% and 75% for the three months ended September 30, 2018 and 2017, respectively.  The increase in the ratio of research and development expenses to total expenses of 3% was primarily due to increases in clinical development activities.

General and Administrative Expenses

General and administrative expenses increased by $1.3 million, or 22%, for the three months ended September 30, 2018, compared to the three months ended September 30, 2017.  The increase was primarily due to $0.8 million in compensation expense, and $0.7 million in personnel expense to support growth in the organization and expanded development activities.

General and administrative expenses, as a percentage of total expenses, was 22% and 25%, for the three months ended September 30, 2018 and 2017, respectively.  The decrease in the ratio of general and administrative expenses to total expenses of 3% was primarily due to increases in clinical development activities, which increased research and development expenses.

Investment Income

The increase in investment income for the three months ended September 30, 2018, compared to the three months ended September 30, 2017, was due to investment and interest income earned on cash equivalents.

Interest Expense

Interest expense increased by $1.9 million, or 388%, for the three months ended September 30, 2018 compared to the three months ended September 30, 2017.  The increase was attributable to interest charge associated with additional borrowings under our Restated Agreement entered in June 2018.

 

Provision for Taxes on Income

Provision for taxes on income was immaterial for the three months ended September 30, 2018 and 2017.

Comparison of the Nine Months Ended September 30, 2018 and 2017 (unaudited)

The following table sets forth our results of operations for the nine months ended September 30:

 

 

Revenue

License and milestone revenue represented approximately 98% and 99% of total revenue for the nine months ended September 30, 2018 and 2017, respectively.  License and milestone revenue increased by $6.9 million, or 18%, for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.  The increase was primarily due to additional revenue of $22.4 million related to the KHK agreement, including $21.9 million related to the KHK milestone payment that was partially recognized in accordance with Topic 606 during the nine months ended September 30, 2018, offset by the full recognition of deferred revenue for the AbbVie license agreement in November 2017.

Other revenue increased by $0.2 million, or 37%, during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017, primarily due to revenue recognized for reimbursements of expenses from KHK for expenses incurred.

 

Deferred revenue for the AbbVie license agreement was fully recognized in November 2017.  Deferred revenue for the AbbVie collaboration agreement and the KHK agreement are recognized ratably through December 2026 and December 2021, respectively.  The following table summarizes the sources of our revenue for the nine months ended September 30:

 

 

Research and Development Expenses

Research and development expenses increased by $21.1 million, or 42%, for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.  The increase was primarily due to $13.7 million in expanded clinical and manufacturing activities, primarily for CATALYST, CARDINAL, MOXIe, and PHOENIX, offset by decreased clinical activities for LARIAT and RTA 901, and preclinical and manufacturing activities for bardoxolone methyl and omaveloxolone, $3.7 million in increased medical affairs activities, $2.2 million in personnel expense to support growth in our development activities, and $1.2 million in equity compensation expense.

Research and development expenses, as a percentage of total expenses, was 74% for the nine months ended September 30, 2018 and 2017.  Increases in clinical development activities, which increased research and development expenses, were offset by increases in sublicense fees and other expenses related to the achievement of the KHK milestone, which increased general and administrative expenses.

General and Administrative Expenses

General and administrative expenses increased by $7.5 million, or 43%, for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.  The increase was primarily due to $3.6 million sublicense fees and other expenses from the achievement of the KHK milestone, $1.9 million in equity compensation expense, $1.0 million in personnel expense to support growth in the organization and expanded development activities, and $1.1 million in commercial research activities.

General and administrative expenses, as a percentage of total expenses, was 26% and 25% for the nine months ended September 30, 2018 and 2017, respectively.  Increases in sublicense fees and other expenses related to the achievement of the KHK milestone, which increased general and administrative expenses, were offset by increases in clinical development activities, which increased research and development expenses.

Investment Income

The increase in investment income for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017, was due to investment and interest income earned on cash equivalents.

 

Interest Expense

Interest expense increased by $2.8 million, or 295%, for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.  The increase was attributable to interest charge associated with additional borrowings under our Restated Agreement entered in June 2018.

Loss on Extinguishment of Debt

Loss on extinguishment of debt increased by $1.0 million, or 100%, for the nine months ended September 30, 2018, compared to nine months ended September 30, 2017, due to the terms of our Restated Agreement.  The loss on modification of debt represents the differences between the amount paid to modify the debt and the net carrying amount of the extinguished debt.

Provision for Taxes on Income

Provision for taxes on income was immaterial for the nine months ended September 30, 2018 and 2017.

Cash-based Operating Expenses (non-GAAP) for the Three and Nine Months ended September 30, 2018

Our cash-based operating expenses (a non-GAAP measure calculated as total expenses, less stock-based compensation expense and depreciation and amortization expense) were $31.9 million and $89.0 million for the three and nine months ended September 30, 2018, respectively, compared to $22.9 million and $63.4 million for the three and nine months ended September 30, 2017, respectively.  

