Lipid Sciences 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Commission File Number: 0-497
Lipid Sciences, Inc.
(Exact name of registrant as specified in its charter)
7068 Koll Center Parkway, Suite 401, Pleasanton, California 94566
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
LIPID SCIENCES, INC.
For the Period Ended March 31, 2008
TABLE OF CONTENTS
Lipid Sciences, Inc.
(A Development Stage Company)
(In thousands, except share amounts)
See accompanying Notes to Condensed Consolidated Financial Statements
Lipid Sciences, Inc.
(A Development Stage Company)
See accompanying Notes to Condensed Consolidated Financial Statements
Lipid Sciences, Inc.
(A Development Stage Company)
See accompanying Notes to Condensed Consolidated Financial Statements
Lipid Sciences, Inc.
NOTE 1: ORGANIZATION AND BASIS OF PRESENTATION
In this Quarterly Report on Form 10-Q, unless the context otherwise requires, Lipid Sciences, Inc., a Delaware corporation, is referred to as we, the Company or Lipid Sciences.
On November 29, 2001, Lipid Sciences, Inc., a privately-held corporation, merged with and into NZ Corporation, an Arizona corporation. Immediately after the completion of the merger, NZ Corporation changed its name to Lipid Sciences, Inc. On June 26, 2002, Lipid Sciences changed its state of incorporation from Arizona to Delaware. In this Quarterly Report on Form 10-Q, we refer to our former name, NZ Corporation, as NZ, and we refer to the merged corporation, Lipid Sciences, Inc., as Pre-Merger Lipid.
The Company is engaged in research and development of products and processes intended to treat major medical indications such as cardiovascular disease and viral infections in which lipids, or fat components, play a key role. Our primary activities since incorporation have been conducting research and development (including pre-clinical studies); conducting a clinical trial; performing business, strategic and financial planning; and raising capital. Accordingly, the Company is considered to be in the development stage.
In the course of our research and development activities, we have incurred significant operating losses and we expect these losses to continue for the foreseeable future as we continue to invest in research and development and begin to allocate significant and increasing resources to clinical testing and other activities related to seeking approval to market our products. As of March 31, 2008, we had cash and cash equivalents equal to approximately $4.2 million. We anticipate that existing cash and cash equivalents, in addition to any proceeds received from current or future licensing partnerships, will provide sufficient working capital for our operations, including our current development projects, into the third quarter of 2008. Our estimate of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties. Actual results could vary significantly. We have based this estimate on current assumptions that may prove to be wrong, and we could, utilize our available capital resources sooner than we currently expect. We will need to raise additional capital. We intend to seek capital necessary to fund our operations through public or private financings, new collaborations, such as licensing or other arrangements or through research and development grants. There can be no assurance, however, that funds secured from any of these efforts, if obtained, will be sufficient to meet the Companys future cash requirements. If adequate funds are not available to satisfy our financial obligations, we may have to substantially reduce or eliminate certain areas of our product development activities.
The Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated upon consolidation.
The accompanying interim unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (SEC), and do not contain all of the information and footnotes required by GAAP and the SEC for annual financial statements. The results for interim periods are not necessarily indicative of the results to be expected for the full year. The December 31, 2007 balance sheet, as presented, was derived from the audited Consolidated Financial Statements as of December 31, 2007. These Condensed Consolidated Financial Statements should be read in conjunction with the Companys audited Consolidated Financial Statements and notes thereto included in the Companys Annual Report on Form 10-K filed with the SEC on March 28, 2008.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates and assumptions.
In connection with the collaborative research and license agreement entered into with Elanco Animal Health (Elanco), the Company may periodically record revenue resulting from various financial components described in
the agreement. These components may include: reimbursable expenses incurred by us pertaining to the development of certain immunological products for animal health using our delipidation immunological technology; technology access fees which provide for exclusive license rights in a limited field of use; and milestone payments for regulatory submission by Elanco, as well as the subsequent regulatory approval, if received. In addition, the agreement provides for patent and technology royalties which are paid based on a percentage of sales revenue received by Elanco. Consistent with Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, the Company recognizes revenue as reimbursable expenses are incurred, and upon the realization of the milestones as described in the agreement. The period or periods for recognition are determined based on the ongoing obligation of the Company, if any, under the contract or Elancos intent to further develop the related product.
