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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 0-18311

NEUROGEN CORPORATION
(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction
of incorporation or organization)
22-2845714
(I.R.S. Employer
Identification No.)

 

35 Northeast Industrial Road
Branford, Connecticut
(Address of principal executive offices)

 

06405
(Zip Code)

 

(203) 488-8201
(Registrant's 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 check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes X No _

As of November 14, 2003 the registrant had 17,965,147 shares of Common Stock outstanding.



FORM 10-Q
For the Third Quarter Ended
September 30, 2003

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Consolidated Balance Sheets at September 30, 2003 and December 31, 2002

Consolidated Statements of Operations for the three-month and nine-month periods ended September 30, 2003 and 2002

Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2003 and 2002

Notes to Consolidated Financial Statements

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities and the Use of Proceeds

Item 3. Defaults upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits and Reports on Form 8-K

Signature

 



FINANCIAL INFORMATION


ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS


NEUROGEN CORPORATION CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(UNAUDITED)

 

 
September 30, 2003
December 31, 2002
 

Assets
Current assets:
  Cash and cash equivalents
$            10,451
$             12,248
  Marketable securities
42,842
67,164
  Receivables from corporate partners
1,066
1,333
  Other current assets, net
1,304
1,615
 

    Total current assets
55,663
82,360
 
Property, plant & equipment:
  Land, building and improvements
31,303
31,280
  Equipment and furniture
17,315
17,328
  Construction in progress
109
109
 

 
48,727
48,717
  Less accumulated depreciation and amortization
17,933
15,933
 

    Net property, plant and equipment
30,794
32,784
 
Other assets, net
368
635
 

  Total assets
$             86,825
$             115,779
 

Liabilities and Stockholders' Equity
Current liabilities:
  Accounts payable and accrued expenses
$               2,842
$                 3,547
  Unearned revenue from corporate partner, current portion
2,000
2,000
  Current portion of loans payable
1,392
1,380
 

    Total current liabilities
6,234
6,927
 
Unearned revenue from corporate partner, net of current portion
4,385
5,905
Loans payable, net of current portion
15,204
19,650
 

  Total liabilities
25,823
32,482
 
Commitments and Contingencies
 
Stockholders' Equity:
  Preferred stock, par value $0.025 per share
    Authorized 2,000 shares; none issued
-
-
  Common stock, par value $0.025 per share
    Authorized 50,000 and 30,000 shares, respectively; issued
    and outstanding 17,965 shares and 17,919 shares, respectively
449
448
  Additional paid-in capital
176,591
176,615
  Accumulated deficit
(114,475)
(91,377)
  Deferred compensation
(2,197)
(3,257)
  Accumulated other comprehensive income
634
868
 

 
61,002
83,297
 

  Total liabilities and stockholders' equity
$           86,825
$             115,779
 

 
See accompanying notes to consolidated financial statements

 

 

NEUROGEN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)
(UNAUDITED)

Three Months
Ended
Sept. 30, 2003
Three Months
Ended
Sept. 30, 2002
Nine Months
Ended
Sept. 30, 2003
Nine Months
Ended
Sept. 30, 2002
 



               
Operating revenues:
  License fees
$           500
$         500
$         1,500
$         8,949
  Research and development
989
1,009
2,967
3,468
 




    Total operating revenues
1,489
1,509
4,467
12,417
 
Operating Expenses:
  Research and development
    Stock compensation
86
57
219
39
    Other research and development
8,107
8,163
24,044
27,435
 




    Total research and development
8,193
8,220
24,263
27,474
 
  General and administrative:
    Stock compensation
158
139
474
429
    Other general and administrative
1,304
1,644
4,126
5,350
 




  Total general and administrative
1,462
1,783
4,600
5,779
 




  Total operating expenses
9,655
10,003
28,863
33,253
 




Operating loss
(8,166)
(8,494)
(24,396)
(20,836)
 
Other income (expense):
  Other income
609
609
1,643
2,156
  Interest expense
(226)
(274)
(692)
(828)
 




    Total other income, net
383
335
951
1,328
 




Net loss before income taxes
(7,783)
(8,159)
(23,445)
(19,508)
 
Income tax benefit
347
361
347
288
 




Net loss
$       (7,436)
$        (7,798)
$       (23,098)
$       (19,220)
 




Basic and diluted loss per share
$         (0.42)
$         (0.44)
$         (1.31)
$          (1.09)
 




Shares used in calculation of loss per share:
  Basic and diluted
17,717
17,620
17,688
17,607
 




See accompanying notes to consolidated financial statements.

