Arena Pharmaceuticals 10-Q 2008
Washington, D.C. 20549
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. x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
The number of shares of common stock outstanding as of the close of business on July 31, 2008:
ARENA PHARMACEUTICALS, INC.
In this report, Arena Pharmaceuticals, Arena, we, us and our refer to Arena Pharmaceuticals, Inc. and our wholly owned subsidiaries, unless the context otherwise provides.
Arena Pharmaceuticals®, Arena® and our corporate logo are registered service marks of Arena. CART and BRL Screening are unregistered service marks of Arena. Any other brand names or trademarks appearing in this Quarterly Report on Form 10-Q are the property of their respective holders.
Arena Pharmaceuticals, Inc.
Note: The balance sheet at December 31, 2007 has been derived from audited financial statements at that date. It does not include, however, all of the information and notes required by US generally accepted accounting principles for complete financial statements.
See accompanying notes to unaudited condensed consolidated financial statements.
Arena Pharmaceuticals, Inc.
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 subsidiaries, 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, 2007, as filed with the Securities and Exchange Commission, or SEC. The accompanying financial statements have been prepared in accordance with US generally accepted accounting principles, or 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 to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year.
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 included in the Companys annual report on Form 10-K for the year ended December 31, 2007.
2. Adoption of New Accounting Standards
In June 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and was adopted by the Company on January 1, 2008. The adoption of SFAS No. 157 did not have a material impact on the Companys consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of SFAS No. 115, which expands the use of fair value accounting but does not affect existing standards that require financial assets or liabilities to be carried at fair value. Under SFAS No. 159, a company may make an irrevocable election to measure certain financial assets and liabilities using fair value, with changes in fair value recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, and was adopted by the Company on January 1, 2008. The adoption of SFAS No. 159 did not have an impact on the Companys consolidated financial statements as the Company did not elect to account for any of its financial assets using the provisions of SFAS No. 159.
In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force, or EITF, on EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities. EITF Issue No. 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed or such time when the entity does not expect the goods to be delivered or services to be performed. EITF Issue No. 07-3 is effective, on a prospective basis, for fiscal years beginning after December 15, 2007, and was adopted by the Company on January 1, 2008. The adoption of EITF Issue No. 07-3 did not have a material impact on the Companys consolidated financial statements.
3. Net Loss Per Share
Basic and diluted net loss per share allocable to common stockholders are presented in conformity with SFAS No. 128, Earnings per Share, for all periods presented. In accordance with SFAS No. 128, basic and diluted net loss per share have been computed using the weighted-average number of shares of common stock outstanding during the period, less any shares subject to repurchase or forfeiture.
The total number of shares of common stock outstanding excluded from the calculation of basic and diluted net loss per share because they were subject to repurchase or forfeiture was 29,312 and 58,924 for each of the three and six-month periods ended June 30, 2008 and 2007, respectively. Had they been dilutive, such shares would have been included in the computation of diluted net loss per share allocable to common stockholders. In addition, because the Company is in a net operating loss position, the Company has excluded all unvested performance-based restricted stock unit awards, which are subject to forfeiture, outstanding stock options, preferred stock and warrants from the calculation of basic and diluted net loss per share allocable to common stockholders because these securities are antidilutive for all periods presented.
4. Comprehensive Income (Loss)
In accordance with SFAS No. 130, Reporting Comprehensive Income, all components of comprehensive income (loss), including foreign currency translation gain and loss and unrealized gains and losses on investment securities, are reported in the financial statements in the period in which they are recognized. Comprehensive income (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, in thousands, of net loss to comprehensive loss for all periods presented.
5. Share-based Activity
The Company recognized share-based compensation expense in accordance with SFAS No. 123R, Share-Based Payment, as follows, in thousands, except per share data:
The Company uses the Black-Scholes option pricing model to estimate the grant-date fair value of share-based awards in determining the share-based compensation expense recognized under SFAS No. 123R. The table below sets forth the weighted-average assumptions and estimated fair value of stock options granted under the Companys 2006 Long-Term Incentive Plan, as amended, during the three and six-month periods ended June 30, 2008 and 2007:
The table below sets forth the weighted-average assumptions and estimated fair value of the options to purchase stock granted under the 2001 Arena Employee Stock Purchase Plan, as amended, during the three and six months ended June 30, 2008 and for multiple offering periods during the three and six months ended June 30, 2007:
Expected volatility for awards granted after the adoption of SFAS No. 123R is based on a combination of 75% historical volatility of the Companys common stock and 25% market-based implied volatilities from traded options on its common stock, with historical volatility being more heavily weighted due to the low volume of traded options on its common stock. The expected life of options granted under SFAS No. 123R is determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and post-vesting cancellations. The risk-free interest rates are based on the US 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 at 5.1% for the three and six months ended June 30, 2008 and 5.4% for the three and six months ended June 30, 2007, based on historical experience. If actual forfeitures vary from estimates, the Company will recognize the difference in compensation expense in the period the actual forfeitures occur or when options vest.
Tax benefits recognized and related to share-based compensation and related cash flow impacts were not material during the three and six months ended June 30, 2008 and 2007 because the Company is in a net operating loss position. The Company has a full valuation allowance on all of its deferred tax assets.
Share-based Award Activity
The following table summarizes the Companys stock option activity during the six months ended June 30, 2008:
The following table summarizes activity with respect to the Companys performance-based restricted stock unit awards during the six months ended June 30, 2008:
6. Fair Value Disclosures
On January 1, 2008, the Company adopted SFAS No. 157, which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. SFAS No. 157 defines fair value as the exchange price that would be received to sell an asset or paid to transfer a liability, based upon an exit price, in an orderly transaction between market participants at the measurement date.
SFAS No. 157 establishes a three-level valuation hierarchy of valuation techniques that is based on observable and unobservable inputs. Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement.
Level 1 - unadjusted quoted prices in active markets for identical instruments.
Level 2 - quoted prices for similar instruments in active markets or inputs that are observable for the asset or liability, either directly or indirectly.
Level 3 - unobservable inputs based on the Companys own assumptions.
In accordance with SFAS No. 157, the following table presents the Companys valuation hierarchy for its financial assets measured at fair value on a recurring basis as of June 30, 2008, in thousands:
7. 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 a separate component of accumulated other comprehensive gain 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.
8. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following, in thousands:
9. Asset Acquisition from Siegfried Ltd and Related Agreements
On January 9, 2008, the Company acquired from Siegfried Ltd, or Siegfried, certain drug product manufacturing and packaging facility assets, including fixtures, equipment, other personal property and real estate assets in Zofingen, Switzerland, under an Asset Purchase Agreement between Siegfried and the Companys wholly owned Swiss subsidiary, Arena Pharmaceuticals GmbH, or Arena GmbH. This facility is being used to manufacture the Companys own proprietary drug candidates and certain drug products for Siegfried. This transaction was not determined to be an acquisition of a business since a self-sustaining integrated set of activities and assets was not acquired and the revenue stream of Arena GmbH is significantly different than it was as part of Siegfried.
The purchase price under such agreement, in Swiss francs, was CHF 31.8 million in cash and 1,488,482 shares of the Companys common stock, which were issued to Siegfried in January 2008. The Company paid CHF 21.8 million, or $19.6 million, of the cash purchase price in January 2008, and will pay the remaining CHF 10.0 million cash portion of the purchase price in three equal installments in the third, fourth and fifth years after closing. The present value of this liability, which is classified as a note payable to Siegfried on the accompanying condensed consolidated balance sheet, was the US dollar equivalent of $8.8 million at June 30, 2008.
This transaction, including the cash payment made in January 2008, the value of the common stock when it was issued and the present value of the remaining cash payments, was recorded as follows, in US dollars:
In connection with this transaction, the Company and Siegfried also entered into a long-term supply agreement, at market rates, for the active pharmaceutical ingredient of lorcaserin, the Companys lead drug candidate for the treatment of obesity that is in Phase 3 clinical trials, a contract manufacturing agreement and a technical services agreement.
Pursuant to the contract manufacturing agreement, the Company recognized $2.0 million and $4.0 million of revenue in the three and six months ended June 30, 2008, respectively, for manufacturing drug products for Siegfried. Upon Siegfrieds acceptance of drug products manufactured by the Company, the Company recognizes contract manufacturing revenues at agreed upon prices for such drug products, which the Company expects will be less than the related cost for it to manufacture such drug products. The related cost to manufacture the drug products was $2.3 million and $4.6 million in the three and six months ended June 30, 2008, respectively.
The Company also recorded expenses of $0.6 million and $1.0 million for services incurred under the technical services agreement in the three and six months ended June 30, 2008, respectively. The technical services agreement provides the Company with administrative and other services to operate the facility. The Company determined that it is receiving an identifiable benefit for these services and is recording such fees in the operating expense section of the accompanying condensed consolidated statement of operations.
10. Concentration of Credit Risk and Major Customers
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, in accordance with its board-approved investment policy, placing its cash and investments in US government, agency and government-sponsored enterprise obligations and in corporate debt instruments that are rated investment grade.
The Company manufactures drug products for Siegfried under a contract manufacturing agreement, and all of the Companys contract manufacturing revenues are attributable to Siegfried.
Percentages of the Companys total revenues derived from its contract manufacturing agreement and from its two most significant collaborations are as follows:
11. Redeemable Convertible Preferred Stock and Warrants
In December 2003, the Company sold to two institutional investors 3,500 shares of series B-1 redeemable convertible preferred stock, or 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 $10.00 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, or Series B-2 Preferred, and collectively with the Series B-1 Preferred, Series B Preferred, and additional seven-year warrants to purchase up to 450,000 shares of common stock at an initial exercise price of $10.00 per share. The aggregate purchase price in such transaction was $35.0 million, and the Company received $34.2 million in net cash proceeds after closing costs. In April 2005, the investors exercised their unit warrants in full, resulting in aggregate gross proceeds to the Company of $11.5 million.