NOTE 2: NET LOSS PER SHARE
The Company computes its net loss per share under the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. Basic net loss per share is calculated by dividing net loss by the weighted average number of shares of common stock outstanding during the period.
Diluted net loss per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company had securities outstanding, which could potentially dilute basic net earnings per share, but because the Company incurred a net loss for all periods presented, such securities were excluded from the computation of diluted net loss per share as their effect would have been antidilutive. The securities excluded from diluted loss per share consist of the following:
NOTE 3: STOCK-BASED COMPENSATION
Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment, FAS 123(R), which requires that we recognize compensation cost relating to share-based payment transactions in our financial statements. We have adopted FAS 123(R) on a modified prospective basis, which requires that we recognize compensation cost relating to all new awards and to awards modified, repurchased, or cancelled in our financial statements beginning January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service had not been rendered and were outstanding as of January 1, 2006 will be recognized as the requisite service is rendered on or after January 1, 2006. The pro forma disclosures previously permitted under SFAS No. 123, Accounting for Stock-Based Compensation, are no longer an alternative to financial statement recognition. To calculate the excess tax benefits available for use in offsetting potential future tax shortfalls, the Company follows the alternative method discussed in Financial Accounting Standards Board (FASB) staff Position No. 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.
Stock Option Plans
Prior to the merger, we maintained stock-based compensation plans for our employees, consultants and Directors. The 2000 Stock Option Plan (the 2000 Plan), adopted by the Board of Directors in May 2000 and approved by stockholders on March 20, 2001, allows for the granting of options for up to 3,118,040 shares of common stock. Stock options granted under the 2000 Plan may be either incentive stock options or nonstatutory stock options. Options may be granted with exercise prices not less than the fair value of the Companys common stock at the date of grant, as determined by the Board of Directors. All options granted pursuant to the 2000 Plan are to have a term not greater than 10 years from the date of grant. Options vest as determined by the Board of Directors, but generally over four years (but not less than 20% of the total number of shares granted per year).
In October 1997, NZs Board of Directors approved the New Mexico and Arizona Land Company 1997 Stock Incentive Plan (the 1997 Plan). The 1997 Plan provides that the following types of awards may be granted under the 1997 Plan: stock appreciation rights, incentive stock options, non-qualified stock options, restricted stock awards, unrestricted stock awards, and performance share awards which entitle recipients to acquire shares upon the attainment of specified performance goals. Under the 1997 Plan, awards may be granted with respect to a maximum of 900,000 shares of the Companys common stock, subject to adjustment in connection with certain events such as a stock split, merger or other recapitalization of the Company. We assumed the 1997 Plan as a result of the merger.
In November 2001, the Companys Board of Directors approved the 2001 Performance Equity Plan (the 2001 Plan). The stockholders approved the Plan on November 29, 2001. The 2001 Plan allows for the granting of options for up to 5,000,000 shares of common stock to employees, officers, consultants, and Directors. The number of shares authorized automatically increased on January 1, in each of the calendar years 2002 through 2006 by 500,000 shares of common stock, which was the maximum amount allowable in each year, under the terms of the 2001 Plan. Stock options granted under the 2001 Plan may be either incentive stock options or nonstatutory stock options. Options may be granted with exercise prices not less than the fair value of the Companys common stock at the date of grant, as determined by the Board of Directors. All options granted pursuant to the 2001 Plan are to have a term not greater than 10 years from the date of grant. Options vest as determined by the Board of Directors, generally over four years (but not less than 20% of the total number of shares granted per year).
All options in the 2000 Plan were adjusted to reflect the 1.55902 merger exchange ratio with the number of shares underlying each option multiplied by the ratio and the related exercise prices divided by the ratio. All the above disclosures reflect the share and per share amounts on a post merger equivalent basis. Additionally, all historical stock option information of Pre-Merger Lipid provided herein has been similarly restated.
