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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
or
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the transition period
from to
COMMISSION FILE NUMBER 000-31161
ARENA PHARMACEUTICALS, INC.
(Exact
name of registrant as specified in its charter)
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Delaware
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23-2908305
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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6166 Nancy Ridge Drive, San Diego, CA
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92121
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(Address
of principal executive offices)
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(Zip
Code)
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(858) 453-7200
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to 12(b) of the Act: None
Securities
registered pursuant to 12(g) of the Act:
Common Stock, $0.0001 par value
(Title
of Class)
Preferred Stock Purchase Rights
(Title
of Class)
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 ý
No o
Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of the registrant’s knowledge, in the definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 under
the Securities Exchange Act of 1934). Yes ý No o
The approximate aggregate market value of the
voting and non-voting common equity held by non-affiliates of the registrant
was approximately $102.8 million as of June 30, 2004, based on the closing
price of the Common Stock as reported on the NASDAQ National Market on such
date. For purposes of this calculation, shares of Common Stock held by
directors and officers and stockholders whose beneficial ownership in the
registrant is known by the registrant to exceed 10% have been excluded. This
number is provided only for purposes of this report and does not represent an
admission by either the registrant or any such person as to the status of such
person.
As of February 15, 2005, there were
35,205,869 shares of the registrant’s Common Stock outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Certain information required by Part III of this Annual Report on Form
10-K is incorporated by reference from the registrant’s definitive proxy
statement for the annual meeting of stockholders to be held in June 2005,
which will be filed with the Securities and Exchange Commission within
120 days after the close of the registrant’s fiscal year ended
December 31, 2004.
ARENA PHARMACEUTICALS, INC.
TABLE OF CONTENTS
i
INFORMATION RELATING TO FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking
statements. These forward-looking statements involve a number of risks and uncertainties.
Such forward-looking statements include statements about our strategies,
intentions, expectations, goals, objectives, discoveries, collaborations,
preclinical and clinical programs, and our future achievements. These
forward-looking statements can generally be identified as such because the
context of the statement will include words such as “may,” “will,” “intends,” “plans,”
“believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,”
or “opportunity,” the negative of these words or words of similar import. For
such statements, we claim the protection of the Private Securities Litigation
Reform Act of 1995. Readers of this Annual Report on Form 10-K are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date on which they are made. These forward-looking statements
are based largely on our expectations and projections about future events and
future trends affecting our business, and are subject to risks and uncertainties
that could cause actual results to differ materially from those anticipated in
the forward-looking statements. Important factors that could cause actual
results to differ materially from those in these forward-looking statements are
disclosed in this Annual Report on Form 10-K, including, without limitation,
those discussions under “RISK FACTORS” in “Item 1. Business” and in “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” In addition, past financial and/or operating performance is not
necessarily a reliable indicator of future performance and you should not use
our historical performance to anticipate results or future period trends. We
can give no assurances that any of the events anticipated by the forward-looking
statements will occur or, if any of them do, what impact they will have on our
results of operations and financial condition. Except as required by law, we
undertake no obligation to publicly revise our forward-looking statements to
reflect events or circumstances that arise after the filing of this Form 10-K
or documents incorporated by reference herein that include forward-looking
statements.
Arena Pharmaceuticals®,
Arena® and our corporate logo are registered service marks of Arena. CART™ and
BRL Screening™ are unregistered service marks of Arena.
In this Annual Report on
Form 10-K, “Arena Pharmaceuticals,” “Arena,” “we,” “us” and “our” refer to
Arena Pharmaceuticals, Inc. and our wholly owned subsidiary, BRL Screening, Inc.,
unless the context otherwise provides.
We are a biopharmaceutical company with a pipeline of internally
discovered, small-molecule product candidates that target G protein-coupled
receptors, or GPCRs. Our product candidates act on or through known and orphan
GPCRs, and have been discovered using our GPCR-focused drug discovery
technologies and capabilities. Two of our product candidates are in clinical
trials: APD356 for the treatment of obesity is in a Phase 2 clinical trial; and
APD125 for the treatment of insomnia is in a Phase 1 clinical trial. We also
have active collaborations with two major pharmaceutical companies,
Ortho-McNeil Pharmaceutical, Inc., a Johnson & Johnson company,
for the treatment of type 2 diabetes, and Merck & Co., Inc., for
the treatment of atherosclerosis and related disorders. We incorporated in
April 1997.
Our goal is to
discover, develop, and commercialize novel, orally available drugs that address
major unmet medical needs by targeting GPCRs. GPCRs are a class of receptors
that mediate the majority of cell-to-cell communication within humans, and a
high percentage of today’s prescription drugs target one or more GPCRs. We
believe that approved GPCR-based drugs target about 60, or 30%, of the approximately
190 known GPCRs, predominantly in the biogenic amine family, a sub-family of
class I GPCRs. GPCRs are categorized as “known” when their naturally
occurring, or native, ligands have been identified. Scientists have used
molecular cloning in combination with the sequencing of the human genome to
identify both additional receptor subtypes of known GPCRs as well as hundreds
of novel GPCRs. These novel GPCRs are categorized as “orphan” GPCRs because
their native ligands have not been identified. We believe orphan GPCRs offer
promise for the development of novel GPCR-based therapeutics, and, therefore,
are a major focus of our discovery research.
We focus on four therapeutic areas:
metabolic, central nervous system (or CNS), cardiovascular and inflammatory
diseases. We believe our technologies and integrated discovery and development
capabilities will allow us to continue to build our pipeline of unique and
selective product candidates.
We intend to commercialize our product
candidates independently and with partners. We have retained commercial rights
for our most advanced development programs, except for our diabetes partnership
with Ortho-McNeil and our cardiovascular collaboration with Merck. We
have not received regulatory approval for, or generated commercial revenues
from, marketing or selling drugs.
1
In 2004, we made significant progress, including:
• announcing results for single and multiple
dose Phase 1 clinical trials of our product candidate for obesity, APD356;
• initiating a Phase 2 study of APD356;
• initiating a Phase 1 clinical trial of our
product candidate for insomnia, APD125;
• announcing a two-year extension and
expansion of our cardiovascular collaboration with Merck and receiving
three milestone payments and an equity
investment totaling $15.5 million; and
• establishing a world-wide partnership with
Ortho-McNeil for our diabetes program, 19AJ, under which we received an upfront
payment of $17.5 million and two milestone payments totaling
$5.0 million in January 2005.
Our Strategy
The key elements of our scientific and business strategy are to:
• Continue
to advance our lead programs. We
intend to advance our current product candidates, either alone or in
conjunction with pharmaceutical and biotechnology companies, through clinical
development and, if successful, commercialization.
• Discover
and develop additional small molecule product candidates targeting GPCRs. We intend to continue to develop
orally available, small molecule compounds for GPCRs identified or validated by
our research efforts.
• Focus on
attractive market opportunities. Obesity,
insomnia, diabetes and thrombosis each represent multi-billion dollar market
opportunities. We intend to continue to focus on these and other programs with
attractive commercial potential.
• Retain
significant commercial rights and/or economic value for our product
candidates. We intend to
maximize the value of our product candidates through either internal
development or commercial partnerships in which we retain significant economic
value and/or targeted copromotion rights.
• Continue
to build our development capabilities. To
capitalize on our discoveries, we plan to continue to expand our clinical
development capabilities as our product candidates enter into, and move
through, clinical trials.
• Maintain
strong research discovery capabilities. Our proprietary technologies, including CART
and Melanophore, and our drug discovery infrastructure, have allowed us to identify
a number of GPCR targets and novel compounds. We believe these and other
discoveries will continue to fuel our pipeline.
Our Research & Development Programs
Our product candidates range from being in a Phase 2 clinical trial to
the early stages of drug research. The following table summarizes our most
advanced internal and partnered research and development programs:
Link to searchable text of slide shown above
APD356
Our most advanced product candidate, which we call APD356, is a novel
and selective 5-HT2C receptor agonist for the treatment of obesity.
In animal studies, stimulation of this hypothalamic receptor has resulted in
decreased food intake and weight loss. Obesity and a related condition known as
metabolic syndrome affect tens of millions of adults and children in the United
States and pose a serious long-term threat to their health and welfare. Medical
treatment options for obesity and metabolic syndrome are currently very
limited.
Our preclinical studies show APD356 stimulates the 5-HT2C serotonin
receptor more selectively than fenfluramine and dexfenfluramine. Based on these
studies, we believe that APD356 is less likely to cause the cardiovascular side
effects associated with fenfluramine and dexfenfluramine. Until 1997, Wyeth
marketed fenfluramine and dexfenfluramine, serotonin-releasing agents and
non-selective serotonin receptor agonists, which were often used in combination
with
2
phentermine for the treatment of obesity. The combination of
fenfluramine or dexfenfluramine with phentermine is commonly referred to as
fen-phen. Despite their efficacy as appetite suppressants, both fenfluramine
and dexfenfluramine were withdrawn from the market in 1997 after reported
incidences of heart valve disease and pulmonary hypertension associated with
their usage.
Mechanism and Preclinical Data. APD356 selectively stimulates the 5-HT2C serotonin receptor,
a GPCR located in the hypothalamus. We have conducted preclinical studies
examining the activity and 5-HT receptor subtype specificity of APD356. In
these studies, APD356 demonstrated a high affinity and specificity for the 5-HT2C
receptor, with approximately 15-fold and 100-fold selectivity over the
5-HT2A and 5-HT2B receptors, respectively, and no
pharmacologic activity at other serotonin receptors. In addition, in these
studies, APD356 did not release serotonin. The fenfluramines release serotonin,
and their primary metabolite, norfenfluramine, also has activity at the 5-HT2B
receptor, stimulation of which has been implicated in the heart valve
abnormalities associated with these drugs. Because of its selectivity, we
believe that APD356 is less likely to cause the cardiovascular side effects
associated with fenfluramine and dexfenfluramine.
In a free-fed animal model, APD356 reduced total food intake in a
dose-dependent manner. APD356 dosed once, orally at 6 mg/kg, 12 mg/kg and 24
mg/kg reduced food intake approximately 12% to 25% over 22 hours compared
to a saline control. In the same model, dexfenfluramine dosed once, orally at
0.3 mg/kg, 1 mg/kg, and 3 mg/kg reduced food intake approximately 10% to 30%
over the same time period.
In an obese animal model, APD356 caused dose-dependent reductions in
body weight after 14 days of oral administration. APD356 dosed at 4.5
mg/kg, 9 mg/kg, 18 mg/kg twice-daily, and 36 mg/kg once-daily reduced
bodyweight by approximately 3%, 6%, 11%, and 12%, respectively. We believe this
compares favorably to Meridia, a drug marketed by Abbott Laboratories, which
reduced bodyweight by approximately 12% when dosed at 6 mg/kg once-daily in the
same model. The reductions in bodyweight caused by APD356 appeared to be due to
lowered body fat, as lean body mass in the obese animals was unaffected at all
APD356 doses.
Clinical Development.
In
July 2004, we announced results from a three-part Phase 1a study of
APD356. In part A, safety was assessed in 45 subjects who received single
doses of APD356. We began dose escalation at 10 mg and ended at 40 mg due to
CNS-related side effects, including nausea, dizziness, headache and
disorientation. Doses of 10 mg and 20 mg were well tolerated. In part B,
we evaluated the effect of food consumption on APD356 absorption and
pharmacokinetics in 12 volunteers, and found that APD356 was well-tolerated
with food, and that food neither reduced maximum concentrations of the drug
reached in the blood nor the amount of the drug absorbed. Finally, in part C,
we evaluated the effect of single doses of APD356 on food intake in 20 subjects
in a four-period crossover study. Each subject received single doses of placebo
and 0.1 mg, 1 mg, or 10 mg doses of APD356 in random order over four successive
weeks, and two hours after each dosing was offered a standard test meal in a
controlled setting. In this way, subjects acted as their own control. At the 10
mg dose, average food intake declined 6.5% versus the placebo period, which is
not statistically significant. Excluding a single outlier, who ate more than
twice as much during period one (which also was the period in which he received
the highest dose) as during each of the other three periods, average food
intake declined 10.7%, which would be statistically significant. We believe
this effect is a clinically meaningful signal of pharmacology.
In November 2004, we announced results from a Phase 1b clinical
safety trial of APD356 in obese volunteers. In this trial, 27 subjects (15
males and 12 females) with an average body mass index, or BMI, of 31, and a BMI
range of 25 to 58, were enrolled. Participants were administered 3 mg, 10 mg
and 20 mg doses of APD356 or placebo daily for 14 days in successive
cohorts of nine subjects (six received APD356 and three received placebo) and
remained within a Phase 1 unit throughout the dosing period. Participants were
instructed to maintain their usual exercise patterns, and were offered
sufficient food to maintain their desired intake levels. APD356 was well
tolerated; there were no severe or serious adverse events reported, no
withdrawals due to an adverse event, and no reports of euphoria, dysphoria, or
disorientation. The most common side effects, occurring primarily at the 20 mg
dosage level, were headache and nausea, sometimes with vomiting. These side
effects were occasional and generally mild in nature. APD356 continued to
demonstrate very predictable pharmacokinetic behavior, similar to that found in
its Phase 1a trial. The maximum plasma concentration and exposures increased in
proportion with increasing doses of APD356, and there were no apparent gender
differences in pharmacokinetic parameters. Based on a comparison of
echocardiograms taken at screening with those taken at the end of treatment and
two and three months thereafter, there was no apparent drug effect on heart
valves or pulmonary artery pressure. This Phase 1b study was neither designed
nor powered to detect significant weight change between treatment groups. When
compared with placebo, none of the mean changes in weight in the groups that
received APD356 were statistically significant.
Based on these results, in December 2004 we began a randomized,
double-blinded, multiple-dose, 28-day Phase 2 clinical trial of APD356 in obese
subjects. We expect that the trial will compare doses of 1 mg, 5 mg and 15 mg
of APD356 to
3
placebo, evaluating weight loss after administration once daily for
28 days. We expect to announce initial results from this trial in the
second quarter of 2005.
Intellectual Property. We have patent applications covering compositions of matter for APD356
and related compounds, and related methods of treatment, pending in 26
countries including the United States and Japan, and before the European Patent
Office, or EPO. In addition, we have a pending patent application covering the
synthetic route for APD356 before the World Intellectual Property Organization,
or WIPO, designating all contracting states. We also have a patent application
that covers the particular hydrate and crystal form of APD356 that we intend to
use in late-phase clinical trials and perhaps commercially.
APD125
Our lead product candidate for insomnia, which we call APD125, is a
novel and selective 5-HT2A receptor inverse agonist that is
presently in a Phase 1 clinical trial. According to the National Institutes of
Health, as many as 25% of Americans report occasional sleeping problems, and
insomnia is a chronic problem for about 10% of the population. In these cases,
the lack of restful sleep impairs the person’s ability to carry out daily
responsibilities because they are too tired or have trouble concentrating.
However, only a fraction of those suffering from insomnia seek medical
treatment, as fewer than 10% of adults with this disorder report using
medication for treatment. Currently marketed therapies include Ambien, marketed
by sanofi-aventis, zaleplon, an off-patent compound, and various
benzodiazepines, including Valium. These therapies generally work by activating
the GABA-A receptor in the brain, and cause a general CNS-suppressive effect.
While these drugs are effective at initiating sleep, they have side effects
including the risk of developing tolerance to the drug and the potential for
causing a sensation of dullness and lethargy upon awakening, often referred to
as the “hangover effect.” In addition, these drugs are DEA-scheduled controlled
substances due to their potential for abuse. Despite these limitations, current
medications for insomnia are expected to have worldwide sales in excess of
$2 billion in 2005.
Mechanism and Preclinical Data. APD125 is our lead compound in a series we have discovered that
selectively inhibits the 5-HT2A receptor. APD125 acts through a
different mechanism than currently marketed insomnia drugs, and we believe that
because of this APD125 may not have the side effects associated with such
drugs. Rather than activating a general CNS-suppressive system (GABA), APD125
inhibits a CNS activating system mediated through 5-HT2A receptors.
In our animal studies, we have demonstrated that APD125 increases both the
quality and total time of non-REM sleep, the most restorative phase of the
sleep cycle in humans, while having no effect on REM (rapid eye movement or
dream) sleep. In addition, APD125 appeared to promote sleep onset. The total
increase in non-REM sleep time was manifested by fewer bouts of longer
duration, indicating an increase in sleep consolidation. In addition, animals
treated with APD125 showed an increase in delta power during non-REM sleep, a
brain wave activity associated with increased sleep intensity. The improvements
in non-REM duration and quality observed with APD125 administration were at
least as robust as those observed with a prototypic GABA-A hypnotic control
drug, Ambien. However, unlike Ambien, APD125 did not adversely affect REM sleep
in these studies. We believe these animal data suggest that APD125 has the
potential to improve the treatment of insomnia over GABA-A hypnotics.
Clinical Development.
In
December 2004, we initiated a Phase 1 clinical trial of APD125 in healthy
volunteers. This dose-ranging study will evaluate the safety, tolerability and
pharmacokinetics of single doses of APD125. We expect to announce results from
this trial in the middle of 2005. Depending on the results of this trial, we
intend to initiate multiple-dose tolerability and single-dose pharmacology
trials.
Intellectual Property. We have patent applications covering compositions of matter for APD125,
and related methods of treatment, pending in the United States, in 12
additional jurisdictions that are not contracting states of the WIPO, and
before the EPO and the WIPO, designating all contracting states. We also have
two separate pending patent applications covering the synthetic route for APD125,
one of which is before the WIPO, designating all contracting states.
19AJ /
Ortho-McNeil Collaboration
Our lead product candidate for diabetes targets an orphan GPCR, which
we call 19AJ, found in the pancreas. Our two lead compounds for this target are
currently in preclinical development in partnership with Ortho-McNeil. Diabetes
is a major worldwide disease. The International Diabetes Foundation has
estimated that in 2001 there were 177 million adults with diabetes
worldwide, an increase of 17% over the number in 2000. This estimate includes
21.4 million in the United States and 32.2 million in the European
Union. Approximately 90%, or 160 million, of diabetics suffer from type 2
diabetes, the adult-onset form of the disease. Type 2 diabetes is characterized
by inadequate response to insulin and/or inadequate secretion of insulin as
blood glucose levels rise. Therapies for type 2 diabetes are directed toward
correcting the body’s
4
inadequate response with oral medications, or directly modifying
insulin levels through direct injection of insulin or insulin analogs.
Oral medications for type 2 diabetes include insulin releasers such as
Glyburide, insulin sensitizers such as Actos and Avandia and agents which slow
the uptake of glucose into the bloodstream such as Precose and Glyset. The
worldwide market for oral diabetes medications was expected to exceed
$10 billion in 2004. However, a significant portion of type 2 diabetics
fail oral medication and require injected insulin therapy. Current oral
medications for type 2 diabetes have a number of side effects, including
hypoglycemia, weight gain and edema. Numerous pharmaceutical and biotechnology
companies are seeking to develop insulin sensitizers, novel insulin
formulations and other therapeutics to improve the treatment of diabetes.
Mechanism and Preclinical Data. 19AJ is a receptor that we have found to be preferentially expressed in
beta cells, the cells in the pancreas responsible for producing insulin in
response to increases in blood glucose. The pharmaceutical industry has
discovered three main mechanisms that have resulted in beta-cell therapeutics:
GLP-1 receptor peptide agonists, DPP-IV inhibitors and sulphonylureas. We
believe 19AJ represents a novel mechanism for generating a new class of drugs
for diabetes that may offer advantages over current approaches. Our preclinical
results indicate that stimulating the 19AJ receptor allows beta cells to
produce insulin more efficiently in response to changes in blood glucose
levels. In addition, we have found in these studies that stimulation of the
19AJ receptor leads to increased levels and activity of intracellular factors
thought to be involved in the preservation of beta cells. Unlike the GLP-1 receptor,
we have found that the 19AJ receptor is amenable to small molecule drug
development. We have discovered potent, selective and orally available small
molecule agonists of the receptor that improve glucose tolerance and lower
blood glucose levels in animal models of diabetes. The 19AJ mechanism is
glucose dependent, so that in our animal studies our compounds only lowered
blood glucose when it rose above normal levels, such as after a meal. Our
preclinical results indicate these compounds do not lower normal fasting
baseline glucose levels in animal models and, therefore, do not cause
hypoglycemia, unlike the glucose-insensitive sulphonylureas.
Development Plans and Partnership Status. In December 2004, we entered into a collaboration and license agreement
with Ortho-McNeil to further develop compounds for the potential treatment of
type 2 diabetes and other disorders. Our two lead compounds are currently in
preclinical development with Ortho-McNeil. In January 2005, we received a
$17.5 million upfront payment, and two milestones payments of
$2.5 million each. We are eligible to receive up to $295.0 million in
milestone payments for each compound, as well as royalty payments associated
with Ortho-McNeil’s commercialization of any drugs discovered under the
agreement. These milestone payments include development and approval milestone
payments of up to $132.5 million for the first indication and
$62.5 million for the second indication for each compound, and up to
$100.0 million in sales milestone payments for each product resulting from
the collaboration.
Merck
Cardiovascular Collaboration
In October 2002, we entered into a research and licensing agreement
with Merck to collaborate on three GPCRs to develop therapeutics for
atherosclerosis and related disorders. We believe one or more of these GPCRs
plays a role in regulating plasma lipid profiles, including HDL cholesterol,
the so-called “good cholesterol,” and is responsible for the HDL-raising
activity of niacin. In October 2004, we extended and expanded our collaboration
with Merck and Merck selected one of our compounds for preclinical development.
As of December 31, 2004, we had received $19.5 million from Merck in
upfront and milestone payments and an equity investment. We may receive additional
milestone payments of up to $34.0 million for Merck’s clinical and
marketing achievements, as well as royalty payments associated with Merck’s
commercialization of any drugs discovered under the agreement. In addition, we
have received research funding from Merck since the inception of our
collaboration, and, under our agreement, Merck will pay us $5.7 million a
year for collaboration research through October 19, 2007.
There are very successful drugs available for lowering LDL cholesterol.
However, development of novel, effective therapies to increase HDL cholesterol
remains a major focus of research. We believe that such therapies may reduce
the risk of atherosclerotic heart disease and compete in the large
anti-hyperlipidemic market.
Other
Research and Development Programs
Cardiovascular.
In addition to
our Merck collaboration, our programs in the cardiovascular area include ones
directed toward the prevention of thrombosis and cardiac reperfusion injury.
The American Heart Association estimates that in the United States alone over
12 million people alive in 2001 have survived either a myocardial
infarction or a stroke. To reduce the risk of future events, many subjects
receive daily anti-platelet therapy. In 2003, worldwide sales of Plavix, a leading
antithrombotic marketed by Bristol-Myers Squibb, exceeded $2.4 billion.
5
Platelet aggregation results in the formation of a blood clot and
vessel occlusion leading to cardiovascular disease such as myocardial
infarction and stroke. There are several important signals that increase the
platelet aggregation response, such as thrombin, ADP, epinephrine,
prostaglandins and collagen. Activated platelets are a rich source of a
secondary signal, serotonin, that when released into the blood acts to amplify
the aggregation response produced by the various primary signals. This
serotonin-induced amplification process is mediated through 5-HT2A receptors
present on platelets. We have developed potent and selective small molecule
inhibitors of the 5-HT2A receptor that can block the
serotonin-amplified aggregation response and have antithrombotic activity in
animal models. In contrast to our 5-HT2A lead compounds for insomnia
which distributes significantly to the CNS, we have designed our lead
antithrombotic compounds to have limited exposure to the brain through the
blood-brain barrier. Moreover, in animal models, these compounds demonstrate a
better therapeutic index due to a separation of antithrombotic activity from the
increased bleeding that may be seen as a treatment effect of currently marketed
products. Acute myocardial infarction, which is commonly known as a heart
attack, is often followed by heart failure in survivors. Myocardial infarction,
and often heart failure, are direct consequences of atherosclerosis, and both
remain major causes of death. We have identified certain GPCRs that we believe
play a role in these processes and are seeking to identify small molecules
directed at these GPCR targets that we believe could provide cardio-protection
following myocardial infarction.
Inflammatory Disorders. We are developing small molecule therapeutics that target GPCRs
involved in the inflammatory process. TNF-α is an important
pro-inflammatory mediator in diseases such as rheumatoid arthritis. Biologic
therapeutics, such as Enbrel, Remicade and Humira, function to inhibit the
activity of TNF-α. In 2003, worldwide sales of these three drugs exceeded
$3.3 billion. However, biologic treatments are expensive and restricted to
intravenous or subcutaneous administration. We have discovered small molecule
compounds which can be orally administered and that in preclinical studies act
to target GPCRs in the immune system to inhibit the production of TNF-α.
We plan to continue to test the efficacy of these molecules in animal models of
inflammatory diseases, such as arthritis, in 2005.
Diseases such as inflammatory bowel disease, which includes Crohn’s
disease and ulcerative colitis, and asthma, are initiated and exacerbated by an
aberrant inflammatory response. Immune cells such as monocytes, dendritic
cells, eosinophils, neutrophils, mast cells and specific T cell subsets play a
role in these diseases. We have identified GPCRs that are found in specific
immune cell types. We believe these GPCRs modulate the inflammatory process,
and we are applying our screening technologies to these targets to identify
small molecules that could activate or inhibit these GPCRs.
CNS Disorders.
Many GPCRs are
found predominately in the brain or the CNS, and, therefore, we believe
targeting GPCRs provides an opportunity to selectively treat various CNS
diseases. Many approved drugs for indications ranging from insomnia and
narcolepsy to depression, schizophrenia, and Parkinson’s disease target GPCRs.
Our discovery efforts in CNS disorders are focused on indications with large
market opportunities where current therapies have significant limitations. For
example, we are developing small molecules targeting a GPCR through a different
mechanism than serotonin or norepinephrine, and have confirmed that inhibitors
of this GPCR show activity in animal models of depression and anxiety. We
intend to continue our research and development of these compounds.
Other Diabetes Programs. For metabolic diseases, we are working on a series of orphan GPCR
targets other than 19AJ in order to develop orally available therapies to treat
type 1 and type 2 diabetes. We are focusing our discovery efforts on
approximately 10 known and orphan GPCR targets that we believe regulate
important mechanisms involved in glucose control. For example, we are
conducting research with receptors that may act to regulate glucose uptake,
glucose absorption, insulin sensitivity, insulin secretion, lipid levels and
production of glucose in the liver. In order to treat general metabolic
disease, we have prioritized GPCRs that have the potential to modulate blood
glucose and lipid levels. We have identified selective small molecule agonists
to an orphan receptor we call 20PO. In preclinical studies, oral administration
of these compounds improved glucose tolerance in a standard glucose tolerance
test and lowered free fatty acids in vivo.
We believe that agonists to the 20PO receptor have potential for the treatment
of diabetes and lipid disorders.
Other Obesity Programs. In addition to APD356 and other compounds that act on the 5-HT2C serotonin
receptor, we have discovery programs focused on several different GPCRs
implicated in obesity. Our drug discovery efforts are directed at identifying novel
product candidates that target GPCRs in the CNS and peripheral tissues to
reduce fat mass in people. We have identified both known and orphan GPCRs
expressed in the hypothalamus, an area of the brain known to be critical for
regulating satiety and metabolism, that we believe regulate food intake and
weight. We have also identified targets in fat cells that may represent targets
for obesity. We have identified early lead compounds for obesity targets other
than the 5-HT2C serotonin receptor, and are currently evaluating
these compounds for their ability to reduce food intake and body weight.
Our Proprietary GPCR Technologies and Programs
Our product candidates have
resulted from our GPCR-focused drug discovery technologies, capabilities and
programs,
6
including Constitutively
Activated Receptor Technology, or CART, our Melanophore technology and Project
Genesis. Our integrated drug discovery platform allows us to determine
GPCR function, tissue and cell distribution, and potential relation to disease.
CART
Traditional ligand-based drug screening methods require the
time-consuming identification and use of the receptor’s native ligand to
discover small molecule compounds that will bind at, or close to, the native
ligand’s binding site on the receptor. In contrast, we have developed
technologies that do not require the use of the native ligand. Instead, we are
able to activate the GPCR so that the G protein signals without the presence of
the native ligand. We call this Constitutively Activated Receptor Technology,
or CART. CART allows us to discover drug-like compounds by activating the GPCR
to mimic the biological response that occurs when the native ligand binds to
the receptor. Therefore, CART avoids a major bottleneck in drug discovery
efforts at orphan receptors by eliminating the step of first identifying the
native ligand. We have found that CART can be applied broadly to GPCRs.
Screening using CART allows us to simultaneously identify drug leads that
act as receptor activators, or agonists, which increase the detected biological
response, or act as receptor inhibitors, which decrease the detected response.
We can also identify inverse agonists, which inhibit ligand-independent, as
well as ligand-dependent, receptor activity.
We believe that CART offers several key advantages for drug discovery
over traditional screening techniques that require the use of the native ligand
including:
• not requiring prior identification of the
native ligand for an orphan receptor;
• enhancing the detection of, and allowing us
to simultaneously identify, both receptor inhibitor and receptor activator drug
leads;
• allowing for the identification of drug
leads that inhibit both ligand-independent and ligand-dependent activity; and
• providing the ability to discover novel and
improved therapeutics directed at known receptors.
Melanophore
Technology
Our patented Melanophore technology is a broadly applicable
high-throughput screen for GPCRs. When a GPCR is activated (either by a ligand
or independent of a ligand through CART), the GPCR couples to one or more G
proteins, including those belonging to the Gs, Gq, and Gi/o classes.
Melanophore technology can detect GPCRs that couple to major G protein classes.
We believe our Melanophore technology is, therefore, also well-suited for
studies of orphan receptors whose coupling parameters are unknown. We believe
Melanophore technology provides us with a robust, reproducible, high-throughput
and low-cost means for identifying and optimizing GPCR agonists, antagonists,
and inverse agonists, and is sensitive enough to detect the constitutive
activity of many GPCRs.
Project
Genesis
We have substantially completed our efforts under Project Genesis, a
program to identify human GPCRs, determine where these GPCRs are expressed in
normal and diseased tissues, and utilize our CART and Melanophore technologies
to screen against our chemical libraries.
Through Project Genesis, we have learned, among other things, where and
how GPCRs function in the body and how they interact with the small molecule
chemicals that modulate their activity. We believe that this knowledge will
allow us to more efficiently advance our therapeutic programs. We are applying
medicinal chemistry to further develop the small molecule leads identified
through screening.
