U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

Commission File Number: 000-31979

 

Array BioPharma Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

Check 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 ý   No o

 

Check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý   No o

 

As of May 9, 2003, the registrant had  28,102,177 shares of common stock, par value $.001 per share, outstanding.

 

 

ARRAY BIOPHARMA INC.

TABLE OF CONTENTS

 

 

PART I - FINANCIAL INFORMATION			3
Item 1.		Financial Statements	3
		Condensed Balance Sheets at March 31, 2003 (unaudited) and June 30, 2002	3
		Condensed Statements of Operations - Three and Nine Months Ended March 31, 2003 and 2002 (unaudited)	4
		Condensed Statements of Cash Flows - Nine Months Ended March 31, 2003 and 2002 (unaudited)	5
		Notes to Condensed Financial Statements (unaudited)	6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	17
Item 4.		Controls and Procedures	17
PART II - OTHER INFORMATION				18
Item 6.	Exhibits and Reports on Form 8-K		18
SIGNATURES				19

 

2

 

PART I.

 

Item 1. Financial Statements

 

ARRAY BIOPHARMA INC.

CONDENSED BALANCE SHEETS

 

		March 31, 2003			June 30, 2002
		(Unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	26,837,163		$	35,385,675
Marketable securities		14,171,485			24,212,076
Accounts receivable, net		1,433,659			2,491,749
Inventories, net		12,254,466			8,469,663
Prepaid expenses, advances and deposits		563,634			805,244
Total current assets		55,260,407			71,364,407
Property, plant and equipment, net		39,566,151			35,788,062
Other assets		870,492			762,516
Total assets		$	95,697,050		$	107,914,985
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable trade		$	2,818,351		$	6,369,541
Advance payments from customers		3,740,621			5,897,467
Accrued compensation and benefits		1,206,309			1,102,402
Other current liabilities		1,188,592			644,539
Total current liabilities		8,953,873			14,013,949
Stockholders’ equity
Preferred stock		—			—
Common stock		28,069			27,520
Additional paid-in capital		124,457,306			123,274,749
Accumulated deficit		(34,803,488		)	(24,581,893		)
Notes receivable for common stock - related party		—			(155,625		)
Accumulated other comprehensive income		31,610			33,300
Deferred compensation		(2,970,320		)	(4,697,015		)
Total stockholders’ equity		86,743,177			93,901,036
Total liabilities and stockholders’ equity		$	95,697,050		$	107,914,985

 

See notes to condensed financial statements

 

3

 

ARRAY BIOPHARMA INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2003			2002			2003			2002
Revenue
Collaboration revenue		$	7,744,103		$	9,241,968		$	26,979,525		$	24,099,614
License, royalty and milestone revenue		282,414			261,533			1,053,177			954,519
Total revenue		8,026,517			9,503,501			28,032,702			25,054,133
Costs and expenses
Cost of revenue*		5,753,574			5,254,253			17,423,544			14,791,726
Research and development expenses*		6,013,884			3,663,681			14,657,475			9,711,158
Selling, general and administrative expenses*		2,544,759			1,726,831			6,832,263			5,275,563
Total operating expenses		14,312,217			10,644,765			38,913,282			29,778,447
Loss from operations		(6,285,700		)	(1,141,264		)	(10,880,580		)	(4,724,314		)
Interest income		172,205			276,986			658,985			1,089,157
Net loss		$	(6,113,495	)	$	(864,278	)	$	(10,221,595	)	$	(3,635,157	)
Basic and diluted net loss per share		$	(0.22	)	$	(0.03	)	$	(0.37	)	$	(0.15	)
Number of shares used to compute per share data		27,930,326			25,437,724			27,734,848			24,091,905
*  Includes compensation related to option grants
Cost of revenue		$	264,902		$	270,755		$	794,706		$	812,265
Research and development expenses		176,602			180,504			529,806			541,510
Selling, general and administrative expenses		134,061			137,456			402,183			579,071
Total		$	575,565		$	588,715		$	1,726,695		$	1,932,846

 

See notes to condensed financial statements

 

4

 

