ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion and analysis should be read together with our consolidated financial statements and the notes to those statements included elsewhere in this Form 10-Q. This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the section entitled “Risk Factors” and this Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-looking statements include, but are not limited to:

 

•

the sufficiency of our cash and cash equivalents and cash generated from operations to meet our working capital and capital expenditure needs for the next 12 months, including our belief that we have sufficient cash resources to fund our costs leading up to the potential commercial launch of PF708 in the United States as early as the fourth quarter of 2019, subject to FDA approval of the new drug application and other factors;

 

•

our and any potential future collaboration partner’s ability to enroll patients in our clinical studies at the pace that we project;

 

•

our expectations regarding the initiation, timing, progress and the success of the design, primary and secondary end points, and duration of the clinical trials and planned clinical trials and studies for PF708, and our other product candidates, including our human factors study for PF708, and reporting results from same;

 

•

whether the results of our and our collaboration partners’ trials and studies will be sufficient to support domestic or global regulatory filings and approvals for PF708, including our expectations regarding the timing of receipt of approval by FDA of our NDA submitted in December 2018 for PF708 and whether we are able to obtain an “A” therapeutic equivalence designation for PF708 to the reference listed drug Forteo;

 

•

our and our collaboration partners’ ability to seek, obtain and maintain regulatory approval of PF708 or our other product candidates, and the timing of such potential regulatory approvals;

 

•

our ability to obtain an FDA determination that PF708 is therapeutically equivalent to Forteo;

 

•

our expectations regarding the earliest potential commercial launch of PF708 in the United States;

 

•

our reliance on third-parties to conduct clinical studies;

 

•

our reliance on third-party contract manufacturers and Alvogen to manufacture and supply our product candidates for us;

 

•

the benefits of the use of PF708, Px563L, RPA563 or any of our other product candidates;

 

•

the rate and degree of market acceptance of PF708, Px563L, RPA563 or any of our other product candidates, if approved for sale;

 

•

regulatory developments in the United States and foreign countries;

 

•

our expectations regarding government and third-party payor coverage and reimbursement;

 

•

our and our collaboration partners’ ability to manufacture PF708, Px563L, RPA563 and our other product candidates in conformity with regulatory requirements and to scale up manufacturing of PF708, Px563L, RPA563 and our other product candidates to commercial scale;

 

•

our ability to successfully build a specialty sales force, or collaborate with third-parties including our existing collaboration partners, Alvogen and NT Pharma, to commercialize PF708 and our other product candidates;

 

•

our and our collaboration partners’ ability to compete with companies currently producing the reference products, including Forteo;

 

•

our ability to compete with companies that may also seek and obtain approval for therapeutically equivalent versions of Forteo;

 

•

our reliance on Jazz, Alvogen, NT Pharma and any future collaboration partner’s performance over which we do not have control;

 

•

our ability to retain and recruit key personnel, including development of a sales and marketing function;

 

21

•

our ability to obtain and maintain intellectual property protection for PF708, Px563L, RPA563, our Pfēnex Expression Technology or any other product candidates;

 

•

our estimates of our expenses, ongoing losses, future revenue, capital requirements and our needs for or ability to obtain additional financing;

 

•

our expectations regarding the market size, size of patient populations, and growth potential for our product candidates, if approved for commercial use;

 

•

our estimates of the expected patent expiration timelines for Forteo and other branded reference drugs and biologics;

 

•

our expectations regarding the time during which we will be an emerging growth company under the Jumpstart Our Business Startups Act;

 

•

our ability to develop new products and product candidates;

 

•

our ability to successfully establish and successfully maintain appropriate collaborations and derive significant revenue from those collaborations;

 

•

our financial performance; and

 

•

developments and projections relating to our competitors and our industry.

Forward-looking statements include statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” or similar expressions and the negatives of those terms.

Forward-looking statements 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 the forward-looking statements. We discuss these risks in greater detail in Part II, Item 1A, “Risk Factors,” elsewhere in this Form 10-Q filed with the Securities and Exchange Commission, or SEC. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Form 10-Q. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this prospectus, and although we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted a thorough inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.

Except as required by law, we assume no obligation to update these forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. You should read this Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect.

This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain diseases, including data regarding the estimated size of those markets. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market, and other data from reports, research surveys, studies, and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data, and similar sources.

Pfēnex ^TM and Pfēnex Expression Technology ^® are our primary registered trademarks. Other service marks, trademarks, and trade names referred to in this Form 10-Q are the property of their respective owners.

In this Form 10-Q, “we,” “us” and “our” refer to Pfenex Inc. and its subsidiaries.

Overview

We are a clinical-stage development and licensing biotechnology company focused on leveraging our Pf ēnex Expression Technology to develop and improve protein therapies for unmet patient needs. Using the patented Pf ēnex Expression Technology platform, we have created an advanced pipeline of potential therapeutic equivalents, novel biologics, vaccine and vaccine components, and biosimilars. Our lead product candidate is PF708, under development as a therapeutic equivalent drug candidate to Forteo ^® (teriparatide) indicated for the treatment of osteoporosis. In December 2018, we submitted our new drug application (NDA) for PF708 to the United States Food and Drug Administration (FDA) and the FDA accepted the submission for substantive review in February 2019. In addition, we are developing

 

22

hematology/oncology products including PF743, a recombinant crisantaspase, and PF745, a recombinant crisantaspase with half-life extension, in collaboration with Jazz Pharmaceuticals Ireland Limited (Jazz). Both PF743 and PF745 are being developed for the treatment of Acute Lymphoblastic Leukemia (ALL). We also use our Pf ēnex Expression Technology platform to produce CRM197, a diphtheria toxoid carrier protein used in prophylactic and therapeutic vaccine candidates under development by third parties.

Product Candidates and Collaborations

The following table summarizes certain information about our lead product candidates and collaborations:

 

Product Candidate		Branded Reference Drug		Program		Proposed Indication
Proposed Therapeutic Equivalent
PF708 – Teriparatide		Forteo		•  Licensed in the United States, EU, MENA, and Rest of World to Alvogen •  Licensed in Mainland China, Hong Kong, Singapore, Malaysia, Thailand to NT Pharma		Osteoporosis
Multiple Hematology/Oncology Product Candidates		Various		•  Jazz Pharmaceuticals Ireland Limited		Various

Our lead product candidate and collaborations include the following:

 

•

PF708 – our teriparatide drug candidate.  PF708 is being developed as a therapeutic equivalent candidate to Forteo, which is approved and marketed by Eli Lilly and Company for the treatment of osteoporosis in certain patients with a high risk of fracture. Forteo achieved $1.6 billion in global product sales in 2018. PF708 is being developed pursuant to the 505(b)(2) regulatory pathway in the U.S. and references Forteo as the Reference Listed Drug. In November 2017, we announced the interim pharmacokinetic (PK) results from Study PF708-301, which compared the effect of PF708 and Forteo in osteoporosis patients. In May 2018, we announced positive top-line results from our PF708-301 study, which showed comparable overall profiles between PF708 and Forteo after 24 weeks of daily injection in osteoporosis patients.

The PF708-301 study enrolled a total of 181 patients, with 90 patients receiving PF708 and 91 patients receiving Forteo. There were 82 patients who completed the study in the PF708 treatment group, compared with 81 patients in the Forteo treatment group. The primary study endpoint was anti-drug antibody (ADA) incidence after 24 weeks of drug treatment. The secondary study endpoints included mean percentage changes in lumbar-spine bone mineral density (BMD) and median percentage changes in bone turnover markers (BTM) after 24 weeks of drug treatment, as well as pharmacokinetic (PK) parameters for up to four hours after the first dose. Safety study endpoints were incidences of adverse events (AE) and serious adverse events (SAE).

There were two PF708-treated patients and two Forteo-treated patients that developed ADA during the study. These low rates of immunogenicity are consistent with historical Forteo results (~3%) in postmenopausal osteoporosis patients. At Week 24, there were two ADA-positive findings for PF708 compared with none for Forteo, but the difference was not statistically significant. The ADA findings in the two PF708 patients were low in titer and resolved during follow-up. One of the two patients had  in vitro neutralizing activity transiently detected at Week 4. However, pharmacological activity, as assessed by increases in BMD and BTM, was observed during the study for this patient. There were no apparent safety issues or abnormal serum calcium levels related to ADA or neutralizing antibody findings. These findings are consistent with observations in follow-on biologics and biosimilars approved in the United States, with almost all of the products demonstrating an ADA treatment difference of less than 5% in comparative patient studies. The overall ADA results are shown in Table 1, and individual titer results for all ADA-positive patients are shown in Table 2 (below).

PF708 and Forteo demonstrated comparable effects on lumbar-spine BMD, P1NP (N-terminal propeptide of type 1 procollagen), which is a marker of bone formation and CTX (cross-linked C-terminal telopeptide of type 1 collagen), which is a marker of bone resorption. There were no statistically significant differences in any of these parameters between PF708 and Forteo. The lumbar-spine BMD results are shown in Figure 1 (below), and BTM results are shown in Figure 2 (below).

There were no significant imbalances in AE incidences or severity profiles between PF708 and Forteo. Treatment-emergent AE and SAE profiles are shown in Table 3 (below), and the severity of treatment-emergent AEs is shown in Table 4 (below).

 

23

The PF708-301 study assessed PF708 and Forteo across multiple endpoints in both female and male osteoporosis patients and showed comparable overall profiles. We believe the PF708-301 and PF708-101 study results meet the requirements for demonstrating clinical safety, effectiveness and bioequivalence to support regulatory approval. These results from the PF708-301 study, along with the previously announced bioequivalence findings from the PF708-101 study in healthy subjects, supported our PF708 NDA submitted in December 2018. In July 2018 we had a constructive Pre-NDA meeting with the FDA which confirmed there were no additional clinical, nonclinical or analytical comparability studies requested by the FDA. We filed our NDA in December 2018 and the FDA accepted our submission for substantive review in February 2019, which we believe puts us and Alvogen on-track for a potential commercial launch in the United States as early as the fourth quarter of 2019, subject to FDA approval of the application and other factors.

PF708 is being developed pursuant to the 505(b)(2) regulatory pathway in the U.S. and references Forteo as the Reference Listed Drug. While we believe our application strategy could lead to launch in the U.S. as early as the fourth quarter of 2019, subject to FDA approval of the application, it is possible that various factors may delay potential approval and launch. We believe that our existing cash and cash equivalents and our cash inflow from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months, including to fund all our necessary obligations leading up to the potential commercial launch in the United States as early as the fourth quarter of 2019, subject to FDA approval of the NDA and other factors. We believe the PF708 program in the U.S. may be leveraged for regulatory filings in other geographies, such as the European Union (EU). Alvogen, our collaboration partner, submitted a centralized application to the European Medicines Agency for Teriparatide on May 6, 2019.