Research and Development Expenses
Research
and development activities are the primary source of our expenses, which
include personnel costs, research supplies, facility and equipment costs and preclinical
study fees. Research expenses related to the development and improvement of our
technology and product candidates totaled $57.7 million for the year ended
December 31, 2004, $50.9 million for the year ended December 31,
2003, and $44.4 million for the year ended December 31, 2002. Included in
these expenses is research that was sponsored by our collaborators. We estimate
that research expenses incurred on projects
7
sponsored by our collaborators totaled $3.4 million
for the year ended December 31, 2004, $5.8 million for the year ended
December 31, 2003 and $5.9 million for the year ended December 31,
2002.
Corporate Collaborations
In addition to Ortho-McNeil and Merck, we have entered into strategic
collaborations with other pharmaceutical and biotechnology companies to
discover and develop novel drug leads using our GPCR technologies. We intend to
continue to pursue collaborations in an effort to access our partners’
research, drug development, manufacturing, marketing and financial resources.
Ninety-five percent of our revenues during the year ended December 31, 2004,
were from our collaboration with Merck, which included research funding,
milestone achievements and technology access and development fees. Please see “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” for a more detailed discussion of our collaborations, including
financial information, activities being conducted and termination provisions.
Intellectual Property
Our success depends in large part on our ability to protect our
proprietary technology, compounds and information, and to operate without
infringing the proprietary rights of third parties. We rely on a combination of
patent, trade secret, copyright, and trademark laws, as well as confidentiality
agreements, licensing agreements, and other agreements, to establish and
protect our proprietary rights.
As of January 31, 2005, we owned or had exclusively licensed the
following patents: 15 in the United States, 11 in European countries, six in
Australia, five in New Zealand, one in Japan, one in Singapore, and one in
Israel. In addition, as of January 31, 2005, we had approximately 273
patent applications before the United States Patent and Trademark Office,
foreign patent offices and international patent authorities. These patents and
patent applications are directed to drug lead discovery techniques using CART,
genetically altered GPCRs, GPCRs that we have discovered, new uses for previously
discovered GPCRs, and compounds discovered using CART and Melanophore and other
technologies. These patents and patent applications are divided into 76
distinct families of related patents that are directed to CART, Melanophore
technology, other novel screening methods, chemical compositions of matter,
methods of treatment using chemical compositions, or GPCR genes. One of our
patent families was exclusively in-licensed and contains a single issued
patent. Eight of our patent families containing a total of seven patents and 23
patent applications were the subject of joint inventions by our employees and
the employees of other entities. The remaining 67 patent families containing a
total of 32 patents and 250 patent applications were invented solely by our
employees. There is no assurance
that any of these patent applications will issue, or that any of the patents
will be enforceable or cover a drug product or other commercially significant
product or method. Except for the U.S. patents relating to our Melanophore
technology, the term of all of our other current patents commenced, and our
future patents, if any, will commence, on the date of issuance and terminate
20 years from the earliest effective filing date of the patent
application. Since our U.S. Melanophore patents were issued under now
superceded rules that provided a patent term of 17 years from the date of
issuance, the term of these patents are scheduled to end in 2012. Because the
time from filing to issuance of biotechnology patent applications is often more
than three years, the resulting term of our pending patent applications, if
any, on our products and technologies may be substantially less than
20 years. In the United States, patent term extensions are available for
certain delays in patent office proceedings and United States Food and Drug
Administration, or FDA, approval. However, due to the specific requirements for
obtaining these extensions, there is no assurance that our patents will be
afforded extensions even if we encounter significant delays in patent office
proceedings or FDA approval.
We seek patent protection for our key inventions, including clinical
candidates and product candidates we identify, routes for chemical synthesis,
CART, new receptors that we discover, and genetically altered receptors. It has
generally been possible to obtain broad composition of matter patents on novel
chemical compounds. It has also generally been possible to obtain broad method
patents for techniques and procedures for screening and drug-identification
technologies. It has generally been more difficult to obtain broad composition
of matter patents for nucleic acid and amino acid sequences. However, it has
been possible to obtain patents that protect specific sequences and functional
equivalents of those sequences. Furthermore, intellectual property law allows
for separate and distinct patents for novel, altered genetic sequences that
have improved properties over previously disclosed sequences. We believe that
we can obtain patents on certain of our CART-activated receptor sequences
because they are not functional equivalents of the natural version of the
receptor. We expect to continue to develop other means of activating GPCRs for
drug screening and to file patent applications with respect thereto.
In March 2003, we became aware that the Japanese Patent Office had
issued a Notification of Reasons for Revocation of our Japanese patent. In
December 2004, we succeeded in having our Japanese patent on our Melanophore
technology reinstated with a narrower claim scope, which we do not believe
materially impacts our ability to utilize the Melanophore technology.
8
In addition to patent protection, we rely on trade secrets, proprietary
know-how, and continuing technological advances to develop and maintain our
competitive position. To maintain the confidentiality of our trade secrets and
proprietary information, all of our employees are required to enter into and
adhere to an employee confidentiality and invention assignment agreement,
laboratory notebook policy, and invention disclosure protocol, as a condition
of employment. Additionally, our employee confidentiality and invention
assignment agreement requires that our employees not bring to us, or use
without proper authorization, any third-party proprietary technology. We also
require our consultants and collaborators that have access to proprietary
property and information to execute confidentiality and invention rights
agreements in our favor before beginning their relationship with us. While such
arrangements are intended to enable us to better control the use and disclosure
of our proprietary property and provide for our ownership of proprietary
technology developed on our behalf, they may not provide us with meaningful
protection for such property and technology in the event of unauthorized use or
disclosure.
Competition
The biotechnology and pharmaceutical industries are highly competitive
and are subject to rapid and significant change. We face significant
competition from organizations that are pursuing the same or similar
technologies. We also face significant competition from organizations that are
pursuing drugs that would compete with the product candidates we are
developing. We may not be able to compete successfully against these
organizations, which include many large and well-financed and experienced
pharmaceutical and biotechnology companies, as well as academic and research
institutions and government agencies.
The focus of our scientific and business strategy is GPCRs. We believe
that many pharmaceutical and biotechnology companies and other organizations
have internal drug discovery programs focused on GPCRs. In addition, other
companies have attempted to overcome the problems associated with traditional
drug screening by embarking on a variety of alternative strategies.
Developments by others may render our product candidates or technologies
obsolete or noncompetitive.
Our present competitors with respect to APD356 include Abbott, which
markets Meridia, and Roche, which markets Xenical. A potential future
competitor is sanofi-aventis, which is developing rimonabant, a cannabinoid-1
blocker. In addition, we are aware of potentially competing 5-HT2C programs
at Roche and GlaxoSmithKline.
In addition to the marketed compounds described above under the APD125
discussion, Pfizer/Neurocrine have submitted an NDA for Indiplon, and Sepracor
has recently received FDA approval for Lunesta, formally called Estorra. We
believe sanofi-aventis and Eli Lilly have been developing potentially competing
5-HT2A programs for insomnia.
Many of our existing and potential competitors have substantially
greater product development capabilities and financial, scientific, and
marketing resources than we do. Additional consolidation in the pharmaceutical
industry may result in even more resources being concentrated with our
competitors. As a result, our competitors may be able to devote greater
resources than we can to the research, development, marketing, and promotion of
drug discovery techniques or therapeutic products, or to adapt more readily to
technological advances than we can. Accordingly, our competitors may succeed in
obtaining patent protection, receiving FDA approval, or commercializing
products before we do.
We expect to encounter significant competition for the principal
product candidates we are developing. Companies that complete clinical trials,
obtain regulatory approvals, and commence commercial sales of their products
before us may achieve a significant competitive advantage. Furthermore, we will
be competing against companies with substantially greater manufacturing,
marketing, distributing, and selling capabilities, and any product candidate
that we successfully develop may compete with existing therapies that have long
histories of safe and effective use.
We rely on our collaborators for support of development programs and
for the manufacturing and marketing of product candidates. Our collaborators
may be conducting multiple product development efforts within the same disease
areas that are the subject of their agreements with us, which may negatively
impact the development of drugs that they discover that are subject to our
agreements. Generally, our agreements with our collaborators do not preclude
them from pursuing development efforts in one or more therapeutic areas of
interest in which we have internal development efforts ongoing. In addition, we
face and will continue to face intense competition from other companies for
such collaborative arrangements, and technological and other developments by
others may make it more difficult for us to establish such relationships.
Government Regulation
We plan
to develop and commercialize selected drug candidates by ourselves and license
other candidates to partners for further development and commercialization. Our
and our collaborator’s on-going drug development activities are subject to
9
the laws
and regulations of governmental authorities in the United States and other
countries in which these products may be tested or marketed. The regulatory
review and approval process, which includes preclinical testing and clinical
trials of each product candidate, is lengthy and uncertain. Before marketing in
the United States, any pharmaceutical or therapeutic product must undergo
rigorous preclinical testing and clinical trials and an extensive regulatory
approval process implemented by the FDA under the federal Food, Drug and
Cosmetic Act. Moreover, the FDA imposes substantial requirements on new product
research and the clinical development, manufacture and marketing of
pharmaceutical products, including testing and clinical trials to establish the
safety and effectiveness of these products. In the United States, we are also
subject to other federal, state and local environmental and safety laws and
regulations, including regulation of the use and care of laboratory animals. In
addition, the state of California imposes licensing requirements on facilities
manufacturing drugs for clinical trials or for commercial marketing.
Governments
in other countries have similar requirements for testing, approval and
marketing, including in the European Union (the “EU”). Before commencing
clinical trial investigations in humans in Europe, we and/or our collaborators
must submit the appropriate applications to applicable authorities in member
countries.
Before
commencing clinical investigations in humans in the United States, we and/or
our collaborators must submit an investigational new drug, or IND, application
to the FDA. Clinical trials are typically conducted in three sequential phases,
although the phases may overlap or be combined. Phase 1 represents the initial
administration of the drug to a small group of humans, either healthy
volunteers or patients, to test for safety, dosage tolerance, absorption,
metabolism, excretion and clinical pharmacology. Phase 2 involves studies in
patients to begin to assess the effectiveness of the product, to ascertain dose
tolerance and the optimal dose range and to gather additional data relating to
safety and potential adverse effects. Once a drug is found to have some
effectiveness and an acceptable safety profile in the targeted patient
population, Phase 3 studies are initiated to establish safety and effectiveness
in an expanded patient population and at multiple clinical study sites. The FDA
may require further post-marketing studies, referred to as Phase 4 studies. The
FDA reviews both the clinical plans and the results of the trials and we, our
collaborators or the FDA may decide that clinical trials should be discontinued
at any time if any significant safety issues are identified. Clinical testing
must meet requirements for institutional review board or ethics committee oversight,
informed consent, good clinical practices and other FDA or other regulatory
authority oversight.
The
length of time necessary to complete clinical trials varies significantly and
is difficult to predict. Clinical results are frequently susceptible to varying
interpretations that may delay, limit or prevent regulatory approvals.
Additional factors that may cause delay, termination or increased cost of our
or our collaborators’ clinical trials include, among other factors:
• slow patient enrollment;
• the eligibility criteria for the study;
• competition with clinical trials for other drug
candidates;
• lack of sufficient clinical supplies of the product
candidate;
• lack of effectiveness of the product being tested;
• adverse medical effects or side effects in treated
patients;
• inadequately trained or insufficient personnel at a
study site to assist in overseeing and monitoring the clinical trial;
• delays in approval from a study site’s institutional
review board; and
• longer treatment time required to demonstrate
effectiveness or to determine the appropriate product dose.
If
preclinical and clinical studies are successful, the results, together with
other information about the product and its manufacture, are submitted to the
FDA in the form of a New Drug Application, or NDA, to request marketing
approval. Before receiving FDA approval to market a product, we or our
collaborators must demonstrate that the product is safe and effective through
clinical trials in the patient population that will be treated. The approval
process is likely to require substantial time and effort and there can be no
assurance that any approval will be granted on a timely basis, if at all.
10
Additional
animal studies or clinical trials may be requested during the FDA review period
that may delay marketing approval. As part of the approval process, each
manufacturing facility must be inspected by the FDA. Among the conditions of
approval is the requirement that a manufacturer’s quality control and
manufacturing procedures conform with federally mandated current good
manufacturing practices, or cGMPs. Both before and after approval,
manufacturers must expend time, money and effort to ensure compliance with
cGMPs, and the FDA conducts periodic inspections to certify such compliance.
Violations may result in the issuance of warning letters, restrictions on the product or manufacturer, including
costly recalls or withdrawal of the product from the market, or other enforcement
action.
If
regulatory approval of a product is granted by the FDA, this approval will be
limited to those specific conditions for which the product, as demonstrated
through clinical studies, has an appropriate safety and efficacy balance. After
FDA approval for the initial indications, further clinical trials will be
necessary to gain approval for the use of the product for additional
indications. Marketing or promoting a drug for an unapproved indication is
prohibited. The FDA requires that adverse effects be reported to the FDA and
may also require post-marketing testing to monitor for adverse effects, which
can involve significant expense. Even after FDA approvals are obtained, a
marketed product is subject to continual review. Later discovery of previously
unknown information or failure to comply with the applicable regulatory
requirements may result in restriction on the marketing of a product or
withdrawal of the product from the market as well as possible civil or criminal
sanctions. Furthermore, failure to obtain reimbursement coverage from
governmental or third-party insurers may adversely impact successful
commercialization.
We have a
chemical development facility that we are using for process research, the
scale-up and production of intermediates and other compounds for research and
development purposes, and the production of active pharmaceutical ingredients
for use in human clinical trials. California law prohibits the shipment of
product from a manufacturing facility in California for any clinical testing or
commercial use prior to satisfaction of drug manufacturing licensing
requirements. The facility was inspected and licensed by the California
Department of Health Services and is in compliance with state regulatory
requirements for the manufacture and distribution of active pharmaceutical
ingredients.
Sources and Availability of Raw Materials and Clinical
Supplies
In
general, we purchase raw materials and supplies on the open market.
Substantially all such materials are obtainable from a number of sources so
that the loss of any one source of supply would not have a material adverse
effect on us. However, we currently only have two sources of supply for the
active pharmaceutical ingredient for our lead development projects. The loss of
that supply would temporarily delay our lead development projects, APD356 and
APD125.
Compliance with Environmental Regulations
We are
subject to regulation under the Occupational Safety and Health Act, the
Environmental Protection Act, the Toxic Substances Control Act, the Resource
Conservation and Recovery Act, the Controlled Substances Act and other present
and potential future federal, state or local regulations. Our research and
development programs involve the controlled use of hazardous materials, chemicals,
biological materials and various radioactive compounds.
Although
we believe that our operations comply in all material respects with the
applicable environmental laws and regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated.
In the event of such an accident, we could be held liable for any damages that
result, and the extent of that liability could exceed our resources. Our
compliance with these laws and regulations did not, and is not expected to,
have a material effect upon our capital expenditures, earnings or competitive
position.
Employees
As of February 1, 2005, we had 291 employees, including 243 in
research and development and 48 employees in administration, which includes
finance, legal, facilities and other general support areas. None of our
employees is covered by a collective bargaining agreement. We consider our
relationship with our employees to be good.
Available
Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act of 1934 are available free of charge on our website (www.arenapharm.com) as
soon as reasonably practicable after they are filed with, or furnished to, the
Securities and Exchange Commission.
11
Risk
Factors
An investment in our stock involves a high
degree of risk. You should consider carefully the risks described below,
together with other information in this Form 10-K, before making investment
decisions regarding our stock. If any of the following events actually occur, our
business, operating results, prospects or financial condition could be
materially and adversely affected. This could cause the trading price of our
common stock to decline and you may lose all or part of your investment. The
risks described below are not the only ones that we face. Additional risks not
presently known to us or that we currently deem immaterial may also affect our
business operations.
Risks Relating to Our Business
We will need additional funds to conduct our planned
research and development efforts, and we may not be able to obtain such funds.
We had losses of $61.3 million for the year ended
December 31, 2004, and we had an accumulated deficit of
$168.8 million from our inception in April 1997 through
December 31, 2004. Our losses have resulted in large part from the
significant research and development expenditures we have made in seeking to
identify and validate new drug targets and compounds that could become marketed
drugs.
We expect our operating expenses over the next several years will be
significant and that we will continue to have significant operating losses in
the near term, even if we or our collaborators are successful in advancing
compounds discovered using our technologies.
We do not have any commercial products. It takes many years and
potentially hundreds of millions of dollars to successfully develop a
preclinical or early clinical compound into a marketed drug. We have
substantially less money than we will need to successfully develop a compound
into a marketed drug. Additional financing may not be available to us or may
not be available on terms that you or we believe are favorable.
Our stock has not performed as well as the stock of many of our peers
for some time, and we presently are aware of only a small number of securities
analysts covering our stock, which means limited third-party information is
available to investors. We believe that institutional and other investors value
third-party information in making investment decisions regarding our stock.
These factors, and many others, may affect our ability to access capital markets.
If additional financing is not available, we may be required to delay,
reduce the scope of or eliminate one or more of our research or development
programs.
We expect to announce results for our two most
advanced product candidates by the middle of 2005, and our stock price could
decline significantly based on those clinical results.
By the middle of 2005, we expect to announce results from separate
clinical trials currently in progress for our two most advanced product
candidates, APD356 and APD125. These results may not be favorable or viewed
favorably by us or third parties, including investors, analysts and potential
collaborators. Biotechnology company stock prices have declined significantly
in certain instances where clinical results were not favorable, were perceived
negatively or otherwise did not meet expectations. Unfavorable results or
negative perceptions regarding the results of our clinical trials of APD356,
APD125, or any of our other product candidates could cause our stock price to decline
significantly.
Clinical trials for our product candidates are
expensive, time consuming and their outcome is uncertain.
Clinical trials are very expensive and difficult to design and
implement. The clinical trial process is also time consuming. We estimate that
the clinical trials of our most advanced drug candidates will continue for
several years, but may take significantly longer to complete. Before we can
obtain regulatory approval for the commercial sale of any product candidate
that we wish to develop, we are required to complete extensive clinical trials
in humans to demonstrate its safety and efficacy. The timing of the
commencement, continuation and completion of clinical trials may be subject to
significant delays relating to various causes, including:
• delays or inability to manufacture or obtain
sufficient quantities of materials for use in clinical trials;
• delays in obtaining regulatory approvals to
commence a study;
12
• delays in identifying and reaching agreement
on acceptable terms with prospective clinical trial sites;
• slower than expected rates of patient
recruitment and enrolment;
• uncertain dosing issues;
• inability or unwillingness of medical
investigators to follow our clinical protocols;
• variability in the number and types of
subjects available for each study and resulting difficulties in identifying and
enrolling subjects who meet trial eligibility criteria;
• scheduling conflicts with participating
clinicians and clinical institutions;
• difficulty in maintaining contact with
subjects after treatment, resulting in incomplete data;
• unforeseen safety issues or side effects;
• lack of effectiveness during the clinical
trials; or
• other regulatory delays.
The results of preclinical studies and initial
clinical trials are not necessarily predictive of future results, and our
current product candidates may not have favorable results in later testing or
trials.
Preclinical tests and Phase 1 and Phase 2 clinical trials are not
primarily designed to test the efficacy of a product candidate, but rather to
test safety, to study pharmacokinetics and pharmacodynamics, and to understand
the product candidate’s side effects at various doses and schedules. Success in
preclinical or animal studies and early clinical trials does not ensure that
later large-scale trials will be successful nor does it predict final results.
Favorable results in early trials may not be repeated in later trials.
A number of companies in the biotechnology industry have suffered
significant setbacks in advanced clinical trials, even after promising results
in earlier trials. Clinical results are frequently susceptible to varying
interpretations that may delay, limit or prevent regulatory approvals. Negative
or inconclusive results or adverse medical events during a clinical trial could
cause a clinical trial to be delayed, repeated or terminated. In addition,
failure to construct appropriate clinical trial protocols could result in the
test or control group experiencing a disproportionate number of adverse events
and could cause a clinical trial to be repeated or terminated.
Initial clinical trials of APD356 have been conducted only in small
numbers of subjects. Preclinical data and the limited clinical results we have
obtained for APD356 may not predict results from studies in larger numbers of
subjects drawn from more diverse populations, and also may not predict the
ability of APD356 to achieve a sustained reduction in bodyweight, or to do so
safely. We have designed APD356 to more selectively stimulate the 5-HT2C serotonin
receptor because we believe this selectivity may avoid the cardiovascular side
effects associated with fenfluramine and dexfenfluramine, both of which were
withdrawn from the market in 1997 after reported incidences of heart valve
disease and pulmonary hypertension associated with their usage. We may not be
correct in this belief, however, and APD356’s selectivity profile may not avoid
the undesired side effects. Moreover, the potential relationship between the
activity of APD356 and fenfluramine and dexfenfluramine may result in increased
FDA regulatory scrutiny of the safety of our product candidates and may raise
potential adverse publicity in the marketplace. In response to our IND
submission for APD356, the FDA requested that we provide an assessment of the
abuse potential of APD356 as well as plans for cardiac valve monitoring during
Phase 2 and Phase 3 clinical trials. We have submitted to the FDA our plan for
cardiac valve monitoring and our communication with the FDA on these issues is
on-going. Preclinical data also may not predict the ability of APD125 to be
effective at initiating sleep and/or improving sleep quality.
We will be required to demonstrate through larger-scale clinical trials
that these product candidates are safe and effective for use in a diverse
population before we can seek regulatory approvals for their commercial sale.
There is typically an extremely high rate of attrition from the failure of
product candidates proceeding through clinical trials. To date, long-term
safety and efficacy have not yet been demonstrated in clinical trials for any
of our product candidates. If APD356 or APD125 fails to demonstrate sufficient
safety and efficacy in any clinical trial, we will experience potentially
significant delays in, or decide to abandon development of, that product
candidate. We expect to announce the results of clinical trials for both APD356
and
13
APD125 by the middle of 2005. However, if we delay or abandon our
development efforts related to APD356 or APD125, or any other product
candidate, we may not be able to generate sufficient revenues to continue our
operations at the current level or become profitable, our reputation in the
industry and in the investment community would likely be significantly damaged,
and our stock price is likely to decrease significantly.
Our research and development programs are in early
stages of development, and may not result in the commencement of clinical
trials.
Our research and development programs are in the discovery, preclinical
or early clinical stage of development. The process of discovering compounds
with therapeutic potential is expensive, time-consuming and unpredictable.
Similarly, the process of conducting preclinical studies of compounds that we
discover requires the commitment of a substantial amount of our technical,
financial and human resources. We may not discover additional compounds with
therapeutic potential, and any of the compounds for which we are conducting
preclinical studies may not result in the commencement of clinical trials. If
we are unable to identify and develop new product candidates, we may not be
able to establish or maintain a clinical development pipeline or generate
revenue.
The technologies on which we rely may not result in
the discovery or development of commercially viable products.
Our GPCR technologies allow us to discover drug-like compounds that act
on receptor subtypes of known GPCRs and novel GPCRs where the native ligands
have not been identified. These methods of identifying, prioritizing and
screening molecular targets are unproven approaches to the identification of
drug leads that may possess therapeutic potential, and may not result in the
regulatory approval and commercialization of any therapeutic products. We do
not believe that there are any drugs on the market that have been discovered or
developed using our proprietary technologies. If we are unable to identify additional
product candidates using our proprietary drug discovery technologies, we may
not be able to maintain a clinical development pipeline or generate revenues.
Another company, organization or individual could have, or could
develop, a technology using GPCRs to discover and develop compounds into drugs
more effectively or more efficiently than our screening and other technologies.
Such a technology could render our technologies, in particular our
constitutively activated receptor technology, or CART, and Melanophore
technology, obsolete or noncompetitive.
Our product candidates are subject to extensive
regulation, which can be costly and time consuming, cause unanticipated delays,
or prevent the receipt of the required approvals to commercialize products.
The clinical development, manufacturing, labeling, packaging, storage,
record-keeping, advertising, promotion, export, marketing, and distribution of
our product candidates are subject to extensive regulation by the FDA and other
regulatory agencies in the United States and by comparable governmental
authorities in foreign markets. Neither we nor our collaborators are permitted
to market our potential products in the United States until we receive
regulatory approval from the FDA. Neither we nor our collaborators have
received marketing approval for any of our product candidates. The process of
obtaining regulatory approval is expensive, often takes many years, and can
vary substantially based upon the type, complexity and novelty of the products
involved. A new drug approval, or NDA, application must be supported by
extensive clinical and preclinical data regarding manufacturing, process and
controls to demonstrate the safety and effectiveness of the product candidate.
Approval policies or regulations may change. Moreover, failure to comply with
the FDA and other applicable foreign and United States regulatory requirements
may subject us to administrative or judicially imposed sanctions. These include
warning letters, civil and criminal penalties, injunctions, product seizure and
detention, product recalls, total or partial suspension of production, and
refusal to approve pending NDAs, or supplements to approved NDAs.
In addition, we have not previously filed NDAs with the FDA. This lack
of experience may impede our ability to obtain FDA approval in a timely manner,
if at all, for our product candidates for which development and
commercialization is our responsibility. Despite the time and expense invested,
regulatory approval is very uncertain and never guaranteed and we could
encounter problems that cause us to abandon clinical trials or to repeat or
perform additional preclinical testing and clinical trials. The FDA has
substantial discretion in the drug approval process. The number of preclinical
studies and clinical trials that will be required for FDA approval varies
depending on the product candidate, the disease or condition that the product
candidate is designed to address, and the regulations applicable to any
particular drug candidate. The FDA can delay, limit or deny approval of a
product candidate for many reasons, including:
• not finding a product candidate safe and
effective;
• not finding the data from preclinical
testing and clinical trials sufficient;
14
• not approving of our or a third-party
manufacturers’ processes or facilities; or
• changes in its approval policies or the
adoption of new regulations.
Because, in part, of the early stage of our product candidate research
and development process, we cannot predict whether or not regulatory approval
will be obtained for any product we develop. Only two of our product
candidates, APD356 and APD125, are undergoing clinical trials. Compounds
developed by us, alone or with other parties, may not prove to be safe and
effective in clinical trials and may not meet all of the applicable regulatory
requirements needed to receive marketing approval. Administering any of our
product candidates to humans may produce undesirable side effects. These side
effects could interrupt, delay or halt clinical trials of our product
candidates and could result in the FDA or other regulatory authorities denying
approval of our product candidates for any or all of the targeted indications.
If regulatory approval of a product is granted, the approval will be limited to
those disease states and conditions for which the product is demonstrated
through clinical trials to be safe and effective. Failure to obtain regulatory
approval will delay or prevent us from commercializing products. These risks
also apply to the development activities of our collaborators, and we do not
expect any drugs resulting from our collaborators’ research and development
efforts to be commercially available for many years, if ever. The FDA, other
regulatory authorities, our collaborators or we may suspend or terminate
clinical trials at any time. Any failure or significant delay in completing
clinical trials for our drug candidates, or in receiving regulatory approval
for the sale of any drugs resulting from our product candidates, may severely
harm our business and reputation.
If we are not successful in advancing our lead
programs, we may have to curtail some of our activities.
If we are not successful in achieving additional milestones under our
cardiovascular collaboration with Merck or our 19AJ collaboration with
Ortho-McNeil, or developing or partnering APD356 or APD125 or any of our other
lead programs, we may not be able to raise new financing or generate
significant partnering revenues in the short term. If we do not receive new
financing or partnering revenues, we may need to license some or all of our
programs on financial terms that are unfavorable to us. Also, without
additional financing or partnering revenues, we would need to re-evaluate our
strategy of moving multiple drug discovery and development programs forward
while at the same time maintaining our research and discovery capabilities.
Based on such evaluation, we may need to significantly curtail some of our
current and planned programs and expenditures. We do not know what programs, if
any, we would need to curtail, but we believe narrowing our pipeline would
reduce our opportunity for success.
Our revenues depend upon the actions of our existing
and potential collaborators.
Our revenues were $13.7 million, $12.8 million and $19.4 million for
the years ended December 31, 2004, 2003 and 2002, respectively. Our revenues depend upon the success of our
existing collaborations and on our ability to enter into new collaborations. We
will receive little additional revenue under our existing collaboration
agreements if our own or our collaborators’ research, development or,
ultimately, marketing efforts are unsuccessful, or if our agreements are
terminated early. Typically, our collaborators (and not us) control the
development of compounds into drugs after we have met early preclinical
scientific milestones, and we are not entitled to the more significant
milestone payments under our agreements until our collaborators have advanced
compounds into clinical testing, which may not occur for many years, if ever.
We cannot guarantee that any of the development, approval or sales milestones
in our existing or future collaborations will be satisfied, or that we will
receive any payments for the achievement of those milestones.
For the year ended December 31, 2004, revenues recognized under
our collaboration with Merck represented approximately 95% of our total
revenues. On December 20, 2004, we entered into a collaboration and
license agreement with Ortho-McNeil for which we received an upfront payment of
$17.5 million in January 2005. In addition, we received milestone payments
totaling $5.0 million upon Ortho-McNeil’s selection of two
Arena-discovered compounds for preclinical development in January 2005. We
expect substantially all of our revenues for 2005 will be derived from our
collaborations with Merck and Ortho-McNeil. Our revenues will be materially
impacted if:
• our agreement with either Merck or
Ortho-McNeil is terminated;
• our collaborators do not devote their time
and financial resources to develop compounds under our collaborations;
• our collaborators dispute whether we have
achieved a milestone, rights to a particular receptor or compound, or other
terms of our agreements;
• our collaborators use alternative
technologies to our technologies and compete with us in developing products; or
15
• our collaborators experience failures in the
discovery or development of compounds identified with our technologies or in
the clinic or marketplace with other products that cause them to discontinue or
slow down our collaboration.
Our ability to enter into new collaborations depends on the outcomes of
our preclinical and clinical testing. We do not control these outcomes. In
addition, even if our testing is successful, pharmaceutical companies may not
partner with us on terms that we believe are acceptable until we have advanced
our product candidates into the clinic and, possibly, through a Phase 2
clinical trial, if at all.
Our collaboration agreements with Merck and
Ortho-McNeil may be terminated in certain circumstances.
The term of our amended collaborative research program with Merck is
three years from October 21, 2004. Merck can terminate this program:
(i) for “Technical Grounds,” by giving 30 days prior notice, if both
Merck and we agree that Technical Grounds have occurred; or (ii) in the
event of our change in control (as defined in the agreement), by giving
30 days prior notice. Technical Grounds include circumstances where:
(1) our joint research committee (a committee of an equal number of Merck
and our representatives) concludes that (a) a significant adverse event
affecting all the targets, all program compounds and all active compounds under
the program has arisen during the conduct of the program, or
(b) continuation of the program is no longer scientifically promising
because the role of all the targets proves incorrect, or none of the targets
are valid as a suitable target for development of a pharmaceutical product; or
(2) Merck’s patent department, upon consultation with our patent
attorneys, makes a reasonable determination that valid third-party patent
rights block the achievement of significant program goals.