At March 31, 2008, options to purchase an aggregate of 4,602,614 shares of common stock remain available for grant under all the plans.
Other Required FAS 123(R) Disclosures
The following table represents stock option activity for the three months ended March 31, 2008:
We use the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the following weighted-average assumptions for the indicated periods:
No assumptions were made in the first quarter of 2008 because no stock options were granted during the period. For the quarter ending March 31, 2007, the assumptions are based on multiple factors, including historical exercise patterns of employees and post-vesting employment termination behaviors. We use historical data to estimate the options expected term, which represents the period of time that options granted are expected to be outstanding. Due to the relatively low trading volume of options on our common stock, we do not use implied volatility to determine the expected volatility of our common stock. Rather, the historical volatility that is commensurate with the expected life of the option on the date that it is measured is used as our estimate of future expected volatility. Since we have never paid any dividends and do not anticipate paying any dividends at least through the expected life of our stock options outstanding, we use an expected dividend yield of zero when calculating the fair value of stock options. The risk-free interest rate for periods within the contracutal life of the option is based on the U.S. Treasury yield curve in effect at the measurement date of the option.
FAS 123(R) requires that we estimate forfeitures, or the number of shares that are expected to be cancelled prior to vesting, at the time of grant, and adjust for actual forfeitures in subsequent periods if they differ from our original estimates. Based on our historical experience of options that have been cancelled prior to vesting, we have assumed an annualized forfeiture rate of 12% for all new option grants.
Total compensation cost for share-based payment arrangements recognized in income for the three month periods ended March 31, 2008 and 2007 is presented in the following table:
The total compensation cost related to nonvested awards not yet recognized as of March 31, 2008 was approximately $881,000 and the weighted average expected remaining recognition period as of March 31, 2008 was approximately 1.5 years.
We did not receive any gross proceeds in the current quarter since no stock options were exercised in either of the periods ending March 31, 2008 or 2007. We did not recognize any tax benefit related to these share-based arrangements as we are in a loss position and have a full valuation allowance against our tax benefits.
NOTE 4: RECENTLY ISSUED ACCOUNTING STANDARDS
In March 2008 the FASB issued SFAS No. 161, Disclosures About Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133. This statement is intended to enhance current disclosure framework in Statement 133, Accounting for Derivative Instruments and Hedging Activities. This statement changes the disclosure requirements for derivative instruments and hedging activities, and requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. We believe that the adoption of this statement will not have a material impact on our financial position, results of operations, or cash flows.
NOTE 5: RELATED PARTY TRANSACTIONS
In December 1999, we entered into an Intellectual Property License Agreement to obtain the exclusive worldwide rights to certain patents, trademarks, and technology with Aruba International Pty. Ltd., an Australian company controlled by Bill E. Cham, Ph.D., a founding stockholder of Pre-Merger Lipid and one of our former Directors. As consideration for the license, we issued Aruba 4,677,060 shares of our common stock valued at $250,000. Under this agreement, we are obligated to pay Aruba a continuing royalty on revenue in future years, subject to a minimum annual royalty amount of $500,000 and 10% of any External Research Funding initiated by Dr. Cham and received by us to further this technology, as defined in the agreement. In November 2004, all rights,
title, interest and obligations covered under the Intellectual Property License Agreement were assigned to Aruba International B.V., a Netherlands company controlled by Dr. Cham. We have expensed to research and development approximately $125,000 in both three month periods ended March 31, 2008 and 2007 related to this agreement. Accrued related party royalties under this agreement were $375,000 and $250,000 at March 31, 2008 and December 31, 2007, respectively.