ARRAY BIOPHARMA INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine Months Ended March 31,
		2003			2002
Operating activities
Net loss		$	(10,221,595	)	$	(3,635,157	)
Adjustments to reconcile net loss to net cash provided by  (used in) operating activities:
Depreciation		5,166,198			3,237,219
Compensation related to stock option grants		1,726,695			1,932,846
Changes in operating assets and liabilities		(7,546,737		)	(576,696		)
Net cash provided by (used in) operating activities		(10,875,439		)	958,212
Investing activities
Purchases of property, plant and equipment and long-term assets		(9,052,263		)	(16,522,372		)
Purchases of marketable securities		(32,002,379		)	(29,046,456		)
Proceeds from sale or maturity of marketable securities		42,041,280			39,656,000
Net cash provided by (used in) investing activities		986,638			(5,912,828		)
Financing activities
Proceeds from sale of common stock, net of issuance costs		—			31,888,047
Proceeds from exercise of stock options, shares issued under the employee stock purchase plan and repayment of notes receivable		1,340,289			1,193,274
Net cash provided by financing activities		1,340,289			33,081,321
Net increase (decrease) in cash and cash equivalents		(8,548,512		)	28,126,705
Cash and cash equivalents, beginning of period		35,385,675			17,961,699
Cash and cash equivalents, end of period*		$	26,837,163		$	46,088,404

 

* Excludes marketable securities totaling $14,171,485 and $18,912,027 as of March 31, 2003 and 2002, respectively.

 

See notes to condensed financial statements

 

5

 

ARRAY BIOPHARMA INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

March 31, 2003

(Unaudited)

 

Note 1: Basis of Presentation

 

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the three-month and nine-month periods ended March 31, 2003, are not necessarily indicative of the results that may be expected for the year ending June 30, 2003. For further information, refer to the financial statements and footnotes thereto as of and for the year ended June 30, 2002, included in the Annual Report on Form 10-K of Array BioPharma Inc. (the “Company” or “Array”) filed on September 30, 2002, with the Securities and Exchange Commission.

 

Note 2: Inventory Components

 

		March 31, 2003			June 30, 2002
Fine chemicals		$	3,145,512		$	2,624,354
Lead Generation Libraries, custom libraries and Optimer building blocks		9,984,263			6,464,234
Total inventories at cost		13,129,775			9,088,588
Less reserves		(875,309		)	(618,925		)
Total inventories, net		$	12,254,466		$	8,469,663

 

Note 3: Comprehensive Loss

 

A reconciliation of net loss to comprehensive loss is as follows:

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2003			2002			2003			2002
Net loss		$	(6,113,495	)	$	(864,278	)	$	(10,221,595	)	$	(3,635,157	)
Change in unrealized gain (loss) on  marketable securities		(33,720		)	(173,049		)	(1,690		)	(228,585		)
Total comprehensive loss		$	(6,147,215	)	$	(1,037,327	)	$	(10,223,285	)	$	(3,863,742	)

 

6

 

Note 4: Preferred and Common Stock

 

On November 17, 2000, the Company completed an initial public offering of 7,475,000 shares of its common stock, including 975,000 shares for the exercise of the underwriters’ over-allotment option. Concurrent with the initial public offering, all of the 11,501,666 shares of convertible preferred stock outstanding automatically converted into common stock at a one-to-one ratio. The Company received net proceeds of $50.8 million from its initial public offering, net of $5.3 million in expenses and underwriters’ discount relating to the issuance and distribution of the securities.

 

On February 12, 2002, the Company completed a follow-on public offering of 3,450,000 shares of its common stock, including 450,000 shares for the exercise of the underwriters’ over-allotment option. The Company received net proceeds of $31.8 million from this public offering, net of $2.7 million in expenses and underwriters’ discount relating to the issuance and distribution of the securities.

 

In September 2002, the Company received $157,183 from a Company founder as full repayment of an outstanding note receivable balance, including accrued interest, payable in connection with the purchase by the founder of shares of the Company’s common stock in May 1998. All notes receivable for common stock have been fully repaid by the Company founders.

 

Note 5: Revenue Recognition

 

The Company recognizes revenue from fees under its collaboration agreements on a monthly basis as research is performed. Development and fixed-fee revenue is recognized on a percentage-of-completion basis. Per-compound revenue is recognized as compounds are shipped. Revenue from license fees and up-front fees is recognized over the term of the license or over the expected term of the collaboration agreement. Royalty revenue is recorded when earned. Milestone payments are recognized as revenue based upon the stage of completion of the Company’s performance obligations under the related contract.

 

In general, contract provisions include predetermined payment schedules or the submission of appropriate billing detail. Any payments received in advance from these agreements are recorded as advanced payments from customers until the revenue is earned. The Company reports revenue from collaboration agreements, which include lead generation and lead optimization research, custom synthesis and process research and the development and sale of chemical compounds, as collaboration revenue in its statement of operations. License, royalty and milestone revenue are combined and reported separately from collaboration revenue.

