Arena Pharmaceuticals 10-Q 2006
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-31161
ARENA PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes ý No
The number of shares of common stock outstanding as of the close of business on April 30, 2006:
ARENA PHARMACEUTICALS, INC.
Arena Pharmaceuticals®, Arena® and our corporate logo are registered service marks of Arena. CART and BRL Screening are unregistered service marks of Arena.
In this report, Arena Pharmaceuticals, Arena, we, us and our refer to Arena Pharmaceuticals, Inc. and/or our wholly owned subsidiary, BRL Screening, Inc., unless the context otherwise provides.
Arena Pharmaceuticals, Inc.
Note: The balance sheet at December 31, 2005, has been derived from audited financial statements at that date. It does not include, however, all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.
Arena Pharmaceuticals, Inc.
(In thousands, except per share data)
See accompanying notes to unaudited condensed consolidated financial statements.
Arena Pharmaceuticals, Inc.
See accompanying notes to unaudited condensed consolidated financial statements.
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Arena Pharmaceuticals, Inc. (together with its wholly owned subsidiary BRL Screening, Inc., the Company) should be read in conjunction with the audited financial statements and notes thereto included in the Companys annual report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission (SEC). The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, since they are interim statements, the accompanying financial statements do not include all of the information and notes required by GAAP for complete financial statements. The accompanying financial statements reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. Certain prior period amounts have been reclassified to conform to current period presentation.
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements and notes thereto. The Companys critical accounting policies and estimates and assumptions are described in Managements Discussion and Analysis of Financial Condition and Results of Operations, which is included below in this quarterly report on Form 10-Q.
2. Net Loss Per Share
Basic and diluted net loss per share of common stock are presented in conformity with Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share, for all periods presented. In accordance with SFAS No. 128, basic and diluted loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase or forfeiture.
The Company has excluded all outstanding stock options, unvested restricted stock, preferred stock, warrants and shares subject to repurchase or forfeiture from the calculation of diluted loss per share of common stock because all such securities are antidilutive for all periods presented. The total number of shares subject to repurchase or forfeiture excluded from the calculation of diluted net loss per share allocable to common stockholders was 140,533 and 238,164 for the three months ended March 31, 2006 and 2005, respectively.
3. Comprehensive Loss
In accordance with SFAS No. 130, Reporting Comprehensive Loss, all components of comprehensive loss, including net loss, are reported in the financial statements in the period in which they are recognized. Comprehensive loss is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Below is a reconciliation of net loss to comprehensive loss for all periods presented.
4. Stock-based Compensation
Equity Compensation Plans
Through March 31, 2006, an aggregate of 6.25 million shares of common stock have been authorized for issuance under the Amended and Restated Arena Pharmaceuticals, Inc. 1998 Equity Compensation Plan, Amended and Restated Arena Pharmaceuticals, Inc. 2000 Equity Compensation Plan and Arena Pharmaceuticals, Inc. 2002 Equity Compensation Plan (collectively, the Equity Compensation Plans). The Equity Compensation Plans provide designated employees, certain consultants and advisors who perform services for the Company, and non-employee members of the Companys board of directors with the opportunity to receive grants of stock options and restricted stock. Stock options generally vest 25% a year for four years and are immediately exercisable for up to 10 years from the date of grant. Restricted stock generally vests over
a two, three or four-year period and the recipient, at the date of grant, has all rights of a stockholder, subject to certain restrictions on transferability and a risk of forfeiture.
In the event of termination of employment or engagement, unvested restricted common stock is subject to forfeiture and restricted common stock issued from the exercise of unvested stock options is subject to repurchase at the original purchase price. In the event the Company elects to not buy back any such unvested shares, any related compensation will immediately be expensed at their fair value. In accordance with SFAS No. 128, the Company has excluded unvested restricted stock and common stock issued from the exercise of unvested stock options from its calculation of basic and diluted net loss per share.
Employee Stock Purchase Plan
The Companys 2001 Arena Employee Stock Purchase Plan (the Purchase Plan) was adopted by its board of directors in March 2001. The Purchase Plan qualifies under Section 423 of the Internal Revenue Service and permits substantially all employees to purchase shares of the Companys common stock. Under the Purchase Plan, employees can choose to have up to 15% of their annual compensation withheld to purchase shares of common stock, subject to certain limitations. The shares of common stock may be purchased over an offering period with a maximum duration of two years at 85% of the lower of the fair market value of the common stock on the first day of the applicable offering period or on the last day of the three-month purchase period. The aggregate number of shares of common stock that may be issued pursuant to the Purchase Plan is 1,000,000. During the three months ended March 31, 2006, and 2005, 82,018 and 41,691 shares were purchased, respectively. As of March 31, 2006, 589,612 shares have been issued pursuant to the Purchase Plan.
Impact of Adoption of SFAS No. 123R
Prior to January 1, 2006, the Company accounted for stock-based compensation in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and its related Interpretations, which state that no compensation expense is recorded for stock options or other stock-based awards to employees and directors that are granted with an exercise price equal to or above the fair value per share of the companys common stock on the grant date. In the event that stock options were granted with an exercise price below the fair value of the companys common stock on the grant date, the difference between the fair value of its common stock and the exercise price of the stock option was recorded as deferred compensation. For stock options granted to the Companys employees and directors, the Company adopted the disclosure-only requirements of SFAS No. 123, Accounting for Stock-Based Compensation, which allowed compensation expense to be disclosed in the notes to the financial statements based on the fair value of the options granted at the date of the grant. Compensation expense for options granted to non-employees other than directors had been determined in accordance with SFAS No. 123 and Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services. Such expense was based on the fair value of the options issued using the Black-Scholes method and was periodically remeasured as the underlying options vested in accordance with EITF Issue No. 96-18.
On January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment, using the modified-prospective transition method. Under this method, prior period results are not restated. Compensation cost recognized subsequent to adoption includes: (i) compensation cost for all share-based payments granted prior to, but unvested as of, January 1, 2006, based on the grant date fair value, which is determined in accordance with the original provision of SFAS No. 123, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value, which is determined in accordance with the provisions of SFAS No. 123R. Compensation cost related to share-based payments is included in research and development and in general and administrative expenses in the financial statements.
The Company measures restricted stock awards at the fair value of the stock on the grant date. The restrictions generally lapse in equal annual installments over the vesting period of two, three or four years. Prior to the adoption of SFAS No. 123R, deferred compensation for grants of restricted stock equivalent to the fair value of the shares at the date of grant was recorded as a separate component of stockholders equity and subsequently amortized to compensation expense over the awards vesting period. In accordance with SFAS No. 123R, stockholders equity is credited commensurate with the recognition of compensation expense. All unamortized deferred compensation at January 1, 2006, was reclassified to additional paid-in capital.
As a result of the adoption of SFAS No. 123R, the Company recognized share-based compensation expense for the three months ended March 31, 2006, of $1.1 million, which includes $681,000 in research and development expenses and $459,000 in general and administrative expenses. The $1.1 million in share-based compensation for the three months ended March 31, 2006, includes $923,000 and $217,000 in share-based compensation expense related to the Equity Compensation Plans and Purchase Plan, respectively. Accordingly, basic and diluted net loss per share allocable to common stockholders for the three
months ended March 31, 2006, would have been $0.03 lower had the Company not adopted SFAS No. 123R effective January 1, 2006.
Tax benefits recognized related to stock-based compensation and related cash flow impacts were not material during the three months ended March 31, 2006, because the Company is in a net operating loss position.
Valuation of Share-based Compensation under SFAS No. 123R
The Company uses a Black-Scholes option pricing model to estimate the grant date fair value of share-based awards under SFAS No. 123R. The weighted-average estimated fair value of stock options granted under the Equity Compensation Plans during the three months ended March 31, 2006, was $10.04 per share using the following assumptions:
The weighted-average estimated fair values of stock purchased under the Purchase Plan for multiple offering periods during the three months ended March 31, 2006, ranged from $1.99 to $6.57 per share using the following assumptions:
Expected volatility for awards granted after adoption of SFAS No. 123R was based on a combination of historical volatility of the Companys common stock and market-based implied volatilities from traded options on its common stock, with historical volatility being more heavily weighted due to low volume of traded options on its common stock. Prior to adoption of SFAS No. 123R, the Companys computation of expected volatility was based only on historical volatility of its common stock. The expected life of options granted under SFAS No. 123R was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and post-vesting cancellations. Prior to the adoption of SFAS No. 123R, an average expected life of five years was used in determining the fair value of option grants based on the vesting period of the options and, due to the short period of time the Companys stock had been publicly traded. The risk-free interest rates are based on the U.S Treasury yield curve, with a remaining term approximately equal to the expected term used in the option pricing model.
SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures of unvested options were estimated to be approximately 7.2% during the three months ended March 31, 2006, based on historical experience. As a result, the Company reduced its share-based compensation expense for the three months ended March 31, 2006, by $59,000. If actual forfeitures vary from this estimate, the Company will recognize the difference in compensation cost in the period the actual forfeitures occur. Prior to the adoption of SFAS No. 123R, the Company accounted for forfeitures as they occurred in the pro forma disclosure required under SFAS No. 123.
The Company recorded $1.1 million in share-based compensation expense during the three months ended March 31, 2006.
Stock-based Award Activity
The following table summarizes the Companys stock option activity during the three months ended March 31, 2006:
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Companys common stock for the 3.9 million options that had strike prices below the then current market price of its common stock at March 31, 2006. The total intrinsic value of options exercised during the three months ended March 31, 2006, was $899,000. Cash received from option exercises of all stock-based payment arrangements during the three months ended March 31, 2006, was $912,000. Upon option exercise and purchases made under the Purchase Plan, the Company issues new shares of stock. As of March 31, 2006, a total of 539,328 shares are available for issuance under the Equity Compensation Plans and Purchase Plan.
The following table summarizes the Companys unvested restricted stock activity during the three months ended March 31, 2006:
At March 31, 2006, total unrecognized estimated compensation cost related to unvested stock options and restricted stock was $10.6 million, which is expected to be recognized over a weighted-average remaining requisite service period of 1.66 years. The total fair value of shares vested during the three months ended March 31, 2006, was $80,000.
During the three months ended March 31, 2006, 82,018 shares of common stock were purchased under the Purchase Plan, resulting in compensation cost of $217,000.
Pro Forma Information under SFAS No. 123 for Periods Prior to January 1, 2006
Prior to adopting the provisions of SFAS No. 123R, the Company provided pro forma disclosures of estimated stock-based compensation expense as permitted under SFAS No. 123. The following pro forma information illustrates the effect on net loss allocable to common stockholders and net loss per share for the three months ended March 31, 2005, as if the Company had accounted for its employee and director stock options and stock issued under the Purchase Plan using the fair value method prescribed by SFAS No. 123. The fair value of options was estimated at the date of grant using a Black-Scholes option pricing model and amortized to expense over the options vesting periods.
5. Short-Term Investments, Available-for-Sale
In accordance with SFAS No. 115, Accounting for Certain Debt and Equity Securities, short-term investments are classified as available-for-sale. The Company defines short-term investments as income-yielding securities that can be readily converted to cash. These securities are carried at fair value, with unrealized gains and losses reported as accumulated other comprehensive income or loss. The cost of debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion is included in interest income. Realized gains and losses and declines in securities judged to be other than temporary are included in other income or expense. The cost of securities sold is based on the specific identification method. Interest and dividends on available-for-sale securities are included in interest income. Investments held as of March 31, 2006, consist primarily of U.S. Federal agency notes and U.S. corporate debt securities.