Table 1. Study PF708-301 Overall Anti-Drug Antibody Results

 

Time (wk)		PF708								Forteo								P value
0			0/90				0	%			0/91				0	%			1.00
1			1/87				1.2	%			0/90				0	%			0.49
4			1/86				1.2	%			0/89				0	%			0.49
12			2/82				2.4	%			2/86				2.3	%			1.00
24			2/81				2.5	%			0/81				0	%			0.50
24 week overall			2/87				2.3	%			2/90				2.2	%			1.00

Table 2. Study PF708-301 Anti-Drug Antibody Titer Results for Individual Patients

 

Time (wk)		PF708 Patient 1		PF708 Patient 2		Forteo Patient 1		Forteo Patient 2
0		Neg		Neg		Neg		Neg
1		1:1		Neg		Neg		Neg
4		1:1 *		Neg		Neg		Neg
12		1:1		1:1		1:8		1:2
24		1:1		1:1		Neg		Neg
Follow-up		Neg		Neg		N/A		N/A

 

 

*	In vitro neutralizing activity detected; pharmacological activity, as assessed by changes in BMD and BTM, was observed during the study for this patient.

Antibody titer measures how much ADA is present in a positive sample. A value of 1:1 is the lowest possible finding, whereas a value of 1:8 represents an 8-fold increase.

Neg: negative; N/A: not applicable

Table 3. Study PF708-301 Treatment-Emergent Adverse Event Profiles

 

Number and Percent of Patients with:		PF708								Forteo
Any AE			75				83.3	%			73				80.2	%
Any SAE			6				6.7	%			8				8.8	%
Any treatment-related AE			48				53.3	%			45				49.5	%
Any AE leading to early withdrawal			3				3.3	%			5				5.5	%
Any AE leading to death			0				0	%			0				0	%

AE: adverse event; SAE: serious adverse event

 

24

Table 4. Study PF708-301 Severity of Treatment-Emergent Adverse Events

 

				Grade     1				Grade     2				Grade     3				Grade     4				Total
All Findings		PF708			169				84				6				2				261
		Forteo			203				61				9				3				276
				Grade     1				Grade     2				Grade     3				Grade     4				Total
Injection Site Findings		PF708			36				1				0				0				37
		Forteo			33				1				0				0				34

Severity of AEs was assessed according to the Common Terminology Criteria for Adverse Events. Version 4.03

Figure 1. Study PF708-301 Lumbar-Spine Bone Mineral Density Results in Female and Male Patients

 

Figure 2. Study PF708-301 Bone Turnover Markers Results in All Patients

 

In June 2018, we and Alvogen entered into a Development and License Agreement (US Alvogen Agreement) pursuant to which Alvogen received the exclusive right to commercialize and manufacture PF708 in the United States. In February 2019 we and Alvogen expanded our collaboration, granting Alvogen exclusive rights to commercialize and manufacture PF708 in the EU, certain countries in the Middle East and North Africa (MENA), and the rest of world (ROW) territories (the latter defined as all countries

 

25

outside of the EU, US and MENA, excluding Mainland China, Hong Kong, Singapore, Malaysia and Thailand). We believe this collaboration leverages Alvogen’s established international experience and expertise in regulatory, IP and supply chain activities, as well as its established network of specialty marketing and sales pharmaceutical companies in these regions. Subject to applicable regulatory approvals, PF708 will be commercialized in Europe and Switzerland by Theramex, a leading global specialty pharmaceutical company dedicated to Women’s Health, in MENA by SAJA, a Tamer Group company, and in ROW by Alvogen’s current and/or future commercialization partners. Under the terms of the agreements, Alvogen will be responsible for the local activities through Theramex, SAJA and its other commercialization partners and for overseeing any clinical development, regulatory, litigation, commercial manufacturing and commercialization. We are eligible to receive additional upfront and milestone payments of $2.5 million for the EU and MENA and additional potential milestone payments for ROW. For EU, MENA and ROW, we may also be eligible to receive up to 60% of Alvogen’s gross profit derived from product sales, if approved, depending on geography and cost of goods sold.

In April 2018, we and China NT Pharma Group Company Ltd. (NT Pharma) entered into a Development and License Agreement (NT Pharma Agreement), pursuant to which we granted an exclusive license to NT Pharma to commercialize PF708 in Mainland China, Hong Kong, Singapore, Malaysia and Thailand and a non-exclusive license to conduct development activities in such territories with respect to PF708. In accordance with the agreement, we received a payment of $2.5 million upon signing the NT Pharma Agreement and may be eligible to receive additional payments of up to $22.5 million based on the achievement of certain development, regulatory, and sales-related milestones. We may also be eligible to receive double-digit royalties on net sales of PF708. NT Pharma is responsible for any further development required to achieve regulatory approval as well as commercialization activities in the applicable territories.

In accordance with regulatory requirements we provided notice of Paragraph IV certification (“Notice Letter”) to Eli Lilly and Company (“Lilly”) on February 19, 2019 that PF708 does not infringe any valid claim of the ’334 patent. Under the Hatch-Waxman Act, Lilly had 45 days from the receipt of the Notice Letter to file a patent infringement lawsuit against us that would cause a 30-month litigation stay of approval for PF708. On April 11, 2019 we announced the expiration of the 45-day period for Lilly to file a lawsuit under the Hatch-Waxman Act and stay the approval of PF708 for 30 months. Because Lilly did not file a lawsuit within this time period, there will be no 30-month litigation stay delaying approval of PF708, and if approved by the FDA, we and our collaboration partners will be able to engage in the commercial manufacture, use, or sale of PF708.

In addition to seeking FDA approval of our PF708 NDA, we are also seeking “A” therapeutic equivalence designation for PF708 to the reference listed drug Forteo. We have received guidance from the FDA on requirements for a therapeutic equivalence designation, which may allow automatic substitution for the reference listed drug, depending on the applicable health care statutes and policies within each of the 50 states. Consistent with our ongoing dialogue with the FDA and its draft guidance document on demonstrating the therapeutic equivalence of drug-device combination products, we are planning to conduct a comparative human factors study that will directly compare users’ experiences with the pen injectors of PF708 and Forteo. This study is intended to further support a finding that PF708 is therapeutically equivalent to Forteo, and we expect to complete the study and have a full report available for FDA review before the PDUFA date of October 7, 2019 for our PF708 NDA. Even if we complete this comparative human factors study in a timely manner, the FDA does not typically make a therapeutic equivalence determination with an approval decision for a 505(b)(2) NDA. As we have stated previously, therefore, if the FDA approves PF708, we do not anticipate receiving a decision on an A-rating at the same time; instead, we anticipate receiving a decision not long thereafter.

 

•

Jazz Collaboration – multiple early stage hematology/oncology product candidates with Jazz.  In July 2016, we entered into a license and option agreement with Jazz, pursuant to which we and Jazz are collaboratively developing hematology/oncology products, including PF743, a recombinant crisantaspase, and PF745, a recombinant crisantaspase with half-life extension technology, and Jazz will have the exclusive right to manufacture and commercialize such products throughout the world. In addition, pursuant to the agreement, we have granted Jazz certain other rights to negotiate the exclusive right to develop, manufacture and commercialize throughout the world other hematology/oncology products that are currently or in the future may be developed by us. In the third quarter of 2017, we achieved a process development milestone associated with this collaboration. In December 2017, we and Jazz signed an amended and restated agreement under which we will be eligible to receive an additional $43.5 million in amendment fee and development milestone payments as compared to the 2016 agreement, increasing the total value of upfront, option and amendment fee payments and potential payments for the achievement of development, regulatory and sales-related milestones associated with the collaboration to an aggregate of $224.5 million. We will also continue to be eligible to receive tiered royalties on worldwide sales of any products resulting from the collaboration at rates reduced from those under the 2016 agreement. In December 2017, as part of the amended and restated agreement, we received a total payment of $18.5 million, consisting of an upfront payment of $5.0 million and a payment of $13.5 million for development achievement. In the second quarter of 2018, we achieved two development milestones and received $750 thousand for successful achievement of process development milestones for PF745.

 

•

CRM197 – We have both licenses and supply agreements in place for CRM197, which is a non-toxic mutant of diphtheria toxin. It is a well-characterized protein and functions as a carrier for polysaccharides and haptens, making them immunogenic. We developed a unique CRM197 production strain based on our Pseudomonas fluorescens platform and

 

26

sell non-GMP and cGMP CRM197 to vaccine development-focused pharmaceutical partners. As a result of our development efforts, we previously entered into commercial licenses for production strains capable of producing CRM197 with both Merck & Co., Inc. (Merck) and Serum Institute of India Private Ltd., (SIIPL). Merck and SIIPL are currently using our CRM197 in multiple Phase 3 clinical trials for such diseases as pneumococcal and meningitis bacterial infections. These commercial license agreements with Merck and SIIPL contemplate potential maintenance and milestone fees as well as royalties on net sales.

 

•

Novel Modality Pipeline Products Exploration Program – Novel modalities are increasingly driving therapeutic breakthroughs. Our modality exploration program is designed to evaluate and pursue validated biologic pathways that are differentially druggable via a selected modality in specific diseases. We are currently exploring a range of modality platforms that are potentially compatible with our Pf ēnex Expression Technology.

 

•

Additional Biosimilar and Novel Vaccine Pipeline Products – Our pipeline includes biosimilar candidates to certain reference products, including biosimilar candidates to Lucentis and Neulasta and two novel anthrax vaccine candidates, Px563L and RPA563, which are funded by the Biomedical Advanced Research and Development Authority (BARDA). Following our strategic review in November 2017, we decided to pause development activities on PF582, our biosimilar candidate to Lucentis and PF529, our biosimilar to Neulasta, and focus development efforts elsewhere within the product portfolio while we continue to engage potential strategic partners to advance the programs and maximize value. We do not intend to advance our current biosimilar candidates without development and commercial collaboration partners. In March 2019 we received a notice from BARDA advising us of BARDA’s decision not to exercise development options for cGMP manufacturing, Preclinical Studies and Phase 1/2b study readiness in connection with our Px563L and RPA563 novel anthrax vaccine program. Following the receipt of the notice from BARDA and pursuant to ongoing discussions with BARDA, we are assessing the priority of this program in our portfolio.