 

Note 6: Net Loss Per Share

 

Basic and diluted net loss per share has been computed by dividing net loss for the period by the weighted average number of common shares outstanding during the period. The Company has excluded the effects of outstanding stock options from the calculation of diluted net loss per share because all such securities are anti-dilutive for all applicable periods presented.

 

Note 7: Stockholder Rights Plan

 

In August 2001, the Company adopted a Stockholder Rights Plan designed to ensure that the Company’s stockholders receive fair and equal treatment in the event of an unsolicited attempt to take control of the Company and to deter coercive or unfair tactics by potential acquirers. The Stockholder

 

7

 

Rights Plan imposes a significant penalty upon any person or group that acquires 15% or more of the Company’s outstanding common stock without the approval of the Company’s Board of Directors. Under the Stockholder Rights Plan, a dividend of one Preferred Stock Purchase Right was declared for each common share held of record as of the close of business on August 27, 2001. Each right entitles the holder to purchase 1/100^th of a share of Series A Junior Participating Preferred Stock for an exercise price of $70.00 per share. The rights generally will not become exercisable unless an acquiring entity accumulates or initiates a tender offer to purchase 15% or more of the Company’s common stock. In that event, each right will entitle the holder, other than the unapproved acquirer and its affiliates, to purchase upon the payment of the exercise price a number of shares of the Company’s common stock having a value of two times the exercise price. If the Company is not the surviving entity in a merger or stock exchange, or 50% or more of the Company’s assets or earning power are sold in one or more related transactions, each right would entitle the holder thereof to purchase for the exercise price a number of shares of common stock of the acquiring company having a value of two times the exercise price. The rights expire on August 2, 2011.

 

Note 8: Stock-Based Compensation

 

The Company accounts for its stock-based compensation arrangements under the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related pronouncements. Under the provisions of APB 25, no compensation expense is recognized when stock options are granted with exercise prices equal to or greater than market value on the date of grant.

 

The Company adopted the disclosure requirements of FASB Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, which amends the disclosure provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), and APB Opinion No. 28, Interim Financial Reporting, to require disclosure of the method of accounting used for stock-based compensation and the effects of this method on reported net income and earnings per share for annual and interim financial statements.  The following table illustrates the effect on net loss and net loss per share assuming the estimated fair value of the options granted is amortized to expense over the option-vesting period as required by SFAS 123.

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2003			2002			2003			2002
Net loss, as reported		$	(6,113,495	)	$	(864,278	)	$	(10,221,595	)	$	(3,635,157	)
Add: Stock-based employee compensation expense included in reported net loss		575,565			588,715			1,726,695			1,932,846
Less: Total stock-based employee compensation expense determined under fair value based methods for all options granted		(2,110,533		)	(1,380,597		)	(6,264,350		)	(4,016,569		)
Pro forma net loss		$	(7,648,463	)	$	(1,656,160	)	$	(14,759,250	)	$	(5,718,880	)
Net loss per share:
Basic and diluted - as reported		$	(0.22	)	$	(0.03	)	$	(0.37	)	$	(0.15	)
Basic and diluted - pro forma		$	(0.27	)	$	(0.07	)	$	(0.53	)	$	(0.24	)

 

8

 

Note 9: Restructuring

 

In July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS 146 during the third quarter of fiscal 2003. In March 2003, the Company reduced its workforce in order to reduce costs and match its headcount resources with the near-term demand for its collaboration programs. As of March 31, 2003, 31 employees were terminated across all employee levels and business functions. This reduction resulted in a charge to operations in the third quarter of fiscal 2003 of approximately $579,000 for termination-related costs. Termination costs include severance packages and out-placement services for affected employees and are included in selling, general and administrative expenses on the statement of operations and in other current liabilities on the balance sheet at March 31, 2003. As of March 31, 2003, approximately $39,000 in termination-related costs had been paid and the remaining termination costs are expected to be paid in full by June 30, 2003. The table below displays the activity and liability balance of this charge.

 

		Balance at 6/30/2002			Charges			Payments			Balance at 3/31/2003
Termination-related costs		$	—		$	579,300		$	39,183		$	540,117

 

Note 10: Financial Guarantees

 

At March 31, 2003, the Company had restricted cash of $1.1 million as a compensating balance to support outstanding letters of credit that were issued during the prior fiscal year in relation to its facilities leases.

 

Note 11: Collaboration Agreement

 

In September 2002, the Company entered into a drug discovery collaboration agreement with InterMune, Inc. to create small molecule therapeutics for hepatitis. InterMune will fund drug discovery research conducted by the Company based on the number of Company scientists working on the research phase of the agreement. InterMune will be responsible for all development and commercialization. The Company will be entitled to receive milestone payments based on the selection and progress of clinical drug candidates, as well as royalties on net sales of products derived from the collaborative efforts. 