6. Concentration of Credit Risk
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and short-term investments. The Company limits its exposure to credit loss by placing its cash with high quality financial institutions and, in accordance with the Companys investment policy, in debt instruments that are rated investment grade.
The Companys revenues were derived from two collaborators for the periods presented. The percentages of total revenues from each of the Companys significant collaborations are as follows:
7. Redeemable Convertible Preferred Stock and Warrants
In December 2003, the Company sold 3,500 shares of Series B-1 redeemable convertible preferred stock (Series B-1 Preferred) together with (i) seven-year warrants to purchase up to 1,486,200 shares of common stock at an exercise price of $10 per share; and (ii) unit warrants giving such investors the right to purchase from the Company for a period of approximately 16 months from December 24, 2003, at their option, up to $11.5 million of Series B-2 redeemable convertible preferred stock (Series B-2 Preferred) and additional seven-year warrants to purchase up to 450,000 shares of common stock at an exercise price of $10 per share, to two institutional investors for an aggregate purchase price of $35.0 million. The Company received approximately $34.2 million in net cash proceeds after closing costs.
The holders of the Companys Series B-1 Preferred can require the Company to redeem all or some of their shares of the Series B-1 Preferred at such shares stated value, plus accrued but unpaid dividends thereon to the date of payment and any applicable penalties. The stated value is the original holders investment plus any dividends settled by increasing the stated value at the time the dividend is payable. The aggregate redemption price of the Series B-1 Preferred at March 31, 2006, was approximately $38.3 million, and accrues interest at a rate of four percent annually. The Company may be able to satisfy a portion of any redemption with shares of its common stock. Due to the Series B-1 Preferred becoming redeemable in the first quarter of 2005, the Company recorded a charge of $7.4 million to accrete the discount and deemed dividend on redeemable convertible preferred stock in that quarter. Any redemption amount settled in equity would be computed based on the lesser of the applicable conversion price of $7.50 and 95% of the arithmetic average of the volume weighted average prices of common stock for the 10 consecutive trading days prior to the date of delivery of the applicable Series B-1 Preferred redemption notice.
On April 22, 2005, the Companys preferred stockholders exercised their unit warrants in full. The aggregate gross proceeds to the Company from the exercise of the unit warrants were $11.5 million.
If not previously converted,
the Company must redeem the Series B-2 Preferred in five years from
April 22, 2005, or earlier under certain circumstances, at such shares
stated value, plus accrued but unpaid dividends thereon to the date of payment
and any applicable penalties. The Company may be able to satisfy a portion of
any redemption with shares of its common stock. The Series
On March 31, 2006, following the Companys call notice to one of the two warrant holders, such holder exercised its warrants to purchase 829,856 shares of the Companys common stock. Such holder believes the terms of its exercised warrants provide that it is entitled to receive exchange warrants to purchase 829,856 shares of the Companys common stock at an exercise price of $23.363 per share. The Company has not issued exchange warrants, but is reviewing the matter. The Company may determine to issue such exchange warrants. In such event, the Company could also be required to issue additional exchange warrants to purchase shares of the Companys common stock following future call notices to this holder, as well as to the other warrant holder who owns warrants to acquire 1,106,344 shares of common stock at an exercise price of $10 per share.
8. Effect of New Accounting Standards
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, Share-Based Payment. This statement, which became effective on January 1, 2006, changed how the Company accounts for share-based compensation, and will have a negative impact on the Companys results of operations.
Through December 31, 2005, the Company accounted for share-based payments to employees and directors using the intrinsic value method. Under this method, the Company generally did not recognize any compensation related to stock option grants issued under the Equity Compensation Plans or the discounts the Company provided under the Purchase Plan.
SFAS No. 123R requires the Company to recognize share-based compensation as compensation expense in the statement of operations based on the fair values of such equity on the date of the grant, with the compensation expense recognized over the period in which the recipient is required to provide service in exchange for the equity award. The Company adopted the modified-prospective transition method of recognition of compensation expense related to share-based payments. In the three months ended March 31, 2006, the Company recorded $1.1 million in compensation expense related to share-based payments. The impact of adoption of SFAS No. 123R on future periods is difficult to predict because it will depend on levels of share-based payments granted in the future. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. SFAS No. 123R may also delay when the Company may become profitable.
This discussion and analysis should be read in conjunction with our financial statements and notes thereto included in this quarterly report on Form 10-Q (this Quarterly Report) and the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2005 (the 2005 Annual Report), as filed with the Securities and Exchange Commission (the SEC). Operating results are not necessarily indicative of results that may occur in future periods.
This Quarterly Report includes forward-looking statements. These forward-looking statements involve a number of risks and uncertainties. Such forward-looking statements include statements about our strategies, objectives, discoveries, collaborations, clinical or other internal or partnered programs, and other statements that are not historical facts, including statements which may be preceded by the words may, intend, will, plan, expect, anticipate, estimate, believe or similar words. For such statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. Readers of this Quarterly Report are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the time this Quarterly Report was filed with the SEC. We undertake no obligation to update publicly or revise any forward-looking statements, other than as required by law. Actual events or results may differ materially from our expectations. Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, the risk factors identified in our SEC reports, including this Quarterly Report.
OVERVIEW AND RECENT DEVELOPMENTS
We are a clinical-stage biopharmaceutical company with a pipeline of internally discovered small molecule product candidates that target G protein-coupled receptors, or GPCRs. Four of our drug candidates are in clinical development: Lorcaserin hydrochloride, previously referred to by us as APD356, for the treatment of obesity has completed a Phase 2b clinical trial; APD125 for the treatment of insomnia has completed a Phase 1 clinical trial program; a drug candidate for the treatment of atherosclerosis and related disorders is in a Phase 1 clinical trial as part of our collaboration with Merck & Co., Inc. (Merck); and APD668, a drug candidate for the treatment of type 2 diabetes, is in a Phase 1 clinical as part of our collaboration with Ortho-McNeil, Inc., a Johnson & Johnson company (Ortho-McNeil). We believe our GPCR-focused approach and drug discovery technologies and capabilities will allow us to continue to discover novel product candidates in our therapeutic areas of focus, which are metabolic, cardiovascular, inflammatory and central nervous system (or CNS) diseases. We incorporated on April 14, 1997, in the state of Delaware and commenced operations in July 1997.
Our recent developments include:
Reporting results from the chronic twelve and six-month pre-clinical toxicology studies of lorcaserin hydrochloride that did not demonstrate any apparent drug effect on heart valves or pulmonary vasculature.
Initiating a Phase 1 clinical trial of APD668, a novel orally administered drug candidate discovered by us and being developed in collaboration with Ortho-McNeil, for the treatment of type 2 diabetes. The initiation of the Phase 1 trial triggered a $5 million milestone payment to us under our collaboration with Ortho-McNeil to develop compounds targeting the Glucose-Dependent Insulinotropic receptor, or the GDI receptor (previously referred to by us as the 19AJ receptor). The GDI receptor is a novel receptor discovered by us that has the potential to stimulate insulin production in response to increases in blood glucose.
Completing a follow-on stock offering of 10,637,524 share of common stock at the public offering price of $16.90 per share, resulting in net proceeds to us of approximately $169.0 million.
Promoting Robert E. Hoffman to Chief Financial Officer. Mr. Hoffman also serves as our Vice President, Finance, and has been one of our employees since 1997.
Receiving $8.3 million in proceeds in March 2006 from the exercise of 829,856 warrants to purchase common stock at $10 per share.
RESULTS OF OPERATIONS
We are providing the following summary of our revenues and expenses to supplement the more detailed discussion below. The following tables are stated in millions.
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
Revenues. We recorded record quarterly revenues of $12.1 million during the three months ended March 31, 2006, compared to $4.4 million in revenues during the three months ended March 31, 2005. One hundred percent of our revenues during the three months ended March 31, 2006, were from our collaborations with Ortho-McNeil and Merck, which included research funding, milestone achievements, additional sponsored research and patent activities, and technology access and development fees. Included in revenues for the three months ended March 31, 2006, was $5.0 million for a milestone achievement under our Ortho-McNeil collaboration in connection with the initiation of a Phase 1 clinical trial. We recognized the milestone achievement immediately in accordance with our revenue recognition policy. Also included in revenues for the three months ended March 31, 2006, was additional sponsored research and patent activities totaling $2.7 million from our collaborators. One hundred percent of our revenues during the three months ended March 31, 2005, were from our collaborations with Ortho-McNeil and Merck, which included research funding, milestone achievements, and technology access and development fees.
In October 2004, we extended and expanded our collaboration with Merck, and Merck purchased $7.5 million of our stock at a price of $8.00 per share, a 70% premium to the then current market price. In addition, under our agreement, Merck will pay us $5.7 million a year for collaboration research through October 19, 2007. We performed an evaluation on the Merck stock purchase and determined that $3.9 million of the $7.5 million purchase was an upfront payment related to the collaboration extension and expansion. Accordingly, we are recognizing the $3.9 million upfront payment as well as the remaining unamortized upfront payment balance of $1.3 million at October 2004 over the extended collaboration term of three years. In addition, in October 2004, we achieved a $1.0 million milestone under our Merck collaboration which we are recognizing over the extended collaboration term of three years because the milestone was reasonably assured to be achieved at the time we extended and expanded our collaboration with Merck. In December 2004, we entered into our collaboration and license agreement with Ortho-McNeil. This collaboration included a $17.5 million upfront payment, as well as research funding of $2.4 million per year through December 19, 2006. Ortho-McNeil has the option to extend our collaboration one year until December 2007 and, therefore, we are amortizing the $17.5 million upfront payment over three years. In December 2004, we achieved two milestones under our Ortho-McNeil collaboration of $2.5 million each, which we are recognizing as revenues over three years because the milestones were reasonably assured to be achieved at the time we entered into the collaboration.
Our collaborators often pay us before we recognize such payments as current revenues and, accordingly, these payments are recorded as deferred revenues until earned. As of March 31, 2006, we had deferred revenues totaling approximately $21.7 million. Absent any new collaborators, our revenues for the rest of 2006 are expected to be substantially dependent on Ortho-McNeil and Merck. Future revenues for research or clinical milestones that have not yet been achieved are difficult to predict, and we expect our revenues from quarter to quarter and year to year to vary significantly. Our future revenues are dependent upon the clinical success of our partnered programs and whether we partner lorcaserin hydrochloride, APD125, APD791 or other of our drug candidates.
Research and development expenses. Research and development expenses consisted primarily of costs associated with external preclinical and clinical studies and internal development of our drug candidates, internal programs and our technologies. Other than partnered and preclinical and more advanced research programs, we generally do not track our research and development expenses by project; rather, we track such expenses by the type of cost incurred. Research and development expenses increased $1.6 million to $20.5 million for the three months ended March 31, 2006, from $18.9 million for the three months ended March 31, 2005. The difference was due primarily to (i) personnel costs increasing by $1.8 million as we increased the number of our research and development employees from 238 at the end of March 2005 to 278 at the end of March 2006 as well as $0.7 million in additional share-based compensation related to the implementation of expensing of share-based compensation under the Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, in the three month period ended March 31, 2006, (ii) research supplies increasing by $0.3 million due to the greater number of research and development personnel, and (iii) external preclinical and clinical study fees and expenses decreasing by $0.9 million as we had less ongoing preclinical and clinical study fees and expenses in the first quarter of 2006. Nearly all of the increase in research and development employees was development staff needed to support our internal programs including lorcaserin hydrochloride, APD125 and APD791. Included in the $5.7 million in external preclinical and clinical study fees and expenses for the three months ended March 31, 2006, was $2.9 million in external fees and expenses related to our lorcaserin hydrochloride program, $1.5 million in external fees and expenses related to our APD125 program and $0.7 million in external fees and expenses related to our APD791 program. Included in the $6.6 million in external preclinical and clinical study fees and expenses for the three months ended March 31, 2005, was $5.0 million in external fees and expenses related to our lorcaserin hydrochloride program and $1.1 million in external fees and expenses related to our APD125 program. We expect research and development expenses to be greater in 2006 than in 2005 primarily due to the initiation of more costly later stage clinical trials for lorcaserin hydrochloride and APD125. We also expect that research and development expenses will be greater in 2006 than in 2005 due to the implementation of SFAS No. 123R.