On May 16, 2005 we entered into a consulting agreement with H. Bryan Brewer, Jr., M.D., a Director of the Company, and Washington Cardiovascular Associates, LLC (WCA), an entity co-owned by Dr. Brewer and his spouse, Silvia Santamarina-Fojo, Ph.D., pursuant to which WCA provides the services of Dr. Brewer as the Companys Chief Scientific Director. Dr. Brewer was also appointed Vice Chairman of the Companys Board of Directors on May 16, 2005, and serves as Chairman of the Companys Scientific Advisory Board. The consulting agreement was for an initial three-year term. On July 31, 2007 the consulting agreement was amended to extend the term of the consulting agreement until May 16, 2011. Upon expiration, the agreement automatically renews for an additional three-year term unless the Company or WCA provides at least 30 days notice of intent not to renew. In consideration for Dr. Brewers services as Chief Scientific Director we are required to pay WCA annual fees of $395,000. For each of the three month periods ended March 31, 2008 and 2007, approximately $99,000 was charged to selling, general and administrative expenses for fees related to the consulting agreement. In addition to the annual fee, we granted Dr. Brewer an option award of 100,000 shares of our common stock to vest in three equal annual installments on the first, second and third anniversaries of the consulting agreement. Dr. Brewers 100,000 option share award was re-priced in December 2007 as a result of the Companys election to re-price certain stock options that had been previously granted to employees, Directors, and consultants of the Company. The options were re-priced to the fair market value of our stock as of market closing on December 3, 2007, $0.89 per share. The other terms of the options, including the vesting schedules, remained unchanged. For the three month periods ended March 31, 2008 and 2007, approximately $16,000 and $9,000, respectively, was recorded as non-cash compensation charges related to the stock option awarded to Dr. Brewer under the consulting agreement.
On November 13, 2007, the Company entered into a consulting agreement with Dr. Santamarina-Fojo and Washington Cardiovascular Associates, LLC, an entity co-owned by Dr. Brewer and Dr. Santamarina-Fojo, pursuant to which WCA provides the services of Dr. Santamarina-Fojo as co-investigator responsible for the execution of all aspects of the mouse atherosclerosis study using the Companys HDL Mimetic Peptide technology. In consideration for Dr. Santamarina-Fojos services, the Company pays WCA fees of $150.00 per hour, plus reimbursement of expenses incurred in the performance of the contract. In connection with this effort, on December 13, 2007, the Company issued to Dr. Santamarina-Fojo a non-qualified stock option to purchase 50,000 shares of common stock at an exercise price of $0.78 per share, with immediate vesting upon grant. For the period ended March 31, 2008 approximately $1,000 was charged to research and development expense for fees related to the consulting agreement.
NOTE 6: INCOME TAX
The Companys effective tax rate was zero for the three months ended March 31, 2008 and 2007. The effective tax rate was calculated using an estimate of our expected annual pretax income for 2008. The effective tax rate for 2008 differs from the statutory federal income tax rate primarily due to additional valuation allowance provided.
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The Company has established a valuation allowance against its net operating loss carryforward and credits due to uncertainty of realizing future benefits.
This Form 10-Q contains forward-looking statements concerning plans, objectives, goals, strategies, future events or performance as well as all other statements which are not statements of historical fact. These statements contain words such as, but not limited to, believes, anticipates, expects, estimates, projects, will, may and might. The forward-looking statements contained in this Form 10-Q reflect our current beliefs and expectations on the date of this Form 10-Q. Actual results, performance or outcomes may differ materially from what is expressed in the forward-looking statements. We have discussed the important factors, which we believe could cause actual results, performance or outcomes to differ materially from what is expressed in the forward-looking statements, in Item 1A. Risk Factors in our Annual Report on Form 10-K, filed with the SEC on March 28, 2008. We are not obligated to publicly announce any revisions to these forward-looking statements to reflect a change in facts or circumstances.
You should read the discussion below in conjunction with Part I, Item 1, Financial Statements, of this Form 10-Q and Part II, Items 7, 7A and 8, Managements Discussion and Analysis of Financial Condition and Results of Operation, Quantitative and Qualitative Disclosures About Market Risk and Financial Statements and Supplementary Data, respectively, of our Annual Report on Form 10-K for the year ended December 31, 2007.
We are a development-stage biotechnology company engaged in research and development of products and processes intended to treat major medical indications such as cardiovascular disease and viral infections in which lipids, or fat components, play a key role. Our primary activities since incorporation have been: conducting research and development (including pre-clinical studies); conducting a clinical trial; performing business, strategic and financial planning; and raising capital. Accordingly, the Company is considered to be in the development stage.