 

 

NEUROGEN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
(UNAUDITED)

 

Nine months ended September 30  
2003
2002

 

Cash flows from operating activities:  
  Net loss  
$(23,098)
$(19,220)
  Adjustments to reconcile net loss to  
    net cash used in operating activities:  
    Depreciation and amortization expense  
2,157
2,342
    Stock compensation expense  
692
469
    Other non-cash expense  
1,320
1,323
   
Changes in operating assets and liabilities:  
  (Decrease) increase in accounts payable and accrued expenses  
(705)
(60)
  Decrease in unearned revenue from corporate partners  
(1,520)
(6,199)
  Decrease in receivables from corporate partners  
267
93
  Decrease in other assets, net  
517
1,460
  Income tax benefits from exercise of stock options  
-
350
   

  Net cash used in operating activities  
(20,370)
(19,442)
   

Cash flows from investing activities:  
  Purchases of property, plant and equipment  
(196)
(1,953)
  Purchases of marketable securities  
(9,624)
(59,289)
  Maturities and sales of marketable securities  
32,816
55,200
  Proceeds from sales of property and equipment  
11
101
   

    Net cash provided by (used in) investing activities  
23,007
(5,941)
   

Cash flows from financing activities:  
  Principal payments under loans payable  
(4,434)
(1,022)
  Change in restricted cash  
-
487
  Exercise of employee stock options  
-
 
2
   

    Net cash used in financing activities  
(4,434)
(533)
   

    Net decrease in cash and cash equivalents  
(1,797)
(25,916)
Cash and cash equivalents at beginning of period  
12,248
51,062
   

Cash and cash equivalents at end of period
 
$10,451
$25,146
   

   
 
See accompanying notes to consolidated financial statements.  

 




NEUROGEN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(UNAUDITED)

(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The unaudited consolidated financial statements have been prepared from the books and records of Neurogen Corporation ("Neurogen" or the "Company") in accordance with generally accepted accounting principles for interim financial information pursuant to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements including the significant accounting policies described in Note 1, for the year ended December 31, 2002 included in the Company's Annual Report on Form 10-K. Interim results are not necessarily indicative of the results that may be expected for the full fiscal year.

(2) COMPREHENSIVE INCOME
Comprehensive loss for the three-month periods ended September 30, 2003 and 2002 was $8,045,000 and $7,405,000, respectively. Comprehensive loss for the nine-month periods ended September 30, 2003 and 2002 was $23,332,000 and $19,076,000, respectively. The differences between net loss and comprehensive net loss are due to changes in the net unrealized gain (loss) on marketable securities.

(3) STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board issued SFAS No. 148 to address alternative methods of transition for a voluntary change from the intrinsic to the fair value method of accounting for stock-based employee compensation. The statement also amends certain disclosure provisions in SFAS No. 123. Neurogen continues to utilize the intrinsic value method to account for stock-based employee compensation. However, the disclosure provisions of SFAS No. 148 have been implemented in the 2002 and 2003 financial statements.

The Company primarily grants qualified stock options for a fixed number of shares to employees with an exercise price equal to the fair market value of the shares at the date of grant. The Company has also issued restricted stock to key executives and records an expense over the vesting periods. The Company accounts for grants of stock options and restricted stock in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for the options when the option grants have an exercise price equal to the fair market value at the date of grant. The Company has adopted the disclosure only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation – Transition and Disclosure."