The holders of the Series B Preferred can require the Company at any time to redeem all or some of their shares of Series B 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 or penalties settled by increasing the stated value at the time the dividend or penalty, as applicable, is payable. The Company may be able to satisfy all or a portion of any redemption with shares of its common stock.
The Series B-1 Preferred is convertible into common stock at a fixed conversion price of $7.50 per share. If not previously converted or redeemed, the Company must redeem any shares of the Series B-1 Preferred that remain outstanding on December 24, 2008 at such shares stated value, plus accrued but unpaid dividends thereon to the date of payment and any applicable penalties. 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, depending on the circumstances, the 10 or 15 consecutive trading days immediately prior to a specified date or notice. The Series B-1 Preferred, which accrues dividends at 4% annually, had an aggregate redemption price of $41.9 million at June 30, 2008. The expected aggregate redemption price at the mandatory redemption date of December 24, 2008 is $42.8 million.
The Series B-2 Preferred is convertible into common stock at a fixed conversion price of $7.00 per share. If not previously converted or redeemed, the Company must redeem any shares of the Series B-2 Preferred that remain outstanding on April 22, 2010 at such shares stated value, plus accrued but unpaid dividends thereon to the date of payment and any applicable penalties. Any redemption amount settled in equity would be computed based on the lesser of the applicable conversion price of $7.00 and 95% of the arithmetic average of the volume weighted-average prices of common stock for, depending on the circumstances, the 10 or 15 consecutive trading days immediately prior to a specified date or notice. The Series B-2 Preferred, which accrues dividends at 4% annually, had an aggregate redemption price of $13.1 million at June 30, 2008. The expected aggregate redemption price at the mandatory redemption date of April 22, 2010 is $14.0 million.
On March 31, 2006, following the Companys call notice to one of the two warrant holders, Smithfield Fiduciary LLC, an affiliate of Highbridge Capital Management, LLC, such holder exercised its warrants to purchase 829,856 shares of the Companys common stock, resulting in an aggregate purchase price and net cash proceeds to the Company of $8.3 million. In connection with this exercise in full of its warrants, Smithfield claimed that it was entitled to receive exchange warrants that would include a provision that could require the Company to issue additional exchange warrants in the future. The Company disagreed with this interpretation. On June 30, 2006, the Company entered into a Settlement Agreement and Release with Smithfield. As part of the Settlement Agreement and Release, (a) Smithfield and the Company provided each other with a release of any claims relating to (i) Smithfields demand for, and the Companys non-issuance of, exchange warrants, and (ii) any breach or default under certain of the agreements on account of the foregoing, (b) the Company issued Smithfield a seven-year warrant to purchase 829,856 shares of the Companys common stock at an initial exercise price of $15.49 per share, and (c) the Company filed a registration statement covering the sale of the shares of common stock issuable under the new warrant. The new warrant does not contain any right for the Company, or for the holder to require the Company, to call the warrant, nor does it provide the holder the right to receive any exchange warrants in the future. The Company recorded a $4.6 million non-cash charge related to the warrant settlement in the second quarter of 2006. In addition, the Company has recorded a non-cash warrant settlement provision related to the other warrant holder, Mainfield Enterprises, Inc., in the amount of $2.0 million at June 30, 2008 based on the estimated value and the likelihood of a settlement of a similar disagreement.
Each investor agrees that for so long as it holds Series B Preferred, it shall vote its shares of Series B Preferred and common stock on all matters in which such investor is entitled to vote and on which holders of common stock have the right to vote, in the manner recommended by the Companys board of directors to all of its stockholders unless the Companys board of directors elects to permit the investors to vote such shares in their own discretion.
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, or 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, 2007, or 2007 Annual Report, as filed with the Securities and Exchange Commission, or SEC. Operating results are not necessarily indicative of results that may occur in future periods.
This Quarterly Report includes forward-looking statements, which involve a number of risks and uncertainties. These forward-looking statements can generally be identified as such because the context of the statement will include words such as may, will, intends, plans, believes, anticipates, expects, estimates, predicts, potential, continue, likely, or opportunity, the negative of these words or other similar words. Similarly, statements that describe our future plans, strategies, intentions, expectations, objectives, goals or prospects and other statements that are not historical facts are also forward-looking statements. 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. These forward-looking statements are based largely on our expectations and projections about future events and future trends affecting our business, and are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. These risks and uncertainties include, without limitation, the risk factors identified in our SEC reports, including this Quarterly Report. In addition, past financial or operating performance is not necessarily a reliable indicator of future performance, and you should not use our historical performance to anticipate results or future period trends. We can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations and financial condition. Except as required by law, we undertake no obligation to update publicly or revise our forward-looking statements.
OVERVIEW AND RECENT DEVELOPMENTS
We are a clinical-stage biopharmaceutical company focused on discovering, developing and commercializing oral drugs in four major therapeutic areas: cardiovascular, central nervous system, inflammatory and metabolic diseases. Our most advanced drug candidate, lorcaserin hydrochloride, or lorcaserin, is being investigated in a Phase 3 clinical trial program for the treatment of obesity. We have a broad pipeline of novel compounds that target known and orphan G protein-coupled receptors, or GPCRs, and includes compounds being evaluated independently and with partners, including Ortho-McNeil Pharmaceutical, Inc., a Johnson & Johnson company, or Ortho-McNeil, and Merck & Co., Inc., or Merck. We incorporated on April 14, 1997 in the state of Delaware and commenced operations in July 1997.
Our recent developments include:
· Completed BLOSSOM enrollment with 4,008 obese and overweight patients in about 95 clinical sites in the United States. BLOSSOM is a one-year, randomized, double-blind, placebo-controlled clinical trial. BLOSSOM and BLOOM comprise our pivotal trial program evaluating lorcaserins safety and efficacy for the treatment of obesity.
· Reported positive Phase 1b clinical trial results of APD791, our internally discovered oral drug candidate intended for the treatment and prevention of arterial thrombosis and other related conditions. This Phase 1b trial was a randomized, double-blind, placebo-controlled multiple-ascending dose trial in 50 healthy volunteers.
· Dr. Thomas Roth of Henry Ford Hospital presented data from our positive Phase 2a clinical trial of APD125, our internally discovered oral drug candidate intended to reduce insomnia symptoms and improve sleep maintenance and quality, in an oral presentation at the SLEEP 2008 22nd Annual Meeting of the Associated Professional Sleep Societies. When compared to placebo, APD125 significantly improved endpoints measuring improvements in sleep maintenance without next day impairment of cognition or coordination.
· Initiated a Phase 2b clinical trial of APD125. This is a randomized, double-blind, placebo-controlled subjective study that is expected to enroll approximately 675 patients in about 65 clinical sites in the United States.
· Taisho Pharmaceutical Co., Ltd. initiated a Phase 1 clinical trial of a drug candidate under a GPCR-focused partnership with us to develop compounds to treat psychiatric disorders. The drug candidate is a novel oral compound intended for the treatment of an undisclosed, common psychiatric disorder.
RESULTS OF OPERATIONS
We are providing the following summary of our revenues, research and development expenses and general and administrative expenses to supplement the more detailed discussion below. The following tables are stated in millions.
Research and development expenses
General and administrative expenses
THREE MONTHS ENDED JUNE 30, 2008 AND 2007
Revenues. We recorded revenues of $2.6 million during the three months ended June 30, 2008, compared to $4.8 million during the three months ended June 30, 2007. Our revenues for the three months ended June 30, 2008 included $2.0 million in contract manufacturing revenue under our contract manufacturing agreement with Siegfried and $0.6 million for patent activities from our collaborations with Ortho-McNeil and Merck. All of our revenues for the three months ended June 30, 2007 were from our collaborations with Ortho-McNeil and Merck, and included $2.6 million in amortization of milestone achievements and technology access and development fees, $1.6 million in research funding, and $0.6 million for patent activities. Because the research funding portion of our collaborations with both Ortho-McNeil and Merck ended in the fourth quarter of 2007, no revenues from amortization of previously achieved milestones and technology access and development fees or research funding will be recognized in 2008 or thereafter from these collaborations.
Absent any new collaborations or achievement of a milestone in one of our existing collaborations, we expect our 2008 revenues will consist of reimbursement for patent activities from our collaborators and contract manufacturing revenue under our contract manufacturing agreement with Siegfried. Under such agreement, until at least December 31, 2010, Siegfried may sub-contract to us the manufacture of certain drug products previously manufactured by Siegfried for its customers, and we agreed to perform such manufacturing up to certain specified amounts. In addition, under the contract manufacturing agreement, Siegfried guarantees the following minimum level of cost absorption, which we will record as revenues, through December 31, 2010: CHF 8.2 million for all of 2008, CHF 7.0 million in 2009 and CHF 6.6 million in 2010. In the remaining two quarters of 2008, we expect to recognize CHF 4.0 million of revenues from our contract manufacturing agreement, which will be more than offset by related costs and expenses. Using the exchange rate in effect on June 30, 2008, this would translate to approximately $3.9 million in contract manufacturing revenues for the remaining two quarters of 2008.
Revenues from our collaborators for milestones that may be achieved in the future are difficult to predict, and our revenues may vary significantly from quarter to quarter and year to year. We expect that any significant revenues over the next several years will depend on the clinical success of our partnered programs as well as whether we partner lorcaserin, APD125, APD791, APD916, our wakefulness promoter drug candidate, or any of our other current or future drug candidates. Ultimately, we expect our revenues in the long term to primarily depend upon the regulatory approval and commercialization of our partnered or internally developed drugs.