In the course of our research and development activities, we have incurred significant operating losses and we expect these losses to continue for the foreseeable future as we continue to invest in research and development and allocate significant and increasing resources to clinical testing and other activities related to seeking approval to market our products.
We intend to finance our operations through existing cash on hand, proceeds received from public or private financings, any proceeds received from our current or future licensing partnerships, and research and development grants. We anticipate that existing cash and cash equivalents, in addition to any proceeds received from our current or future licensing partnerships, will provide sufficient working capital for our operations, including our current development projects, into the third quarter of 2008. In the longer term, we expect to additionally finance our operations through revenues from product sales and licenses. We will need to raise additional capital to fund the continued development of our technology, to meet our license and contractual obligations, and to fulfill our financial requirements. If adequate funds are not available to satisfy our requirements we may have to substantially reduce, or eliminate, certain areas of our product development activities, significantly limit our operations, modify our business strategy, or cease business operations.
In November 2006, we entered into a collaborative research and license agreement with Elanco Animal Health, a division of Eli Lilly and Company, to develop one or more immunological products for animal health applications beginning with a vaccine directed against certain lipid-enveloped organisms. Under the agreement, the Company granted to Elanco a worldwide exclusive license to research, develop, manufacture, and sell certain immunological products for animal health, which will be developed using its delipidation immunological technology. Pursuant to the terms of the agreement, Elanco will pay for all the associated research and development expenses for each targeted product. In exchange for the license, subject to completion of Elancos due diligence and sales of products meeting various thresholds, we may receive a technology access fee, milestone payments and royalties. Elanco has exercised its option for the first vaccine indication developed by us. As a result, we received a technology access fee from Elanco and may receive payments in the future including milestone payments and royalties from product sales.
In January 2008, the Company demonstrated a positive therapeutic effect with the Companys proprietary delipidated autologous virus vaccine in Simian Immunodeficiency Virus (SIV)-infected non-human primates. Primates infected with SIV are a widely-accepted model for Human Immunodeficiency Virus (HIV). The 22-month study, conducted at the Yerkes National Primate Research Center at Emory University in Atlanta, included six animals in the treatment arm and six placebo animals. Vaccination with autologous SIV, delipidated by our proprietary process, led to an average 15.5 times viral load reduction in the treated animals. All six animals in the treatment arm of the study responded with an average drop in viral load in excess of 90%. While the study was not powered for statistical significance, it revealed a trend of p=0.1, indicating the benefit of autologous delipidated viral vaccination in lowering viral loads in chronically-infected animals.
In March 2008, we released the intravascular ultrasound data analysis from our first in man clinical trial initiated in June 2006. The clinical trial, entitled A Randomized Single-Blind, Placebo-Controlled Study to Evaluate the Safety of the Lipid Sciences PDS-2 in Subjects with Prior Acute Coronary Syndrome, consisted of 28 patients (14 treatment patients and 14 placebo patients), and was conducted at the Washington Hospital Center in Washington, D.C. Dr. Ron Waksman, Associate Director, Division of Cardiology at the Washington Hospital Center, was the principal investigator for the trial. The intravascular ultrasound (IVUS) analysis was conducted at the Cardiovascular Research Institute, MedStar Research Institute, under the direction of Dr. Neil J. Weissman, Director of the Cardiac Ultrasound and Ultrasound Core Laboratories. The clinical trial subjects were between the ages of 18 and 85 with angiographic evidence of Coronary Artery Disease in the target artery, as defined by at least one lesion with an occlusion between 20-50%. Each potential participant underwent an initial screening, which included a blood panel and IVUS assessment to determine eligibility for enrollment and randomization into the study. The trial consisted of a total of seven weekly delipidation/re-infusion procedures. The treatment subjects received infusions of their own plasma that had been delipidated by the PDS-2 system; the control subjects received infusions of their own untreated plasma that had not been delipidated. The study duration for each participant was approximately ten weeks. The data revealed a strong trend of regression of coronary atherosclerosis as measured by IVUS in the group of patients treated by the Companys proprietary HDL Selective Delipidation technology. These measurements showed that the average total atheroma volume in the target coronary arteries decreased by 5.31% in the treatment group versus a 1.33% increase in the placebo group. The effect on the average of the 10mm most diseased arterial segments was a 7.34% decrease for the treated group as compared to a 2.10% decrease in the placebo group. While the results of this trial were not statistically significant due to the small number of patients enrolled in the trial, they were, nevertheless, an indication of the potential of this therapy to reverse coronary artery disease. The patients in the trial tolerated the process very well, and a 93% patient retention rate demonstrated feasibility in a clinical setting. We will continue to analyze data from the clinical trial utilizing our PDS-2 device and prepare a final study report, as well as seek clarity from the Food and Drug Administration (FDA) on the design of a future pivotal trial leading to a Pre-Market Approval (PMA) application and subsequent approval for commercialization.