General and administrative expenses. General and administrative expenses increased $2.8 million to $5.6 million for the three months ended March 31, 2006, from $2.8 million for the three months ended March 31, 2005. This increase is due primarily to patent costs related to our partnered programs increasing by $1.6 million, the patent costs related to our internal programs and technologies increasing by $0.7 million, and personnel costs increasing by $0.4 million due to the implementation of expensing of share-based compensation under SFAS No. 123R. To the extent our partners reimburse us for patent costs, the reimbursements are classified as revenues. Such reimbursements totaled $1.6 million and $0 in the three months ended March 31, 2006 and 2005, respectively. We expect general and administrative expenses to be greater in 2006 than in 2005 due to the cost of maintaining a growing and maturing portfolio of patent applications and patents for our internal and partnered programs and expenses related to accounting rules and regulations, including SFAS No. 123R.
Interest income and other, net. Interest income and other, net, totaled $2.1 million for the three months ended March 31, 2006, compared to $0.4 million for the three months ended March 31, 2005. Interest income and other, net, for the three
months ended March 31, 2006, was primarily comprised of (i) $2.5 million in interest income, (ii) interest expense and financing costs of $0.5 million, which includes lease payments accounted for in accordance with SFAS No. 66, Accounting for Sales of Real Estate, on our 6138-6150 Nancy Ridge Drive facility that we sold in 2003 and are leasing back and (iii) $0.1 million in other income. Interest income and other, net, for the three months ended March 31, 2005, was primarily comprised of (a) $0.8 million in interest, and (b) $0.5 million in interest expense and financing costs, which includes lease payments accounted for in accordance with SFAS No. 66.
Dividends on redeemable convertible preferred stock. We recorded a dividend expense of $0.5 million related to our redeemable convertible preferred stock for the three months ended March 31, 2006, compared to $0.4 million for the three months ended March 31, 2005. In April 2005, we issued an additional $11.5 million in redeemable convertible preferred stock as a result of the preferred stockholders exercise of their unit warrants. The holders of our series B redeemable convertible preferred stock are entitled to dividends that accrue at an annual rate of four percent. This dividend expense, payable in additional shares of redeemable convertible preferred stock or in common stock, increases the net loss allocable to common stockholders. Assuming that the redeemable convertible preferred stock is held until the mandatory redemption date, we expect to record dividends on redeemable convertible preferred stock of $1.5 million for the remaining nine months of 2006, and $2.1 million, $2.2 million, $0.5 million and $0.2 million for the years ending December 31, 2007, 2008, 2009 and 2010, respectively.
Accretion of discount and deemed dividend on redeemable convertible preferred stock. We recorded as an expense accretion of discount and deemed dividend on our series B-1 redeemable convertible preferred stock (Series B-1 Preferred) in the amount of $7.4 million for the three months ended March 31, 2005. In accordance with Emerging Issues Task Force (EITF) Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, we allocated the total proceeds received in our preferred stock financing among the Series B-1 Preferred and the related warrants and unit warrants. We estimated the value of the warrants and unit warrants at $6.5 million using the Black-Scholes method. The fair value of the common stock into which the Series B-1 Preferred was convertible into on the date of issuance exceeded the proceeds allocated to the Series B-1 Preferred by $2.8 million, resulting in a beneficial conversion feature that we recognized as an increase to paid-in capital and as a deemed dividend to the Series B-1 Preferred. As a result of the public offering we completed in February 2005, which resulted in the Series B-1 Preferred becoming immediately redeemable at the option of the holders, we recorded a charge in the first quarter of 2005 of $7.4 million to accrete the remaining unaccreted discount and deemed dividend on the Series B-1 Preferred. At March 31, 2006, the aggregate redemption price of the Series B-1 Preferred was approximately $38.3 million.
LIQUIDITY AND CAPITAL RESOURCES
We anticipate that our research and development expenditures will increase significantly as we continue to move our lead drug candidates, lorcaserin hydrochloride and APD125 into more costly later stage clinical trials. We believe we have sufficient cash to meet our objectives over at least the next year, including initiating our planned clinical trials for lorcaserin hydrochloride and APD125, advancing APD791 and other lead internal development programs, discovering and developing additional drug candidates, continuing to build our development capabilities and maintaining our research discovery capabilities. We will continue to monitor and evaluate the proper level of research and development expenditures, and may adjust our expenditures based upon a variety of factors such as our clinical trial results and our ability to generate cash through collaborative and financing activities.
The holders of our Series B-1 Preferred can require us to redeem all or some of their outstanding shares of Series B-1 Preferred. The aggregate redemption price at March 31, 2006, was approximately $38.3 million. If required to redeem, we may be able to satisfy all or a portion of this amount with shares of our common stock. Our ability and decision whether to use cash or equity to satisfy any redemption will depend on, among other factors, the amount of cash we have, our stock price and the amount of common stock then held by our preferred stockholders.
Our sources of liquidity include our cash balances and short-term investments. As of March 31, 2006, we had $291.1 million in cash and cash equivalents and short-term investments, which includes the approximately $169.0 million in net proceeds received from the public offering we completed in February 2006, the payment for the $5.0 million milestone we achieved in February 2006 under our Ortho-McNeil collaboration, and the approximately $8.3 million in proceeds we received in March 2006 from the exercise of 829,856 warrants at $10 per share.
In addition to our cash balances and short-term investments, other potential sources of near-term liquidity include (i) research funding and milestone payments from our collaborators, (ii) the out-licensing of our drug candidates, internal drug programs
and technologies, (iii) the sale of either or both of the facilities that we own, neither of which is subject to any outstanding loans, and (iv) equity or debt financing.
We also continue to regularly evaluate potential acquisitions and in-licensing opportunities. Any such transaction may impact our liquidity as well as affect our expenses if, for example, our operating expenses increase as a result of such license or acquisition or we use our cash to finance the license or acquisition.
We will need to raise or generate significant amounts of cash to achieve our objectives of internally developing drugs, which take many years and potentially hundreds of millions of dollars to develop, and continuing our research programs. We do not currently have adequate internal liquidity to meet these objectives in the long term. In order to do so, we will need to continue our out-licensing activities and look to other external sources of liquidity, including the public and private financial markets and strategic partners.
The length of time that our current cash and cash equivalents, short-term investments and available borrowings will sustain our operations will be based on, among other things, our progress in preclinical and clinical testing, the time and costs related to current and planned clinical studies and regulatory approvals, if any, the progress in our collaborations, our research and development costs (including personnel costs), costs associated with intellectual property, and costs associated with securing in-licensing opportunities, if at all. We do not know whether adequate funding will be available to us or, if available, that such funding will be available on acceptable terms. Any significant shortfall in funding could result in the partial or full curtailment of our development and/or research efforts, which, in turn, will affect our development pipeline and ability to generate cash in the future.
In addition to the public and private financial markets, a potential source of liquidity in the long term is from milestone and royalty payments from existing and future collaborators.
Sources and Uses of Our Cash
Net cash used in operating activities was approximately $12.8 million during the three months ended March 31, 2006, and was primarily used to fund our net losses in the period, adjusted for non-cash expenses. Such non-cash expenses included $1.7 million in depreciation and amortization expense, $1.1 million in share-based compensation, $0.4 million in amortization of acquired technology and other purchased intangibles, and changes in operating assets and liabilities. Net cash provided by operating activities was approximately $5.8 million during the three months ended March 31, 2005, and was primarily the result of funds received to reduce our accounts receivable by $22.4 million, less cash used to fund our net loss for the period, adjusted for non-cash expenses, including $1.7 million in depreciation and amortization expense, $0.2 million in amortization of deferred compensation, $0.4 million in amortization of acquired technology and other purchased intangibles, and changes in operating assets and liabilities. We expect net cash used in operating activities to be greater in 2006 than in 2005 as we continue to move our lead internal drug candidates, lorcaserin hydrochloride and APD125, into more costly later stage clinical trials, and continue to experience increases in legal and accounting fees related to the complexity and demands of the laws and regulations applicable to public companies, and the cost of maintaining a growing and maturing portfolio of patent applications and patents.
Net cash used in investing activities was approximately $3.4 million during the three months ended March 31, 2006, and was primarily the result of $1.1 million used for the purchase of equipment, leasehold improvements to the facilities we lease and capital improvements to the facilities we own, net purchases of short-term investments of $1.2 million, and $1.1 million used in the changes to other assets. Net cash used in investing activities was approximately $1.3 million during the three months ended March 31, 2005, and was primarily the result of the purchase of equipment, leasehold improvements to the facilities we lease and capital improvements to the facilities we own totaling $1.1 million as well as net purchases of short-term investments of $0.5 million, partially offset by $0.3 million provided from changes to other assets. We expect our capital expenditures to be significantly greater in 2006 than in 2005 due to the purchase of a new facility and scientific equipment, leasehold improvements to the facilities that we lease and capital improvements to the facilities that we own.
Net cash provided by financing activities was $178.2 million during the three months ended March 31, 2006, and was primarily attributable to the net proceeds of approximately $169.0 million we received in February 2006 from the public offering of 10,637,524 shares of our common stock at $16.90 per share as well as receiving $8.3 million in March 2006 from the exercise of warrants to purchase 829,856 shares of our common stock at an exercise price of $10 per share. Net cash provided by financing activities was $48.3 million during the three months ended March 31, 2005, and was primarily
attributable to the net proceeds of $48.2 million we received in February 2005 from the public offering of 8,625,000 shares of our common stock at $6 per share.
CRITICAL ACCOUNTING POLICIES AND MANAGEMENT ESTIMATES
The SEC defines critical accounting policies as those that are, in managements view, important to the portrayal of our financial condition and results of operations and demanding of managements judgment. Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on experience and on various assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates.
Our critical accounting policies include:
Revenue recognition. Our revenue recognition policies are in accordance with the SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, and EITF 00-21, Revenue Arrangements with Multiple Deliverables, which provide guidance on revenue recognition in financial statements, and are based on the interpretations and practices developed by the SEC. Some of our agreements contain multiple elements, including technology access and development fees, research funding, milestones and royalty obligations.
Revenues from a milestone achievement are recognized when earned, as evidenced by acknowledgment from our collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the milestone represents the culmination of an earnings process, (iii) the milestone payment is non-refundable and (iv) our performance obligations after the milestone achievement will continue to be funded by our collaborator at a level comparable to the level before the milestone achievement. If all of these criteria are not met, the milestone achievement is recognized over the remaining minimum period of our performance obligations under the agreement. We defer non-refundable upfront fees under our collaborations and recognize them over the period the related services are provided or over the estimated collaboration term using various factors specific to the collaboration. Amounts we receive for research funding for a specified number of full-time researchers are recognized as revenues as the services are performed. Advance payments we receive in excess of amounts earned are classified as deferred revenues until earned.
Clinical trial expenses. We review and accrue clinical trial expenses based on work performed. We rely on estimates of total costs incurred based on enrollment of subjects, completion of studies and other events. We follow this method because reasonably dependable estimates of the costs applicable to various stages of a clinical trial can be made. Accrued clinical costs are subject to revisions as clinical trials progress, and any revisions are charged to expense in the period in which the facts that give rise to the revisions become known.