In addition, either party can terminate the agreement if the other
party breaches its material obligations under the agreement by causes and
reasons within its control, has not cured such breach within 90 days of
receiving a letter requesting such cure, and there is no dispute as to whether
such breach has occurred. In lieu of terminating the agreement, however, Merck
can terminate the research program and certain other aspects of the agreement
after giving 90 days prior notice if we materially breach our obligations
during the course of the program and fail to cure such breach, if such default
cannot be cured within such 90-day period, or if we do not commence and
diligently continue good faith efforts to cure such default during such period.
Our agreement with Ortho-McNeil will continue until the expiration of
Ortho-McNeil’s payment obligations for research funding, milestone payments and
royalties, unless the agreement is terminated earlier by either party. We and Ortho-McNeil
each have the right to terminate the agreement early if the other party commits
an uncured material breach of its obligations. Further, Ortho-McNeil may
terminate the agreement without cause during the term of the research program,
provided that in such event it pays us the balance of its research funding
obligation in a lump sum, unless the termination is due to a change of control
of Arena (as defined in the agreement), in which case Ortho-McNeil may
terminate either the agreement or the research program under the agreement,
without the payment of additional research funding to us. At any time after the
end of the research program, Ortho-McNeil may terminate the agreement by
providing us at least 60 days prior written notice. Upon termination of
the agreement, all rights to the compounds developed under the collaboration
will revert to us.
We may have conflicts with our collaborators that
could delay or prevent the development or commercialization of our product
candidates.
We may have conflicts with our collaborators, such as conflicts
concerning the interpretation of clinical data, the achievement of milestones,
or the ownership of intellectual property developed during the collaboration.
If any conflicts arise with Ortho-McNeil, Merck or any other collaborators,
such collaborator may act in its self-interest, which may be adverse to our
best interests. Any such disagreement could result in one or more of the
following, each of which could delay or prevent the development or
commercialization of our product candidates, and in turn prevent us from
generating revenues:
• unwillingness on the part of a collaborator
to pay us research funding, milestone payments or royalties we believe are due
to us under a collaboration;
• uncertainty regarding ownership of
intellectual property rights arising from our collaborative activities, which
could prevent us from entering into additional collaborations;
• unwillingness on the part of a collaborator
to keep us informed regarding the progress of its development and
commercialization activities or to permit public disclosure of the results of
those activities; or
• slowing or cessation of a collaborator’s
development or commercialization efforts with respect to our product
candidates.
16
Drug discovery and development is intensely
competitive in the therapeutic areas on which we focus. If our competitors
develop treatments that are approved faster, marketed better or demonstrated to
be more effective than our product candidates, our commercial opportunity will
be reduced or eliminated.
We focus our efforts on GPCRs. Because GPCRs are an important target
class for drug discovery efforts, we believe that many pharmaceutical and
biotechnology companies and other organizations have internal drug discovery
programs focused on GPCRs. Many of the drugs that we or our collaborators are
attempting to discover and develop would compete with existing therapies. In
addition, many companies are pursuing the development of new drugs that target
the same diseases and conditions that we target. Many of our competitors,
particularly large pharmaceutical companies, have substantially greater
research and development capabilities and greater financial, scientific and
human resources than we do. Companies that complete clinical trials, obtain
required regulatory agency approvals and commence commercial sale of their
drugs before we do for the same indication may achieve a significant
competitive advantage, including certain patent and FDA marketing exclusivity
rights. In addition, our competitors may develop drugs with fewer side effects,
more desirable characteristics (such as route of administration or frequency of
dosing) or greater efficacy than our drugs, if any, for the same indication.
Any results from our research and development efforts, or from our joint
efforts with our existing or any future collaborators, may not compete
successfully with existing or newly discovered products or therapies.
Consolidation and setbacks in our industry and our or
our collaborator’s inability to obtain acceptable prices for drugs could make
partnering more difficult and diminish our revenues.
Consolidation in the pharmaceutical and biotechnology industry,
setbacks caused by safety concerns relating to high-profile drugs like Vioxx and
Celebrex, competition from generic drugs and litigation may have an adverse
effect on us. In addition, pharmaceutical companies may be less willing to
enter into a new collaboration if they are integrating a new operation as a
result of a merger or acquisition, if their therapeutic areas of focus change
following a merger, or if they have reduced research budgets as a result of
some financial setback.
Our and our collaborators’ ability to commercialize future drugs will
depend in part on government regulation and the reimbursement policies of
government authorities, private health insurers and other third-party payors.
Government and third-party payors are increasingly attempting to contain
healthcare costs by limiting coverage and reimbursement levels for new drugs.
These efforts may limit our commercial opportunities by reducing the amount a
potential collaborator is willing to pay to license our programs or product
candidates in the future by reducing the potential revenues that we and our
collaborators could generate from drug sales.
We rely on third parties to conduct our clinical
trials. If those parties do not successfully carry out their contractual duties
or meet expected deadlines, we may not be able to advance our product
candidates in a timely manner or at all.
In the course of our discovery, preclinical testing and clinical
trials, we have relied and continue to rely on third parties, including
laboratories, investigators, clinical research organizations and manufacturers,
to perform critical services for us. For example, we are relying on contract
clinical sites to conduct our clinical trials for APD356 and APD125. Clinical
research organizations will be responsible for many aspects of the trials,
including finding and enrolling subjects for testing and administering the
trials. These third parties may not be available when we need them or, if they
are available, may not comply with all regulatory and contractual requirements
or may not otherwise perform their services in a timely or acceptable manner.
These independent third parties may also have relationships with other
commercial entities, some of which may compete with us. As a result of our
dependence on third parties, we may face delays or failures outside of our
direct control. These risks also apply to the development activities of our
collaborators, and we do not expect any drugs resulting from our collaborators’
research and development efforts to be commercially available for many years,
if ever.
Any performance failure on the part of a third-party manufacturer could
delay clinical development or regulatory approval of our product candidates.
Third-party manufacturers often encounter difficulties involving production
yields, quality control and quality assurance, as well as shortages of
qualified personnel. The manufacturers are subject to ongoing periodic
unannounced inspection by the FDA, the DEA and corresponding state agencies to
ensure strict compliance with cGMP and other applicable government regulations
and corresponding foreign standards; however, we do not have control over
third-party manufacturers’ compliance with these regulations and standards. If
one of our manufacturers fails to maintain compliance, the production of our
product candidates could be interrupted, resulting in delays, additional costs
and potentially lost revenues.
17
We may engage in strategic transactions that could
impact our liquidity, increase our expenses and present significant
distractions to our management.
From time to time we consider strategic transactions, such as
acquisitions of companies, asset purchases and out-licensing or in-licensing
compounds developed by us or others. Additional potential transactions we may
consider include a variety of different business arrangements, including
spin-offs, strategic partnerships, joint ventures, restructurings,
divestitures, business combinations and investments. Any such transaction may
require us to incur non-recurring or other charges, may increase our near and
long-term expenditures and may pose significant integration challenges or
disrupt our management or business, which could harm our operations and
financial results.
Our efforts will be seriously jeopardized if we are
unable to retain and attract key employees.
Our success depends on the continued contributions of our principal
management, development and scientific personnel, and the ability to hire and
retain key personnel, particularly in the clinical development area as we
transition more of our programs from research into drug development. We face
intense competition for such personnel. The loss of services of any principal
member of our management or scientific staff, particularly Jack Lief, our
President and Chief Executive Officer, and Dominic P. Behan, Ph.D., our Senior
Vice President and Chief Scientific Officer, could adversely impact our
operations and ability to raise additional capital. To our knowledge, neither
Mr. Lief nor Dr. Behan plans to leave, retire or otherwise disassociate
with us in the near future.
We may encounter significant delays or problems with
our new chemical development facility.
We have a chemical development facility for process research, the
scale-up and production of intermediates and other compounds for research and
development purposes, and the production of active pharmaceutical ingredients.
We may encounter delays and problems in operating our chemical
development facility due to:
• governmental approvals, permits and
regulation of the facility;
• accidents during operation of the facility;
• failure of equipment for the facility;
• delays in receiving raw materials from
suppliers;
• natural or other disasters; or
• other factors inherent in operating a
complex manufacturing facility.
We may not be able to operate our chemical development facility in a
cost-effective manner or in a time frame that is consistent with our expected
future manufacturing needs. If this were the case, we would need to seek
alternative means to fulfill our manufacturing needs, which could delay
progress on our programs.
We use biological materials, hazardous materials,
chemicals and radioactive compounds.
Our research and development activities involve the use of potentially
harmful biological materials as well as hazardous materials, chemicals and
various radioactive compounds that could be hazardous to human health, safety
or the environment. These materials and various wastes resulting from their use
are stored at our facility pending ultimate use and disposal. We cannot completely
eliminate the risk of contamination, which could cause:
• an interruption of our research and
development efforts;
• injury to our employees and others;
• environmental damage resulting in costly
clean up; and
• liabilities under federal, state and local
laws and regulations governing the use, storage, handling and disposal of these
materials and specified waste products.
18
In such an event, we could be held liable for any resulting damages, and
any such liability could exceed our resources. Although we believe that we
carry insurance in amounts and type that we consider commercially reasonable,
we do not have insurance coverage for losses relating to an interruption of our
research and development efforts caused by contamination, and we cannot be
certain that the coverage or coverage limits of our insurance policies will be
adequate.
We may incur substantial liabilities from any product
liability claims if our insurance coverage for those claims is inadequate.
We face an inherent risk of product liability exposure related to the
testing of our product candidates in human clinical trials, and will face an
even greater risk if we sell our product candidates commercially. An individual
may bring a liability claim against us if one of our product candidates causes,
or merely appears to have caused, an injury. If we cannot successfully defend
ourselves against the product liability claim, we will incur substantial
liabilities. Regardless of merit or eventual outcome, liability claims may
result in:
• decreased demand for our product candidates;
• injury to our reputation;
• withdrawal of clinical trial subjects;
• costs of related litigation;
• substantial monetary awards to subjects or
other claimants;
• loss of revenues; and
• the inability to commercialize our product
candidates.
We have product liability insurance that covers our clinical trials up
to an annual aggregate limit of $5.0 million. We intend to expand our
insurance coverage to include the sale of commercial products if marketing
approval is obtained for any of our product candidates. However, insurance
coverage is increasingly expensive. We may not be able to maintain insurance
coverage at a reasonable cost and we may not be able to obtain insurance
coverage that will be adequate to satisfy any liability that may arise.
We may incur increased costs as a result of recently
enacted changes in laws and regulations relating to corporate governance
matters.
Changes in the laws and regulations affecting public companies,
including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by
the Securities and Exchange Commission and by the Nasdaq National Market, may
result in increased costs to us. These laws, rules and regulations could make
it more difficult or costly for us to obtain certain types of insurance,
including director and officer liability insurance, and we may be forced to
accept reduced policy limits and coverage or incur substantially higher costs
to obtain the same or similar coverage. The impact of these events could also
make it more difficult for us to attract and retain qualified persons to serve
on our board of directors, our board committees or as executive officers. We
cannot predict or estimate the amount or timing of additional costs we may
incur to respond to their requirements.
Our operations might be interrupted by the occurrence
of a natural disaster or other catastrophic event.
We depend on our collaborators, contractors and vendors and on our
laboratories and other facilities for the continued operation of our business.
Natural disasters or other catastrophic events, including terrorist attacks,
power interruptions, wildfires and other fires, actions of animal rights
activists, earthquakes and wars could disrupt our operations or those of our
collaborators, contractors and vendors. Even though we believe we carry
reasonably adequate business interruption and liability insurance, and our
contractors may carry liability insurance, that protect us in certain events,
we might suffer losses as a result of business interruptions that exceed the
coverage available under our and our contractors’ insurance policies or for
which we or our contractors do not have coverage. For example, we are not
insured against a terrorist attack. Any natural disaster or catastrophic event
could have a significant negative impact on our operations and financial
results.
19
Even if any of our product candidates receives regulatory
approval, our product candidates will still be subject to extensive post-market
regulation.
If we or our collaborators receive regulatory approval for our drug
candidates, we will also be subject to ongoing FDA obligations and continued
regulatory review, such as continued safety reporting requirements, and we may
also be subject to additional FDA post-marketing obligations, all of which may
result in significant expense and limit our ability to commercialize our
product.
If any of our product candidates receive United States regulatory
approval, the FDA may still impose significant restrictions on the indicated
uses for which the product may be marketed or impose ongoing requirements for
potentially costly post-approval studies. In addition, regulatory agencies
subject a product, its manufacturer and the manufacturer’s facilities to
continual review and periodic inspections. The subsequent discovery of
previously unknown problems with a product, including adverse events of
unanticipated severity or frequency, or problems with the facility where the
product is manufactured, may result in restrictions on the marketing of that
product, and could include withdrawal of the product from the market. Failure
to comply with applicable regulatory requirements may result in:
•
issuance of warning letters by the FDA;
• fines
and other civil penalties;
•
criminal prosecutions;
•
injunctions, suspensions or revocations of marketing licenses;
•
suspension of any ongoing clinical trials;
•
suspension of manufacturing;
•
delays in commercialization;
•
refusal by the FDA to approve pending applications or supplements to
approved applications filed by us or our collaborators;
•
refusals to permit products to be imported or exported to or from the
United States;
•
restrictions on operations, including costly new manufacturing
requirements; and
•
product recalls or seizures.
The FDA’s policies may change and additional government regulations may
be enacted that could prevent or delay regulatory approval of our drug
candidates or further restrict or regulate post-approval activities. We cannot
predict the likelihood, nature or extent of adverse government regulation that
may arise from future legislation or administrative action, either in the
United States or abroad. If we are not able to maintain regulatory compliance,
we might not be permitted to market our drugs and our business could suffer.
In order to market any products outside of the United States, we and
our collaborators must establish and comply with numerous and varying
regulatory requirements of other countries regarding safety and efficacy.
Approval procedures vary among countries and can involve additional product
testing and additional administrative review periods. The time required to obtain
approval in other countries might differ from that required to obtain FDA
approval. The regulatory approval process in other countries may include all of
the risks associated with FDA approval as well as additional presently
unanticipated risks. Regulatory approval in one country does not ensure
regulatory approval in another, but a failure or delay in obtaining regulatory
approval in one country may negatively impact the regulatory process in others.
Failure to obtain regulatory approval in other countries or any delay or
setback in obtaining such approval could have the same adverse effects
associated with regulatory approval in the United States, including the risk
that our product candidates may not be approved for all indications requested
and that such approval may be subject to limitations on the indicated uses for
which the product may be marketed.
20
New
Accounting Pronouncements May Impact our Future Results of Operations
In December 2004, the Financial Accounting Standards Board (“FASB”)
issued Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment.” This statement,
which will be effective in our third quarter of 2005, will change how we
account for share-based compensation, and may have a significant impact on our
future results of operations.
We currently account for share-based payments to employees and
directors using the intrinsic value method. Under this method, we generally do
not recognize any compensation related to stock option grants we issue under
our stock option plans or the discounts we provide under our employee stock
purchase plan.
SFAS 123R will require us to recognize share-based compensation as
compensation expense in the statement of operations based on the fair values of
such equity on the date of the grant, with the compensation expense recognized
over the period in which the recipient is required to provide service in
exchange for the equity award. This statement will also require us to adopt a
fair value-based method for measuring the compensation expense related to
share-based compensation. We have begun, but have not completed, evaluating the
impact of the adoption of SFAS 123R on our results of operations. In
connection with evaluating the impact of SFAS 123R, we are considering the
potential implementation of different valuation methods to determine the fair
value of share-based compensation. We believe the adoption of SFAS 123R
will have a material impact on our results of operations, regardless of the
valuation method used. SFAS 123R also requires the benefits of tax deductions
in excess of recognized compensation cost to be reported as a financing cash
flow, rather than as an operating cash flow. This requirement will reduce our
net operating cash flows and increase our net financing cash flows in periods
after adoption. SFAS 123R may also delay when we become profitable, if ever.
Future changes in generally accepted accounting principles, including
pronouncements relating to revenue recognition, may have a significant effect
on our reported results, including reporting of transactions completed before
the effective date of such pronouncements.
Risks Relating to Our Intellectual
Property
Our success is dependent on intellectual property
rights held by us and third parties and our interest in these rights is complex
and uncertain.
Our success will depend on our own and on our collaborators’ abilities
to obtain, secure and defend patents. In particular, the patents directed to
compounds discovered using our technologies are important to commercializing
drugs. We have numerous U.S. and foreign patent applications pending for our
technologies, including patent applications on drug lead discovery techniques
using CART, genetically altered GPCRs, GPCRs that we have discovered, new uses
for previously discovered GPCRs, and compounds discovered using CART and
Melanophore and other technologies. The procedures for obtaining a patent in
the U.S. and in most foreign countries are complex. These procedures require an
analysis of the scientific technology related to the invention and many legal
issues. Consequently, the analysis of our patent applications will be complex
and time consuming. Our patent position is very uncertain and we do not know
when, or if, we will obtain additional patents for our technologies.
As of January 31, 2005, we owned, in part or
in whole, or had exclusively licensed the following patents: 15 in the United
States, 11 in European countries, six in Australia, five in New Zealand, one in
Japan, one in Singapore and one in Israel. In addition, as of January 31, 2005,
we had approximately 273 patent applications before the United States Patent
and Trademark Office, foreign patent offices and international patent
authorities. These patents and patent applications are divided into 76 distinct
families of related patents that are directed to CART, Melanophore technology,
other novel screening methods, chemical compositions of matter, methods of
treatment using chemical compositions, or GPCR genes. One of our patent
families was exclusively in-licensed and contains a single issued patent. Eight
of our patent families containing a total of seven patents and 23 patent
applications were the subject of joint inventions by our employees and the
employees of other entities. The remaining 67 patent families containing a
total of 32 patents and 250 patent applications were invented solely by our employees.
There is no assurance that any of these patent applications will issue, or that
any of the patents will be enforceable or will cover a drug product or other
commercially significant product or method. Our most advanced compounds,
including APD356 and APD125, are the subject of patent applications and not
patents.
In 2000, the United States Patent and Trademark Office began issuing
broad patent claims that could allow patent holders to control the use of all
drug products that modulate a particular drug target or GPCR, regardless of
whether the infringing drug product bears any structural resemblance to a
chemical compound known to the patent holder at the time of patent filing. The
question of whether these new patent claims are valid is highly controversial
and the subject of intense litigation. Whether we
21
or our competitors are able to obtain and enforce such patent claims,
particularly as they apply to the GPCRs that are the subject of our drug
development activities, may have a significant impact on our potential revenues
from any drugs that we are able to develop.
We also rely on trade secrets to protect our technologies. However,
trade secrets are difficult to protect. We require our employees to
contractually agree not to improperly use our trade secrets or disclose them to
others, but we may be unable to determine if our employees have conformed or
will conform with their legal obligations under these agreements. We also
require collaborators, service providers and consultants to enter into
confidentiality agreements, but we may not be able to adequately protect our
trade secrets or other proprietary information in the event of any unauthorized
use or disclosure or the lawful development by others of this information. Many
of our employees and consultants were, and many of them may currently be,
parties to confidentiality agreements with other pharmaceutical and
biotechnology companies, and the use of our technologies could violate these agreements.
In addition, third parties may independently discover our trade secrets or
proprietary information.
Some of our academic institution licensors, research collaborators and
scientific advisors have rights to publish data and information to which we
have rights. We generally seek to prevent our partners from disclosing
scientific discoveries before we have the opportunity to file patent
applications on such discoveries. In some of our collaborations we do not have
control over our partners’ ability to disclose their own discoveries under the
collaboration and in some of our academic collaborations we are limited to
relatively short periods to review a proposed publication and file a
patent application. If we cannot maintain the confidentiality of our
technologies and other confidential information in connection with our
collaborations, our ability to receive patent protection or protect our
proprietary information will be impaired.
A dispute regarding the infringement or
misappropriation of our proprietary rights or the proprietary rights of others
could be costly and result in delays in our research and development
activities.
Our commercial success also depends upon our ability to develop,
manufacture, market and sell our product candidates and conduct our research
and development activities without infringing or misappropriating the
proprietary rights of third parties. There are many patents and patent
applications filed, and that may be filed, by others relating to drug discovery
and development programs that could be determined to be similar, identical or
superior to ours or our licensors or collaborators. We may be exposed to future
litigation by third parties based on claims that our product candidates,
technologies or activities infringe the intellectual property rights of others.
Numerous U.S. and foreign issued patents and pending patent applications owned
by others exist in the area of GPCRs, some of which purport to allow the patent
holder to control the use of all drug products that modulate a particular drug
target or GPCR, regardless of whether the infringing drug product bears any
structural resemblance to a chemical compound known to the patent holder at the
time of patent filing. Numerous U.S. and foreign issued patents and pending patent
applications owned by others also exist in the therapeutic areas in which we
are developing products. These could materially affect our ability to develop
our drug candidates or sell our products, and our activities, or those of our
licensors or collaborators, could be determined to infringe these patents.
Because patent applications can take many years to issue, there may be
currently pending applications, unknown to us, which may later result in issued
patents that our product candidates or technologies may infringe. There also
may be existing patents, of which we are not aware, that our product candidates
or technologies may inadvertently infringe. Further, there may be issued
patents and pending patent applications in fields relevant to our business, of
which we are or may become aware, that we believe we do not infringe or that we
believe are invalid or relate to immaterial portions of our overall drug
discovery and development efforts. We cannot assure you that third parties
holding any of these patents or patent applications will not assert
infringement claims against us for damages or seeking to enjoin our activities.
We also cannot assure you that, in the event of litigation, we will be able to
successfully assert any belief we may have as to non-infringement, invalidity
or immateriality, or that any infringement claims will be resolved in our
favor.
In addition, third parties may infringe or misappropriate our
proprietary rights, and we may have to institute costly legal action to protect
our intellectual property rights. We may not be able to afford the costs of
enforcing or defending our intellectual property rights against third parties.
Other organizations, companies and individuals are seeking proprietary
positions on genomics information that overlap with the government sponsored
project to sequence the human genome. Our activities, or those of our licensors
or collaborators, could be affected by conflicting positions that may exist
between any overlapping genomics information made available publicly as a
result of the government sponsored project and genomics information that other
organizations, companies or individuals consider to be proprietary.
There could be significant litigation and other administrative
proceedings in our industry that affect us regarding patent and other
intellectual property rights. Any legal action or administrative action against
us, or our collaborators, claiming damages
22
or seeking to enjoin commercial activities relating to our drug
discovery and development programs could:
• require us, or our collaborators, to obtain a
license to continue to use, manufacture or market the affected products,
methods or processes, which may not be available on commercially reasonable
terms, if at all;
• prevent us from importing, making, using,
selling or offering to sell the subject matter claimed in patents held by
others and subject us to potential liability for damages;
• consume a substantial portion of our
managerial, scientific and financial resources; or
• be costly, regardless of the outcome.
Furthermore, because of the substantial amount of pre-trial document
and witness discovery required in connection with intellectual property
litigation, there is risk that some of our confidential information could be
compromised by disclosure during this type of litigation. In addition, during
the course of this kind of litigation, there could be public announcements of
the results of hearings, motions or other interim proceedings or developments.
If securities analysts or investors perceive these results to be negative, it
could have a substantial adverse effect on the trading price of our common
stock.
We have been contacted from time to time by third parties regarding
their intellectual property rights, sometimes asserting that we may need a
license to use their technologies. If we fail to obtain any required licenses
or make any necessary changes to our technologies, we may be unable to develop
or commercialize some or all of our product candidates.
We cannot protect our intellectual property rights
throughout the world.
Filing patents on all of our drug discovery technologies throughout the
world would be prohibitively expensive. Competitors may use our technologies in
jurisdictions where we have not obtained patent protection to develop their own
drug products. These products may compete with our products and may not be
covered by any of our patent claims or other intellectual property rights.
Patent law outside the United States is also uncertain and many
countries are currently reviewing and revising patent laws, particularly with
respect to biotechnology and pharmaceutical inventions. The laws of some
countries do not protect our intellectual property rights to the same extent as
U.S. laws. It may be necessary or useful for us to participate in proceedings
to determine the validity of our, or our competitors’, foreign patents, which
could result in substantial cost and divert our efforts and attention from
other aspects of our business.
Risks Relating to Our Securities
Our stock price will likely be volatile, and your
investment in our stock could decline in value.
Our stock price has fluctuated historically. From January 1, 2003,
to December 31, 2004, the market price of our stock was as low as $3.48
per share and as high as $8.57 per share.
Very few biotechnology products being tested will ultimately receive
FDA approval, and a biotechnology company may experience a significant drop in
its stock price based on an adverse clinical trial result or regulatory action.
Our stock price may fluctuate significantly, depending on a variety of factors,
including:
•
our success or failure in clinical trials, including, in the near term, the
results from our clinical trials for either APD356 or APD125;
•
the timing of the discovery of drug leads and the development of our product
candidates;
•
entering into a new collaboration or modifying or terminating an existing
collaboration;
•
the timing and receipt by us of milestone and royalty payments or failing to
achieve and receive the same, if any;
•
changes in the research and development budgets of our existing or potential
collaborators;
•
others introducing new drug discovery techniques or new drugs that target the
same diseases and conditions that we or our collaborators target;
23
•
regulatory actions; and
•
expenses related to, and the results of, litigation and other proceedings
relating to intellectual property rights or other matters.
We are not able to control all of these factors. Period-to-period
comparisons of our financial results are not necessarily indicative of our
future performance. In addition, if our revenues or results of operations in a
particular period do not meet stockholders’ or analysts’ expectations, our
stock price may decline and such decline could be significant.
Holders of our Series B Convertible Preferred Stock
are entitled to require us to redeem their Series B Convertible Preferred
Stock.
On December 24, 2003, we completed the private placement to two
institutional investors of (i) an aggregate of 3,500 shares of our Series B-1
Convertible Preferred Stock, (ii) seven-year warrants to purchase up to an
aggregate of 1,486,200 shares of our common stock at an exercise price of
$10.00 per share and (iii) unit warrants to purchase for a period of
approximately 16 months from December 24, 2003 up to $11.5 million of our
Series B-2 Convertible Preferred Stock and additional seven-year warrants to purchase
up to 450,000 shares of our common stock at an exercise price of $10.00 per
share. The exercise price of our outstanding seven-year warrants are subject to
weighted-average adjustment in certain circumstances. Any warrants issued upon
exercise of our unit warrants will have similar anti-dilution protections for
future issuances.
The holders of our Series B-1 Convertible Preferred Stock are entitled
to require us to redeem all or some of their shares of Series B-1 Convertible
Preferred Stock, at a price equal to the amount of the original holder’s
original investment, plus all accrued but unpaid dividends thereon to the date
of payment and any applicable penalties. The aggregate redemption price of our
Series B-1 Convertible Preferred Stock at December 31, 2004, was approximately
$36.5 million, and accrues interest at 4.0% annually.
Following the exercise of our unit warrants, the holders of our Series
B-2 Convertible Preferred Stock will be entitled to require us to redeem their
shares of Series B-2 Convertible Preferred Stock, at a price equal to the
amount of the original holder’s original investment, plus all accrued but
unpaid dividends thereon to the date of payment and any applicable penalties,
if, following the 21st month anniversary of the original issue date of the
Series B-2 Convertible Preferred Stock, the closing price of our common stock
for any 30 consecutive trading days is below the conversion price for the
Series B-2 Convertible Preferred Stock.
Also, the holders of the Series B-2 Convertible Preferred Stock may
require us to redeem their shares if we issue common stock or common stock
equivalents (excluding, among other things, certain common stock and common
stock equivalents issued or issuable (a) to our officers, directors, employees
or consultants, (b) in connection with certain strategic partnerships or joint
ventures, and (c) in connection with certain mergers and acquisitions) for an
effective net price to us per share less than a price to be determined based on
a formula. “Effective net price” is not defined in the Certificate of
Designations governing our Series B-2 Convertible Preferred Stock. The holders
of our Series B-2 Convertible Preferred Stock may assert that effective net
price should be calculated as the amount we receive after paying any discounts
and other expenses related to any such issuance.
In addition to the foregoing redemption rights, at any time following
the occurrence of a “Triggering Event,” a holder of the Series B Convertible
Preferred Stock may require us to repurchase all or any portion of the Series B
Convertible Preferred Stock then held by such holder at a price per share equal
to the greater of 115.0% of the stated value or the market value (as calculated
under the Certificate of Designations for the Series B-1 Convertible Preferred
Stock and the Series B-2 Convertible Preferred Stock) of such shares of Series
B Convertible Preferred Stock plus all accrued but unpaid dividends thereon to
the date of payment. “Triggering Events” include any of the following events:
(a) immediately prior to a bankruptcy event; (b) we fail for any reason to
timely deliver a certificate evidencing any securities to a purchaser or the
exercise or conversion rights of the holders are otherwise suspended for other
than a permissible reason; (c) any Event (as defined in the Registration Rights
Agreement with the Series B Convertible Preferred Stock holders) occurs and
remains uncured for 60 days; (d) we fail to make any cash payment required
under the Series B Convertible Preferred Stock transaction documents and such
failure is not timely cured; (e) the issuance of a going concern opinion by our
independent registered public accounting firm that is not timely cured; (f) we
breach a section of the Series B Convertible Preferred Stock purchase agreement
relating to indebtedness and subordination; or (g) we default in the timely
performance of any other obligation under the Series B Convertible Preferred
Stock transaction documents and such default is not timely cured. We will also
be required to redeem any shares of the Series B Convertible Preferred Stock
that remain outstanding on the fifth anniversary of their issuance at a price
equal to the amount of the original holder’s original investment, plus all
accrued but
24
unpaid dividends thereon to the date of such payment. “Triggering Event”
is specifically defined in the Certificate of Designations for the Series B-1
Convertible Preferred Stock and the Series B-2 Convertible Preferred Stock.
If we are required to redeem all or some of the currently outstanding
shares of our Series B Convertible Preferred Stock, we may be able to pay a
portion of the redemption price using shares of our common stock if certain
other enumerated conditions are satisfied, including:
• we have
sufficient number of shares of common stock available for issuance;
• the shares of
common stock to be issued are registered under an effective registration
statement or are otherwise available for sale under Rule 144(k) under the
Securities Act;
• our common stock
is listed on The Nasdaq National Market or other eligible market;
• the shares to be
issued can be issued without violating the rules of The Nasdaq National Market
or any applicable trading market or a provision of our certificate of
designations; and
• no bankruptcy event has occurred.