We have developed a synthetic form of HDL that mimics key functions of naturally-occurring human HDL. Our lead HDL Mimetic Peptide compound, LSI-518P, and several back-up compounds have been identified and validated with an extensive battery of in vitro assays. The lead compound was selected as a result of screenings at multiple external research sites. In these in vitro tests, the selected mimetic peptide candidates effluxed cholesterol via the ABCA1 transporter metabolic pathwayknown to be optimal for removing cholesterol from arterial plaque via the reverse cholesterol transport mechanismat a rate similar to naturally-occurring HDL. Having identified a lead compound, we then initiated a study designed to demonstrate its effectiveness in reducing the progression of atherosclerosis, as well as, an additional study to demonstrate its anti-inflammatory properties. On March 18, 2008, we announced that LSI-518P demonstrated the ability to reduce the progression of atherosclerosis by 20% after four weeks of treatment (p=0.106), and by 32% (p=0.01) after eight weeks of treatment, when compared to a placebo group in a well-accepted, Apo E knockout mouse model for atherosclerosis. This placebo-controlled study was conducted at MedStar Research Institute and the data analyzed at an independent laboratory. Because the initial design goals of the HDL Mimetic Peptide therapeutic program have now been met, we will move to validate other key cardio-protective characteristics of LSI-518P and begin conducting a comprehensive series of toxicology studies in the next phase of the LSI-518P development program.
Results of Continuing Operations Three Months Ended March 31, 2008 and 2007
Revenue. We recognized $250,000 in collaboration agreement revenue in the three months ended March 31, 2008 compared to $59,000 of collaboration revenue in the first three months of 2007. This revenue is related to our collaborative research agreement entered into with Elanco in November 2006.
We have had no product revenues since our Inception (May 21, 1999). Future product revenues will depend on our ability to develop and commercialize our HDL Therapy and Viral Immunotherapy platforms.
Research and Development Expenses. Research and development expenses include applied and scientific research, regulatory and business development expenses, and are comprised of 65% of operating expenses in the three months ended March 31, 2008. Research and development expenses decreased approximately $175,000, or 10%, to $1,638,000 in the first quarter of 2008 from $1,813,000 for the same period in 2007. This decrease was primarily related to the conclusion of the clinical trial using our HDL Selective Delipidation technology conducted at the Washington Hospital Center in Washington, D.C., and the completion of the 22-month study of SIV-infected non-human primates, conducted at the Yerkes National Primate Research Center at Emory University in Atlanta, using our Viral Immunotherapy platform. Partially offsetting these decreases were increased costs associated with the Companys HDL Mimetic Peptide program.
While we allocate and track resources when required pursuant to the terms of development arrangements, our research team typically works on different platforms concurrently, and our equipment and intellectual property resources often are deployed over a range of products with a view to maximize the benefit of our investment. Accordingly, we have not, and do not intend to, separately track the costs for each of our research projects on a product-by-product basis. For the three months ended March 31, 2008, we estimate that the majority of our research and development expense was associated with our two primary platforms, HDL Therapy and Viral Immunotherapy.
Selling, General and Administrative Expenses. General and administrative expenses include costs associated with our business operations, inclusive of management, legal and finance, and accounting expenses. General and administrative expenses remained relatively unchanged during the three months ended March 31, 2008 as compared to the same period in 2007, decreasing approximately $9,000, or 1%, from $906,000 in the first quarter of 2007 to $897,000 during the same period of 2008.