Cash-based operating expenses for the quarters ended September 30 and June 30, 2018, were $31.9 million and $31.6 million, respectively.  Cash-based operating expenses for the three months ended June 30, 2018 included the additional sublicense fees and other expenses from the achievement of the KHK milestone. We expect our cash-based operating expenses to continue to increase in the future as we advance bardoxolone methyl and omaveloxolone through ongoing and future clinical trials, scale manufacturing for registrational and validation purposes, advance other product candidates into mid and later stage clinical trials, expand our product candidate portfolio, increase both our research and development and administrative personnel, and plan for commercialization of our product candidates.  

We believe cash-based operating expenses, in addition to GAAP financial measures, provides a meaningful measure of our ongoing business and operating performance, by allowing investors to analyze our financial results similarly to how management analyzes our financial results by viewing period expense totals more indicative of effort directly expended to advance the business and our product candidates. The table below reconciles cash-based operating expenses to total expenses as reported on the Unaudited Consolidated Statements of Operations:

 

 

 

 

 

 

Liquidity and Capital Resources

Since our inception, we have funded our operations primarily through collaboration and license agreements, the sale of preferred and common stock, and secured loans.  Through September 30, 2018, we have raised gross cash proceeds of $476.6 million through the sale of convertible preferred stock and received $780.0 million from payments under license and collaboration agreements, $402.7 million in net proceeds from our IPO and follow-on offering of our Class A common stock, and $77.3 million in net proceeds from our Restated Agreement and Loan Agreement.  As of September 30, 2018, we had available cash and cash equivalents of approximately $375.2 million.  Our cash and cash equivalents are invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation.

On July 27, 2018, the Company closed a follow-on underwritten public offering of 3,450,000 shares of its Class A common stock for gross proceeds of $248.4 million.  Net proceeds to the Company from the offering were approximately $232.8 million, after deducting underwriting discounts and commissions and offering expenses.

Cash Flows

The following table sets forth the primary sources and uses of cash for each of the nine months ended September 30 set forth below:

 

 

Operating Activities

Net cash used in operating activities was $46.3 million for the nine months ended September 30, 2018, consisting primarily of a net loss of $55.0 million adjusted for non-cash items including stock-based compensation expense of $7.8 million, depreciation and amortization expense of $0.9 million, loss on extinguishment of debt of $1.0 million and a net increase in operating assets and liabilities of $1.0 million.  The significant items in the change in operating assets and liabilities include an increase in prepaid expenses, other current assets, and other assets of $1.3 million primarily due to receivables from KHK related to reimbursement for expenses incurred, an increase in accrued direct research and other current and long-term liabilities of $10.8 million due clinical trial activities, and a decrease in deferred revenue of $13.5 million.  The decrease in deferred revenue is due to the ratable recognition of revenue over the expected term of the performance obligations under our collaboration agreements with AbbVie and KHK, which resulted in recognition of $43.5 million of license and milestone revenue, offset by the achievement of the regulatory milestone of $30 million related to the KHK agreement, which was recognized as deferred revenue.

 

Net cash used in operating activities was $58.5 million for the nine months ended September 30, 2017, consisting primarily of net loss of $31.0 million adjusted for non-cash items including stock-based compensation expense of $4.7 million, depreciation and amortization expense of $0.4 million, and a net decrease in operating assets and liabilities of $32.6 million.  The significant items in the change in operating assets and liabilities include an increase of prepaid expenses, other current assets, and other assets of $1.5 million due to clinical trial prepayments and reimbursements due from KHK, a decrease in account payable of $1.4 million due to timing of vendor payments, an increase in accrued direct research and other current liabilities of $7.4 million due clinical trial activities, and a decrease in deferred revenue of $37.1 million.  The decrease in deferred revenue relates to the timing of upfront payments and ratable recognition of revenue over the expected term of the performance obligations under our collaboration agreements with AbbVie and KHK, resulting in recognition of $37.1 million of license and milestone revenue.

Investing Activities

Net cash used in investing activities consisted of purchases and sales of property and equipment.  Net cash used in investing activities for the nine months ended September 30, 2018 and 2017 was not significant.

Financing Activities

Net cash provided by financing activities was $292.1 million, primarily due to net proceeds of $232.8 million from our follow-on public offering and $57.7 million from our Restated Agreement for the nine months ended September 30, 2018.

Net cash provided by financing activities was $128.6 million, primarily due to net proceeds of $108.5 million from our follow-on public offering and $19.7 million from our Loan Agreement for the nine months ended September 30, 2017.

