Array BioPharma 10-K 2007
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission File Number: 000-31979
Array BioPharma Inc.
(Exact Name of Registrant as Specified in Its Charter)
3200 Walnut Street, Boulder, Colorado 80301
(Address of principal executive offices)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $.001 Per Share
The NASDAQ Stock Market LLC
(NASDAQ Global Market)
(Name of Exchange on which Registered)
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The aggregate market value of voting stock held by non-affiliates of the registrant as of December 31, 2006 (based upon the closing sale price of such shares as of the last trading day of the year, December 29, 2006, on the NASDAQ National Market now known as the NASDAQ Global Market) was $371,990,457. Shares of the Registrants common stock held by each executive officer and director and by each entity that owns 5% or more of the Registrants outstanding common stock have been excluded in that such persons or entities may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
Number of shares outstanding of the registrants class of common stock as of August 10, 2007: 47,087,232
Documents incorporated by reference:
Portions of the registrants definitive Proxy Statement to be filed with the Securities and Exchange Commission on Form 14A for the 2007 Annual Meeting of Stockholders Part III
TABLE OF CONTENTS
This Annual Report filed on Form 10-K and other documents we file with the Securities and Exchange Commission contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve significant risks and uncertainties. In addition, we may make forward-looking statements in our press releases or in other oral or written communications with the public. These statements do not relate to historical matters and reflect our current expectations concerning future events. Therefore our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. These factors include, but are not limited to, our ability to continue to fund and successfully progress internal research efforts and to create effective, commercially viable drugs, our ability to achieve and maintain profitability, the extent to which the pharmaceutical and biotechnology industries are willing to in-license drug candidates for their product pipelines and to collaborate with and fund third parties on their drug discovery activities, our ability to out-license our proprietary candidates on favorable terms, risks associated with our dependence on our collaborators for the clinical development and commercialization of our out-licensed drug candidates, the ability of our collaborators and of Array to meet objectives tied to milestones and royalties, our ability to attract and retain experienced scientists and management, and the risk factors set forth below under the caption Risk Factors. We are providing this information as of the date of this report. We undertake no duty to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements or of anticipated or unanticipated events that alter any assumptions underlying such statements.
Array BioPharma Inc. is a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat cancer and inflammatory diseases. Our proprietary drug development pipeline includes clinical candidates that are designed to regulate therapeutically important target proteins and are aimed at large market opportunities. We currently have 10 programs in our development pipeline, eight of which are wholly owned by us.
Our eight most advanced development programs that we wholly own and control consist of ARRY-543, an ErbB-2/EFGR dual inhibitor for cancer; ARRY-162, a MEK inhibitor for inflammation; ARRY-797, a p38 inhibitor for inflammation and for cancer; ARRY-520, a KSP inhibitor for cancer; ARRY-380, an ErbB-2 inhibitor for cancer; and ARRY-614, a p38/Tie 2 dual inhibitor for inflammation and for cancer. We have also out-licensed to AstraZeneca PLC three MEK inhibitors for cancer including ARRY-886 (AZD6244), currently in multiple Phase 2 clinical trials, and ARRY-704 (AZD8330), currently in a Phase 1 clinical trial. In addition to these development programs, we have out-licensed two cancer programs to Genentech, Inc. which are in preclinical development. Through collaborations, we have also invented drug candidates that are currently in clinical development including InterMune, Inc.s hepatitis C virus, or HCV, NS3/4 protease inhibitor, ITMN-191, and Eli Lilly and Companys CHK-1 inhibitor, IC83. The out-license and collaboration agreements with these partners provide for up-front payments, success-based milestone payments and / or royalties on product sales.
We also have a portfolio of discovery programs that we believe will generate two to three Investigational New Drug, or IND, applications during calendar 2008. Our discovery efforts have also generated additional early-stage drug candidates that we may choose to out-license through research partnerships as we did with VentiRx Pharmaceuticals, Inc., which is described below. We believe this business strategy will enable us to receive a greater portion of the potential financial upside than our previous research collaborations while controlling development costs. We also believe this strategy will allow us to maximize our scientific efforts with other resources on programs for which we have particular expertise or which have synergies with our other development programs.
We have built our proprietary pipeline of development and discovery programs on a modest investment of approximately $150 million in research and development expenses from our inception through June 30, 2007. Additionally, we have recognized a total of $258 million in research funding and in up-front and milestone payments from our collaboration partners through June 30, 2007. Under our existing collaboration agreements, we have the potential to earn over $260 million additional milestone payments if we achieve all the drug discovery objectives detailed in these
agreements, as well as royalties on any resulting product sales from 16 drug development programs.
Accomplishments During the Past Fiscal Year
Below is a summary of our accomplishments during the fiscal year and our current plans to execute on our strategies.
ARRY-886 (AZD6244) and ARRY-704 (AZD8330) Targeting MEK for Cancer
ARRY-886 and ARRY-704 inhibit MEK, a critical enzyme at the intersection of several biological pathways that regulate cell proliferation and survival. Both compounds have shown tumor suppressive or regressive activity in multiple preclinical models of human cancer including melanoma, pancreatic, colon, lung and breast cancers.
During fiscal 2007, the following progress was made under our collaboration with AstraZeneca:
· AstraZeneca initiated dosing ARRY-886 in cancer patients in a Phase 2 study. This randomized study compares ARRY-886 to temozolomide in the treatment of metastatic melanoma patients and expects to enroll approximately 180 patients at 40 centers worldwide. Additional Phase 2 studies are underway in colorectal, pancreatic and non-small cell lung cancers. AstraZeneca has reported that it expects to present Phase 2 results in mid-2008.
· We reported Phase 1 results on ARRY-886 at the 18th Annual EORTC-NCI-AACR Symposium on Molecular Targets and Cancer Therapeutics. These results showed inhibition of the MEK pathway by ARRY-886 in tumor tissue at the dose that was later selected for the Phase 2 study and provided prolonged disease stabilization in a number of heavily pre-treated cancer patients.
· AstraZeneca initiated dosing ARRY-704 in a Phase 1 clinical trial in cancer patients.
ARRY-543, Targeting ErbB-2 / EGFR for Cancer
ARRY-543 is an oral, selective, reversible, tyrosine kinase inhibitor of both ErbB-2 and EGFR. In preclinical models, ARRY-543 demonstrated significant dose-related tumor growth inhibition when administered orally. Tykerb® (lapatinib), a small molecule drug that modulates ErbB-2 and EGFR, has been approved for the treatment of certain Herceptin® (trastuzumab)-resistant breast cancers and is still undergoing clinical trials for other cancers. We believe ARRY-543 has significant advantages over Tykerb, including greater inhibition of EGFR, improved human drug exposure and an improved safety profile.
During fiscal 2007, the following progress was made on the program:
· Advanced ARRY-543 in a Phase 1a clinical trial in the United States and Canada and began preparations for an expansion trial.
· Reported interim Phase 1a data at our Analyst Day Meeting in December 2006, showing that ARRY-543 demonstrated consistent drug exposure and that four patients had stable disease at well tolerated doses.
· Initiated plans to begin Phase 2 trials.
ARRY-520, Targeting KSP for Cancer
ARRY-520 inhibits kinesin spindle protein, or KSP, a protein that plays an essential role in mitotic spindle formation. Similar to the taxanes and vinca alkaloids, KSP inhibitors inhibit tumor growth by preventing mitotic spindle formation and cell division. However, unlike taxanes and vinca alkaloids, KSP inhibitors do not demonstrate certain side effects such as peripheral neuropathy. ARRY-520 caused marked tumor regression in preclinical models of human cancer at tolerated doses.
During fiscal 2007, the following progress was made on the program:
· Filed an IND application with the U.S. Food and Drug Administration, or FDA, in December 2006 and dosed cancer patients in a Phase 1 trial.
ARRY-380, Targeting ErbB-2 for Cancer
ARRY-380, a selective, orally-active ErbB-2 inhibitor, has shown efficacy and is well-tolerated in preclinical models of human cancer. ErbB-2 is a receptor kinase target that is over-expressed in breast and other cancers. Herceptin, the intravenously-dosed protein therapeutic currently on the market, modulates ErbB-2 and generated over $3 billion in revenue in 2006.
During fiscal 2007, the following progress was made on the program:
· Completed regulated safety assessment testing.
· Filed an IND application with the FDA, and are able to proceed with a Phase 1 clinical trial.
ARRY-162, Targeting MEK for Inflammation
ARRY-162, an orally active MEK inhibitor, has shown efficacy and is well-tolerated in preclinical models of human arthritis and other inflammatory diseases. Injected protein therapeutics currently on the market bind to and modulate the activity of the cytokines TNF or IL-1. MEK modulates biosynthesis of certain pro-inflammatory cytokines, in particular, TNF, IL-1 and IL-6. We believe inhibition of MEK will have applications in inflammatory diseases driven by these cytokines, such as arthritis, Crohns disease, psoriasis and chronic obstructive pulmonary disease, or COPD.
During fiscal 2007, the following progress was made on the program:
· Initiated a Phase 1 clinical trial in healthy volunteers.
· Presented Phase 1 data at the Annual European Congress of Rheumatology, or EULAR, and the International Association of Inflammation Societies, or IAIS, 8th World Congress on Inflammation. The multiple ascending dose, or MAD, study showed 50 to 90% inhibition of IL-1, TNF and IL-6 when measured over a 24-hour period with 40 mg daily. ARRY-162 was well-tolerated with no serious adverse events and showed dose proportional human pharmacokinetics.
· Advanced ARRY-162 in a Phase 1b combination trial with methotrexate in rheumatoid arthritis, or RA, patients.
· Conducted long-term toxicology studies.
· Initiated plans to begin a Phase 2 RA trial.
ARRY-797, Targeting p38 for Inflammation and Cancer
ARRY-797, a selective orally active p38 inhibitor, has shown good efficacy, controlled tissue distribution and is well-tolerated in preclinical models of human arthritis and certain cytokine-driven cancers. p38 is a kinase target that regulates the production of TNF, IL-1, IL-6 and PGE2. As described above, we believe that inhibition of p38 will also regulate inflammatory cytokine production and will benefit patients with inflammatory disease. These cytokines can also act as cellular growth factors or are up-regulated in certain cancers including prostate, ovarian and multiple myeloma, and may play a role in certain resistance mechanisms or metastatic progression in cancer.
During fiscal 2007, the following progress was made on the program:
· Filed an IND application with the FDA and initiated Phase 1 clinical trials in healthy volunteers.
· Filed an IND application and are able to proceed with a Phase 1b clinical trial in cancer patients.
· Presented Phase 1 single ascending dose, or SAD, data at the EULAR and IAIS meetings. ARRY-797 met study objectives and was well-tolerated with no serious adverse events. There were linear increases in exposure with increasing oral dose ranging between 25 and 400 mg. ARRY-797 demonstrated a maximum inhibition of greater than 90% for the production of IL-1, TNF and PGE2, and showed greater than 50% inhibition at 24 hours at the highest dose.
· Initiated a Phase 1 MAD study.
ARRY-614, Targeting p38 / Tie2 for Inflammation and Cancer
ARRY-614, an orally active compound that inhibits both p38 and Tie2, blocks angiogenesis, inhibits inflammation and reduces growth of certain cytokine-driven cancers in preclinical models. ARRY-614 is well-tolerated in preclinical models of human cancer and arthritis. Increased production of certain cytokines can cause aberrant tissue proliferation. The growth, differentiation and maintenance of new blood vessels, or angiogenesis, in proliferating tissue can lead to the uncontrolled cell growth that characterizes cancer and inflammatory diseases.
During fiscal 2007, the following progress was made on the program:
· Advanced ARRY-614 into regulated safety assessment testing.
Growing Partnered Research
During fiscal 2007, the following progress was made in our partnered research programs:
· Received $5 million in payments from AstraZeneca for achieving clinical milestones on the MEK for cancer program.
· InterMune, Inc. initiated patient dosing in January 2007 on a Phase 1a clinical trial with ITMN-191, an orally available HCV protease inhibitor, triggering a milestone payment to Array.
· Received a milestone payment from Eli Lilly and Company for dosing the CHK-1 inhibitor, IC83, in a Phase 1 clinical trial. Scientists at Array and ICOS Corporation, which was acquired by Eli Lilly in 2007, collaborated to invent IC83.
· Entered into a license agreement with VentiRx Pharmaceuticals Inc., granting VentiRx exclusive worldwide rights to Arrays toll-like receptor, or TLR, program. Array received an equity stake in VentiRx, a privately held company, as well as an up-front payment, and is entitled to receive potential milestone payments and royalties on product sales. Array retains the option to acquire a 50% ownership position in all VentiRx clinical oncology products developed under this agreement.
During fiscal 2007, the following additions were made to our leadership team:
· Appointed John Yates, M.B. Ch.B., M.D., to the newly created position of Chief Medical Officer. Dr. Yates oversees the medical strategy and clinical development of Arrays drug pipeline.
· Appointed Neil Spector, M.D., to our Scientific Advisory Board. Dr. Spector is helping Array in the development of our cancer drug portfolio.
· Appointed Jonathan Kay, M.D., to our Scientific Advisory Board. Dr. Kay is working with Array in the development of our inflammation drug portfolio.
Strengthening Financial Position
We continued to maintain our strong financial performance during fiscal 2007:
· Recognized $37 million in revenue, while investing $57 million in our proprietary research and development.
· Raised $85 million, net of offering costs, through an underwritten public offering of 7,000,000 shares of common stock at a price to the public of $13.00 per share in May 2007.
· Secured expansion space through 2016 and received $32 million in net cash as a result of our sale of purchase options and lease-back of our Boulder and Longmont facilities.
· Ended fiscal 2007 with approximately $141 million in cash, cash equivalents and marketable securities.
Research and Development
Our primary research efforts are centered on the treatment of cancer and inflammatory disease. We believe there is significant synergy between these two research areas, and developing drugs in one of the areas may lead to therapies in the other area. Our research focuses on biologic functions, or pathways, that have been identified as important in the treatment of human
disease based on human clinical, genetic or preclinical data. Within these pathways, we seek to create first-in-class drugs regulating important therapeutic targets to treat patients with serious or life-threatening conditions, primarily in cancer, inflammatory disease and other important disease areas. In addition, we seek to identify opportunities to improve upon existing therapies or drugs in clinical development by creating clinical candidates with superior, or best-in-class, drug characteristics, including efficacy, tolerability or dosing, to provide safer, more effective drugs.
Drug Development Pipeline
The following pipeline chart shows our ten most advanced programs and their stage in the drug development process.
(1) A single IND for this compound is expected to be filed in fiscal 2008.
ARRY-886 (AZD6244) and ARRY-704 (AZD8330) Targeting MEK for Cancer
We initiated an anti-cancer research program targeting MEK in July 2001, and within 17 months identified ARRY-886, an orally active clinical candidate. ARRY-886 and a subsequently identified candidate, ARRY-704, have both shown tumor suppressive or regressive activity in multiple preclinical models of human cancer including melanoma, pancreatic, colon, lung, and breast cancers. Potential advantages of MEK inhibitors over current therapies include potential improved efficacy and reduced side effects. In December 2003, we entered into an out-licensing and collaboration agreement with AstraZeneca to develop our MEK program solely in the field of oncology. We retain the rights to all MEK compounds not selected by AstraZeneca.
Under our collaboration with AstraZeneca, we were responsible for conducting Phase 1 clinical testing, which we initiated in June 2004. The trial evaluated tolerability and pharmacokinetics of ARRY-886 following oral administration to patients with advanced cancer. In addition, the trial examined patients for indications of biological activity as well as pharmacodynamic and tumor biomarkers. As we reported in November 2006, Phase 1 testing showed that ARRY-886 inhibited the MEK pathway in tumor tissue at the dose that was later selected for the Phase 2 study and provided prolonged disease stabilization in a number of heavily pre-treated cancer patients.
In June 2006, AstraZeneca initiated a Phase 2 study for ARRY-886 in malignant melanoma, resulting in a $3 million milestone payment to us. The trial is a randomized Phase 2 study that compares ARRY-886 to temozolomide in the treatment of stage III / IV melanoma patients. AstraZeneca expects to enroll approximately 180 patients at 40 centers worldwide. AstraZeneca initiated additional Phase 2 studies for ARRY-886 in colorectal, pancreatic and non-small cell lung cancer during the second half of 2006. AstraZeneca has indicated that it expects to present Phase
2 results in mid-2008.