Interest and Other Income. Interest and other income for the three months ended March 31, 2008 decreased approximately $158,000, or 78% to $46,000, compared with the same period in 2007. This decrease was primarily due to a lower cash balances and interest rate yields in the first quarter of 2008 as compared with the same period in 2007.
Liquidity and Capital Resources
Net cash used in operating activities was approximately $2,169,000 and $2,208,000 for the three months ended March 31, 2008 and 2007, respectively, resulting primarily from operating losses incurred as adjusted for non-cash compensation charges and partially offset by the payment or accrual of accounts payable.
Net cash used by investing activities of approximately $55,000 and $44,000 for the three months ended March 31, 2008 and 2007, respectively, was the result of capital equipment purchases.
No cash was provided by, or used in, financing activities during the three months ended March 31, 2008. During the three months ended March 31, 2007, approximately $20,000 was provided by financing activities and was attributable to an adjustment to offering costs related to the December 2006 private placement of our common stock.
Our principal uses of funds are expected to be the payment of operating expenses and continued research and development funding to support our HDL Therapy platform the majority of which will strengthen our HDL Mimetic Peptide program. We will seek to further develop our HDL Mimetic Peptide program, including additional pre-clinical data and toxicology studies, to support an IND filing and the initiation of Phase I clinical trials. The expected use of funds related to our HDL Selected Delipidation technology include costs associated with the data analysis and final study report from the clinical trial utilizing our PDS-2 device, as well as obtaining clarity from the FDA on the design of a future pivotal trial leading to a PMA application and subsequent approval for commercialization. Our primary strategy for our Viral Immunotherapy technology is to pursue external grant funding for the further development both of a preventive and therapeutic vaccine for HIV, and to continue to expand our collaborative research and license agreement with Elanco to develop immunological products in the field of animal health. We anticipate our principal sources of funds to be cash on hand, proceeds received from public or private financings and any proceeds received from our current or future licensing partnerships and research and development grants. As of March 31, 2008, we had cash and cash equivalents equal to approximately $4,235,000. We anticipate that these assets will provide sufficient working capital for our operations, including our current development projects, into the third quarter of 2008. We will need to raise additional capital to fund the continued
development of our technology, to meet our license and contractual obligations, and to meet our financial requirements. The Company continues to consider public or private financings, to plan the formation of strategic development or licensing partnerships, to apply for research and development grants, and to explore strategic initiatives. However, there can be no assurance that funds secured from any of these efforts, if obtained, will be sufficient to meet the Companys future cash requirements.
Future estimated contractual obligations are:
*We have agreed to pay annual royalties in the amount of $500,000 to Aruba International B.V. in exchange for the exclusive worldwide rights to certain patents, trademarks, and technology. Under certain circumstances, additional payments related to this agreement could be required in the future. The amounts presented in the above table reflect the minimum annual royalty amount payable through the next five years.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or Special Purpose Entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies
The SEC has indicated that a critical accounting policy is one which is both important to the portrayal of the Companys financial condition and results of operations and requires managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We consider the accounting policies described below to be our most critical accounting policies because they are impacted significantly by estimates we make. We base our estimates on past experience and on various other assumptions our management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ, and may differ materially from these estimates under different assumptions or conditions. Additionally, changes in accounting estimates could occur in the future from period to period. Our management has discussed the development and selection of our most critical financial estimates with the Audit Committee of our Board of Directors. Our most critical accounting policies are:
In connection with the collaborative research and license agreement entered into with Elanco Animal Health, the Company may periodically record revenue resulting from various financial components described in the agreement. These components may include: reimbursable expenses incurred by us pertaining to the development of certain immunological products for animal health using our delipidation immunological technology; technology access fees which provide for exclusive license rights in a limited field of use; and milestone payments for regulatory submission by Elanco, as well as the subsequent regulatory approval, if received. In addition, the agreement provides for patent and technology royalties which are paid based on a percentage of sales revenue received by Elanco. Consistent with EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, the Company recognizes revenue as reimbursable expenses are incurred, and upon the realization of the milestones as described in the agreement. The period or periods for recognition are determined based on the ongoing obligation of the Company, if any, under the contract or Elancos intent to further develop the related product.