If we are permitted to satisfy a portion of a redemption by using
shares of our common stock, and if we elect to do so, the number of shares to
be issued to holders of Series B Convertible Preferred Stock will be determined
by dividing their cash redemption price by the lesser of the conversion price
or 95.0% of the average of the volume weighted average price of our common
stock for either 10 or 15 trading days.
There can be no assurance that if we have to redeem our Series B
Convertible Preferred Stock, that we will be able to pay a portion of the
redemption price using shares of our common stock. If we use common stock to
redeem a portion of the Series B Convertible Preferred Stock, your ownership
interest may be significantly diluted. If we are required or elect to redeem
shares of the Series B Convertible Preferred Stock using cash, we may not have
sufficient cash to redeem these shares or to continue our planned research and
discovery activities. In such event we may try to raise additional capital by
issuing new stock, but there can be no assurance that capital will be available
on acceptable terms or at all.
There are a substantial number of shares of our common
stock eligible for future sale in the public market, and the sale of these
shares could cause the market price of our common stock to fall.
There were 35,205,869 shares of our common stock outstanding as of
February 15, 2005. The outstanding shares of our Series B-1 Convertible
Preferred Stock are convertible into up to 4,861,899 shares of common stock at
$7.50 per share of common stock. Holders of the Series B-1 Convertible
Preferred Stock are entitled to receive a 4.0% annual dividend that is payable
by issuing common stock or by increasing the amount of common stock that is
issuable upon conversion of the Series B-1 Convertible Preferred Stock. In
addition, holders of our Series B-1 Convertible Preferred Stock own
warrants to acquire common stock and unit warrants to acquire Series B-2
Convertible Preferred Stock and additional warrants to acquire common stock,
which, if exercised and converted, would obligate us to issue up to 3,620,174
additional shares of common stock at a weighted average exercise price of $8.52
per share. In addition, as of February 15, 2005, there were 3,697,520 common
stock options issued and outstanding under our equity compensation plans at a
weighted average exercise price of $8.04, 625,712 additional shares of common
stock issuable under our equity compensation plans, 690,268 shares of common
stock reserved for issuance under our 2001 Employee Stock Purchase Plan and
141,669 shares issuable under our Deferred Compensation Plan. A substantial
number of the shares described above, when issued upon exercise, will be
available for immediate resale in the public market. The market price of our
common stock could fall as a result of such resales due to the increased number
of shares available for sale in the market.
Any future equity or debt issuances by us may have
dilutive or adverse effects on our existing stockholders.
We have financed our operations, and we expect to continue to finance
our operations, primarily by issuing and selling our common stock or securities
convertible into or exercisable for shares of our common stock. In light of our
need for additional financing, we may issue additional shares of common stock
or additional convertible securities that could dilute your ownership in our
company and may include terms that give new investors rights that are superior
to yours. Moreover, any issuances by us of equity securities may be at or below
the prevailing market price of our common stock and in any event may have a
dilutive impact on your ownership interest, which could cause the market price
of our common stock to decline. The terms of our Series B Convertible Preferred
Stock limit our ability to engage in certain equity issuances.
25
We may also raise additional funds through the incurrence of debt, and
the holders of any debt we may issue would have rights superior to your rights
in the event we are not successful and are forced to seek the protection of the
bankruptcy laws. The terms of our Series B Convertible Preferred Stock
limits our ability to incur debt.
Our largest stockholders may take actions that are
contrary to your interests, including selling their stock.
A small number of our stockholders hold a significant amount of our
outstanding stock. These stockholders may support competing transactions and
have interests that are different from yours. In addition, the average number
of shares of our stock that trade each day is generally low. As a result, sales
of a large number of shares of our stock by these large stockholders or other
stockholders within a short period of time could adversely affect our stock
price.
We may face litigation or other adverse actions as a
result of a result of our recent public stock sale.
On January 27, 2005, one of our stockholders informed us by letter that
it was opposed to the public stock offering that we closed on February 4, 2005.
On January 31, 2005, this same stockholder filed with the SEC a Schedule 13D
which attached as an exhibit its January 27, 2005 letter. The Schedule 13D
reiterated the stockholder’s opposition to the offering, indicated that it
believed the offering was not in the best interests of our stockholders, and
stated that the stockholder is considering all potential legal remedies,
including a potential suit against us and our Board of Directors for breach of
fiduciary responsibility to our stockholders. The Schedule 13D also stated the
stockholder may consider, among other options, solicitation of a proxy to
replace certain of our Board members. Other of our stockholders verbally
expressed opposition to the offering. Any litigation, proxy contest or other
similar action could result in significant costs and divert management’s
attention and resources, which could adversely affect our business.
Provisions of our Series B Convertible Preferred
Stock may prevent or make it more difficult for us to raise funds or take
certain other actions.
Provisions of our Series B Convertible Preferred Stock require us
to obtain approval of the preferred stockholders, or otherwise trigger rights
of first refusal or payment provisions, to (i) offer or sell new
securities, other than in specified underwritten offerings or strategic
partnerships or joint venture and certain other exceptions, (ii) sell or
issue common stock or securities issuable into common stock below certain
prices, (iii) incur debt or allow liens on our property, other than
certain permitted debt and liens, (iv) amend our certificate of
incorporation so as to affect adversely any rights of the preferred stockholders,
(v) authorize or create a new class of stock that will be senior or equal
to the Series B Convertible Preferred Stock in terms of dividends,
redemption or distribution of assets, (vi) use more than
$25.0 million in cash for acquisitions or (vii) take certain other
actions. These provisions may make it more difficult for us to take certain
corporate actions and could delay, discourage or prevent future financings.
Our rights agreement and certain provisions in our
charter documents and Delaware law could delay or prevent a change in
management or a takeover attempt that you may consider to be in your best
interest.
We have adopted certain anti-takeover provisions, including a
stockholders’ rights plan, dated as of October 30, 2002, between us and
Computershare Trust Company, Inc., as Rights Agent, as amended on
December 24, 2003. The rights plan will cause substantial dilution to any
person who attempts to acquire us in a manner or on terms not approved by our
board of directors.
The rights agreement and Certificate of Designations for the
Series B Convertible Preferred Stock, as well as other provisions in our
certificate of incorporation and by-laws and under Delaware law, could delay or
prevent the removal of directors and other management and could make more
difficult a merger, tender offer or proxy contest involving us that you may
consider to be in your best interest. For example, these provisions:
• allow our board of directors to issue
preferred stock without stockholder approval;
• limit who can call a special meeting of
stockholders;
• eliminate stockholder action by written
consent; and
• establish advance notice requirements for
nomination for election to the board of directors or for proposing matters to
be acted upon at stockholders meetings.
26
Item 2. Properties.
The facilities that we occupy consist of approximately 206,000 square
feet of research, development, warehouse and office space located at 6114,
6124-6126, 6138-6150, 6154 and 6166 Nancy Ridge Drive, San Diego, California.
At our 6166 Nancy Ridge Drive facility, we lease approximately 37,000 square
feet of space, of which 23,000 square feet is laboratory space and 14,000
square feet is office space. In 2001, we purchased the 6138-6150 Nancy Ridge
Drive facility whose square footage is approximately 55,000 square feet and
consists of 33,000 square feet of laboratory space and 22,000 square feet of
office space. In December 2003, we completed a sale and leaseback of the
6138-6150 Nancy Ridge Drive facility for net proceeds of $12.6 million. In
March 2002, we entered into a lease for our 6124-6126 Nancy Ridge Drive
facility, which is approximately 31,000 square feet of space, and approximately
17,000 square feet is laboratory space and 14,000 square feet is office space.
We sublease approximately 6,000 square feet, primarily office space, of the
6124-6126 facility to ChemNavigator. In November 2001, we acquired a
13,000 square foot warehouse facility at 6114 Nancy Ridge Drive. We have
converted this facility into a 40,000 square foot chemical development facility
of which approximately 5,000 square feet is office space. The remaining 35,000
square feet, which include engineering support areas, are dedicated to process
research and scale up chemistry, the production of intermediates and other
compounds for research and development purposes, and the manufacture of active
pharmaceutical ingredients to support our clinical trials. We currently occupy
this facility and it is in use for the production of scale-up lots for internal
research programs, animal safety studies and human clinical trials. We
commenced cGMP operations in this facility in the second quarter of 2004. Also
in November 2001, we acquired a 49,000 square foot facility at 6154 Nancy
Ridge Drive. We are using a
portion of this facility as a warehouse and office space and are evaluating
options for this facility, including, among others, expanding it for our own
use or selling it. We believe these facilities will be adequate to meet our
near-term space requirements.
Item 3. Legal Proceedings.
None.
Item 4. Submissions of Matters to a Vote of Security
Holders.
No matters were submitted to
a vote of security holders during the fourth quarter of the fiscal year covered
by this Annual Report on Form 10-K.
27
PART II
Item 5. Market for the Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock has traded
on the NASDAQ National Market under the symbol “ARNA” since our initial public
offering on July 28, 2000. The following table sets forth, for the period
indicated, the high and low sale prices for the common stock as reported by the
NASDAQ National Market.
|
|
|
High
|
|
Low
|
|
|
Year ended December 31, 2003
|
|
|
|
|
|
|
First Quarter
|
|
$
|
7.14
|
|
$
|
6.11
|
|
|
Second Quarter
|
|
$
|
8.36
|
|
$
|
6.00
|
|
|
Third Quarter
|
|
$
|
7.74
|
|
$
|
6.50
|
|
|
Fourth Quarter
|
|
$
|
8.57
|
|
$
|
6.17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
Low
|
|
|
Year ended December 31, 2004
|
|
|
|
|
|
|
First Quarter
|
|
$
|
7.10
|
|
$
|
5.68
|
|
|
Second Quarter
|
|
$
|
6.70
|
|
$
|
5.00
|
|
|
Third Quarter
|
|
$
|
5.50
|
|
$
|
3.48
|
|
|
Fourth Quarter
|
|
$
|
6.80
|
|
$
|
4.19
|
|
|
|
|
|
|
|
|
|
|
|
As of February 15, 2005,
there were approximately 241 stockholders of record of our common stock, one of
which is Cede & Co., a nominee for Depository Trust Company (or DTC).
Shares of common stock that are held by financial institutions as nominees for
beneficial owners are deposited into participant accounts at DTC, and are
considered to be held of record by Cede & Co. as one stockholder.
Dividends
We have never paid any cash dividends on our capital stock. We
anticipate that we will retain earnings, if any, to support operations and to
finance the growth and development of our business. Therefore, we do not expect
to pay cash dividends in the foreseeable future. In addition, we are prohibited
from paying cash dividends on any of our capital stock other than our Series B
Convertible Preferred Stock without the approval of the holders of our Series B
Convertible Preferred Stock.
Securities
Authorized for Issuance Under Equity Compensation Plans
The following table summarizes our compensation plans under which our
equity securities are authorized for issuance as of December 31, 2004:
|
Plan Category
|
|
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
|
|
Weighted average
exercise price of
outstanding options,
warrants and rights
|
|
Number of securities remaining
available for future issuance
under equity compensation plans
(excluding securities reflected in
column (a))
|
|
|
|
|
(a)
|
|
(b)
|
|
(c)
|
|
|
Equity compensation plans
approved by security holders
|
|
2,780,399
|
|
$
|
8.66
|
|
2,237,651
|
*
|
|
Equity compensation plans
not approved by security holders
|
|
—
|
|
—
|
|
—
|
|
|
Total
|
|
2,780,399
|
|
$
|
8.66
|
|
2,237,651
|
*
|
* Includes 690,268 shares of common stock available for future issuance
under our 2001 Employee Stock Purchase Plan.
In January
2005, we issued an aggregate of 931,335 stock options to our employees, executive
officers and directors. The
28
following
table summarizes our compensation plans under which our equity securities are
authorized for issuance as of January 31, 2005:
|
Plan Category
|
|
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
|
|
Weighted average
exercise price of
outstanding options,
warrants and rights
|
|
Number of securities remaining
available for future issuance
under equity compensation plans
(excluding securities reflected in
column (a))
|
|
|
|
|
(a)
|
|
(b)
|
|
(c)
|
|
|
Equity compensation plans approved by
security holders
|
|
3,699,120
|
|
$
|
8.04
|
|
1,314,480
|
*
|
|
Equity compensation plans not approved by
security holders
|
|
—
|
|
—
|
|
—
|
|
|
Total
|
|
3,699,120
|
|
$
|
8.04
|
|
1,314,480
|
*
|
* Includes 690,268 shares of common stock available for future issuance
under our 2001 Employee Stock Purchase Plan.
Item 6. Selected Financial Data.
The following
Selected Financial Data should be read in conjunction with “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and “Item
8. Financial Statements” included elsewhere in this Annual Report on
Form 10-K.
|
|
|
Years ended December 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Collaborative agreements
|
|
$
|
13,685,822
|
|
$
|
12,734,279
|
|
$
|
18,005,765
|
|
$
|
16,643,999
|
|
$
|
7,683,396
|
|
|
Collaborative agreements with affiliates
|
|
—
|
|
100,000
|
|
1,416,000
|
|
1,416,000
|
|
—
|
|
|
Total revenues
|
|
13,685,822
|
|
12,834,279
|
|
19,421,765
|
|
18,059,999
|
|
7,683,396
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
57,729,138
|
|
50,885,417
|
|
44,399,136
|
|
22,864,250
|
|
12,080,204
|
|
|
General and administrative
|
|
10,449,281
|
|
8,553,910
|
|
7,499,011
|
|
5,390,446
|
|
2,678,980
|
|
|
Amortization of deferred compensation
|
|
1,466,245
|
|
3,236,087
|
|
2,264,934
|
|
4,239,740
|
|
4,342,896
|
|
|
Amortization of acquired technology and
other purchased intangibles
|
|
1,824,761
|
|
1,621,220
|
|
1,586,127
|
|
1,280,830
|
|
—
|
|
|
Total operating expenses
|
|
71,469,425
|
|
64,296,634
|
|
55,749,208
|
|
33,775,266
|
|
19,102,080
|
|
|
Interest and other, net
|
|
(208,167
|
)
|
4,402,916
|
|
5,284,302
|
|
8,832,543
|
|
5,056,714
|
|
|
Investment writedown
|
|
—
|
|
—
|
|
(1,786,797
|
)
|
—
|
|
—
|
|
|
Net loss
|
|
(57,991,770
|
)
|
(47,059,439
|
)
|
(32,829,938
|
)
|
(6,882,724
|
)
|
(6,361,970
|
)
|
|
Non-cash preferred stock charge
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(22,391,068
|
)
|
|
Dividends on redeemable convertible
preferred stock
|
|
(1,437,384
|
)
|
(26,858
|
)
|
—
|
|
—
|
|
—
|
|
|
Accretion of discount and deemed dividend
related to redeemable convertible preferred stock
|
|
(1,851,883
|
)
|
(35,516
|
)
|
—
|
|
—
|
|
—
|
|
|
Net loss allocable to common stockholders
|
|
$
|
(61,281,037
|
)
|
$
|
(47,121,813
|
)
|
$
|
(32,829,938
|
)
|
$
|
(6,882,724
|
)
|
$
|
(28,753,038
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted
|
|
$
|
(2.40
|
)
|
$
|
(1.74
|
)
|
$
|
(1.19
|
)
|
$
|
(0.28
|
)
|
$
|
(2.84
|
)
|
|
Shares used in calculating net loss per
share, basic and diluted
|
|
25,527,617
|
|
27,159,234
|
|
27,487,537
|
|
24,989,067
|
|
10,139,755
|
|
29
|
|
|
As of December 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
58,686,129
|
|
$
|
60,471,856
|
|
$
|
61,871,305
|
|
$
|
176,676,669
|
|
$
|
144,413,176
|
|
|
Short-term investments
|
|
54,627,710
|
|
93,545,027
|
|
123,271,580
|
|
50,247,624
|
|
—
|
|
|
Accounts receivable
|
|
22,590,323
|
|
27,712
|
|
3,519,209
|
|
3,481,250
|
|
2,116,146
|
|
|
Total assets
|
|
206,364,995
|
|
229,898,109
|
|
254,890,047
|
|
276,973,710
|
|
152,711,929
|
|
|
Deferred revenues
|
|
30,070,188
|
|
3,972,848
|
|
6,592,938
|
|
2,776,856
|
|
705,000
|
|
|
Long-term obligations, net of current
portion
|
|
13,259,326
|
|
13,000,000
|
|
45,737
|
|
402,092
|
|
960,517
|
|
|
Redeemable convertible preferred stock
|
|
29,092,228
|
|
25,776,104
|
|
—
|
|
—
|
|
—
|
|
|
Deferred compensation
|
|
(779,972
|
)
|
(2,647,610
|
)
|
(1,060,689
|
)
|
(3,611,933
|
)
|
(7,899,970
|
)
|
|
Accumulated deficit
|
|
(168,806,515
|
)
|
(107,525,478
|
)
|
(60,403,665
|
)
|
(27,573,727
|
)
|
(20,691,003
|
)
|
|
Total stockholders’ equity
|
|
206,364,995
|
|
183,148,132
|
|
242,051,701
|
|
269,473,678
|
|
148,784,325
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30
Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations.
You should read the following discussion and analysis in conjunction with
“Item 8. Financial Statements and Supplementary Data” included below in
this Annual Report on Form 10-K (this “Annual Report”). Operating results
are not necessarily indicative of results that may occur in future periods.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. The actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including, but not limited to, those set forth under “Risk Factors” in
“Item 1. Business” included above in this Annual Report. All forward-looking
statements included in this document are based on information available to us
on the date of this document and, except as required by law, we undertake no
obligation to publicly revise our forward-looking statements to reflect events
or circumstances.
OVERVIEW
We have incurred net losses of approximately $168.8 million since our
inception in April 1997 through December 31, 2004, and expect to
incur substantial and increasing net losses for the next several years or more
as we continue our research and development activities. To date, we have
generated cash and funded our operations primarily through the sale of common
and preferred equity securities, payments from collaborators and the sale and
lease back of one of our facilities. From our inception through
December 31, 2004, we have generated approximately $415.4 million in cash
from these sources, of which approximately $326.9 million was through sales of
equity and approximately $75.9 million was through payments from our
collaborators. This does not include the proceeds from the public offering we
completed in February 2005 or payments we received in January 2005 from
Ortho-McNeil Pharmaceutical, Inc., a Johnson & Johnson Company (“Ortho-McNeil”),
which are discussed below.
In October 2004, we extended and expanded our collaboration with Merck
& Co., Inc., which is focused on developing therapeutics for
atherosclerosis and related disorders, and Merck purchased $7.5 million of our
stock at a price of $8.00 per share and selected one of our compounds for
preclinical development. We believe one or more of the three GPCRs
subject to this collaboration play a role in regulating plasma lipid profiles,
including HDL cholesterol, the so-called “good cholesterol,” and is responsible
for the HDL-raising activity of niacin. In addition, under our
agreement, Merck will pay us $5.7 million a year for collaboration research
through October 19, 2007. During
2004, we achieved three milestones under the collaboration and received
payments totaling $8.0 million.
In December 2004, we entered into a collaboration and license agreement
with Ortho-McNeil to further develop compounds for the potential
treatment of type 2 diabetes and other disorders. Our two lead compounds are
currently in preclinical development with Ortho-McNeil. In January 2005,
we received a $17.5 million upfront payment and two milestone payments of $2.5
million each. In addition, under our agreement, Ortho-McNeil will pay us $2.4
million a year for collaboration research through December 19, 2006.
In February 2005, we sold 8,625,000 shares of our common stock in a
public offering at $6.00 per share and received net proceeds of approximately
$48.3 million. As a result of the offering, the holders of our Series B-1
Convertible Preferred Stock are entitled to require us to redeem all or some of
their outstanding preferred shares. The aggregate redemption price at December
31, 2004, was approximately $36.5 million. If required to redeem, we may be
able to satisfy a portion of this amount with shares of our common stock.
Although we have recently been successful in our collaborative and
financing efforts, certain industry trends may affect our ability to generate
additional cash from collaborators and investors. First, companies in our
industry with products on the market or in late-stage clinical development
continue to be favored by investors and potential licensing partners over
companies with technologies for discovering products. Our potential partners
are now more interested in product candidates for a specific therapeutic area,
and particularly drug candidates with clinical data, rather than just the
technologies that could be used to find such candidates. We believe that this
trend may delay our ability to partner our programs on favorable terms.
Other industry trends that may be significant to us are the
consolidation that has occurred in our industry and setbacks to pharmaceutical
companies caused by product litigation and competition by generics. In addition
to reducing the number of potential partners, the consolidation and setbacks
may make potential partners less willing to enter into new collaborations or
cause existing partners to terminate or slow work on their existing
collaborations for a variety of reasons, including their reluctance to enter
new collaborations when they are integrating new operations, a change in
research focus and direction following a merger or reduced budgets for research
and development.
Our most significant short-term opportunities are with APD356 and
APD125. If we are able to demonstrate in our Phase 2 clinical trial that APD356
is effective in humans, we believe that we will be able to successfully partner
this program on
31
favorable terms or issue additional equity securities, potentially at a
valuation higher than our current market price. We expect to have the results
of our Phase 2 clinical trial for APD356 in the second quarter of 2005. Our
APD125 Phase 1 clinical trial will evaluate safety, tolerability and
pharmacokinetics in healthy volunteers. We expect to have the results of our
Phase 1 clinical trial in the middle of 2005. If either of these clinical trial
programs is not successful, we expect to re-evaluate our currently planned
expenditures for the remainder of this year. Even if the results of the
clinical trials for APD125 and APD356 are favorable, we expect our losses will
be substantial this year because it will take some period of time after
learning such results to partner either product candidate.
In the long term, we will need to raise a substantial amount of cash to
develop our product candidates and sustain our research efforts. We believe
this will be possible through the issuance of additional equity securities or
through partnering our more advanced programs which have entered into clinical
development. We are optimistic about our pipeline of internally discovered
compounds and our ability to find additional product candidates in attractive
markets by using our technologies, and believe that over time many of these
programs will enter into clinical trials. We believe our ability to
successfully partner our most advanced programs on favorable terms will depend
on the results of our pending and future clinical trials.
However, the risks we face are substantial. The drug discovery process
is long and uncertain and our ability to achieve our goals depends on many
factors, many of which are out of our control. We will seek to balance the need
to invest heavily in research and development to find new drugs against the
need to sustain our operations long enough for our collaborators or us to
commercialize the results of our efforts.
SUMMARY OF
REVENUES AND EXPENSES
We
are providing the following summary of our revenues and expenses to supplement
the more detailed discussion below.
Revenues
(in millions)
|
|
|
Years ended December 31,
|
|
|
Collaborator
|
|
2004
|
|
2003
|
|
2002
|
|
|
Merck
|
|
$
|
13.0
|
|
$
|
7.9
|
|
$
|
1.6
|
|
|
Ortho-McNeil
|
|
0.3
|
|
—
|
|
—
|
|
|
Eli Lilly
|
|
—
|
|
3.1
|
|
14.2
|
|
|
Others
|
|
0.4
|
|
1.8
|
|
3.6
|
|
|
Total revenues
|
|
$
|
13.7
|
|
$
|
12.8
|
|
$
|
19.4
|
|
Research and development expenses (in
millions)
|
|
|
Years ended December 31,
|
|
|
Type
of expense
|
|
2004
|
|
2003
|
|
2002
|
|
|
Personnel costs
|
|
$
|
23.8
|
|
$
|
23.9
|
|
$
|
20.2
|
|
|
Facility and equipment costs
|
|
11.7
|
|
9.9
|
|
6.9
|
|
|
Research supplies
|
|
10.4
|
|
12.6
|
|
14.2
|
|
|
External preclinical and clinical study
fees and expenses
|
|
10.1
|
|
3.5
|
|
1.6
|
|
|
Other
|
|
1.7
|
|
1.0
|
|
1.5
|
|
|
Total research and development expenses
|
|
$
|
57.7
|
|
$
|
50.9
|
|
$
|
44.4
|
|
General
and administrative expenses (in millions)
|
|
|
Years ended December 31,
|
|
|
Type
of expense
|
|
2004
|
|
2003
|
|
2002
|
|
|
Personnel costs
|
|
$
|
5.1
|
|
$
|
4.8
|
|
$
|
4.2
|
|
|
Legal and other professional fees
|
|
2.2
|
|
1.5
|
|
1.2
|
|
|
Facility and equipment costs
|
|
1.9
|
|
1.5
|
|
1.3
|
|
|
Other
|
|
1.2
|
|
0.8
|
|
0.8
|
|
|
Total general and administrative expenses
|
|
$
|
10.4
|
|
$
|
8.6
|
|
$
|
7.5
|
|
YEAR ENDED
DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
Revenues. We recorded revenues of $13.7 million
during the year ended December 31, 2004, compared to $12.8 million in
revenues during the year ended December 31, 2003. Ninety-five percent of
our revenues during the year ended December 31, 2004, were from our
collaboration with Merck, which included research funding, milestone
achievements, and technology
32
access and development fees.
Eighty-six percent of our revenues during the year ended December 31,
2003, were from our collaborations with Merck and Eli Lilly and Company, which
included research funding, milestone achievements, and technology access and
development fees. On April 14, 2003, we completed our research activities under
our Eli Lilly collaboration, and, accordingly, we have not received research
funding from Eli Lilly since such date. In October 2004, we extended and
expanded our collaboration with Merck, and Merck purchased $7.5 million of our
stock at a price of $8.00 per share, a 70% premium to the then current market
price. In addition, under our agreement, Merck will pay us $5.7 million a year
for collaboration research through October 19, 2007. We performed an evaluation
on the Merck stock purchase and determined that $3.9 million of the $7.5
million purchase was an upfront payment related to the collaboration extension
and expansion. Accordingly, we are recognizing the $3.9 million upfront payment
as well as the remaining unamortized upfront payment balance of $1.3 million at
October 2004 over the extended collaboration term of three years. In addition,
in October 2004, we achieved a $1.0 million milestone under our Merck
collaboration which we are recognizing over the extended collaboration term of
three years as achievability was reasonably assured at the time we extended and
expanded our collaboration with Merck. In December 2004, we entered into a
collaboration and license agreement with Ortho-McNeil. This collaboration
included a $17.5 million upfront payment, which we received in January 2005, as
well as research funding of $2.4 million per year through December 19, 2006.
Ortho-McNeil has the option to extend our collaboration one year until December
2007 and, therefore, we are amortizing the $17.5 million upfront payment over
three years. In December 2004, we achieved two milestones under our
Ortho-McNeil collaboration of $2.5 million each, which we are recognizing as
revenues over three years as achievability was reasonably assured at the time
we entered into the collaboration. We received the milestone payments in
January 2005.
Our collaborators often pay
us before we recognize such payments as current revenues and, accordingly,
these payments are recorded as deferred revenues until earned. As of
December 31, 2004, we had deferred revenues totaling approximately $30.0 million.
Our revenues for 2005 are expected to be substantially dependent on our most
significant collaborators, Merck and Ortho-McNeil. Future revenues for research
or clinical milestones that have not yet been achieved are difficult to
predict, and we expect our revenues from quarter to quarter and year to year to
vary significantly. Our future
revenues are dependent upon the clinical success of our partnered programs and
whether we partner APD356, APD125 or other of our product candidates.
Research and development expenses. In 2004 and 2003, research and development expenses consisted
primarily of costs associated with internal development of our product
candidates, internal programs and our technologies. We generally do not track
our research and development costs by project; rather, we track such costs by
the type of cost incurred. Research
and development expenses increased $6.8 million to $57.7 million for the
year ended December 31, 2004, from $50.9 million for the year ended
December 31, 2003. The difference was due primarily to (i) external
preclinical and clinical study fees and expenses increasing by $6.6 million as
we continued to develop APD356 and APD125, (ii) facility and equipment costs,
including depreciation, increasing by $1.8 million due to the expansion of our
facilities, and (iii) research supplies decreasing by $2.2 million due to cost
saving efforts and a reduction in the number of our research employees.
Included in the $10.1 million in external preclinical and clinical study fees
and expenses for the year ended December 31, 2004, is $5.2 million in
external fees and expenses related to our APD356 program and $2.4 million in
external fees and expenses related to our APD125 program. We expect the number
of our research and development employees totaling 239 at December 31, 2004, to
be about the same at the end of 2005. We also expect research and development
expenses to be greater in 2005 than in 2004 due to greater external preclinical
and clinical study fees and expenses related to developing our product
candidates, including APD356 and APD125.
General and administrative expenses. General and administrative expenses increased
$1.8 million to $10.4 million for the year ended December 31, 2004,
from $8.6 million for the year ended December 31, 2003. The increase
is due primarily to (i) an increase in professional fees, including legal
and accounting fees, of $700,000 related to the complexity and demands of the
laws and regulations applicable to public companies, including the
implementation of Section 404 of the Sarbanes-Oxley Act of 2002, and the
cost of maintaining a growing and maturing portfolio of patent applications and
patents, (ii) an increase of $400,000 from increases in utilities and other
facility related costs, (iii) an increase in board and consulting services of
$400,000, and (iv) an increase in personnel costs of $300,000 from increases in
salaries and related benefits. We expect general and administrative expenses to
be greater in 2005 than in 2004 due to increases in legal and accounting fees
related to the complexity and demands of the laws and regulations applicable to
public companies, and the cost of maintaining a growing and maturing portfolio
of patent applications and patents.
Amortization of deferred compensation. For the year ended December 31, 2004, we
recorded amortization of deferred compensation of $1.5 million, of which
$850,000 relates to research and development employees and consultants and
$617,000 relates to general and administrative employees. For the year ended
December 31, 2003, we recorded amortization of deferred compensation of
$3.2 million, of which $2.0 million relates to research and development
employees and consultants and $1.2 million relates to general and
administrative employees. In December 2004, the Financial Accounting
33
Standards Board (“FASB”) issued Statement
of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based
Payment.” We have begun, but have not
completed, evaluating the impact of SFAS 123R on our results of operations. We
expect amortization of deferred compensation as a result of our implementation
of SFAS 123R to be significantly higher beginning in the third quarter of 2005
than in previous periods. Please see “Recently issued accounting standards”
below for a more detailed discussion.
Interest income and other, net. Interest income and other, net, was a net
expense of $208,000 for the year ended December 31, 2004, compared to a
net income of $4.4 million for the year ended December 31, 2003.
Interest income and other, net, for the year ended December 31, 2004, was
primarily comprised of (i) $2.4 million in interest income and gains on sales
of investments and assets of $75,000, (ii) interest expense and financing costs
of $1.9 million, which includes lease payments accounted for in accordance with
SFAS No. 66 “Accounting for Sales of Real Estate” on our 6138-6150 Nancy Ridge
Drive facility that we sold in 2003 and are leasing back and (iii) $936,000 in
expense attributable to our share of the net loss of TaiGen Biotechnology Co.,
Ltd. (“TaiGen”), which we have accounted for by the equity method of
accounting. Interest income and other, net, for the year ended
December 31, 2003, was primarily comprised of interest income of $3.6
million, gain on sale of investments and assets of $1.8 million and rental and
other income of $164,000, partially offset by $1.1 million attributable to our
share of the net loss of TaiGen.