In March 2007, AstraZeneca dosed its first cancer patient in a Phase 1 clinical trial with our MEK inhibitor, ARRY-704 (AZD8330), triggering a $2 million milestone payment to us.
ARRY-543, Targeting ErbB-2 / EGFR for Cancer
ErbB-2 and EGFR are receptor kinase targets that are over-expressed in a number of malignancies, including breast, lung, pancreas, colon and head and neck cancers. Herceptin is an intravenously-dosed protein therapeutic currently on the market for the treatment of breast cancers that over-express ErbB-2. Herceptin has also recently been reported to show promising therapeutic benefits in early, post-surgery, breast cancer patients being treated chronically. We believe these results suggest a high potential value for an orally active drug that regulates ErbB-2 and that can be conveniently dosed for extended periods of time. Erbitux® (cetuximab), an intravenously-dosed protein therapeutic, and Tarceva® (erlotinib), a small molecule inhibitor, are currently marketed drugs that modulate EGFR only. Tykerb, a small molecule drug that modulates ErbB-2 and EGFR, has been approved for the treatment of certain Herceptin-resistant breast cancers and is still undergoing clinical trials for other cancers.
We believe the concurrent inhibition of ErbB-2 and EGFR provides enhanced efficacy in cancer treatment. ARRY-543, a novel orally active dual inhibitor of EGFR and ErbB-2, behaves as a reversible ATP-competitive inhibitor with nanomolar potency both in vitro and in cell-based proliferation assays. Selectivity for inhibition of ErbB family target proteins has been demonstrated by profiling against a panel of kinases in vitro. In preclinical models, ARRY-543 demonstrated significant dose related tumor growth inhibition when administered orally. ARRY-543 has demonstrated efficacy in certain preclinical models where Tarceva or Herceptin are not active and we believe has shown equivalent or improved efficacy compared to Tykerb.
We are nearing completion of a Phase 1a clinical trial in the United States and Canada of ARRY-543 and are preparing to initiate an expansion trial. We reported interim Phase 1a data in December 2006 for ARRY-543: the compound demonstrated consistent drug exposure and four patients had stable disease at well-tolerated doses. We are planning to initiate Phase 2 trials.
ARRY-520, Targeting KSP for Cancer
ARRY-520 inhibits kinesin spindle protein, or KSP, a protein that plays an essential role in mitotic spindle formation. Similar to the taxanes and vinca alkaloids, KSP inhibitors inhibit tumor growth by preventing mitotic spindle formation and cell division. However, unlike taxanes and vinca alkaloids, KSP inhibitors do not demonstrate certain side effects such as peripheral neuropathy. ARRY-520 caused marked tumor regression in preclinical models of human cancer at tolerated doses.
In vivo, ARRY-520 caused marked tumor regression in preclinical models of human cancer at tolerated doses. In studies comparing the most clinically advanced competitor against standard of care agents like taxanes and vinca alkaloids, ARRY-520 has shown superior efficacy in multiple preclinical models. We filed an IND application with the FDA in December 2006 and began a Phase 1 clinical trial in May 2007.
ARRY-380, Targeting ErbB-2 for Cancer
ErbB-2 is a receptor kinase target that has been found to be over-expressed in breast and other cancers. Our orally active ErbB-2 inhibitor, ARRY-380, has shown efficacy and a low side effect profile in preclinical models of human cancer. Recently, Herceptin, the intravenously-dosed protein inhibitor currently on the market that modulates ErbB-2, has shown promising therapeutic benefit when dosed as an adjuvant to surgery in cancer patients. This scientific finding expanded an already large market for an ErbB-2 inhibitor. We believe this oral drug may broadly benefit HER2-positive cancer patients, including those that do not respond to Herceptin. We filed an IND application for ARRY-380 with the FDA and plan to initiate a Phase 1 clinical trial.
ARRY-162, Targeting MEK for Inflammation
Pro-inflammatory proteins, or cytokines, have been broadly implicated as playing detrimental roles in a number of inflammatory diseases. Modulation of certain cytokines has been shown to provide clinical benefit for the treatment of inflammatory disease. Injected protein therapeutics currently on the market, including Enbrel® (etanercept), Remicade® (infliximab), Humira® (adalimumab) and Kineret® (anakinra), bind to and modulate the activity of the cytokines of TNF or IL-1. MEK has been demonstrated to modulate the biosynthesis of certain pro-inflammatory cytokines, in particular, TNF, IL-1 and IL-6. We believe inhibition of MEK will have applications in inflammatory diseases driven by these cytokines, such as arthritis, psoriasis and inflammatory bowel diseases such as Crohns. Our extensive experience with inhibitors of MEK leads us to believe that this target may be amenable to chronic modulation that is well tolerated by patients. ARRY-162, an orally-active MEK inhibitor, has shown efficacy and a low side effect profile in preclinical models of human arthritis and other inflammatory diseases. We believe this compound may provide broad therapeutic benefits in the treatment of inflammatory and chronic degenerative diseases. We initiated Phase 1 clinical trials in healthy volunteers in April 2006 and reported interim data in June 2007. ARRY-162 showed no serious adverse events through 14 days of continuous dosing and significantly inhibited cytokine production after ex-vivo stimulation of clinical samples. We are completing a Phase 1b combination trial with methotrexate in RA patients and long-term toxicology studies. Given appropriate results, we plan to initiate a Phase 2 trial.
ARRY-797, Targeting p38 for Inflammation and Cancer
p38 is another kinase target that modulates the production of TNF, IL-1 and IL-6. As described above, we believe that inhibition of p38 will modulate inflammatory cytokine production and will benefit patients with inflammatory disease. These cytokines can also act as cellular growth factors including multiple myeloma. Additionally, p38 may play a role in certain resistance mechanisms or metastatic progression in cancer. As a result, we believe inhibition of p38 may provide a therapeutic benefit in certain cancer patients. ARRY-797, a selective orally active p38 inhibitor, has shown good efficacy, controlled tissue distribution and a low side effect profile in preclinical models of human arthritis and certain cytokine-driven cancers. We filed an IND application with the FDA in October 2006 and initiated Phase 1 clinical trials in healthy volunteers. We also filed an application to initiate a Phase 1b trial in cancer patients in April 2007. We plan to initiate Phase 2 trails.
ARRY 614, Targeting p38/Tie2 for Inflammation and Cancer
Increased production of certain cytokines can cause aberrant tissue proliferation. The growth, differentiation and maintenance of new blood vessels, or angionenesis, in proliferating tissue can lead to uncontrolled cell growth that characterizes cancer and chronic inflammatory diseases. p38 regulates the production of numerous pro-inflammatory and pro-proliferative cytokines, such as TNF, IL-1 and IL-6. Tie2 plays an important role in angiogenesis and blood vessel growth. ARRY-614, an orally active compound that inhibits both p38 and Tie2, has been shown to block angiogenesis, to inhibit inflammation and to antagonize tumor growth, while showing a low side effect profile after prolonged dosing in preclinical models. We believe this compound will have broad therapeutic benefits in various cancers and inflammatory diseases. This compound is in regulated safety assessment and we plan to file an IND application in the second half of 2007.
There is a tremendous opportunity in creating drugs for debilitating and life-threatening diseases, especially in cancer and inflammation. The medical community is seeking targeted therapies that treat both the underlying disease as well as control symptoms more effectively and/or more safely than currently available drugs. We believe future patient care will improve with the use of biomarkers to select targeted therapies for more effective disease treatment. Also, clinical trials aimed at a well defined patient population should show an improved response rate and increase the chances for approval by the FDA. This approach may result in a greater number of marketed drugs aimed at a smaller subset of patients. Our research benefits from the evolving scientific understanding of how modulating specific protein targets can potentially treat both cancer and inflammatory disease. As a result, a drug designed to treat cancer may also be useful in treating inflammatory disease, and vice-versa.
The worldwide market for targeted cancer drugs is expected to grow from $16 billion in 2006 to $47 billion in 2012, representing the cancer drug markets fastest growing segment. The inflammatory disease market is highly diverse and includes RA, osteoarthritis, COPD, cardiovascular disease, psoriasis, and kidney diseases. According to EvaluatePharma, the worldwide market for injectable targeted therapies for RA alone is expected to grow from $10 billion in 2006 to $18 billion in 2012. Additionally, with the safety concerns over the class of pain medications
known as COX-2 inhibitors, new markets for replacement drugs to treat pain associated with RA and osteoarthritis, as well as other painful inflammatory disorders, are likely to develop.
Another positive trend for us is the pharmaceutical industrys ongoing need to fill their clinical development pipelines with new drugs to drive future revenue growth. Despite increased spending on internal research, the industry has been unable to meet this demand. As a result, they have become increasingly reliant on biotech companies to acquire new drug candidates. The scarcity of later stage clinical assets available for in-licensing is driving these companies to enter into licensing deals at earlier stages. We believe deal terms have increased significantly for early stage drug candidates over the last several years and this trend will continue. As a result, this increasing demand for a limited number of clinical assets should continue to increase the value of our drug pipeline.
Despite a wide range of available cancer therapies, patient responses remain limited and variable. Targeted therapies offer a more specific approach than first generation, cytotoxic chemotherapy drugs by regulating discrete aspects of cellular function affecting cancer cells to a greater extent than normal cells, providing an improved side effect profile and potentially increased efficacy. We believe certain cancers will eventually become chronic diseases, treated with a combination of targeted therapies. Arrays research focus in the cancer market is to build a pipeline of complementary targeted therapies.
According to the American Cancer Society, approximately 10.5 million Americans with a history of cancer were alive in January 2003 and more than 1.4 million new cases are expected to be diagnosed in 2007. The following table shows estimated new cases diagnosed in the United States:
Inflammation is a natural biologic response to injury or infectious attack to the human body. Unregulated inflammation results in a broad range of conditions, most of which are classified by the tissue or organ where the inflammation occurs. These conditions include RA in the joint, psoriasis in the skin, COPD in the lung, fibrotic disease in the liver and kidney, Crohns disease in the intestine, and atherosclerosis in the arteries. Currently, some of the most effective treatments for these diseases are injectable protein therapeutics, which have significant cost and patient compliance issues. Injectable protein therapeutics currently on the market, such as Enbrel, Remicade, Humira and Kineret, bind to and/or modulate the activity of the inflammatory cytokines TNF or IL-1. There remains a significant unmet medical need for therapies to treat COPD, asthma, fibrosis and to manage pain. We believe there are significant opportunities to create orally active drugs to treat many of these often-chronic diseases and conditions. We are developing drugs that modulate important biological targets in key intracellular pathways that control inflammation, potentially providing the ability to treat multiple diseases and conditions with a single oral agent.
Partnered Research and Development
We have research partnerships with leading pharmaceutical and biotechnology companies for which we design, create and optimize drug candidates, and conduct preclinical testing across a broad range of therapeutic areas. In certain partnerships, we also perform process research and development, and manufacture clinical supplies. These partnerships involve either continued research and development on programs we have out-licensed or drug discovery and development on targets selected by our partners. These collaborations provide research funding and, in a number of our current agreements, up-front fees, milestone payments and/or royalties based upon the success of the program. Our largest partners, from whom we are receiving research funding or have the potential for future milestones or royalties, include AstraZeneca, Genentech, InterMune, Ono Pharmaceutical Co., Ltd., Amgen Inc., Eli Lilly and Company (ICOS
Corporation), Japan Tobacco Inc., and Takeda Pharmaceutical Company, Ltd.
Our research team has produced more early-stage discovery assets than we can develop internally. During the next three years, we intend to out-license certain of these assets through research partnerships of higher value than our traditional collaborations. We believe this strategy will create opportunities for greater financial upside while continuing to provide a revenue stream and will allow us to maintain a critical mass of scientists required for a world-class research platform.
Information about collaborators that comprise 10% or more of our total revenue and about revenue we receive within and outside the United States can be found in Note 11 Customer and Geographic Information to our audited financial statements included elsewhere in this Annual Report.
Below are summaries of some of our partnered programs in which we are receiving research funding and/or are based on our out-licensed programs.
AstraZeneca MEK for Cancer Program / ARRY-886 and ARRY-704
In December 2003, we entered into an out-licensing and collaboration agreement with AstraZeneca to develop our MEK program solely in the field of oncology. Under the agreement, AstraZeneca acquired exclusive worldwide rights to our clinical development candidate, ARRY-886, together with ARRY-704 and another second-generation compound for oncology indications we developed during the collaboration. We retain the rights to all non-oncology therapeutic indications for MEK compounds not selected by AstraZeneca for development. To date, we have earned $21.5 million in up-front and milestone payments. The agreement also provides for research funding, which is now complete, and potential additional development milestone payments of approximately $75 million and royalties on product sales. AstraZeneca is responsible for further clinical development and commercialization for ARRY-886, and for clinical development and commercialization for ARRY-704 and for the third compound it licensed.
Genentech Oncology Programs
We entered into a licensing and collaboration agreement with Genentech in December 2003 to develop small molecule drugs against multiple therapeutic targets in the field of oncology. We initiated this collaboration with Genentech to advance two of our proprietary oncology programs into clinical development. These programs included small molecule leads we had developed along with additional, related intellectual property. Under the agreement, Genentech made an up-front payment to us, provides research funding and paid a milestone payment to us for nominating a clinical candidate and advancing it into regulated safety assessment testing. In addition, Genentech has agreed to make additional potential development milestone payments and pay us royalties on any resulting product sales. Genentech is responsible for clinical development and commercialization of the resulting products.
In April 2005, we expanded our collaboration agreement with Genentech to develop clinical candidates directed against an additional cancer target. Under the expanded agreement, we receive additional research funding, as well as potential research and development milestone payments and product royalties based on the success of the new program. Genentech has the sole responsibility for clinical development and commercialization of any resulting products. In October 2005, we further expanded our collaboration with Genentech. Under the current agreement, we expect to receive a total of $50 million in research funding through December 2008, plus milestone and royalty payments based on success of the programs. Genentech may terminate its agreement with us upon 120 days notice.
InterMune Hepatitis C Virus Programs
Our scientists and InterMune scientists have collaborated since 2002 to discover novel small molecule inhibitors of the HCV NS3/4 protease. During this collaboration, our team of scientists discovered ITMN-191, which InterMune is now developing. Under the terms of the agreement, InterMune funded drug discovery, preclinical testing, process development and manufacturing in conformity with current Good Manufacturing Practices, or cGMP, and will make milestone payments to us based on the selection and progress of clinical drug candidates, as well as royalties on sales of any products derived from the collaboration. As a result of our research progress, we received our first milestone payment from InterMune in June 2004. Research funding under this agreement ended June 30, 2007.
We designed compounds under this program using computational modeling techniques and optimized them to achieve superior efficacy and targeted tissue penetration. During 2006, we produced and delivered cGMP clinical supplies of
ITMN-191, and InterMune initiated a Phase 1 clinical trial. We received a $500,000 milestone payment in February 2007 after the first subject was dosed.
Ono Pharmaceutical Research Program
We entered into a drug discovery collaboration with Ono Pharmaceutical in October 2005 to create small molecule drug candidates against a series of kinases selected by Ono. Ono provides research funding and milestone and royalty payments based on the success of the program. Ono is responsible for clinical development and commercialization of any resulting products. The research funding for this program ends May 1, 2008.
VentiRx Pharmaceuticals Toll-Like Receptor Program
We entered into a licensing and collaboration agreement with VentiRx, a privately held biopharmaceutical company, in February 2007, under which we granted VentiRx exclusive worldwide rights to our TLR program. The program contains a number of compounds targeting TLRs to activate innate immunity. VentiRx has indicated that it expects to develop its first two candidates in oncology and allergy. We received an equity stake in VentiRx as well as an up-front payment, potential milestone payments and royalties on product sales. We retain the option to acquire a 50% ownership position in all VentiRx clinical oncology products developed under this agreement.
Eli Lilly and Company IC83 / CHK-1 Program
We entered into a collaboration agreement with ICOS Corporation in 1999 to create small molecule CHK-1 inhibitors. Array and ICOS scientists invented IC83, and Array received a milestone payment after the first patient was dosed with this molecule in a Phase 1 clinical trial in early 2007. The agreement provided research funding, which has now ended, and Array is entitled to receive additional milestone payments based on Eli Lillys achievement of clinical milestones. Eli Lilly acquired ICOS in 2007.
