Cocrystal Pharma, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. This is an annual report, not a standalone fourth-quarter filing. Financial amounts below are in U.S. dollars; unless stated otherwise, amounts are rounded to millions.
Business context
Cocrystal is a preclinical-stage biopharmaceutical company developing antiviral medicines using structure-based drug design. In January 2014, the former Biozone Pharmaceuticals sold substantially all of its legacy product assets to MusclePharm and merged with Cocrystal Discovery. In November 2014, Cocrystal acquired RFS Pharma, adding drug-development programs and intellectual property. The company reports one operating segment and had 22 full-time employees, 18 in research and development.
Its programs target hepatitis C (HCV), norovirus and influenza. The pipeline remained preclinical; the company had no approved products and no product-sale revenue.
Financial performance and position
| Metric | 2014 | 2013 |
|---|---|---|
| Revenue | $9,000 grant revenue | None |
| Research and development expense | $4.071 million | $3.862 million |
| General and administrative expense | $1.737 million | $219,000 |
| Operating loss | $5.799 million | $4.081 million |
| Net loss | $99,000 | $3.887 million |
| Net cash used in operating activities | $6.009 million | $3.686 million |
The 2014 net loss was substantially smaller than the operating loss chiefly because of noncash income from the decline in the fair value of liability-classified warrants. Other income, net, was $5.648 million and included a $5.730 million favorable change in derivative fair value, a $1.359 million realized gain on marketable securities, and offsetting items. Management advised investors to focus on operating loss rather than net loss. No gross margin or product margin is meaningful because the company had no product sales.
At year-end, cash and cash equivalents were $3.970 million; current assets were $6.376 million and current liabilities were $9.157 million. Current assets included $1.975 million of MusclePharm shares held in escrow. The company also reported a mortgage note receivable with a $2.596 million carrying amount, bearing 7.24% interest and maturing in 2032. No conventional funded debt balance is identified in the balance sheet; derivative liabilities were $8.464 million, and the acquisition-related deferred tax liability was $65.195 million. Total assets were $259.283 million and total liabilities were $74.414 million.
Operating cash use rose from 2013, reflecting increased R&D and public-company and merger-related costs. Investing activities provided $6.079 million, primarily from marketable-security sales, partly offset by the mortgage-note investment. Financing activities provided $2.866 million, primarily from the January 2014 stock-and-warrant financing.
Material changes and unusual items
- RFS Pharma was acquired on November 25, 2014 for consideration valued at approximately $184.8 million, primarily preferred stock and replacement options. The purchase accounting recorded $184.966 million of in-process research and development, $65.195 million of goodwill and a corresponding $65.195 million deferred tax liability. These large acquisition-related balances materially changed the year-end balance sheet; the acquired research asset is indefinite-lived and subject to impairment testing.
- R&D expense increased 5% year over year. G&A expense increased by $1.518 million, largely due to merger, financing, professional-service and public-company costs.
- The company issued 5.5 million common shares and 5.5 million warrants in January 2014 for $2.75 million. The warrants were liability-classified; their valuation changes significantly affected reported other income and expense.
- After year-end, shareholders approved increasing authorized common shares from 200 million to 800 million. Series A and Series B preferred shares then converted into a combined 545.8 million common shares. The filing reported 673.6 million common shares outstanding on March 23, 2015.
- MusclePharm shares received in the legacy-asset sale remained partly in escrow, subject to resolution of a lease-related matter. A separate lawsuit seeks recovery on a purported $295,000 promissory note; the company says it intends to defend the case. The lease-eviction proceeding settled in March 2015.
Outlook, risks and controls
Management estimated negative cash flow of approximately $11 million over the 12 months ending December 31, 2015. The company reported a $15 million private stock placement commitment in March 2015 and approximately $11.8 million received by March 31. Management stated that year-end cash together with financing proceeds should fund the current operating plan for at least 12 months, but additional capital will be needed if losses continue; future funding may not be available on acceptable terms. Management expects R&D spending to increase as preclinical work expands.
The company’s drug candidates require extensive preclinical and clinical testing and regulatory approval, and commercial revenue was not expected for at least several years. Key risks include development and safety failures, regulatory delays, competition from better-resourced companies, intellectual-property challenges, reliance on outside research and manufacturing providers, and dependence on additional financing. The company also highlighted potential limits on use of tax-loss carryforwards following ownership changes.
The independent auditor issued an unqualified opinion on the financial statements. However, management concluded disclosure controls and internal control over financial reporting were ineffective at year-end, citing insufficient personnel, inadequate review and documentation, and lack of segregation of duties. The auditor was not engaged to audit internal control effectiveness. The filing describes remediation efforts for a previously reported weakness in accounting for complex financial instruments.
Important facts for investors to verify
- Cash runway: reconcile the stated 2015 cash needs with the timing and final receipt of the $15 million placement; $11.8 million had been received by March 31, 2015.
- Warrant exposure: review the $8.464 million derivative liability, its settlement terms, and the effect of subsequent cashless warrant exercises.
- Acquisition valuation: assess the assumptions, development prospects and impairment sensitivity of the $184.966 million in-process R&D asset and $65.195 million goodwill.
- Share dilution and control: confirm post-conversion share counts, remaining warrants and options, and the implications of the increase in authorized shares.
- Contingencies and liquidity of assets: monitor the escrowed MusclePharm shares, the mortgage note tied to property leased to MusclePharm, and the pending $295,000 note lawsuit.
- Financial reporting controls: track remediation of the material weakness and whether management reports effective controls in subsequent filings.