The Company occasionally grants stock option awards to consultants. Such grants are accounted for pursuant to Emerging Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," and, accordingly, the Company recognizes compensation expense equal to the fair value of such awards and amortizes such expense over the performance period.

As of September 30, 2003 compensation expense has not been recognized for the stock option plans, except as noted above. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 2003 and 2002 consistent with the provisions of SFAS No. 123, the Company's net loss and loss per share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):

Three Months Ended
Sept. 30, 2003
Three Months Ended
Sept. 30, 2002
Nine Months Ended
Sept. 30, 2003
Nine Months Ended
Sept. 30, 2002
 
 
 
 
Net loss as reported
$(7,436)
$(7,798)
$(23,098)
$(19,220)
Stock-based employee compensation included
  in reported net loss
12
12
86
33
Total stock-based compensation expense
  determined under fair value-based method for all
  awards, including consultant compensation above
(1,611)
(2,826)
(5,110)
(8,450)
 




Net loss pro forma
(9,035)
(10,612)
(28,122)
(27,637)
Basic and diluted loss per share as reported
(.42)
(.44)
(1.31)
(1.09)
Basic and diluted loss per share-pro forma
(.51)
(.60)
(1.59)
(1.57)
 




In calculating the stock compensation expense above the Black-Scholes method was used with the following assumptions in order to calculate the fair value of the options for the three months ended September 30, 2003 and 2002, respectively: 1) an expected life of five years and five years; 2) a risk-free interest rate of 3.2% and 3.0%; 3) a volatility factor of 86% and 84%; and 4) an expected dividend yield of 0% and 0%. As additional options are expected to be granted in future years which may vest over several years, the above pro forma results are not necessarily indicative of future pro forma results.

(4) NET LOSS PER COMMON SHARE
The Company computes and presents net loss per common share in accordance with SFAS No. 128, "Earnings Per Share." Basic loss per common share was based on the weighted average number of shares outstanding during the period. Diluted loss per share for the same periods was based on the weighted average number of shares after consideration of any dilutive effect of stock options. Since the Company has incurred a net loss for all periods presented, basic and diluted per share amounts are equivalent as the effect of potential common share equivalents is anti-dilutive. Total stock options outstanding (including both exercisable and non-exercisable) as of September 30, 2003 and 2002 were 5,011,709 and 4,910,714 respectively.

(5) INCOME TAXES
In the third quarter of 2003, the Company filed its 2002 tax return with the State of Connecticut and elected to exchange its 2002 research and development credits for cash at a rate of 65%. The Company recorded a benefit of $347,000, which is recorded in the statement of operations, and a corresponding income tax receivable for the same amount, which is included in other current assets.

(6) REDUCTION IN FORCE
In October 2002, the Company announced a reduction in force as part of its Operational Excellence program to further enhance the efficiency of its drug discovery platform, reduce costs and to more closely align the Company’s investment of resources with long-term business goals. As part of this plan, Neurogen reorganized certain departments and eliminated 24 employee positions inclusive of both administrative and research functions, representing approximately 10% of its total workforce. The reduction in force was communicated to respective employees and severance agreements were executed in October 2002. The total amount of costs incurred was $350,000, which included $303,000 in one-time termination benefits and $47,000 in associated costs.

Severance payments were completed by March 2003. The following table summarizes the activity recorded in the employee termination cost accrual during 2003 (in thousands):

 
Nine Months Ended September 30, 2003
 
 
One-Time
Benefits
Total
 

Accrual balance, beginning of year
$ 23 
$ 23 
Cash payments on costs
(23)
(23)
 