 

9

 

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

 

The Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about our expectations related to realizing new revenue streams and obtaining future collaboration agreements that include milestone and/or royalty payments, the success of our internal proprietary drug discovery activities and our future headcount requirements. These statements involve significant risks and uncertainties, including those discussed below and those described more fully in other reports filed by Array BioPharma with the Securities and Exchange Commission. Because these statements reflect our current expectations concerning future events, our actual results could differ materially from those anticipated in these forward-looking statements. The factors that could cause actual results to differ from our expectations include, but are not limited to, our ability to achieve and maintain profitability, the willingness of the pharmaceutical and biotechnology industries to collaborate with third parties, particularly Array, on their drug discovery activities, our ability to create successful drug candidates, and our ability to attract and retain experienced scientists and management, and the risk factors contained in the Annual Report on Form 10-K filed by Array with the Securities and Exchange Commission on September 30, 2002.  We are providing the information in this quarterly report filed on Form 10-Q as of the date of this report. We undertake no duty to update any forward-looking statements to reflect the effect on those statements of subsequent events or changes in our expectations or assumptions.

 

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this report.

 

Overview

 

Array BioPharma is a drug discovery company creating new small molecule drugs through the integration of chemistry, biology and informatics. Our experienced scientists use the Array Discovery Platform, our integrated set of drug discovery technologies, to invent novel small molecule drugs in collaboration with leading pharmaceutical and biotechnology companies and to build our own pipeline of proprietary drug candidates.

 

We have incurred net losses since inception and expect to incur losses in the near future as we increase our investment in our own proprietary drug candidates. To date, we have funded our operations primarily through the issuance of equity securities and revenue from our collaborators. As of March 31, 2003, we had an accumulated deficit of $34.8 million.

 

We generate revenue by researching, designing, synthesizing and screening chemical compounds for the invention of drug candidates for our collaborators. We report revenue from collaboration agreements, which include lead generation and lead optimization research, custom synthesis and process research and the development and sale of chemical compounds, as collaboration revenue in our statement of operations. License, royalty and milestone revenue are combined and reported separately from collaboration revenue.

 

Our collaborations include lead generation, lead optimization, custom synthesis and process research and development. We provide lead generation capabilities, including structural biology and screening compound libraries, to invent lead candidates for our collaborators and lead optimization capabilities to refine and optimize potential drug candidates. We also design, synthesize and provide libraries of chemical compounds or single compounds to our collaborators on a custom basis, with either an exclusive or non-exclusive license to use the compounds. We assist collaborators in process research and development, which involves developing the processes to make, and synthesizing for delivery, the

 

10

 

larger quantities of chemical compounds required for clinical testing.  We have completed construction of a manufacturing facility, which will allow us to produce chemical compounds that meet current good manufacturing practices (cGMP) requirements for Phase I clinical testing. We recently completed validation of this capability in accordance with FDA regulations and initiated our first cGMP manufacturing campaign in January 2003 for a proprietary preclinical drug candidate.

 

We license our Lead Generation Libraries, which are a collection of structurally related chemical compounds that may have the potential of becoming drug candidates, on a non-exclusive basis to our collaborators for internal research purposes. We retain all other rights to the compounds, which permits us to license the same compounds to other customers. Some of our agreements allow our collaborators to obtain exclusive rights to commercialize particular compounds upon the payment of additional fees. We sell our Optimer^â building blocks, which are the starting materials used to create more complex chemical compounds in the drug discovery process, on a per-compound basis without any restrictions on use. We are also paid under our collaboration agreements based on the number of full-time equivalent employees contractually assigned to a project, plus certain expenses. Custom collections of chemical compounds we create and custom chemical syntheses we perform under our collaboration agreements are typically charged on a per-compound basis, plus a charge for research and development services. In addition, seven of our current and two of our past collaboration agreements provide for additional payments upon the achievement of certain drug development milestones, and provide for royalty payments based on sales of products created as a result of these collaborations. Three of our collaboration agreements provided an up-front license or technology access fee, and one of our collaboration agreements generates a low level of royalty payments. In general, our collaborators may terminate their collaboration agreement with us on 30 to 90 days’ prior notice. During November 2001, we earned our first milestone payment from ICOS Corporation with the commencement of a Phase I clinical trial on a jointly identified drug candidate.