The Company accounts for all stock options in accordance with the provisions of FAS 123(R), which requires that we recognize compensation cost relating to share-based payment transactions in our financial statements. The Company accounts for stock-based awards to non-employees in accordance with FAS 123(R) and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Significant judgment is required on the part of management in determining the proper assumptions to use in the computation of the amounts to be recorded pursuant to the provisions of FAS 123(R). We estimate the fair value of each option granted to an employee on the date of grant using the Black-Scholes option valuation model. The assumptions used in the Black-Scholes option valuation model include the risk free interest rate, expected life, expected volatility, expected forfeitures and dividend yield of the option. Management bases its assumptions on historical data where available. However, these assumptions consist of estimates of future market conditions, which are inherently uncertain, and therefore are subject to managements judgment.
Prior to the adoption of FAS 123(R) in the first quarter of 2006, the Company accounted for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, as interpreted by FASB Interpretation No. 44, Accounting for Transactions Involving Stock Compensationan Interpretation of APB No. 25. The Company accounted for stock based awards to non-employees in accordance with SFAS No. 123, Accounting for Stock-Based Compensation and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.
The impact of the adoption of FAS 123(R) is more fully described in Note 3 of the Condensed Consolidated Financial Statements.
The Company follows SFAS No. 109, Accounting for Income Taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities resulting from a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by a valuation allowance if the corresponding future tax benefits are not expected to be realized.
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes by creating a framework for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions that they have taken or expect to take in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 on January 1, 2007. Since its adoption we have not recorded any adjustments as a result of our adoption of the new interpretation.
The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for managements judgment in their application. There are also areas in which managements judgment in selecting any available alternative would not produce a materially different result. Our significant accounting policies are more fully described in our audited Consolidated Financial Statements and notes thereto for the year ended December 31, 2007, which appear in the Companys Annual Report on Form 10-K filed with the SEC on March 28, 2008.
Our exposure to market risk associated with changes in interest rates relates to our investment portfolio. We maintain an investment portfolio consisting typically of government issued securities, although at March 31, 2008, we did not have any investments on our balance sheet. When we carry an investment balance, these investments are classified as held-to-maturity and are accounted for at their amortized cost, as per Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Every quarter we evaluate our investment portfolio and follow the guidance of FASB Staff Position No. 115-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, to determine if any of our investments are impaired. We have not booked any impairment charges during 2008 and have concluded that an impairment analysis was not necessary. Since we held no investments at March 31, 2008, a sensitivity analysis of a 10% change in market interest rates was not performed.
(a) Evaluation of Disclosure Controls and Procedures. Our President and Chief Executive Officer and our Chief Financial Officer have performed an evaluation, required pursuant to Rule 13a-15(b) or 15d-15(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act), of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q (the Evaluation Date). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in alerting them, on a timely basis, to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic filings under the Exchange Act.
(b) Changes in Internal Controls Over Financial Reporting. There have not been any significant changes in our internal controls over financial reporting (as such Item is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Our management, including our President and Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met due to numerous factors, ranging from errors to conscious acts of an individual, or individuals acting together. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, misstatements due to error and/or fraud may occur and not be detected.
We are from time to time, a party to legal proceedings. Any legal proceeding we may be currently involved in is ordinary and routine. Outcomes of the legal proceedings are uncertain until they are completed. We believe that the results of any current proceedings will not have a material adverse effect on our business or financial condition or results of operations.
Please refer to our Annual Report on Form 10-K filed with the SEC on March 28, 2008, which discloses legal proceedings involving the Company.
There have been no material changes to the risk factors previously disclosed in our 2007 Form 10-K, filed on March 28, 2008.
(a) Exhibits - See Exhibit Index, which is incorporated by reference.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
*Signing on behalf of the Registrant as a duly authorized officer and as the Principal Financial Officer of the Registrant