Dividends on redeemable convertible preferred stock. We recorded a dividend expense of $1.4 million related to our redeemable
convertible preferred stock in the year ended December 31, 2004, compared
to $27,000 for the year ended December 31, 2003. This dividend expense, payable
in additional shares of redeemable convertible preferred stock or in common
stock, increases the net loss allocable to common stockholders. Assuming that
the redeemable convertible preferred stock is held until the mandatory
redemption date, we expect to record dividends on redeemable convertible
preferred stock of $1.5 million for each of the years ending December 31,
2005, 2006 and 2007 and $1.4 million for the year ending December 31, 2008.
Accretion
of discount and deemed dividend on redeemable convertible preferred stock. We recorded as an expense accretion of
discount and deemed dividend on our redeemable convertible preferred stock in
the amount of $1.9 million for the year ended December 31, 2004, compared
to $36,000 for the year ended December 31, 2003. In accordance with Emerging
Issues Task Force (“EITF”) 00-27, “Application of Issue No. 98-5 to Certain
Convertible Instruments,” we allocated the total proceeds received in our
preferred stock financing among the Series B-1 Convertible Preferred Stock, the
warrants and the unit warrants. We
estimated the value of the warrants and unit warrants at $6.5 million using the
Black-Scholes method. The fair
value of the common stock into which the redeemable convertible preferred stock
was convertible into on the date of issuance exceeded the proceeds allocated to
the redeemable convertible preferred stock by $2.8 million, resulting in a
beneficial conversion feature that was recognized as an increase to paid-in
capital and as a deemed discount to the redeemable convertible preferred stock.
As a result of the public offering we completed in February 2005, the
holders of our Series B-1 Convertible Preferred Stock are entitled to require
us to redeem all or some of their outstanding preferred shares. At December 31,
2004, the aggregate redemption price was approximately $36.5 million. Due to
this redemption right, we will record a charge of $7.4 million to accretion of
discount and deemed dividend on redeemable convertible preferred stock in the
first quarter of 2005.
YEAR ENDED
DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Revenues. We recorded revenues of $12.8 million
during the year ended December 31, 2003, compared to $19.4 million in
revenues during the year ended December 31, 2002. Eighty-six percent and
81% of our revenues during the years ended December 31, 2003, and 2002,
respectively, were from our collaborations with Merck and Eli Lilly, which
included research funding, milestone payments, and technology access and
development fees. The decrease in revenues in 2003 was primarily the result of
completing our research activities under our Eli Lilly collaboration on
April 14, 2003. Accordingly, we have not received research funding
from Eli Lilly since such date. TaiGen, a related party, accounted for $100,000
in royalty revenues and $1.4 million in revenues related to the transfer of
activated receptors in the years ended December 31, 2003 and 2002,
respectively. As of December 31, 2003, we had deferred revenues totaling
approximately $4.0 million.
Research and development expenses. Research and development expenses increased
$6.5 million to $50.9 million for the year ended December 31, 2003,
from $44.4 million for the year ended December 31, 2002. The
difference was due primarily to (i) personnel costs increasing by $3.7 million
due to a higher average number of employees during all of 2003, (ii) research
supplies decreasing by $1.6 million due to aggressive cost saving efforts,
(iii) facility and equipment costs, including depreciation, increasing by $3.0
million due to expansion of our facilities, and (iv) preclinical study fees
increasing by $1.9 million as we moved APD356 closer to clinical testing. As of
December 31, 2003, all research and development costs have been expensed
as incurred. Our research and development employees decreased from 276 at
December 31, 2002, to 254 at
34
December 31, 2003, primarily the result of our December 2003
reduction in our research and development staff of 28 employees. The cost of
the reduction in force related to research and development personnel totaled
approximately $310,000.
General
and administrative expenses. General and
administrative expenses increased $1.1 million to $8.6 million for the
year ended December 31, 2003, from $7.5 million for the year ended
December 31, 2002. The increase was due primarily to an increase in
personnel costs of $600,000 due to a higher average number of employees during
all of 2003 as well as professional fees, including legal and accounting fees,
increasing by $300,000 due to increases
in legal and accounting fees related to the complexity and demands of the laws
and regulations applicable to public companies, and the cost of maintaining a
growing and maturing portfolio of patent applications and patents.
Amortization of deferred compensation.
For the year ended December 31, 2003, we recorded amortization of deferred
compensation of $3.2 million, of which $2.0 million relates to research and
development and $1.2 million relates to general and administrative. For the
year ended December 31, 2002, we recorded amortization of deferred
compensation of $2.3 million, of which $1.6 million relates to research and
development and $700,000 relates to general and administrative.
Interest
income and other, net. Interest income and other, net,
was $4.4 million for the year ended December 31, 2003, compared to
$5.3 million for the year ended December 31, 2002. Interest income
and other, net, for the year ended December 31, 2003, was primarily comprised
of interest income of $3.6 million and gains on sales of investments of $1.8
million, partially offset by $1.1 million attributable to our share of the net
loss of TaiGen, which we have accounted for by the equity method of accounting.
Interest income and other, net, for the year ended December 31, 2002, was
primarily comprised of interest income of $5.4 million, gain on sale of
investments of $417,000 and rental and other income of $560,000, partially
offset by $1.0 million attributable to our share of the net loss of TaiGen.
Investment
write-down. In the year ended December 31, 2002,
we recorded a $1.8 million write-down of our investment in Axiom
Biotechnologies, Inc. (“Axiom”) which investment on September 3, 2002, was
converted into 109,167 restricted shares of Sequenom, Inc. (“Sequenom”) upon
the closing of the acquisition of Axiom by Sequenom. In 2003, we sold all
109,167 shares of Sequenom stock for net proceeds of $405,000 and recognized a
gain of $192,000.
Dividends on
redeemable convertible preferred stock. We recorded a dividend
expense of $27,000 related to our redeemable convertible preferred stock in the
year ended December 31, 2003. We did not have any outstanding redeemable
convertible preferred stock during the year ended December 31, 2002.
Accretion
of discount and deemed dividend on redeemable convertible preferred stock. We
recorded accretion of discount and deemed dividend on our convertible preferred
stock in the amount of $36,000 in the year ended December 31, 2003. We did
not have any outstanding redeemable convertible preferred stock during the year
ended December 31, 2002.
LIQUIDITY AND
CAPITAL RESOURCES
Short term
We anticipate increases in research and development expenditures as we
continue to move our product candidates, APD356 and APD125, and our research
programs forward. We believe we have sufficient cash to meet our objectives
over the next year, including completing our current and planned clinical
trials for APD356 and APD125, advancing our other lead internal development
projects into clinical trials, discovering and developing additional small
molecule product candidates, continuing to build our development capabilities
and maintaining our research discovery capabilities. We will, however, continue
to monitor and evaluate the proper level of research and development
expenditures, and may adjust our expenditures based upon a variety of factors
such as our clinical trial results and ability to generate cash through
collaborative and financing activities.
In the short-term, our sources of liquidity include our cash balances
and short-term investments. As of December 31, 2004, we had
$113.3 million in cash and cash equivalents and short-term investments. In
January 2005, we received approximately $23.2 million from Ortho-McNeil and, in
February 2005, we received net proceeds of approximately $48.3 million from the
public offering of 8,625,000 shares of our common stock at $6.00 per share. As
a result of the offering, the holders of our Series B-1 Convertible Preferred
Stock are entitled to require us to redeem all or some of their outstanding
preferred shares. The aggregate redemption price at December 31, 2004, was
approximately $36.5 million. If required to redeem, we may be able to satisfy a
portion of this amount with shares of our common stock. Our ability and
decision whether to use cash or equity to satisfy any redemption will depend
on, among other factors, our stock price.
35
In addition to our cash balances and short-term investments, other
potential sources of near-term liquidity are (i) the license of our product
candidates, internal drug programs and technologies, (ii) the sale of two of
the facilities that we own, neither of which is subject to any outstanding
loans, and (iii) the sale of additional equity securities.
The industry trends discussed in the overview above will affect the
terms of any near-term license agreement with a partner or issuance of equity.
Our current licensing strategy, however, is generally to move our lead program
compounds towards or into the clinic to potentially realize greater value from
partners. If we partner a program, we expect that our partner will be
responsible for a majority or all of the clinical trial expenses under the
collaboration.
We also continue to regularly evaluate potential acquisitions and
in-licensing opportunities. Any such transaction may impact our liquidity as
well as affect our expenses if, for example, our operating expenses increase as
a result of such license or acquisition or we use our cash to finance the
license or acquisition.
Long term
Looking beyond 2005, we will need to raise or generate significant
amounts of cash to execute our objectives of internally developing drugs, which
take many years and potentially hundreds of millions of dollars to develop, and
to continue our research programs. We do not currently have adequate internal
liquidity to meet this long-term goal. In order to do so, we will need to
continue our out-licensing activities and look to external sources of
liquidity, including the public or private financial markets and strategic
partners, if available.
The length of time that our current cash and cash equivalents,
short-term investments and available borrowings will sustain our operations
will be based on, among other things, the scientific progress in our research
and development programs, our research and development costs (including
personnel costs), our progress in preclinical and clinical testing, the time
and costs related to current and planned clinical studies and regulatory
approvals, if any, costs associated with securing in-licensing opportunities,
if any, and costs associated with intellectual property. We do not know whether
adequate funding will be available to us or, if available, that such funding
will be available on acceptable terms. Any significant shortfall in funding
could result in the partial or full curtailment of our development and/or
research efforts, which, in turn, will affect our development pipeline and
ability to generate cash in the future.
A source of potential liquidity in the long term is from milestone and
royalty payments from existing collaborations. A more detailed discussion of
our collaborations is set forth below. We believe it is important to find
partners to share the costs, responsibilities and risks of developing drugs.
Sources and Uses of Our Cash
Net cash used in operating activities was
approximately $39.2 million during the year ended December 31, 2004,
and was used to fund our net loss in the period, adjusted for non-cash
expenses, including $7.1 million in depreciation and amortization expense, $1.8
million in amortization of acquired technology and other purchased intangibles,
$1.5 million in amortization of deferred compensation, $936,000 for our minority
interest in TaiGen’s operations, and changes in operating assets and
liabilities. We expect net cash used in operating activities to be
greater in 2005 than in 2004 as we continue to develop our product candidates,
APD356 and APD125, as well as other programs and continue to experience
increases in legal and accounting fees related to the complexity and demands of
the laws and regulations applicable to public companies, and the cost of
maintaining a growing and maturing portfolio of patent applications and
patents. These increases in expenditures will be partially offset by funds
received from our collaborators, including approximately $23.2 million we
received from Ortho-McNeil in January 2005. Net cash used in operating
activities was approximately $34.6 million during the year ended
December 31, 2003, and was used to fund our net loss in the period,
adjusted for non-cash expenses, including $5.6 million in depreciation and
amortization expense, $3.2 million in amortization of deferred compensation, $1.6
million in amortization of acquired technology and other purchased intangibles,
$1.1 million for our minority interest in TaiGen’s operations, and changes in
operating assets and liabilities. Net
cash used in operating activities was approximately $17.2 million during
the year ended December 31, 2002. The primary use of cash for the year
ended December 31, 2002, was to fund our net loss in the period, adjusted
for non-cash expenses, including $3.5 million in depreciation and amortization,
$2.3 million in amortization of deferred compensation, $1.6 million in
amortization of acquired technology and other purchased intangibles, $1.0
million for our minority interest in TaiGen’s operations, and changes in
operating assets and liabilities.
Net cash provided by investing activities was approximately
$33.3 million during the year ended December 31, 2004, and was
primarily the result of net proceeds received from the sale and maturities of
short-term investments of $37.0 million partially offset by $4.4 million for
the purchase of equipment, leasehold improvements to the facilities we lease and
capital
36
improvements to the facilities we own. We expect our capital
expenditures in 2005 will be less than our capital expenditures in 2004. Net
cash provided by investing activities was approximately $8.9 million
during the year ended December 31, 2003, and was primarily the result of
net proceeds received from the sale and maturities of short-term investments of
$26.0 million partially offset by $17.3 million for the purchase of equipment,
leasehold improvements to the facilities we lease and capital improvements to
the facilities we own. In particular, we incurred $11.5 million in improvements
to our chemical development facility. Net cash used in investing
activities was approximately $97.6 million during the year ended
December 31, 2002, and was primarily the result of net purchases of
short-term investments of $71.8 million, as well as $24.3 million for the
purchase of equipment, leasehold improvements to the facilities we lease and
capital improvements to the facilities we own, including the capital
improvements to our chemical development facility.
Net cash provided by financing activities was $4.0 million during the
year ended December 31, 2004, and was primarily attributable to the equity
component of the payment we received from Merck for the expansion and extension
of our collaboration of $3.6 million and proceeds of $489,000 from the issuance
of common stock upon exercise of options. Net cash provided by financing
activities was $24.2 million during the year ended December 31, 2003, and
was primarily attributable to net cash proceeds of $34.2 million from a private
placement, net cash proceeds of $12.6 million from the sale and leaseback of
one of our facilities, and proceeds of $892,000 from the issuance of common
stock upon exercise of options. In February 2005, we sold 8,625,000 shares of
our common stock in a public offering at $6.00 per share and received net
proceeds of approximately $48.3 million. Net cash provided by financing
activities was partially offset by the purchase of 3.0 million shares of our
common stock from a group of related stockholders for an aggregate cash amount
of $23.1 million. Net cash provided by financing activities was
approximately $32,000 during the year ended December 31, 2002, and was
attributable to the net proceeds of $524,000 from the issuance of common stock
upon exercise of options partially offset by principal payments of $492,000 on
our capital leases.
Contractual Obligations Table
The following summarizes our long-term contractual obligations as of
December 31, 2004:
|
|
|
|
|
Payment due by period
|
|
|
Contractual
Obligations
|
|
Total
|
|
Less than 1
year
|
|
1-3
years
|
|
3-5
years
|
|
More than 5
years
|
|
|
Series B-1 Convertible Preferred Stock
|
|
$
|
36,464,242
|
|
$
|
—
|
|
$
|
—
|
|
$
|
36,464,242
|
|
$
|
—
|
|
|
Operating leases
|
|
8,483,940
|
|
976,887
|
|
2,027,147
|
|
2,129,152
|
|
3,350,754
|
|
|
Purchase obligations
|
|
98,195
|
|
98,195
|
|
—
|
|
—
|
|
—
|
|
|
Financing obligation
|
|
22,464,151
|
|
1,359,902
|
|
2,822,646
|
|
2,965,542
|
|
15,316,061
|
|
|
Total
|
|
$
|
67,510,528
|
|
$
|
2,434,984
|
|
$
|
4,849,793
|
|
$
|
41,558,936
|
|
$
|
18,666,815
|
|
The aggregate redemption price of our Series B-1 Convertible Preferred
Stock at December 31, 2004, was approximately $36.5 million and is mandatorily
redeemable in December 2008. As a result of the public offering we completed in February 2005,
the holders of our Series B-1 Convertible Preferred Stock are currently
entitled to require us to redeem all or some of their outstanding preferred
shares. If required to redeem, we may be able to satisfy a portion of this
amount with shares of our common stock.
As of December 31, 2004, we have and we will continue to enter into
agreements with clinical sites and contract research organizations to conduct
clinical trials. We will make payments to these sites and organizations based
upon the number of subjects enrolled and the length of their participation in
the trials. In determining the amount of our purchasing obligations for these
and other contracts, we have included only the minimum obligation we have under
our contracts (which analysis often assumed that such contracts were terminated
on December 31, 2004) and did not include any amount which was previously paid,
accrued, expensed or associated with a contingent event, such as a change of
control or termination of a key employee.
On December 30, 2003, we completed a sale and leaseback of our
facility at 6138-6150 Nancy Ridge Drive for $13.0 million. We have accounted for
this transaction in accordance with SFAS No. 98, “Accounting for Leases” and
SFAS 66, “Accounting for Sales of Real Estate.” Our ability to repurchase this
facility at a future date is considered continued involvement under SFAS 98
and, therefore, we must use the financing method under SFAS 66. Under the
financing method, the book value of the facility and related accumulated
deprecation remain on our balance sheet and no sale is recognized. Instead, the
sales price of the facility is recorded as a financing obligation and lease
payments are being expensed to interest expense. We have included our lease
obligations on this facility in “financing obligation” above.
37
The following is a summary of our significant collaborations as of
December 31, 2004:
Ortho-McNeil
Pharmaceutical, Inc.
In December 2004, we
entered into a collaboration and license agreement with Ortho-McNeil to further
develop compounds for the potential treatment of type 2 diabetes and other
disorders. Our two lead compounds are currently in preclinical development with
Ortho-McNeil. In January 2005, we received a non-refundable $17.5 million
upfront payment, and two milestones payments of $2.5 million each. We are
eligible to receive up to $295.0 million in milestone payments for each
compound, as well as royalty payments associated with Ortho-McNeil’s
commercialization of any drugs discovered under the agreement. These milestone
payments include development and approval milestone payments of up to
$132.5 million for the first indication and $62.5 million for the
second indication for each compound, and up to $100.0 million in sales
milestone payments for each product resulting from the collaboration. In
addition, under our agreement, Ortho-McNeil will pay us $2.4 million a year for
collaboration research through December 19, 2006. Ortho-McNeil has the option
to extend our two-year collaboration for one additional year. Under our
agreement, we will have no further performance obligations beyond December 19,
2006, or, if the agreement is extended, December 19, 2007. As a result of the
option to extend, we are recognizing the upfront payment ratably over three
years. In addition, we are recognizing the two milestones we achieved over
three years as achievability was reasonably assured at the time we entered into
the collaboration.
Our agreement with Ortho-McNeil will continue until the expiration of
Ortho-McNeil’s payment obligations for research funding, milestone payments and
royalties, unless the agreement is terminated earlier by either party. We and
Ortho-McNeil each have the right to terminate the agreement early if the other
party commits an uncured material breach of its obligations. Further,
Ortho-McNeil may terminate the agreement without cause during the term of the
research program, provided that in such event it pays us the balance of its
research funding obligation in a lump sum, unless the termination is due to our
change of control (as defined in the agreement), in which case Ortho-McNeil may
terminate either the agreement or the research program under the agreement,
without the payment of additional research funding to us. At any time after the
end of the research program, Ortho-McNeil may terminate the agreement by
providing us at least 60 days prior written notice. Upon termination of
the agreement, all rights to the compounds developed under the collaboration
will revert to us.
For the year ended December 31, 2004, we recognized revenues under
the Ortho-McNeil agreement of approximately $319,000, which included
approximately $192,000 from the amortization of the upfront payment, research
funding of approximately $77,000, and approximately $50,000 in amortization
from the two milestones achieved. At December 31, 2004, deferred revenues under
the agreement totaled approximately $22.3 million.
Merck
& Co., Inc.
In
October 2002, we entered into a research and licensing agreement with Merck to
collaborate on three GPCRs to develop therapeutics for atherosclerosis and
related disorders. We believe one or more of these GPCRs plays a role in
regulating plasma lipid profiles, including HDL cholesterol, the so-called “good
cholesterol,” and is responsible for the HDL-raising activity of niacin. In
October 2004, we extended and expanded our collaboration with Merck, and Merck
selected one of our compounds for preclinical development. As of December 31,
2004, we had received $19.5 million from Merck in upfront and milestone
payments and an equity investment. We may receive additional milestone payments
of up to $34.0 million for Merck’s clinical and marketing achievements, as
well as royalty payments associated with Merck’s commercialization of any drugs
discovered under the agreement. There is no guarantee we will receive
any further milestone payments or royalty payments under this agreement. In addition, we have received research
funding from Merck since the inception of our collaboration, and, under our
agreement, Merck will pay us $5.7 million a year for collaboration
research through October 19, 2007.
The term of our amended collaborative research program with Merck is
three years from October 21, 2004. Merck can terminate this program:
(i) for “Technical Grounds,” by giving 30 days prior notice, if both
Merck and we agree that Technical Grounds have occurred; or (ii) in the
event of our change in control (as defined in the agreement), by giving
30 days prior notice. Technical Grounds include circumstances where:
(1) our joint research committee (a committee of an equal number of Merck
and our representatives) concludes that (a) a significant adverse event
affecting all the targets, all program compounds and all active compounds under
the program has arisen during the conduct of the program, or
(b) continuation of the program is no longer scientifically promising
because the role of all the targets proves incorrect, or none of the targets
are valid as a suitable target for development of a pharmaceutical product; or
(2) Merck’s patent department, upon consultation with our patent
attorneys, makes a reasonable determination that valid third-party patent
rights block the achievement of significant program goals. In addition, either
party can terminate the agreement if the other party breaches its material
obligations under the agreement by causes and reasons within its control, has
not cured such breach within 90 days of receiving a letter requesting such
cure, and there is no dispute as to whether such breach has occurred. In
38
lieu of terminating the agreement, however, Merck can terminate the
research program and certain other aspects of the agreement after giving
90 days prior notice if we materially breach our obligations during the
course of the program and fail to cure such breach, if such default cannot be
cured within such 90-day period, or if we do not commence and diligently
continue good faith efforts to cure such default during such period.
As
part of the extension and expansion of our collaboration with Merck in October
2004, Merck purchased $7.5 million of our stock at a 70% premium to the then
current market price. We performed an evaluation on the Merck stock purchase
and determined that $3.9 million of this $7.5 million purchase was an upfront
payment related to the collaboration extension and expansion. Accordingly, we
are recognizing the $3.9 million upfront payment as well as the remaining
unamortized upfront payment balance of $1.3 million at October 2004 over the
extended collaboration term of three years. In addition, in October 2004, we
achieved a $1.0 million milestone under the collaboration, which we are
recognizing over the extended collaboration term of three years as
achievability was reasonably assured at the time we extended and expanded our
collaboration with Merck.
For the year ended December 31, 2004, we recognized revenues under
the Merck agreement of approximately $13.0 million, which included $7.1 million
in milestones, research funding of approximately $4.5 million and approximately
$1.4 million from the amortization of the upfront payments. For the year ended
December 31, 2003, we recognized revenues under the agreement of
approximately $7.9 million, which included research funding of approximately
$6.6 million and approximately $1.3 million from the amortization of the
upfront payment. For the year ended December 31, 2002, we recognized
revenues under the agreement of approximately $1.6 million, which included
research funding of approximately $1.4 million and approximately $200,000 from
the amortization of the upfront payment. At December 31, 2004, deferred
revenues under the agreement totaled approximately $7.3 million.
Recently issued accounting standards
In
December 2004, the FASB issued SFAS No. 123R “Share-Based Payment.”
This statement is a revision to SFAS 123 and supersedes Accounting Principles
Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to
Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.”
The statement eliminates the ability to account for share-based compensation
using the intrinsic value method allowed under APB 25 and will require us to
recognize share-based compensation as compensation expense in the statement of
operations based on the fair values of such equity on the date of the grant,
with the compensation expense recognized over the period in which the recipient
is required to provide service in exchange for the equity award. This statement
will also require us to adopt a fair value-based method for measuring the
compensation expense related to share-based compensation. This statement also
provides guidance on valuing and expensing these awards, as well as disclosure
requirements of these equity arrangements.
SFAS 123R permits public companies to choose
between the following two adoption methods:
• A “modified prospective” method in which
compensation cost is recognized beginning with the effective date
(a) based on the requirements of SFAS 123R for all share-based payments
granted after the effective date and (b) based on the requirements of SFAS
123 for all awards granted to employees prior to the effective date of SFAS
123R that remain unvested on the effective date, or
• A “modified retrospective” method which
includes the requirements of the modified prospective method described above,
but also permits companies to restate based on the amounts previously
recognized under SFAS 123 for purposes of pro forma disclosures either
(a) all prior periods presented or (b) prior interim periods of the
year of adoption.
We have begun, but have not completed, evaluating the impact of the
adoption of SFAS 123R on our results of operations. In connection with
evaluating the impact of SFAS 123R, we are considering the potential
implementation of different valuation methods to determine the fair value of share-based
compensation. We believe the adoption of SFAS 123R will have a material
impact on our results of operations, regardless of the valuation method used.
SFAS 123R also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow. This requirement will reduce our net operating cash flows
and increase our net financing cash flows in periods after adoption. SFAS 123R
may also delay when we become profitable, if ever.
39
CRITICAL ACCOUNTING POLICIES AND MANAGEMENT ESTIMATES
The SEC defines critical accounting policies as those that are, in
management’s view, important to the portrayal of our financial condition and results
of operations and demanding of management’s judgment. Our discussion and
analysis of our financial condition and results of operations are based on our
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States (“GAAP”). The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses. We base our estimates on experience and on various assumptions that
we believe are reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from those estimates.
Our critical accounting policies include:
Revenue recognition. Our revenue recognition policies are in
accordance with the SEC Staff Accounting Bulletin (“SAB”) No. 101, “Revenue
Recognition in Financial Statements,” as amended by SAB No. 104, “Revenue
Recognition,” and EITF 00-21, “Revenue Arrangements with Multiple Deliverables,”
which provide guidance on revenue recognition in financial statements, and are
based on the interpretations and practices developed by the SEC. Some of our
agreements contain multiple elements, including technology access fees,
research funding, milestones and royalty obligations.
Revenues from a milestone achievement is recognized when earned, as
evidenced by acknowledgment from our collaborator, provided that (i) the
milestone event is substantive and its achievability was not reasonably assured
at the inception of the agreement, (ii) the milestone represents the
culmination of an earnings process, (iii) the milestone payment is
non-refundable and (iv) our performance obligations after the milestone
achievement will continue to be funded by our collaborator at a level
comparable to the level before the milestone achievement. If all of these
criteria are not met, the milestone achievement is recognized over the
remaining minimum period of our performance obligations under the agreement. We
defer non-refundable upfront fees under our collaborations and recognize them
over the period the related services are provided or over the estimated collaboration
term using various factors specific to the collaboration. Amounts we receive
for research funding for a specified number of full-time researchers are
recognized as revenues as the services are performed. Advance payments we
receive in excess of amounts earned are classified as deferred revenues until
earned.
Clinical trial expenses. We review and accrue clinical trials expenses based
on work performed. We rely on estimates of total costs incurred based on
enrollment of subjects, completion of studies and other events. We follow this
method since reasonably dependable estimates of the costs applicable to various
stages of a research agreement or clinical trial can be made. Accrued clinical
costs are subject to revisions as clinical trials progress to completion.
Revisions are charged to expense in the period in which the facts that give
rise to the revisions become known.
Intangibles. Purchase accounting requires estimates and judgments to allocate the
purchase price to the fair market value of the assets received and liabilities
assumed. In February 2001, we acquired Bunsen Rush, Inc. for
$15.0 million in cash and assumed $400,000 in liabilities. We allocated
$15.4 million to the patented Melanophore technology acquired in such
transaction. The Melanophore technology, our primary screening technology, is
being amortized over its estimated useful life of 10 years, which was
determined based on an analysis, as of the acquisition date, of the conditions
in, and the economic outlook for, the pharmaceutical and biotechnology
industries and the patent life of the technology. As with any intangible asset,
we will continue to evaluate the value of the Melanophore technology, and we
will record a future write-down of the carrying value of the technology if we determine
that the technology has become impaired or we no longer use this technology
internally as our primary screening technology or we will accelerate the
amortization if we determine that the technology life has been shortened. In
2004, we wrote off the entire unamortized balance of $204,000 for acquired
technology related to our agreement with the University of Glasgow.
Stock-based compensation. We account for stock options granted to
employees and directors using the intrinsic value method in accordance with APB
Opinion No. 25, “Accounting for Stock Issued to Employees,” and its
related interpretations. Pursuant to this method, we measure the intrinsic
value of the option on its grant date as the difference between the exercise
price of the option and the fair market value of our stock. We then expense the
difference, if any, over the vesting period of the option, on an accelerated
basis, in accordance with FASB Issued Interpretation No. 28, “Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”
We have adopted the disclosure-only requirements of SFAS 123, “Accounting
for Stock-Based Compensation.” If we had adopted SFAS 123 to recognize an
expense for options granted to employees and directors under our stock-based
40
compensation plans, our earnings would have been materially impacted.
The impact of this method is disclosed in the notes to the consolidated
financial statements included elsewhere in this Annual Report.
Options issued to non-employees other than directors are accounted for
under the fair value method in accordance with SFAS 123 and EITF Issue
No. 96-18, “Accounting for Equity Instruments that are Issued to Other
than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”
Under the fair value method, compensation cost is measured at the grant date of
the option based on the value of the award using the Black-Scholes method.
Compensation cost is periodically remeasured as the underlying options vest in
accordance with EITF Issue No. 96-18 and is recognized over the service
period.
In
December 2004, the FASB issued SFAS 123R. This statement is a revision to
SFAS 123, supersedes APB 25, and amends SFAS 95, “Statement of Cash Flows.”
SFAS 123R eliminates the ability to account for share-based compensation using
the intrinsic value method allowed under APB 25 and requires public companies
to recognize such transactions as compensation expense in the statement of
operations based on the fair values of such equity on the date of the grant,
with the compensation expense recognized over the period in which the recipient
is required to provide service in exchange for the equity award. This statement
also provides guidance on valuing and expensing these awards, as well as
disclosure requirements of these equity arrangements. This statement is
effective for the first interim reporting period that begins after
June 15, 2005, and the Company will adopt the statement on July 1,
2005. See “Recently Issued Accounting Pronouncements.”
Valuation of our Series B Convertible Preferred Stock,
and related warrants and unit warrants. In accordance with EITF 00-27, “Application
of Issue No. 98-5 to Certain Convertible Instruments,” we allocated the total
proceeds received in our preferred stock financing among the Series B-1
Convertible Preferred Stock, the warrants and the unit warrants. We estimated
the value of the warrants and unit warrants at $6.5 million using the
Black-Scholes method. The fair value of the common shares into which the Series
B-1 Convertible Preferred Stock was convertible into on the date of issuance
exceeded the proceeds allocated to the Series B-1 Convertible Preferred Stock
by $2.8 million, resulting in a beneficial conversion feature that was
recognized as an increase to paid-in-capital and as a deemed dividend to the
Series B-1 Convertible Preferred Stock. As a result of the public offering we completed in February
2005, the holders of our Series B-1 Convertible Preferred Stock are currently
entitled to require us to redeem all or some of their outstanding preferred
shares. At December 31, 2004, the aggregate redemption price was approximately
$36.5 million. Due to this redemption right, we will record a charge of $7.4
million to accretion of discount and deemed dividend on redeemable convertible
preferred stock in the first quarter of 2005.