To date, none of our product candidates, other than PF708, has completed clinical development or been submitted for regulatory review, and none of our product candidates has received marketing authorization from any regulatory agency. Therefore, we have not received revenue from the sale of any of our product candidates. Our product candidates are enabled by our patented protein production platform, Pf ēnex Expression Technology, which we believe confers several important competitive advantages compared to traditional techniques for protein production. The platform has demonstrated a high success rate for the production of complex proteins with higher titers of high quality protein, as well as speed and cost advantages. The development of proteins requires several competencies which represent both challenges and barriers to entry. Due to their inherent complexity, proteins require the use of living organisms to efficiently produce them at a large scale. Traditional techniques for protein production employ a trial and error approach to production organism, or strain, selection and process optimization, which is inherently inefficient and typically produces suboptimal results. This historically inefficient process provides barriers to creating or replicating complex proteins, adds significant time to market and results in the high cost of goods typical of biologic therapeutics. Together, these limitations pose significant hurdles for companies interested in entering the market with novel biologics, biosimilars and therapeutic equivalents. Our platform utilizes a proprietary high throughput robotically-enabled parallel approach, which allows the construction and testing of thousands of unique protein production strains in parallel, thereby allowing us to produce and characterize complex proteins while reducing the time and cost of development and long-term production.

We have developed PF708 as a therapeutic equivalent candidate to Forteo, which achieved global product sales of approximately $1.6 billion in 2018. Almost half of these product sales came from the U.S. alone. In 2019, Forteo is expected to lose patent protection with respect to claims of patents listed in the Orange Book related to compounds, methods of treatment, and formulations in the U.S. An additional Orange Book listed patent, which has claims relating to the delivery system, U.S. Patent No. 7,517,334 (“the ’334 patent”) expires in 2025.

Our revenue for the three months ended March 31, 2019 and 2018 was $10.4 million and $3.7 million, respectively. Our historical revenue has been primarily derived from monetizing our Pf ēnex Expression Technology platform through collaboration agreements, service agreements, government contracts and reagent protein product sales, which provide for various types of payments, including upfront payments, funding of research and development, milestone payments, intellectual property access fees and licensing fees.

As of March 31, 2019, we had an accumulated deficit of $205.0 million, of which $89.8 million was attributable to recognizing the accretion in the redemption value of our convertible preferred stock. We recognized net losses of $3.7 million and $11.0 million for the three months ended March 31, 2019 and 2018, respectively. As we continue to develop and invest more resources into the development and commercialization of our product candidates, our net operating losses will increase over the next several years. As a result, our research and development expenses will increase materially as we incur further costs of development. We currently utilize third-party clinical research organizations (CROs) to carry out our clinical development and we do not yet have an extensive sales organization. We will need substantial additional funding to support our operating activities, especially as we approach anticipated

 

27

regulatory approval in the United States, Europe and other territories, and begin to establish our commercialization capabilities. Adequate funding may not be available to us on commercially reasonable terms, or at all. Since our inception we have funded our operations primarily through the sale and issuance of common stock in our public offerings, revenue from our collaboration agreements, government contracts, service agreements, and reagent protein product sales, our prior credit facility and the private placement of equity securities. We have devoted substantially all of our capital resources to the research and development of our product candidates and working capital requirements.

Recent Developments

On April 11, 2019 we announced the expiration of the 45-day period for Eli Lilly and Company (Lilly) to file a lawsuit under the Hatch-Waxman Act and stay the approval of PF708 for 30 months. Because Lilly did not file a lawsuit within this time period, there will be no 30-month litigation stay delaying approval of PF708, and if approved by the FDA, Pfenex will be able to engage in the commercial manufacture, use, or sale of PF708.

Critical Accounting Policies, Significant Judgments and Use of Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions. The accompanying unaudited consolidated financial statements and related financial information should be read in conjunction with the audited financial statements and related footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2018. Except as otherwise disclosed, there have been no material changes in our critical accounting policies and estimates in the preparation of our financial statements during the three months ended March 31, 2019 compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the SEC on March 11, 2019.

Results of Operations

Comparison of the three months ended March 31, 2019 and 2018

The following table summarizes our net loss during the periods indicated:

 

		Three Months Ended March 31,
(in thousands, except percentages)		2019				2018				Change
Revenue		$	10,362			$	3,746				177	%
Cost of revenue			1,572				1,520				3	%
Gross profit			8,790				2,226				295	%
Operating expense
Research and development			7,923				8,806				(10	)%
Selling, general and administrative			4,597				4,450				3	%
Total operating expense			12,520				13,256				(6	)%
Loss from operations			(3,730	)			(11,030	)			(66	)%
Other income, net			69				3				2200	%
Net loss		$	(3,661	)		$	(11,027	)			(67	)%

 

28

Revenue

 

		Three Months Ended March 31,
(in thousands, except percentages)		2019				2018				Change
Revenue		$	10,362			$	3,746				177	%

Revenue increased by $6.6 million, or 177%, to $10.4 million in the three month period ended March 31, 2019, compared to $3.7 million in the same period in 2018. The increase in revenue was primarily due to a milestone payment from Alvogen and recognition of deferred revenue from NT Pharma upon FDA acceptance of our NDA for PF708 for substantive review, and increases in sales of our CRM197 product, partially offset by a decrease in activity related to our Px563L product candidate under our government contract.

Given the nature of the therapeutic protein development process, revenue will fluctuate depending on stage of development.

Cost of Revenue

 

		Three Months Ended March 31,
(in thousands, except percentages)		2019				2018				Change
Cost of revenue		$	1,572			$	1,520				3	%

Cost of revenue increased by approximately $0.1 million, or 3%, to $1.6 million in the three month period ended March 31, 2019, compared to $1.5 million in the same period in 2018. The increase was primarily due to greater sales of our CRM197 product, partially offset by decreased costs relating to our Px563L product candidate under our government contract.

Given the nature of the therapeutic protein development process, these costs will fluctuate depending on stage of development.

Research and Development

 

		Three Months Ended March 31,
(in thousands, except percentages)		2019				2018				Change
Research and development		$	7,923			$	8,806				(10	)%

Research and development expenses decreased by approximately $0.9 million, or 10%, to $7.9 million in the three month period ended March 31, 2019, compared to $8.8 million in same period in 2018. This was primarily due to timing of expenses related to our lead product candidate PF708. Significant activity occurred leading up to submission of the NDA to the FDA, which occurred in December 2018.

We expect research and development expenses to vary considerably in the near future depending on the phase of the programs we are advancing. The timing and amount of expenses incurred for our product candidates will depend largely upon the outcomes of current or future clinical studies for our product candidates, as well as the related regulatory requirements, manufacturing costs and any costs associated with the advancement of our preclinical programs.

Selling, General and Administrative

 

		Three Months Ended March 31,
(in thousands, except percentages)		2019				2018				Change
Selling, general and administrative		$	4,597			$	4,450				3	%

Selling, general and administrative expenses increased by $0.1 million, or 3%, to $4.6 million in the three month period ended March 31, 2019, compared to $4.5 million in the same period in 2018.

 

29

In future periods, we expect selling, general and administrative expenses to increase as we expand our operating activities and prepare for the commercialization of our product candidates.

Liquidity and Capital Resources

To date, we have funded our operations primarily through the sale and issuance of common stock in our public offerings, revenue from our collaboration agreements, government contracts, service agreements, and reagent protein product sales, our prior credit facility and the private placement of equity securities. At March 31, 2019, we had $45.8 million in cash and cash equivalents and $0.2 million in restricted cash as bank collateral for our corporate credit card program compared to $56.2 million in cash and cash equivalents and $0.2 million in restricted cash as of December 31, 2018.

In July 2016, we entered into a development and license agreement with Jazz Pharmaceuticals for the development and commercialization of multiple early stage hematology/oncology product candidates, including PF743, a recombinant crisantaspase, and PF745, a recombinant crisantaspase with half-life extension technology, and in the third quarter of 2017, achieved a process development milestone. The agreement also includes an option for Jazz to negotiate a license for a recombinant pegaspargase product candidate with us. Under the terms of the agreement, we received an upfront and option payment totaling $15.0 million in July 2016, and may be eligible to receive additional payments based on the achievement of certain research and development, regulatory, and sales-related milestones.

In December 2017, we and Jazz entered into an amended and restated agreement, bringing the total value of payments and potential payments associated with the collaboration to $224.5 million. In addition, we may be eligible to receive tiered royalties on worldwide sales of any products resulting from the collaboration at rates reduced from those under the 2016 agreement. Under the amended and restated agreement, in the second quarter of 2018, we achieved two process development milestones for PF745.

In March 2018, we entered into an equity sales agreement (Sales Agreement) with William Blair & Company, L.L.C. (William Blair) to sell shares of our common stock having aggregate sales proceeds of up to $20.0 million, from time to time, through an “At the market” equity offering program under which William Blair will act as sales agent. Under the Sales Agreement, we set the parameters for the sale of shares, including the number of shares to be issued, the time period during which sales are requested to be made, limitation on the number of shares to be issued, the time period during which sales are requested to be made, limitation on the number of shares that may be sold in any one trading day and any minimum price below which sales may not be made. The Sales Agreement provides that William Blair will be entitled to compensation for its services that will equal 3.0% of the gross sales price per share of all shares sold through William Blair under the Sales Agreement. The Sales Agreement shall automatically terminate upon the issuance and sale of placement shares equaling sales proceeds of $20.0 million and may be terminated earlier by either us or William Blair upon five days’ notice. We have no obligation to sell any shares under the Sales Agreement and may at any time suspend solicitation and offers under the Sales Agreement. We have not sold any shares under the Sales Agreement.

On May 25, 2018, we closed an underwritten public offering of 7,820,000 shares of our common stock at a price of $5.50 per share, which included the full exercise by the underwriters of their option to purchase an additional 1,020,000 shares of our common stock, pursuant to our existing shelf registration statement. Net proceeds from the offering were approximately $39.5 million.