Accrual balance, end of quarter
$ -
$ -
 


(7) LOAN PAYABLE
In December 2001, the Company entered into a $17.5 million loan agreement with Webster Bank, a commercial banking institution (the "Bank"), which is collateralized by a mortgage on the real properties at 15 and 35 Northeast Industrial Road. The properties represent approximately two-thirds of the Company’s total physical facilities. A provision of the loan agreement required that the ratio of the outstanding loan balance less any cash collateral to the appraised value of the real property ("loan to value" ratio), as periodically determined by the Bank in its sole but reasonable discretion, will not exceed 72%. In the second quarter of 2003, the Company received notice from the Bank asserting that this ratio exceeded 72%. Neurogen was informed by the Bank that it was using a different standard in calculating the Company’s compliance with this covenant than that used when Neurogen and the Bank entered into the loan agreement and that federal regulations required the bank to use this different standard. In the third quarter, the Company and the Bank agreed to amend the loan to value ratio from 72% to 85%, and the Company agreed to pay $3.4 million of the loan balance, in addition to the previously scheduled loan repayments. As of the end of the third quarter the Company believes it is in compliance with all loan covenants.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Judgments and Estimates
The discussion and analysis of financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The presentation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities. Management makes estimates in the areas of revenue recognition, income taxes, stock-based compensation, and marketable securities, and bases the estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. For a complete description of the Company’s accounting policies, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, "Overview," and Notes to Consolidated Financial Statements in Neurogen Corporation’s Form 10-K for the year ended December 31, 2002. These judgments and estimates have not changed since year end.

RESULTS OF OPERATIONS
Results of operations may vary from period to period depending on numerous factors, including the timing of revenue earned under existing or future collaborative research agreements, technology transfer agreements or joint ventures, the progress of the Company's partnered research and development projects, the size of the Company’s staff and the level of preclinical and clinical development spending on drug candidates in unpartnered programs. Neurogen believes its research and development costs may increase significantly over the next several years as its drug development programs progress. In addition, general and administrative expenses would be expected to increase to support any expanded research and development activities.

Three Months Ended September 30, 2003 and 2002
The Company's operating revenues for each of the three month periods ended September 30, 2003 and 2002 were $1.5 million. Revenues for both periods consisted of license fees and funding for research services performed under the Aventis agreement (described below).

Research and development expenses, excluding non-cash stock compensation charges, decreased 1% for the three months ended September 30, 2003 compared to the same period in 2002, due to an increase in clinical trials expense for Neurogen’s Phase II inflammation trials, offset by decreases in salaries, benefits and laboratory expenses from a reduced research staff (lower by an average of 22%). In October 2002 the Company announced a reduction in force as part of its Operational Excellence program, in order to further enhance the efficiency of its drug development platform, reduce costs and to more closely align the Company’s investment of resources with long-term business goals. Research expenses were 86% and 83% of total operating expenses (excluding non-cash stock compensation charges) for the three months ended September 30, 2003 and 2002 respectively.

General and administrative expenses, excluding non-cash stock compensation charges, decreased 21% for the three months ended September 30, 2003 compared to the same period in 2002 due primarily to a reduced administrative staff (lower by an average of 22%), which resulted in lower salaries and benefits as well as decreases in legal and investor relations expenses as part of the company’s Operational Excellence program mentioned above, offset by an increase in the Company’s insurance expense.

The stock compensation expense portion of research and development and general and administrative expense is composed of continuing non-cash charges for grants of certain stock awards in 1997, 2001, 2002 and 2003 to certain officers of the Company and consultants. A portion of these stock compensation charges (those relating to the 1997 awards) are variable and as a result may fluctuate significantly in the future.

Other income, net of interest expense, was $0.4 million for the three months ended September 30, 2003 compared to $0.3 million for the same period in 2002. The $0.1 million increase in 2003 is primarily due to a decrease in interest expense as a result of a declining outstanding principal loan balance.

For the three month period ended September 30, 2003, the Company recorded a net income tax benefit of $0.3 million. This benefit is the result of the filing in September 2003 of the Company’s 2002 tax return with the State of Connecticut whereby the Company elected to exchange its 2002 research and development credits for cash at the statutorily provided exchange rate of 65%.

The Company recognized a net loss of $7.4 million for the three months ended September 30, 2003 compared to $7.8 million for the same period in 2002. The $0.4 million decrease in the 2003 net loss is primarily due to the decrease in operating expenses as described above.