Cost of contract manufacturing. Cost of contract manufacturing is comprised of direct costs associated with manufacturing drug products for Siegfried under our contract manufacturing agreement, including related salaries, other personnel costs and machinery depreciation costs. Cost of contract manufacturing was $2.3 million for the three months ended June 30, 2008. Since we entered into the contract manufacturing agreement with Siegfried in January 2008, no cost of contract manufacturing was recorded prior to the beginning of 2008.
Research and development expenses. Research and development expenses, which account for the majority of our expenses, consisted primarily of costs associated with external clinical and preclinical study fees, manufacturing costs and other related expenses, and the development of our earlier-stage programs and technologies. Our most significant research and development costs are for clinical trials (including payments to contract research organizations, or CROs), preclinical study fees, salaries and personnel, research supplies, and facility and equipment costs. We expense research and development costs to operations as they are incurred when these expenditures relate to our research and development efforts and have no alternative future uses. Other than external expenses for our clinical and preclinical 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 $15.5 million to $56.4 million for the three months ended June 30, 2008, from $40.9 million for the three months ended June 30, 2007. The difference was due primarily to (i) an increase of $13.9 million in external clinical and preclinical study fees and expenses, including manufacturing costs, due mostly to our three ongoing Phase 3 clinical trials of lorcaserin and (ii) an increase of $0.8 million in salary and personnel costs as we increased the number of our US research and development employees from 331 at the end of June 2007 to 358 at the end of June 2008. The increase in the number of US research and development employees related to the development of our internal programs, primarily lorcaserin, APD125, APD791 and APD916. We expect to continue to incur substantial research and development expenses, primarily related to lorcaserin, as we continue our ongoing and planned clinical programs.
Included in the $36.0 million total external clinical and preclinical study fees and expenses noted in the table above for the three months ended June 30, 2008 was $31.1 million related to our lorcaserin program, $3.9 million related to our APD125 program, $0.2 million related to our APD791 program and $0.5 million related to our APD916 program. Included in the $22.1 million in external clinical and preclinical study fees and expenses for the three months ended June 30, 2007 was $11.7 million related to our lorcaserin program, $8.7 million related to our APD125 program and $1.0 million related to our APD791 program.
General and administrative expenses. General and administrative expenses increased $0.4 million to $7.2 million for the three months ended June 30, 2008, from $6.8 million for the three months ended June 30, 2007. This change was primarily comprised of (i) an increase of $0.7 million in salary and personnel costs as we increased the number of our general and administrative employees from 64 at the end of June 2007 to 76 at the end of June 2008, (ii) an increase in marketing and investor relations expenses of $0.4 million, (iii) a decrease of $0.5 million in non-cash, share-based compensation under Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment, and (iv) a decrease of $0.6 million in patent costs related to our partnered programs and our internal programs and technologies. To the extent our partners reimburse us for patent activities, the reimbursements are classified as revenues. Such reimbursements totaled $0.6 million each of the three months ended June 30, 2008 and 2007. We expect that reimbursements from our partners for patent activities will be lower for all of 2008 than they were in 2007. However, we expect that the total amount of our internal patent costs and those reimbursed by our partners will be comparable in both 2007 and 2008. We expect that our general and administrative expenses will continue to increase in the future due primarily to costs relating to the integration of our Swiss operations and increases in commercialization, marketing and business development expenses.
Amortization of acquired technology. We recorded $0.4 million for amortization of acquired technology in each of the three months ended June 30, 2008 and 2007 related to our patented Melanophore technology, our primary screening technology, which we acquired in 2001 for $15.4 million. The Melanophore technology is being amortized over its estimated useful life of 10 years. We expect to record charges of $1.5 million per year through the end of 2010 and $0.3 million in 2011 for amortization of this technology.
Interest and other income, net. Interest and other income, net, for the three months ended June 30, 2008 decreased $6.4 million to an expense of $1.7 million, from income of $4.7 million for the three months ended June 30, 2007, due primarily to (i) a $3.1 million decrease in interest income attributable to both lower cash balances and lower interest rates, (ii) a $2.0 million non-cash provision charge related to our disagreement with one of our two warrant holders, and (iii) a $1.3 million increase in interest expense and financing costs, which included lease payments on our lease financing obligations accounted for in accordance with SFAS No. 66, Accounting for Sales of Real Estate and SFAS No. 98 Accounting for Leases. The increase in interest expense and financing costs primarily relates to our sale and leaseback transaction completed in May 2007. Due to declining interest rates and lower cash balances resulting from our ongoing and planned clinical development, we expect our interest income will continue to decrease.
Dividends on redeemable convertible preferred stock. We recorded a dividend expense of $0.5 million related to our series B redeemable convertible preferred stock, or Series B Preferred, in each of the three months ended June 30, 2008 and 2007. The holders of our Series B Preferred are entitled to dividends that accrue at 4% annually. This dividend expense, which may be paid in common stock or by increasing the stated value of the Series B Preferred, increases the net loss allocable to common stockholders. Assuming that the Series B Preferred is held until the applicable mandatory redemption dates, we expect to record dividends on the Series B Preferred of $1.1 million for the remainder of 2008, and $0.5 million and $0.2 million for the years ending December 31, 2009 and 2010, respectively.
SIX MONTHS ENDED JUNE 30, 2008 AND 2007
Revenues. We recorded revenues of $5.2 million during the six months ended June 30, 2008, compared to $9.7 million during the six months ended June 30, 2007. Our revenues for the six months ended June 30, 2008 included $4.0 million in contract manufacturing revenue under our contract manufacturing agreement with Siegfried and $1.2 million for patent activities from our collaborations with Ortho-McNeil and Merck. All of our revenues for the six months ended June 30, 2007 were from our collaborations with Ortho-McNeil and Merck, and included $5.1 million in amortization of milestone achievements and technology access and development fees, $3.5 million in research funding, and $1.1 million for patent activities.
Cost of contract manufacturing. Cost of contract manufacturing was $4.6 million for the six months ended June 30, 2008. Since we entered into the contract manufacturing agreement with Siegfried in January 2008, no cost of contract manufacturing was recorded prior to the beginning of 2008.
Research and development expenses. Research and development expenses increased $27.4 million to $104.0 million for the six months ended June 30, 2008, from $76.6 million for the six months ended June 30, 2007. The difference was due primarily to (i) an increase of $23.5 million in external clinical and preclinical study fees and expenses, including manufacturing costs, due mostly to our three ongoing Phase 3 clinical trials of lorcaserin and (ii) an increase of $2.4 million in salary and personnel costs as we increased the number of our US research and development employees. Included in the $63.0 million total external clinical and preclinical study fees and expenses for the six months ended June 30, 2008 was $54.3 million related to our lorcaserin program, $5.7 million related to our APD125 program, $1.1 million related to our APD791 program and $1.3 million related to our APD916 program. Included in the $39.5 million total external clinical and preclinical study fees and expenses for the six months ended June 30, 2007 was $25.4 million related to our lorcaserin program, $11.4 million related to our APD125 program and $1.5 million related to our APD791 program.
General and administrative expenses. General and administrative expenses increased $4.2 million to $16.0 million for the six months ended June 30, 2008, from $11.8 million for the six months ended June 30, 2007. This increase is due primarily to (i) an increase of $1.3 million in salary and personnel costs as we increased the number of our general and administrative employees, and (ii) an increase of $1.1 million in patent costs related to our partnered programs and our internal programs and technologies. Reimbursements for patent activity revenues totaled $1.2 million and $1.1 million in the six months ended June 30, 2008 and 2007, respectively.
Amortization of acquired technology. We recorded $0.8 million for amortization of acquired technology in each of the six-month periods ended June 30, 2008 and 2007 related to our Melanophore screening technology.
Interest and other income, net. Interest and other income, net, for the six months ended June 30, 2008 decreased $8.5 million to $0.4 million, from $8.9 million for the six months ended June 30, 2007, due primarily to (i) a $4.4 million decrease in interest income, (ii) a $2.3 million increase in interest expense and financing costs, which included lease payments on our lease financing obligations accounted for in accordance with SFAS Nos. 66 and 98, and (iii) a $2.0 million non-cash provision charge related to our disagreement with one of our two warrant holders.
Dividends on redeemable convertible preferred stock. We recorded a dividend expense of $1.1 million and $1.0 million related to our Series B Preferred for the six months ended June 30, 2008 and 2007, respectively. The holders of our Series B Preferred are entitled to dividends that accrue at 4% annually.
LIQUIDITY AND CAPITAL RESOURCES
Our sources of liquidity include our cash balances and short-term investments. As of June 30, 2008, we had $272.2 million in cash and cash equivalents and short-term investments. In addition to such sources, other potential sources of near-term liquidity include (i) equity, debt or other financing, (ii) the out-licensing of our drug candidates, internal drug programs and technologies, (iii) the sale of facilities that we own, and (iv) milestone payments from our collaborators. We will continue to be opportunistic in our efforts to generate cash.
We anticipate that our research and development expenditures will continue to be substantial as we continue our Phase 3 clinical trial program for lorcaserin and our Phase 2b clinical trial of APD125. We expect that the majority of the external expenses for our Phase 3 lorcaserin program will be expensed through the first half of 2009. A large portion of these external clinical trial expenses are expected to be paid through CROs. Our contracts with the primary CROs for our Phase 3 lorcaserin program can be terminated if we give either, depending on the contract, five or 30 days prior written notice, or less in certain circumstances. In addition to costs related to these clinical trials, we expect to incur significant manufacturing and other pre-launch costs for lorcaserin.