We believe that our existing cash and cash equivalents and our cash inflow from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months including our obligations for PF708 leading up to the potential commercial launch in the United States as early as the fourth quarter of 2019, subject to FDA approval of the NDA and other 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. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development and commercialization sooner than planned. We currently have no credit facility or committed sources of capital although we may receive milestone and other contingent payments under our current license and collaboration agreements. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates and the extent to which we may enter into additional agreements with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials and studies. Our future capital requirements will depend on many factors, including:

 

•

the timing and extent of spending on our research and development efforts, including with respect to PF708 and our other product candidates;

 

•

our ability to enter into and maintain collaboration, licensing, commercialization and other arrangements and the terms and timing of such arrangements;

 

•

the timing of the marketing approval for PF708, if any;

 

30

•

the cost to us of development, manufacturing and commercialization activities for PF708 and our other product candidates, if any;

 

•

the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

 

•

the receipt of any collaboration or milestone payments;

 

•

the scope, rate of progress, results and cost of our clinical trials and studies, preclinical testing and other related activities;

 

•

the emergence of competing technologies or other adverse market developments;

 

•

the time and costs involved in seeking and obtaining regulatory and marketing approvals in multiple jurisdictions for our product candidates that successfully complete clinical trials and studies;

 

•

the introduction of new product candidates and the number and characteristics of product candidates that we pursue;

 

•

the timing, receipt and amount of sales, profit sharing or royalties, if any, from our potential products;

 

•

the degree and rate of market acceptance of any products launched by us or our collaboration partner;

 

•

the expansion of our sales and marketing activities; and

 

•

the potential acquisition and in-licensing of other technologies, products or assets.

We will need to raise additional capital to fund our operations in the near future. Funding may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate financing when needed, we may have to delay, reduce the scope of or suspend one or more of our clinical trials, research and development programs or commercialization efforts. We may seek to raise any necessary additional capital through a combination of public or private equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements and other marketing and distribution arrangements. To the extent that we raise additional capital through marketing and distribution arrangements or other collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our product candidates, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

Cash Flows

The following table sets forth the primary sources and uses of cash, cash equivalents and restricted cash for each of the periods presented below:

 

		Three Months Ended March 31,
		2019				2018
		(in thousands)
Net cash (used in) provided by:
Operating activities		$	(10,338	)		$	(10,238	)
Investing activities			(111	)			(333	)
Financing activities			(17	)			(38	)
Net decrease in cash, cash equivalents and restricted cash		$	(10,466	)		$	(10,609	)

Net cash used in operating activities

Net cash used in operating activities was $10.3 million during the three months ended March 31, 2019 compared to $10.2 million during the same period in 2018. The decrease in net cash used in operating activities was primarily due to an increase in total revenues recognized in 2019 related to the FDA’s acceptance of the NDA for PF708.

Net cash used in investing activities

Net cash used in investing activities was $0.1 million during the three months ended March 31, 2019 compared to $0.3 million used in the same period in 2018. We used the funds to purchase property and equipment in both three month periods, with a greater amount of lab equipment acquired in the three months ended March 31, 2018 to support work used in preparing the NDA for PF708 filed in December 2018.

 

31

Net cash used in financing activities

Cash used in financing activities was $17 thousand during the three months ended March 31, 2019 compared to $38 thousand during the same period in 2018. In both periods, cash was used for repayment of capital lease obligations, offset by proceeds from cash provided by the issuance of common stock in connection with our Employee Stock Purchase Plan (ESPP). In addition, during the three months ended March 31, 2018, cash was used for the payment of employee taxes related to net share settlement of an equity award.

Off-Balance Sheet Arrangements

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. As of March 31, 2019, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.

Contractual Obligations and Commitments

There have been no material changes during the three months ended March 31, 2019 to our contractual obligations disclosed in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2018.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09,  Revenue from Contracts with Customers (Topic 606) , which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. Numerous updates were issued in 2016 that provide clarification on a number of specific issues as well as requiring additional disclosures. The financial information included in our 2019 Form 10-K will be updated for the January 1, 2019 adoption date; this new guidance will be reflected for the first time in our 2019 Form 10-K but effective as of January 1, 2019 in that filing. However, we will continue to account for revenue recognition under ASC Topic 605 for interim periods in 2019 and will not be required to amend our Form 10-Q filings filed throughout 2019 to reflect the January 1, 2019 adoption date. The guidance allows for the use of one of two retrospective application methods: the full retrospective method or the modified retrospective method. We plan to adopt the standard in fiscal year 2019 using the modified retrospective method. We do not expect the new standard to have a material impact on the recognition of revenue from our reagent protein product sales. We are currently evaluating the impact of the new standard on historical revenue recorded for our collaboration agreements.

In February 2016, the FASB issued ASU No. 2016-02,  Leases (Topic 842) , which was subsequently amended by ASU No. 2018-10,  ASU No. 2018-11, ASU No. 2018-20 and ASU No. 2019-01. This ASU, as amended, increases transparency and comparability by recognizing a lessee’s rights and obligations resulting from leases by recording them on the balance sheet as right-of-use assets and lease liabilities. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification dictates whether lease expense is to be recognized based on an effective interest method or on a straight-line basis over the term of the lease. Additional qualitative and quantitative disclosures will be required to give financial statement users information on the amount, timing and judgments related to a reporting entity’s cash flows arising from leases. The financial information included in our 2019 Form 10-K will be updated for the January 1, 2019 adoption date; this new guidance will be reflected for the first time in our 2019 Form 10-K but effective as of January 1, 2019 in that filing. However, we will continue to account for leases under ASC Topic 840 for interim periods in 2019 and will not be required to amend our Form 10-Q filings filed throughout 2019 to reflect the January 1, 2019 adoption date. We are currently evaluating the impact of the adoption of this accounting standard update on our consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment .  This updated guidance eliminates Step 2 from the current two-step quantitative model for goodwill impairment tests. Step 2 required an entity to calculate an implied fair value, which included a hypothetical purchase price allocation requirement,

 

32

for reporting units that failed Step 1. Per this updated guidance, a goodwill impairment will instead be measured as the amount by which a reporting unit’s carrying value exceeds its fair value as identified in Step 1. This guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within that reporting period. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07,  Compensation-Stock Compensation (Topic 718),  which simplifies the accounting for nonemployee share-based payment transactions. The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The standard will be effective for us in the first quarter of fiscal year 2020, although early adoption is permitted (but no sooner than the adoption of Topic 606). The adoption of this guidance is not expected to have a material impact on the consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15,  Intangibles—Goodwill and  Other-Internal-Use Software (Subtopic  350-40):  Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for us beginning in the first quarter of fiscal year 2020, with early adoption permitted. We are currently evaluating this guidance to determine the impact on our financial statements and related disclosures.

In November 2018, the FASB issued ASU No. 2018-18,  Collaborative Arrangements (Topic 808)—Clarifying the Interaction between Topic 808 and Topic 606 . The amendments in ASU No. 2018-18 make targeted improvements to generally accepted accounting principles for collaborative arrangements by clarifying that certain transactions between collaborative arrangement participants should be accounted for as revenue under Accounting Standard Codification 606, Revenue from Contracts with Customers , or ASC 606, when the collaborative arrangement participant is a customer in the context of a unit of account. In those situations, all the guidance in ASC 606 should be applied, including recognition, measurement, presentation, and disclosure requirements. In addition, unit-of-account guidance in ASC 808 was aligned with the guidance in ASC 606 when an entity is assessing whether the collaborative arrangement or a part of the arrangement is within the scope of ASC 606. ASU No. 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The amendments in ASU No. 2018-18 are required to be applied retrospectively to the date of initial application of ASC 606. We are currently evaluating the impact of ASU No. 2018-08 on our consolidated financial statements.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates and foreign currency exchange rates. As of March 31, 2019, we did not hold or issue financial instruments for trading purposes.

Interest rate fluctuation risk

The primary objective of our investment activities is to preserve our capital to fund our operations. We also seek to maximize income from our cash and cash equivalents without assuming significant risk. To achieve our objectives, we invest our cash and cash equivalents in money market funds, treasury obligations, short term certificates of deposit and high-grade corporate securities, directly or through managed funds, with maturities of six months or less. As of March 31, 2019, we had cash and cash equivalents of $45.8 million consisting of cash of $12.2 million and investments of $33.6 million in highly liquid U.S. money market funds. A portion of our investments may be subject to interest rate risk and could fall in value if market interest rates increase. However, because our investments are primarily short-term in duration, we believe that our exposure to interest rate risk is not significant and a 100 basis point movement in market interest rates would not have a significant impact on the total value of our portfolio. We actively monitor changes in interest rates.

Foreign currency exchange risk

We contract with clinical research organizations, investigational sites and suppliers in foreign countries. We are therefore subject to fluctuations in foreign currency rates in connection with these agreements. We have not entered into any material foreign currency hedging contracts although we may do so in the future. To date we have not incurred any material effects from foreign currency changes on these contracts. The effect of a 10% adverse change in exchange rates on foreign currency denominated cash and payables as of March 31, 2019 would not have been material. However, fluctuations in currency exchange rates could harm our business in the future.

 

33

Inflation risk

Inflation may affect us by increasing our cost of labor and clinical trial costs. We do not believe that inflation has had a material effect on our business, financial condition or results of operations for any period presented herein.

 

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (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 Securities and Exchange Commission’s (SEC) 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 management, including its principal executive and principal financial officers, or persons performing similar functions, 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 upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2019 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Management recognizes that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

On May 6, 2019, Pfenex filed two petitions for  inter partes  review of U.S. Patent No. 9,422,345 (“the ‘345 patent”; entitled “Expression System”), which is owned by GlaxoSmithKline Biologicals S.A., with the Patent Trial and Appeal Board (“PTAB”) of the U.S. Patent and Trademark Office seeking,  inter alia , a determination that certain claims in the ‘345 patent” are invalid. The ‘345 patent relates to polynucleotides that express diphtheria toxin mutants, including the diphtheria toxin mutant CRM197. An institution decision by the PTAB is expected within the 2019 calendar year, and a final written decision determining the validity of the challenged claims of the ‘345 patent, if the petitions are instituted by the PTAB, by the end of 2020.

 

ITEM 1A.

RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Quarterly Report on Form 10-Q, before making an investment decision. The risks and uncertainties described below may not be the only ones we face. If any of the risks actually occur, our business, financial condition, operating results, cash flows and prospects could be materially and adversely affected. In that event, the market price of our common stock could decline, and you could lose part or all of your investment.

 

34

Risks Relating to our Financial Condition and Need for Additional Capital

We have a limited operating history and expect to generate significant losses for the foreseeable future. If we do not generate significant revenue, we will not be profitable.