Our Research and Development Technologies and Expertise
Our scientists use the Array Discovery Platform, an integrated suite of drug discovery technologies, to create drug candidates and conduct preclinical and clinical development. A critical capability within the Array Discovery Platform is our proprietary software, which enables our scientists to share information across our company, analyze databases of existing drugs, generate novel predictive databases and design novel drugs with potential competitive advantages over current therapies. We use in vitro and in vivo predictive pharmacodynamic and pharmacokinetic models to select compounds for potential development. Early in the drug discovery process, our scientists engineer desirable drug characteristics, such as improved potency, specificity and dosing regimen and reduced side effect profile, into drug candidates. The resulting compounds are tested for safety, efficacy and metabolism to select the most promising clinical candidates.
Our expanding development capabilities include clinical trial designs that incorporate early markers of biological activity; in-house cGMP facilities, which allow us to rapidly produce clinical drug supplies; clinical development strategies that incorporate trials to provide rapid proof of concept; therapeutically focused clinical teams that drive rapid protocol development, clinical site selection, trial initiation and monitoring, and study result evaluation.
We believe our drug discovery and development approach can significantly improve on the industrys existing clinical attrition rates through our use of:
· Proprietary chemoinformatic databases that relate chemical structure to compound development potential;
· Multiple lead generation strategies including high throughput screening, virtual screening and proprietary de novo design software;
· State-of-the-art protein x-ray crystallography, structural databases and computational modeling;
· An extensive battery of in vivo and in vitro metabolic and safety drug profiling assays;
· A company-wide electronic laboratory notebook that enables our scientists to collect, analyze and share information across the organization; and
· Innovative clinical trial designs, incorporating markers of biological activity.
We are building a fully integrated, commercial-stage biopharmaceutical company that invents, develops and markets safe and effective small molecule drugs to treat patients afflicted with cancer and inflammatory disease. We intend to accomplish this through the following strategies:
· Inventing targeted small molecule drugs that are either first-in-class or second generation drugs that demonstrate a competitive advantage over drugs on the market or in clinical development;
· Commercializing drugs that require a therapeutic specialty sales force;
· Partnering late-stage development and commercialization of select drugs that require worldwide distribution or aimed at the primary care market;
· Partnering select early-stage programs for continued research and development under which we would receive research funding, plus significant milestones and royalties; and
· Evaluating opportunities to in-license later stage clinical or commercial programs to accelerate our transition to a commercial-stage biotech company.
The pharmaceutical and biotechnology industries are characterized by rapid and continuous technological innovation. We compete with companies worldwide that are engaged in the research and discovery, licensing, development and commercialization of drug candidates, including Arena Pharmaceuticals Inc.; Arqule; Cytokinetics Inc.; Exelixis Inc.; Incyte Corporation.; Theravance, Inc.; and Vertex Pharmaceuticals Incorporated. Some of our competitors have a broader range of capabilities and have greater access to financial, technical, scientific, regulatory, business development, recruiting and other resources than we do. Their access to greater resources may allow them to develop processes or products that are more effective, safer or less costly, or gain greater market acceptance, than products we develop or for which they obtain FDA approval more rapidly than we do. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become available.
Research and Development Expenses
Research and development expenses consist of costs associated with our proprietary drug programs for salaries and benefits of scientific personnel, consulting and outsourced services, laboratory supplies, allocated facilities costs and depreciation. Research and development expenses were $57.5 million for the year ended June 30, 2007, compared to $33.4 million for fiscal 2006 and $22.9 million for fiscal 2005.
Biopharmaceutical companies are subject to substantial regulation by governmental agencies in the United States and other countries. Virtually all pharmaceutical products are subject to rigorous preclinical and clinical testing and other approval procedures by the FDA and by foreign regulatory agencies. Before a drug product is approved by the FDA for commercial marketing, three phases of human clinical trials are usually conducted to test the safety and effectiveness of the product. Phase 1 clinical trials most typically involve testing the drug on a small number of healthy volunteers to assess the safety profile of the drug at different dosage levels. Phase 2 clinical trials, which also enroll a relatively small number of volunteers, are designed to further evaluate the drugs safety profile and to provide preliminary data as to the drugs effectiveness in humans. Phase 3 clinical trials consist of larger, well-controlled studies that may involve several hundred volunteers representing the drugs targeted population. During any of these phases, the clinical trial can be placed on clinical hold, or temporarily or permanently stopped for a variety of reasons, principally for safety concerns.
The approval process is time-consuming and expensive, and there are no assurances that approval will be granted on a timely basis, or at all. Even if regulatory approvals are granted, a marketed product is subject to continual review under federal and state laws and regulations. Post-marketing requirements include reporting adverse events, recordkeeping, compliance with current good manufacturing practices (cGMP) and marketing requirements.
If drug candidates we develop are approved for commercial marketing by the FDA, they would be subject to the provisions of the Drug Price Competition and Patent Term Restoration Act of 1984 known as the Hatch-Waxman Act. The Hatch-Waxman Act provides companies with marketing exclusivity for new chemical entities and allows companies to apply to extend patent protection for up to five additional years. It also provides a means for approving generic versions
of a drug product once the marketing exclusivity period has ended and all relevant patents have expired (or have been successfully challenged and defeated). The period of exclusive marketing may be shortened, however, by a successful patent challenge.
All facilities and manufacturing processes used in the production of Active Pharmaceutical Ingredients for clinical use in the United States must be operated in conformity with cGMP as established by the FDA. We have a cGMP manufacturing facility, which allows us to produce cGMP compliant compounds. In our facility, we have the capacity to produce Active Pharmaceutical Ingredients for Phase 1 clinical testing. We have validated this capability for compliance with FDA regulations and began our first cGMP manufacturing campaign in 2002. Our cGMP facility is subject to periodic regulatory inspections to ensure compliance with cGMP requirements. We could also be required to comply with specific requirements or specifications of our collaborators, which may be more stringent than regulatory requirements. If we fail to comply with applicable regulations, the FDA could require us to cease ongoing research or disqualify the data submitted to regulatory authorities. A finding that we had materially violated cGMP requirements could result in additional regulatory sanctions and, in severe cases, could result in a mandated closing of our cGMP facility, which would materially and adversely affect our business, financial condition and results of operations.
In the course of our business, we handle, store and dispose of chemicals and biological samples. We are subject to various federal, state and local laws and regulations relating to the use, manufacture, storage, handling and disposal of hazardous materials and waste products. These environmental laws generally impose liability regardless of the negligence or fault of a party and may expose us to liability for the conduct of, or conditions caused by, others.
Most health care providers, including research institutions from whom we or our collaborators obtain patient information, are subject to privacy rules under the Health Insurance Portability and Accountability Act of 1996 (HIPAA). Although our clinical development efforts are not directly regulated by these privacy regulations, we could face substantial criminal penalties if we knowingly receive individually identifiable health information from a health care provider that has not satisfied HIPAAs disclosure standards. In addition, certain state privacy laws and genetic testing laws may apply directly to our operations and/or those of our collaborators and may impose restrictions on the use and dissemination of individuals health information.
We are subject to other regulations, including regulations under the Occupational Safety and Health Act, regulations promulgated by the United States Department of Agriculture, and regulations under other federal, state and local laws.
Our success depends in part on our ability to protect our proprietary software, potential drug candidates and other intellectual property rights. To establish and protect our proprietary technologies and products, we rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality provisions in our contracts with collaborators.
We attempt to protect our trade secrets by entering into confidentiality agreements with our employees, third parties and consultants. Our employees also sign agreements requiring that they assign to us their interests in inventions, original expressions and any corresponding patents and copyrights arising from their work for us. However, it is possible that these agreements may be breached, invalidated or rendered unenforceable, and if so, we may not have an adequate remedy available. Despite the measures we have taken to protect our intellectual property, parties to our agreements may breach the confidentiality provisions or infringe or misappropriate our patents, copyrights, trademarks, trade secrets and other proprietary rights. In addition, third parties may independently discover or invent competing technologies or reverse-engineer our trade secrets or other technology.
Our patent strategy is designed to protect technology, inventions and improvements to inventions that are commercially important to our business. We currently have fourteen issued United States patents and numerous patent applications on file with the United States Patent and Trademark Office and around the world. The source code for our proprietary software programs is protected both as a trade secret and as a copyrighted work.
United States patents issued from applications filed on or after June 8, 1995, have a term of 20 years from the application filing date or earlier claimed priority. All of our patent applications were filed after June 8, 1995. Patents in most other countries have a term of 20 years from the date of filing of the patent application. Because the time from filing patent applications to issuance of patents is often several years, this process may result in a period of patent protection
significantly shorter than 20 years, which may adversely affect our ability to exclude competitors from our markets. Our success will depend in part upon our ability to develop proprietary products and technologies and to obtain patent coverage for these products and technologies. We intend to continue to file patent applications covering newly developed products and technologies. We may not, however, commercialize the technology underlying any or all of our existing or future patent applications.
Patents provide some degree of protection for our proprietary technology. However, the pursuit and assertion of patent rights, particularly in areas like pharmaceuticals and biotechnology, involve complex legal and factual determinations and, therefore, are characterized by some uncertainty. In addition, the laws governing patentability and the scope of patent coverage continue to evolve, particularly in biotechnology. As a result, patents may not be issued from any of our patent applications or from applications licensed to us. The scope of any of our patents, if issued, may not be sufficiently broad to offer meaningful protection. In addition, our patents or patents licensed to us, if they are issued, may be successfully challenged, invalidated, circumvented or rendered unenforceable so that our patent rights might not create an effective competitive barrier. Moreover, the laws of some foreign countries may not protect our proprietary rights to the same extent as do the laws of the United States. Any patents issued to us or our strategic partners may not provide a legal basis for establishing an exclusive market for our products or provide us with any competitive advantages. Moreover, the patents held by others may adversely affect our ability to do business or to continue to use our technologies freely. In view of these factors, our intellectual property positions bear some degree of uncertainty.
As of June 30, 2007, we had 311 full-time employees, including 237 scientists, of whom 113 have PhDs. None of our employees are covered by collective bargaining agreements, and we consider our employee relations to be good.
Our Corporate Information
Founded in 1998, we are headquartered in Boulder, Colorado and have laboratory facilities in Longmont, Colorado, which together with our headquarters, encompass 230,000 square feet of laboratory facilities. We became a public company in November 2000, and our stock is listed on the Nasdaq Global Market under the symbol ARRY. The mailing address and telephone number of our principal executive offices are 3200 Walnut Street, Boulder, Colorado 80301, (303) 381-6600.
The annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, that we file with or furnish to the SEC are available on our web site free of charge as soon as reasonably practicable following the filing or furnishing of these reports to the SEC. Our web site can be found at www.arraybiopharma.com. Information on our web site does not constitute any part of this Annual Report on Form 10-K.
In addition to the other factors discussed elsewhere in this report and in other reports we file with the SEC, the following factors could cause actual results or events to differ materially from those contained in any forward-looking statements made by us or on our behalf. In addition, other risks and uncertainties not presently known to us or that we currently deem immaterial may impair our business operations. If any of the following risks or such other risks occur, it could adversely affect our business, operating results and financial condition, as well as cause the value of our common stock to decline.
RISKS RELATED TO OUR BUSINESS
We have a history of losses and may not achieve or sustain profitability.
We are at an early stage of executing our business plan, and we have a limited history of developing and out-licensing our proprietary drug candidates and offering our drug discovery capabilities. We have incurred significant operating and net losses and negative cash flows from operations since our inception. As of June 30, 2007, we had an accumulated deficit of $189.1 million. We had net losses of $55.4 million, $39.6 million and $23.2 million for the fiscal years ended June 30, 2007, 2006 and 2005, respectively. We expect to incur additional losses and negative cash flows in the future, and these losses may continue or increase due in part to anticipated increases in expenses for research and development, particularly clinical development, expansion of our clinical and scientific capabilities, acquisitions of complementary technologies or in-licensed drug candidates. At the same time, we expect that revenue from the sale of our research tools and services will continue to decline as a percentage of total revenue as we devote more resources to drug discovery and our proprietary drug programs. As a result, we may not be able to achieve or maintain profitability. Moreover, if we do achieve profitability, the level of any profitability cannot be predicted and may vary significantly.
Much of our current revenue is non-recurring in nature and unpredictable as to timing and amount. While several of our out-license and collaboration agreements provide for royalties on product sales, given that none of our drug candidates have been approved for commercial sale, that our drug candidates are at early stages of development and that drug development entails a high risk of failure, we do not expect to receive any royalty revenue for several years, if at all. For the same reasons, we may never realize much of the milestone revenue provided for in our out-license and collaboration agreements. Similarly, drugs we select to commercialize ourselves or partner for later-stage co-development and commercialization may not generate revenue for several years, or at all.
Our drug candidates are at early stages of development, and we may not successfully develop a drug candidate that becomes a commercially viable drug.
The drug discovery and development process is highly uncertain, and we have not developed, and may never develop, a drug candidate that ultimately leads to a commercially viable drug. All of our drug candidates are in the early stages of development, and we do not have any drugs approved for commercial sale. Before a drug product is approved by the FDA for commercial marketing, it is tested for safety and effectiveness in clinical trials that can take up to six years or longer. At any time, the FDA may place a clinical trial on clinical hold, or temporarily or permanently stop the trial for a variety of reasons, principally for safety concerns. Only one of our candidates, ARRY-886, is in a Phase 2 clinical trial initiated in June 2006 by our partner AstraZeneca. AstraZeneca has initiated a Phase 1 clinical trial for ARRY-704; five of our other candidates, ARRY-543, ARRY-162, ARRY-797, ARRY-520 and ARRY-380, are currently in Phase 1 trials; and another, ARRY-614, is expected to enter a Phase 1 trial. Promising results in preclinical development or clinical trials may not be predictive of results obtained in later clinical trials. A number of pharmaceutical companies have experienced significant setbacks in advanced clinical trials, even after obtaining promising results in earlier preclinical and clinical trials. We or our collaborators may experience numerous unforeseen events during, or as a result of, the clinical process that could delay or prevent our drug candidates from being approved, including:
· the failure to achieve clinical trial results that indicate a candidate is effective in treating a specified condition or illness in humans;
· the presence of harmful side effects;
· the FDAs determination that the submitted data do not satisfy the criteria for approval;
· the lack of commercial viability of the drug;
· the failure to acquire, on reasonable terms, intellectual property rights necessary for commercialization; and
· the existence of therapeutics that are more effective.
At any time, we or our collaborators may decide to discontinue the development of a drug candidate or not to commercialize a candidate. If we terminate a preclinical program in which we have invested significant resources, we will have expended resources on a program that will not provide any or a full return on our investment and we will have missed the opportunity to have allocated those resources to potentially more productive uses. Even if one of our drug candidates receives regulatory approval for marketing, physicians or consumers may not find that its effectiveness, ease of use, side effect profile, cost or other factors make it effective in treating disease or more beneficial than or preferable to other drugs on the market. Additionally, third party payors, such as government health plans and health insurance plans or maintenance organizations, may choose not to include our drugs on their formulary lists for reimbursement. As a result, our drugs may not be used or may be used only for restricted applications.
We may not be successful in entering into additional out-license agreements on favorable terms.
We are committing significant resources to create our own proprietary drug candidates and to build a commercial-stage biopharmaceutical company. In fiscal 2007, we increased our investment in proprietary research to $57.5 million in research and development expenses, compared to $33.4 million, and $22.9 million for fiscal years 2006 and 2005, respectively. Our proprietary drug discovery programs are in their early stage of development and are unproven. To date, we have entered into four out-licensing agreements for the development and commercialization of our drug candidates. Although we have expended, and continue to expend, resources on internal research and development for our proprietary programs, we may not be successful in entering into additional out-licensing agreements with favorable terms, including up-front, milestone, royalty and/or license payments, as a result of factors, many of which are outside of our control, and which include:
· our ability to create valuable proprietary drug candidates targeting large market opportunities;
· the research and spending priorities of potential licensing partners;
· the willingness of and the resources available to pharmaceutical and biotechnology companies to in-license drug candidates to fill their clinical pipelines;
· our ability or inability to agree with the potential partner on the value of the proprietary drug candidates, or on the related terms; or
· our belief that the maximum value of a proprietary drug candidate is best achieved by retaining the rights and not seeking a partner.