We are prioritizing our available cash towards funding activities that support filing an NDA for lorcaserin, which we expect to file in late 2009. In connection with prioritizing lorcaserin activities, we are deferring certain expenditures for our other clinical and earlier stage programs. With such adjustments, we believe we have sufficient cash to meet our objectives over at least the next 12 months, including continuing our development programs for lorcaserin, APD125, APD791 and APD916, continuing development of our other lead internal programs, discovering and developing additional drug candidates, integrating our Swiss operations, continuing to build our development and manufacturing capabilities, including our manufacturing facilities in Switzerland, and maintaining our research discovery capabilities. We will continue to monitor and evaluate the proper level of research, development and manufacturing expenditures, and may further adjust such expenditures based upon a variety of factors, such as our available cash, our progress in our clinical and earlier stage programs, the time and costs related to current and planned clinical trials and regulatory decisions and our ability to generate additional cash through financings and collaborative activities.
We expect that our capital expenditures for all of 2008 will be higher than they were in 2007 due to the purchase of our Swiss manufacturing facilities in January 2008 and planned purchases of equipment and improvements to our San Diego facilities, including a significant expansion of approximately 75,000 square feet at our property located at 6154 Nancy Ridge Drive that is expected to cost approximately $15.0 million, of which up to $15.0 million is expected to be reimbursed by the owner of the property around the end of 2008, less applicable commissions.
The holders of our Series B Preferred can require us at any time to redeem all or some of their outstanding shares of Series B Preferred. If not previously converted or redeemed, we will be required to redeem any shares of Series B-1 Preferred that remain outstanding on December 24, 2008 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 or penalties settled by increasing the stated value at the time the dividend or penalty, as applicable, is payable. The aggregate redemption price of our Series B-1 Preferred at June 30, 2008 was $41.9 million, and we expect the aggregate redemption price at the mandatory redemption date of December 24, 2008 to be $42.8 million. The aggregate redemption price of our Series B-2 Preferred at June 30, 2008 was $13.1 million, and we expect the aggregate redemption price at the mandatory redemption date of April 22, 2010 to be $14.0 million. We may be able to satisfy all or a portion of any redemption with shares of our common stock. Our ability and decision whether to use cash or stock 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.
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 several hundreds of millions of dollars to develop, and continuing our research programs. If we decide to market and commercialize lorcaserin or any other drug candidate independently or with a partner, we may need to invest heavily in associated marketing and commercialization costs. Such costs will be substantial and some will need to be incurred prior to receiving marketing approval from the FDA. 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 any available borrowings will sustain our operations will be based on, among other things, our prioritization decisions regarding funding our programs, our progress in our clinical and earlier stage programs, the time and costs related to current and planned clinical trials and regulatory decisions, our research, development, manufacturing and commercialization costs (including personnel costs), the progress in our collaborations, costs associated with intellectual property, our capital expenditures, and costs associated with securing any in-licensing opportunities. 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, potential sources of liquidity in the long term are milestone and royalty payments from existing and future collaborators and revenues from sales of our drugs.
We evaluate from time to time 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.
Sources and Uses of Our Cash
Net cash used in operating activities was $94.1 million during the six months ended June 30, 2008, and was primarily used to fund our net losses in the period, adjusted for non-cash expenses. Non-cash expenses included $5.8 million in depreciation and amortization expense, $4.3 million in share-based compensation, $2.0 million warrant settlement provision charge related to our disagreement with one of our two warrant holders, Mainfield, $1.2 million in amortization of acquired technology and other intangibles, as well as changes in operating assets and liabilities. Net cash used in operating activities during the six months ended June 30, 2007 was $63.2 million, and was primarily used to fund our net loss for the period, adjusted for non-cash expenses, including $4.1 million in share-based compensation, $4.0 million in depreciation and amortization expense, and $0.8 million in amortization of acquired technology, as well as changes in operating assets and liabilities. We expect net cash used in operating activities will continue to increase as we continue our ongoing and planned clinical development programs.
Net cash used in investing activities was $65.3 million during the six months ended June 30, 2008, and was primarily the result of net purchases of short-term investments of $31.7 million, $19.6 million used for the purchase of our drug product manufacturing and packaging facility in Switzerland and $13.7 million used for equipment and improvements to our facilities. Net cash used in investing activities was $31.2 million during the six months ended June 30, 2007, and was the result of net purchases of short-term investments of $26.3 million, $4.4 million used for equipment and improvements to our facilities, and $0.5 million used for the purchases of other non-current assets. We expect our capital expenditures will continue to increase due to planned purchases of equipment and improvements to our San Diego facilities, including a significant expansion of approximately 75,000 square feet at our property located at 6154 Nancy Ridge Drive that is expected to cost approximately $15.0 million, of which up to $15.0 million is expected to be reimbursed by the owner of the property around the end of 2008, less applicable commissions.
Net cash provided by financing activities was $1.9 million during the six months ended June 30, 2008, and was primarily attributable to proceeds of $1.0 million related to our lease financing transaction completed in May 2007 and net proceeds of $1.0 million received from option exercises and purchases under our employee stock purchase plan. Net cash provided by financing activities during the six months ended June 30, 2007 was $50.0 million, and was primarily attributable to net proceeds of $48.5 million we received in May 2007 from the lease financing transaction and net proceeds of $2.0 million received from option exercises, purchases under our employee stock purchase plan, and from the equity component of the $1.0 million payment we received from Merck when our collaboration was amended in February 2007.
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 financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with US generally accepted accounting principles, or 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 and related disclosures. We base our estimates on historical 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 significantly from those estimates.
Our critical accounting policies include:
Clinical trial expenses. We accrue clinical trial expenses based on work performed. In determining the amount to accrue, we rely on estimates of total costs incurred based on the enrollment of subjects, the completion of trials and other events. We follow this method because we believe reasonably dependable estimates of the costs applicable to various stages of a clinical trial can be made. However, the actual costs and timing of clinical trials are highly uncertain, subject to risks and may change depending on a number of factors. Differences between the actual clinical trial costs and the estimated clinical trial costs that we have accrued in any prior period are recorded in the subsequent period in which the actual costs become known. Historically, these differences have not been material and we have not had to make material adjustments in the amounts recorded in a subsequent period; however, material differences could occur in the future.
Revenue recognition. Our revenue recognition policies are in accordance with the SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force, or EITF, 00-21, Revenue Arrangements with Multiple Deliverables, which provide guidance on revenue recognition in financial statements. Some of our agreements contain upfront technology access fees, research funding, milestone achievements and royalties.
Revenue from a milestone achievement is 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 in which we have significant involvement or perform services, using various factors specific to each collaboration. Amounts we receive for research funding for a specified number of full-time researchers are recognized as revenue as the services are performed. Advance payments we receive in excess of amounts earned are classified as deferred revenues until earned.
We manufacture drug products under a contract manufacturing agreement for a single customer, Siegfried. Upon Siegfrieds acceptance of drug products manufactured by us, we recognize contract manufacturing revenues at agreed upon prices for such drug products, which we expect will be less than the related cost for us to manufacture such drug products. We have also contracted with Siegfried for them to provide us with other services, including administrative services, in exchange for a fee paid to Siegfried. We determined that we are receiving an identifiable benefit for these administrative service fees, and are recording such fees in the operating expense section of our consolidated statements of operations.
Share-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 expense recognized subsequent to adoption includes: (i) compensation expense for all share-based awards 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 using the Black-Scholes option pricing model, and (ii) compensation expense for all share-based awards granted subsequent to January 1, 2006, based on the grant-date fair value, estimated in accordance with the provisions of SFAS No. 123R using the Black-Scholes option pricing model.
The determination of the grant-date fair value of share-based awards using the Black-Scholes option pricing model is based on the exercise price of the award and our stock price on the date of grant, as well as assumptions for expected volatility, the expected life of options granted and the risk-free interest rate. Changes in the assumptions can have a material impact on the compensation expense we recognize. Expected volatility for awards granted after adoption of SFAS No. 123R is based on a combination of 75% historical volatility of our common stock and 25% market-based implied volatilities from traded options on our common stock, with historical volatility being more heavily weighted due to the low volume of traded options on our common stock. The expected life of options granted under SFAS No. 123R is determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and post-vesting cancellations. The risk-free interest rates are based on the US Treasury yield curve, with a remaining term approximately equal to the expected term used in the option pricing model.
As compensation expense recognized is based on awards ultimately expected to vest, it is reduced for estimated forfeitures. 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 estimates, we will recognize the difference in compensation expense in the period the actual forfeitures occur or when options vest.
Accounting for lease financing obligations. We have accounted for our sale and leaseback transactions in accordance with SFAS Nos. 66 and 98. Our option to repurchase these properties in the future is considered continued involvement under SFAS No. 66 and, therefore, we have applied the financing method under SFAS No. 98. Under the financing method, the book value of the properties and related accumulated depreciation remain on our balance sheet and no sale is recognized. Instead, the sales price of the properties is recorded as a financing obligation, and a portion of each lease payment is recorded as interest expense. We estimated the borrowing rate that we use to impute interest expense on our lease payments.
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 2007 Annual Report, which contain additional accounting policies and other disclosures required by GAAP.
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 our investments to be placed in US government, agency and government-sponsored enterprise obligations and in corporate debt instruments that are rated investment grade, (iii) establish parameters for diversification in 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 two years. We do not invest in derivative instruments or auction rate securities, or any financial instruments for trading purposes. Our primary market risk exposure as it affects our cash equivalents, short-term investments, and securities available-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 available-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 downward in the US 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 June 30, 2008, we would expect future interest income from our portfolio to decline by approximately $2.7 million over the following 12 months. As of December 31, 2007, this same hypothetical reduction in interest rates would have resulted in a decline in interest income of approximately $4.0 million over the 12 months following December 31, 2007. The difference in these two estimates is due to the difference in our cash and cash equivalents, short-term investments and securities available-for-sale between these 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. These hypothetical changes and assumptions are likely to be different from what actually occurs in the future. Furthermore, such computations do not incorporate any actions our management could take if the hypothetical interest rate changes actually occur. As a result, the impact on actual earnings will likely differ from those quantified herein.