With the exception of two years, we have incurred annual net operating losses since inception, and to date have generated only limited revenue from government contracts, service agreements, collaboration agreements, and reagent protein product sales. We have recognized net losses of $3.7 million and $11.0 million for the three months ended March 31, 2019 and 2018 and $39.6 million for the year ended December 31, 2018, respectively. As of March 31, 2019, we had an accumulated deficit of $205.0 million and net working capital of $43.6 million. To date, we have funded our operations primarily through the sale and issuance of common stock in our public offerings, revenue from our collaboration agreements, government contracts, service agreements, and reagent protein product sales, our prior credit facility and the private placement of equity securities. As of March 31, 2019, we had capital resources consisting of cash and cash equivalents of $45.8 million. As we continue to develop and invest more resources into the development and commercialization of our product candidates, our net operating losses will increase over the next several years. To become profitable, we must successfully develop and obtain regulatory approval for our product candidates, and effectively manufacture and commercialize the product candidates we develop. We submitted our NDA for PF708 on December 10, 2018 and the United States Food and Drug Administration (FDA) accepted our submission for substantive review in February 2019. Alvogen Malta Operations Ltd. (Alvogen), our collaboration partner, submitted a centralized application to the EMA for Teriparatide on May 6, 2019. If we obtain regulatory approval to market PF708, or any other product candidate, our future revenue will depend upon the size of any markets in which PF708, or such other product candidate may receive approval, and our and our collaboration partners’ ability to achieve sufficient market acceptance, pricing, reimbursement from third-party payors, and adequate market share for our product candidates in those markets. We and our collaboration partners may never succeed in these activities and therefore may never generate revenue that is significant or large enough to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable could depress the market price of our common stock and could impair our ability to raise capital, expand our business, diversify our product offerings or continue our operations.

We will require substantial additional funds to seek and obtain regulatory approval for and commercialize our product candidates and, if additional capital is not available, we may need to limit, scale back or cease our operations.

Since our inception, a significant portion of our resources have been dedicated to the preclinical and clinical development of our product candidates, including PF708, Px563L, RPA563, PF582, and PF529. We believe that we will continue to expend substantial resources for the foreseeable future for the preclinical and clinical development of our current product pipeline, and the development of any other indications and product candidates we may choose to pursue, either alone or with a strategic collaboration partner. These expenditures will include costs associated with research and development, conducting preclinical studies and clinical studies, and manufacturing and supply as well as marketing and selling any products that receive marketing authorization. Because the outcome of any clinical trial is highly uncertain, we cannot reasonably estimate the actual amounts necessary to successfully complete the development and commercialization of PF708, Px563L, RPA563, and our pipeline of other product candidates and preclinical products under development. Following our strategic review in November 2017, we decided to pause our development activities for PF582 and PF529 and focus our efforts and resources elsewhere in the product portfolio until strategic partnerships for these candidates are forged. In addition, on March 29, 2019, we received notice from the Biomedical Advanced Research and Development Authority (BARDA) informing us of BARDA’s decision to not exercise development options for cGMP manufacturing and potential Phase 1/2b study readiness for Px563L and RPA563. Following the receipt of the notice from BARDA and pursuant to ongoing discussions with BARDA, we are assessing the priority of this program in our portfolio. In the future, we may be required to devote additional resources to the development of PF582 PF529, Px563L, or RPA563 or obtain a new collaboration partner or government funding on short notice, and the terms of any additional collaboration, government funding or other arrangements that we establish may not be favorable to us. We may also need to obtain substantial additional sources of funding to develop our product candidates as currently contemplated. If such additional funding is not available on favorable terms or at all, we may need to delay or reduce the scope of our product candidate development programs, or grant rights in the United States, as well as outside the United States, to our product candidates to one or more partners.

We believe that our available cash and cash equivalents, including the proceeds from any revenue from our government contracts, service agreements, collaboration agreement, and reagent protein product sales, will be sufficient to meet our anticipated cash needs for at least the next twelve months including our costs leading up to the potential commercial launch of PF708 in the United States as early as the fourth quarter of 2019, subject to FDA approval of the NDA and other factors. However, changing circumstances and risks and uncertainties associated with our product development efforts may cause us to consume capital significantly faster than we currently anticipate, and we may need to spend more money than currently expected. Our future capital requirements may vary depending on the following:

 

•

the timing and extent of spending on our research and development efforts, including with respect to PF708 and our other product candidates;

 

35

•

our ability to enter into and maintain collaboration, licensing, commercialization and other arrangements and the terms and timing of such arrangements;

 

•

the cost of manufacturing and commercialization activities, if any;

 

•

the receipt of any collaboration or milestone payments;

 

•

the scope, rate of progress, results and FDA acceptance of the results, and cost of our clinical trials, preclinical testing and other related activities for our product candidates;

 

•

the emergence of competing technologies or other adverse market developments;

 

•

the time and costs involved in seeking and obtaining regulatory and marketing approvals in multiple jurisdictions for our product candidates that successfully complete clinical trials;

 

•

the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

 

•

the introduction of new product candidates and the number and characteristics of product candidates that we pursue;

 

•

the timing, receipt and amount of sales, profit sharing or royalties, if any, from our potential products;

 

•

if approved, the degree and rate of market acceptance of any products launched by us or our collaboration partners;

 

•

the expansion of our sales and marketing activities; and

 

•

the potential acquisition and in-licensing of other technologies, products or assets.

If we were to experience any delays or encounter issues with any of the above, including clinical holds, failed studies, inconclusive or hard-to-interpret results, safety or efficacy issues, or other regulatory challenges that require longer follow-up of existing studies, additional major studies, or additional supportive studies in order to pursue marketing approval, it could further increase the costs associated with the above and delay revenues.

We will need to raise additional capital to fund our operations in the near future. If we seek additional funding in the future, additional funds may not be available to us on acceptable terms or at all. We may seek to raise additional funds through equity, equity-linked or debt financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness would have rights that are senior to holders of our equity securities and could contain covenants that restrict our operations. We have a sales agreement in place with William Blair to sell up to $20.0 million worth of shares of our common stock, from time to time, through an “at the market” equity offering program under which William Blair will act as sales agent. As of March 31, 2019, $20.0 million worth of shares of our common stock remained available for sale under the “at the market” equity offering program. Any additional equity financing may be dilutive to our stockholders. If we are unable to obtain funding on a timely basis, we may be required to significantly curtail the advancement of one or more of our product candidates. We also could be required to seek funds through arrangements with collaboration partners or others that may require us to relinquish rights to some of our technologies or product candidates which we would otherwise pursue on our own.

Any further development of PF582 and PF529 will require significant resources from us or another collaboration partner, and in the event that we do not find a collaboration partner, the development of PF582 and PF529 could be significantly delayed or result in the discontinuation of the development of PF582 and PF529.

In November 2017, we completed our strategic review of PF582 and PF529, our biosimilar product candidates to Lucentis ^® and Neulasta ^® , respectively. The strategic review considered the timeline for development and cost of both programs. As a result of our strategic review, we decided to pause development activities on PF582 and PF529 and focus development efforts elsewhere within the product portfolio while we continue to engage potential strategic partners to monetize PF582 and PF529. Further development of PF582 and PF529 will require significant resources from us or another collaboration partner. We currently do not intend to advance PF582 or PF529 without development and commercial collaboration partners. We or a new collaboration partner will be responsible for funding any new PF582 and PF529 development and clinical trial activities going forward. Any such further development will require significant resources to develop and commercialize PF582 and PF529, and such further development may not be possible in the near term without a new collaboration partner . There are no assurances that we will have access to additional capital or find a new collaboration partner or that the terms and timing of any such arrangements would be acceptable to us. As a result, we could experience a significant delay in the PF582 and PF529 development processes. If we determine instead to discontinue the development of PF582 or PF529, we will not receive any future return on our investment from that product candidate.

 

36

Our quarterly operating results may fluctuate significantly.

Our operating results are subject to quarterly fluctuations. Our operating results are affected by numerous factors, including:

 

•

variations in the level of expenses related to our PF708, Px563L, RPA563 and other development and future commercialization programs;

 

•

addition or termination of clinical trials;

 

•

any intellectual property infringement lawsuit in which we may become involved;

 

•

regulatory developments affecting any of our products; and

 

•

our execution of any service, collaborative, licensing or similar arrangements, and the timing of payments we may make or receive under these arrangements.

If our quarterly operating results fall below the expectations of investors or securities analysts, the market price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the market price of our stock to fluctuate substantially.

Risks Relating to our Business and our Industry

Our business operations are dependent upon our senior management team and the ability of our other employees to execute on our business strategy. If we fail to attract, integrate, and keep senior management and key scientific personnel, we may be unable to successfully develop PF708, Px563L, RPA563 or any other product candidates, conduct our clinical trials and commercialize PF708, Px563L, RPA563 or any other product candidates we develop.

Our success depends in part on our continued ability to attract, integrate, retain, and motivate highly qualified management, clinical and scientific personnel, including our ability to develop an effective working relationship among senior management. Our senior management has substantially changed since the beginning of the last fiscal year, including, for example, the departure of our former chief medical and scientific officer, Hubert Chen, in 2018. Dr. Chen continues to support the Company as an advisor. Our president and chief executive officer, Eef Schimmelpennink, joined us in August 2017; our senior vice president, chief financial officer, Susan Knudson, joined us in February 2018; our senior vice president, chief operating officer, Dr. Shawn Scranton, joined us in October 2018 and our senior vice president, chief scientific officer, Dr. Martin Brenner, joined us in March 2019.

As new employees gain experience in their roles, we could experience inefficiencies or a lack of business continuity due to loss of historical knowledge and a lack of familiarity of new employees with business processes, operating requirements, policies and procedures, and we may experience additional costs as new employees gain necessary experience. It is important to our success that these key employees quickly adapt to and excel in their new roles. If they are unable to do so, our business and financial results could be materially adversely affected. In addition, the loss of the services of any member of our senior management or our scientific or technical support staff might significantly delay or prevent the development of our products or achievement of other business objectives by diverting management’s attention to transition matters and identification of suitable replacements, if any, and could have a material adverse effect on our business.

We believe that our future success is highly dependent upon the contributions of our senior management, particularly our Chief Executive Officer, Chief Financial Officer, Chief Business Officer, Chief Operating Officer, and Chief Scientific Officer, as well as our senior scientists and other members of our senior management team. Employment agreements with our Chief Executive Officer, Chief Financial Officer, Chief Business Officer, Chief Operating Officer, and Chief Scientific Officer, as well as our offer letters with our senior scientists, all provide for “at-will” employment. The loss of services of any of these individuals could delay or prevent the successful development of our product pipeline, completion of our planned clinical trials or the commercialization of PF708, Px563L, RPA563, or any other products we develop.