The above listing is not intended to be a comprehensive list of all of
our accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by GAAP. See our audited consolidated
financial statements and notes thereto included elsewhere in this Annual Report
which contains accounting policies and other disclosures required by GAAP.
INCOME
TAXES
As of December 31, 2004, we had approximately $101.6 million
of federal net operating loss carryforwards and $11.2 million of federal
research and development tax credit carryforwards for income tax purposes.
These carryforwards expire on various dates beginning in 2012. These amounts
reflect different treatment of expenses for tax reporting than is used for
financial reporting. United States tax law contains provisions that may limit
our ability to use net operating loss and tax credit carryforwards in any year,
including if there has been a significant ownership change.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
Our management establishes and oversees the implementation of
board-approved policies covering our investments. We manage our market risk in
accordance with our investment guidelines, which: (i) emphasize preservation of
principal over other portfolio considerations, (ii) require investments to be
placed with high credit quality institutions, (iii) establish guidelines for the
diversification of our investment portfolio, and (iv) require investments to be
placed with maturities that maintain safety and liquidity. We target our
portfolio to have an average duration of no more than four years with no one
instrument having a duration exceeding five years and one month. We do not
invest in derivative instruments, or any financial instruments for trading
purposes. Our primary market risk exposure as it affects our cash equivalents,
short-term investments, and securities held for sale is interest rate risk. We
monitor our interest rate risk on a periodic basis and we ensure that our cash
equivalents, short-term investments, and securities held for sale are invested
in accordance with our investments guidelines. Managing credit ratings and the
duration of our financial investments enhances the preservation of our capital.
41
We model interest rate exposure by a sensitivity analysis that assumes
a hypothetical parallel shift downwards in the U.S. Treasury yield curve of 100
basis points. Under these assumptions, if the yield curve were to shift lower
by 100 basis points from the level existing at December 31, 2004, we would
expect future interest income from our portfolio to decline by less than $1.1
million over the next 12 months.
As of December 31, 2003, our estimate for the effect of this same
hypothetical reduction in interest rates was a decline in interest income of
less than $1.5 million. The difference in these two estimates is due to the
difference in the gross amount of our cash and cash equivalents, short-term
investments, and securities held for sale between the two periods.
The model we use is not intended to forecast actual losses in interest
income, but is used as a risk estimation and investment management tool. The
hypothetical changes and assumptions are likely to be different from what
actually occurs in the future. Furthermore, the computations do not incorporate
actions our management could take if the hypothetical interest rate changes
actually occur. As a result, actual earnings consequences will likely differ
from those quantified herein.
42
Item 8. Financial Statements and Supplementary Data.
ARENA
PHARMACEUTICALS, INC.
INDEX TO
FINANCIAL STATEMENTS
43
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENTS
The Board of Directors and
Stockholders of Arena Pharmaceuticals, Inc.
We have
audited the accompanying consolidated balance sheets of Arena Pharmaceuticals,
Inc. as of December 31, 2004 and 2003, and the related consolidated statements
of operations, stockholders’ equity and cash flows for each of the three years
in the period ended December 31, 2004. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Arena Pharmaceuticals, Inc. as of
December 31, 2004 and 2003, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2004 in
conformity with U.S. generally accepted accounting principles.
We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Arena
Pharmaceuticals, Inc.’s internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 25, 2005 expressed an unqualified opinion thereon.
/s/ ERNST
& YOUNG LLP
San Diego, California
February 25, 2005
44
ARENA
PHARMACEUTICALS, INC.
Consolidated
Balance Sheets
|
|
|
December 31,
|
|
December 31,
|
|
|
|
|
2004
|
|
2003
|
|
|
Assets
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
58,686,129
|
|
$
|
60,471,856
|
|
|
Short-term investments, available-for-sale
|
|
54,627,710
|
|
93,545,027
|
|
|
Accounts receivable
|
|
22,590,323
|
|
27,712
|
|
|
Prepaid expenses and other current assets
|
|
5,331,799
|
|
4,730,961
|
|
|
Total current assets
|
|
141,235,961
|
|
158,775,556
|
|
|
|
|
|
|
|
|
|
Land, property and equipment, net
|
|
52,994,209
|
|
55,729,472
|
|
|
Acquired technology, net
|
|
9,486,216
|
|
11,023,212
|
|
|
Other non-current assets
|
|
2,648,609
|
|
4,369,869
|
|
|
Total assets
|
|
$
|
206,364,995
|
|
$
|
229,898,109
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
4,988,586
|
|
$
|
1,741,981
|
|
|
Accrued compensation
|
|
1,300,371
|
|
1,281,486
|
|
|
Current portion of deferred revenues
|
|
11,497,209
|
|
2,861,736
|
|
|
Current portion of obligations under
capital leases
|
|
—
|
|
43,874
|
|
|
Total current liabilities
|
|
17,786,166
|
|
5,929,077
|
|
|
|
|
|
|
|
|
|
Deferred rent
|
|
931,310
|
|
933,684
|
|
|
Deferred revenues, less current portion
|
|
18,572,979
|
|
1,111,112
|
|
|
Financing obligation
|
|
13,259,326
|
|
13,000,000
|
|
|
|
|
|
|
|
|
|
Commitments
|
|
|
|
|
|
|
Series B-1 redeemable convertible preferred
stock, $.0001 par value: 4,650 and no shares authorized at December 31, 2004
and 2003, respectively; 3,500 shares issued and outstanding at December 31,
2004 and 2003, respectively; Liquidation preference $35,000,000
|
|
29,092,228
|
|
25,776,104
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
Series A preferred stock, $.0001 par value:
350,000 shares authorized at December 31, 2004 and 2003; no shares issued and
outstanding at December 31, 2004 and 2003
|
|
—
|
|
—
|
|
|
Common stock, $.0001 par value: 67,500,000
shares authorized at December 31, 2004, and 2003; 26,566,419 and 25,548,372
shares issued and outstanding at December 31, 2004, and December 31, 2003,
respectively
|
|
2,972
|
|
2,867
|
|
|
Additional paid-in capital
|
|
319,539,956
|
|
315,861,773
|
|
|
Treasury stock – 3,000,000 shares at
December 31, 2004 and 2003
|
|
(23,070,000
|
)
|
(23,070,000
|
)
|
|
Accumulated other comprehensive income
(loss)
|
|
(163,455
|
)
|
526,580
|
|
|
Deferred compensation
|
|
(779,972
|
)
|
(2,647,610
|
)
|
|
Accumulated deficit
|
|
(168,806,515
|
)
|
(107,525,478
|
)
|
|
Total stockholders’ equity
|
|
126,722,986
|
|
183,148,132
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
206,364,995
|
|
$
|
229,898,109
|
|
See accompanying notes.
45
ARENA
PHARMACEUTICALS, INC.
Consolidated Statements of Operations
|
|
|
Years ended December 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Collaborative agreements
|
|
$
|
13,685,822
|
|
$
|
12,734,279
|
|
$
|
18,005,765
|
|
|
Collaborative agreements with affiliates
|
|
—
|
|
100,000
|
|
1,416,000
|
|
|
Total revenues
|
|
13,685,822
|
|
12,834,279
|
|
19,421,765
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Research and development
|
|
57,729,138
|
|
50,885,417
|
|
44,399,136
|
|
|
General and administrative
|
|
10,449,281
|
|
8,553,910
|
|
7,499,011
|
|
|
Amortization of deferred compensation
($849,554, $1,981,648 and $1,576,661 related to, research and development
expenses and $616,691, $1,254,439 and $688,273 related to general and
administrative expenses for 2004, 2003 and 2002, respectively)
|
|
1,466,245
|
|
3,236,087
|
|
2,264,934
|
|
|
Amortization of acquired technology
|
|
1,824,761
|
|
1,621,220
|
|
1,586,127
|
|
|
Total operating expenses
|
|
71,469,425
|
|
64,296,634
|
|
55,749,208
|
|
|
Loss from operations
|
|
(57,783,603
|
)
|
(51,462,355
|
)
|
(36,327,443
|
)
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
Interest income
|
|
2,390,066
|
|
3,594,580
|
|
5,423,742
|
|
|
Investment write-down
|
|
—
|
|
—
|
|
(1,786,797
|
)
|
|
Interest expense
|
|
(1,854,124
|
)
|
(37,231
|
)
|
(76,536
|
)
|
|
Gain on sale of investments
|
|
74,926
|
|
1,820,246
|
|
416,910
|
|
|
Other income, net
|
|
116,496
|
|
163,929
|
|
552,849
|
|
|
Equity in losses of TaiGen
|
|
(935,531
|
)
|
(1,138,608
|
)
|
(1,032,663
|
)
|
|
Net loss
|
|
(57,991,770
|
)
|
(47,059,439
|
)
|
(32,829,938
|
)
|
|
|
|
|
|
|
|
|
|
|
Dividends on redeemable convertible
preferred stock
|
|
(1,437,384
|
)
|
(26,858
|
)
|
—
|
|
|
Accretion of discount and deemed dividend
related to redeemable convertible preferred stock
|
|
(1,851,883
|
)
|
(35,516
|
)
|
—
|
|
|
Net loss allocable to common stockholders
|
|
$
|
(61,281,037
|
)
|
$
|
(47,121,813
|
)
|
$
|
(32,829,938
|
)
|
|
|
|
|
|
|
|
|
|
|
Net loss per share, basic and diluted
|
|
$
|
(2.40
|
)
|
$
|
(1.74
|
)
|
$
|
(1.19
|
)
|
|
|
|
|
|
|
|
|
|
|
Shares used in calculating net loss per
share, basic and diluted
|
|
25,527,617
|
|
27,159,234
|
|
27,487,537
|
|
See accompanying notes.
46
ARENA
PHARMACEUTICALS, INC.
Consolidated Statements of Stockholders’
Equity
|
|
|
|
|
|
|
Additional
Paid-In
Capital
|
|
Treasury
Stock
|
|
Accumulated
Other
Comprehensive
Income
|
|
Deferred
Compensation
|
|
Accumulated
Deficit
|
|
Total
Stockholders’
Equity
|
|
|
Common
Stock
|
|
Shares
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2001
|
|
27,585,048
|
|
$
|
2,759
|
|
$
|
300,649,789
|
|
$
|
—
|
|
$
|
6,790
|
|
$
|
(3,611,933
|
)
|
$
|
(27,573,727
|
)
|
$
|
269,473,678
|
|
|
Issuance of
common stock upon exercise of options, net of repurchases
|
|
83,975
|
|
8
|
|
50,391
|
|
—
|
|
—
|
|
—
|
|
—
|
|
50,399
|
|
|
Issuance of
common stock under the employee stock purchase plan
|
|
77,513
|
|
8
|
|
474,047
|
|
—
|
|
—
|
|
—
|
|
—
|
|
474,055
|
|
|
Deferred
compensation related to stock options
|
|
—
|
|
—
|
|
(286,310
|
)
|
—
|
|
—
|
|
286,310
|
|
—
|
|
—
|
|
|
Amortization of
deferred compensation
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
2,264,934
|
|
—
|
|
2,264,934
|
|
|
Net loss
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(32,829,938
|
)
|
(32,829,938
|
)
|
|
Net unrealized
gain on available-for-sale securities
|
|
—
|
|
—
|
|
—
|
|
—
|
|
2,618,573
|
|
—
|
|
—
|
|
2,618,573
|
|
|
Net comprehensive
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(30,211,365
|
)
|
|
Balance
at December 31, 2002
|
|
27,746,536
|
|
$
|
2,775
|
|
$
|
300,887,917
|
|
$
|
—
|
|
$
|
2,625,363
|
|
$
|
(1,060,689
|
)
|
$
|
(60,403,665
|
)
|
$
|
242,051,701
|
|
|
Issuance of
common stock upon exercise of options, net of repurchases
|
|
36,851
|
|
4
|
|
54,414
|
|
—
|
|
—
|
|
—
|
|
—
|
|
54,418
|
|
|
Issuance of
common stock, warrants and units warrants related to preferred financing
|
|
45,000
|
|
4
|
|
9,561,808
|
|
—
|
|
—
|
|
—
|
|
—
|
|
9,561,812
|
|
|
Issuance of
common stock under the employee stock purchase plan
|
|
103,486
|
|
10
|
|
534,700
|
|
—
|
|
—
|
|
—
|
|
—
|
|
534,710
|
|
|
Issuance of
restricted stock, net of cancellations
|
|
744,000
|
|
74
|
|
4,811,611
|
|
—
|
|
—
|
|
(4,811,685
|
)
|
—
|
|
—
|
|
|
Repurchase of
common shares
|
|
(3,000,000
|
)
|
—
|
|
—
|
|
(23,070,000
|
)
|
—
|
|
—
|
|
—
|
|
(23,070,000
|
)
|
|
Deferred
compensation related to stock options
|
|
—
|
|
—
|
|
94,278
|
|
—
|
|
—
|
|
(49,371
|
)
|
—
|
|
44,907
|
|
|
Amortization of
deferred compensation
|
|
—
|
|
—
|
|
(82,955
|
)
|
—
|
|
—
|
|
3,274,135
|
|
—
|
|
3,191,180
|
|
|
Dividends on
redeemable convertible preferred stock
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(26,858
|
)
|
(26,858
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretion of
discount and deemed dividend related to redeemable convertible preferred
stock
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(35,516
|
)
|
(35,516
|
)
|
|
Restricted shares
deferred in company deferred compensation plan
|
|
(127,501
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Net loss
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(47,059,439
|
)
|
(47,059,439
|
)
|
|
Net unrealized
loss on available-for-sale securities and investments
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(2,098,783
|
)
|
—
|
|
—
|
|
(2,098,783
|
)
|
|
Net comprehensive
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(49,158,222
|
)
|
|
Balance
at December 31, 2003
|
|
25,548,372
|
|
$
|
2,867
|
|
$
|
315,861,773
|
|
$
|
(23,070,000
|
)
|
$
|
526,580
|
|
$
|
(2,647,610
|
)
|
$
|
(107,525,478
|
)
|
$
|
183,148,132
|
|
|
Issuance of
common stock upon exercise of options, net of repurchases
|
|
63,700
|
|
6
|
|
37,564
|
|
—
|
|
—
|
|
—
|
|
—
|
|
37,570
|
|
|
Issuance of
common stock under the employee stock purchase plan
|
|
105,098
|
|
11
|
|
451,475
|
|
—
|
|
—
|
|
—
|
|
—
|
|
451,486
|
|
|
Cancellations of
restricted stock, net of issuances
|
|
(64,083
|
)
|
(6
|
)
|
(414,198
|
)
|
—
|
|
—
|
|
414,204
|
|
—
|
|
—
|
|
|
Issuance of
common stock to Merck
|
|
937,500
|
|
94
|
|
3,590,531
|
|
—
|
|
—
|
|
—
|
|
—
|
|
3,590,625
|
|
|
Deferred
compensation related to stock options
|
|
—
|
|
—
|
|
12,811
|
|
—
|
|
—
|
|
(12,811
|
)
|
—
|
|
—
|
|
|
Amortization of
deferred compensation
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
1,466,245
|
|
—
|
|
1,466,245
|
|
|
Dividends on
redeemable convertible preferred stock
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(1,437,384
|
)
|
(1,437,384
|
)
|
|
Accretion of
discount and deemed dividend related to redeemable convertible preferred
stock
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(1,851,883
|
)
|
(1,851,883
|
)
|
|
Restricted shares
deferred in company deferred compensation plan, net of distributions and
forfeitures
|
|
(24,168
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Net loss
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(57,991,770
|
)
|
(57,991,770
|
)
|
|
Net unrealized
loss on available-for-sale securities and investments
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(690,035
|
)
|
—
|
|
—
|
|
(690,035
|
)
|
|
Net comprehensive
loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(58,325,430
|
)
|
|
Balance
at December 31, 2004
|
|
26,566,419
|
|
$
|
2,972
|
|
$
|
319,539,956
|
|
$
|
(23,070,000
|
)
|
$
|
(163,455
|
)
|
$
|
(779,972
|
)
|
$
|
(168,806,515
|
)
|
$
|
126,722,986
|
|
See
accompanying notes.
47
ARENA
PHARMACEUTICALS, INC.
Consolidated Statements of Cash Flows
|
|
|
Years ended December 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(57,991,770
|
)
|
$
|
(47,059,439
|
)
|
$
|
(32,829,938
|
)
|
|
Adjustments to reconcile net loss to net
cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
7,134,030
|
|
5,590,050
|
|
3,507,470
|
|
|
Equity in losses of TaiGen
|
|
935,531
|
|
1,138,608
|
|
1,032,663
|
|
|
Amortization of acquired technology
|
|
1,824,761
|
|
1,621,220
|
|
1,586,127
|
|
|
Amortization of deferred compensation
|
|
1,466,245
|
|
3,236,087
|
|
2,264,934
|
|
|
Amortization/accretion of short-term
investment premium/discount
|
|
1,266,537
|
|
1,822,005
|
|
1,423,181
|
|
|
Deferred rent
|
|
(2,374
|
)
|
20,743
|
|
41,074
|
|
|
Deferred interest expense
|
|
259,326
|
|
—
|
|
—
|
|
|
Loss on disposal of equipment
|
|
7,959
|
|
25,188
|
|
7,066
|
|
|
Investment write-down
|
|
—
|
|
—
|
|
1,786,797
|
|
|
Change in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
(22,562,611
|
)
|
3,491,497
|
|
(37,959
|
)
|
|
Prepaid expenses and other assets
|
|
(888,603
|
)
|
84,338
|
|
(1,793,408
|
)
|
|
Deferred revenues
|
|
26,097,340
|
|
(2,620,090
|
)
|
3,816,082
|
|
|
Accounts payable and accrued expenses
|
|
3,292,347
|
|
(1,926,810
|
)
|
1,973,589
|
|
|
Net cash used in operating activities
|
|
(39,161,282
|
)
|
(34,576,603
|
)
|
(17,222,322
|
)
|
|
INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
Purchases of short-term investments,
available-for-sale
|
|
(95,314,008
|
)
|
(174,527,521
|
)
|
(207,336,208
|
)
|
|
Proceeds from sales/maturities of
short-term investments
|
|
132,274,753
|
|
200,510,138
|
|
135,543,996
|
|
|
Purchases of land, property and equipment
|
|
(4,414,741
|
)
|
(17,286,030
|
)
|
(24,325,234
|
)
|
|
Proceeds from sale of equipment
|
|
8,015
|
|
14,687
|
|
5,900
|
|
|
Deposits, restricted cash and other assets
|
|
785,729
|
|
225,872
|
|
(1,503,519
|
)
|
|
Net cash provided by (used in) investing
activities
|
|
33,339,748
|
|
8,937,146
|
|
(97,615,065
|
)
|
|
FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
Principal payments on capital leases
|
|
(43,874
|
)
|
(365,174
|
)
|
(492,431
|
)
|
|
Proceeds from issuance of redeemable
convertible preferred stock and warrants
|
|
—
|
|
34,172,026
|
|
—
|
|
|
Proceeds from issuance of common stock
|
|
4,079,681
|
|
891,526
|
|
524,454
|
|
|
Proceeds from sale of facility
|
|
—
|
|
12,611,630
|
|
—
|
|
|
Purchase of common stock
|
|
—
|
|
(23,070,000
|
)
|
—
|
|
|
Net cash provided by financing activities
|
|
4,035,807
|
|
24,240,008
|
|
32,023
|
|
|
Net decrease in cash and cash equivalents
|
|
(1,785,727
|
)
|
(1,399,449
|
)
|
(114,805,364
|
)
|
|
Cash and cash equivalents at beginning of
period
|
|
60,471,856
|
|
61,871,305
|
|
176,676,669
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
58,686,129
|
|
$
|
60,471,856
|
|
$
|
61,871,305
|
|
|
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
1,418,591
|
|
$
|
144,873
|
|
$
|
70,120
|
|
See accompanying notes.
48
ARENA PHARMACEUTICALS, INC.
Notes to Consolidated Financial Statements
(1) THE COMPANY AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
The Company
Arena
Pharmaceuticals, Inc. (the “Company”) was incorporated on April 14,
1997, and commenced operations in July 1997. The Company operates in one
business segment and is a biopharmaceutical company with a pipeline of
internally discovered small molecule product candidates that target G
protein-coupled receptors (“GPCRs”).
Principles of Consolidation
The Company’s financial
statements include the activity of its wholly owned subsidiary, BRL
Screening, Inc. since its formation in February 2001.
Use of Estimates
The preparation of financial
statements in conformity with generally accepted accounting principles in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents
consist of cash and highly liquid investments with original maturities of three
months or less when purchased.
Short-term Investments, Available-for-sale
In accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain
Debt and Equity Securities,” short-term investments are classified as
available-for-sale. The Company defines short-term investments as
income-yielding securities that can be readily converted to cash. These
securities are carried at fair value, with unrealized gains and losses reported
as accumulated other comprehensive income. The cost of debt securities is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Realized gains and losses and
declines in securities judged to be other than temporary, are included in other
income or expense. The cost of securities sold is based on the specific
identification method. Interest and dividends on available-for-sale securities
are included in interest income. Investments held as of December 31, 2004,
consist primarily of U.S. Federal agency notes and U.S. corporate debt
securities.
Fair Value of Financial Instruments
Cash and cash equivalents,
accounts receivable, accounts payable and accrued liabilities, are carried at
cost, which management believes approximates fair value due to the short-term
maturity of these instruments. Short-term investments, available-for-sale are
carried at fair value.
Concentration of Credit Risk and Major
Customers
Financial instruments, which
potentially subject the Company to concentrations of credit risk, consist
primarily of cash, cash equivalents and short-term investments. The Company
limits its exposure to credit loss by placing its cash with high credit quality
financial institutions and in accordance with the Company’s investment policy,
debt that is rated investment grade.
Merck & Co., Inc. (“Merck”)
accounted for 94.6% of total revenues during the year ended December 31, 2004,
and Merck and Eli Lilly and Company (“Eli Lilly”) together accounted for 86.3%
of total revenues during the year ended December 31, 2003. Ortho-McNeil
Pharmaceutical, Inc., a Johnson & Johnson company (“Ortho-McNeil”),
accounted for 100% of accounts receivable as of December 31, 2004.
49
Property
and Equipment
Property and equipment are
stated at cost and depreciated over the estimated useful lives of the assets
(three to seven years) using the straight-line method. Buildings and
building improvements are stated at cost and depreciated over the estimated
useful life of approximately 20 years using the straight-line method.
Amortization of leasehold improvements and assets under capital leases are
stated at cost and amortized over the shorter of the estimated useful lives of
the assets or the lease term.
Intangible Assets
Purchase accounting requires estimates and
judgments to allocate the purchase price to the fair market value of the assets
received and liabilities assumed. In February 2001, the Company acquired Bunsen
Rush Laboratories, Inc. (“Bunsen Rush”) for $15.0 million in cash and assumed $400,000 in liabilities. Acquired
technology from the Company’s acquisition of Bunsen Rush is being amortized
over its estimated useful life of 10 years, which was determined based on an analysis, as of the acquisition date,
of the conditions in, and the economic outlook for, the pharmaceutical and
biotechnology industries and the patent life of the technology. The
Company allocated $15.4 million to
the patented Melanophore technology, its primary screening technology, acquired
in such transaction. As with any intangible asset, the Company will continue to
evaluate the value of the Melanophore technology, and will record a future
write-down of the carrying value of the technology if the Company determines
that the technology has become impaired or no longer uses this technology
internally as a primary screening technology or the Company will accelerate the
amortization if it determines that the technology life has been shortened. Accumulated
amortization from acquired technology totaled approximately $6.1 million and $4.5
million at December 31, 2004, and 2003, respectively. As of
December 31, 2004, the Company anticipates that total charges to be
recognized in future periods from the amortization of acquired technology will
be approximately $1.5 million for each of the next five years.
In 2004, the Company wrote off the
unamortized balance of $204,000 for acquired technology related to the
Company’s agreement with the University of Glasgow.
Long-lived Assets
The Company reviews the
recoverability of long-lived and finite-lived intangible assets when
circumstances indicate that the carrying amount of assets may not be
recoverable. This evaluation is based on various analyses including
undiscounted cash flow projections. In the event undiscounted cash flow
projections indicate an impairment, the Company would record an impairment
loss, if any, based on the fair value of the assets. Effective January 1,
2002, the Company accounts for impairments under SFAS No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets.” Other than the write-off of
the unamortized balance of $204,000 for acquired technology related to the
Company’s agreement with the University of Glasgow, the Company did not record
impairments or write-offs of long-lived assets in 2004, 2003 or 2002.
Deferred Rent
Rent expense is recorded on a
straight-line basis over the term of the lease. The difference between rent
expense and amounts paid under the lease agreements is recorded as deferred
rent in the accompanying balance sheets.
Stock-based Compensation
The Company accounts for
stock-based compensation in accordance with the provisions of Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to
Employees” and its related Interpretations, which state that no compensation
expense is recorded for stock options or other stock-based awards to employees
and directors that are granted with an exercise price equal to or above the
fair value per share of the Company’s common stock on the grant date. In the
event that stock options are granted with an exercise price below the fair
value of the Company’s common stock on the grant date, the difference between
the fair value of the Company’s common stock and the exercise price of the
stock option is recorded as deferred compensation. For stock options granted to
its employees and directors, the Company has adopted the disclosure-only
requirements of SFAS No. 123 “Accounting for Stock-Based Compensation,” which
allows compensation expense to be disclosed in the notes to the financial
statements based on the fair value of the options granted at the date of the
grant. Compensation expense for options granted to non-employees other than
directors has been determined in accordance with SFAS 123 and 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.” Such expense is based on the fair value of the
options issued using the Black-Scholes method and is periodically remeasured as
the underlying options vest in accordance with EITF Issue No. 96-18.
50
The Company issued an aggregate
of 755,500 shares of restricted common stock to key employees in 2004 and
2003, which generally vest over a two or four-year period. In connection with
the issuance of restricted stock to employees, the Company recorded deferred
stock compensation totaling $30,000, $4.8 million and $0 during the years ended
December 31, 2004, 2003 and 2002, respectively. This deferred compensation
related to restricted stock awards was calculated by multiplying the quoted
market value of the Company’s stock by the number of shares issued and is
amortized to expense over the vesting period.
The Company recorded
amortization of deferred compensation expense of approximately $1.5 million,
$3.2 million and $2.3 million during the years ended December 31, 2004,
2003 and 2002, respectively. The Company expects that charges to be recognized
in future periods from amortization of deferred compensation related to equity
grants will be $430,000, $323,000 and $27,000 for the years ending
December 31, 2005, 2006 and 2007, respectively.
In 2003, the Company set up a
deferred compensation plan for its executive officers, whereby executive
officers may elect to defer their shares of restricted stock. At
December 31, 2004 and 2003, a total of 151,669 and 127,501 shares of
restricted stock were contributed to the plan, respectively.
The following pro forma information
regarding net loss and net loss per share has been determined as if the Company
had accounted for its employee and director stock options and stock issued
under the employee stock purchase plan under the fair value method prescribed
by SFAS 123. The fair value of options was estimated at the date of grant using
a Black-Scholes option valuation model using the assumptions stated below.
|
|
|
Years ended December 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
Net loss allocable to common stockholders,
as reported
|
|
$
|
(61,281,037
|
)
|
$
|
(47,121,813
|
)
|
$
|
(32,829,938
|
)
|
|
Add: Stock-based employee and non-employee
compensation expense included in net loss allocable to common stockholders,
as reported, net of related tax effects
|
|
1,466,245
|
|
3,236,087
|
|
2,264,934
|
|
|
Fair value of stock-based employee
compensation
|
|
(6,009,292
|
)
|
(7,272,597
|
)
|
(8,825,934
|
)
|
|
Pro forma net loss
|
|
$
|
(65,824,084
|
)
|
$
|
(51,158,323
|
)
|
$
|
(39,390,938
|
)
|
|
Net loss per share:
|
|
|
|
|
|
|
|
|
Basic and diluted — as reported
|
|
$
|
(2.40
|
)
|
$
|
(1.74
|
)
|
$
|
(1.19
|
)
|
|
Basic and diluted — pro forma
|
|
$
|
(2.58
|
)
|
$
|
(1.88
|
)
|
$
|
(1.43
|
)
|
|
|
|
|
|
|
|
|
|
|
Assumptions used for Employee Stock
Options:
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
3.0
|
%
|
2.8
|
%
|
2.8
|
%
|
|
Dividend yield
|
|
0
|
%
|
0
|
%
|
0
|
%
|
|
Stock price volatility
|
|
78
|
%
|
81
|
%
|
93
|
%
|
|
Expected life (years)
|
|
5.0
|
|
5.0
|
|
5.0
|
|
|
Weighted-average fair value
|
|
$
|
3.74
|
|
$
|
4.38
|
|
$
|
6.78
|
|
|
|
|
|
|
|
|
|
|
|
Assumptions used for Employee Stock
Purchase Plan:
|
|
|
|
|
|
|
|
|
Risk-free interest rate
|
|
2.1
|
%
|
1.2
|
%
|
1.8
|
%
|
|
Dividend yield
|
|
0
|
%
|
0
|
%
|
0
|
%
|
|
Stock price volatility
|
|
76
|
%
|
86
|
%
|
98
|
%
|
|
Expected life (years)
|
|
0.25
|
|
0.25
|
|
0.25
|
|
|
Weighted-average fair value
|
|
$
|
1.69
|
|
$
|
2.22
|
|
$
|
2.90
|
|
The effects of applying SFAS
123 for providing pro forma disclosures may not be representative of the effect
on reported net income (loss) for future years.
Revenue Recognition
The Company’s revenue recognition policies are in accordance with the
SEC Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in
Financial Statements,” as amended by SAB No. 104, “Revenue Recognition,” and
EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables” which
provides guidance on revenue recognition in financial statements, and are based
on the interpretations and practices developed by the SEC. Some of the
Company’s agreements contain multiple elements, including technology access
fees, research funding, milestones and royalty obligations.
51
Revenues from a milestone achievement is recognized when earned, as
evidenced by acknowledgment from the Company’s collaborator, provided that
(i) the milestone event is substantive and its achievability was not
reasonably assured at the inception of the agreement, (ii) the milestone
achievement represents the culmination of an earnings process, (iii) the
milestone payment is non-refundable and (iv) the Company’s performance
obligations after the milestone achievement will continue to be funded by the
Company’s collaborator at a level comparable to the level before the milestone
achievement. If all of these criteria are not met, the milestone is recognized
over the remaining minimum period of the Company’s performance obligations
under the agreement. Non-refundable upfront fees under the Company’s
collaborations are deferred and recognized over the period the related services
are provided or over the
estimated collaboration term using various factors specific to the
collaboration. Amounts received for research funding for a specified number of
full-time researchers are recognized as revenues as the services are performed.