Nine Months Ended September 30, 2003 and 2002
The Company's operating revenues for the nine months ended September 30, 2003 were $4.5 million compared to $12.4 million for the comparable period in 2002. The $7.9 million decrease consists of a $7.4 million decrease in license fee revenues and a $0.5 million decrease in research and development revenues. The decrease in license fees is due to a decrease in AIDD™ technology development and improvement services related to the Pfizer Technology Transfer Agreement (described below) which was concluded in June 2002 and the decrease in research revenues is due to variable timing of research services performed under the Aventis agreement (described below) due to stages of the research in progress.

Research and development expenses, excluding non-cash stock compensation charges decreased 12% for the nine months ended September 30, 2003 compared to the same period in 2002 due to a reduced staff (lower by an average of 19%), which resulted in lower salaries, benefits and laboratory expenses offset by an increase in clinical trials expense for Neurogen’s Phase II inflammation trials. In October 2002, the Company announced a reduction in force as part of its Operational Excellence program to further enhance the efficiency of its drug development platform, reduce costs and to more closely align the Company’s investment of resources with long-term business goals. Research expenses were 85% and 84% of total operating expenses (excluding non-cash stock compensation charges) for the nine months ended September 30, 2003 and 2002 respectively.

General and administrative expenses, excluding non-cash stock compensation charges, decreased 23% for the nine months ended September 30, 2003 compared to the same period in 2002 due primarily to a reduced administrative staff (lower by an average of 22%), which resulted in lower salaries and benefits as well as decreases in legal, consulting and investor relations expenses as part of the Company’s Operational Excellence program mentioned above, offset by an increase in the Company’s insurance expense.

The stock compensation expense portion of research and development and general and administrative expense is composed of continuing non-cash charges for grants of certain stock awards in 1997, 2001, 2002 and 2003 to certain officers of the Company and consultants. A portion of these stock compensation charges (those relating to the 1997 awards) are variable and as a result may fluctuate significantly in the future.

Other income, net of interest expense, was $1.0 million for the nine months ended September 30, 2003 compared to $1.3 million for the nine months ended September 30, 2002. The $0.3 million decrease in 2003 is primarily due to a decrease in investment income due to lower average cash and marketable securities balances offset by a decrease in interest expense as a result of a declining outstanding principal loan balance.

For the nine month period ended September 30, 2003, the Company recorded a net income tax benefit of $0.3 million. This benefit is the result of the filing in September 2003 of the Company’s 2002 tax return with the State of Connecticut whereby the Company elected to exchange its 2002 research and development credits for cash at the statutorily provided exchange rate of 65%.

The Company recognized a net loss of $23.1 million for the nine months ended September 30, 2003 compared to $19.2 million for the same period in 2002. The $3.9 million increase in the 2003 net loss is primarily due to decreases in operating revenues and investment income as described above, offset with the decrease in research and development and general and administrative expenses as described above.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2003 and December 31, 2002, cash, cash equivalents and marketable securities in the aggregate were $53.3 million and $79.4 million, respectively. A total amount of $20.6 million of the marketable securities at September 30, 2003 have maturities greater than one year. However, the Company can and may liquidate such investments prior to maturity to meet its strategic and/or investment objectives. The Company's cash and other short-term investment levels decreased in the first nine months of 2003, due primarily to continued operating expenses and payments on outstanding loans (described below). This decrease was partially offset by the receipt of the funded research and development payments from Aventis. The levels of cash, cash equivalents and marketable securities have fluctuated significantly in the past and are expected to do so in the future as a result of the factors described below. The Company plans to use its cash, cash equivalents and marketable securities for its research and development activities, working capital and general corporate purposes.

Neurogen's cash requirements to date have been met by the proceeds of its equity financing activities, amounts received pursuant to collaborative research, licensing or technology transfer arrangements, certain debt arrangements and interest earned on invested funds. The Company's equity financing activities have included underwritten public offerings of common stock, private placement offerings of common stock and private sales of common stock in connection with collaborative research and licensing agreements. Total funding received from these financing activities was approximately $146.6 million. The Company's expenditures have been primarily to fund research and development and general and administrative expenses and to construct and equip its research and development facilities.