Competition for qualified personnel in the biotechnology and pharmaceuticals industry is intense due to the limited number of individuals who possess the skills and experience required. To help attract, retain, and motivate qualified employees, we use share-based incentive awards such as employee stock options. Other companies may provide more generous compensation and benefits, more diverse opportunities and better chances for career advancement than we do. Some of these advantages may be more appealing to high-quality candidates and employees than those we have to offer. In addition, the decline in our stock price has created additional challenges related to our ability to compete effectively with respect to equity compensation. We may need to hire additional personnel as we expand our clinical development and commercial activities. We may not be able to attract and retain quality personnel on acceptable terms, or at all, which may cause our business and operating results to suffer.

 

37

If an improved version of a reference product or reference listed drug, such as Forteo, is developed, or if the market for a reference product or reference listed drug significantly declines, sales or potential sales of our therapeutic equivalent product candidates may suffer.

Reference product or reference listed drug (“originator”) sponsor companies may develop improved versions as part of a life cycle extension strategy and may obtain regulatory approval of the improved version under a supplemental biologics license application (BLA) or NDA. If an originator sponsor company succeeds in obtaining an approval of an improved product, it may capture a significant share of the collective market and significantly reduce the market for the reference product/reference listed drug, and thereby the potential size of the market for our therapeutic equivalent product candidates. In addition, the improved product may be protected by additional patent rights.

Additionally, competition in the pharmaceutical market is intense. Reference products/reference listed drugs face competition on numerous fronts as technological advances are made that may offer patients a more convenient form of administration or increased efficacy, or as new products are introduced. As new products are approved that compete with the reference product/reference listed drug for our therapeutic equivalent product candidates, such as Forteo, sales may be significantly and adversely impacted and may render the originator obsolete. If the market for the originator is impacted, we in turn may lose significant market share or market potential for our products and product candidates. As a result, the value of our product pipeline could be negatively impacted and our business, prospects and financial condition could suffer.

Our product candidates, if approved, will face significant competition from the reference products and from other therapeutic equivalent products of the reference products, and from other products. Our or our collaboration partners’ failure to effectively compete may prevent us from achieving significant market penetration and expansion.

We and our collaboration partners expect to enter highly competitive pharmaceutical markets. Successful competitors in the pharmaceutical market have the ability to effectively discover, obtain patents, develop, test and obtain regulatory approvals for products, as well as the ability to effectively commercialize, market and promote approved products, including communicating the effectiveness, safety and value of products to consumers and medical professionals. Numerous companies, universities, and other research institutions are engaged in developing, patenting, manufacturing and marketing of products competitive with those that we are developing. For example, in April 2017, the FDA approved Radius Health’s TYMLOS ^® , and in April 2019 the FDA approved Evenity (romosozumab) a once monthly monoclonal antibody product developed by Amgen and UCB, each of which could potentially compete with PF708, if approved. Many of these potential competitors, such as Amgen Inc., Eli Lilly and Company, Teva Pharmaceutical Industries Limited, Emergent BioSolutions Inc., and Radius Health are large, experienced companies that enjoy significant competitive advantages, such as substantially greater financial, research and development, manufacturing, personnel and marketing resources. Recent and potential future merger and acquisition activity in the biotechnology and pharmaceutical industries is likely to result in even more resources being concentrated among a smaller number of our competitors. These companies also maintain greater brand recognition and more experience and expertise in undertaking preclinical testing and clinical trials of product candidates and obtaining the FDA and other regulatory approvals of products. Established pharmaceutical companies may also invest heavily to accelerate discovery and development of novel compounds that could make our product candidates obsolete.

In addition, our therapeutic equivalent and vaccine products may face competition from companies that develop and commercialize products that compete directly with our products. See  “Risks Related to Government Regulation—If other therapeutic equivalent or generic products to Forteo are approved and successfully commercialized before PF708, our business would suffer.”

Use of our product candidates could be associated with side effects or adverse events.

Use of our product candidates could be associated with side effects or adverse events which can vary in severity (from minor reactions to death) and frequency (infrequent or prevalent). Side effects or adverse events associated with the use of our product candidates may be observed at any time, including in clinical trials or when a product is commercialized, and any such side effects or adverse events may negatively affect our and our collaboration partners’ ability to obtain and maintain regulatory approval or market our product candidates. Side effects such as toxicity or other safety issues associated with the use of our product candidates could require us or our collaboration partners to perform additional studies or halt development or sale of these product candidates or expose us or our collaboration partners to product liability lawsuits which would harm our business. We or our collaboration partners may be required by regulatory agencies to conduct additional animal or human studies regarding the safety and efficacy of our product candidates which were not planned or anticipated. We or our collaborators may also be required to change our product labeling, including increasing the prominence and content of warnings and contraindications for our products. The FDA could require us or our collaboration partners to develop a Risk Evaluation and Mitigation Strategy (REMS) for such product or, if a REMS is already in place, to incorporate additional requirements under the REMS, and foreign regulatory authorities may require similar risk management strategies. There can be no assurance that we or our collaboration partners will resolve any issues related to any product-related adverse events to the satisfaction of the FDA or any regulatory agency in a timely manner or ever, which could harm our business, prospects and financial condition.

 

38

In addition, if we and our collaboration partners are successful in commercializing PF708, Px563L, RPA563 or any other product candidates, the FDA, European Medicines Agency (EMA), competent authorities of the Member States of the European Economic Area (EEA), and other foreign regulatory agency regulations require that the application holder timely report certain information about adverse medical events. We or our collaboration partners may fail to report adverse events we become aware of within the prescribed timeframe. We or our collaboration partners may also fail to appreciate that we or our collaboration partners have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or delayed in time from the use of our products. If we or our collaboration partners fail to comply with our reporting obligations, the FDA, the EMA, competent authorities of the Member States of the EEA, or other foreign regulatory agencies could take action including criminal prosecution, the imposition of civil monetary penalties, seizure of our products, or delay in approval or clearance of our products.

We currently rely on a limited number of third parties for a substantial portion of our revenue. The loss of or a change in any of these third parties, including its creditworthiness, could materially reduce our revenue and adversely impact our financial position.

Two third-parties accounted for more than 10% of our 2018 and 2017 revenue and one third party accounted for more than 10% of our 2016 revenue. Jazz and BARDA each accounted for more than 10% of our revenue in 2018 and 2017, and Pfizer accounted for more than 10% of our 2016 revenue. We have also entered into agreements with Alvogen and China NT Pharma Group Company Ltd. (NT Pharma) to develop and commercialize PF708. The prospects for PF708 depend on the expertise, development and commercial skills, and financial strength of Alvogen and NT Pharma.

In addition, in August 2016, we entered into a termination agreement with Pfizer pursuant to which our development and license agreement was terminated and all rights to PF582 returned to us. The termination accelerated recognition of $45.8 million of revenue that had been previously deferred, and we will not recognize any additional future revenue under this agreement. Pfizer will no longer be responsible for manufacturing, clinical studies and commercialization of PF582. We will not receive additional revenue from Pfizer.

The loss of any key collaboration partner or any significant adverse change in the size or terms of a contract with a key third party could significantly reduce our revenue over the short term. Moreover, having our revenue concentrated among a limited number of entities creates a concentration of financial risk for us, and in the event that any significant third party is unable to fulfill its payment obligations to us, our operating results and cash position would suffer. See “Risks Relating to our Reliance on Third Parties—We are substantially dependent on the expertise of Alvogen, Jazz, and NT Pharma to develop and commercialize certain product candidates. If we fail to maintain our current strategic relationship with Alvogen, Jazz, our business, commercialization prospects and financial condition may be materially adversely affected. ”

We may fail to select or capitalize on the most scientifically, clinically or commercially promising or profitable product candidates.

We continue to evaluate our business strategy and, as a result, may modify our strategy in the future. In this regard, we may, from time to time, focus our product development efforts on different product candidates or may delay, suspend or terminate the future development of a product candidate at any time for strategic, business, financial or other reasons. For example, in 2017 we decided to pause development activities on PF582 and PF529 and focus development efforts elsewhere within the product portfolio while we continue to engage potential strategic partners for PF582 and PF529 to advance the programs and maximize value. As a result of changes in our strategy, we have and may in the future change or refocus our existing product development, commercialization and manufacturing strategies. This could require changes in our facilities and our personnel. Any product development changes that we implement may not be successful. In particular, we may fail to select or capitalize on the most scientifically, clinically or commercially promising or profitable product candidates. Our decisions to allocate our research and development, management and financial resources toward particular product candidates may not lead to the development of viable commercial products and may divert resources from better opportunities. Similarly, our decisions to delay or terminate product development programs may also prove to be incorrect and could cause us to miss valuable opportunities.

We currently have limited marketing capabilities and no sales organization.

We currently have limited sales and marketing capabilities. We have no prior experience in the marketing, sale and distribution of pharmaceutical products and there are significant risks involved in building and managing a sales organization, including our ability to hire, retain and incentivize qualified individuals, generate sufficient sales leads, provide adequate training to sales and marketing personnel and effectively manage a geographically dispersed sales and marketing team.

To commercialize PF708, we have entered into collaboration agreements with Alvogen and NT Pharma and the prospects for PF708 depend on the expertise, development and commercial skills, and financial strength of Alvogen and NT Pharma. Under the Alvogen agreements, Alvogen has the exclusive right to commercialize and manufacture PF708 in the United States, European Union,

 

39

Middle East, North Africa, and the rest of the world not covered by the NT Pharma territory. Under the NT Pharma agreement, we granted an exclusive license to NT Pharma to commercialize PF708 in certain Asian countries and a non-exclusive license to conduct development activities in such territories with respect to PF708. For Px563L, RPA563, and our other product candidates, if approved, we will need to identify potential sales, marketing and distribution partners or establish our own internal sales force. In the future, we may choose to collaborate with other third parties that have direct sales forces and established distribution systems, either to augment our own sales force or in lieu of our own sales force. If we are unable to enter into such arrangements on acceptable terms or at all, we may not be able to successfully commercialize our product candidates. If we are not successful in commercializing our product candidates, either on our own or through collaborations with one or more third parties, our future product revenue will suffer and we would incur significant additional losses.

We enter into various contracts in the normal course of our business that periodically incorporate provisions whereby we indemnify the other party to the contract. In the event we would have to perform under these indemnification provisions, it could have a material adverse effect on our business, financial position and results of operations.

In the normal course of business, we periodically enter into academic, commercial and consulting agreements that contain indemnification provisions. With respect to our academic agreements, we may be required to indemnify the institution and related parties from losses arising from claims relating to the products, processes or services made, used, sold or performed pursuant to the agreements for which we have secured licenses, and from claims arising from our or our sublicensees’ exercise of rights under the agreement. With respect to commercial agreements entered into with our protein production customers, we typically provide indemnification for claims from third parties arising out of any potential intellectual property infringement associated with our Pf ēnex Expression Technology ^® in the course of performing our services. With respect to our commercial agreements, the bulk of which are with contract manufacturers, we indemnify our vendors from third-party product liability claims which result from the production, use or consumption of the product, as well as for certain alleged infringements of any patent or other intellectual property right by a third party. With respect to consultants, we indemnify them from claims arising from the good faith performance of their services. In all of the above cases, we do not indemnify the parties for claims resulting from the negligence or willful misconduct of the indemnified party.