 

We have increased the number of our collaboration agreements, which has diversified our revenue base. During the nine months ended March 31, 2003, ICOS Corporation, Merck & Co., Inc., Eli Lilly and Company, and Amgen Inc. accounted for 19%, 15%, 11% and 10%, respectively, of our total revenue. During fiscal year 2002, ICOS, Pfizer Inc, Merck and Eli Lilly accounted for 17%, 16%, 15% and 14%, respectively, of our total revenue.

 

We recognize revenue from fees under our collaboration agreements on a monthly basis as research is performed. Development and fixed-fee revenue is recognized on a percentage-of-completion basis. Per-compound revenue is recognized as compounds are shipped. Revenue from license fees and up-front fees is recognized over the term of the license or over the expected term of the collaboration agreement. Royalty revenue is recorded when earned. Milestone payments are recognized as revenue based upon the stage of completion of our performance obligations under the related contract.

 

Cost of revenue consists mainly of compensation, associated fringe benefits and other collaboration-related costs, including recruiting and relocation, fine chemicals, supplies, small tools, facilities, depreciation and other direct and indirect chemical handling and laboratory support costs, excluding any costs related to research and development.

 

Research and development expenses consist of the same type of scientific expenditures that comprise cost of revenue, except that the expenses are related to the development of our early-stage intellectual property and compounds where we have not yet proven technological feasibility. Costs associated with activities where technological feasibility has been proven are charged directly to cost of revenue.

 

Selling, general and administrative expenses consist mainly of compensation and associated fringe benefits and other management, business development, accounting, information technology and

 

11

 

administration costs, including recruiting and relocation, consulting and professional services, travel and meals, advertising, sales commissions, facilities, depreciation and other office expenses. In addition, termination-related costs associated with a reduction in workforce completed in March 2003 are recorded as selling, general and administrative expenses.

 

We currently license or sell our compounds and enter into collaborations directly with pharmaceutical and biotechnology companies through opportunities identified by our senior management, scientists and customer referrals. In addition, we license or sell our compounds and collaborations in Japan through an agent. International revenue represented 9% and 12% of our total revenue during fiscal years 2001 and 2002, respectively, and 13% for the first nine months of fiscal year 2003. During fiscal year 2001, as well as the first nine months of fiscal year 2003, the majority of international revenue was attributed to Japanese sales. During fiscal year 2002, the majority of international revenue was attributed to both European and Japanese sales. All of our collaboration agreements and purchase orders are denominated in United States dollars.

 

We plan to grow revenue with our existing collaborators and realize new revenue streams through collaborations with a diversified group of pharmaceutical and biotechnology companies. In addition, we expect to enter into additional agreements that allow us to participate in the success of potential drug candidates with our collaborators through milestone and/or royalty payments. We also expect to enter into agreements to participate in the success of our proprietary potential drug candidates through a combination of licensing fees, milestone and/or royalty payments.

 

Deferred Stock Compensation

 

We recorded approximately $576,000 and $1.7 million of compensation expense related to stock option grants for the three and nine-month periods ended March 31, 2003, respectively. The compensation expense related to stock option grants is charged to cost of revenue, research and development expenses, and selling, general and administrative expenses, based on the functional responsibility of the associated employee. As of March 31, 2003, we had a total of $3.0 million of remaining deferred stock compensation to be amortized. We expect to amortize deferred stock compensation recorded through March 31, 2003, as follows: approximately $575,000 during the remainder of fiscal year 2003; $2.2 million in fiscal year 2004; and approximately $183,000 in fiscal year 2005.

 

Results of Operations

 

Three and Nine Months Ended March 31, 2003 and 2002

 

Revenue. Total revenue for the three months ended March 31, 2003 was $8.0 million, down 16% from $9.5 million in the same period of the prior year. This decrease was primarily the result of lower revenue from subscriptions and sales of our chemical compounds from our Array Discovery Platform, which decreased by $3.8 million during the third quarter of fiscal 2003 over the comparable period of fiscal 2002. The $3.8 million decrease is attributable to a single major pharmaceutical company. During the third quarter of fiscal 2003, our revenue from lead optimization collaborations increased by $2.3 million, compared to the same period in the prior year primarily from our new collaboration agreements with Japan Tobacco Inc., Syrrx, Inc. and InterMune, Inc., as well as our custom library collaboration with Merck. Total revenue increased to $28.0 million for the nine months ended March 31, 2003, up 12% from $25.1 million in the same period of the prior year. This increase was primarily the result of $7.4 million of additional revenue generated from our lead optimization collaborations with ICOS, Vertex Pharmaceuticals Incorporated, Takeda Chemical Industries, Ltd., Japan Tobacco, Syrrx, and InterMune, and our custom library collaboration with Merck.  In addition, revenue from subscriptions and sales of

 

12

 

chemical compounds from our Array Discovery Platform decreased by $4.5 million for the nine months ended March 31, 2003, compared to the same period in the prior year. This decrease is attributable to the net reduction of $5.5 million of sales of chemical compounds to a single major pharmaceutical company. Two of our lead optimization collaborations ended on March 31, 2003. As a result, we expect a decline in our revenue for the fourth quarter of fiscal 2003, compared to the levels achieved in the quarter ended March 31, 2003.