In addition, we may undertake and fund, solely at our expense, further development, clinical trials, manufacturing and marketing activities for a greater number of proprietary candidates than we planned. As a result, our requirements for capital could increase significantly, and we may be unable to raise additional capital on favorable terms, or at all, or we may be required to substantially reduce our development efforts, which would delay, limit or prevent our ability to commercialize our drug candidates.
We may not out-license our proprietary programs at the most appropriate time to maximize the total value or return of these programs to us.
A critical aspect of our business strategy is to out-license drug candidates for late-stage development, co-development and/or commercialization to obtain the highest possible value while also evaluating earlier out-licensing opportunities to maximize our risk-adjusted return on our investment in proprietary research. Because the costs and risk of failure of bringing a drug to market are high, the value of out-licensing a drug candidate generally increases as it successfully progresses through clinical trials. We may choose or be forced to out-license a drug candidate or program on terms that require us to relinquish commercial or market rights or at a point in the research and development process that does not provide as great a value or return than what might have been obtained if we had further developed the candidate or program internally. Likewise, we may decline, or be unable to obtain favorable, early out-licensing opportunities in programs that do not result in a commercially viable drug, which could leave the resulting program with little or no value even though significant resources were invested in its development.
We expect that revenue from our funded research collaborations will decline in the future as we focus more resources on our proprietary research programs.
We expect that revenue from our funded research collaborations to discover drug candidates against targets our collaborators select will decline. Historically, revenue from these collaborations has partially funded development of a
drug discovery platform for identifying and developing early stage drug candidates. We believe the value of the drug candidates we have created for many of our collaborators under these collaboration agreements has exceeded the economic reward provided to us under the agreements. One of our primary business strategies is to transition to a partnering strategy where, in addition to potentially obtaining higher milestone and royalty rates, we would out-license later stage candidates and retain commercialization or promotional rights in parts of the world. In order to transition to this approach, we expect to make significant investments in our own drug discovery efforts to discover additional candidates for out-licensing and that our collaboration revenue will decline as our historical collaborations end.
We have limited clinical development and commercialization experience.
One of our business strategies is to develop select drug candidates through later stage clinical trials before out-licensing them to a pharmaceutical or biotechnology partner for further clinical development and commercialization and to commercialize select drug candidates ourselves. We have not yet conducted a Phase 2 or later stage clinical trial ourselves, nor have we commercialized a drug. We have limited experience conducting clinical trials and obtaining regulatory approvals, and we may not be successful in some or all of these activities. We have no experience as a company in the sales, marketing and distribution of pharmaceutical products and do not currently have a sales and marketing organization. We expect to expend significant amounts to recruit and retain high quality personnel with clinical development experience. Developing commercialization capabilities would be expensive and time-consuming, could delay any product launch, and we may never be able to develop this capacity. To the extent we are unable or determine not to develop these resources internally, we may be forced to rely on third-party clinical investigators, clinical research or marketing organizations, which could subject us to costs and to delays that are outside our control. If we are unable to establish adequate capabilities independently or with others, we may be unable to generate product revenues for certain candidates.
Delays in the commencement or completion of clinical testing could result in increased costs to us and delay or limit our ability to generate revenues.
Delays in the commencement or completion of clinical testing could significantly affect our product development costs and the value of such products. We do not know whether planned clinical trials will begin on time or be completed on schedule, if at all. The commencement and completion of clinical trials can be delayed for a number of reasons, including delays related to:
· obtaining regulatory approval to commence a clinical trial;
· reaching agreement on acceptable terms with prospective clinical research organizations, or CROs, and trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;
· manufacturing sufficient quantities of a product candidate for use in clinical trials;
· obtaining institutional review board, or IRB, approval to conduct a clinical trial at a prospective site;
· recruiting and enrolling patients to participate in clinical trials for reasons including competition from other clinical trial programs for the same or similar indications; and
· retaining patients who have initiated a clinical trial but may be prone to withdraw due to side effects from the therapy, lack of efficacy or personal issues, or who are lost to further follow-up.
Clinical trials may also be delayed as a result of ambiguous or negative interim results. In addition, a clinical trial may be suspended or terminated by us, the FDA, the IRB overseeing the clinical trial at issue, any of our clinical trial sites with respect to that site, or other regulatory authorities due to a number of factors, including:
· failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols;
· inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;
· unforeseen safety issues, and
· lack of adequate funding to continue the clinical trial.
Additionally, changes in regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect these changes. Amendments may require us to resubmit our clinical trial protocols to IRBs for reexamination, which may impact the costs, timing or successful completion of a clinical trial. If we experience delays in completion of, or if we terminate, any of our clinical trials, the commercial prospects for our product candidates may be harmed and our ability to generate product revenues will be delayed and/or reduced. In addition, many of the factors that cause, or lead to, a
delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of a product candidate.
Drug candidates that we develop with our collaborators or on our own may not receive regulatory approval.
The development and commercialization of drug candidates for our collaborators and our own internal drug discovery efforts are subject to regulation. Pharmaceutical products require lengthy and costly testing in animals and humans and regulatory approval by governmental agencies prior to commercialization. It takes several years to complete testing, and failure can occur at any stage of testing. Results attained in preclinical testing and early clinical trials for any of our drug candidates may not be indicative of results that are obtained in later studies, and significant setbacks in advanced clinical trials may arise, even after promising results in earlier studies. Clinical trials may not demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals or result in marketable products. Furthermore, data obtained from preclinical and clinical studies are susceptible to varying interpretations that may delay, limit or prevent regulatory approval. In addition, the administration of any drug candidate we develop may produce undesirable side effects or safety issues that could result in the interruption, delay or suspension of clinical trials, or the failure to obtain FDA or other regulatory approval for any or all targeted indications. Based on results at any stage of testing, we or our collaborators may decide to repeat or redesign a trial or discontinue development of a drug candidate.
Approval of a drug candidate as safe and effective for use in humans is never certain, and regulatory agencies may delay or deny approval of drug candidates for commercialization. These agencies may also delay or deny approval based on additional government regulation or administrative action, on changes in regulatory policy during the period of clinical trials in humans and regulatory review or on the availability of alternative treatments. Similar delays and denials may be encountered in foreign countries. None of our collaborators have obtained regulatory approval to manufacture and sell drug candidates owned by us or identified or developed under an agreement with us. If we or our collaborators cannot obtain this approval, we will not realize milestone or royalty payments based on commercialization goals for these drug candidates.
In light of widely publicized events concerning the safety of certain drug products, such as Vioxx, regulatory authorities, members of Congress, the Government Accountability Office (GAO), medical professionals, and the general public have raised concerns about potential drug safety issues. These events have resulted in the withdrawal of drug products, revisions to drug labeling that further limit use of the drug products, and establishment of risk management plans that may, for instance, restrict distribution of drug products. Although drug safety concerns have occurred over time, the increased attention to this issue may result in a more cautious approach by the FDA. As a result, data from clinical trials may receive greater scrutiny with respect to safety. Safety concerns may result in the FDA or other regulatory authorities terminating clinical trials before completion or requiring longer or additional clinical trials that may result in substantial additional expense and a delay or failure in obtaining approval or approval for a more limited indication than originally sought.
Even if our drug candidates obtain regulatory approval, we and our collaborators will be subject to ongoing government regulation.
Even if regulatory authorities approve any of our drug candidates, the manufacture, labeling, storage, recordkeeping, distribution, marketing and sale of these drugs will be subject to strict and ongoing regulation. Compliance with this regulation consumes substantial financial and management resources and may expose us and our collaborators to the potential for other adverse circumstances. For example, approval for a drug may be conditioned on costly post-marketing follow-up studies. Based on these studies, if a regulatory authority does not believe that the drug demonstrates a clinical benefit to patients, it could limit the indications for which a drug may be sold or revoke the drugs marketing approval. In addition, identification of certain side effects after a drug is on the market may result in the subsequent withdrawal of approval, reformulation of a drug, additional preclinical and clinical trials and changes in labeling or distribution. Any of these events could delay or prevent us from generating revenue from the commercialization of these drugs and cause us to incur significant additional costs.
Given the number of recent high profile safety events with certain drug products, the FDA may require, as a condition of approval, costly risk management programs with components including safety surveillance, restricted distribution and use, patient education, enhanced labeling, special packaging or labeling, expedited reporting of certain adverse events, preapproval of promotional materials, and restrictions on direct-to-consumer advertising. Furthermore, heightened Congressional scrutiny on the adequacy of the FDAs drug approval process and the agencys efforts to assure the safety of
marketed drugs has resulted in the proposal of new legislation addressing drug safety issues. If enacted, any new legislation could result in delays or increased costs for manufacturers and drug sponsors during the period of product development, clinical trials, and regulatory review and approval, as well as increased costs to assure compliance with any new post-approval regulatory requirements.
In addition, the marketing of these drugs by us or our collaborators will be regulated by federal and state laws pertaining to health care fraud and abuse, such as the federal anti-kickback law prohibiting bribes, kickbacks or other remuneration for the order, purchase or recommendation of items or services reimbursed by federal health care programs. Many states have similar laws applicable to items or services reimbursed by commercial insurers. Violations of fraud and abuse laws can result in fines and/or imprisonment.
If our drug candidates do not gain market acceptance, we may be unable to generate significant revenue.
Even if our drug candidates are approved for sale, they may not be successful in the marketplace. Market acceptance of any of our drug candidates will depend on a number of factors including:
· demonstration of clinical effectiveness and safety;
· the potential advantages of our drug candidates over alternative treatments;
· the ability to offer our drug candidates for sale at competitive prices;
· the availability of adequate third-party reimbursement; and
· the effectiveness of marketing and distribution methods for the products.
If our drug candidates do not gain market acceptance among physicians, patients and others in the medical community, our ability to generate meaningful revenues from our drug candidates would be limited.
If we need but are unable to obtain additional funding to support our operations, we could be unable to successfully execute our operating plan or be forced to reduce our operations.
We have historically funded our operations through revenue from our collaborations and the issuance of equity securities. We used $44.5 million in our operating activities in fiscal 2007 while we used $24.3 million and $17.2 million in our operating activities in fiscal 2006 and 2005, respectively. Although we anticipate that we will use more cash in our operating activities in future periods, we believe that our existing cash, cash equivalents and marketable securities and anticipated cash flow from existing out-license and collaboration agreements will be sufficient to support our current operating plan for at least the next 12 months. However, our current operating plan and assumptions could change as a result of many factors, and we could require additional funding sooner than anticipated.
To the extent that the cash from our future operating activities is insufficient to meet our future capital requirements, we will have to raise additional funds to continue our proprietary research and development. We may not be able to raise funds on favorable terms, if at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the issuance of those securities would result in dilution to our stockholders. We have a credit facility providing for a $10 million term loan, and a $5 million equipment line of which a total of $15 million was advanced to us as of June 30, 2007. In addition we have a $6.8 million revolving line of credit to support standby letters of credit. A portion of our cash flow will be dedicated to the payment of principal and interest on such indebtedness, and possibly to fund increased compensating and restricted cash balances with the lender, which could render us more vulnerable to competitive pressures and economic downturns and imposes some restrictions on our operations. If we are unable to obtain additional funds when needed, we may be required to curtail operations significantly or to obtain funds through other arrangements on unattractive terms, which could prevent us from successfully executing our operating plan.
Our collaborators have substantial control and discretion over the timing and the continued development and marketing of drug candidates we create for them.
Our collaborators have significant discretion in determining the efforts and amount of resources that they dedicate to our collaborations. Our collaborators may determine not to proceed with clinical development or commercialization of a particular drug candidate for a number of reasons that are beyond our control, even under circumstances where we might have continued such a program. In addition, our ability to generate milestone payments and royalties from our collaborators depends on our collaborators abilities to establish the safety and efficacy of our drug candidates, obtain regulatory approvals and achieve market acceptance of products developed from our drug candidates. We also depend on
our collaborators to manufacture clinical scale quantities of some of our drug candidates and would depend on them in the future for commercial scale manufacture, distribution and direct sales. Our collaborators may not be successful in manufacturing our drug candidates on a commercial scale or in successfully commercializing them.
We face additional risks in connection with our collaborations, including the following:
· our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with the products that are the subject of the collaboration with us;
· our collaborators may under fund or not commit sufficient resources to the testing, marketing, distribution or other development of our drug candidates;
· our collaborators may not properly maintain or defend our intellectual property rights or they may utilize our proprietary information in such a way as to invite litigation that could jeopardize or potentially invalidate our intellectual property or proprietary information or expose us to potential liability;
· our collaborators may encounter conflicts of interest, changes in business strategy or other business issues which could adversely affect their willingness or ability to fulfill their obligations to us (for example, pharmaceutical and biotechnology companies historically have re-evaluated their priorities following mergers and consolidations, which have been common in recent years in these industries); and
· disputes may arise between us and our collaborators delaying or terminating the research, development or commercialization of our drug candidates, resulting in significant litigation or arbitration that could be time-consuming and expensive, or causing collaborators to act in their own self-interest and not in the interest of our stockholders.
Revenue from collaborations depends on the extent to which the pharmaceutical and biotechnology industries collaborate with other companies for one or more aspects of their drug discovery process.
Our capabilities include aspects of the drug discovery process that pharmaceutical and biotechnology companies have traditionally performed internally. The willingness of these companies to expand or continue drug discovery collaborations to enhance their research and development process is based on several factors that are beyond our control, any of which could cause our revenue to decline. These include their ability to hire and retain qualified scientists, the resources available for entering into drug discovery collaborations and the spending priorities among various types of research activities. In addition, our ability to convince these companies to use our drug discovery capabilities, rather than develop them internally, depends on many factors, including our ability to:
· develop and implement drug discovery technologies that will result in the identification of higher-quality drug candidates;
· attract and retain experienced, high caliber scientists;
· achieve timely, high-quality results at an acceptable cost; and
· design, create and manufacture our chemical compounds in quantities, at purity levels and at costs that are acceptable to our collaborators.
The importance of these factors varies depending on the company and type of discovery program, and we may be unable to meet any or all of them in the future. Even if we are able to address these factors, these companies may still decide to perform these activities internally or retain other companies that provide drug research and development expertise similar to ours.
Our research and development capabilities may not produce viable drug candidates.
We have entered into several research and development collaborations under which we provide drug discovery and development services to identify drug candidates for our collaborators. We also seek to identify and develop drug candidates for our proprietary programs. It is uncertain whether we will be able to provide drug discovery more efficiently or create high quality drug candidates that are suitable for our or our collaborators purposes, which may result in delayed or lost revenue, loss of collaborators or failure to expand our existing relationships. Our ability to create viable drug candidates for ourselves and our collaborators depends on many factors, including the implementation of appropriate technologies, the development of effective new research tools, the complexity of the chemistry and biology, the lack of predictability in the scientific process and the performance and decision-making capabilities of our scientists. Our information-driven technology platform, which we believe allows our scientists to make better decisions, may not enable our scientists to make correct decisions or develop viable drug candidates.
If our drug discovery and development programs do not progress as anticipated, our revenue and stock price could be negatively impacted.
We estimate the timing of a variety of preclinical, clinical, regulatory and other milestones for planning purposes, including when a drug candidate is expected to enter clinical trials, when a clinical trial will be completed or when an application for regulatory approval will be filed. Some of our estimates are included in this report. We base our estimates on facts that are currently known to us and on a variety of assumptions, many of which are beyond our control. Delays may be caused by regulatory or patent issues, interim or final results of on-going clinical trials, scheduling conflicts with participating clinics and the availability of patients who meet the criteria for, and the rate of patient enrollment in, clinical trials. If we or our collaborators do not achieve milestones when anticipated, we may not achieve our planned revenue, and our stock price could decline.
We may not realize anticipated benefits from future acquisitions.
As part of our business strategy, we may acquire, invest in or form strategic partnerships with businesses with complementary products, services and/or technologies. Acquisitions and strategic partnerships involve numerous risks, including, but not limited to:
· difficulties and increased costs in connection with integration of the personnel, operations, technologies and products of acquired companies;
· diversion of managements attention from other operational matters;
· the potential loss of key employees;
· the potential loss of key collaborators;
· lack of synergy, or the inability to realize expected synergies, resulting from the acquisition or partnership; and
· impairment of acquired intangible assets as a result of technological advancements or worse-than-expected clinical results or performance of the acquired company or the partnered assets.