We have a wholly owned subsidiary in Switzerland that exposes us to foreign exchange risk. The functional currency of our subsidiary in Switzerland is the Swiss franc. Accordingly, all assets and liabilities of our subsidiary are translated to US dollars based on the applicable exchange rate on the balance sheet date. Revenue and expense components are translated to US dollars at weighted-average exchange rates in effect during the period. Gains and losses resulting from foreign currency translation are reported as a separate component of accumulated other comprehensive gain or loss in our stockholders equity. Other foreign currency transaction gains and losses are included in results of operations and, to date, have not been significant for us. We have not hedged exposures denominated in foreign currencies, but may do so in the future.
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 13a-15(e) under the Securities Exchange Act of 1934) were effective. There was no change in our internal control over financial reporting that occurred during the quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Investment in our stock involves a high degree of risk. You should consider carefully the risks described below, together with other information in this quarterly report on 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 all or part of your investment. Moreover, 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 condition.
The risk factors set forth below with an asterisk (*) before the title are new risk factors or risk factors containing substantive changes, including any material changes, from the risk factors previously disclosed in Item 1A to Part I of our annual report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission.
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.
Our accumulated deficit since inception has 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 for at least the next several years, even if we or our collaborators are successful in advancing our compounds or partnered compounds.
We do not have any commercially available 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, and our efforts may not result in a marketed drug. We have substantially less money than we need to develop our compounds into marketed drugs. 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.
In addition, provisions of our series B redeemable convertible preferred stock require us to obtain approval of the preferred stockholders, or otherwise trigger rights of first refusal or payment provisions, which may make it more difficult for us to take certain corporate actions and could delay, discourage or prevent future financings.
*Our stock price could decline significantly based on the results and timing of clinical trials and preclinical studies of, and decisions affecting, our lead drug candidates.
Results of clinical trials and preclinical studies (including preclinical studies conducted after initiation of clinical trials) of our lead drug candidates may not be viewed favorably by us or third parties, including investors, analysts, potential collaborators, the academic and medical community, and regulators. The same may be true of how we design the development programs of our lead drug candidates and regulatory decisions (including by us or regulatory authorities) affecting those development programs. 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 have several drug programs that are currently in clinical trials. In addition to successfully completing clinical trials, in order to conduct long-term clinical trials and gain regulatory approval to commercialize drug candidates, regulatory authorities require that all drug candidates complete short- and long-term preclinical toxicity and carcinogenicity studies. These studies in animals are required to help determine the potential risk that drug candidates may be toxic or cause cancer in humans. The preclinical assessment of carcinogenic potential includes short-term in vitro and in vivo studies to look for chromosomal damage. Short-term carcinogenicity and toxicity studies have been completed for all of our clinical-stage programs. To date, we have only completed long-term preclinical toxicity studies for lorcaserin, and we have not completed carcinogenicity studies for lorcaserin or any of our other clinical-stage programs. The results of our clinical trials and preclinical studies are uncertain, and the design of these trials and studies (which may change significantly and be more expensive than currently anticipated depending on our results and regulatory decisions) may also be viewed negatively by third parties. We may not be successful in advancing our programs on our projected timetable, if at all. Failure to initiate or delays in the development programs for any of our drug candidates, or unfavorable results or decisions or negative perceptions regarding any of such programs, could cause our stock price to decline significantly. This is particularly the case with respect to our most advanced drug candidate, lorcaserin, for which we have three ongoing Phase 3 clinical trials.
Our development of lorcaserin may be adversely impacted by cardiovascular side effects previously associated with fenfluramine and dexfenfluramine.
We have developed lorcaserin to more selectively stimulate the 5-HT2C serotonin receptor because we believe this may avoid the cardiovascular side effects associated with fenfluramine and dexfenfluramine (often used in combination with phentermine, the combination of which was commonly referred to as fen-phen), 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, or lorcaserins selectivity profile may not avoid these undesired side effects. Moreover, the potential relationship between the activity of lorcaserin and the activity of fenfluramine and dexfenfluramine may result in increased United States Food and Drug Administration, or FDA, regulatory scrutiny of the safety of lorcaserin and may raise potential adverse publicity in the marketplace, which could affect clinical enrollment or ultimately sales if lorcaserin is approved for sale.
The development programs for our drug candidates are expensive, time consuming, uncertain and susceptible to change, interruption, delay or termination.
Drug development programs are very expensive, time consuming and difficult to design and implement. Our drug candidates are in various stages of development and are prone to the risks of failure inherent in drug development. We will need to complete additional clinical trials and preclinical studies before we can demonstrate that our drug candidates are safe and effective to the satisfaction of the FDA and similar non-US regulatory authorities. These trials are expensive and uncertain processes that take years to complete. Failure can occur at any stage of the process, and successful early clinical or preclinical trials do not ensure that later trials or studies will be successful. In addition, the commencement of our planned clinical trials could be substantially delayed or prevented by several factors, including:
· limited number of, and competition for, suitable patients required for enrollment in our clinical trials;
· limited number of, and competition for, suitable sites to conduct our clinical trials;
· delay or failure to obtain FDA approval or agreement to commence a clinical trial;
· delay or failure to obtain sufficient supplies of our drug candidates for our clinical trials;
· delay or failure to reach agreement on acceptable clinical trial agreement terms or clinical trial protocols with prospective sites or investigators; and
· delay or failure to obtain institutional review board, or IRB, approval to conduct a clinical trial at a prospective site.
Even if the results of our development programs are favorable, the development programs of our most advanced drug candidates, including those being developed by our collaborators, may take significantly longer than expected to complete. In addition, the FDA, other regulatory authorities, our collaborators, or we may suspend, delay or terminate our development programs at any time for various reasons, including:
· lack of effectiveness of any drug candidate during clinical trials;
· side effects experienced by study participants or other safety issues;
· slower than expected rates of patient recruitment and enrollment or lower than expected patient retention rates;
· delays or inability to manufacture or obtain sufficient quantities of materials for use in clinical trials;
· inadequacy of or 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 authority, such as the FDA, after a study is commenced;
· changes in applicable regulatory policies and regulations;
· delays in identifying and reaching agreement on acceptable terms with prospective clinical trial sites;
· uncertainty regarding proper dosing;
· unfavorable results from ongoing clinical trials and preclinical studies;
· failure of our clinical research organizations to comply with all regulatory and contractual requirements or otherwise perform their services in a timely or acceptable manner;
· scheduling conflicts with participating clinicians and clinical institutions;
· failure to construct appropriate clinical trial protocols;
· insufficient data to support regulatory approval;
· termination of clinical trials by one or more clinical trial sites;
· inability or unwillingness of medical investigators to follow our clinical protocols;
· difficulty in maintaining contact with subjects during or after treatment, which may result in incomplete data; or
· lack of sufficient funding to continue clinical trials and preclinical studies.
There is typically a high rate of attrition from the failure of drug candidates proceeding through clinical trials, and many companies have experienced significant setbacks in advanced development programs even after promising results in earlier studies or trials. We may experience similar setbacks in our development programs. If we or our collaborators abandon or are delayed in our development efforts related to lorcaserin, APD125, APD791 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, additional funding may not be available to us or may not be available on terms you or we believe are favorable, and our stock price would likely decrease significantly.
Our drug candidates are subject to extensive regulation, and we may not receive required regulatory approvals for any of our drug candidates.
The clinical development, manufacturing, labeling, packaging, storage, recordkeeping, advertising, promotion, export, marketing and distribution, and other possible activities relating to 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. Neither our collaborators nor we are permitted to market our drug candidates 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. Specific preclinical data, chemistry, manufacturing and controls data, a proposed clinical study protocol and other information must be submitted to the FDA as part of an investigational new drug, or IND, application, and clinical trials may commence only after the IND application becomes effective. To market a new drug in the United States, we must submit to the FDA and obtain FDA approval of a New Drug Application, or NDA. An NDA must be supported by extensive clinical and preclinical data, as well as extensive information regarding chemistry, manufacturing and controls to demonstrate the safety and effectiveness of the drug candidate.
Obtaining approval of an NDA can be a lengthy, expensive and uncertain process. In addition, failure to comply with FDA and other applicable regulatory requirements may, either before or after product approval, if any, subject our company to administrative or judicially imposed sanctions, including:
· Warning Letters;
· civil and criminal penalties;
· withdrawal of approved products;
· product seizure or detention;
· product recalls;
· total or partial suspension of production;
· imposition of restrictions on operations, including costly new manufacturing requirements; and
· refusal to approve pending NDAs or supplements to approved NDAs.
Regulatory approval of an NDA or NDA supplement is not guaranteed. Despite the time and expense exerted, failure can occur at any stage, and we could encounter problems that cause us to abandon clinical trials or to repeat or perform additional preclinical studies and clinical trials. 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 target, 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:
· a drug candidate may not be deemed adequately safe and effective;
· FDA officials may not find the data from preclinical studies and clinical trials sufficient;
· the FDA may not approve the manufacturing processes or facilities; or
· the FDA may change its approval policies or adopt new regulations.