The Company is in the early stage of product development. It has not derived any product revenues from product sales and does not expect to derive any product revenues for at least the next several years, if at all. Prior to deriving any such product revenues, the Company expects to incur significant losses and negative cash flows which in the aggregate could exceed the Company’s existing cash resources. To provide cash to fund its operations until such time as it achieves sustainable revenues, the Company relies extensively on its ability to develop drug discovery programs of sufficient value to either partner the programs with pharmaceutical companies or raise capital through equity financings.

To the extent that drug candidates progress in the Company’s currently unpartnered programs, such as its program for the treatment of inflammatory disorders or its program for the treatment of pain, such progress could lead to the opportunity to partner on terms which provide capital, revenues and cash flows to the Company or the opportunity to raise capital through equity offerings. If unpartnered programs do not progress or do not progress on schedule, such opportunities would be delayed or may not materialize at all.

To the extent that drug candidates progress in the Company’s partnered programs, such as the Company’s depression and anxiety program partnered with Aventis or its insomnia program partnered with Pfizer, such progress could result in milestone payments and, in the case of Aventis, additional research and development funding to the Company under the respective collaboration agreements. Such progress could also provide the opportunity to raise capital through equity offerings. If partnered programs do not progress or do not progress on schedule, such opportunities would be delayed or may not materialize at all.

Lack of progress, scheduling delays or failures in any of the Company’s major programs could significantly reduce the Company’s levels of revenues, cash flows and cash available to fund its business. It could also significantly increase the Company’s cost of capital and limit its ability to raise equity capital. All of the Company’s compounds in development, whether in human clinical trials or not, will require significant additional research, development and testing before they can be commercialized. Furthermore, the scope, magnitude and timing of future research and development expenses, as well as anticipated project completion dates, are a series of steps, ranging from preclinical testing to clinical studies in humans. Each step in the process is typically more expensive than the previous step, but actual timing and cost for completion depends on the specific progress of each product being tested.

While the Company cannot accurately predict the time required or the cost involved in commercializing any one of its candidates, new drug development typically takes many years and tens or hundreds of millions of dollars. In addition, developing new drugs is an extremely uncertain process where most candidates fail and uncertain developments such as clinical or regulatory delays, side effects, undesirable drug properties or ineffectiveness of a drug candidate would slow or prevent the development of a product. If we or our partners are unable to commercialize one or more of our drug products, we will never achieve product revenues and may eventually be unable to continue our operations. This result would cause our shareholders to lose all or a substantial portion of their investment.

The debt agreements entered into by the Company to date include a commercial term mortgage loan financing in December 2001 with Webster Bank, and a construction loan entered into in October 1999 with Connecticut Innovations, Inc. ("CII"). Total proceeds received under these agreements were $22.5 million, which are repayable through monthly installments over a maximum term of 15 years, bearing various interest rates which approximated 3.6%-7.5% from 1999 through 2003. Of these amounts received $12.1 million and $4.5 million remained outstanding as of September 30, 2003 under the Webster Bank facility and the CII facility, respectively. An approximate aggregate amount of $1.4 million is due and payable in each of the next five years. Thereafter, approximately $9.6 million is payable in regular installments until the scheduled maturity dates, including a balloon payment of $2.5 million on the mortgage loan upon maturity in December 2011. As of September 30, 2003, Neurogen is not engaged in any significant lease or capital expenditure commitments.

Under the Webster Bank facility agreement the Company is required to comply with certain covenants, including a requirement that the Company maintain at least $25 million in cash and marketable securities and that the ratio of the outstanding loan balance less any cash collateral to the appraised value of the real property ("loan to value" ratio), as periodically determined by the Bank in its sole but reasonable discretion, will not exceed 72%. In the second quarter of 2003, the Company received notice from the Bank asserting that this ratio exceeded 72%. Neurogen was informed by the Bank that it was using a different standard in calculating the Company’s compliance with this covenant than that used when Neurogen and the Bank entered into the loan agreement and that federal regulations required the bank to use this different standard. In the third quarter, the Company and the Bank agreed to amend the loan to value ratio from 72% to 85%, and the Company agreed to pay $3.4 million of the loan balance, in addition to the previously scheduled loan repayments. As of the end of the third quarter the Company believes it is in compliance with all loan covenants.