Operating Capital Requirements

To date, we have not generated any revenue from product sales.  We do not know when or whether we will generate any revenue from product sales.  We do not expect to generate significant revenue from product sales unless and until we obtain regulatory approval of and commercialize one or more of our current or future product candidates.  The probability of success for each of our product candidates and clinical programs and our ability to generate product revenue and become profitable depend upon a variety of factors, including the quality of the product candidate, clinical results, investment in the program, competition, manufacturing capability, commercial viability, and our collaborators’ ability to successfully execute our development and commercialization plans.  We anticipate that we will continue to generate losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin to commercialize any approved products.  We are subject to all the risks related to the development and commercialization of novel therapeutics, and we may encounter unforeseen expenses, difficulties, complications, delays, and other unknown factors that may adversely affect our business.  

We expect our research and development expense to continue to increase in the future as we advance bardoxolone methyl and omaveloxolone through ongoing and future clinical trials, scale manufacturing for registrational and validation purposes, advance other product candidates into mid and later stage clinical trials, and expand our product candidate portfolio.

We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our increased research and development efforts, expand facilities to accommodate growth, and plan for commercialization of our product candidates.  We have also incurred increased expenses associated with being a public company, including exchange listing and SEC requirements, director and officer insurance premiums, legal, audit, and tax fees, regulatory compliance programs, and investor relations costs.  Additionally, if and when we believe the first regulatory approval of one of our product candidates appears likely, we anticipate an increase in payroll and related expenses as a result of our preparation for commercial operations, especially for the sales and marketing of our product candidates.  We anticipate that we will need substantial additional funding in connection with our continuing operations.

 

On June 14, 2018, we amended and restated our Loan Agreement.  Under our Restated Agreement, the Term A Loan was increased from $20 million to $80 million, of which Reata borrowed an additional $60 million on June 14, 2018, which resulted in an outstanding principal balance of $80 million under the Term A Loan at June 14, 2018.  We may, at our sole discretion, borrow additional $45 million under the Term B Loan, upon the achievement of one of two milestones.  If we borrow under the Term B Loan, we expect to incur additional related interest expense.

In November 2017, the Company entered into an at-the-market equity offering sales agreement with Stifel, Nicolaus & Company, Incorporated, that established a program pursuant to which it may offer and sell up to $50 million of its Class A common stock from time to time in at-the-market transactions as stated in the prospectus supplement filed with the SEC pursuant to Rule 424(b)(5), dated as of November 9, 2017.  In July 2018, the Company suspended this program. The Company intends to reopen this program following the filing of its Form 10-Q for the quarter ending September 30, 2018.  To date, no sales have been made under the Company’s at-the-market offering program.

On July 27, 2018, the Company closed a follow-on underwritten public offering of 3,450,000 shares of its Class A common stock for gross proceeds of $248.4 million.  Net proceeds to the Company from the offering were approximately $232.8 million, after deducting underwriting discounts and commissions and offering expenses.

Our longer term liquidity requirements will require us to raise additional capital, such as through additional equity financings, debt financings, collaborations, or license agreements.  Our future capital requirements will depend on many factors, including the receipt of milestones under our current collaboration agreements and the timing of our expenditures related to clinical trials.  We believe our existing cash and cash equivalents will be sufficient to enable us to fund our operating expenses and capital expenditure requirements into 2021.  However, we anticipate opportunistically raising additional capital before that time through equity offerings, collaboration or license agreements, or additional debt in order to maintain adequate capital reserves.  In addition, we may choose to raise additional capital at any time for the further development of our existing product candidates and may also need to raise additional funds sooner to pursue other development activities related to additional product candidates.  Decisions about the timing or nature of any financing will be based on, among other things, our perception of our liquidity and of the market opportunity to raise equity or debt.  Additional securities may include common stock, preferred stock, or debt securities.  We may explore strategic collaborations or license arrangements for certain of our earlier stage assets, including RTA 901 and RTA 1701.  If we do explore any arrangements, there can be no assurance that any agreement will be reached, and we may determine to cease exploring a potential transaction for any or all of the assets at any time.  If an agreement is reached, there can be no assurance that any such transaction would provide us with a material amount of additional capital resources.

Until we can generate a sufficient amount of revenue from our product candidates, if ever, we expect to finance future cash needs through public or private equity or debt offerings, commercial loans, and collaboration or license transactions.  Additional capital may not be available on reasonable terms, if at all.  If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back, or discontinue the development or commercialization of one or more of our product candidates.  If we raise additional funds through the issuance of additional equity or debt securities, it could result in dilution to our existing stockholders or increased fixed payment obligations, and any such securities may have rights senior to those of our common stock.  If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell, or license intellectual property rights, and other operating restrictions that could adversely affect our ability to conduct our business, and any such debt could be secured by some or all of our assets.  Any of these events could significantly harm our business, financial condition, and prospects.  For a description of the numerous risks and uncertainties associated with product development and raising additional capital, see “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Our forecast of the period 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.  We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.  Our future funding requirements, both near- and long-term, will depend on many factors, including, but not limited to:

If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition, and results of operations could be materially adversely affected.