Intangibles. Purchase accounting requires estimates and judgments to allocate the purchase price to the fair market value of the assets received and liabilities assumed. In February 2001, we acquired Bunsen Rush, Inc. for $15.0 million in cash and assumed $0.4 million in liabilities. We allocated $15.4 million to the patented Melanophore technology acquired in such transaction. The Melanophore technology, our primary screening technology, is being amortized over its estimated useful life of 10 years, which was determined based on an analysis, as of the acquisition date, of the conditions in, and the economic outlook for, the pharmaceutical and biotechnology industries and the patent life of the technology. As with any intangible asset, we will continue to evaluate the value of the Melanophore technology. We will record a future write-down of the carrying value of the Melanophore technology if we determine that it has become impaired or we no longer use it internally as our primary screening technology or we will accelerate the amortization if we determine that its life has been shortened.
Stock-based compensation. On January 1, 2006, we adopted SFAS No. 123R using the modified-prospective transition method. Under this method, prior period results are not restated. Compensation cost recognized subsequent to adoption includes: (i) compensation cost for all share-based payments granted prior to, but unvested as of January 1, 2006, based on the grant date fair value, which is determined in accordance with the original provision of SFAS No. 123 using a Black-Scholes option pricing model, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value, which is determined in accordance with the provisions of SFAS No. 123R using a Black-Scholes option pricing model to estimate the grant date fair value of share-based awards.
Expected volatility for awards granted after adoption of SFAS No. 123R was based on a combination of historical volatility of our common stock and market-based implied volatilities from traded options on our common stock, with historical volatility being more heavily weighted due to low volume of traded options on our common stock. Prior to adoption of
SFAS No. 123R, our computation of expected volatility was based only on historical volatility of our common stock. The expected life of options granted under SFAS No. 123R was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and post-vesting cancellations. Prior to the adoption of SFAS No. 123R an average expected life of five years was used in determining the fair value of option grants based on the vesting period of the options and, due to the short period of time the Companys stock had been publicly traded. The risk-free interest rates are based on the U.S Treasury yield curve, with a remaining term approximately equal to the expected term used in the option pricing model.
SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. If actual forfeitures vary from our estimates, we will recognize the difference in compensation cost in the period the actual forfeitures occur.
We recorded $1.1 million in share-based compensation expense during the three months ended March 31, 2006.
The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. See our audited consolidated financial statements and notes thereto included in our 2005 Annual Report, which contains accounting policies and other disclosures required by GAAP.
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Section 16 reports and our other filings with the SEC, and any amendments to such reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website (www.arenapharm.com) as soon as reasonably practicable after they are filed with, or furnished to, the SEC.
Our management establishes and oversees the implementation of board-approved policies covering our investments. We manage our market risk in accordance with our investment guidelines, which: (i) emphasize preservation of principal over other portfolio considerations, (ii) require investments to be placed with high quality financial institutions, (iii) establish guidelines for the diversification of our investment portfolio, and (iv) require investments to be placed with maturities that maintain safety and liquidity. We target our portfolio to have an average duration of no more than four years with no one instrument having a duration exceeding five years and one month. We do not invest in derivative instruments, or any financial instruments for trading purposes. Our primary market risk exposure as it affects our cash equivalents, short-term investments, and securities held for sale is interest rate risk. We monitor our interest rate risk on a periodic basis and we ensure that our cash equivalents, short-term investments, and securities held for sale are invested in accordance with our investments guidelines. Managing credit ratings and the duration of our financial investments enhances the preservation of our capital.
We model interest rate exposure by a sensitivity analysis that assumes a hypothetical parallel shift downwards in the U.S. Treasury yield curve of 100 basis points. Under these assumptions, if the yield curve were to shift lower by 100 basis points from the level existing at March 31, 2006, we would expect future interest income from our portfolio to decline by less than $2.9 million over the next 12 months.
As of December 31, 2005, our estimate for the effect of this same hypothetical reduction in interest rates was a decline in interest income of less than $1.3 million. The difference in these two estimates is due to the difference in the gross amount of our cash and cash equivalents, short-term investments, and securities held for sale between the two periods.
The model we use is not intended to forecast actual losses in interest income, but is used as a risk estimation and investment management tool. The hypothetical changes and assumptions are likely to be different from what actually occurs in the future. Furthermore, the computations do not incorporate actions our management could take if the hypothetical interest rate changes actually occur. As a result, actual earnings consequences will likely differ from those quantified herein.
Evaluation of Disclosure Controls and Procedures
Based on an
evaluation carried out as of the end of the period covered by this quarterly
report, under the supervision and with the participation of our management,
including our Chief Executive Officer and Vice President, Finance and Chief
Financial Officer of the effectiveness of our disclosure controls and
procedures, our Chief Executive Officer and Vice President, Finance and Chief
Financial Officer have concluded that, as of the end of such period, our
disclosure controls and procedures (as defined in Rule
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the last quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
An investment in our stock involves a high degree of risk. You should consider carefully the risks described below, together with other information in this Form 10-Q and our other public filings, before making investment decisions regarding our stock. If any of the following events actually occur, our business, operating results, prospects or financial condition could be materially and adversely affected. This could cause the trading price of our common stock to decline and you may lose part or all of your investment. The risks described below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also affect our business, operating results, prospects or financial conditions.
The risk factors set forth below with an asterisk (*) next to the title are new risk factors or risk factors containing changes, including any material changes, from the risk factors previously disclosed in Item 1A of our annual report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission. We did not asterisk risk factors where the only change was to substitute APD356 with its new name, lorcaserin hydrochloride.
Risks Relating to Our Business
*We will need additional funds to conduct our planned research and development efforts, and we may not be able to obtain such funds.
We had losses of $12.7 million for the three months ended March 31, 2006, and we had an accumulated deficit of $258.6 million from our inception in April 1997 through March 31, 2006. Our losses have resulted in large part from the significant research and development expenditures we have made in seeking to identify and validate new drug targets and develop compounds that could become marketed drugs.
We expect that our operating expenses over the next several years will be significant and that we will continue to have significant operating losses in the near term, even if we or our collaborators are successful in advancing our compounds or partnered compounds.
We do not have any commercial drugs. It takes many years and potentially hundreds of millions of dollars to successfully develop a preclinical or early clinical compound into a marketed drug. We have substantially less money than we need to successfully develop a compound into a marketed drug. Additional funding may not be available to us or may not be available on terms that you or we believe are favorable. If additional funding is not available, we may have to delay, reduce the scope of or eliminate one or more of our research or development programs.
*Our stock price could decline significantly based on the results and timing of clinical trials and nonclinical studies of, and decisions affecting, our lead drug candidates.
Results of clinical trials and nonclinical studies of our lead drug candidates may not be viewed favorably by us or third parties, including investors, analysts and potential collaborators. The same may be true of our how we decide to design the clinical trials of our lead drug candidates and regulatory decisions affecting those clinical trials. Biotechnology company stock prices have declined significantly when such results and decisions were unfavorable or perceived negatively or when a drug candidate did not otherwise meet expectations.
We are discussing with the FDA a Phase 3 clinical trial program for our obesity drug candidate, lorcaserin hydrochloride (previously referred to by us as APD356), and expect to announce the commencement of this Phase 3 program in the second half of 2006. The final program may not meet analysts and investors expectations or be perceived negatively, including regarding clinical trial design or cost, and we may not be successful in commencing these clinical trials on our projected timetable, if at all.
We previously submitted an IND application to the FDA to permit us to commence a Phase 2 trial of APD125 in the United States. The FDA will not allow us to proceed with this trial until we address to the FDAs satisfaction issues relating to our IND application. We believe that these issues may be resolvable using data available to us, but we or the FDA may determine that additional data need to be generated before we can initiate our planned Phase 2 trial. We expect to be able to start a Phase 2 trial of APD125 in the second half of this year, but we cannot be sure when, if ever, the trial will proceed.
Failure to initiate or delays in our clinical trials of lorcaserin hydrochloride, APD125 or any of our other drug candidates, or unfavorable results or decisions or negative perceptions regarding any of such trials, could cause our stock price to decline significantly.
*Clinical trials for our drug candidates are expensive and time consuming, and their progress may be interrupted and their outcome is uncertain.
Clinical trials are very expensive, difficult to design and implement, and can be more expensive than originally anticipated. The clinical trial process is also time consuming. Assuming favorable results, we estimate that the clinical trials of our most advanced drug candidates will continue for several years and may take significantly longer to complete. Before we can obtain regulatory approval for the commercial sale of any drug candidate that we wish to develop, we are required to complete extensive clinical trials in humans to demonstrate its safety and efficacy for treatment of specific indications and monitor safety throughout the clinical development process. All of our drug candidates are prone to the risks of failure inherent in drug development. Even if we believe the data collected from clinical trials of our drug candidates are promising, such data may not be sufficient to support approval by the FDA or any other U.S. or foreign regulatory approval. Administering any of our drug candidates to humans may produce undesirable side effects. These side effects could interrupt, delay or halt clinical trials of our drug candidate for any or all of the targeted indications. The FDA, other regulatory authorities, our collaborators, or we may suspend or terminate clinical trials at any time. Any failure or significant delay in completing clinical trials for our drug candidates, or in receiving regulatory approval for the sale of any drugs resulting from our drug candidates, may severely harm our business and reputation. The timing of the commencement, continuation and completion of clinical trials may be subject to significant delays relating to various causes, including:
lack of effectiveness during the clinical trials;
side effects experienced by study participants or other safety issues;
slower than expected rates of patient recruitment and enrollment;
delays or inability to manufacture or obtain sufficient quantities of materials for use in clinical trials;
changes in our manufacturing process or compound formulation;
delays in obtaining regulatory approvals to commence a study or clinical holds or delays requiring suspension or termination of a study by a regulatory agency such as the FDA after a study is commenced;
delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;
uncertainty regarding proper dosing;
unfavorable results from on-going clinical trials and preclinical studies;
failure of our clinical research organizations to comply with all regulatory and contractual requirements or otherwise fail to perform their services in a timely or acceptable manner;
scheduling conflicts with participating clinicians and clinical institutions;
inability or unwillingness of medical investigators to follow our clinical protocols; or
difficulty in maintaining contact with subjects during or after treatment, which may result in incomplete data.
*Our drug candidates are subject to extensive regulation, which can be costly and time consuming, cause unanticipated delays, or prevent the receipt of the required approvals to develop or commercialize drugs.
The clinical development, manufacturing, labeling, packaging, storage, record-keeping, advertising, promotion, export, marketing and distribution of our drug candidates are, and any resulting drugs will be, subject to extensive regulation by the FDA and other regulatory agencies in the United States and by comparable governmental authorities in foreign markets. Neither our collaborators nor we are permitted to market our potential drugs in the United States until we receive regulatory approval from the FDA. Neither our collaborators nor we have received marketing approval for any of our drug candidates. The process of obtaining regulatory approval is expensive, often takes many years, and can vary substantially based upon the type, complexity and novelty of the drug candidate involved. Specific preclinical data, chemical data, a proposed clinical study protocol and other information must be submitted to the FDA as part of an IND application. Clinical trials may commence only after the IND application becomes effective. A New Drug Application, or NDA, must be supported by extensive clinical and preclinical data regarding manufacturing, process and controls to demonstrate the safety and effectiveness of the drug candidate. Approval policies or regulations may change. Moreover, failure to comply with the FDA and other applicable foreign and United States regulatory requirements may subject us to administrative or judicially imposed sanctions. These include warning letters, civil and criminal penalties, injunctions, product seizure and detention, product recalls, total or partial suspension of production, and refusal to approve pending NDAs, or supplements to approved NDAs.