Advance payments received in excess of amounts earned are classified as
deferred revenues until earned.
Research and Development Costs
All research and development
expenses are expensed in the year incurred and consist primarily of personnel
related expenses and laboratory expenses.
Clinical Trial Expenses
The
Company reviews and accrues clinical trials expenses based on work performed.
The Company relies on estimates of total costs incurred based on enrollment of
subjects, completion of studies and other events. The Company follows this
method since reasonably dependable estimates of the costs applicable to various
stages of a research agreement or clinical trial can be made. Accrued clinical
costs are subject to revisions as clinical trials progress to completion.
Revisions are charged to expense in the period in which the facts that give
rise to the revisions become known.
Patent Costs
Costs related to filing and
pursuing patent applications are expensed as incurred as recoverability of such
expenditures is uncertain.
Income Taxes
In accordance with SFAS
No. 109, “Accounting for Income Taxes,” a deferred tax asset or liability
is determined based on the difference between the financial statement and tax
basis of assets and liabilities as measured by the enacted tax rates which will
be in effect when these differences reverse. The Company provides a valuation
allowance against net deferred tax assets unless, based upon the available
evidence, it is more likely than not that the deferred tax assets will be
realized.
Comprehensive Loss
In accordance with SFAS
No. 130, “Reporting Comprehensive Loss,” all components of comprehensive
loss, including net loss, are reported in the financial statements in the
period in which they are recognized. Comprehensive loss is defined as the
change in equity during a period from transactions and other events and
circumstances from non-owner sources. The Company’s accumulated other
comprehensive income (loss) consisted of an unrealized loss on
available-for-sale securities of $163,455 for the year ended December 31, 2004,
and an unrealized gain on available for sale securities of $526,580 for the
year ended December 31, 2003.
Net Loss Per Share
Basic and diluted net loss per
common share are presented in conformity with SFAS No. 128, “Earnings per
Share,” for all periods presented. In accordance with SFAS 128, basic and
diluted loss per share has been computed using the weighted-average number of
shares of common stock outstanding during the period, less shares subject to
repurchase.
The Company has excluded all
outstanding stock options, preferred stock and warrants, and shares subject to
repurchase from the calculation of diluted loss per common share because all
such securities are antidilutive for all years presented. The total number of
shares subject to repurchase excluded from the calculation of diluted net loss
per share, prior to application of the treasury stock method for stock options,
was 0, 54,249 and 184,123 for the years ended December 31, 2004, 2003 and
2002, respectively. Such securities, had they been dilutive, would have been
included in the computation of diluted net loss per share.
52
Effect of New Accounting Standards
In December 2004, the FASB issued SFAS
No. 123R “Share-Based Payment.” This statement is a revision to SFAS 123,
supersedes APB 25, and amends FASB Statement No. 95, “Statement of
Cash Flows.” SFAS 123R eliminates the ability to account for share-based
compensation using the intrinsic value method allowed under APB 25 and will
require us to recognize share-based compensation as compensation expense in the
statement of operations based on the fair values of such equity on the date of
the grant, with the compensation expense recognized over the period in which
the recipient is required to provide service in exchange for the equity award.
This statement will also require us to adopt a fair value-based method for
measuring the compensation expense related to share-based compensation. This
statement also provides guidance on valuing and expensing these awards, as well
as disclosure requirements of these equity arrangements.
SFAS 123R permits public companies to choose
between the following two adoption methods:
• A “modified prospective” method in which
compensation cost is recognized beginning with the effective date
(a) based on the requirements of SFAS 123R for all share-based payments
granted after the effective date and (b) based on the requirements of SFAS
123 for all awards granted to employees prior to the effective date of SFAS
123R that remain unvested on the effective date, or
• A “modified retrospective” method which
includes the requirements of the modified prospective method described above,
but also permits companies to restate based on the amounts previously
recognized under SFAS 123 for purposes of pro forma disclosures either
(a) all prior periods presented or (b) prior interim periods of the
year of adoption.
The Company has begun, but has not completed, evaluating the impact of
the adoption of SFAS 123R on its results of operations. In connection with
evaluating the impact of SFAS 123R, the Company is considering the
potential implementation of different valuation method to determine the fair
value of share-based compensation. The Company believes the adoption of
SFAS 123R will have a material impact on its results of operations,
regardless of the valuation method used. SFAS 123R also requires the benefits
of tax deductions in excess of recognized compensation cost to be reported as a
financing cash flow, rather than as an operating cash flow. This requirement
will reduce the Company’s net operating cash flows and increase its net
financing cash flows in periods after adoption. SFAS 123R may also delay when
the Company may become profitable, if ever.
(2) INVESTMENT IN CHEMNAVIGATOR
In January 1999, the
Company began development of an Internet-based search engine that allows
scientists to search for compounds based primarily on the similarity of
chemical structures. In May 1999, ChemNavigator was incorporated and in
June 1999, the Company licensed to ChemNavigator a website, the trademark
“ChemNavigator” and goodwill associated with the trademark, intellectual
property related to the search engine, as well as technology needed to perform
chemical similarity searches. In return, the Company received 2,625,000 shares
of preferred stock in ChemNavigator valued at approximately $2.6 million
based on independent investors’ participation in ChemNavigator’s Series A
preferred round of financing. However, the Company’s historical cost basis in
the licensed technology was zero and the Company, therefore, recorded its
investment in ChemNavigator at zero. As of both December 31, 2004, and
2003, the Company’s equity ownership represented approximately 35% of the
outstanding voting equity securities of ChemNavigator. Although ChemNavigator
has an accumulated deficit, the Company is not under an obligation to reimburse
other ChemNavigator stockholders for its share of ChemNavigator’s losses, and,
therefore, have not included any of ChemNavigator’s losses in the Company’s
Consolidated Statements of Operations. In March 2002, the Company entered
into an additional license agreement with ChemNavigator for the use of their
cheminformatic software program and in September 2003, the Company amended
this license agreement to include additional development work to be performed
by ChemNavigator. In 2002, the Company paid ChemNavigator $165,000 under this
agreement. In each of 2003 and 2004, the Company renewed its license under this
agreement for $50,000. The Company paid ChemNavigator $86,000 and $68,000 for
development work performed for the years ended December 31, 2004 and 2003,
respectively. The Company has an option to renew its license in subsequent years
for $50,000 per year.
The Company subleases office
space to ChemNavigator. Lease payments were subject to a 2% increase in
April 2003 and annually thereafter. In 2004 and 2003, the Company
recognized approximately $100,000 and $98,000, respectively, in other income
for this sublease.
Jack Lief, the Company’s
President and Chief Executive Officer, was the Chairman of the Board of
ChemNavigator until he resigned in January 2004. As compensation for his
services he has received 200,000 shares of common stock of ChemNavigator, which
vested over a period of four years. Robert E. Hoffman, the Company’s Vice
President, Finance, was
53
the Chief Financial Officer of
ChemNavigator until he resigned in December 2004. Mr. Hoffman entered into a
four-year service agreement with ChemNavigator in May of 1999, in which he
agreed to provide up to 200 hours of service per year. As compensation for his
services he has received 100,000 shares of common stock of ChemNavigator, which
vested over a period of four years. Steven W. Spector, the Company’s Senior
Vice President and General Counsel, is a director of ChemNavigator. Mr. Spector
does not receive any compensation from ChemNavigator for the services he
provides to ChemNavigator.
(3)
INVESTMENT IN AXIOM BIOTECHNOLOGIES, INC. AND SUBSEQUENT ACQUISITION BY
SEQUENOM, INC.
In April 2001, the Company
signed a binding letter of intent with Axiom Biotechnologies, Inc.
(“Axiom”) for a collaborative research program involving Axiom’s proprietary
RHACE™ Technology and Human Cell Bank, and purchased $2.0 million of
Axiom’s preferred stock. The Company accounted for this investment using the
cost method of accounting. The Company determined that its investment in Axiom
was impaired and accordingly recorded a $1.7 million write-down during the
quarter ended June 30, 2002. In September 2002, Axiom was acquired by
Sequenom, Inc. (“Sequenom”), and the Company further wrote down its
investment by $87,000 to its fair value, less a discount for restrictions on
the sale of Sequenom stock, on the date of acquisition of Axiom by Sequenom. At
December 31, 2002, the Company valued its investment in Sequenom at its
fair value as quoted on the NASDAQ national market, less a 10% discount for
restrictions on the sale of Sequenom stock. In 2003, the Company sold all
109,167 shares of Sequenom stock for net proceeds of $405,000 and recognized a
gain of $192,000.
(4) AVAILABLE-FOR-SALE SECURITITES
The following table summarizes
the various investment categories for available-for-sale securities at
December 31, 2004, and 2003:
|
December
31, 2004
|
|
Amortized Cost
|
|
Gross Unrealized
Gains
|
|
Gross Unrealized
Losses
|
|
Estimated Fair
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal agency notes
|
|
$
|
40,741,844
|
|
$
|
—
|
|
$
|
(134,281
|
)
|
$
|
40,607,563
|
|
|
Corporate debt securities
|
|
14,050,203
|
|
2,635
|
|
(32,691
|
)
|
14,020,147
|
|
|
Mortgage-backed securities
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Total available-for-sale securities
|
|
$
|
54,792,047
|
|
$
|
2,635
|
|
$
|
(166,972
|
)
|
$
|
54,627,710
|
|
|
December
31, 2003
|
|
Amortized Cost
|
|
Gross Unrealized
Gains
|
|
Gross Unrealized
Losses
|
|
Estimated Fair
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal agency notes
|
|
$
|
42,585,765
|
|
$
|
112,383
|
|
$
|
(3,803
|
)
|
$
|
42,694,345
|
|
|
Corporate debt securities
|
|
35,251,013
|
|
239,594
|
|
(1,058
|
)
|
35,489,549
|
|
|
Mortgage-backed securities
|
|
15,181,690
|
|
179,443
|
|
—
|
|
15,361,133
|
|
|
Total available-for-sale securities
|
|
$
|
93,018,468
|
|
$
|
531,420
|
|
$
|
(4,861
|
)
|
$
|
93,545,027
|
|
The amortized cost and
estimated fair value of available-for-sale securities by contractual maturity
at December 31, 2004, are shown below:
|
|
|
Amortized Cost
|
|
Estimated Fair Value
|
|
|
Due in one year or less
|
|
$
|
51,292,047
|
|
$
|
51,125,075
|
|
|
Due after one year through four years
|
|
3,500,000
|
|
3,502,635
|
|
|
Total
|
|
$
|
54,792,047
|
|
$
|
54,627,710
|
|
In 2004, proceeds from the sale of
available-for sale securities totaled $132.3 million; gross realized gains
totaled $404,000 and gross realized losses totaled $321,000. In 2003, proceeds
from the sales of available-for-sale securities totaled $200.5 million; gross
realized gains totaled $2.1 million and gross realized losses totaled $437,000.
In 2002, proceeds from the sales of available-for-sale securities totaled
$135.5 million; gross realized gains totaled $592,000 and gross realized losses
totaled $166,000.
54
(5) PROPERTY AND EQUIPMENT
Property and equipment consisted of the
following:
|
|
|
December 31,
|
|
|
|
|
2004
|
|
2003
|
|
|
Laboratory and computer equipment
|
|
$
|
23,297,791
|
|
$
|
20,872,029
|
|
|
Furniture, fixtures and office equipment
|
|
1,357,518
|
|
1,241,384
|
|
|
Land, building and capital improvements
|
|
41,950,993
|
|
40,716,085
|
|
|
Leasehold improvements
|
|
5,217,791
|
|
4,631,013
|
|
|
|
|
71,824,093
|
|
67,460,511
|
|
|
Less accumulated depreciation and
amortization
|
|
(18,829,884
|
)
|
(11,731,039
|
)
|
|
Net property and equipment
|
|
$
|
52,994,209
|
|
$
|
55,729,472
|
|
Depreciation expense was
approximately $7.1 million, $5.6 million and $3.5 million for the years ended
December 31, 2004, 2003 and 2002, respectively.
(6) COMMITMENTS
Leases
In 1997, the Company leased its
facility located at 6166 Nancy Ridge Drive in San Diego, California under an
operating lease that had an expiration date in 2004. The Company had an option
to buy the facility during the first 12 months of the lease term for
approximately $2.1 million. In 1998, the Company assigned the option to a
publicly traded Real Estate Investment Trust (“REIT”) in exchange for
approximately $733,000 in cash. The $733,000 is being recognized on a
straight-line basis as a reduction in the rent expense on the underlying lease.
In addition, the Company signed a new lease with the REIT, which expires in
2013. The lease provides the Company with an option to extend the lease term
via two five-year options. Under the terms of the new lease, effective
April 1998, monthly rental payments will be increased in April 2000
and annually thereafter by 2.75%. The Company recognizes rent expense on a
straight line basis of the term of the lease. In accordance with the terms of
the new lease, the Company is required to maintain restricted cash balances
totaling approximately $80,000 on behalf of the landlord as rent deposits
throughout the term of the lease.
In March 2002, the Company
leased an additional facility located at 6124-6126 Nancy Ridge Drive in San
Diego, California, consisting of approximately 31,000 square feet of office and
laboratory space. Under the terms of the lease, effective April 2003,
monthly rental payments increased by 2% and are subject to a 2% increase
annually thereafter. At the end of the lease in March 2012, the lease
provides the Company with an option to buy the entire building, comprised of
approximately 58,000 square feet, for $7.9 million. The Company subleases
approximately 6,000 square feet, primarily office space, of the 6126 facility
to ChemNavigator on a month-to-month basis. Sublease payments from
ChemNavigator were subject to a 2% increase in April 2003 and annually
thereafter. In 2004, the Company received approximately $100,000 for the
sublease.
On December 30, 2003, the
Company completed a sale and leaseback of its facility at 6138-6150 Nancy Ridge
Drive. The sales price for this facility was $13.0 million and net proceeds to
the Company were $12.6 million. The Company has accounted for this transaction
in accordance with SFAS 98 “Accounting for Leases” and SFAS 66 “Accounting for
Sales of Real Estate.” The Company’s
ability to repurchase this facility at a future date is considered continued
involvement under SFAS 98 and therefore the Company has applied the financing
method under SFAS 66. Under the financing method, the book value of the
facility and related accumulated deprecation remain on the Company’s balance
sheet and no sale is recognized. Instead, the sales price of the facility is
recorded as a financing obligation and all lease payments are being expensed to
interest expense. The term of the lease, which became effective
December 2003, is 15 years. Under the terms of the lease, monthly rental
payments will be increased in January 2005 and annually thereafter by
2.5%. For the years ended December 31, 2004 and 2003, the Company recorded
interest expense of $1.6 million and $4,000, respectively, related to this
lease. In accordance with the terms of the lease, the Company is required to
maintain restricted cash balances totaling approximately $663,000, included in
other non-current assets, on behalf of the landlord as rent deposits throughout
the term of the lease. The Company has the right to repurchase the facility
through year 14 of the lease.
The Company recognizes rent
expense on a straight line basis over the term of a lease. Rent expense was
$953,000, $953,000 and $869,000 for the years ended December 31, 2004,
2003 and 2002, respectively.
55
Annual future obligations as of
December 31, 2004, are as follows:
|
Year
ending December 31,
|
|
Financing Obligation
|
|
Operating Leases
|
|
|
2005
|
|
1,359,902
|
|
976,887
|
|
|
2006
|
|
1,393,899
|
|
1,001,142
|
|
|
2007
|
|
1,428,747
|
|
1,026,005
|
|
|
2008
|
|
1,464,465
|
|
1,051,503
|
|
|
2009
|
|
1,501,077
|
|
1,077,649
|
|
|
Thereafter
|
|
15,316,061
|
|
3,350,754
|
|
|
Total minimum lease payments
|
|
$
|
22,464,151
|
|
$
|
8,483,940
|
|
|
|
|
|
|
|
|
|
(7) COLLABORATIONS
Ortho-McNeil Pharmaceutical, Inc.
In December 2004, the Company entered into a collaboration and
license agreement with Ortho-McNeil to further develop compounds for the potential
treatment of type 2 diabetes and other disorders which included a
non-refundable upfront fee of $17.5 million. The Company’s two lead compounds
are in preclinical development with Ortho-McNeil. In addition, under the
agreement, Ortho-McNeil will pay the Company $2.4 million a year for
collaboration research through December 19, 2006. Ortho-McNeil has the option
to extend the two-year collaboration for one additional year and, therefore,
the Company is amortizing the $17.5 million upfront fee over three years. In
December 2004, the Company achieved two milestones under the collaboration of
$2.5 million each, which the Company is recognizing as revenues over three
years as achievability was reasonably assured at the time the Company entered
into the collaboration. Under the agreement, the Company will have no further
performance obligations beyond December 19, 2006, or, if the collaboration is
extended, December 19, 2007. At December 31, 2004, the Company had an accounts
receivable balance of $22.6 million for the upfront fee, the milestone
achievements and for research funding and received payment in January 2005. The
Company is eligible to receive up to $295.0 million in milestone payments
for each compound, as well as royalty payments associated with Ortho-McNeil’s
commercialization of any drugs discovered under the agreement. The milestone
payments include development and approval milestone payments of up to
$132.5 million for the first indication and $62.5 million for the
second indication for each compound, and up to $100.0 million in sales
milestone payments for each product resulting from the collaboration.
The agreement with Ortho-McNeil will continue until the expiration of
Ortho-McNeil’s payment obligations for research funding, milestone payments and
royalties, unless the agreement is terminated earlier by either party. The
Company and Ortho-McNeil each have the right to terminate the agreement early
if the other party commits an uncured material breach of its obligations.
Further, Ortho-McNeil may terminate the agreement without cause during the term
of the research program, provided that in such event it pays the Company the
balance of its research funding obligation in a lump sum, unless the
termination is due to the Company’s change of control (as defined in the
agreement), in which case Ortho-McNeil may terminate either the agreement or
the research program under the agreement, without the payment of additional
research funding to the Company. At any time after the end of the research
program, Ortho-McNeil may terminate the agreement by providing us at least
60 days prior written notice. Upon termination of the agreement, all
rights to the compounds developed under the collaboration will revert to the
Company.
For the year ended
December 31, 2004, the Company recognized revenues under the Ortho-McNeil
agreement of approximately $319,000, which included approximately $192,000 from
the amortization of the upfront payment, research funding of approximately
$77,000, and approximately $50,000 in amortization from the two milestones
achieved. At December 31, 2004, deferred revenues under the Ortho-McNeil
collaboration totaled approximately $22.3 million.
Merck & Co., Inc.
In October 2002, the Company entered into a
research and licensing agreement with Merck to collaborate on three GPCRs to
develop therapeutics for atherosclerosis and related disorders. The Company
believes one or more of these GPCRs plays a role in regulating plasma lipid
profiles, including HDL cholesterol, the so-called “good cholesterol,” and is
responsible for the HDL-raising activity of niacin. In October 2004, Merck
extended and expanded the collaboration and selected one compound for
preclinical development. From the inception of the collaboration through
December 31, 2004, the Company has received $19.5 million from Merck,
which was comprised of a nonrefundable upfront fee of $4.0 million, milestone
payments of $8.0 million, and an equity investment of $7.5 million. The Company
may receive additional milestone payments of up to $34.0 million for Merck’s
clinical and marketing achievements, as well as royalty payments associated
with Merck’s commercialization of any drugs discovered under the agreement.
There is no guarantee the Company will receive any further milestone payments
or royalty payments under the agreement. In addition, the Company has received
56
research funding from Merck since the
inception of the collaboration, and, under the Company’s agreement with Merck,
Merck will pay the Company $5.7 million a year for collaboration research
through October 19, 2007.
The term of the amended collaborative research program with Merck is
three years from October 21, 2004. Merck can terminate this program:
(i) for “Technical Grounds,” by giving 30 days prior notice, if both
Merck and the Company agree that Technical Grounds have occurred; or
(ii) in the event of a change in control of Arena (as defined in the
agreement), by giving 30 days prior notice. Technical Grounds include circumstances
where: (1) the joint research committee (a committee of an equal number of
Merck and Company representatives) concludes that (a) a significant
adverse event affecting all the targets, all program compounds and all active
compounds under the program has arisen during the conduct of the program, or
(b) continuation of the program is no longer scientifically promising
because the role of all the targets proves incorrect, or none of the targets
are valid as a suitable target for development of a pharmaceutical product; or
(2) Merck’s patent department, upon consultation with the Company’s patent
attorneys, makes a reasonable determination that valid third-party patent
rights block the achievement of significant program goals. In addition, either
party can terminate the agreement if the other party breaches its material
obligations under the agreement by causes and reasons within its control, has
not cured such breach within 90 days of receiving a letter requesting such
cure, and there is no dispute as to whether such breach has occurred. In lieu
of terminating the agreement, however, Merck can terminate the research program
and certain other aspects of the agreement after giving 90 days prior
notice if the Company materially breaches its obligations during the course of
the program and fail to cure such breach, if such default cannot be cured
within such 90-day period, or if the Company does not commence and diligently
continue good faith efforts to cure such default during such period.
As part of the extension and expansion of the
collaboration with Merck in October 2004, Merck purchased $7.5 million of the
Company’s stock at a 70% premium to the then current market price. The Company
performed an evaluation on the Merck stock purchase and determined that $3.9
million of the $7.5 million purchase was an upfront payment related to the
collaboration extension and expansion. Accordingly, the Company will recognize
the $3.9 million upfront payment as well as the remaining unamortized upfront
payment balance of $1.3 million at October 2004 over the extended collaboration
term of three years. In addition, in October 2004, the Company achieved a $1.0
million milestone under the collaboration which the Company is recognizing over
the extended collaboration term of three years as achievability was reasonably
assured at the time the Company extended and expanded its collaboration with
Merck.
For the year ended
December 31, 2004, the Company recognized revenues under the Merck
agreement of approximately $13.0 million, which included $7.1 million in
milestones, research funding of approximately $4.5 million and approximately
$1.4 million from the amortization of the original and extension and expansion
upfront payments. For the year ended December 31, 2003, the Company
recognized revenues under the Merck agreement of approximately $7.9 million,
which included research funding of approximately $6.6 million and approximately
$1.3 million from the amortization of the upfront payment. For the year ended
December 31, 2002, the Company recognized revenues under the Merck
agreement of approximately $1.6 million, which included research funding of
approximately $1.4 million and approximately $200,000 from the amortization of
the upfront payment. At December 31, 2004, deferred revenues under the
Merck agreement totaled approximately $7.3 million.
Eli Lilly and Company
In April 2000, the Company
entered into a research and licensing agreement with Eli Lilly focused on GPCRs
in the central nervous system, or CNS. The Company received an upfront payment
of $500,000, which the Company was amortizing ratably over five years. The
Company received research funding from Eli Lilly for its internal resources
committed to the collaboration, which had been augmented by substantial resources
at Eli Lilly.
The Company’s research
activities under this collaboration were completed on April 14, 2003.
Accordingly the Company has not received research funding from Eli Lilly under
this collaboration since such date. Upon receiving notice from Eli Lilly that
the Company’s research activities were scheduled to be completed under the
collaboration, the Company amortized the remaining upfront payment over the
remaining period the Company performed services. The Company will, however, be
eligible to receive additional preclinical milestones of $750,000 per receptor
based upon Eli Lilly’s sanction of drug discoveries based on internal
milestones which Eli Lilly has an obligation to apply reasonable commercial
efforts to obtain, clinical milestones totaling $6.0 million based upon
clinical development for each drug candidate discovered, and marketing
milestone payments of up to $6.0 million for each drug that is marketed for a
disease not already covered by another drug marketed under the collaboration, and
royalties on sales of products discovered by Eli Lilly as a result of this
collaboration, if any. There is no guarantee the Company will receive any
royalty payments or further milestone payments under this agreement.
57
For the year ended December 31,
2004, the Company did not recognize any revenues under the Eli Lilly
collaboration. For the year ended December 31, 2003, the Company
recognized revenues under the Eli Lilly collaboration of approximately $3.1
million, consisting of research funding of $1.7 million, milestone achievements
of $1.3 million, and approximately $100,000 from amortization of the upfront
payment. For the year ended December 31, 2002, the Company recognized
revenues under the Eli Lilly collaboration of approximately $14.2 million,
consisting of research funding of $6.0 million, milestone achievements of $8.0
million, and approximately $200,000 from amortization of the upfront payment.
TaiGen Biotechnology Co., Ltd.
In July 2001, the Company
entered into a license agreement with TaiGen Biotechnology Co., Ltd., a
biopharmaceutical organization (“TaiGen”) focused on the discovery and
development of innovative therapeutics, particularly in the fields of oncology
and immunology. Under the agreement, as amended, in exchange for a license to
the Company’s technologies, including TaiGen’s right to select and obtain four
GPCRs from the Company, the Company received $3.3 million in equity in TaiGen’s
Series A Preferred financing. The Company recorded the $3.3 million in equity
as deferred revenues to be recognized as revenues upon the transfer of
activated receptors. The $3.3 million valuation was based on independent
investors purchasing for cash, shares of TaiGen’s Series A preferred stock. For
each GPCR that TaiGen selects, the Company will have an obligation to work
diligently to transfer a screening assay to TaiGen for the selected receptor.
TaiGen, in turn, will develop or license to third parties compounds for each
receptor the Company transfers. The Company may also receive royalty payments
based on TaiGen’s licensing revenues and drug sales for products, if any, they
develop using the receptors the Company provides them. The Company may receive
additional equity of approximately $3.3 million in 2005 in exchange for TaiGen
receiving the right to obtain five additional GPCRs. If TaiGen or its licensees
are not successful in developing drugs at a particular receptor, the Company
will have the right to such receptor and any compounds identified using the
Company’s assays. In such event, the Company may have an obligation to pay
royalties to TaiGen. There is no guarantee that the Company will achieve any
further milestones or receive further royalty payments under this agreement.
The Company accounts for its ownership interest in TaiGen using the
equity method of accounting because of the level of the Company’s ownership and
the Company’s President and CEO, Jack Lief, is a member of TaiGen’s board of
directors. This is a method of accounting for an investment that requires
increasing or decreasing the value of the Company’s investment on its balance
sheet based on its proportionate share of TaiGen’s earnings or losses. The
Company shared in TaiGen’s losses and thereby increased its net loss for the
year ended December 31, 2004, 2003, and 2002 by approximately $936,000,
$1.1 million and $1.0 million, respectively. The Company’s investment in TaiGen
was valued at $936,000 at December 31, 2003. At December 31, 2004, the
Company’s investment in TaiGen was valued at zero and, therefore, will not
share in any additional losses TaiGen incurs until the Company receives
additional equity from TaiGen. The Company is not under an obligation to
reimburse other TaiGen stockholders for its share of TaiGen’s losses.
This agreement is effective until the expiration of TaiGen’s obligation
to make royalty payments under the agreement, if any. Additionally, either
party may terminate this agreement if the other party fails to cure a material
breach of the agreement within two months of receiving notice of such breach,
becomes insolvent or commences bankruptcy proceedings, or dissolves or
liquidates.
For the year ended December 31,
2004, the Company did not recognize any revenues under the TaiGen agreement.
For the year ended December 31, 2003, the Company recognized related party
royalty revenues under the TaiGen agreement of $100,000. For the year ended
December 31, 2002, the Company recognized non-cash related party revenues
under the TaiGen agreement of $1.4 million for the transfer of GPCR assays to
TaiGen. At December 31, 2004, deferred revenues under the TaiGen agreement
totaled $478,000.
(8) STOCKHOLDERS’ EQUITY
Preferred Stock
In October 2002, and in
conjunction with the stockholders rights plan (see “Stockholders’ Rights Plan”
below in this note), the Company’s board of directors created a series of
preferred stock, consisting of 350,000 shares, par value $.0001 per share,
designated as Series A Junior Participating Preferred Stock (the “Series A
Preferred Stock”). Such number of shares may be increased or decreased by the
board of directors, provided that no decrease shall reduce the number of shares
of Series A Preferred Stock to a number less than the number of shares then
outstanding, plus the number of shares reserved for issuance upon the exercise
of outstanding options, rights or warrants or upon the conversion of any
outstanding securities issued by the Company convertible into Series A
Preferred Stock. As of December 31, 2004, no shares of Series A Preferred
Stock were issued or outstanding.
58
Treasury Stock
In October 2003,
Biotechnology Value Fund, L.P. and certain of its affiliates accepted the
Company’s offer to purchase from them 3.0 million shares of the Company’s
common stock at a cash price per share of $7.69. The Company made the offer on
October 7, 2003, pursuant to the Stockholders Agreement dated as of
January 17, 2003, with the Company and Biotechnology Value Fund, L.P.,
Biotechnology Value Fund II, L.P., BVF Investments, L.L.C., BVF Partners L.P.,
BVF Inc. and Investment 10, L.L.C. The Company paid $23.1 million for this
purchase.
Equity Compensation Plans
Since inception through
December 31, 2004, the Company has authorized an aggregate of 6.25 million
shares of common stock for issuance under the Amended and Restated 1998 Equity
Compensation Plan, the Amended and Restated 2000 Equity Compensation Plan and
the 2002 Equity Compensation Plan (collectively the “Option Plans”). The Option
Plans provide designated employees of the Company, certain consultants and
advisors who perform services for the Company, and non-employee members of the
Company’s board of directors with the opportunity to receive grants of
incentive stock options, nonqualified stock options and restricted stock. The
options generally vest 25% a year for four years and are immediately
exercisable up to 10 years from the date of grant. The restricted stock
generally vest over a two or four-year period and the recipient, at the date of
grant, has all rights of a stockholder, subject to certain restrictions on
transferability and a risk of forfeiture.
Unvested shares issued to the
Company’s employees, consultants, advisors and non-employee members of the
Company’s board of directors pursuant to the exercise of options are subject to
repurchase, at the original purchase price, in the event of termination of
employment or engagement. In the event the Company elects not to buy back any
such unvested shares, the unvested options will be expensed at their fair value
at that point in time. In accordance with SFAS 128, the Company has
excluded unvested common stock arising from exercised options in its net basic
loss per share calculations.