Mergers and acquisitions and strategic partnerships are inherently risky and involve significant investments in time and resources to effectively manage these risks and integrate an acquired business or create a successful drug with a strategic partner. Even with investments in time and resources, an acquisition or strategic partnership may not produce the revenues, earnings or business synergies we anticipate. An acquisition or strategic partnership that fails to meet our expectations could materially and adversely affect our business, financial condition and results of operations.
Because we rely on a small number of collaborators for a significant portion of our revenue, if one or more of our major collaborators terminates or reduces the scope of their agreement with us, our revenue may significantly decrease.
A relatively small number of collaborators account for a significant portion of our revenue. Genentech, InterMune, AstraZeneca and Ono accounted for 42%, 21%, 14% and 13%, respectively of our total revenue in fiscal 2007. In fiscal 2006, the same collaborators accounted for 35%, 24%, 16% and 7% respectively of our total revenue. We expect that revenue from a limited number of collaborators, including Genentech, Ono and VentiRx Pharmaceuticals, Inc. will account for a large portion of our revenue in future quarters. In general, our collaborators may terminate their contracts with us upon 90 to 120 days notice for a number of reasons. In addition, some of our major collaborators can determine the amount of products delivered and research or development performed under these agreements. As a result, if any one of our major collaborators cancels, declines to renew or reduces the scope of its contract with us, our revenue may significantly decrease.
We may not be able to recruit and retain the experienced scientists and management we need to compete in the drug research and development industry.
We have approximately 311 employees as of June 30, 2007, and our future success depends upon our ability to attract, retain and motivate highly skilled scientists and management. Our ability to achieve our business strategies, including progressing drug candidates through later stage development or commercialization, attracting new collaborators and retaining, renewing and expanding existing collaborations, depends on our ability to hire and retain high caliber scientists and other qualified experts. We compete with pharmaceutical and biotechnology companies, contract research companies and academic and research institutions to recruit personnel and face significant competition for qualified personnel, particularly clinical development personnel. We may incur greater costs than anticipated, or may not be successful, in
attracting new scientists or management or in retaining or motivating our existing personnel.
Our future success also depends on the personal efforts and abilities of the principal members of our senior management and scientific staff to provide strategic direction, manage our operations and maintain a cohesive and stable environment. In particular, we rely on the services of Robert E. Conway, our Chief Executive Officer; Dr. Kevin Koch, our President and Chief Scientific Officer; Dr. David L. Snitman, our Chief Operating Officer and Vice President, Business Development; Dr. John Yates, our Chief Medical Officer, R. Michael Carruthers, our Chief Financial Officer; and John R. Moore, our Vice President and General Counsel. We have employment agreements with all of the above personnel that are terminable upon 30 days prior notice.
Our cGMP and pharmacology facilities and practices may fail to comply with government regulations.
All facilities and manufacturing processes used in the production of drug products, including Active Pharmaceutical Ingredients for clinical use in the United States must be operated in conformity with current Good Manufacturing Practices (cGMP), as established by the FDA. Similar requirements exist for manufacture of drug products for clinical use in other countries. These requirements include, among other things, quality control, quality assurance and the maintenance of records and documentation. If we fail to comply with these requirements, we may not be able to continue the production of our products, and we could be subject to fines and penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. We operate a clinical-scale manufacturing facility that we believe conforms to cGMP requirements. This facility and our cGMP practices are subject to periodic regulatory inspections to ensure compliance with cGMP requirements. In addition, we could be required to comply with specific requirements of our collaborators, which may exceed FDA or other applicable regulations. Failure on our part to comply with applicable regulations and specific requirements of our collaborators could result in the termination of ongoing research, disqualification of data for submission to regulatory authorities, delays or denials of new product approvals, warning letters, fines, consent decrees restricting or suspending manufacturing operations, injunctions, civil penalties, recall or seizure of products, and criminal prosecution. Material violations of cGMP requirements could result in regulatory sanctions and, in severe cases, could result in a mandated closing of our cGMP facility.
In connection with our application for commercial approvals and, if any drug candidate is approved by the FDA or other regulatory agencies for commercial sale, a significant scale-up in manufacturing may require additional validation studies. If we are unable to successfully increase the manufacturing capacity for a drug candidate, the regulatory approval or commercial launch of that drug candidate may be delayed, or there may be a shortage of supply, which could limit our ability to commercialize the drug.
In addition, our pharmacology facility may be subject to the United States Department of Agriculture (USDA) regulations for certain animal species. Failure on our part to comply with applicable regulations and specific requirements of our collaborators could result in the termination of ongoing pharmacology research. Material violations of USDA requirements could result in additional regulatory sanctions and, in severe cases, could result in a mandated closing of our pharmacology facility for certain species.
Our development, testing and manufacture of drug candidates may expose us to product liability and other lawsuits.
We develop, test and manufacture drug candidates that are generally intended for use in humans. Our drug discovery activities, including clinical trials we or our collaborators conduct, that result in the future manufacture and sale of drugs by us or our collaborators expose us to the risk of liability for personal injury or death to persons using these drug candidates. We may be required to pay substantial damages or incur legal costs in connection with defending any of these product liability claims, or we may not receive revenue from expected royalty or milestone payments if the commercialization of a drug is limited or ceases as a result of such claims. We have product liability insurance that contains customary exclusions and provides coverage up to $7.0 million per occurrence and in the aggregate, which we believe is customary in our industry for our current operations. However, our product liability insurance does not cover every type of product liability claim that we may face or loss we may incur, and may not adequately compensate us for the entire amount of covered claims or losses or for the harm to our business reputation. We may be unable to acquire or maintain additional or maintain our current insurance policies at acceptable costs or at all.
If our use of chemical and hazardous materials violates applicable laws or regulations or causes personal injury we may be liable for damages.
Our drug discovery activities, including the analysis and synthesis of chemical compounds, involve the controlled use
of chemicals, including flammable, combustible, toxic and radioactive materials that are potentially hazardous. Our use, storage, handling and disposal of these materials is subject to federal, state and local laws and regulations, including the Resource Conservation and Recovery Act, the Occupational Safety and Health Act and local fire codes, and regulations promulgated by the Department of Transportation, the Drug Enforcement Agency, the Department of Energy, the Colorado Department of Public Health and Environment, and the Colorado Department of Human Services, Alcohol and Drug Abuse Division. We may incur significant costs to comply with these laws and regulations in the future. In addition, we cannot completely eliminate the risk of accidental contamination or injury from these materials, which could result in material unanticipated expenses, such as substantial fines or penalties, remediation costs or damages, or the loss of a permit or other authorization to operate or engage in our business. Those expenses could exceed our net worth and limit our ability to raise additional capital.
Our operations could be interrupted by damage to our specialized laboratory facilities.
Our operations are dependent upon the continued use of our highly specialized laboratories and equipment in Boulder and Longmont, Colorado. Catastrophic events, including fires or explosions, could damage our laboratories, equipment, scientific data, work in progress or inventories of chemical compounds and may materially interrupt our business. We employ safety precautions in our laboratory activities in order to reduce the likelihood of the occurrence of these catastrophic events; however, we cannot eliminate the chance that such an event will occur. The availability of laboratory space in these locations is limited, and rebuilding our facilities could be time consuming and result in substantial delays in fulfilling our agreements with our collaborators. We maintain business interruption insurance in the amount of $18.0 million to cover continuing expenses and lost revenue caused by such occurrences. However, this insurance does not compensate us for the loss of opportunity and potential harm to customer relations that our inability to meet our collaborators needs in a timely manner could create.
RISKS RELATED TO OUR INDUSTRY
The concentration of the pharmaceutical and biotechnology industry and any further consolidation could reduce the number of our potential collaborators.
There are a limited number of pharmaceutical and biotechnology companies, and these companies represent a significant portion of the market for our capabilities. The number of our potential collaborators could decline even further through consolidation among these companies. If the number of our potential collaborators declines even further, they may be able to negotiate greater rights to the intellectual property they license from us, price discounts or other terms that are unfavorable to us.
Capital market conditions may reduce our biotechnology collaborators ability to fund research.
Traditionally, many unprofitable biotechnology companies have funded their research and development expenditures through raising capital in the equity markets. Declines and uncertainties in these markets have severely restricted raising new capital at times in the past and have affected these companies ability to continue to expand or fund existing research and development efforts. If our current or future biotechnology collaborators are unable to raise sufficient capital to fund research and development expenditures, we may not be able to expand or maintain current revenue.
Health care reform and cost control initiatives by third-party payors could reduce the prices that can be charged for drugs, which could limit the commercial success of our drug candidates.
In the United States, there have been and we expect there will continue to be a number of legislative and regulatory proposals to change the healthcare system in ways that could significantly affect our business. Federal and state lawmakers regularly propose and, at times, enact legislation that would result in significant changes to the healthcare system, some of which are intended to contain or reduce the costs of medical products and services. For instance, the Medicare Prescription Drug Improvement and Modernization Act of 2003, among other things, added a new Part D prescription drug benefit for Medicare beneficiaries otherwise without prescription drug coverage. Furthermore, future legislation may limit the prices that can be charged for drugs we develop and may limit our commercial opportunity and reduce any associated revenue and profits. For example, federal laws require drug manufacturers to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for out-patient medicines purchased by certain public health service entities and disproportionate share hospitals and for purchases by some federal governmental departments such as the Department of Veterans Affairs and the Department of Defense. In some countries other than the United States, reimbursement, pricing
and profitability of prescription pharmaceuticals and biopharmaceuticals are subject to government control. We are unable to predict what additional legislation or regulation, if any, relating to the healthcare industry or third-party coverage and reimbursement may be enacted in the future or what effect such legislation or regulation would have on our business.
Also, we expect managed care plans will continue to put pressure on the pricing of pharmaceutical and biopharmaceutical products. Cost control initiatives could decrease the price that we, or any potential collaborators, receive for any of our future products, which could adversely affect our profitability. These initiatives may also have the effect of reducing the resources that pharmaceutical and biotechnology companies can devote to in-licensing drug candidates and the research and development of new drugs, which could reduce our resulting revenue. Any cost containment measures or other reforms that are adopted could have a negative impact on our ability to commercialize successfully our products or could limit or eliminate our spending on development of new drugs and affect our profitability.
We or our collaborators may not obtain favorable reimbursement rates for our drug candidates.
The commercial success of our drug candidates will depend on the availability and adequacy of coverage and reimbursement from third-party payors, including government and private insurance plans. Third-party payors are increasingly challenging the prices charged for pharmaceuticals and other medical products. Our products may be considered less cost-effective than existing products, and, as such, coverage and reimbursement to the patient may not be available or be sufficient to allow the sale of our products on a competitive basis.
In addition, the market for our drug candidates will depend significantly on access to third-party payors drug formularies, or lists of medications for which third-party payors provide coverage and reimbursement. Industry competition to be included in such formularies can result in downward pricing pressures on pharmaceutical companies. As such, we cannot provide assurances that our products will be placed on third-party payors formularies. To the extent that our products are listed on third-party payors formularies, we or our collaborators may not be able to negotiate favorable reimbursement rates for our products. If we or our collaborators fail to obtain an adequate level of reimbursement for our products by third-party payors, sales of the drugs would be adversely affected or there may be no commercially viable market for the products.
The drug research and development industry has a history of patent and other intellectual property litigation, and we may be involved in costly intellectual property lawsuits.
The drug research and development industry has a history of patent and other intellectual property litigation, and we believe these lawsuits are likely to continue. Legal proceedings relating to intellectual property would be expensive, take significant time and divert managements attention from other business concerns. Because we produce drug candidates for a broad range of therapeutic areas and provide many different capabilities in this industry, we face potential patent infringement suits by companies that control patents for similar drug candidates or capabilities or other suits alleging infringement of their intellectual property rights. There could be issued patents of which we are not aware that our products infringe or patents that we believe we do not infringe that we are ultimately found to infringe. Moreover, patent applications are in many cases maintained in secrecy for eighteen months after filing or even until patents are issued. The publication of discoveries in the scientific or patent literature frequently occurs substantially later than the date on which the underlying discoveries were made and patent applications were filed. Because patent applications can take many years to issue, there may be currently pending applications of which we are unaware that may later result in issued patents that we infringe with our products. In addition, technology created under our research and development collaborations may infringe the intellectual property rights of third parties, in which case we may not receive milestone or royalty revenue from those collaborations.
If we do not prevail in an infringement lawsuit brought against us, we might have to pay substantial damages, including triple damages, and we could be required to stop the infringing activity or obtain a license to use the patented technology or redesign our products so as not to infringe the patent. We may not be able to enter into licensing arrangements at a reasonable cost or effectively redesign our products. Any inability to secure licenses or alternative technology could delay the introduction of our products or prevent us from manufacturing or selling products.
The intellectual property rights we rely on to protect our proprietary drug candidates and the technology underlying our tools and techniques may be inadequate to prevent third parties from using our technology or developing competing capabilities or to protect our interests in our proprietary drug candidates.
Our success depends in part on our ability to protect patents and maintain the secrecy of proprietary processes and
other technologies we develop for the testing and synthesis of chemical compounds in the drug discovery process. We currently have fourteen issued United States patents and numerous patent applications on file with the United States Patent and Trademark Office and around the world.
Any patents that we may own or license now or in the future may not afford meaningful protection for our drug candidates or our technology and tools. In order to protect or enforce our intellectual property rights, we may have to initiate legal proceedings against third parties. Our efforts to enforce and maintain our intellectual property rights may not be successful and may result in substantial costs and diversion of management time. In addition, other companies may challenge our patents and, as a result, these patents could be narrowed, invalidated or rendered unenforceable, or we may be forced to stop using the technology covered by these patents or to license the technology from third parties. In addition, current and future patent applications on which we depend may not result in the issuance of patents in the United States or foreign countries. Even if our rights are valid, enforceable and broad in scope, competitors may develop drug candidates or other products based on similar research or technology that is not covered by our patents.
Patent applications relating to or affecting our business may have been filed by a number of pharmaceutical and biopharmaceutical companies and academic institutions. A number of the technologies in these applications or patents may conflict with our technologies, patents or patent applications, which could reduce the scope of patent protection we could otherwise obtain. We could also become involved in interference proceedings in connection with one or more of our patents or patent applications to determine priority of inventions. We cannot be certain that we are the first creator of inventions covered by pending patent applications, or that we were the first to file patent applications for any such inventions.
Drug candidates we develop that are approved for commercial marketing by the FDA would be eligible for market exclusivity for varying time periods during which generic versions of a drug may not be marketed, and we could apply to extend patent protection for up to five additional years under the provisions of the Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act. The Hatch-Waxman Act provides a means for approving generic versions of a drug once the marketing exclusivity period has ended and all relevant patents have expired. The period of exclusive marketing, however, may be shortened if a patent is successfully challenged and defeated, which could reduce the amount of royalties we receive on the product.
Agreements we have with our employees, consultants and collaborators may not afford adequate protection for our trade secrets, confidential information and other proprietary information.
In addition to patent protection, we also rely on copyright and trademark protection, trade secrets, know-how, continuing technological innovation and licensing opportunities. In an effort to maintain the confidentiality and ownership of our trade secrets and proprietary information, we require our employees, consultants and advisors to execute confidentiality and proprietary information agreements. However, these agreements may not provide us with adequate protection against improper use or disclosure of confidential information and there may not be adequate remedies in the event of unauthorized use or disclosure. Furthermore, we may from time to time hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities we conduct. In some situations, our confidentiality and proprietary information agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisors have prior employment or consulting relationships. Although we require our employees and consultants to maintain the confidentiality of all proprietary information of their previous employers, these individuals, or we, may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. Finally, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Our failure or inability to protect our proprietary information and techniques may inhibit or limit our ability to compete effectively, or exclude certain competitors from the market.
The drug research and development industry is highly competitive, and we compete with some companies that offer a broader range of capabilities and have better access to resources than we do.
The pharmaceutical and biotechnology industries are characterized by rapid and continuous technological innovation. We compete with companies worldwide that are engaged in the research and discovery, licensing, development and commercialization of drug candidates, including Arena Pharmaceuticals Inc.; Arqule; Cytokinetics Inc.; Exelixis Inc.; Incyte Corporation.; Theravance, Inc.; and Vertex Pharmaceuticals Incorporated. Some of our competitors have a broader range of capabilities and have greater access to financial, technical, scientific, regulatory, business development, recruiting and other resources than we do. Their access to greater resources may allow them to
develop processes or products that are more effective, safer or less costly, or gain greater market acceptance, than products we develop or for which they obtain FDA approval more rapidly than we do. We anticipate that we will face increased competition in the future as new companies enter the market and advanced technologies become available.