In certain circumstances, we maintain insurance coverage which we believe may limit our obligations under certain of these indemnification provisions. However, we do not carry insurance for all risks that our business may encounter, including our obligations under certain indemnification provisions. To the extent we do not have insurance to cover certain indemnification obligations, we are denied insurance coverage, or our obligation under an indemnification provision exceeds applicable insurance coverage, any significant, uninsured liability may require us to pay substantial amounts, which would adversely affect our working capital and results of operations.

We may have difficulty expanding our operations successfully.

As we advance our product candidates through the development process, we will need to expand our development, regulatory, manufacturing, quality, sales and marketing capabilities or contract with other organizations to provide these capabilities for us. As our operations expand, we expect that we will need to manage additional relationships with various collaboration partners, suppliers and other organizations, including with respect to the commercialization of PF708, if PF708 receives regulatory approval.

As of March 31, 2019, we had 70 full-time employees, including a total of 14 employees who hold Ph.D. degrees. Our management and personnel, systems and facilities currently in place may not be adequate to support this future growth. Therefore, we will need to continue to expand our managerial, operational, finance and other resources to manage our operations and clinical trials, continue our development activities and commercialize our product candidates, if approved. In order to effectively execute our growth strategy, we will be required to:

 

•

manage our clinical trials effectively;

 

•

identify, recruit, retain, incentivize and integrate additional employees;

 

•

establish and maintain collaborations with third parties for the development and commercialization of our product candidates, or otherwise build and maintain a sales, marketing and distribution infrastructure to commercialize any products for which we may obtain marketing approval;

 

•

manage our internal development efforts effectively while carrying out our contractual obligations to third parties; and

 

•

continue to improve our operational, financial and management controls, reporting systems and procedures.

 

40

Due to our limited financial resources and our limited experience in managing a company with such anticipated growth, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel. In addition, this expansion of our operations may lead to significant costs and may divert our management and business development resources. Any inability to manage growth could delay the execution of our development and strategic objectives, or disrupt our operations, which could materially impact our business, revenue, and operating results.

The U.S. government holds certain intellectual property rights related to our Anthrax vaccines, Px563L and RPA563 and Malaria vaccine, Px533.

Although we have intellectual property related to expression of recombinant protective antigen in  P.  fluorescens , the U.S. government holds certain patents related to the recombinant protective antigen in Px563L and RPA563, as well as certain license rights to intellectual property related to other Px563L components used to produce the final vaccine, which, if exercised, could materially impact our business, revenue and operating results. We have rights to utilize this intellectual property held by the U.S. government by virtue of the Authorization and Consent clauses of our contracts with the U.S. government.

Our contracts with the U.S. government, and our subcontracts with U.S. government contractors, require ongoing funding decisions by the U.S. government; reduced or discontinued funding of these contracts could cause our financial condition and operating results to suffer materially.

Development of our anthrax vaccines, Px563L and RPA563, is funded by BARDA and development of our Px563L-SDI anthrax vaccine and our malaria vaccine, Px533, is funded by The National Institute of Allergy and Infectious Diseases (NIAID). The funding for government programs is subject to Congressional appropriations, often made on a fiscal year basis, even for programs designed to continue for several years. These appropriations can be subject to political considerations and stringent budgetary constraints. For example, on March 29, 2019, we received notice from BARDA informing us of BARDA’s decision to not exercise development options for cGMP manufacturing and potential Phase 1/2b study readiness for Px563L and RPA563. Following the receipts of the notice from BARDA and pursuant to ongoing discussions with BARDA, we are assessing the priority of this program in our portfolio. Additionally, our government-funded development contracts give the U.S. government the right, exercisable in its sole discretion, to extend this contract for successive options following a base period of performance. The value of the services to be performed during these options may constitute the majority of the total value of the underlying contract. If levels of government expenditures and authorizations for biodefense decrease or shift to programs in areas where we do not offer products or are not developing product candidates, or if the U.S. government otherwise declines to exercise its options under its contracts with us, our business, revenue and operating results would suffer.

Our current contract with BARDA is a cost-plus fixed fee contract and potential future contracts with the U.S. government may also be structured this way. Under our cost-plus fixed fee contracts, we are allowed to recover our approved costs plus a fixed fee. The total price on a cost-plus fixed fee contract is based primarily on allowable costs incurred, but generally is subject to contract funding limitations. U.S. government regulations require us to notify our customer of any cost overruns or underruns on a cost-plus fixed fee contract. If we incur costs in excess of the funding limitation specified in the contract, we may not be able to recover those cost overruns.

Moreover, changes in U.S. government contracting policies could directly affect our financial performance. Factors that could materially adversely affect our U.S. government contracting business include:

 

•

budgetary constraints affecting U.S. government spending generally, or specific departments or agencies in particular;

 

•

changes in U.S. government fiscal policies or available funding;

 

•

changes in U.S. government defense and homeland security priorities;

 

•

changes in U.S. government programs or requirements;

 

•

adoption of new laws or regulations;

 

•

technological developments;

 

•

U.S. government shutdowns, threatened shutdowns or budget delays;

 

•

competition and consolidation in our industry; and

 

•

general economic conditions.

These or other factors could cause U.S. government departments or agencies to reduce their development funding or future purchases under contracts, to exercise their right to terminate contracts or fail to exercise their options to extend our contracts, any of which could have a material adverse effect on our business, financial condition, operating results and ability to meet our financial obligations.

 

41

Unfavorable provisions in government contracts, some of which are customary, may subject our business to material limitations, restrictions and uncertainties and may have a material adverse impact on our financial condition and operating results.

Government contracts contain provisions that give the U.S. government substantial rights and remedies, many of which are not typically found in commercial contracts, including provisions that allow the U.S. government to:

 

•

terminate existing contracts, in whole or in part, for any reason or no reason;

 

•

unilaterally reduce or modify the government’s obligations under such contracts or subcontracts, without the contractor’s consent, including by imposing equitable price adjustments;

 

•

audit contract-related costs and fees, including allocated indirect costs;

 

•

claim rights, including intellectual property rights, in products and data developed under such agreements;

 

•

under certain circumstances involving public health and safety, license inventions made under such agreements to third parties;

 

•

suspend the contractor from receiving new contracts pending resolution of alleged violations of procurement laws or regulations;

 

•

impose U.S. manufacturing requirements for products that embody inventions conceived or first reduced to practice under such contracts;

 

•

suspend or debar the contractor from doing future business with the government;

 

•

decline to exercise an option to continue a contract;

 

•

exercise an option to purchase only the minimum amount, if any, specified in a contract;

 

•

decline to exercise an option to purchase the maximum amount, if any, specified in a contract;

 

•

claim rights to facilities or to products, including intellectual property, developed under the contract;

 

•

require repayment of contract funds spent on construction of facilities in the event of contract default;

 

•

take actions that result in a longer development timeline than expected;

 

•

change the course of a development program in a manner that differs from the contract’s original terms or from our desired development plan, including decisions regarding our partners in the program;

 

•

pursue civil or criminal remedies under the False Claims Act (FCA) and False Statements Act; and

 

•

control or prohibit the export of products.

Generally, government contracts, including our contract with BARDA, contain provisions permitting unilateral termination or modification, in whole or in part, at the U.S. government’s convenience. Under general principles of government contracting law, if the U.S. government terminates a contract for convenience, the government contractor may recover only its incurred or committed costs, settlement expenses and profit on work completed prior to the termination. If the U.S. government terminates a contract for default, the government contractor is entitled to recover costs incurred and associated profits on accepted items only and may be liable for excess costs incurred by the government in procuring undelivered items from another source. In addition, government contracts normally contain additional requirements that may increase our costs of doing business, reduce our profits, and expose us to liability for failure to comply with these terms and conditions. These requirements include, for example:

 

•

specialized accounting systems unique to government contracts;

 

•

mandatory financial audits and potential liability for price adjustments or recoupment of government funds after such funds have been spent;

 

•

public disclosures of certain contract information, which may enable competitors to gain insights into our research program;

 

•

mandatory internal control systems and policies; and

 

•

mandatory socioeconomic compliance requirements, including labor standards, non-discrimination and affirmative action programs and environmental compliance requirements.

If we fail to maintain compliance with these requirements, we may be subject to potential contract or FCA liability and to termination of our contracts.

 

42

Furthermore, we are required to enter into agreements and subcontracts with third parties, including suppliers, consultants and other third-party contractors in order to satisfy our contractual obligations pursuant to our agreements with the United States government. Negotiating and entering into such arrangements can be time-consuming and we may not be able to reach agreement with such third parties. Any such agreement must also be compliant with the terms of our government contract. Any delay or inability to enter into such arrangements or entering into such arrangements in a manner that is non-compliant with the terms of our contract, may result in violations of our contract.

We may not have the right to prohibit the U.S. government from using certain technologies developed by us, and we may not be able to prohibit third-party companies, including our competitors, from using those technologies in providing products and services to the U.S. government. The U.S. government generally takes the position that it has the right to royalty-free use of technologies that are developed under U.S. government contracts.

Most U.S. government contracts grant the U.S. government the right to use on a royalty free basis, for or on behalf of the U.S. government, any technologies developed and data first produced by the contractor under the government contract. If we were to develop technology under a contract with such a provision, we might not be able to prohibit third parties, including our competitors, from using that technology in providing products and services to the U.S. government.

Our business is subject to audit by the U.S. government and a negative audit could adversely affect our business.

U.S. government agencies such as the Department of Health and Human Services (HHS) and the Defense Contract Audit Agency (DCAA) routinely audit and investigate government contractors and recipients of federal grants and contracts. These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards.

The HHS and the DCAA also review the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s accounting, purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while such costs already reimbursed must be refunded. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including:

 

•

termination of contracts;

 

•

forfeiture of profits;

 

•

suspension of payments;

 

•

fines; and

 

•

suspension or prohibition from conducting business with the U.S. government.

In addition, we could suffer serious reputational harm if allegations of impropriety were made against us, which could cause our stock price to decrease.

The United States government’s determination to award a future contract may be challenged by an interested party, such as another bidder, at the United States Government Accountability Office (GAO) or in federal court. If such a challenge is successful, any future contract we may be awarded may be terminated.