We have not previously filed NDAs with the FDA, nor have we previously conducted large scale Phase 3 trials, which are significantly larger and more complex than earlier stage trials. This lack of experience may impede our ability to successfully complete these trials and obtain FDA approval in a timely manner, if at all, for our drug candidates for which development and commercialization is our responsibility. Despite the time and expense invested, regulatory approval is very uncertain and never guaranteed and we could encounter problems that cause us to abandon clinical trials or to repeat or perform additional preclinical testing and clinical trials. The FDA has substantial discretion in the drug approval process. The number of preclinical studies and clinical trials that will be required for FDA approval varies depending on the drug candidate, the disease or condition that the drug candidate is designed to address, and the regulations applicable to any particular drug candidate. The FDA can delay, limit or deny approval of a drug candidate for many reasons, including:
not finding a drug candidate sufficiently safe and/or effective;
not finding the data from preclinical testing and clinical trials sufficient to prove safety or efficacy;
not approving of our or a third-party manufacturers processes or facilities; or
changes in its approval policies or the adoption of new regulations.
Because, in part, of the early stage of our drug candidate research and development process, we cannot predict whether or not regulatory approval will be obtained for any drug we develop. We are conducting clinical trials on two of our drug candidates, lorcaserin hydrochloride and APD125, and two of our drug candidates are undergoing clinical trials by our partners, Ortho-McNeil and Merck. Compounds developed by us, alone or with other parties, may not prove to be safe and effective in clinical trials and may not meet all of the applicable regulatory requirements needed to receive marketing approval. Administering any of our drug candidates to humans may produce undesirable side effects. These side effects could interrupt, delay or halt clinical trials of our drug candidates and could result in the FDA or other regulatory authorities denying approval of our drug candidates for any or all of the targeted indications. If regulatory approval of a drug candidate is granted, the approval will be limited to those disease states and conditions for which the drug candidate is demonstrated through clinical trials to be sufficiently safe and effective. Failure to obtain regulatory approval will delay or prevent us from commercializing drugs. These risks also apply to the development activities of our collaborators, and we do not expect any drugs resulting from our collaborators research and development efforts to be commercially available for many years, if ever. The FDA, other regulatory authorities, our collaborators or we may suspend or terminate clinical trials at any time. Any failure or significant delay in completing clinical trials for our drug candidates, or in receiving regulatory approval for the sale of any drugs resulting from our drug candidates, may severely harm our business and reputation.
The results of preclinical studies and completed clinical trials are not necessarily predictive of future results, and our current drug candidates may not have favorable results in later studies or trials.
Preclinical studies and Phase 1 and Phase 2 clinical trials are not primarily designed to test the efficacy of a drug candidate, but rather to test safety, to study pharmacokinetics and pharmacodynamics, and to understand the drug candidates side effects at various doses and schedules. Success in preclinical studies or completed clinical trials does not ensure that later studies or trials, including continuing preclinical studies and large-scale clinical trials, will be successful nor does it necessarily predict future results. Favorable results in early studies or trials may not be repeated in later studies or trials, and drug candidates in later stage trials may fail to show desired safety and efficacy despite having progressed through initial-stage
trials. Unfavorable results from ongoing preclinical studies or clinical trials could result in delays, modifications or abandonment of ongoing or future clinical trials. In addition, we may report top-line data from time to time. Top-line data is based on preliminary analysis of key efficacy and safety data, and is subject to change.
A number of companies in the biotechnology industry have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be delayed, repeated or terminated. In addition, failure to construct appropriate clinical trial protocols could result in the test or control group experiencing a disproportionate number of adverse events and could cause a clinical trial to be delayed, repeated or terminated.
Our most advanced drug candidates, lorcaserin hydrochloride and APD125, have not completed the large, pivotal Phase 3 trials for efficacy and safety that are required for FDA approval. Preclinical data and the limited clinical results that we have obtained for lorcaserin hydrochloride and APD125 may not predict results from studies in larger numbers of subjects drawn from more diverse populations treated for longer periods of time or, in the case with APD125, when patients with insomnia are studied rather than normal volunteers. They also may not predict the ability of lorcaserin hydrochloride or APD125 to achieve or sustain the desired effects in the intended population or to do so safely. In addition, in December 2005 we announced the commencement of preclinical studies with our anti-platelet compound, APD791, under investigation for the potential prevention of thromboembolic diseases, such as heart attacks and strokes. We cannot be certain that results sufficiently favorable to justify commencement of Phase 1 studies around the end of 2006 will be obtained in these preclinical investigations.
We have developed lorcaserin hydrochloride to more selectively stimulate the 5-HT2C serotonin receptor because we believe this selectivity may avoid the cardiovascular side effects associated with fenfluramine and dexfenfluramine, two serotonin-releasing agents and non-selective serotonin receptor agonists, both of which were withdrawn from the market in 1997 after reported incidences of heart valve disease and pulmonary hypertension associated with their usage. We may not be correct in this belief, however, and lorcaserin hydrochlorides selectivity profile may not avoid the undesired side effects. Moreover, the potential relationship between the activity of lorcaserin hydrochloride and the activity of fenfluramine and dexfenfluramine may result in increased FDA regulatory scrutiny of the safety of lorcaserin hydrochloride and may raise potential adverse publicity in the marketplace, which could affect clinical enrollment or ultimately sales if lorcaserin hydrochloride is approved for sale. In response to our Investigational New Drug, or IND, submission for lorcaserin hydrochloride, the FDA recommended we assess the abuse potential and requested that we provide our plans for cardiac valve monitoring during Phase 2 and Phase 3 clinical trials. We expect our communication with the FDA on these issues to be ongoing.
We have developed APD125 to selectively inhibit the 5-HT2A serotonin receptor because we believe this mechanism may be better tolerated and improve sleep quality and maintenance as compared to existing sleep therapies. Preclinical data and the results from our Phase 1 clinical trial in subjects with normal sleep patterns may not predict APD125s effects on sleep quality, sleep maintenance or sleep onset latency in patients with insomnia.
We will be required to demonstrate through larger-scale clinical trials that these drug candidates are safe and effective for use in a diverse population before we can seek regulatory approvals for their commercial sale. There is typically a high rate of attrition from the failure of drug candidates proceeding through clinical trials. To date, long-term safety and efficacy have not yet been demonstrated in clinical trials for any of our drug candidates. If lorcaserin hydrochloride or APD125 fails to demonstrate sufficient safety and efficacy in any clinical trial, we will experience potentially significant delays in, or decide to abandon development of, that drug candidate. If we abandon or are delayed in our development efforts related to lorcaserin hydrochloride, APD125 or any other drug candidate, we may not be able to generate sufficient revenues to continue our operations at the current level or become profitable, our reputation in the industry and in the investment community would likely be significantly damaged, it may not be possible to complete financings, and our stock price would likely decrease significantly.
Many of our research and development programs are in early stages of development, and may not result in the commencement of clinical trials.
Many of our research and development programs are in the discovery or preclinical stage of development. The process of discovering compounds with therapeutic potential is expensive, time consuming and unpredictable. Similarly, the process of conducting preclinical studies of compounds that we discover requires the commitment of a substantial amount of our technical and financial resources and personnel. We may not discover additional compounds with therapeutic potential, and any of the compounds for which we are conducting preclinical studies may not result in the commencement of clinical trials.
If we are unable to identify and develop new drug candidates, we may not be able to maintain a clinical development pipeline or generate revenues.
The technologies on which we rely may not result in the discovery or development of commercially viable drugs.
Our GPCR technologies include technologies that allow us to discover drug-like compounds that act on receptor subtypes of known GPCRs and novel GPCRs where the native ligands have not been identified. These methods of identifying, prioritizing and screening molecular targets are unproven, and may not result in the regulatory approval and commercialization of any therapeutic products. We do not believe that there are any drugs on the market that have been discovered or developed using our proprietary technologies. If we are unable to identify additional drug candidates using our proprietary drug discovery technologies, we may not be able to maintain a clinical development pipeline or generate revenues.
Another company, organization or individual could have, or could develop, a technology targeting GPCRs to discover and develop compounds into drugs more effectively or efficiently than our screening and other technologies. Such a technology could render our technologies, in particular our constitutively activated receptor technology, or CART, and Melanophore technology, obsolete or noncompetitive.
If we are not successful in advancing our lead programs, we may have to curtail some of our activities.
If we are not successful in achieving additional milestones under our cardiovascular collaboration with Merck or our diabetes collaboration with Ortho-McNeil, or developing or partnering lorcaserin hydrochloride or APD125 or any of our other lead programs, we may not be able to raise additional capital or generate significant partnering revenues in the short term. If we do not receive additional capital or partnering revenues, we may need to license some or all of our programs on financial terms that are unfavorable to us. Also, without additional capital or partnering revenues, we would need to re-evaluate our strategy of moving multiple drug discovery and development programs forward while at the same time maintaining our research and discovery capabilities. Based on such evaluation, we may need to significantly curtail some of our current and planned programs and expenditures. We do not know what programs, if any, we would need to curtail, but we believe narrowing our pipeline would reduce our opportunities for success.
*Our revenues depend upon the actions of our existing and potential collaborators.
Our revenues were $23.2 million and $13.7 million for the years ended December 31, 2005 and 2004, respectively, and were $12.1 million for the three months ended March 31, 2006. Our revenues depend upon the success of our existing collaborations and on our ability to enter into new collaborations. We will receive little additional revenues from our existing collaborators if our own or our collaborators research, development or, ultimately, marketing efforts are unsuccessful, or if our agreements are terminated early. Typically, our collaborators (and not us) control the development of compounds into drugs after we have met early preclinical scientific milestones. In addition, we may not have complete access to information about the results and status of our collaborators clinical trials and regulatory programs and strategies. We are not entitled to the more significant milestone payments under our agreements until our collaborators have advanced compounds in clinical testing. Our partners may not devote adequate resources to the development of our compounds and may not develop or implement a successful clinical or regulatory strategy. Only two of our partners, Merck and Ortho-McNeil, have advanced our drug candidates into clinical testing and paid us the applicable milestones. We cannot guarantee that any of the other development, approval or sales milestones in our existing or future collaborations will be satisfied, or that we will receive any payments for the achievement of those other milestones.
For both of the years ended December 31, 2005 and 2004, and for the three months ended March 31, 2006, 100% of our revenues were from our collaborations with Merck and Ortho-McNeil. Absent any new collaborators, we expect substantially all of our revenues for 2006 to be derived from our collaborations with Merck and Ortho-McNeil. Our revenues will be materially impacted if:
our agreement with either Merck or Ortho-McNeil is terminated;
our collaborators do not devote their time and financial resources to develop compounds under our collaborations;
our collaborators dispute whether we have achieved a milestone, rights to a particular receptor or compound, or other terms of our agreements;
our collaborators use alternative technologies to our technologies and compete with us in developing drugs; or
our collaborators experience failures in the discovery or development of compounds identified with our technologies or in the clinic or marketplace with other products that cause them to discontinue or slow down our collaboration.
Our ability to enter into new collaborations depends on the outcomes of our preclinical and clinical testing. We do not control these outcomes. In addition, even if our testing is successful, pharmaceutical companies may not partner with us on terms that we believe are acceptable until we have advanced our drug candidates into the clinic and, possibly, through later-stage clinical trials, if at all.
Our collaboration agreements with Merck and Ortho-McNeil may be terminated in certain circumstances.