We face potential liability related to the privacy of health information we obtain from research institutions.
Most health care providers, including research institutions from which we or our collaborators obtain patient information, are subject to privacy regulations promulgated under the Health Insurance Portability and Accountability Act of 1996, or HIPAA. Our clinical research efforts are not directly regulated by HIPAA. However, conduct by a person that may not be prosecuted directly under HIPAAs criminal provisions could potentially be prosecuted under aiding and abetting or conspiracy laws. Consequently, depending on the facts and circumstances, we could face substantial criminal penalties if we receive individually identifiable health information from a health care provider or research institution that has not satisfied HIPAAs disclosure standards. In addition, certain state privacy laws and genetic testing laws may apply directly to our operations and/or those of our collaborators and may impose restrictions on our use and dissemination of individuals health information. Moreover, patients about whom we or our collaborators obtain information, as well as the providers who share this information with us, may have contractual rights that limit our ability to use and disclose the information. Claims that we have violated individuals privacy rights or breached our contractual obligations, even if we are not found liable, could be expensive and time-consuming to defend and could result in adverse publicity that could harm our business.
RISKS RELATED TO OUR STOCK
Our officers and directors have significant control over us and their interests may differ from those of our stockholders.
At June 30, 2007, our directors and officers beneficially owned or controlled approximately 11% of our common stock. Individually and in the aggregate, these stockholders significantly influence our management, affairs and all matters requiring stockholder approval. These stockholders may vote their shares in a way with which other stockholders do not agree. In particular, this concentration of ownership may have the effect of delaying, deferring or preventing an acquisition of us or entrenching management and may adversely affect the market price of our common stock.
Our quarterly operating results could fluctuate significantly, which could cause our stock price to decline.
Our quarterly operating results have fluctuated in the past and are likely to fluctuate in the future. Entering into licensing or drug discovery collaborations typically involves significant technical evaluation and/or commitment of capital by our collaborators. Accordingly, negotiation can be lengthy and is subject to a number of significant risks, including collaborators budgetary constraints and internal acceptance reviews. In addition, a significant portion of our revenue is attributable to up-front payments and milestones that are non-recurring. Further, some of our collaborators can influence when we deliver products and perform services, and therefore receive revenue, under their contracts with us. Due to these factors, our operating results could fluctuate significantly from quarter to quarter. In addition, we may experience significant fluctuations in quarterly operating results due to factors such as general and industry-specific economic conditions that may affect the research and development expenditures of pharmaceutical and biotechnology companies.
Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. If we do not meet analysts and/or investors expectations, our stock price could decline.
Because our stock price may be volatile, our stock price could experience substantial declines.
The market price of our common stock has historically experienced and may continue to experience volatility. The high and low closing bids for our common stock were $14.40 and $7.55 respectively in fiscal 2007, $9.67 and $5.99 respectively in fiscal 2006, and $9.73 and $5.66, respectively, in fiscal 2005. Our quarterly operating results, the success or failure of our internal drug discovery efforts, changes in general conditions in the economy or the financial markets and other developments affecting our collaborators, our competitors or us could cause the market price of our common stock to fluctuate substantially. This volatility coupled with market declines in our industry over the past several years have affected the market prices of securities issued by many companies, often for reasons unrelated to their operating
performance, and may adversely affect the price of our common stock. In the past, securities class action litigation has often been instituted following periods of volatility in the market price of a companys securities. A securities class action suit against us could result in potential liabilities, substantial costs and the diversion of managements attention and resources, regardless of whether we win or lose.
Because we do not intend to pay dividends, stockholders will benefit from an investment in our common stock only if it appreciates in value.
We have never declared or paid any cash dividends on our common stock and are restricted in our ability to do so under our current credit agreement. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend entirely upon any future appreciation. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased their shares.
The ability of our stockholders to control our policies and effect a change of control of our company is limited, which may not be in the best interests of our stockholders.
There are provisions in our certificate of incorporation and bylaws that may discourage a third party from making a proposal to acquire us, even if some of our stockholders might consider the proposal to be in their best interests. These include the following provisions in our certificate of incorporation:
· Our certificate of incorporation provides for three classes of directors with the term of office of one class expiring each year, commonly referred to as a staggered board. By preventing stockholders from voting on the election of more than one class of directors at any annual meeting of stockholders, this provision may have the effect of keeping the current members of our board of directors in control for a longer period of time than stockholders may desire.
· Our certificate of incorporation authorizes our board of directors to issue shares of preferred stock without stockholder approval and to establish the preferences and rights of any preferred stock issued, which would allow the board to issue one or more classes or series of preferred stock that could discourage or delay a tender offer or change in control.
In addition, our board of directors approved a Rights Agreement on August 2, 2001, which could prevent or deter a potential unsolicited takeover of us by causing substantial dilution of an acquirer of 15% or more of our outstanding common stock. We are also subject to the business combination provisions of Section 203 of the Delaware General Corporation Law, which, in general, imposes restrictions upon acquirers of 15% or more of our stock. As a result, it is difficult for a third party to acquire control of us without the approval of the board of directors and, therefore, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.
We are headquartered in Boulder, Colorado, where we lease approximately 150,000 square feet of office and laboratory space under a lease that expires July 7, 2016. We also lease a facility of approximately 78,000 total square feet of laboratory space in Longmont, Colorado under a lease that expires August 9, 2016. We have options to extend each of the leases for up to two terms of five years each.
We may be involved, from time to time, in various claims and legal proceedings arising in the ordinary course of our business. We are not currently a party to any such claims or proceedings that, if decided adversely to us, would either individually or in the aggregate have a material adverse effect on our business, financial condition or results of operations.
No matters were submitted to a vote of our security holders, through solicitation of proxies or otherwise, during the fourth quarter ended June 30, 2007.
ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth, for the periods indicated, the range of the high and low closing bid information or sales prices for Arrays common stock as reported by the Nasdaq Stock Market.
As of August 10, 2007, there were approximately 77 holders of record of our common stock. This does not include the number of persons whose stock is in nominee or street name accounts through brokers.
We have never declared or paid any cash dividends on our common stock and we do not intend to pay any cash dividends in the foreseeable future. In addition, the terms of our loan agreement restrict our ability to pay cash dividends to our stockholders. We currently intend to retain all available funds and any future earnings for use in the operations of our business and to fund future growth.
This performance graph shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of the company under the Securities Act of 1933, as amended or the Exchange Act.
The following graph compares, for the five year period ended June 30, 2007, the cumulative total stockholder return for our common stock, the Nasdaq Stock Market (U.S. companies) Index (the Nasdaq Composite), the Nasdaq Pharmaceutical Index (the Nasdaq Pharmaceutical) and the Nasdaq Biotechnology Index. The graph assumes that $100 was invested on June 30, 2002 in the common stock of the company, and in the Nasdaq Composite, the Nasdaq Pharmaceutical and the Nasdaq Biotechnology Index and assumes reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
The following selected financial data is derived from our audited financial statements. These historical results do not necessarily indicate future results. When you read this data, it is important that you also read our financial statements and related notes, as well as the section Managements Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Annual Report on Form 10-K.
(1) Operating expenses include share-based compensation expense of $4.8 million, $6.2 million, $151,000, $2.0 million, and $1.9 million for fiscal 2007, 2006, 2005, 2004, and 2003, respectively. See Note 8 Stock Compensation Plans of the Notes to Financial Statements for further information regarding share-based compensation.
(2) Cost of revenue includes a provision for excess inventory of $5.6 million and $4.1 million in fiscal years 2004 and 2003, respectively.
The Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about our expectations related to the progress and success of our internal proprietary drug discovery activities, realizing new revenue streams and obtaining future out-licensing collaboration agreements that include up-front milestone and/or royalty payments, our ability to realize such up-front milestone and royalty payments under our existing or any future agreements, future research and development spending, our working capital requirements and our future headcount requirements. In some cases, forward-looking statements can be identified by the use of terminology such as may, will, expects, intends, plans, anticipates, estimates, potential, or continue, or the negative thereof or other comparable terminology. These statements are based on current expectations and projections about our industry and assumptions made by management and are not guarantees of future performance. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition, as well as any forward-looking statements are subject to significant risks and uncertainties, including but not limited to the factors set forth under the heading Risk Factors in Item 1A of this Annual Report on Form 10-K. All forward looking statements and reasons why results may differ included in this Annual Report on Form 10-K are made as of the date hereof, and, unless required by law, we undertake no obligation to update any forward-looking statements or reasons why actual results may differ in this Annual Report on Form 10-K.
The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this report.
Array BioPharma Inc. is a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat debilitating and life-threatening diseases. Our proprietary drug development pipeline is focused on the treatment of cancer and inflammatory disease and includes clinical candidates that are designed to regulate therapeutically important target proteins. We currently have 10 programs in our development pipeline, eight of which are wholly owned by us.
Our eight most advanced development programs that we wholly own and control consist of ARRY-543, an ErbB-2/EGFR dual inhibitor for cancer; ARRY-162, a MEK inhibitor for inflammation; ARRY-797, a p38 inhibitor for inflammation and for cancer; ARRY-520, a KSP inhibitor for cancer; ARRY-380, an ErbB-2 inhibitor for cancer; and ARRY-614, a p38 and Tie2 dual inhibitor for inflammation and for cancer. In addition, we have out-licensed to AstraZeneca PLC three MEK inhibitors for cancer including ARRY-886 (AZD6244), currently in multiple Phase 2 clinical trials, and ARRY-704 (AZD8330), currently in a Phase 1 clinical trial. The out-license and collaboration agreements with these collaborators provide for up-front payments, research funding, success-based milestone payments and royalties on product sales. Through collaborations we have also invented drug candidates that are currently in clinical development, including one for InterMune, Inc. (HCV NS3/4 protease inhibitor, ITMN-191), and one for Eli Lilly and Company (ICOS Corporation), IC83, a CHK1 inhibitor.
In addition to these development programs, we have out-licensed two cancer programs to Genentech and we have a portfolio of discovery programs that we believe will generate two to three Investigational New Drug, or IND, applications per year over the next three years. Our discovery efforts have also generated additional early-stage drug candidates that we may choose to out-license through research partnerships. We have evolved our research collaboration strategy to include seeking opportunities to out-license early-stage drug candidates that do not meet our development criteria. We believe this strategy will result in our receiving a greater portion of the potential financial upside than our previous research collaborations. A recent example of this is our collaboration with VentiRx Pharmaceuticals, Inc., which is described above under Partnered Research and Development. We also believe this strategy will allow us to maximize our scientific efforts and other resources on programs for which we have particular expertise or which have synergies with our other development programs.
We have created our proprietary pipeline of development and discovery programs on a modest investment of approximately $150 million in research and development expenses from our inception through June 30, 2007. Additionally, we have recognized a total of $258 million in research funding and in up-front and milestone payments from
our collaboration partners through June 30, 2007. Under our existing collaboration agreements, we have the potential to earn over $260 million in additional milestone payments if we achieve all of the drug discovery objectives detailed in these agreements, as well as royalties on any resulting product sales from 16 different drug development programs.
We currently license certain of our compounds and/or programs and enter into collaborations directly with pharmaceutical and biotechnology companies through opportunities identified by our business development group, senior management, scientists and customer referrals. In addition, we license our compounds and enter into collaborations in Japan through an agent.
Our top 10 collaborators contributed approximately 98% of our total revenue during fiscal 2007, and our current top four collaborators, Genentech, InterMune, AstraZeneca and Ono accounted for 42%, 21%, 14% and 13%, respectively, of our total revenue. During fiscal year 2006 Genentech, InterMune, AstraZeneca and Ono accounted for 35%, 24%, 16% and 7%, respectively, of our total revenue. In general, certain of our collaborators may terminate their collaboration agreements with us on 90 to 120 days prior notice, including our agreement with Genentech which can be terminated on 120 days notice.
International revenue represented 31% of our total revenue during fiscal years 2007 and 2006. Our international revenue is primarily attributable to European and Japanese collaborations. International revenue remained constant as a proportion of total revenues during fiscal year 2007 compared to fiscal year 2006 due to full recognition of two milestone payments from AstraZeneca in the current fiscal year totaling $5.0 million for advancing ARRY-886 into Phase 2 clinical trials and for the advancement of ARRY-704 into Phase 1 clinical trials. This amount compares to revenues from the research funded portion of the same agreement with AstraZeneca which expired during fiscal 2006. All of our collaboration agreements are denominated in United States dollars.
We have incurred net losses since inception and expect to incur losses in the near future as we continue to invest in our proprietary drug discovery programs. As of June 30, 2007, we had an accumulated deficit of $189.1 million.
Critical Accounting Policies
Our financial statements and related notes are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which requires us to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances for making judgments about the carrying value of assets and liabilities and other items that are not readily apparent from other sources. Actual results may differ from these estimates due to actual outcomes that prove different from those upon which we based our assumptions. Our senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. We believe the following critical accounting policies have the most significant impact on the estimates and judgments used when preparing our financial statements. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. We believe the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of our financial statements:
Most of our revenue is derived from designing, creating, optimizing, evaluating and developing drug candidates for our collaborators. Our agreements with our collaboration partners include fees based on contracted annual rates for full time equivalent employees working on a project, and may also include non-refundable license and up-front fees, non-refundable milestone payments that are triggered upon achievement of specific research or development goals, and future royalties on sales of products that result from the collaboration. A small portion of our revenue comes from fixed fee agreements or from sales of compounds on a per-compound basis.
We report revenue for lead generation and lead optimization research, custom synthesis and process research, the
development and sale of chemical compounds and the co-development of proprietary drug candidates we out-license, as collaboration revenue. License and milestone revenue is combined and reported separately from collaboration revenue.
Arrangements that include multiple elements are evaluated under Emerging Issues Task Force No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables, to determine whether the element has value to the customer on a stand-alone basis and whether reliable evidence of fair value for the delivered and undelivered elements exists. Deliverables in an arrangement that do not meet the separation criteria of EITF 00-21 are treated as a single unit of accounting, generally applying applicable revenue recognition guidance for the final deliverable to the combined unit of accounting as defined in Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104). SAB 104 in turn established four criteria, each of which must be met, in order to recognize revenue related to the performance of services or the shipment of products. Revenue is recognized when (a) persuasive evidence of an arrangement exists, (b) products are delivered or services are rendered, (c) the sales price is fixed or determinable and (d) collectability is reasonably assured.
We recognize revenue from non-refundable up-front payments and license fees on a straight line basis over the term of performance under the agreement, which is generally the research term specified in the agreement. These advance payments are deferred and recorded as advance payments from collaborators upon receipt, pending recognition, and are classified as a short-term or long-term liability on our balance sheet. When the performance period is not specifically identifiable from the agreement, we estimate the performance period based upon provisions contained within the agreement, such as the duration of the research term, the specific level number of full time equivalent scientists working a defined number of hours per year at a stated price under the agreement, the existence or likelihood of development commitments, and other significant commitments of the company. We determined that the performance periods applicable to our agreements with AstraZenca and Genentech were both for two years, which ended in November 2005; and we determined the performance period for our agreement with VentiRx to be one year ending in March 2008. Each of these periods coincides with the research terms specified in each agreement. We periodically review the expected performance periods under each of our agreements that provide for non-refundable up-front payments and license fees. To date, there has not been a significant change in an estimate or assumption of the expected period of performance that has had a material effect on the timing or amount of revenue recognized.
Similarly to advance payments, for agreements that provide for milestone payments, a portion of each milestone payment is recognized as revenue when the specific milestone is achieved based on the applicable percentage of the estimated research term that has elapsed to the total estimated research term. Revenue recognition related to non-refundable license fees and up-front payments and to milestone payments could be accelerated in the event of early termination of programs.
In February 2007, we entered into a collaboration and licensing agreement in which we received a non-refundable cash technology access fee and shares of preferred stock valued at $1.5 million based on the price at which such preferred stock was sold to investors in a private offering. Both the technology access fee and the value of the preferred stock were recorded as advance payments from collaborators and deferred revenue, and are being recognized as revenue on a straight-line basis over the estimated one-year research term. The preferred stock value has been recorded as a long-term asset.