We do not expect any drugs resulting from our research and development efforts to be commercially available until 2010 or later. Our most advanced drug candidates, including lorcaserin and APD125, have not completed all preclinical studies and the large, pivotal Phase 3 clinical trials for efficacy and safety that are required for FDA approval. Also, we have not previously filed NDAs with the FDA, nor have we previously conducted Phase 3 clinical trials, which are significantly larger and more complex than earlier-stage trials. This lack of corporate 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. Even if we believe that data collected from our preclinical studies and clinical trials of our drug candidates are promising and that our information and procedures regarding chemistry, manufacturing and controls are sufficient, our data may not be sufficient to support approval by the FDA or any other United States or foreign regulatory authority. As a result, we cannot predict when or whether regulatory approval will be obtained for any drug we develop. In addition, we believe that the regulatory review of NDAs for drug candidates intended for widespread use by a large proportion of the general population is becoming increasingly focused on safety. In this regard, it is possible that some of our drug candidates, including lorcaserin and APD125, will be subject to increased scrutiny to show adequate safety than would drug candidates for more acute and life-threatening diseases such as cancer. Even if approved, drug candidates may not be approved for all indications requested and such approval may be subject to limitations on the indicated uses for which the drug may be marketed. Our business and reputation may be harmed by any failure or significant delay in receiving regulatory approval for the sale of any drugs resulting from our drug candidates.
In order to market any drugs outside of the United States, we and our collaborators must comply with numerous and varying regulatory requirements of other countries. 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.
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. To date, long-term safety and efficacy have not yet been demonstrated in clinical trials for any of our drug candidates. Favorable results in our early studies or trials may not be repeated in later studies or trials, including continuing preclinical studies and large-scale clinical trials, and our drug candidates in later-stage trials may fail to show desired safety and efficacy despite having progressed through earlier-stage trials. In particular, preclinical data and the limited clinical results that we have obtained for lorcaserin and APD125 may not predict results from studies in larger numbers of subjects drawn from more diverse populations treated for longer periods of time. They also may not predict the ability of lorcaserin or APD125 to achieve or sustain the desired effects in the intended population or to do so safely. Unfavorable results from ongoing preclinical studies or clinical trials could result in delays, modifications or abandonment of ongoing or future clinical trials, or abandonment of a clinical program. Preclinical and clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals or commercialization. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be delayed, repeated or terminated, or a clinical program abandoned. In addition, we may report top-line data from time to time, which is based on a preliminary analysis of key efficacy and safety data, and is subject to change following a more comprehensive review of the data related to the applicable clinical trial.
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. We cannot be certain that results sufficiently favorable to justify commencement of Phase 1 clinical trials will be obtained in these preclinical investigations. 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.
*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, less expensive 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, development and marketing 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. Our competitors may also market generic or other drugs that compete with our drugs at a lower price than our drugs, which may negatively impact our drug sales, if any. 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.
If we do not partner one or more unpartnered programs or raise additional funds, we may have to curtail some of our activities.
Without additional capital or funding from partners, 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.
We expect that, for at least the next few years, our revenues will depend upon the success of our existing collaborations, our ability to enter into new collaborations and our ability to generate revenues under our subsidiary, Arena Pharmaceuticals GmbHs, or Arena GmbH, contract manufacturing agreement with Siegfried Ltd. Our revenues of $19.3 million for the year ended December 31, 2007 were derived exclusively from our collaborations with Merck and Ortho-McNeil. Absent any new collaboration, we expect our revenues for 2008 to be derived under Arena GmbHs contract manufacturing agreement with Siegfried Ltd and, to a lesser extent, from our collaborations with Merck and Ortho-McNeil. In 2008 and beyond, our revenues from our collaborations with Merck and Ortho-McNeil will depend on, in addition to patent reimbursements, milestone and royalty payments, if any. Thus, we will receive little additional revenues from our existing collaborators if our own or our collaborators research, development or, ultimately, marketing efforts are unsuccessful.
Typically, our collaborators (and not us) control the development of partnered 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. We cannot guarantee that any development, approval or sales milestones in our existing or future collaborations will be achieved in the future, or that we will receive any payments for the achievement of any future milestones. In addition, our existing collaborations, including our collaborations with Merck and Ortho-McNeil, may be terminated early in certain circumstances, in which case we may not receive future milestone or royalty payments or patent reimbursements.
Moreover, 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.
Collaborative relationships may lead to delays in drug development and commercialization and disputes.
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. Our collaborators may stop supporting our drug candidates if they develop or obtain rights to competing drug candidates or drugs. 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 interests. Any such disagreement could result in one or more of the following, each of which could delay, or lead to termination of development or commercialization of our partnered 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;
· slowing or cessation of a collaborators development or commercialization efforts with respect to our drug candidates; or
· litigation or arbitration.
*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 Avandia, Vioxx and Celebrex, or drug candidates such as rimonabant and torcetrapib, as well as competition from generic drugs, 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 any of our drugs that may be approved will depend in part on government regulation and the availability of coverage and adequate reimbursement from third-party payers, including private health insurers and government payers, such as the Medicaid and Medicare programs, increases in government-run, single-payer health insurance plans and compulsory licenses of drugs. Government and third-party payers are increasingly attempting to contain healthcare costs by limiting coverage and reimbursement levels for new drugs. Given the continuing discussion regarding the cost of healthcare, managed care, universal healthcare coverage and other healthcare issues, we cannot predict with certainty what additional healthcare initiatives, if any, will be implemented or the effect any future legislation or regulation will have on our business. 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. Moreover, legislation and regulations affecting the pricing of pharmaceuticals may change before regulatory agencies approve our drug candidates for marketing. Adoption of such legislation and regulations could further limit pricing approvals for, and reimbursement of, drugs. A government or third-party payer decision not to approve pricing for, or provide adequate coverage and reimbursements of, our drugs, if any, could limit market acceptance of such drugs.
We rely on third parties to conduct our clinical trials and many of our preclinical studies. If those parties do not successfully carry out their contractual duties or meet expected deadlines, our drug candidates may not advance in a timely manner or at all.
In the course of our discovery, preclinical testing and clinical trials, we rely on third parties, including laboratories, investigators, clinical research organizations and manufacturers, to perform critical services for us. For example, we rely on third parties to conduct our clinical trials and many of our preclinical studies. Clinical research organizations are responsible for many aspects of the trials, including finding and enrolling subjects for testing and administering the trials. Although we rely on these third parties to conduct our clinical trials, we are responsible for ensuring that each of our clinical trials is conducted in accordance with its investigational plan and protocol. Moreover, the FDA and foreign regulatory authorities require us to comply with regulations and standards, commonly referred to as good clinical practices, or GCPs, for conducting, monitoring, recording and reporting the results of clinical trials to ensure that the data and results are scientifically credible and accurate and that the trial subjects are adequately informed of the potential risks of participating in clinical trials. Our reliance on third parties does not relieve us of these responsibilities and requirements. 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, and we may need to enter into new arrangements with alternative third parties and our clinical trials may be extended, delayed or terminated. These independent third parties may also have relationships with other commercial entities, some of which may compete with us. In addition, if such third parties fail to perform their obligations in compliance with our clinical trial protocols or GCPs, our clinical trials may not meet regulatory requirements or may need to be repeated. Furthermore, we may not be able to obtain regulatory approval to commercialize the drug candidate being tested in such trials. 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 rely on third-party manufacturers and we or such third parties may encounter failures or difficulties that could delay the clinical development or regulatory approval of our drug candidates, or their ultimate commercial production if approved.
We and third parties manufacture our drug candidates. We do not have manufacturing facilities that can produce sufficient quantities of drug candidates for large-scale clinical trials. Accordingly, we must either develop such facilities, which will require substantial additional funds, or rely, at least to some extent, on third-party manufacturers for the production of drug candidates. Furthermore, should we obtain FDA approval for any of our drug candidates, we expect to rely, at least to some extent, on third-party manufacturers for commercial production. Our dependence on others for the manufacture of our drug candidates may adversely affect our ability to develop and deliver such drug candidates on a timely and competitive basis.
Any performance failure on the part of us or a third-party manufacturer could delay clinical development, regulatory approval or, ultimately, sales of our drug candidates. We or third-party manufacturers may encounter difficulties involving production yields, regulatory compliance, quality control and quality assurance, as well as shortages of qualified personnel. Approval of our drug candidates could be delayed, limited or denied if the FDA does not approve our or a third-party manufacturers processes or facilities. Moreover, the ability to adequately and timely manufacture and supply drug candidates is dependent on the uninterrupted and efficient operation of the manufacturing facilities, which is impacted by many manufacturing variables including:
· availability or contamination of raw materials and components used in the manufacturing process, particularly those for which we have no other source or supplier;
· facility capacity of our facilities or those of our contract manufacturers;
· facility contamination by microorganisms or viruses;
· compliance with regulatory requirements;
· changes in forecasts of future demand;
· timing and actual number of production runs;
· production success rates and bulk drug yields; and
· timing and outcome of product quality testing.
In addition, we or our third-party manufacturers may encounter delays and problems in manufacturing our drug candidates or drugs for a variety of reasons, including accidents during operation, failure of equipment, delays in receiving materials, natural or other disasters, political or governmental changes, or other factors inherent in operating complex manufacturing facilities. Supply chain management is difficult. Commercially available starting materials and reagents may become scarce or more expensive to maintain, and we may not be able to obtain favorable terms in agreements with subcontractors. We or our third-party manufacturers may not be able to operate our respective manufacturing facilities in a cost-effective manner or in a time frame that is consistent with our expected future manufacturing needs. If we or our third-party manufacturers cease or interrupt production or if our third-party manufacturers and other service providers fail to supply materials, products or services to us for any reason, such interruption could delay progress on our programs, or interrupt the commercial supply, with the potential for additional costs and lost revenues. If this were to occur, we may also need to seek alternative means to fulfill our manufacturing needs.