 

Cost of revenue. Cost of revenue increased to $5.8 million for the three months ended March 31, 2003, from $5.3 million in the same period of the prior year. Cost of revenue was $17.4 million and $14.8 million for the nine months ended March 31, 2003 and 2002, respectively.  These increases reflect the increased cost to support the growth in our lead optimization collaborations over the same period. The cost increase was primarily attributed to additional scientific staff, associated salaries and benefits, and the expenditures associated with equipping and commencing operations in our new and expanded facilities. Cost of revenue increased to 72% of revenue for the three months ended March 31, 2003, from 55% in the same period of the prior year. Cost of revenue was 62% of revenue and 59% for the nine months ended March 31, 2003 and 2002, respectively.   The increased cost of revenue as a percentage of revenue for the three and nine months ended March 31, 2003, was due primarily to lower revenue being generated from subscriptions and sales of chemical compounds from our Array Discovery Platform.

 

Research and development expenses.  Research and development expenses increased to $6.0 million for the three months ended March 31, 2003, from $3.7 million in the same period of the prior year. Research and development expenses were $14.7 million and $9.7 million for the nine months ended March 31, 2003 and 2002, respectively. Approximately $1.4 million and $3.8 million of the increase in research and development expenses for the three and nine month periods ended March 31, 2003, respectively, was attributed to expansion of our own proprietary drug discovery efforts, while the remainder of the increase was for our Lead Generation Libraries, Optimer^â building blocks and custom library collaborations. These expanded research efforts required the recruitment and relocation of additional scientific staff and associated salaries and benefits, and the expenditures associated with equipping and commencing operations in our new and expanded facilities.

 

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $2.5 million for the three months ended March 31, 2003, compared to $1.7 million in the same period of the prior year. Selling, general and administrative expenses were $6.8 million and $5.3 million for the nine months ended March 31, 2003 and 2002, respectively. During March 2003, we reduced our workforce by 31 employees in order to reduce costs and match our headcount resources with the near-term demand for our collaboration programs. This reduction resulted in a charge to operations of approximately $579,000 for termination-related costs consisting primarily of severance payments and out-placement services for affected employees. As of March 31, 2003, approximately $39,000 of these costs had been paid, and we expect that the remaining costs will be paid by June 30, 2003. Selling, general and administrative expenses for the three months ended March 31, 2003, without these termination-related costs, were $2.0 million, up from $1.7 million in the same period of the prior year. For the nine months ended March 31, 2003, selling, general and administrative expense without these termination-related costs were $6.3 million, up from $5.3 million in the same period of the prior year. These increases since the third quarter of the prior year were primarily attributed to expanded management and increased business development and administrative staffing levels as well as increased facilities-related expenditures during the current fiscal year.

 

Compensation related to stock option grants. Compensation expense related to certain stock option grants was approximately $576,000 for the three months ended March 31, 2003, compared to approximately $589,000 in the same period of the prior year. For the nine months ended March 31, 2003, these charges were $1.7 million, down from $1.9 million in the same period of the prior year. This

 

13

 

noncash charge is recognized on a straight-line basis over the vesting periods of the related options, which are generally four years, except for options with performance-based vesting provisions.

 

Interest income. Interest income decreased to approximately $172,000 for the three months ended March 31, 2003, from approximately $277,000 in the same period of the prior year primarily due to lower interest rates on a lower average cash balance. For the nine months ended March 31, 2003, interest income decreased to approximately $659,000, from $1.1 million in the same period of the prior year primarily due to lower interest rates earned on investments, which more than offset our increased average cash balance.

 

Liquidity and Capital Resources

 

We have historically funded our operations through revenue from our collaborations and the issuance of equity securities. As of March 31, 2003, cash, cash equivalents and marketable securities totaled $41.0 million compared to $59.6 million at June 30, 2002. Net cash used in operating activities was $10.9 million for the nine months ended March 31, 2003, compared to net cash provided by operating activities of approximately $958,000 for the same period in 2002. During the first nine months of fiscal year 2003, our net loss of $10.2 million was reduced by noncash charges of $6.9 million, and our working capital increased by $7.5 million to account for the majority of net cash used in operations. Working capital rose due to increases in inventory, while accounts payable and advance payments from customers declined.