Contractual Obligations and Commitments

As of September 30, 2018, there have been no material changes, outside of the ordinary course of business, in our outstanding contractual obligations from those disclosed within “Management's Discussion and Analysis of Financial Condition and Results of Operations”, as contained in our Annual Report on Form 10-K for year ended December 31, 2017, other than the following:

As of September 30, 2018, our contractual obligations were as follows:

 

 

 

Clinical Trials

As of September 30, 2018, we have several ongoing clinical trials in various stages.  Under agreements with various CROs and clinical trial sites, we incur expenses related to clinical trials of our product candidates and potential other clinical candidates.  The timing and amounts of these disbursements are contingent upon the achievement of certain milestones, patient enrollment, and services rendered or as expenses are incurred by the CROs or clinical trial sites.  Therefore, we cannot estimate the potential timing and amount of these payments and they have been excluded from the table above.

 

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities in our financial statements.  On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, accrued research and development expenses, income taxes, and stock-based compensation.  We base our estimates on historical experience, known trends and events, and various other factors that we believe 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.  Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 of Part I, Item 1 of this Quarterly Report on Form 10-Q and in Part I, Item 7, “Critical Accounting Policies and Significant Judgments and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2017.  During the quarter ended March 31, 2018, we adopted Topic 606.  As a result of this adoption, we updated our Revenue Recognition policies.  There have been no other changes to our critical accounting policies and estimates since our Annual Report on Form 10-K for the year ended December 31, 2017.

Off-Balance Sheet Arrangements

Since our inception, we have not had any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements, and we have not engaged in any other off-balance sheet arrangements, as defined in the rules and regulations of the SEC.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements, please see Note 2 of Notes to Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.

Non-GAAP Financial Measures

In addition to the U.S. GAAP financial measures, this Form 10-Q includes cash-based operating expenses, a non-GAAP financial measure, which the Company defines as total expenses excluding stock-based compensation expense and depreciation and amortization expense.  A reconciliation of this non-GAAP financial measure to its most directly comparable U.S. GAAP financial measure is included.  

Non-GAAP financial measures should be considered in addition to, not in isolation or as a substitute for, U.S. GAAP financial measures.  In addition, our non-GAAP financial measure may differ from similarly named measures used by other companies.  

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to market risks in the ordinary course of our business.  These market risks are principally limited to interest rate fluctuations.  We had cash and cash equivalents of $375.2 million at September 30, 2018,

 

consisting primarily of funds in operating cash accounts.  The primary objective of our investment activities is to preserve principal and liquidity while maximizing income without significantly increasing risk.  We do not enter into investments for trading or speculative purposes.  Due to the short-term nature of our investment portfolio, we do not believe an immediate increase of 100 basis points in interest rates would have a material effect on the fair market value of our portfolio, and accordingly we do not expect a sudden change in market interest rates to affect materially our operating results or cash flows.

We also have interest rate exposure as a result of our Term A Loan.  As of September 30, 2018, the outstanding principal amount of our Term A Loan was $80.0 million.  Our Term A Loan bears interest at a floating per annum rate calculated as 7.79% plus the greater of the 30-day U.S. Dollar LIBOR rate reported in The Wall Street Journal or 1.91%, with a minimum rate of 9.7% and a maximum rate of 12.29%.  Changes in the U.S. Dollar LIBOR rate may therefore affect our interest expense associated with the Term A Loan.  An increase of 100 basis points in interest rates would increase expense by approximately $0.8 million annually based on the amounts currently outstanding and would not materially affect our results of operations.

We contract with research, development, and manufacturing organizations and investigational sites globally.  Generally, these contracts are denominated in U.S. dollars.  However, we may be subject to fluctuations in foreign currency rates in connection with agreements not denominated in U.S. dollars.  We do not hedge our foreign currency exchange rate risk.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2018.  The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are 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 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, 2018, 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 have been no changes in our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15(d)-15(f) promulgated under the Exchange Act, during the nine months ended September 30, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently subject to any material legal proceedings.

 

Item 1A. Risk Factors.

In addition to other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors and other cautionary statements described under the heading “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2017, which could materially affect our businesses, financial condition, or future results.  Additional risks and uncertainties currently unknown to us, or that we currently deem to be immaterial, also may materially adversely affect our business, financial condition, or future results.  There have been no material changes in our risk factors from those described in the Annual Report on Form 10-K for the year ended December 31, 2017.

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

Unregistered Sales of Equity Securities

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information.

None.

 

Item 6. Exhibits.

 

 

 

 

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.