We may not be able to enter into agreements for the manufacture of our drug candidates with manufacturers whose facilities and procedures comply with applicable law. Manufacturers are subject to ongoing periodic unannounced inspection by the FDA, the Drug Enforcement Administration of the United States Department of Justice, or DEA, and corresponding state and foreign authorities to ensure strict compliance with current Good Manufacturing Practices, or cGMPs, 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. In addition, our Swiss subsidiary, Arena GmbH has contracted with Siegfried Ltd to provide safety, health and environmental services and assess compliance, train personnel and oversee Arena GmbHs compliance with the applicable safety, health and environmental regulations. We are, therefore, relying at least in part on Siegfried Ltds judgment, experience and expertise. If we or one of our manufacturers fails to maintain compliance, we or they could be subject to civil or criminal penalties, the production of our drug candidates could be interrupted or suspended, or our product could be recalled or withdrawn, resulting in delays, additional costs and potentially lost revenues.
We may not be able to effectively integrate or manage our international operations and such difficulty could adversely affect our stock price, business operations, financial condition and results from operations.
In January 2008, we purchased from Siegfried Ltd certain drug product facility assets, including fixtures, equipment, other personal property and real estate assets and acquired 69 employees in Zofingen, Switzerland. There are significant risks associated with the establishment of foreign operations, including, but not limited to, compliance with local laws and regulations, the protection of our intellectual property, the ability to integrate our corporate culture with local customs and cultures, the distraction to our management and foreign currency exchange rates and the impact of shifts in the US and local economies on those rates. We will also be contract manufacturing drug products for Siegfried for at least the next several years and, therefore, be subject to liability for non-performance, product recalls and other claims against manufacturers.
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, require additional expertise or disrupt our management or business, which could harm our operations and financial results.
As part of an effort to acquire a business or drug candidate or to enter into other significant transactions, we conduct business, legal and financial due diligence with the goal of identifying and evaluating material risks involved in the transaction. Despite our efforts, we ultimately may be unsuccessful in ascertaining or evaluating all such risks and, as a result, might not realize the intended advantages of the transaction. If we fail to realize the expected benefits from acquisitions we may consummate, whether as a result of unidentified risks, integration difficulties, regulatory setbacks or other events, our business, results of operations and financial condition could be adversely affected.
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, Chief Executive Officer and Chairman, 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 use biological materials, hazardous materials, chemicals and radioactive compounds.
Our research and development and manufacturing activities involve the use of potentially harmful biological materials as well as 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:
· interruption of our research and development or manufacturing efforts;
· injury to our employees and others;
· environmental damage resulting in costly clean up; and
· liabilities under domestic or foreign 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 cannot be certain that the coverage or coverage limits of our insurance policies will be adequate and we do not have insurance coverage for losses relating to an interruption of our research and development efforts caused by contamination.
We may incur substantial liabilities from any product liability claims if our insurance coverage for those claims is inadequate.
We develop, test and, to a limited extent, manufacture drugs that are used by humans. We face an inherent risk of product liability exposure related to the testing of our drug candidates in clinical trials, and will face an even greater risk if we sell our own 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 obtain or 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.
Damages awarded in a product liability action could be substantial and could have a negative impact on our financial condition. Whether or not we were ultimately successful in product liability litigation, such litigation would consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business.
Our operations might be interrupted by the occurrence of a natural disaster or other catastrophic event.
Our United States operations, including laboratories, offices and a chemical development facility are located in the same business park in San Diego. We also have a drug product facility that is located in Zofingen, Switzerland. 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, political and governmental changes, 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.
*There may be sales of our stock by our executive officers and directors, and these sales could adversely affect our stock price.
Sales of our stock by our executive officers and directors, or the perception that such sales will occur, could adversely affect the market price of our stock. Some of our executive officers have adopted trading plans under SEC Rule 10b5-1 in order to dispose of a portion of their stock. Other executive officers or directors may adopt such trading plans in the future.
Even if any of our drug candidates receives regulatory approval, our drug candidates will still be subject to extensive post-marketing regulation.
If we or our collaborators receive regulatory approval for our drug candidates in the United States or other jurisdictions, we will also be subject to ongoing obligations and continued regulatory review from the FDA and other applicable regulatory agencies, such as continued adverse event reporting requirements. 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 in the United States or other jurisdictions.
If any of our drug candidates receive United States regulatory approval or approval in other jurisdictions, the FDA or other regulatory agencies 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. If the FDA or other regulatory agencies approve any of our drug candidates, the labeling, packaging, adverse event reporting, storage, advertising and promotion for the drug will be subject to extensive regulatory requirements. We and the manufacturers of our products are also required to comply with cGMP regulations, which include requirements relating to quality control and quality assurance as well as the corresponding maintenance of records and documentation. Further, regulatory agencies must approve these manufacturing facilities before they can be used to manufacture our products, and these facilities are subject to ongoing regulatory inspections. 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, up to and including withdrawal of the drug from the market. In the United States, the DEA and comparable state-level agencies also heavily regulate the manufacturing, holding, processing, security, recordkeeping and distribution of drugs that are considered controlled substances. If any of our drug candidates are scheduled by the DEA as controlled substances (due to abuse potential), we will become subject to the DEAs regulations. The DEA periodically inspects facilities for compliance with its rules and regulations. If our manufacturing facilities or those of our suppliers fail to comply with applicable regulatory requirements, it could result in regulatory action and additional costs to us. Failure to comply with applicable FDA and other regulatory requirements may, either before or after product approval, if any, subject our company to administrative or judicially imposed sanctions, including:
· issuance of Warning Letters by the FDA or other regulatory agencies;
· imposition of fines and other civil penalties;
· criminal prosecutions;
· injunctions, suspensions or revocations of regulatory approvals;
· suspension of any ongoing clinical trials;
· total or partial 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 into or exported from the United States;
· restrictions on operations, including costly new manufacturing requirements; and
· product recalls or seizures.
The FDAs and other regulatory agencies 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.
Even if we receive regulatory approval to market our drug candidates, our ability to generate revenues from any resulting products will be subject to a variety of risks, many of which are out of our control.
Even if our drug candidates obtain regulatory approval, resulting products may not gain market acceptance among physicians, patients, healthcare payers or the medical community. We believe that the degree of market acceptance and our ability to generate revenues from such products will depend on a number of factors, including:
· timing of market introduction of competitive drugs;
· efficacy and safety of our drug candidates;
· prevalence and severity of any side effects;
· potential or perceived advantages or disadvantages over alternative treatments;
· strength of sales, marketing and distribution support;
· price of our future products, both in absolute terms and relative to alternative treatments;
· the effect of current and future healthcare laws on our drug candidates;
· availability of coverage and reimbursement from government and other third-party payers; and
· product labeling or product insert requirements of the FDA or other regulatory authorities.
If our approved drugs, if any, fail to achieve market acceptance, we may not be able to generate significant revenue to achieve or sustain profitability.
Currency fluctuations may negatively affect our financial condition.
We primarily spend and generate cash in US dollars, and present our consolidated financial statements in US dollars. However, a portion of our expected and potential payments and receipts under our agreements are in foreign currencies, including Swiss francs. For example, payments and receipts under our asset purchase agreement, contract manufacturing agreement and long-term API manufacturing agreement with Siegfried Ltd are required to be paid in Swiss francs. A fluctuation of the exchange rates of foreign currencies versus the US dollar may, thus, adversely affect our financial results, including cash balances, expenses and revenues. We may enter into hedging transactions to try to reduce our foreign currency exposure in the future, but there is no assurance that such transactions will occur or be successful.
Laws, rules 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, or SEC, and by the Nasdaq Global Market, as well as the laws and regulations of foreign governments, may result in increased costs to us, particularly as we continue to develop the required capabilities in the United States and abroad to commercialize our products. 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 estimate accurately the amount or timing of additional costs we may incur to respond to these laws, rules and regulations.
The technologies on which we rely may not result in the discovery or development of commercially viable drugs or could become obsolete.
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.
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 or that are otherwise part of our collaborations are important to commercializing drugs. We have numerous United States and foreign patent applications pending for our technologies. 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 technology or method, or that the patents will be held to be valid for their expected terms.
The procedures for obtaining a patent in the United States and in most foreign countries are complex. These procedures require an analysis of the scientific technology related to the invention and many sophisticated legal issues. Obtaining patent rights outside the United States often requires the translation of highly technical documents and an improper translation may lead to the loss of, or otherwise jeopardize, the patent protection of our inventions. Ensuring adequate quality of translators and foreign patent attorneys is often very challenging. Consequently, the process for having our pending patent applications issue as patents will be difficult, 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, or if the scope of the patents obtained will be sufficient to protect our drugs.
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 or 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 or elimination of our patents coverage.
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.
The United States Patent and Trademark Office has recently tried to enact and/or proposed changes in the rules governing (i) the duties of patent applicants to disclose information that relates to their applications, (ii) the ability of patent applicants to file unlimited numbers of patent applications and patent claims that concern closely related inventions and/or different aspects of the same invention, and (iii) the manner in which the United States Patent and Trademark Office will decide whether to require patent applicants to separate closely related inventions into separate patent applications. In addition, the United States Congress is considering a change to the federal laws dealing with patents on several issues including, but not limited to: (i) what types of information can be used to determine whether an invention is not new and, therefore, not patentable, (ii) the limits on the independent administrative rulemaking authority of the United States Patent and Trademark Office, (iii) the duties of patent applicants to disclose information that relates to their applications, (iv) whether, under what circumstances, and how many times a third party will have an opportunity to challenge an issued United States patent before the United States Patent and Trademark Office, (v) whether and under what circumstances patent applicants can lose their ability to enforce their patents in the United States based on their failure to disclose certain information relating to their inventions, and (vi) how damages for patent infringement may be limited and apportioned based on a number of factors including the similarity of a patented invention to pre-existing technologies.