Revenue from sales of compounds in our Lead Generation Library and Optimer building blocks is generally recognized as the compounds are shipped. We recognize revenue based on contracted annual rates for full time equivalent employees working on a project on a monthly basis as work is performed.
Preclinical Study and Clinical Trial Accruals
Substantial portions of our preclinical studies and all of our clinical trials have been performed by third-party medical centers or contract research organizations (which we refer to collectively as CROs). Some CROs bill monthly for services performed, while others bill based upon milestone achievement. We accrue expenses each month for agreements involving significant costs and that bill based on milestone achievement. For preclinical studies, accruals are based upon the estimated percentage of work completed and the contract milestones remaining. For costs for clinical study activities performed by CROs, accruals are estimated based upon the estimated work completed on each study, and for clinical trial expenses, accruals are based upon the number of patients enrolled and the expected duration of the study for which they will be enrolled. We monitor patient enrollment and related activities to the extent possible through internal reviews, correspondence with the CROs, clinical site visits, and review of contractual terms. Our estimates are highly dependant upon the timeliness and accuracy of the data provided by its CROs regarding the status of each program and total program spending. We periodically evaluate our estimates to determine if adjustments are necessary or appropriate based on information we receive concerning changing circumstances, conditions or events that may affect such estimates. No material adjustments to preclinical study and clinical trial expenses have been recognized to date.
Investments in Marketable Securities
Our short-term investments in marketable securities are comprised of U.S. Treasury, government or agency obligations, state and municipal obligations and domestic public corporate debt securities. Investments are classified as short-term or long-term based on their original or remaining maturities and whether the securities represent the investment of funds available for current operations. All of our investments are held in our name at two major U.S. financial institutions. At June 30, 2007 and 2006, all of our investments were classified as available-for-sale and are reported at fair value based on quoted market prices at the end of each reporting period. Unrealized gains or losses are recorded as a separate component of cumulative other comprehensive income (loss) in stockholders equity. If these investments are sold at a loss or are considered to have experienced a decline in value that is other than temporary, a charge to operations is recorded. The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in interest income, net.
We amortize leasehold improvements for our Boulder and Longmont facilities over the shorter of their estimated economic useful lives or the related lease terms. We determined the lease terms to be the original, fixed, non-cancelable ten-year lease terms. This period does not include the optional lease extension periods available to us under the lease agreements because we have determined that the exercise of these options is not reasonably assured. Consequently, the leasehold improvements for our facilities are amortized over the original ten-year lease term as it is shorter than the remaining estimated useful life of the improvements. We periodically reassess the expected remaining useful lives of our leased facilities to determine whether the amortization period remains consistent with current expectations and plans, and if there is any change, we will make appropriate adjustments to the estimated lease terms and disclosures.
During July and August 2006, we terminated our existing facility leases and executed new lease agreements with a different landlord. Accordingly, the entire June 30, 2006 deferred rent balance of $1.6 million was reversed and recorded as a reduction to our recognized rent expense for the first quarter of fiscal 2007. Additionally, in conjunction with the assignment of facility purchase options as described in Note 10 - Operating Leases to our audited financial statements included in this Annual Report, we received net proceeds of $32.3 million which was recorded as deferred rent and is being recognized on a straight-line basis as a reduction to rent expense over the related ten-year term of each of the new facilities leases. The current facilities leases provide for annual rent increases, and we recognize the average annual rent expense over the term of these leases on a straight-line basis. The current portion of the deferred rent balance reflected on our balance sheet represents the amount of expected deferred rent credits to be applied as a reduction to our rent expense over the next twelve-month period.
On July 1, 2005, we adopted Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)). SFAS 123(R), requires the measurement and recognition of compensation expense based on estimated fair values for all share-based payment awards made to employees and directors, including stock options and purchases of common stock by employees at a discount to market price under our Employee Stock Purchase Plan (or the ESPP). Stock-based compensation expense recognized under SFAS 123(R) was $4.8 million and $6.2 million, representing a loss of $0.12 and $0.16 per basic and diluted share, for the fiscal years ended June 30, 2007 and 2006, respectively. For the year ended June 30, 2005, prior to the adoption of FAS123(R), stock compensation expense of $151,000 was recognized. In accordance with the modified prospective transition method of adoption of SFAS 123(R) that we elected, comparative results for the fiscal year 2005 have not been restated and therefore are not comparable to the results for fiscal years 2006 and 2007. See Note 1 Accounting for Share-Based Compensation and Note 8 Stock Compensation Plans for additional information. The estimated fair value of stock options is expensed on a straight-line basis over the expected term of the option. Compensation expense for purchases under the ESPP is recognized based on the estimated fair value of the common stock during each offering period and the percentage of the purchase discount.
Upon adoption of SFAS 123(R), we began to estimate the fair value of employee stock options on the date of grant, and the fair value of our common stock during each offering period under the ESPP, using a Black-Scholes model. Prior to the adoption of SFAS 123(R), the fair value of each stock option was estimated on the grant date using a Black-Scholes model in order to provide the pro forma financial disclosure information in accordance with SFAS 123. The determination of fair value for share-based payment awards using an option pricing model is highly judgmental and affected by our stock price as well as assumptions and estimates concerning other highly complex and subjective variables. These variables and
estimates include, but are not limited to, the number of options that will ultimately vest or conversely, be forfeited prior to vesting; the expected option term, or the length of time between the grant date and date of exercise of the option; the expected volatility of our stock price, or the amount that the market value per share of our stock price will fluctuate over the estimated option term; and the expected risk free market rate of interest over the estimated option term.
The weighted average estimated fair value of stock option awards granted during the year ended June 30, 2007 was $7.42 per share, using the Black-Scholes option model with the following weighted average assumptions:
We estimated the expected option term in accordance with the method described in SEC Staff Accounting Bulletin No. 107 (SAB 107). We estimated volatility based upon historical experience because we have not identified a more reliable or appropriate method to estimate future volatility over the expected option term. Our risk free interest rate estimate is based upon observed interest rates comparable to the expected term of our options. Our dividend yield assumption is based upon historical and expected dividends. Our estimates for the pre-vesting forfeiture rate and the estimated option term have the most significant impacts on the grant date option award fair values. If any of these estimates change and we employ different estimates, assumptions, or a different valuation model in our application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may be significantly different than what we have recorded in the current period.
In addition, SFAS 123(R) requires the expense for stock-based compensation to be reduced for estimated forfeitures of unvested equity awards based on an estimate of such forfeitures as of the grant date, which must be revised in subsequent periods, if necessary, if actual pre-vesting forfeitures differ from these estimates. We estimated expected pre-vesting forfeitures using our historical forfeiture experience.
Deferred Income Taxes
We estimate our actual current tax expense together with our temporary differences resulting from differing treatment of items for tax and accounting purposes. These temporary differences result in deferred tax assets and/or liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent that we believe that it is more likely than not we will not recover these deferred tax assets, we must establish a valuation allowance against these tax assets. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance against our deferred tax assets. To the extent that we believe a valuation allowance is required, we must include and expense the tax effect of the allowance within the tax provision in our statement of operations. As of June 30, 2007 and 2006, we have $71.8 million and $51.6 million in deferred tax assets, respectively. In order to fully utilize all or any portion of these deferred tax assets, we need to generate sufficient amounts of future U.S. taxable income. Based upon our history of losses and an analysis of projected net taxable income for future operating periods, we determined that it is more likely than not that we will not realize our tax net operating loss carry forwards, tax credit carry forwards and other deferred tax assets, and have recorded a valuation allowance for the full amount of our deferred tax assets, reducing the carrying amount of net deferred tax assets to zero as of June 30, 2007 and 2006.
We plan to increase our investment in drug development to advance our product pipeline and to further enhance our clinical and regulatory capabilities. We will consider commercializing select programs ourselves with appropriate market characteristics while continuing to evaluate out-licensing opportunities to maximize the risk-adjusted return of our proprietary programs. As part of these efforts, we expect near term general and administrative costs to rise in connection with increased patent and other intellectual property related costs incurred to protect and enforce our intellectual property rights in our proprietary programs and research and development for proprietary drug discovery costs to rise in connection with building our clinical and regulatory capabilities. Because of our strategy to retain other proprietary programs until later in clinical development before out-licensing them or commercializing them ourselves, we may not recognize significant revenue from new out-licensing opportunities in the near term. Our statements about future events in this
paragraph are subject to many risks and uncertainties, including many that are beyond our control. These risks are described more fully under the caption Risk Factors and elsewhere herein and in other reports filed by Array BioPharma with the Securities and Exchange Commission.
Results of Operations
Fiscal Years Ended June 30, 2007, 2006, and 2005
Collaboration revenue consists of revenue for lead generation and lead optimization research, custom synthesis and process research, the development and sale of chemical compounds and the co-development of proprietary drug candidates we out-license. License and milestone revenue is combined and reported separately from collaboration revenue.
Fiscal 2007 as compared to Fiscal 2006: Total revenue for fiscal 2007 decreased 18% from 2006 due to a decrease in collaboration revenue of $7.6 million and a decrease in license and milestone revenue of approximately $400,000. Collaboration revenue declined by $10.2 million due to the expiration of collaborations with AstraZeneca, Roche and Eli Lilly and Company (ICOS Corporation) during the prior fiscal year as well as the research portions of collaborations with InterMune and Takeda Pharmaceutical Company, Ltd., that expired in fiscal 2007. Additionally, collaboration revenue from the sale of Optimer building blocks and Lead Generation Libraries decreased by $1.0 million during these same periods. Partially offsetting these decreases was increased revenue of $3.6 million from our collaborations with Genentech and Ono, as well as the initiation of a new research agreement with VentiRx Pharmaceuticals, Inc.
As of June 30, 2006 previously received license and milestone payments from AstraZeneca and Genentech had been fully recognized as revenue, which accounted for a decrease in license and milestone revenue of $6.7 million during fiscal 2007. This decrease was partially offset by the recognition of two milestone payments totaling $5.0 million from AstraZeneca during fiscal 2007 for the advancement of ARRY-886 into Phase 2 clinical trials and ARRY-704 into Phase 1 clinical trials. Additional license and milestone revenue of $1.3 million was recognized in fiscal 2007 from VentiRx, InterMune and Eli Lilly (ICOS Corporation).
Fiscal 2006 as compared to Fiscal 2005: Total revenue for fiscal 2006 decreased 1% from 2005 due to a decrease in license and milestone revenue of $3.9 million, which was offset by improvements in collaboration revenue totaling $3.4 million. The improvement in collaboration revenue was the result of increased revenue, totaling $16.1 million, from expanded programs with InterMune and Genentech and a new research collaboration with Ono Pharmaceutical. This increase was partially offset by decreased collaboration revenue of $11.1 million related to research programs that expired in fiscal 2005 with Eli Lilly (ICOS Corporation) and QLT Inc., as well as the research program with AstraZeneca that expired in November 2005. Additionally, collaboration revenue from the sale of Lead Generation Libraries decreased during fiscal 2006 by $1.6 million, due to the sale of a large number of our Lead Generation Library compounds to a single collaborator during fiscal 2005.
All previously received license fee and milestone payments from AstraZeneca and Genentech were fully recognized during fiscal 2006 resulting in a decrease in recognized revenue from fiscal 2005 of $5.8 million. Partially offsetting this decrease was the recognition of $2.5 million of milestone payments received from AstraZeneca during fiscal 2006 related to the advancement of ARRY-886 into Phase 1b clinical trials and the selection of two additional drug candidates, as well as $500,000 of milestones earned from our collaboration with Takeda.
Cost of Revenue
Cost of revenue represents research and development conducted for our collaborators and the cost of chemical compounds sold from our inventory. These costs consist mainly of compensation, associated fringe benefits and other collaboration-related costs, including supplies, small tools, facilities, depreciation, recruiting and relocation and other direct and indirect chemical handling and laboratory support costs. Fine chemicals consumed as well as any required inventory reserve adjustments are also recorded as cost of revenue. We review the levels and values of our chemical inventories periodically and, when required, write down the carrying cost of our inventories for non-marketability to estimated net realizable value through an appropriate reserve.
Fiscal 2007 as compared to Fiscal 2006: Cost of revenue for fiscal 2007 decreased by 37% from fiscal 2006 primarily reflecting a decrease in collaboration related services as a greater percentage of our resources were focused on advancing our proprietary drug discovery programs. Cost of revenue as a percentage of collaboration revenue decreased to 83% for the 2007 fiscal year compared with 105% for the prior fiscal year. These decreases were largely the result of increased average pricing received from collaborations for full-time equivalent scientists during fiscal 2007 resulting in fewer scientific resources used in generating the same approximate level of collaboration revenue. Additionally, share-based compensation expense charged to cost of revenue for 2007 fiscal year decreased by approximately $960,000 due to option shares that became fully vested in the prior fiscal year.
On June 22, 2006, we assigned options we owned to purchase our Boulder and Longmont, Colorado facilities to BioMed Realty L.P., or BioMed, which purchased those facilities in July and August 2006. We entered into new lease agreements for these facilities with BioMed over a ten-year lease term and began amortizing our leasehold improvement costs for these facilities over a ten-year life. Prior to completing these transactions, we had determined that we were reasonably assured during fiscal 2006 that we would be vacating our Boulder facility at the end of the initial lease term in March 2008 and therefore amortized the cost of leasehold improvements for that facility over an approximate two-year life. We determined the lease terms under our new facilities leases to be the fixed, non-cancelable ten-year term because we concluded that the exercise of optional extension periods available under the leases is not reasonably assured. This conclusion was based on our experience with prior lease facilities and managements determination that it was unable to predict in the early years of a long-term lease whether it would remain in the facilities beyond the initial lease term as a result of changing business, economic or other conditions. The change in the amortization period from two to ten years resulted in a decrease of approximately $775,000 in amortized leasehold improvement costs charged to cost of revenue for 2007 fiscal year compared to the prior fiscal year. In addition, during the first quarter of fiscal 2007, following termination of our prior facility leases and execution of new lease agreements with BioMed, we reversed and recorded the entire deferred rent balance of $1.6 million associated with our prior facilities leases and listed as a current liability on June 30, 2006, as a reduction to our recognized rent expense. This resulted in a decrease to cost of revenue for the 2007 fiscal year of approximately $600,000.
Fiscal 2006 as compared to Fiscal 2005: Cost of revenue for fiscal 2006 increased 4% over 2005 primarily due to the recording of $2.1 million of share-based compensation expense in accordance with SFAS 123(R). In addition, in June 2005, we determined that we were reasonably assured that we would be vacating our Boulder, Colorado facility at the end of the lease term in March 2008 and therefore began amortizing the cost of leasehold improvements for our facility over the remaining months of the initial lease term. Prior to that, all leasehold improvements were amortized over a period of 15 years, which included optional lease extension periods we were reasonably assured of exercising at that time. This change in estimated useful life resulted in an increase of approximately $505,000 in amortized leasehold improvement costs being charged to cost of revenue for the 2006 fiscal year. Improvements in cost of revenue as a percentage of collaboration revenue of 105% in fiscal 2006 compared to 111% in fiscal 2005 is the result of improved average pricing from collaboration agreements.
Research and Development Expenses
Our research and development expenses for proprietary drug discovery include costs associated with our proprietary drug programs for scientific personnel, supplies, equipment, consultants, sponsored research, allocated facility costs, costs related to preclinical and clinical trials, and share-based compensation. We manage our proprietary programs based on scientific data and achievement of research plan goals. Our scientists record their time to specific projects when possible.
However, many activities simultaneously benefit multiple projects and cannot be readily attributed to a specific project. Accordingly, the accurate assignment of time and costs to a specific project is difficult and may not give a true indication of the actual costs of a particular project. As a result, we do not report costs on a program basis. The following table shows our research and development expenses by categories of costs for the periods presented:
Fiscal 2007 as compared to Fiscal 2006: Research and development expenses increased 72% over the prior comparative fiscal year as a result of increases in the number of scientists devoted to proprietary programs, reflecting both increased headcount as well as a shift of existing scientific resources from collaborative projects to internal proprietary discovery. The most significant increase in costs came from outsourced pharmacology studies and clinical trial related expenses supporting the advancement of our ErbB-2/EGFR, MEK for inflammation, ErbB-2, P38/Tie2 and other programs. During fiscal 2007 we expensed $1.7 million of share-based compensation expense to research and development expenses compared to $1.3 million for the prior fiscal year. We expect that proprietary research and development spending will continue to increase significantly as we focus more resources on our proprietary drug discovery programs and continue to advance our programs through clinical development.