 

During the nine months ended March 31, 2003, we invested $9.1 million in capital equipment and leasehold improvements associated with equipping and commencing operations in our new and expanded facilities. Financing activities provided $1.2 million of cash from the exercise of stock options under our stock option plan and the issuance of stock under our employee stock purchase plan. Approximately $157,000 was received in September 2002 from one of Array’s founders as full repayment of an outstanding note receivable balance, including accrued interest.

 

Our future capital requirements will depend on a number of factors, including the rate at which we grow our business and our investment in proprietary research activities, the ability of our current and future collaborators to fund outside research and development activities, our success in increasing sales of both existing and new products and collaborations, expenses associated with unforeseen litigation, regulatory changes, competition, technological developments, general economic conditions and potential future merger and acquisition activity. We believe that our existing cash, cash equivalents and marketable securities and anticipated cash flow from existing collaboration agreements will be sufficient to support our current operating plan for at least the next 12 months. This estimate of our future capital requirements is a forward-looking statement that is based on assumptions that may prove to be wrong and that involve substantial risks and uncertainties. Our actual future capital requirements could vary as a result of a number of factors, including:

 

• the progress of our research activities;

• the number and scope of our research programs;

• the progress of our preclinical and potential clinical development activities;

• the progress of the development efforts of our collaborators;

• our ability to establish and maintain current and new collaboration agreements;

• the ability of our collaborators to fund research and development programs;

• the costs involved in enforcing patent claims and other intellectual property rights;

• the costs and timing of regulatory approvals; and

• the costs of establishing business development and distribution capabilities.

 

14

 

Future capital requirements will also depend upon the extent to which we acquire or invest in other businesses, products and technologies. Until we can generate sufficient levels of cash from our operations, which we do not expect to achieve in the foreseeable future, we expect to continue to utilize our existing cash and marketable securities resources that were primarily generated from the proceeds of our equity offerings. In addition, we may finance future cash needs through the sale of equity securities, strategic collaboration agreements and debt financing. We cannot assure that we will be successful in obtaining new or in retaining existing collaboration agreements, or in receiving milestone and/or royalty payments under those agreements, that our existing cash and marketable securities resources will be adequate or that additional financing will be available when needed or that, if available, this financing will be obtained on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose, or may adversely affect our ability to operate as an ongoing concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders may result.

 

Obligations and Commitments

 

There has been no material change in the obligations and commitments of Array during the nine months of fiscal year 2003.

 

At March 31, 2003, we had restricted cash of $1.1 million as a compensating balance to support outstanding letters of credit that were issued during the prior fiscal year in relation to our facilities leases.

 

Critical Accounting Policies

 

We believe the policies identified below are critical to the understanding of our results of operations and require our management to make significant judgments in preparing the financial statements included in this report.  Management has made estimates and assumptions based on these policies. We do not believe that there is a great likelihood that materially different amounts would be reported if different assumptions were used.  However, the application of these policies involves judgments and assumptions as to future events and, as a result, actual results could differ. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results.

 

Revenue Recognition

 

We believe our revenue recognition policy is significant because the amount and timing of revenue is a key component of our results of operations. We follow the guidance of Staff Accounting Bulletin No. 101, which requires that a series of criteria be met in order to recognize revenue related to the performance of services or the shipment of products. If these criteria are not met, the associated revenue is deferred until the criteria are met. We recognize revenue when (a) persuasive evidence of an arrangement exists, (b) products are delivered or services are rendered, (c) the sales price is fixed or determinable and (d) collectibility is assured.

 

We recognize revenue from fees under our collaboration agreements on a monthly basis as research is performed. Development and fixed-fee revenue is recognized on a percentage-of-completion basis. Per-compound revenue is recognized as compounds are shipped. Revenue from license fees and up-front fees is recognized over the term of the license or over the expected term of the collaboration agreement. Royalty revenue is recorded when earned. Milestone payments are recognized as revenue based upon the stage of completion of our performance obligations under the related contract. In general, contract provisions include predetermined payment schedules or the submission of appropriate billing

 

15

 

detail. Any payments received in advance from these agreements are recorded as advanced payments from customers until the revenue is earned.  Revenue recognition related to license fees, up-front payments and milestone payments could be accelerated in the event of early termination of agreements, or extended over longer periods in the event of extensions to agreements.