Neurogen anticipates its current cash balance, as supplemented by research funding pursuant to its collaborative research agreement with Aventis, will be sufficient to fund its current and planned operations into at least early 2005. However, Neurogen's funding requirements may change and will depend upon numerous factors, including but not limited to: the progress of the Company's research and development programs; the timing and results of preclinical testing and clinical studies; the timing of regulatory approvals; determinations as to the commercial potential of its proposed products; the status of competitive products and the ability of the Company to establish and maintain collaborative arrangements with others for the purpose of funding certain research and development programs; conducting clinical studies; obtaining regulatory approvals and, if such approvals are obtained, manufacturing and marketing products. Many of these factors could significantly increase the Company's expenses and use of cash. The Company anticipates that it may augment its cash balance through financing transactions, including the issuance of debt or equity securities and further corporate alliances. The Company has filed an S-3 registration statement which became effective in February 2003, under which the Company may issue debt, common or preferred stock or warrants of up to $75 million in total financing within two years of the effective date. No assurances can be given that adequate levels of additional funding can be obtained on favorable terms, if at all.

As of December 31, 2002, the Company had approximately $112.5 million and $7.0 million of net operating loss and research and development credit carryforwards, respectively, available for federal income tax purposes, which expire in the years 2004 through 2022. The Company also had approximately $98.9 million and $3.9 million of Connecticut state tax net operating loss and research and development credit carryforwards, respectively, which expire in the years 2003 through 2022. Because of "change in ownership" provisions of the Tax Reform Act of 1986, the Company's utilization of its net operating loss and research and development credit carryforwards may be subject to an annual limitation in future periods.

COLLABORATIVE RESEARCH AGREEMENTS

Aventis
In December 2001, Neurogen entered into a collaboration and license agreement with Aventis pursuant to which Aventis made an initial payment of $10 million and agreed, among other things, to fund a specified level of resources for three years for Neurogen's program for the discovery and research of CRF-1 receptor-based drugs for a broad range of applications, including the therapeutic treatment of depression and anxiety disorders. Aventis has the option to extend the discovery and research effort for up to an additional two years or terminate the collaboration prior to its scheduled conclusion and transfer all rights to the collaborative program to Neurogen. As of September 30, 2003, the Company has received $6.4 million of research funding from Aventis. Neurogen is also eligible to receive milestone payments if certain compound discovery, product development or regulatory objectives are achieved subject to the collaboration. In return, Aventis received the exclusive worldwide rights to develop, manufacture and market collaboration drugs that act through the CRF-1 receptor, for all therapeutic indications for which the drugs may be used. Aventis will pay Neurogen royalties based upon net sales levels, if any, for collaboration products. Also under the agreement, Aventis is responsible for funding the cost of development, including clinical trials, manufacturing and marketing of collaboration products, if any.

Pfizer
In June 1999, Neurogen and Pfizer entered into the Pfizer Technology Transfer Agreement. Under the terms of this agreement, Pfizer agreed to pay Neurogen up to a total of $27.0 million over a three year period for the licensing and transfer to Pfizer of certain of Neurogen's AIDD™ technologies for the discovery of new drugs, along with the installation of an AIDD™ system. Additional payments were also possible upon Pfizer's successful utilization of this technology. Pfizer received a non-exclusive license to certain AIDD™ intellectual property and the right to employ this technology in its own drug discovery programs. As of September 30, 2003, Pfizer had provided $29.0 million pursuant to the Pfizer Technology Transfer Agreement, which terminated on schedule in June 2002. Total fees include a $2.0 million one-time payment in December 2002 to satisfy all future obligations from Pfizer’s use of the AIDD™ technology.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board issued FIN No. 46, "Consolidation of Variable Interest Entities" to improve financial reporting by enterprises involved with variable interest entities. The Interpretation addresses how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. The Interpretation is effective immediately for variable interest entities created after January 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not hold any investments or interest that would be considered variable interest entities and, accordingly, the adoption of FIN No. 46 did not have any impact on the Company’s operating results or financial position.