These increases were partially offset by reductions in leasehold improvement amortization and rent expense allocated to research and development expenses as described in cost of revenue above. The change in estimated useful life of our leasehold improvements resulted in a reduction of amortization of leasehold improvement costs charged to research and development expenses for the 2007 fiscal year of approximately $900,000. Additionally, the reversal of the prior year deferred rent balance resulted in a reduction to rent expense allocated to research and development expenses for the 2007 fiscal year of approximately $850,000.
Fiscal 2006 as compared to Fiscal 2005: Research and development expenses increased 46% in fiscal 2006 over the prior fiscal year primarily due to additional scientists working on proprietary programs, related increases in laboratory supplies, share-based compensation expense, and increased pharmacology studies supporting our expanded efforts to advance proprietary compounds into regulated safety testing and clinical trials. The most significant increase in costs came from outsourced pharmacology studies and clinical trial related expenses supporting the advancement of our ErbB-2/EGFR, MEK for inflammation, P38, KSP and other programs. For fiscal year 2006, we expensed $1.3 million to research and development expenses related to share-based compensation in accordance with SFAS 123(R). In addition, as described in cost of revenue above, we recorded approximately $981,000 of additional leasehold improvement amortization to research and development expenses during the 2006 fiscal year.
The scope and magnitude of future research and development expenses are difficult to predict given the number of studies that will need to be conducted for any of our potential products, as well as our limited capital resources. In general, drug development involves a series of steps beginning with identification of a potential target and including, among others, proof of concept in animal studies and Phase 1, 2 and 3 clinical studies in humans each of which is typically more expensive than the previous step. Therefore, we expect our research and development costs to increase as we progress our programs through later-stage development.
The successful development and commercialization of drugs resulting from our proprietary programs is highly uncertain and subject to a number of risks that are beyond our control. The duration and cost of discovery, preclinical, non-clinical and clinical trials may vary significantly based on the type, complexity and novelty of a product and are
difficult to predict. The FDA and comparable agencies in foreign countries impose substantial requirements on the introduction of therapeutic pharmaceutical products, typically requiring lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures. Data obtained from preclinical, non-clinical and clinical activities at any step in the testing process may be adverse and lead to discontinuation or redirection of development activity or be susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. Accurate and meaningful estimates of the ultimate costs to bring our drug candidates to market are not available. Given the uncertainties related to development, we are currently unable to reliably estimate when, if ever, our drug candidates will generate revenue and net cash inflows.
Status of Significant Proprietary Programs
The following table summarizes the status of our most advanced drug programs.
(1) A single IND for this compound is expected to be filed in fiscal 2008.
Clinical timelines, likelihood of success and total completion costs vary significantly for each drug candidate and are difficult to estimate. We estimate that it takes 10 to 15 years, or possibly longer, to discover, develop and bring to market a new pharmaceutical product in the United States as outlined in the following table:
Animal and other non-clinical studies are often conducted during each phase of human clinical studies.
We anticipate that we will make determinations as to which research programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of each drug candidate. The lengthy process of seeking regulatory approvals, and subsequent compliance with applicable regulations, require the expenditure of substantial resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals could cause our research and development expenditures to increase and, in turn, have a material adverse effect on our results of operations.
General and Administrative Expenses
General and administrative expenses consist mainly of compensation and associated fringe benefits not included in cost of revenue or research and development expenses and include other management, business development, accounting, information technology and administration costs, including patent prosecution, recruiting and relocation, consulting and professional services, travel and meals, advertising, sales commissions, facilities, depreciation and other office expenses.
Fiscal 2007 as compared to Fiscal 2006: General and administrative expenses decreased by approximately $145,000 during the 2007 fiscal year over the prior fiscal year primarily as a result of decreased share-based compensation expense of approximately $790,000 recognized upon the vesting of option shares in the prior fiscal year. As described in cost of revenue above, the change in estimated useful life of our leasehold improvements resulted in a reduction of amortization of leasehold improvement costs charged to general and administrative expenses for the 2007 fiscal year of approximately $90,000 and the reversal of the prior year deferred rent balance resulted in a reduction to rent expense allocated to general and administrative expenses for the 2007 fiscal year of approximately $150,000. Partially offsetting all these decreases in general and administrative expenses were increases in patents and patent application costs of approximately $830,000 for the 2007 fiscal year associated with the advancement of our propriety drug development programs. The remaining increase in general and administrative expenses from the prior year was attributable to increases in compensation and benefit expenses.
Fiscal 2006 as compared to Fiscal 2005: The increase in general and administrative expenses for fiscal 2006 over fiscal 2005 was primarily related to the recording of $2.7 million of share-based compensation expense in accordance with SFAS 123(R). Patents and patent application costs increased by approximately $353,000 related to our expanding proprietary drug development programs. In addition, as described in cost of revenue above, we recorded approximately $132,000 of additional leasehold improvement amortization to general and administrative expenses during the 2006 fiscal year. The remaining increase within general and administrative expenses from the prior year was attributable to increases in compensation and benefit related expenses.
Interest Expense and Income
Fiscal 2007 as compared to Fiscal 2006: Interest expense increased in fiscal 2007 compared to fiscal 2006 due to increased borrowings and higher effective interest rates related to our long term borrowings. Interest income increased in fiscal 2007 compared to fiscal 2006 primarily due to higher effective interest rates and higher average cash and investment balances.
Fiscal 2006 as compared to Fiscal 2005: The increase in interest income in fiscal 2006 compared to fiscal 2005 is due to higher investment interest rates earned on higher average cash and investment balances. We incurred interest expense associated with our long term borrowings in fiscal 2006. There were no borrowings in 2005.
Liquidity and Capital Resources
Fiscal 2007 as compared to Fiscal 2006: We have historically funded our operations through revenue from our collaborations and the issuance of equity securities. As of June 30, 2007, cash, cash equivalents, and marketable securities totaled $141.3 million compared with $70.1 million at June 30, 2006. Net cash used in operating activities for fiscal year 2007 was $44.5 million, compared to $24.3 million for fiscal 2006. During fiscal year 2007, our net loss of $55.4 million was reduced by noncash charges of $6.7 million, primarily associated with depreciation, share-based compensation expense, and deferred rent credits. For fiscal year 2007, our net operating assets and liabilities excluding cash decreased by $4.2 million. This was primarily due to increases in accounts payable and accrued compensation and benefits and decreases in accounts receivable which were partially offset by decreases in advance payments from collaborators. Accounts payable increased by $3.9 million due to increased obligations for outsourced pharmacology and clinical trial expenses, fine chemicals, and facilities improvements. Accrued compensation and benefits increased by $1.0 million, half of which was due to increased amounts reserved for fiscal year 2007 employee bonuses with the remainder due to increased vacation reserves as well as increased 401(k), deferred compensation and Employee Stock Purchase Plan payroll withholdings attributable to our larger employee base. Advance payments from collaborators decreased by approximately $516,000 as we concluded collaboration programs with InterMune and Takeda, which accounted for a year over year decrease of $3.3 million, and we recorded $2.9 million of advance payments including $1.1 million non-cash equity stake, net of related amortization, as a result of a new collaboration agreement with VentiRx Pharmaceuticals, Inc. Accounts receivable decreased by $1.2 million in conjunction with collaboration agreements that expired during fiscal 2007 as well as decreased receivables from sales of our Optimer building blocks.
During fiscal year 2007, we received net proceeds of $32.3 million from BioMed related to the assignment of purchase options of our Boulder and Longmont, Colorado facilities. We invested $7.1 million in property, plant and equipment, primarily in lab equipment for drug metabolism, analytical research and development operations, process chemistry and biology, as well as in improvements to our facilities, and various computer hardware and software. Purchases of marketable securities used $144.9 million of cash while proceeds from the sale and maturity of marketable securities provided $69.2 million of cash. Financing activities provided $90.3 million of cash consisting of $85.2 million in net proceeds from our public common stock offering, $4.2 million of cash resulting from the exercise of stock options under our stock option plan and purchases of stock under our ESPP, and approximately $850,000 of proceeds received from the issuance of long-term debt used to finance purchases of capital equipment.
Fiscal 2006 as compared to Fiscal 2005: As of June 30, 2006, cash, cash equivalents, restricted cash and marketable securities totaled $70.1 million compared with $92.7 million at June 30, 2005. Net cash used in operating activities for fiscal year 2006 was $24.3 million, compared to $17.2 million for fiscal 2005. During fiscal year 2006, our net loss of $39.6 million was reduced by non cash charges of $15.2 million, primarily associated with depreciation and share-based compensation expense. For the fiscal year 2006, our net operating assets and liabilities, excluding cash, decreased by approximately $154,000. This was primarily due to increases in accounts payable and accrued compensation and benefits, which were slightly offset by decreases in advance payment balances from collaborators. Accounts payable increased by $2.5 million due to increased obligations for outsourced pharmacology and clinical trial related expenses, as well as laboratory equipment received in June 2006. Accrued compensation and benefits increased by $1.4 million, half of which was due to increased amounts reserved for fiscal year 2006 employee bonuses as well as $420,000 related to employee payroll withholdings for the Employee Stock Purchase Plan due to the change in purchase dates within the plan. Advance payments from collaborators decreased by $3.8 million during fiscal year 2006 due to the recognition of revenue from previously received up-front license and milestone payments, slightly offset by the receipt of new milestone payments during the fiscal year.
During fiscal year 2006, we invested $5.2 million in laboratory equipment, primarily for biology, drug metabolism and analytical research and development operations, as well as in various computer hardware and software. Purchases of
marketable securities used $67.2 million of cash while proceeds from the sale and maturity of marketable securities provided $90.9 million of cash. Additionally, $2.0 million of previously restricted cash became available for use in operations. Financing activities provided $6.8 million of cash consisting of $4.2 million for proceeds received from the issuance of long term debt used to finance purchases of capital equipment and $2.7 million of cash resulting from the exercise of stock options under our stock option plan and purchases of stock under our employee stock purchase plan.
Our future capital requirements will depend on a number of factors, including the rate at which we invest in proprietary research, the growth of our clinical development capabilities, the growth or decline of our collaboration business and the amount of collaboration research funding we receive, the timing of milestone and royalty payments, if any, from our collaboration and out-licensed programs, our capital spending on new facilities and equipment, the number and size of Phase 2 or Phase 3 clinical trials we decide to run, expenses associated with unforeseen litigation, regulatory changes, competition, technological developments, general economic conditions and the extent to which we acquire or invest in other businesses, products and technologies.
In addition, our future capital requirements may be impacted if we do not receive potential milestone or royalty payments under our existing or future collaboration agreements. Our ability to realize these payments is subject to a number of risks, many of which are beyond our control and include the following: the drug development process is risky and highly uncertain, and we or our collaborators may not be successful in commercializing drug candidates we create; our collaborators have substantial control and discretion over the timing and continued development and marketing of drug candidates we create; the sale and manufacture of drug candidates we develop may not obtain regulatory approval; and, if regulatory approval is received, drugs we develop will remain subject to regulation or may not gain market acceptance, which could delay or prevent us from generating milestone, royalty revenue or product revenue from the commercialization of these drugs.
We believe that our existing cash, cash equivalents and marketable securities and anticipated cash flow from existing collaboration agreements will be sufficient to support our current operating plan for at least the next 12 months. This estimate of our future capital requirements is a forward-looking statement that is based on assumptions that may prove to be wrong and that involve substantial risks and uncertainties. Our actual future capital requirements could vary as a result of a number of factors, including:
· the progress of our research and development activities;
· our ability to enter into agreements to out-license and co-develop our proprietary drug candidates, and the timing of those agreements in each candidates development stage;
· the number and scope of our research and development programs;
· the progress of our preclinical and clinical development activities;
· the number and scope of phase 2 and phase 3 studies we may decide to run;
· the progress of the development efforts of our collaborators;
· the availability of resources for revenue generating collaborations as we devote more resources to our proprietary programs;
· our ability to establish and maintain current and new collaboration agreements;
· the ability of our collaborators to fund research and development programs;
· the costs involved in enforcing patent claims and other intellectual property rights;
· the costs and timing of regulatory approvals; and
· the costs of establishing clinical development and distribution or commercialization capabilities.
Until we can generate sufficient levels of cash from our operations, which we do not expect to achieve in the foreseeable future, we expect to continue to utilize our existing cash and marketable securities resources that were primarily generated from the proceeds of our equity offerings and from our collaborations. In addition, we may finance future cash needs through the sale of equity securities, strategic collaboration agreements and debt financing. We cannot assure that we will be successful in obtaining new or in retaining existing out-license or collaboration agreements, in securing agreements for the co-development of our proprietary drug candidates, or in receiving milestone and/or royalty payments under those agreements, that our existing cash and marketable securities resources will be adequate or that additional financing will be available when needed or that, if available, this financing will be obtained on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose, or may adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result.
Obligations and Commitments
The following table shows our contractual obligations and commitments as of June 30, 2007.
We are obligated under non-cancelable operating leases for our facilities and certain equipment leases. Original lease terms for our facilities in effect as of June 30, 2007 were ten years and generally require us to pay the real estate taxes, insurance and other operating costs. Equipment leases generally range from three to five years.
Purchase obligations totaling $9.8 million were primarily for outsourced clinical and pharmacology services, facilities improvements, laboratory equipment, chemicals and supplies.
As described more fully above under Managements Discussion and Analysis of Financial Condition and Results of Operations, on June 22, 2006, we entered into a series of agreements involving the assignment to BioMed of options we acquired to purchase the facilities that we occupy in Boulder and Longmont, Colorado and the subsequent lease of those facilities from BioMed. Total operating lease obligations under the Boulder Lease amount to $52.0 million over the lease term, and account for $47 million of operating lease obligations within the above table. Total operating lease obligations under the Longmont Lease are $24.2 million over the lease term, and account for $22 million of operating lease obligations within the above table.
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices, and interest rates. All of our collaboration agreements and nearly all purchase orders are denominated in United States dollars. As a result, historically and as of June 30, 2007, we have had little or no exposure to market risk in the area of changes in foreign currency or exchange rates.
Our exposure to market risk for changes in interest rates relates primarily to our investments in marketable securities. The investment portfolio is comprised primarily of readily marketable, high-quality securities diversified and structured to minimize market risks while providing a reasonable return on invested funds. We target our average portfolio maturity at one year or less. Nevertheless, the securities held in our investments portfolio are subject to changes in market value in response to changes in interest rates. In addition, a significant change in market interest rates could have a material impact on interest income earned from our investment portfolio.
Given the current balance of $141.3 million of investments classified as cash and cash equivalents and marketable securities available for sale, a theoretical 100 basis point change in interest rates and security prices would impact our net income (loss) positively or negatively by approximately $1.4 million. Because our portfolio of marketable securities available for sale will mature in a short period of time, our exposure to changes in the fair value of these investments is not significant.
We are also impacted by adverse changes in interest rates relating to variable-rate borrowings under our credit facility. We pay interest on advances under our loan agreement at one of three variable rates, which are adjusted periodically for changes in the underlying prevailing rate. Changes in prevailing interest rates will not affect the fair value of our debt, but would impact future results of operations and cash flows. At June 30, 2007, we had $15 million of long-term debt outstanding, and the interest rate on our term loan and equipment advances was 6.5%. This rate is adjusted based on changes in the banks prime lending rate. Assuming constant debt levels, a theoretical change of 100 basis points in our interest rate would result in a change in our annual interest expense of approximately $150,000.
Historically, and as of June 30, 2007, we have not used derivative instruments or engaged in hedging activities.
INDEX TO FINANCIAL STATEMENTS
The Board of Directors and Stockholders
Array BioPharma Inc.:
We have audited the accompanying balance sheets of Array BioPharma Inc. (the Company) as of June 30, 2007 and 2006, and the related statements of operations, stockholders equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended June 30, 2007. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Array BioPharma Inc. as of June 30, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2007 in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1, effective July 1, 2005, the Company changed its method of accounting for stock-based compensation.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Array BioPharma Inc.s internal control over financial reporting as of June 30, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 12, 2007 expressed an unqualified opinion on managements assessment of, and the effective operation of, internal control over financial reporting.
ARRAY BIOPHARMA INC.
(In thousands, except share data)
The accompanying notes are an integral part of these financial statements.
ARRAY BIOPHARMA INC.
(In thousands, except per share data)