The United States is by far the largest single market for pharmaceuticals in the world, responsible for between 40% and 50% of all such sales. Because of the critical nature of patent rights to the pharmaceutical industry, changes in United States patent rules and laws could have a profound effect on our future profits. Several of the patent rule and law changes that are being considered could significantly weaken patent protections in the United States in general. They may also have a disproportionately large negative impact on the biotechnology and pharmaceutical industries in particular, as well as tilt the balance of market control and distribution of profits between the manufacturers of patented pharmaceutical products and the manufacturers of generic pharmaceutical products towards the generics manufacturers. At present there is considerable uncertainty as to which patent rules and laws will be changed and whether changes to the patent rules will ultimately be enforced or struck down by the courts.
A dispute regarding the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be costly and result in delays or termination of our future research, development, manufacturing and sales 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 others. 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 others based on claims that our drug candidates, technologies or activities infringe the intellectual property rights of others. Numerous United States 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 United States and foreign issued patents and pending patent applications owned by others also exist in the therapeutic areas in, and for the therapeutic targets for, which we are developing drugs. There are also numerous issued patents and patent applications to chemical compounds or synthetic processes that may be necessary or useful to use in our research, development, manufacturing or commercialization activities. These could materially affect our ability to develop our drug candidates or manufacture, import or sell drugs, 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 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, development, manufacturing and commercialization efforts. We cannot assure you that others holding any of these patents or patent applications will not assert infringement claims against us for damages or seek 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, others 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 others.
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, development, manufacturing and commercialization activities 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 and all of our potential drug candidates throughout the world would be prohibitively expensive. Competitors may use our technologies to develop their own drugs in jurisdictions where we have not obtained patent protection. 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, 2006 to June 30, 2008, the market price of our stock was as low as $4.55 per share and as high as $20.68 per share.
Very few drug candidates being tested will ultimately receive FDA approval, and biotechnology or biopharmaceutical companies may experience a significant drop in stock price based on a clinical trial result or regulatory action. Our stock price may fluctuate significantly depending on a variety of factors, including:
· the success or failure of our clinical-stage development programs, or other results or decisions affecting, the development of our drug candidates;
· the timing of the discovery of drug leads and the development of our drug candidates;
· the entrance into a new collaboration or the modification or termination of an existing collaboration;
· the timing and receipt by us of milestone and royalty payments or failing to achieve and receive the same;
· changes in our research and development budget or the research and development budgets of our existing or potential collaborators;
· the introduction of new drug discovery techniques or the introduction or withdrawal of drugs by others that target the same diseases and conditions that we or our collaborators target;
· regulatory actions;
· expenses related to, and the results of, litigation and other proceedings relating to intellectual property rights or other matters;
· financing strategy or decisions; and
· accounting changes.
We are not able to control all of these factors. If our financial or scientific results 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 $10.00 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 $10.00 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 Preferred can require us at any time to redeem all or some of their shares of Series B 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 or penalties settled by increasing the stated value at the time the dividend, or penalty, as applicable, is payable. The Series B-1 Preferred, which accrues dividends at 4% annually, had an aggregate redemption price of $41.9 million at June 30, 2008, and we expect the aggregate redemption price at the mandatory redemption date of December 24, 2008 to be $42.8 million. The Series B-2 Preferred, which accrues dividends at 4% annually, had an aggregate redemption price of $13.1 million at June 30, 2008, and we expect the aggregate redemption price at the mandatory redemption date of April 22, 2010 to be $14.0 million.
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% of the stated value or the market value (as calculated under the Certificate of Designations for the Series B 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 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.
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 all or 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 of 1933, as amended, or Securities Act;
· our common stock is listed on the Nasdaq Global Market or other eligible market;
· the shares to be issued can be issued without violating the rules of the Nasdaq Global Market or any applicable trading market or a provision of our Certificate of Designations for the Series B Preferred; and
· no bankruptcy event has occurred.
If we are permitted to satisfy all or 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% of the average of the volume weighted-average price of our common stock for, depending on the specified circumstances, 10 or 15 consecutive trading days prior to the delivery of the redemption notice or date of the triggering event.
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, the ownership interests of the current holders of our common stock 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 73,941,722 shares of our common stock outstanding as of June 30, 2008. In addition, the outstanding shares of our Series B Preferred are convertible into our common stock. The number of shares of common stock issuable upon conversion of the Series B Preferred is dependent on the stated value of the Series B Preferred, which may increase over time in connection with dividends earned or penalties, if any. If all of our outstanding Series B Preferred were converted into common stock on June 30, 2008, holders would have received approximately 7.5 million shares of our common stock.
The holders of the Series B Preferred can require us at any time to redeem all or some of their shares of Series B Preferred. We may decide to satisfy all or a portion of any redemption with shares of our common stock. The number of shares of common stock issuable upon redemption of the Series B Preferred is equal to the stated value of the relevant Series B Preferred divided by the lesser of the applicable conversion price and 95% of the arithmetic average of the volume weighted-average prices of common stock for, depending on the circumstances, the 10 or 15 consecutive trading days immediately prior to a specified date or notice.
In connection with the Series B Preferred financing, we issued warrants to acquire 1,936,200 shares of common stock at an exercise price of $10.00 per share to the two purchasers in our Series B Preferred financing. As of June 30, 2008, 1,106,344 of such warrants were outstanding. Such warrants provide that if the closing price of our common stock is equal to or above $14.00 per share 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 Call Amount (as such term is defined in the warrants). 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 price 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 our two warrant holders, Smithfield Fiduciary LLC, such holder exercised its warrants to purchase 829,856 shares of our common stock. In connection with this exercise in full of its warrants, Smithfield claimed that it was entitled to receive exchange warrants that would include a provision that could require us to issue additional exchange warrants in the future. We disagreed with this interpretation and, on June 30, 2006, we entered into a Settlement Agreement and Release with Smithfield. As part of the Settlement Agreement and Release, (a) Smithfield and we provided each other with a release of any claims relating to (i) Smithfields demand for, and our non-issuance of, exchange warrants, and (ii) any breach or default under certain of our agreements on account of the foregoing, (b) we issued Smithfield a seven-year warrant to purchase 829,856 shares of our common stock at an initial exercise price of $15.49 per share, and (c) we filed a registration statement covering the sale of the shares of common stock issuable under the new warrant. The new warrant does not contain any right for us, or for the holder to require us, to call the warrant, nor does it provide the holder the right to receive any exchange warrants in the future. As of June 30, 2008, 829,856 of such warrants were outstanding.
In addition, as of June 30, 2008, there were (i) options to purchase 6,601,445 shares of our common stock outstanding under our equity incentive plans at a weighted-average exercise price of $9.78, (ii) 1,967,800 performance-based restricted stock unit awards outstanding under our 2006 Long-Term Incentive Plan, as amended, or LTIP (iii) 1,175,651 additional shares of common stock remaining issuable under our LTIP, (iv) 272,172 shares of common stock remaining issuable under our 2001 Employee Stock Purchase Plan, as amended, and (v) 107,919 shares of common stock remaining issuable under our Deferred Compensation Plan.
A substantial number of the shares described above, when issued upon conversion, redemption or exercise, as applicable, 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 bankruptcy laws. The terms of our Series B Preferred limit 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. 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 disagreements with the holders of our Series B Preferred or warrants in the future.
We previously had a disagreement with one of our two warrant holders, Smithfield, regarding whether such holder was entitled to receive exchange warrants following the exercise of its warrants in full. We entered into a Settlement Agreement and Release with this holder. We have a similar disagreement with the other of our two warrant holders, Mainfield. We do not know with certainty the outcome of such disagreement. In addition, we may be involved with other disagreements with the holders of our Series B Preferred or warrants in the future. Such disagreements may lead to litigation which may be expensive and consume managements time, or involve settlements, the terms of which may not be favorable to us.
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 agreement, dated as of October 30, 2002, between us and Computershare Trust Company, Inc., as Rights Agent, as amended. The rights agreement 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 bylaws 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.
The annual meeting of our stockholders was held on June 11, 2008 for the purposes of (i) electing 10 directors to our Board to serve until the next annual meeting of stockholders and until their respective successors are elected and qualified or until their earlier resignation or removal and (ii) ratifying the appointment of Ernst & Young LLP, an independent registered public accounting firm, as our independent auditors for the fiscal year ending December 31, 2008. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934 and there was no solicitation in opposition to the director nominees.
Set forth below are the voting results of our common stock for each of the proposals. There were no broker non-votes with respect to either of the proposals.
Jack Lief, Dominic P. Behan, Ph.D., Donald D. Belcher, Scott H. Bice, Harry F. Hixson, Jr., Ph.D., J. Clayburn La Force, Jr., Ph.D., Tina Nova Bennett, Ph.D., Phillip M. Schneider, Christine A. White, M.D., and Randall E. Woods were elected as directors to our Board to serve until the next annual meeting of stockholders and until their respective successors are elected and qualified or until their earlier resignation or removal. The votes cast by proxy or in person with respect to the election of directors, as determined by the final report of the inspectors of election, are set forth below.
Ratification of the Appointment of Ernst & Young LLP
Stockholders ratified the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending December 31, 2008, and the voting results, as determined by the final report of the inspectors of election, are set forth below.
In addition, all of our outstanding series B redeemable convertible preferred stock voted for for each of the above proposals. As of the record date for our 2008 annual meeting of stockholders, the series B redeemable convertible preferred stock had 7,385,050 votes.
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.