 

Inventory Valuation

 

Our inventories are a significant component of our total assets. In addition, the value at which we carry our inventory directly impacts our results of operations. Our inventories primarily consist of individual chemical compounds in the form of Optimerâ building blocks, our Lead Generation Libraries, custom libraries and commercially available fine chemicals. Our inventories are stated at the lower of cost or market, cost being determined under the first-in, first-out method. We design and produce chemical compounds comprising our Lead Generation Libraries, custom libraries and Optimerâ building blocks and for our proprietary research activities, and begin capitalizing costs into inventory only after technological feasibility has been established. We review inventories periodically and reduce items considered to be slow moving or obsolete to estimated net realizable value through an appropriate reserve. If our estimates of the market value of our inventory are more favorable than actual market conditions, we may be required to make additional inventory write-downs in the future.

 

Recent Accounting Pronouncements

 

In July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”).  SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and replaces EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) (“EITF No 94-3”). The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002 and require companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan as previously required under EITF No. 94-3. Array adopted SFAS 146 during the period ended March 31, 2003 in conjunction with our workforce reduction. See Note 9 of the Notes to Condensed Financial Statements provided elsewhere in this report.

 

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 requires certain guarantees (including standby letters of credit) to be disclosed in interim and annual financial statements and recognized as a liability in the financial statements at the inception of the guarantee, initially for the fair value of the obligation undertaken in issuing the guarantee. The provisions of this interpretation are effective for all guarantees issued or modified after December 31, 2002. The adoption of FIN 45 is not expected to have a significant impact on our financial statements. Array adopted the disclosure requirements of FIN 45 during the period ended March 31, 2003. See Note 10 of the Notes to Condensed Financial Statements provided elsewhere in this report.

 

In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS 148”). SFAS 148 amends FASB Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to provide alternative methods of transition to a voluntary change to SFAS 123’s fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, Interim Financial Reporting, to require disclosure of the method of accounting used for stock-based compensation and the effects of this method on reported net income and earnings per share in annual and interim financial statements. The adoption of SFAS 148 is not expected to have a significant impact on our financial statements. Array adopted the disclosure requirements of SFAS 148 during the period ended March 31, 2003, which can be found in Note 8 of the Notes to Condensed Financial Statements,

 

16

 

contained elsewhere in this report.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Short-term investments. Our interest income is sensitive to changes in the general level of United States interest rates, particularly since a significant portion of our investments are and will be in short-term marketable securities. Due to the nature and maturity of our short-term investments, we have concluded that there is no material market risk exposure.

 

Foreign currency rate fluctuations. All of our collaboration agreements and purchase orders are denominated in United States dollars. Therefore, we are not exposed to changes in foreign currency exchange rates.

 

Inflation. We do not believe that inflation has had a material impact on our business or operating results during the periods presented.

 

 

Item 4. Controls and Procedures.

 

Within 90 days prior to the date of this report, we evaluated, under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer and other senior management personnel, the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, management concluded that, as of the date of the evaluation, Array’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports we file with the SEC under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required.

 

Subsequent to the date management conducted its evaluation, there have been no significant changes in our internal controls or in other factors that could significantly affect our internal controls. There were no significant deficiencies or material weaknesses identified in the evaluation; therefore, no corrective actions were taken.

 

17

 

PART II

 

 

Item 6.  Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

99.1                           Written Certifications of Robert E. Conway and R. Michael Carruthers pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

(b)                                 Reports on Form 8-K during the third quarter of Fiscal 2003

 

The Company filed a Current Report on Form 8-K dated February 13, 2003, to file the certifications required pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, related to the Company’s Quarterly Report on Form 10-Q.

 

The Company filed a Current Report on Form 8-K dated March 31, 2003, to file a press release announcing adjusted growth expectations for fiscal year 2003.

 

 

Items 1 through 5 are not applicable and have been omitted.

 

18

 

SIGNATURES

 

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, in the City of Boulder, State of Colorado.

 

 

		ARRAY BIOPHARMA INC.
Dated:	May 14, 2003	By:	/s/ Robert E. Conway
			Robert E. Conway
			Chief Executive Officer
Dated:	May 14, 2003	By:	/s/ R. Michael Carruthers
			R. Michael Carruthers
			Chief Financial Officer and Secretary
			(Principal Financial Officer and
			Principal Accounting Officer)

 

19

 

CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, Robert E. Conway, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Array BioPharma Inc.;

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 14, 2003	/s/ Robert E. Conway
	Robert E. Conway
	Chief Executive Officer

 

20

 

CERTIFICATION UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

 

I, R. Michael Carruthers, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Array BioPharma Inc.;

 

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: May 14, 2003	/s/ R. Michael Carruthers
	R. Michael Carruthers
	Chief Financial Officer

 

21