The laws and regulations governing the procurement of goods and services by the U.S. government provide procedures by which other bidders and interested parties may challenge the award of a government contract. If we are awarded a government contract, such challenges or protests could be filed even if there are not any valid legal grounds on which to base the protest. If any such protests are filed, the government agency may decide to suspend our performance under the contract while such protests are being considered by the GAO or the applicable federal court, thus potentially delaying delivery of payment. In addition, we could be forced to expend considerable funds to defend any potential award. If a protest is successful, the government may be ordered to terminate the contract and resolicit proposals. The government agencies with which we have contracts could even be directed to award a potential contract to one of the other bidders.

 

43

Laws and regulations affecting government contracts make it more costly and difficult for us to successfully conduct our business.

We must comply with numerous laws and regulations relating to the formation, administration and performance of government contracts, which can make it more difficult for us to retain our rights under our government contracts, including our contract with BARDA. These laws and regulations affect how we conduct business with government agencies. Among the most significant government contracting regulations that affect our business are:

 

•

the Federal Acquisition Regulations (FAR) and agency-specific regulations supplemental to the FAR, which comprehensively regulate the procurement, formation, administration and performance of government contracts;

 

•

the Truth in Negotiations Act, which requires certification and disclosure of cost or pricing data in connection with contract negotiations;

 

•

business ethics and public integrity obligations, which govern conflicts of interest and the hiring of former government employees, restrict the granting of gratuities and funding of lobbying activities and include other requirements such as the Anti-Kickback Statute and Foreign Corrupt Practices Act;

 

•

export and import control laws and regulations; and

 

•

laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of certain products and technical data.

Any material changes in applicable laws and regulations could restrict our ability to maintain our existing BARDA contract and obtain new contracts, which could limit our ability to conduct our business and materially adversely affect our results of operations.

If product liability lawsuits are brought against us, we may incur substantial liabilities and may be required to limit commercialization of products we develop.

We face a risk of product liability as a result of the clinical testing of our product candidates and will face an even greater risk if we commercialize any products. For example, we may incur liability if any product we develop allegedly causes injury or is found to be otherwise unsuitable during product testing, manufacturing, marketing or sale. Any such product liability claims may include allegations of defects in manufacturing, defects in design, a failure to warn of dangers inherent in the product, negligence, strict liability and a breach of warranties. Claims could also be asserted under state consumer protection acts. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit commercialization of our products. Regardless of the merits or eventual outcome, liability claims may result in:

 

•

decreased demand for PF708, Px563L, RPA563 or any other product candidates or products we develop;

 

•

injury to our reputation and significant negative media attention;

 

•

withdrawal of clinical trial participants or cancellation of clinical trials;

 

•

costs to defend the related litigation;

 

•

a diversion of management’s time and our resources;

 

•

substantial monetary awards to trial participants or patients;

 

•

regulatory investigations, product recalls, withdrawals or labeling, marketing or promotional restrictions;

 

•

loss of revenue; and

 

•

the inability to commercialize any products we develop.

Our inability to obtain and maintain sufficient product liability insurance at an acceptable cost and scope of coverage to protect against potential product liability claims could impact the commercialization of PF708, Px563L, RPA563 and any other products we develop. We currently carry product liability insurance covering our clinical trials in the amount of $10.0 million in the aggregate. Although we maintain such insurance, any claim that may be brought against us could result in a court judgment or settlement that is in excess of the limits of our insurance coverage. Our insurance policies also have various exclusions and deductibles, and we may be subject to a product liability claim for which we have no coverage. We will have to pay any amounts awarded by a court or negotiated in a settlement that exceed our coverage limitations or that are not covered by our insurance, and we may not have, or be able to obtain, sufficient capital to pay such amounts. Moreover, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses. If and when we obtain approval for marketing PF708, Px563L, RPA563 or any other product candidates, we intend to expand our insurance coverage to include the sale of such products; however, we may be unable to obtain this liability insurance on commercially reasonable terms.

 

44

Our employees, independent contractors, principal investigators, CROs, CMOs, consultants and collaboration partners may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements and insider trading.

We are exposed to the risk that our employees, independent contractors, principal investigators, third-party clinical research organizations (CROs) and contract manufacturing organizations (CMOs), consultants and collaboration partners may engage in fraudulent conduct or other illegal activity. Misconduct by these parties could include intentional, reckless and/or negligent conduct or unauthorized activities that violate: (1) regulations of the FDA and comparable foreign authorities, including those laws requiring the reporting of true, complete and accurate information to such authorities; (2) manufacturing standards; (3) federal and state healthcare fraud and abuse laws and regulations; or (4) laws that require the reporting of true and accurate financial information and data. In particular, sales, marketing and business arrangements in the healthcare industry are subject to extensive laws and regulations intended to prevent fraud, misconduct, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. These activities also include the improper use of information obtained in the course of clinical trials, which could result in regulatory sanctions and serious harm to our reputation. We have adopted a Code of Ethics and Conduct, but it is not always possible to identify and deter misconduct by employees and other third parties, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business including the imposition of significant civil, criminal and administrative penalties, damages, monetary fines, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, and curtailment of our operations, any of which could adversely affect our ability to operate our business and our results of operations.

Our cash and cash equivalents and short-term investments could be adversely affected if the financial institutions in which we hold our cash and cash equivalents and short-term investments fail.

We regularly maintain cash balances at third-party financial institutions in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit. While we monitor the cash balances in our accounts and adjust the balances as appropriate, these balances could be impacted, and there could be a material adverse effect on our business, if one or more of the financial institutions with which we deposit fails or is subject to other adverse conditions in the financial or credit markets. To date, we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurance that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial and credit markets.

We may be subject to information technology failures, including data protection breaches and cyber-attacks, that could disrupt our operations, damage our reputation and adversely affect our business, operations, and financial results.

We rely on our information technology systems for the effective operation of our business and for the secure maintenance and storage of confidential data relating to our business and third-party businesses. Although we have implemented security controls to protect our information technology systems, experienced programmers or hackers may be able to penetrate our security controls, and develop and deploy viruses, worms and other malicious software programs that compromise our confidential information or that of third parties and cause a disruption or failure of our information technology systems. Any such compromise of our information technology systems could result in the unauthorized publication of our confidential business or proprietary information, result in the unauthorized release of customer, supplier or employee data, result in a violation of privacy or other laws, expose us to a risk of litigation, or damage our reputation. The cost and operational consequences of implementing further data protection measures either as a response to specific breaches or as a result of evolving risks, could be significant. In addition, our inability to use or access our information systems at critical points in time could adversely affect the timely and efficient operation of our business. Any delayed sales, significant costs or lost customers resulting from these technology failures could adversely affect our business, operations and financial results.

Third parties with which we conduct business have access to certain portions of our sensitive data. In the event that these third parties do not properly safeguard our data that they hold, security breaches could result and negatively impact our business, operations and financial results.

Our business involves the use of hazardous materials and we, our collaboration partners, and our third-party manufacturers and suppliers must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

Our research and development and manufacturing activities and our third-party manufacturers’ and suppliers’ activities involve the controlled storage, use and disposal of hazardous materials owned by us, including small quantities of acetonitrile, methanol, ethanol, ethidium bromide and compressed gases, and other hazardous compounds. We and our collaboration partners, manufacturers

 

45

and suppliers are subject to laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials. In some cases, these hazardous materials and various wastes resulting from their use are stored at our and our manufacturers’ facilities pending their use and disposal. We cannot eliminate the risk of contamination, which could cause an interruption of our commercialization efforts, research and development efforts and business operations, environmental damage resulting in costly clean-up and liabilities under applicable laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products.

Although we believe that the safety procedures utilized by us and our third-party manufacturers for handling and disposing of these materials generally comply with the standards prescribed by these laws and regulations, we cannot guarantee that this is the case or eliminate the risk of accidental contamination or injury from these materials. In such an event, we may be held liable for any resulting damages and such liability could exceed our resources and state or federal or other applicable authorities may curtail our use of certain materials and interrupt our business operations.

We are also subject to numerous environmental, health and workplace safety laws and regulations, including those governing laboratory procedures, and the handling of biohazardous materials. Although we maintain workers’ compensation insurance to cover us for costs and expenses we may incur due to injuries to our employees resulting from the use of these materials, this insurance may not provide adequate coverage against potential liabilities. For claims not covered by workers’ compensation insurance, we also maintain an employer’s liability insurance policy in the amount of $1.0 million per occurrence and in the aggregate. We do not maintain insurance for environmental liability or toxic tort claims that may be asserted against us.

Environmental laws and regulations are complex, change frequently and have tended to become more stringent. We cannot predict the impact of such changes and cannot be certain of our future compliance. Any inability to comply with environmental laws and regulations may adversely affect our business and operating results.

Changes in accounting principles, or interpretations thereof, could have a significant impact on our financial position and results of operations.

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, referred to as GAAP. These principles are subject to interpretation by the Securities and Exchange Commission (SEC) and various bodies formed to interpret and create appropriate accounting principles. A change in these principles can have a significant effect on our reported results and may even retroactively affect previously reported transactions. Additionally, the adoption of new or revised accounting principles may require that we make significant changes to our systems, processes and controls.

It is not clear if or when these potential changes in accounting principles may become effective, whether we have the proper systems and controls in place to accommodate such changes and the impact that any such changes may have on our financial position and results of operations.

Even if PF708, Px563L, RPA563 or any of our other product candidates obtain regulatory approval, they may never achieve market acceptance or commercial success.

Even if we obtain FDA or other regulatory approvals, PF708, Px563L, RPA563 or any of our other product candidates may not achieve market acceptance among physicians and patients and may not be commercially successful. The degree and rate of market acceptance of PF708, Px563L, RPA563 or any of our other product candidates for which we receive approval depends on a number of factors, including:

 

•

the performance of our collaboration partners, including Alvogen, Jazz, and NT Pharma;

 

•

the safety and efficacy of the product as demonstrated in clinical trials;

 

•

the clinical indications for which the product is approved;

 

•

acceptance by physicians, major operators of clinics and patients of the product as a safe and effective treatment;

 

•

whether we obtain an “A” therapeutic equivalence designation for PF708, which may allow PF708 to be automatically substituted for Forteo, depending on applicable laws and policies within each of the 50 states;

 

•

proper training and administration of our products by physicians and medical staff;

 

•

the potential and perceived advantages of our products over alternative treatments;

 

•

the cost of treatment in relation to alternative treatments and willingness to pay for our products, if approved, on the part of physicians and patients;

 

46