The term of our amended collaborative research program with Merck is three years from October 21, 2004. Merck can terminate this program: (i) for Technical Grounds, by giving 30 days prior notice, if both Merck and we agree that Technical Grounds have occurred; or (ii) in the event of our change in control (as defined in the agreement), by giving 30 days prior notice. Technical Grounds include circumstances where: (1) our joint research committee (a committee of an equal number of Merck and our representatives) concludes that (a) a significant adverse event affecting all the targets, all program compounds and all active compounds under the program has arisen during the conduct of the program, or (b) continuation of the program is no longer scientifically promising because the role of all the targets proves incorrect, or none of the targets are valid as a suitable target for development of a pharmaceutical product; or (2) Mercks patent department, upon consultation with our patent attorneys, makes a reasonable determination that valid third-party patent rights block the achievement of significant program goals.
In addition, either party can terminate the agreement if the other party breaches its material obligations under the agreement by causes and reasons within its control, has not cured such breach within 90 days of receiving a letter requesting such cure, and there is no dispute as to whether such breach has occurred. In lieu of terminating the agreement, however, Merck can terminate the research program and certain other aspects of the agreement after giving 90 days prior notice if we materially breach our obligations during the course of the program and fail to cure such breach, if such default cannot be cured within such 90-day period, or if we do not commence and diligently continue good faith efforts to cure such default during such period.
The initial term of the research program under our agreement with Ortho-McNeil is until December 20, 2006, unless extended for an additional year by Ortho-McNeil or as we may otherwise agree. We and Ortho-McNeil each have the right to terminate the agreement early if the other party commits an uncured material breach of its obligations. Further, Ortho-McNeil may terminate the agreement without cause during the term of the research program, provided that in such event it pays us the balance of its research funding obligation for the initial term of the research program in a lump sum, unless the termination is due to a change of control of Arena (as defined in the agreement), in which case Ortho-McNeil may terminate either the agreement or the research program under the agreement, without the payment of additional research funding to us. At any time after the end of the research program, Ortho-McNeil may terminate the agreement by providing us at least 60 days prior written notice. Upon termination of the agreement, all rights to the compounds developed under the collaboration will revert to us.
We may have conflicts with our prospective, current or past collaborators that could delay or prevent the development or commercialization of our drug candidates.
We may have conflicts with our prospective, current or past collaborators, such as conflicts concerning the interpretation of preclinical or clinical data, the achievement of milestones, or the ownership of intellectual property. If any conflicts arise with Ortho-McNeil, Merck or any other prospective, current or past collaborator, such collaborator may act in a manner that is adverse to our best interests. Any such disagreement could result in one or more of the following, each of which could delay or prevent the development or commercialization of our drug candidates, and in turn prevent us from generating revenues:
unwillingness on the part of a collaborator to pay us research funding, milestone payments or royalties that we believe are due to us under a collaboration;
uncertainty regarding ownership of intellectual property rights arising from our collaborative activities, which could prevent us from entering into additional collaborations;
unwillingness on the part of a collaborator to keep us informed regarding the progress of its development and commercialization activities or to permit public disclosure of the results of those activities; or
slowing or cessation of a collaborators development or commercialization efforts with respect to our drug candidates.
Drug discovery and development is intensely competitive in the therapeutic areas on which we focus. If our competitors develop treatments that are approved faster, marketed better or demonstrated to be more effective or safer than our drug candidates, our commercial opportunities will be reduced or eliminated.
We focus our efforts on GPCRs. Because GPCRs are an important target class for drug discovery efforts, we believe that many pharmaceutical and biotechnology companies and other organizations have internal drug discovery programs focused on GPCRs. Many of the drugs that our collaborators or we are attempting to discover and develop would compete with existing therapies. In addition, many companies are pursuing the development of new drugs that target the same diseases and conditions that we target. Many of our competitors, particularly large pharmaceutical companies, have substantially greater research and development capabilities and greater financial, scientific and human resources than we do. Companies that complete clinical trials, obtain required regulatory agency approvals and commence commercial sale of their drugs before we do for the same indication may achieve a significant competitive advantage, including certain patent and FDA marketing exclusivity rights. In addition, our competitors may develop drugs with fewer side effects, more desirable characteristics (such as route of administration or frequency of dosing) or greater efficacy than our drug candidates or drugs, if any, for the same indication. Any results from our research and development efforts, or from our joint efforts with our existing or any future collaborators, may not compete successfully with existing or newly discovered products or therapies.
Setbacks and consolidation in the pharmaceutical and biotechnology industries, and our or our collaborators inability to obtain third-party coverage and adequate reimbursement, could make partnering more difficult and diminish our revenues.
Setbacks in the pharmaceutical and biotechnology industries, such as those caused by safety concerns relating to high-profile drugs like Vioxx and Celebrex, competition from generic drugs and litigation, and industry consolidation may have an adverse effect on us. For example, pharmaceutical companies may be less willing to enter into new collaborations or continue existing collaborations if they are integrating a new operation as a result of a merger or acquisition or if their therapeutic areas of focus change following a merger. Moreover, our and our collaborators ability to commercialize future drugs will depend in part on government regulation and the availability of coverage and adequate reimbursement from third-party payers, including government payers, such as the Medicaid and Medicare programs. Government and third-party payers are increasingly attempting to contain healthcare costs by limiting coverage and reimbursement levels for new drugs. These efforts may limit our commercial opportunities by reducing the amount a potential collaborator is willing to pay to license our programs or drug candidates in the future due to a reduction in the potential revenues from drug sales.
We rely on third parties to conduct our clinical trials. If those parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to advance our drug candidates in a timely manner or at all.
In the course of our discovery, preclinical testing and clinical trials, we have relied and continue to rely on third parties, including laboratories, investigators, clinical research organizations and manufacturers, to perform critical services for us. For example, we are relying on contract clinical sites to conduct our clinical trials for lorcaserin hydrochloride and APD125. Clinical research organizations are and will continue to be responsible for many aspects of the trials, including finding and enrolling subjects for testing and administering the trials. These third parties may not be available when we need them or, if they are available, may not comply with all regulatory and contractual requirements or may not otherwise perform their services in a timely or acceptable manner. These independent third parties may also have relationships with other commercial entities, some of which may compete with us. As a result of our dependence on third parties, we may face delays or failures outside of our direct control. These risks also apply to the development activities of our collaborators, and we do not control our collaborators research and development, clinical trials or regulatory activities. We do not expect any drugs resulting from our collaborators research and development efforts to be commercially available for many years, if ever.
We or a third-party manufacturer may encounter a manufacturing failure that could delay the clinical development or regulatory approval of our drug candidates, or their ultimate commercial production if approved.
Any performance failure on the part of us or a third-party manufacturer could delay clinical development or regulatory approval of our drug candidates. Manufacturers often encounter difficulties involving production yields, regulatory compliance, quality control and quality assurance, as well as shortages of qualified personnel. We or a third-party manufacturer may encounter such difficulties. The manufacturers are subject to ongoing periodic unannounced inspection by the FDA, the Drug Enforcement Administration of the U.S. Department of Justice and corresponding state agencies to ensure strict compliance with current good manufacturing practices and other applicable government regulations and corresponding
foreign standards. We do not have control over a third-party manufacturers compliance with these regulations and standards. If one of our manufacturers fails to maintain compliance, the production of our drug candidates could be interrupted, resulting in delays, additional costs and potentially lost revenues.
We may engage in strategic transactions that could impact our liquidity, increase our expenses and present significant distractions to our management.
From time to time we consider strategic transactions, such as acquisitions of companies, asset purchases and out-licensing or in-licensing of compounds or technologies. Additional potential transactions we may consider include a variety of different business arrangements, including spin-offs, strategic partnerships, joint ventures, restructurings, divestitures, business combinations and investments. Any such transaction may require us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disrupt our management or business, which could harm our operations and financial results.
Our efforts will be seriously jeopardized if we are unable to retain and attract key employees.
Our success depends on the continued contributions of our principal management, development and scientific personnel, and the ability to hire and retain key personnel, particularly in the clinical development area as we transition more of our programs from research into drug development. We face intense competition for such personnel. The loss of services of any principal member of our management or scientific staff, particularly Jack Lief, our President and Chief Executive Officer, and Dominic P. Behan, Ph.D., our Senior Vice President and Chief Scientific Officer, could adversely impact our operations and ability to raise additional capital. To our knowledge, neither Mr. Lief nor Dr. Behan plans to leave, retire or otherwise disassociate with us in the near future.
We may encounter significant delays or problems with our chemical development facility.
We have a chemical development facility for process research, the scale-up and production of intermediates and other compounds for research and development purposes, and the production of active pharmaceutical ingredients for use in clinical trials. We may encounter delays and problems in operating our chemical development facility due to:
governmental approvals, permits and regulation of the facility;
accidents during operation of the facility;
failure of equipment for the facility;
delays in receiving raw materials from suppliers;
natural or other disasters; or
other factors inherent in operating a complex manufacturing facility.
We may not be able to operate our chemical development facility in a cost-effective manner or in a time frame that is consistent with our expected future manufacturing needs. If this were the case, we would need to seek alternative means to fulfill our manufacturing needs, which could delay progress on our programs.
We use biological materials, hazardous materials, chemicals and radioactive compounds.
Our research and development activities involve the use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds that could be hazardous to human health and safety or the environment. These materials and various wastes resulting from their use are stored at our facility pending ultimate use and disposal. We cannot completely eliminate the risk of contamination, which could cause:
an interruption of our research and development efforts;
injury to our employees and others;
environmental damage resulting in costly clean up; and
liabilities under federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products.
In such an event, we may be held liable for any resulting damages, and any such liability could exceed our resources. Although we carry insurance in amounts and type that we consider commercially reasonable, we do not have insurance coverage for losses relating to an interruption of our research and development efforts caused by contamination, and we cannot be certain that the coverage or coverage limits of our insurance policies will be adequate.
We may incur substantial liabilities from any product liability claims if our insurance coverage for those claims is inadequate.
We face an inherent risk of product liability exposure related to the testing of our drug candidates in human clinical trials, and will face an even greater risk if we sell drugs commercially. An individual may bring a liability claim against us if one of our drug candidates or drugs causes, or merely appears to have caused, an injury. If we cannot successfully defend ourselves against a product liability claim, we will incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:
decreased demand for our drug;
injury to our reputation;
withdrawal of clinical trial subjects;
costs of related litigation;
substantial monetary awards to subjects or other claimants;
loss of revenues; and
the inability to commercialize our drug candidates.
We have limited product liability insurance that covers our clinical trials. We intend to expand our insurance coverage to include the sale of drugs if marketing approval is obtained for any of our drug candidates. However, insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost, and we may not have insurance coverage that will be adequate to satisfy any liability that may arise.
*Laws and regulations relating to public companies may be costly and impact our ability to attract and retain directors and executive officers.
Laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by the Securities and Exchange Commission and by the NASDAQ National Market, may result in increased costs to us. These laws, rules and regulations could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.
Our operations might be interrupted by the occurrence of a natural disaster or other catastrophic event.
Our laboratories, offices and chemical development facility are located in the same office park in San Diego. We depend on our facilities and on our collaborators, contractors and vendors for the continued operation of our business. Natural disasters or other catastrophic events, including terrorist attacks, power interruptions, wildfires and other fires, actions of animal rights activists, earthquakes and wars could disrupt our operations or those of our collaborators, contractors and vendors. Even though we believe we carry commercially reasonable business interruption and liability insurance, and our contractors may carry liability insurance, that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under our and our contractors insurance policies or for which we or our contractors do not have coverage. For example, we are not insured against a terrorist attack. Any natural disaster or catastrophic event could have a significant negative impact on our operations and financial results. Moreover, any such event could delay our research and development programs.