In May 2003 the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures financial instruments. The standard is effective for new or modified financial instruments after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not currently have any financial instruments within the scope of SFAS No. 150 and, accordingly, the adoption of SFAS No. 150 was not material to the Company’s operating results or financial position.

In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." The standard is effective for transactions after June 30, 2003. The adoption of SFAS No. 149 was not material to the Company’s operating results or financial position.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk. The Company's investment portfolio includes investment grade debt instruments. These securities are subject to interest rate risk, and could decline in value if interest rates fluctuate. Due to the short duration and conservative nature of these instruments, the Company does not believe that it has a material exposure to interest rate risk. Additionally, funds available from investment activities are dependent upon available investment rates. These funds may be higher or lower than anticipated due to interest rate volatility.

Capital market risk. The Company currently has no product revenues and is dependent on funds raised through other sources. One source of funding is through further equity offerings. The ability of the Company to raise funds in this manner is dependent upon capital market forces affecting the stock price of the Company.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the quarter, September 30, 2003, management, including the Company's Chief Executive Officer and Chief Business Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, and as of the end of the quarter for which this report is made, the Chief Executive Officer and Chief Business Officer concluded that the disclosure controls and procedures were effective, in all material respects, as of the end of the period covered by this report. Management, including the Company's Chief Executive Officer and Chief Business Officer, also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the period covered by this report.

 

 

Part II - Other Information

Item 1. Legal Proceedings

Not applicable for the third quarter ended September 30, 2003.

Item 2. Changes in Securities and Use of Proceeds

Not applicable for the third quarter ended September 30, 2003.

Item 3. Defaults upon Senior Securities

Not applicable for the third quarter ended September 30, 2003.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable for the third quarter ended September 30, 2003.

Item 5. Other Information

Not applicable for the third quarter ended September 30, 2003.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) The Company filed an 8-K reporting its financial results in a press release on November 12, 2003.

 


SAFE HARBOR STATEMENT

Statements which are not historical facts, including statements about the Company's confidence and strategies, the status of various product development programs, the sufficiency of cash to fund planned operations and the Company's expectations concerning its development compounds, drug discovery technologies and opportunities in the pharmaceutical marketplace are "forward looking statements" within the meaning of the Private Securities Litigations Reform Act of 1995 that involve risks and uncertainties and are not guarantees of future performance. These risks include, but are not limited to, difficulties or delays in development, testing, regulatory approval, production and marketing of any of the Company's drug candidates, the failure to attract or retain scientific management personnel, any unexpected adverse side effects or inadequate therapeutic efficacy of the Company's drug candidates which could slow or prevent product development efforts, competition within the Company's anticipated product markets, the Company's dependence on corporate partners with respect to research and development funding, regulatory filings and manufacturing and marketing expertise, the uncertainty of product development in the pharmaceutical industry, inability to obtain sufficient funds through future collaborative arrangements, equity or debt financings or other sources to continue the operation of the Company's business, risk that patents and confidentiality agreements will not adequately protect the Company's intellectual property or trade secrets, dependence upon third parties for the manufacture of potential products, inexperience in manufacturing and lack of internal manufacturing capabilities, dependence on third parties to market potential products, lack of sales and marketing capabilities, potential unavailability or inadequacy of medical insurance or other third-party reimbursement for the cost of purchases of the Company's products, and other risks detailed in the Company's Securities and Exchange Commission filings, including its Annual Report on Form 10-K for the year ended December 31, 2002, each of which could adversely affect the Company's business and the accuracy of the forward-looking statements contained herein.

SIGNATURE

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.

 
NEUROGEN CORPORATION
 
By:   
/s/ STEPHEN R. DAVIS
 

 
Stephen R. Davis
Executive Vice President
and Chief Business Officer
Date: November 14, 2003