Even if any of our drug candidates receives regulatory approval, our drug candidates will still be subject to extensive post-market regulation.
If we or our collaborators receive regulatory approval for our drug candidates, we will also be subject to ongoing FDA obligations and continued regulatory review, such as continued safety reporting requirements, and we may also be subject to additional FDA post-marketing obligations, all of which may result in significant expense and limit our ability to commercialize such drugs.
If any of our drug candidates receive United States regulatory approval, the FDA may still impose significant restrictions on the indicated uses for which such drugs may be marketed or impose ongoing requirements for potentially costly post-approval studies. In addition, regulatory agencies subject a drug, its manufacturer and the manufacturers facilities to continual review and inspections. The subsequent discovery of previously unknown problems with a drug, including adverse events of unanticipated severity or frequency, or problems with the facility where the drug is manufactured, may result in restrictions on the marketing of that drug, and could include withdrawal of the drug from the market. Failure to comply with applicable regulatory requirements may result in:
issuance of warning letters by the FDA;
fines and other civil penalties;
injunctions, suspensions or revocations of marketing licenses;
suspension of any ongoing clinical trials;
suspension of manufacturing;
delays in commercialization;
refusal by the FDA to approve pending applications or supplements to approved applications filed by us or our collaborators;
refusals to permit drugs to be imported or exported to or from the United States;
restrictions on operations, including costly new manufacturing requirements; and
product recalls or seizures.
The FDAs policies may change and additional government regulations may be enacted that could prevent or delay regulatory approval of our drug candidates or further restrict or regulate post-approval activities. We cannot predict the likelihood, nature or extent of adverse government regulation that may arise from future legislation or administrative action, either in the United States or abroad. If we are not able to maintain regulatory compliance, we might not be permitted to market our drugs and our business could suffer.
In order to market any drugs outside of the United States, we and our collaborators must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks associated with FDA approval as well as additional presently unanticipated risks. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects associated with regulatory approval in the United States, including the risk that our drug candidates may not be approved for all indications requested and that such approval may be subject to limitations on the indicated uses for which the drug may be marketed.
*New accounting pronouncements may impact our future results of operations.
In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS No. 123R, Share-Based Payment. This statement, which became effective for us on January 1, 2006, changed how we account for share-based compensation and may negatively impact our stock price.
Through December 31, 2005, we accounted for share-based payments to employees and directors using the intrinsic value method. Under this method, we generally did not recognize any compensation related to stock option grants we issued under our equity compensation plans or the discounts we provided under our employee stock purchase plan.
On January 1, 2006, we adopted SFAS No. 123R using the modified-prospective transition method. Under this method, prior period results are not restated. Compensation cost recognized subsequent to adoption includes: (i) compensation cost for all share-based payments granted prior to, but unvested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. SFAS No. 123R may also delay when we may become profitable.
Future changes in GAAP, including pronouncements relating to revenue recognition, might have a significant effect on our reported results, including reporting of transactions completed before the effective date of such pronouncements, if ever.
Risks Relating to Our Intellectual Property
*Our success is dependent on intellectual property rights held by us and third parties and our interest in these rights is complex and uncertain.
Our success will depend on our own and on our collaborators abilities to obtain, secure and defend patents. In particular, the patents directed to our most advanced drug candidates and other compounds discovered using our technologies are important to commercializing drugs. We have numerous U.S. and foreign patent applications pending for our technologies, including patent applications on drug lead discovery techniques using CART, genetically altered GPCRs, GPCRs that we have discovered, new uses for previously discovered GPCRs, and compounds discovered using CART and Melanophore and other technologies.
The procedures for obtaining a patent in the U.S. and in most foreign countries are complex. These procedures require an analysis of the scientific technology related to the invention and many legal issues. Consequently, the analysis of our patent applications will be complex and time consuming. Our patent position is very uncertain and we do not know when, or if, we will obtain additional patents for our technologies.
In addition, other entities may challenge the validity or enforceability of our patents and patent applications in litigation or administrative proceedings. Even the issuance of a patent is not conclusive as to its validity or enforceability. We cannot make assurances as to how much protection, if any, will be given to our patents if we attempt to enforce them and they are challenged. It is possible that a competitor or a generic pharmaceutical provider may successfully challenge our patents and those challenges may result in reduction in our patents coverage.
As of April 30, 2006, we owned, in part or in whole, or had exclusively licensed the following patents: 17 in the United States, 107 in European countries, eight in New Zealand, six in Australia, six in Lebanon, three in Hong Kong, one in Japan, one in China, one in Singapore, and one in Israel. In addition, as of April 30, 2006, we had approximately 626 patent applications before the United States Patent and Trademark Office, foreign patent offices and international patent authorities. These patents and patent applications are divided into 82 distinct families of related patents that are directed to CART, Melanophore technology, other novel screening methods, chemical compositions of matter, methods of treatment using chemical compositions, or GPCR genes. One of our patent families was exclusively in-licensed and contains a single issued patent. Seven of our patent families containing a total of eight patents and 92 patent applications were the subject of joint inventions by our employees and the employees of other entities. The remaining 74 patent families, which include a total of 142 patents and 534 patent applications, were invented solely by our employees. There is no assurance that any of our patent applications will issue, or that any of the patents will be enforceable or will cover a drug or other commercially significant drug or method.
In 2000, the United States Patent and Trademark Office began issuing broad patent claims that could allow patent holders to control the use of all drugs that modulate a particular drug target or GPCR, regardless of whether the infringing drug bears any structural resemblance to a chemical compound known to the patent holder at the time of patent filing. The question of whether these new patent claims are valid is controversial and the subject of litigation. Whether we or our competitors are able to obtain and enforce such patent claims, particularly as they apply to the GPCRs that are the subject of our drug development activities, may have a significant impact on our potential revenues from any drugs that we are able to develop.
We also rely on confidentiality agreements and trade secrets to protect our technologies. However, such information is difficult to protect. We require our employees to contractually agree not to improperly use our confidential information or disclose it to others, but we may be unable to determine if our employees have conformed or will conform to their legal obligations under these agreements. We also enter into confidentiality agreements with prospective collaborators, collaborators, service providers and consultants, but we may not be able to adequately protect our trade secrets or other proprietary information in the event of any unauthorized use or disclosure or the lawful development by others of this information. Many of our employees and consultants were, and many of them may currently be, parties to confidentiality agreements with other pharmaceutical and biotechnology companies, and the use of our technologies could violate these agreements. In addition, third parties may independently discover our trade secrets or proprietary information.
Some of our academic institution licensors, research collaborators and scientific advisors have rights to publish data and information to which we have rights. We generally seek to prevent our partners from disclosing scientific discoveries before we have the opportunity to file patent applications on such discoveries. In some of our collaborations we do not have control over our partners ability to disclose their own discoveries under the collaboration and in some of our academic collaborations we are limited to relatively short periods to review a proposed publication and file a patent application. If we cannot maintain the confidentiality of our technologies and other confidential information in connection with our collaborations, our ability to receive patent protection or protect our proprietary information will be impaired.
A dispute regarding the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be costly and result in delays in our research and development activities.
Our commercial success also depends upon our ability to develop and manufacture our drug candidates and market and sell drugs, if any, and conduct our research and development activities without infringing or misappropriating the proprietary rights of other entities. There are many patents and patent applications filed, and that may be filed, by others relating to drug discovery and development programs that could be determined to be similar, identical or superior to ours or our licensors or collaborators. We may be exposed to future litigation by other entities based on claims that our drug candidates, technologies or activities infringe the intellectual property rights of others. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the area of GPCRs, including some which purport to allow the patent holder to control the use of all drugs that modulate a particular drug target or GPCR, regardless of whether the infringing drug bears any structural resemblance to a chemical compound known to the patent holder at the time of patent filing. Numerous U.S. and foreign issued patents and pending patent applications owned by others also exist in the therapeutic areas in which we are developing drugs. These could materially affect our ability to develop our drug candidates or sell drugs, if any, and our activities, or those of our licensors or collaborators, could be determined to infringe these patents. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our drug candidates or technologies may infringe. There also may be existing patents, of which we are not aware, that our drug candidates or technologies may inadvertently infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we are or may become aware, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall drug discovery and development efforts. We cannot assure you that other entities holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor.
In addition, other entities may infringe or misappropriate our proprietary rights, and we may have to institute costly legal action to protect our intellectual property rights. We may not be able to afford the costs of enforcing or defending our intellectual property rights against other entities.
Other organizations, companies and individuals are seeking proprietary positions on genomics information that overlap with the government-sponsored project to sequence the human genome. Our activities, or those of our licensors or collaborators, could be affected by conflicting positions that may exist between any overlapping genomics information made available publicly as a result of the government sponsored project and genomics information that other organizations, companies or individuals consider to be proprietary.
There could also be significant litigation and other administrative proceedings in our industry that affect us regarding patent and other intellectual property rights. Any legal action or administrative action against us, or our collaborators, claiming damages or seeking to enjoin commercial activities relating to our drug discovery and development programs could:
require us, or our collaborators, to obtain a license to continue to use, manufacture or market the affected drugs, methods or processes, which may not be available on commercially reasonable terms, if at all;
prevent us from importing, making, using, selling or offering to sell the subject matter claimed in patents held by others and subject us to potential liability for damages;
consume a substantial portion of our managerial, scientific and financial resources; or
be costly, regardless of the outcome.
Furthermore, because of the substantial amount of pre-trial document and witness discovery required in connection with intellectual property litigation, there is risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the trading price of our common stock.
We have been contacted from time to time by third parties regarding their intellectual property rights, sometimes asserting that we may need a license to use their technologies. If we fail to obtain any required licenses or make any necessary changes to our technologies, we may be unable to develop or commercialize some or all of our drug candidates.
We cannot protect our intellectual property rights throughout the world.
Filing, prosecuting and defending patents on all of our drug discovery technologies throughout the world would be prohibitively expensive. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop their own drugs. These drugs may compete with our drugs, if any, and may not be covered by any of our patent claims or other intellectual property rights.
The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting and defending such rights in foreign jurisdictions. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for example, the patent owner has failed to work the invention in that country or the third party has patented improvements). In addition, many countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Compulsory licensing of life saving drugs is also becoming increasingly popular in developing countries either through direct legislation or international initiatives. Such compulsory licenses could be extended to include some of our drug candidates, which could limit our potential revenue opportunities. Moreover, the legal systems of certain countries, particularly certain developing countries, do not favor the aggressive enforcement of patents and other intellectual property protection, particularly those relating to biotechnology and/or pharmaceuticals, which makes it difficult for us to stop the infringement of our patents. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial cost and divert our efforts and attention from other aspects of our business.
Risks Relating to Our Securities
*Our stock price will likely be volatile, and your investment in our stock could decline in value.
Our stock price has fluctuated historically. From January 1, 2004, to April 30, 2006, the market price of our stock was as low as $3.48 per share and as high as $20.68 per share.
Very few biotechnology drug candidates being tested will ultimately receive FDA approval, and a biotechnology company may experience a significant drop in its stock price based on an adverse clinical trial result or regulatory action. Our stock price may fluctuate significantly, depending on a variety of factors, including:
our success or failure in clinical trials;
the timing of the discovery of drug leads and the development of our drug candidates;
entering into a new collaboration or modifying or terminating an existing collaboration;
the timing and receipt by us of milestone and royalty payments or failing to achieve and receive the same;
changes in the research and development budgets of our existing or potential collaborators;
others introducing new drug discovery techniques or introducing or withdrawing drugs that target the same diseases and conditions that we or our collaborators target;
expenses related to, and the results of, litigation and other proceedings relating to intellectual property rights or other matters; and
accounting changes, including the expense impact of SFAS No. 123R.
We are not able to control all of these factors. Period-to-period comparisons of our financial results are not necessarily indicative of our future performance. In addition, if our revenues or results of operations in a particular period do not meet stockholders or analysts expectations, our stock price may decline and such decline could be significant.
*Holders of our Series B Preferred can require us to redeem their Series B Preferred.
On December 24, 2003, we completed a private placement of (i) 3,500 shares of our Series B-1 Preferred, (ii) seven-year warrants to purchase 1,486,200 shares of our common stock at an exercise price of $10 per share (subject to weighted-average adjustment in certain circumstances) and (iii) unit warrants to purchase $11.5 million of our Series B-2 Preferred and additional seven-year warrants to purchase 450,000 shares of our common stock at an exercise price of $10 per share (subject to weighted-average adjustment in certain circumstances). On April 22, 2005, the investors exercised their unit warrants in full.
The holders of our Series B-1 Preferred can require us at any time to redeem all or some of their shares of Series B-1 Preferred at such shares stated value, plus accrued but unpaid dividends thereon to the date of payment and any applicable penalties. The stated value is the original holders investment plus any dividends settled by increasing the stated value at the time the dividend is payable. The aggregate redemption price of our Series B-1 Preferred at March 31, 2006, was approximately $38.3 million, and accrues interest at four percent annually.
The holders of our Series B-2 Preferred will be entitled to require us to redeem their shares of Series B-2 Preferred at such shares stated value, plus accrued but unpaid dividends thereon to the date of payment and any applicable penalties if, following the 21st month anniversary of the original issue date of the Series B-2 Preferred, the average of the closing prices of our common stock for any 30 consecutive trading days is below $7.00, which is the conversion price for the Series B-2 Preferred. The aggregate redemption price of our Series B-2 Preferred at December 31, 2005, was approximately $11.8 million, and accrues interest at four percent annually.
Also, the holders of the Series B-2 Preferred may require us to redeem their shares if we issue common stock or common stock equivalents for an effective net price to us per share less than approximately $5.33 (excluding, among other things, certain common stock and common stock equivalents issued or issuable (i) to our officers, directors, employees or consultants, (ii) in connection with certain strategic partnerships or joint ventures, and (iii) in connection with certain mergers and acquisitions). Effective net price is not defined in the Certificate of Designations governing our Series B-2 Preferred. The holders of our Series B-2 Preferred may assert that effective net price should be calculated as the amount we receive after paying any discounts and other expenses related to any such issuance.
At the option of any holder of any Series B Preferred, any Series B Preferred held by such holder may be converted into common stock based on the applicable conversion price then in effect for such shares of Series B Preferred stock.
In addition to the foregoing redemption rights, at any time following the occurrence of a Triggering Event, a holder of the Series B Preferred may require us to repurchase all or any portion of the Series B Preferred then held by such holder at a
price per share equal to the greater of 115.0% of the stated value or the market value (as calculated under the Certificate of Designations for the Series B-1 Preferred and the Series B-2 Preferred) of such shares of Series B Preferred plus all accrued but unpaid dividends thereon to the date of payment. Triggering Event is specifically defined in the Certificate of Designations for the Series B-1 Preferred and the Series B-2 Preferred, and includes any of the following events: (i) immediately prior to a bankruptcy event; (ii) we fail for any reason to timely deliver a certificate evidencing any securities to a purchaser or the exercise or conversion rights of the holders are otherwise suspended for other than a permissible reason; (iii) any of certain events of default (as set forth in the Registration Rights Agreement with the Series B Preferred holders) occur and remain uncured for 60 days; (iv) we fail to make any cash payment required under the Series B Preferred transaction documents and such failure is not timely cured; (v) the issuance of a going concern opinion by our independent registered public accounting firm that is not timely cured; (vi) we breach a section of the Series B Preferred purchase agreement relating to indebtedness and subordination; or (vii) we default in the timely performance of any other obligation under the Series B Preferred transaction documents and such default is not timely cured.
We will also be required to redeem any shares of the Series B Preferred that remain outstanding on the fifth anniversary of their issuance at a price equal to the amount of the original holders original investment, plus all accrued but unpaid dividends thereon to the date of such payment.
If we are required to redeem all or some of the currently outstanding shares of our Series B Preferred, we may be able to pay a portion of the redemption price using shares of our common stock if certain enumerated conditions are satisfied, including:
we have sufficient number of shares of common stock available for issuance;
the shares of common stock to be issued are registered under an effective registration statement or are otherwise available for sale under Rule 144(k) under the Securities Act;
our common stock is listed on the NASDAQ National Market or other eligible market;
the shares to be issued can be issued without violating the rules of the NASDAQ National Market or any applicable trading market or a provision of our certificate of designations; and
no bankruptcy event has occurred.
If we are permitted to satisfy a portion of a redemption by using shares of our common stock, and if we elect to do so, the number of shares to be issued to holders of Series B Preferred will be determined by dividing their cash redemption price by the lesser of the conversion price or 95.0% of the average of the volume weighted average price of our common stock for either 10 or 15 trading days.
There can be no assurance that if we have to redeem our Series B Preferred, that we will be able to pay a portion of the redemption price using shares of our common stock. If we use common stock to redeem a portion of the Series B Preferred, your ownership interest may be significantly diluted. If we are required or elect to redeem shares of the Series B Preferred using cash, we may not have sufficient cash to redeem these shares or to continue our planned research and discovery activities. In such event we may try to raise additional capital by issuing new stock, but there can be no assurance that capital will be available on acceptable terms or at all.
*There are a substantial number of shares of our common stock eligible for future sale in the public market, and the sale of these shares could cause the market price of our common stock to fall.
There were 47,251,618 shares of our common stock outstanding as of April 30, 2006. The outstanding shares of our Series B-1 Preferred are convertible into up to 5,110,460 shares of common stock at $7.50 per share of common stock. The outstanding shares of our Series B-2 Preferred are convertible into up to 1,705,969 shares of common stock at $7.00 per share of common stock. Holders of Series B Preferred are entitled to receive a four percent annual dividend that is payable by issuing common stock or by increasing the amount of common stock that is issuable upon conversion of the Series B Preferred. We issued warrants to acquire 1,936,200 shares of common stock at an exercise price of $10 per share to such holders as part of our Series B Preferred financing. Such warrants provide that if the closing price of our common stock is equal to or above $14 for 30 consecutive trading days, upon 10 trading days prior written notice, we will have the right to, and the warrant holders will have the right to require us to, call and cancel any unexercised portion of the warrants (subject to certain conditions). Following such a call notice, we would be obligated to issue to the warrant holder an exchange warrant entitling the holder to purchase shares of our common stock equal to the unexercised portion of the holders warrant that was called. This exchange warrant would contain the same terms and conditions as the original warrant, except that the maturity
date would be seven years from the date of issuance of such exchange warrant and the exercise price would be equal to 130% of the average of the volume weighted average prices of our common stock for the five trading days preceding the original warrant cancellation date.
On March 31, 2006, following our call notice to one of the two warrant holders, such holder exercised its warrants to purchase 829,856 shares of our common stock. Such holder believes the terms of its exercised warrants provide that it is entitled to receive exchange warrants to purchase 829,856 shares of our common stock at an exercise price of $23.363 per share. We have not issued exchange warrants, but are reviewing the matter. We may determine to issue exchange warrants. In such event, we could also be required to issue additional exchange warrants to purchase shares of our common stock following future call notices to this holder, as well as to the other warrant holder who owns warrants to acquire 1,106,344 shares of our common stock at an exercise price of $10 per share.
In addition, as of April 30, 2006, there were 4,036,922 common stock options issued and outstanding under our equity compensation plans at a weighted average exercise price of $9.20, 7,921 additional shares of common stock issuable under our equity compensation plans, 410,388 shares of common stock reserved for issuance under our 2001 Employee Stock Purchase Plan and 114,169 shares issuable under our Deferred Compensation Plan. A substantial number of the shares described above, when issued upon exercise, will be available for immediate resale in the public market. The market price of our common stock could decline as a result of such resales due to the increased number of shares available for sale in the market.
Any future equity or debt issuances by us may have dilutive or adverse effects on our existing stockholders.
We have financed our operations, and we expect to continue to finance our operations, primarily by issuing and selling our common stock or securities convertible into or exercisable for shares of our common stock. In light of our need for additional financing, we may issue additional shares of common stock or additional convertible securities that could dilute your ownership in our company and may include terms that give new investors rights that are superior to yours. Moreover, any issuances by us of equity securities may be at or below the prevailing market price of our common stock and in any event may have a dilutive impact on your ownership interest, which could cause the market price of our common stock to decline. The terms of our Series B Preferred limit our ability to engage in certain equity issuances.
We may also raise additional funds through the incurrence of debt, and the holders of any debt we may issue would have rights superior to your rights in the event we are not successful and are forced to seek the protection of the bankruptcy laws. The terms of our Series B Preferred limits our ability to incur debt.
Our largest stockholders may take actions that are contrary to your interests, including selling their stock.
A small number of our stockholders hold a significant amount of our outstanding stock. These stockholders may support competing transactions and have interests that are different from yours. In addition, the average number of shares of our stock that trade each day is generally low. As a result, sales of a large number of shares of our stock by these large stockholders or other stockholders within a short period of time could adversely affect our stock price.
*We may have a continuing disagreement with our warrant holders.
One of our two warrant holders exercised in full its warrants to purchase shares of common stock. Such holder believes the terms of its exercised warrants provide that it is entitled to receive exchange warrants to purchase additional shares of our common stock. We may become involved in litigation to determine whether such warrants are required to be issued. Such litigation may be expensive and consume managements time. We could also have a similar dispute with the other warrant holder.
Provisions of our Series B Preferred may prevent or make it more difficult for us to raise funds or take certain other actions.
Provisions of our Series B Preferred require us to obtain approval of the preferred stockholders, or otherwise trigger rights of first refusal or payment provisions, to (i) offer or sell new securities, other than in specified underwritten offerings or strategic partnerships or joint venture and certain other exceptions, (ii) sell or issue common stock or securities issuable into common stock below certain prices, (iii) incur debt or allow liens on our property, other than certain permitted debt and liens, (iv) amend our certificate of incorporation so as to affect adversely any rights of the preferred stockholders, (v) authorize or create a new class of stock that will be senior or equal to the Series B Preferred in terms of dividends, redemption or distribution of assets, (vi) use more than $25.0 million in cash for acquisitions, or (vii) take certain other actions. These
provisions may make it more difficult for us to take certain corporate actions and could delay, discourage or prevent future financings.
Our rights agreement and certain provisions in our charter documents and Delaware law could delay or prevent a change in management or a takeover attempt that you may consider to be in your best interest.
We have adopted certain anti-takeover provisions, including a stockholders rights plan, dated as of October 30, 2002, between us and Computershare Trust Company, Inc., as Rights Agent, as amended on December 24, 2003. The rights plan will cause substantial dilution to any person who attempts to acquire us in a manner or on terms not approved by our board of directors.
The rights agreement and Certificate of Designations for the Series B Preferred, as well as other provisions in our certificate of incorporation and by-laws and under Delaware law, could delay or prevent the removal of directors and other management and could make more difficult a merger, tender offer or proxy contest involving us that you may consider to be in your best interest. For example, these provisions:
allow our board of directors to issue preferred stock without stockholder approval;
limit who can call a special meeting of stockholders;
eliminate stockholder action by written consent; and
establish advance notice requirements for nomination for election to the board of directors or for proposing matters to be acted upon at stockholders meetings.
* Management contract or compensatory plan or arrangement.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
* Management contract or compensatory plan or arrangement.