The following tables summarize
the Company’s stock option activity and related information for the years ended
December 31:
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
Options
|
|
Weighted- Average
Exercise Price
|
|
Options
|
|
Weighted- Average
Exercise Price
|
|
Options
|
|
Weighted- Average
Exercise Price
|
|
|
Outstanding at January 1,
|
|
1,945,468
|
|
$
|
11.20
|
|
2,505,775
|
|
$
|
13.95
|
|
1,730,200
|
|
$
|
16.21
|
|
|
Granted
|
|
1,400,100
|
|
5.80
|
|
311,875
|
|
9.24
|
|
1,136,075
|
|
10.91
|
|
|
Exercised
|
|
(63,700
|
)
|
0.59
|
|
(37,226
|
)
|
1.47
|
|
(89,375
|
)
|
0.60
|
|
|
Cancelled
|
|
(501,469
|
)
|
11.52
|
|
(834,956
|
)
|
19.16
|
|
(271,125
|
)
|
20.07
|
|
|
Outstanding at December 31,
|
|
2,780,399
|
|
$
|
8.66
|
|
1,945,468
|
|
$
|
11.20
|
|
2,505,775
|
|
$
|
13.95
|
|
Pursuant to stock option
agreements between the Company and its employees, its employees are all
entitled to exercise their options prior to vesting. The following table
summarizes information concerning outstanding and exercisable options as of
December 31, 2004.
|
|
|
Options
Outstanding
|
|
Options
Exercisable
|
|
|
Range of Exercise Price
|
|
Number
Outstanding
at December 31,
2004
|
|
Weighted-
Average
Remaining Contractual Life
|
|
Weighted-
Average
Exercise Price
|
|
Number
Exercisable at
December 31, 2004
|
|
Weighted
-Average
Exercise Price
|
|
|
$0.20 — $5.86
|
|
451,758
|
|
7.5 Years
|
|
$
|
2.93
|
|
451,758
|
|
$
|
2.93
|
|
|
$5.87 — $6.00
|
|
869,888
|
|
9.1 Years
|
|
6.00
|
|
869,888
|
|
6.00
|
|
|
$6.30 — $10.46
|
|
568,100
|
|
8.1 Years
|
|
8.52
|
|
568,100
|
|
8.52
|
|
|
$10.47 — $12.25
|
|
580,202
|
|
7.3 Years
|
|
11.62
|
|
580,202
|
|
11.62
|
|
|
$13.60 — $31.34
|
|
310,451
|
|
6.2 Years
|
|
19.18
|
|
310,451
|
|
19.18
|
|
|
$0.20 — $31.34
|
|
2,780,399
|
|
7.9 Years
|
|
$
|
8.66
|
|
2,780,399
|
|
$
|
8.66
|
|
At December 31, 2003 and
2002, 54,249 and 184,123 shares of common stock issued upon the exercise of
options were subject to repurchase at the original purchase price at a
weighted-average price of $.61 and $.60 per share, respectively. No shares of
common stock issued upon the exercise of options were subject to repurchase at
December 31, 2004. At December 31, 2004, 2003 and 2002, 1,547,383,
2,374,431 and 2,594,975 shares, respectively, were available for future grant.
The 2,780,399 options not exercised at December 31, 2004, can be exercised
at any time; however, unvested shares are subject to repurchase at the original
purchase price if a grantee terminates employment prior to vesting.
59
Employee Stock Purchase Plan
The 2001 Arena Employee Stock
Purchase Plan (the “Purchase Plan”) was adopted by the Company’s board of
directors in March 2001. The Purchase Plan qualifies under
Section 423 of the Internal Revenue Service and permits substantially all
employees to purchase shares of common stock of the Company. Under the Purchase
Plan, employees can choose to have up to 15 percent of their annual
compensation withheld to purchase shares of common stock. The purchase price of
the common stock is at 85 percent of the lower of the fair market value of
the common stock at the enrollment date or the purchase date. The aggregate
number of shares of the Company’s common stock that may be issued pursuant to
the Purchase Plan is 1,000,000. As of December 31, 2004, 309,732 shares
have been issued pursuant to the Purchase Plan.
Common Shares Reserved for Future Issuance
The following shares of Common Stock are
reserved for future issuance at December 31, 2004:
|
Stock option plans
|
|
4,327,782
|
|
|
Deferred compensation plan
|
|
151,699
|
|
|
Warrants
|
|
1,936,200
|
|
|
Series B-1 redeemable convertible preferred
stock
|
|
4,861,899
|
|
|
Series B-2 redeemable convertible preferred
stock
|
|
1,642,857
|
|
|
Payment of dividends
|
|
2,671,883
|
|
|
Employee stock purchase plan
|
|
690,268
|
|
|
Total
|
|
16,282,588
|
|
Stockholders’
Rights Plan
In October 2002, the
Company’s board of directors adopted a stockholders’ rights plan (the “Rights
Agreement”) under which all stockholders of record as of November 13,
2002, received rights to purchase shares of the Series A Preferred Stock (the “Rights”).
Each Right entitles the registered holder to purchase from the Company one
one-hundredth of a share of the Series A Preferred Stock at an initial exercise
price of $36, subject to adjustment. The Rights are not exercisable until the
tenth day after such time as a person or group acquires beneficial ownership of
10% or more, or announces a tender offer for 10% or more, of the Company’s
common stock. At such time, all holders of the Rights, other than the acquiror,
will be entitled to purchase shares of the Company’s common stock at a 50%
discount from the then current market price.
The Rights will trade with the
Company’s common stock, unless and until they are separated due to a person or
group acquiring beneficial ownership of 10% or more, or announcing a tender
offer for 10% or more, of the Company’s common stock. The Company’s board of
directors may terminate the Rights Agreement at any time or redeem the Rights
prior to the time a person acquires 10% or more of the common stock.
(9) REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND WARRANTS
In December 2003, the
Company sold 3,500 shares of Series B-1 redeemable convertible preferred stock
(“Series B-1 Preferred”) together with (i) seven-year warrants to purchase up
to 1,486,200 shares of common stock at an exercise price of $10.00 per share;
and (ii) unit warrants giving such investors the right to purchase from the
Company for a period of approximately 16 months from December 24, 2003, at
their option, up to $11.5 million of Series B-2 redeemable convertible
preferred stock (“Series B-2 Preferred”) and additional seven-year warrants to
purchase up to 450,000 shares of common stock at an exercise price of $10.00
per share, to two institutional investors for an aggregate purchase price of
$35.0 million. The Company received approximately $34.2 million in net cash
proceeds after closing costs.
At December 31, 2004, the
Series B-1 Preferred is convertible into 4,861,899 shares common stock of the
Company at a fixed conversion price of $7.50 per share. If not previously
converted, the Company must redeem the Series B-1 Preferred in five years or
earlier under certain circumstances at the original amount invested, plus all
accrued but unpaid dividends. Any such redemption may be made by the Company in
cash or, if certain conditions have been met, in shares of common stock.
Dividends on the Series B-1 Preferred are payable at a rate of 4% per annum,
payable quarterly, commencing on March 31, 2004, by issuing common stock or by increasing the
amount of common stock that is issuable upon conversion of the Series B-1
Preferred.
If issued, the Series B-2
Preferred would be convertible into common stock at a fixed conversion price,
calculated as 110% of the market price of the common stock at the time of
issuance of the Series B-2 Preferred, but not less than $7.00 per share or
greater than $10.00 per share.
60
Each investor agrees that for
so long as it holds Series B-1 Preferred and Series B-2 Preferred, it shall
vote its shares of Series B-1 Preferred and Series B-2 Preferred and Common
Stock on all matters in which such investor is entitled to vote and on which
holders of common stock have the right to vote, in the manner recommended by
the Company’s board of directors to all of its stockholders unless the Company’s
board of directors elects to permit the investors to vote such shares in their
own discretion.
If the Company issues common
stock or common stock equivalents (excluding, among other things, certain
common stock and common stock equivalents issued or issuable (a) to the Company’s
officers, directors, employees, or consultants, (b) in connection with certain
strategic partnerships or joint ventures, and in connection with certain
mergers and acquisitions) for an effective net price per share of less than
$6.72, in the case of the Series B-1 Preferred, or a price to be determined
based on a formula, in the case of the Series B-2 Preferred, the holders of the
Series B Preferred may require the Company to redeem their shares and the
exercise price and number of outstanding seven-year warrants are subject
to weighted-average adjustment in certain circumstances. Any warrants issued
upon exercise of our unit warrants will have similar anti-dilution protections
for future issuances.
If a change of control occurs
before the two-year anniversary of the original issue date of the Series B
Preferred, the Company can repurchase the Series B Preferred at a price equal
to the greater of 125% of the stated value or the market value of such shares
of Series B Preferred plus all accrued but unpaid dividends thereon to the date
of payment. If such change of control occurs following the two-year anniversary
of the original issue date of the Series B Preferred, the Company can
repurchase the Series B Preferred at a price equal to the greater of 115% of
the stated value or the market value of such shares of Series B Preferred plus
all accrued but unpaid dividends thereon to the date of payment. The Company
can elect to pay such redemption price in shares of common stock.
The Company received net cash
proceeds from the Series B-1 Preferred of $34.2 million. In addition, the
Company issued 45,000 shares of common stock as a finder’s fee valued at
$302,000 based on the fair value of the common stock at the date of the closing
of the Series B-1 Redeemable Convertible Preferred Stock.
The Company valued the
components of the Series B-1 Preferred Stock as follows:
|
Series B-1 redeemable convertible preferred
stock
|
|
$
|
25,740,588
|
|
|
Warrants
|
|
4,534,693
|
|
|
Deemed dividend
|
|
2,800,000
|
|
|
Unit warrants
|
|
1,924,719
|
|
|
Total
|
|
$
|
35,000,000
|
|
In accordance with EITF 00-27, “Application of
Issue No. 98-5 for Certain Convertible Instruments,” the Company
allocated the components of the sale of the Series B-1 Preferred between the
Series B-1 Preferred, the warrants and the unit warrants on the basis of the
relative fair values at the date of issuance using the Black-Scholes model. The aggregate amount allocated to the warrants
and unit warrants was $6.5 million. The fair value of the common shares into
which the Series B-1 Preferred was convertible into on the date of issuance
exceeded the proceeds allocated to the Series B-1 Preferred by $2.8 million, resulting
in a beneficial conversion feature that was recognized as an increase to
paid-in capital and as a deemed dividend to the Series B-1 Preferred. The
Company will record amortization of the value of the discount, warrants, unit
warrants and deemed dividend of $1.9 million for each of the years ending
December 31, 2005, 2006 and 2007 and $1.8 million for the year ending
December 31, 2008. The Company recorded accretion of the discount and
deemed dividend of $1.9 million and $36,000 in 2004 and 2003, respectively.
(10) EMPLOYEE BENEFIT
PLAN
The Company has a defined
contribution retirement plan that complies with Section 401(k) of the
Internal Revenue Code. All employees of the Company are eligible to participate
in the plan. The Company matches 100% of each participant’s voluntary
contributions, subject to a maximum Company contribution of 6% of the
participant’s compensation. The Company’s matching portion, which totaled
$876,000, $815,000 and $796,000 for the years ended December 31, 2004,
2003, and 2002 respectively, vests over a five-year period.
61
(11) INCOME TAXES
Significant components of the
Company’s deferred tax assets at December 31, 2004, and 2003 are shown
below. A valuation allowance of $70.3 million and $43.3 million has been
recognized to offset the deferred tax assets as of December 31, 2004, and
2003, respectively, as realization of such assets is uncertain.
|
|
|
December 31,
|
|
|
|
|
2004
|
|
2003
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
37,422,000
|
|
$
|
25,824,000
|
|
|
Research and development credits
|
|
16,488,000
|
|
11,553,000
|
|
|
Capitalized R&D (state)
|
|
3,150,000
|
|
3,417,000
|
|
|
Deferred revenues
|
|
11,978,000
|
|
1,582,000
|
|
|
Other, net
|
|
1,743,000
|
|
1,540,000
|
|
|
Net deferred tax assets
|
|
70,781,000
|
|
43,916,000
|
|
|
Valuation allowance for deferred tax assets
|
|
(70,265,000
|
)
|
(43,324,000
|
)
|
|
Total deferred tax assets
|
|
516,000
|
|
592,000
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
Depreciation
|
|
(516,000
|
)
|
(592,000
|
)
|
|
Net deferred tax assets
|
|
$
|
—
|
|
$
|
—
|
|
The Company’s effective tax rate differed
from the federal statutory rate due to the Company establishing a reserve
against deferred tax assets, primarily net operating losses and tax credits, in
the current year.
At December 31, 2004, the
Company had federal and state tax net operating loss carryforwards of
approximately $101.6 million and $49.3 million, respectively. The federal
and California tax net operating loss carryforwards will begin to expire in
2012 and 2005, respectively, unless previously utilized. The Company also has
federal and California research tax credit carryforwards of approximately
$11.2 million and $8.1 million respectively, which will begin to
expire in 2012 unless previously utilized.
Pursuant to Sections 382 and
383 of the Internal Revenue Code, annual use of the Company’s net operating
loss and credit carryforwards could be limited in the event of cumulative
changes in ownership of more than 50%. Such a change occurred in prior years.
However, the Company does not believe such limitation will have a material
effect upon the Company’s ability to utilize the carryforwards.
(12)
SUBSEQUENT EVENT
In February 2005, the Company
completed a public offering by selling 8,625,000 shares of its common stock at
$6.00 per share and received net proceeds of approximately $48.3 million.
As a result of the Company’s
public offering in February 2005, the holders of the Series B-1 Preferred are
entitled to require the Company to redeem all or some of their shares of the
Series B-1 Preferred, at a price equal to the amount of the original holder’s
original investment, plus all accrued but unpaid dividends thereon to the date
of payment and any applicable penalties. The aggregate redemption price of the
Company’s Series B-1 Preferred at December 31, 2004, was approximately $36.5
million, and accrues interest at 4.0% annually. The Company may be able to
satisfy a portion of any redemption with shares of its common stock. Due to the
Series B-1 Preferred being currently redeemable, the Company will record a
charge of $7.4 million to accretion of discount and deemed dividend on
redeemable convertible preferred stock in the first quarter of 2005. Any
redemption amount settled in equity would be computed as the lesser of the
applicable conversion price of $7.50 and 95% of the arithmetic average of the
volume weighted average prices of common stock for the ten consecutive trading
days prior to the date of delivery of such applicable Series B-1 Preferred
redemption notice.
The Company’s public offering
completed in February 2005 triggered an anti-dilution clause requiring the
Company to issue an additional 41,117 warrants with an exercise price of $9.73
per share to the warrant holders and reduced the exercise price of the existing
1,486,200 outstanding warrants from $10.00 per share to $9.73 per share.
62
(13)
QUARTERLY FINANCIAL DATA (UNAUDITED)
|
2004
for quarter ended
|
|
Dec. 31
|
|
Sept. 30
|
|
June 30
|
|
March 31
|
|
Year
|
|
|
Revenues
|
|
$
|
2,120,822
|
|
$
|
4,383,332
|
|
$
|
1,398,334
|
|
$
|
5,783,334
|
|
$
|
13,685,822
|
|
|
Net loss
|
|
(17,364,434
|
)
|
(12,799,380
|
)
|
(16,138,364
|
)
|
(11,689,592
|
)
|
(57,991,770
|
)
|
|
Net loss allocable to common stockholders
|
|
(18,193,177
|
)
|
(13,624,454
|
)
|
(16,955,929
|
)
|
(12,507,477
|
)
|
(61,281,037
|
)
|
|
Basic and diluted loss per share
|
|
$
|
(0.70
|
)
|
$
|
(0.54
|
)
|
$
|
(0.67
|
)
|
$
|
(0.49
|
)
|
$
|
(2.40
|
)
|
|
2003
for quarter ended
|
|
Dec. 31
|
|
Sept. 30
|
|
June 30
|
|
March 31
|
|
Year
|
|
|
Revenues
|
|
$
|
1,616,394
|
|
$
|
2,868,675
|
|
$
|
2,973,770
|
|
$
|
5,375,440
|
|
$
|
12,834,279
|
|
|
Net loss
|
|
(14,610,054
|
)
|
(11,875,635
|
)
|
(11,762,315
|
)
|
(8,811,435
|
)
|
(47,059,439
|
)
|
|
Net loss allocable to common stockholders
|
|
(14,672,428
|
)
|
(11,875,635
|
)
|
(11,762,315
|
)
|
(8,811,435
|
)
|
(47,121,813
|
)
|
|
Basic and diluted loss per share
|
|
$
|
(0.58
|
)
|
$
|
(0.43
|
)
|
$
|
(0.42
|
)
|
$
|
(0.32
|
)
|
$
|
(1.74
|
)
|
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.
None.
Item 9A. Controls and
Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls
and Procedures
Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) promulgated under the Securities Exchange Act of
1934, as amended (the Exchange Act). Based on this evaluation, our principal
executive officer and our principal financial officer concluded that our
disclosure controls and procedures were effective as of the end of the period
covered by this annual report.
Management’s
Report on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Under the supervision and with the participation of our management,
including our CEO and VP, Finance and Chief Accounting Officer, we conducted an
evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on our evaluation under the
framework in Internal Control — Integrated
Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2004.
Our management’s assessment of the
effectiveness of our internal control over financial reporting as of December
31, 2004, has been audited by Ernst &Young LLP, an independent registered
public accounting firm, as stated in their report which is included herein.
Changes in Internal Control Over
Financial Reporting
There was no change in our internal controls
over financial reporting during the fourth quarter of the period covered by
this Annual Report that has materially affected, or is reasonably likely to
materially affect, our internal controls over financial reporting.
63
Report of
Independent Registered Public Accounting Firm on Internal Control over
Financial Reporting
The Board of Directors and Stockholders of Arena
Pharmaceuticals, Inc.
We have audited
management’s assessment included in the accompanying Management’s Report of
Internal Control Over Financial Reporting, that Arena Pharmaceuticals, Inc.
maintained effective internal control over financial reporting as of December
31, 2004, based on criteria established
in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Arena
Pharmaceuticals, Inc.’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an opinion on the
effectiveness of the company’s internal control over financial reporting based
on our audit.
We conducted our audit
in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial
reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that
Arena Pharmaceuticals, Inc. maintained effective internal control over
financial reporting as of December 31, 2004, is fairly stated, in all material
respects, based on the COSO criteria. Also, in our opinion, Arena
Pharmaceuticals, Inc. maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2004, based on the
COSO criteria.
We also have audited, in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Arena
Pharmaceuticals, Inc. as of December
31, 2004 and 2003, and the related consolidated statements of income,
stockholders’ equity, and cash flows for each of the three years in the period
ended December 31, 2004 of Arena Pharmaceuticals, Inc. and our report
dated February 25, 2005 expressed an
unqualified opinion thereon.
|
|
/s/ ERNST & YOUNG
LLP
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San Diego, California
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February 25, 2005
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64
PART III
Item 10. Directors and Executive Officers of the Registrant.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that applies to
our directors and employees (including our principal executive officer, principal
financial officer, principal accounting officer and controller), and
have posted the text of the policy on our website (www.arenapharm.com) in
connection with “Investor” materials. In addition, we intend to promptly
disclose (i) the nature of any amendment to the policy that applies to our
principal executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions and (ii) the
nature of any waiver, including an implicit waiver, from a provision of the
policy that is granted to one of these specified individuals, the name of such
person who is granted the waiver and the date of the waiver on our website in
the future.
The other information required
by this item is incorporated herein by reference from the information under the
caption “Election of Directors” and the caption “Compensation And Other
Information Concerning Officers, Directors And Certain Stockholders” and the
caption “Section 16(a) Beneficial Ownership Reporting Compliance”
contained in our proxy statement for our fiscal year ended December 31,
2004 (the “Proxy Statement”).
Item 11. Executive Compensation.
The information required by
this item is incorporated herein by reference from the information under the
caption “Compensation And Other Information Concerning Officers, Directors And
Certain Stockholders” under the caption “Compensation Committee Interlocks and
Insider Participation” contained in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder matters.
Information relating to
securities authorized for issuance under our equity compensation plans is set
forth in “Item 5. Market for the Registrant’s Common Equity and Related
Stockholder Matters” above in this Annual Report. The other information
required by this item is incorporated herein by reference from the information
under the caption “Security Ownership Of Certain Beneficial Owners And
Management” contained in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is
incorporated herein by reference from the information under the caption “Certain
Relationships and Related Transactions” contained in the Proxy Statement.
Item 14.
Principal Accounting Fees and Services
The information required by
this item is incorporated herein by reference from the information under the
caption “Audit Committee Report” contained in the Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules.
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(a)
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1.
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FINANCIAL STATEMENTS.
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Reference is made to the
Index to Financial Statements under Item 8, Part II hereof.
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2.
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FINANCIAL STATEMENT SCHEDULES.
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The
Financial Statement Schedules have been omitted either because they are not
required or because the information has been included in the financial
statements or the notes thereto included in this Annual Report on Form 10-K.
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65
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EXHIBIT
NO.
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DESCRIPTION
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3.1
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Fifth Amended and Restated
Certificate of Incorporation of Arena Pharmaceuticals, Inc.
(incorporated by reference to Exhibit 3.1 to Arena’s quarterly report on
Form 10-Q for the period ended June 30, 2002, filed with the Securities
and Exchange Commission on August 14, 2002, Commission File No. 000-31161)
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3.2
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Amended and Restated By-Laws
of Arena (incorporated by reference to Exhibit 3.2 to Arena’s report on Form 8-K
filed with the Securities and Exchange Commission on January 21, 2003,
Commission File No. 000-31161)
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3.3
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Certificate of
Designations of Series A Junior Participating Preferred Stock of Arena, dated
November 4, 2002 (incorporated by reference to Exhibit 3.3 to Arena’s
quarterly report on Form 10-Q for the period ended September 30, 2002,
filed with the Securities and Exchange Commission on September 30, 2002,
Commission File No. 000-31161)
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3.4
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Certificate of
Designations of the Series B Convertible Preferred Stock of Arena, dated
December 24, 2003 (incorporated by reference to Exhibit 3.1 to Arena’s 8-K
filed with the Securities and Exchange Commission on December 30, 2003,
Commission File No. 000-31161)
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4.1
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Rights Agreement, dated
October 30, 2002, between Arena and Computershare Trust Company, Inc.
(incorporated by reference to Exhibit 4.1 to Arena’s 8-K filed with the
Securities and Exchange Commission on November 1, 2002, Commission File
No. 000-31161)
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4.2
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Amendment
No. 1, December 24, 2003, to Rights Agreement dated
October 30, 2002, between Arena and Computershare Trust Company, Inc. (incorporated
by reference to Exhibit 4.1 to Arena’s 8-K filed with the Securities and
Exchange Commission on December 30, 2003, Commission File No. 000-31161)
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4.3
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Form of common stock
certificates (incorporated by reference to Exhibit 4.2 to Arena’s registration
statement on Form S-1, as amended, filed with the Securities and
Exchange Commission on July 19, 2000, Commission File No. 333-3594)
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10.1
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1998 Equity Compensation
Plan (incorporated by reference to Exhibit 10.1 to Arena’s registration
statement on Form S-1, as amended, filed with the Securities and
Exchange Commission on June 22, 2000, Commission File No. 333-3594)
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10.2
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Amended and Restated 2000
Equity Compensation Plan (incorporated by reference to Exhibit 10.2 to Arena’s
report on Form 10-K for the year ended December 31, 2001, filed with the
Securities and Exchange Commission on March 15, 2002, Commission File
No. 000-31161)
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10.3
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Lease, dated
March 1998, by and between ARE 6166 Nancy Ridge, LLC and
Arena, as amended by First Amendment to Lease dated as of June 30, 1998
(incorporated by reference to Exhibit 10.6 to Arena’s registration
statement on Form S-1, as amended, filed with the Securities and
Exchange Commission on June 22, 2000, Commission File No. 333-3594)
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10.4+
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Research Collaboration and
License Agreement, effective as of April 14, 2000, by and between Arena
and Eli Lilly and Company (incorporated by reference to Exhibit 10.9 to
Arena’s registration statement on Form S-1, as amended, filed with the
Securities and Exchange Commission on July 19, 2000, Commission File No.
333-3594)
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10.5
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2001 Arena Employee Stock
Purchase Plan (incorporated by reference to Exhibit B of Arena’s Proxy
Statement regarding Arena’s May 8, 2001, Annual Stockholders Meeting,
filed with the Securities and Exchange Commission on March 21, 2001,
Commission File No. 000-31161)
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10.6
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Arena Pharmaceuticals,
Inc. 2002 Equity Compensation Plan (incorporated by reference to Exhibit A to
Arena’s Proxy Statement regarding Arena’s June 11, 2002, Annual
Stockholders Meeting, filed with the Securities and Exchange Commission on
April 23, 2002, Commission File No. 000-31161)
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10.7
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Stockholders Agreement
dated as of January 17, 2003, by and among Arena, Biotechnology Value
Fund, L.P., Biotechnology Value Fund II, L.P., BVF
Investments, L.L.C., BVF Partners L.P., BVF Inc. and
Investment 10, L.L.C. (incorporated by reference to Exhibit 10 to
Arena’s report on Form 8-K filed with the Securities and Exchange Commission
on January 21, 2003, Commission File No. 000-31161)
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10.8+
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Research Collaboration and
License Agreement, dated effective as of October 21, 2002, by and
between Arena and Merck & Co., Inc., a New Jersey corporation
(incorporated by reference to Exhibit 10.20 to Arena’s annual report on Form
10-K for the period ended December 30, 2003, filed with the Securities
and Exchange Commission on March 28, 2003)
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10.9*
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Form of Termination
Protection Agreement, dated December 20, 2002, by and among Arena and
the employees listed on Schedule 1 thereto (incorporated by reference to
Exhibit 10.1 to Arena’s quarterly report on Form 10-Q for period ended
June 30, 2003, filed with the Securities and Exchange Commission on
August 13, 2003)
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10.10*
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Form of Termination
Protection Agreement, dated December 20, 2002, by and among Arena and
the
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66
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employees listed on
Schedule 1 thereto (incorporated by reference to Exhibit 10.1 to Arena’s
quarterly report on Form 10-Q for the June 30, 2003, filed with the
Securities and Exchange Commission on August 13, 2003)
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10.11
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Securities Purchase
Agreement for Arena’s Series B Convertible Preferred Stock and warrants dated
December 24, 2003, among Arena and the investor signatories thereto
(incorporated by reference to Exhibit 10.1 to Arena’s 8-K filed with the
Securities and Exchange Commission on December 30, 2003, Commission File
No. 000-31161)
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10.12
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Registration Rights
Agreement dated December 24, 2003, among Arena and the investor
signatories thereto (incorporated by reference to Exhibit 10.2 to
Arena’s 8-K filed with the Securities and Exchange Commission on
December 30, 2003, Commission File No. 000-31161)
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10.13
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Form of Warrant dated
December 24, 2003 (incorporated by reference to Exhibit 10.3 to
Arena’s 8-K filed with the Securities and Exchange Commission on
December 30, 2003, Commission File No. 000-31161)
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10.14
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Form of Unit Warrant dated
December 24, 2003 (incorporated by reference to Exhibit 10.4 to Arena’s 8-K
filed with the Securities and Exchange Commission on December 30,
2003, Commission File No. 000-31161)
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10.15
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Purchase and Sale
Agreement and Joint Escrow Instructions, dated December 22, 2003,
between Arena and ARE — Nancy Ridge No. 3, LLC (incorporated by reference to
Exhibit 10.1 to Arena’s 8-K filed with the Securities and Exchange Commission
on January 6, 2004, Commission File No. 000-31161)
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10.16
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Lease Agreement, dated
December 30, 2003, between Arena and ARE — Nancy Ridge No. 3, LLC
(incorporated by reference to Exhibit 10.2 to Arena’s 8-K filed with the
Securities and Exchange Commission on January 6, 2004, Commission File
No. 000-31161)
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10.17*
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Arena’s Deferred
Compensation Plan, effective November 11, 2003, between Arena and
participating executive officers (incorporated by reference to Exhibit 10.29
to Arena’s 10-K filed with the Securities and Exchange Commission on March 1,
2004, Commission File No. 000-31161)
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10.18
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Letter Agreement, dated
February 5, 2004, by and between Arena and William R. Shanahan, Jr., M.D.,
J.D. (incorporated by reference to Exhibit 10.1 to Arena’s 10-Q filed with
the Securities and Exchange Commission on May 7, 2004, Commission File No.
000-31161)
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10.19++
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First Amendment to
Research Collaboration and License Agreement, dated as of October 20, 2004,
by and between Arena and Merck
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10.20++
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Collaboration and License
Agreement, dated as of December 20, 2004, by and between Arena and
Ortho-McNeil Pharmaceutical, Inc., a New Jersey corporation
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10.21*
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Summary of
2005 compensation for non-employee directors (incorporated by reference to
the description of such compensation in Arena’s 8-K filed with the
Securities and Exchange Commission on January 21, 2005, Commission File No.
000-31161)
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10.22*
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Form of
stock option grant for non-employee directors (incorporated by reference to
Exhibit 10.1 to Arena’s 8-K filed with the Securities and Exchange
Commission on January 21, 2005, Commission File No. 000-31161)
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21.1
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Subsidiaries of the
registrant-None
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23.1
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Consent of Independent
Registered Public Accounting Firm
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31.1
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Section 302 Certification
by Arena’s chief executive officer
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31.2
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Section 302
Certification by Arena’s principal financial officer
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32.1
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Section 906
Certification by Arena’s chief executive officer and principal financial
officer
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+ Confidential treatment has been granted for portions of this
document.
++ Confidential treatment has been requested for portions of this
document.
* This is an agreement with management.
(c) EXHIBITS
See Item 15(a)(3) above.
(d) FINANCIAL STATEMENT
SCHEDULES
See Item 15(a)(2) above.
67
SIGNATURES
Pursuant to
the requirements of Section 13 or 15(d) 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, on March 1, 2005.
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Arena Pharmaceuticals, Inc.,
a Delaware Corporation
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By:
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/s/ Jack Lief
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Jack Lief
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Chief Executive Officer
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Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated on March 1, 2005.
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Signatures
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Title
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By:
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/s/ Jack Lief
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President, Chief Executive Officer and Director
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Jack Lief
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By:
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/s/ Robert E. Hoffman
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Vice President, Finance and Chief Accounting Officer (principal
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Robert E. Hoffman, CPA
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financial and accounting officer)
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By:
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/s/ Dominic P. Behan
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Director
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Dominic P. Behan, Ph.D.
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By:
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/s/ Donald D. Belcher
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Director
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Donald D. Belcher
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By:
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/s/ Scott H. Bice
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Director
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Scott H. Bice
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By:
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/s/ Duke K. Bristow
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Director
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Duke K. Bristow, Ph.D.
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By:
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/s/ Harry F. Hixson
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Director
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Harry F. Hixson, Ph.D.
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By:
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/s/ J. Clayburn La Force, Jr.
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Director
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J. Clayburn La Force, Jr., Ph.D.
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By:
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/s/ Louis J. Lavigne, Jr.
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Director
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Louis J. Lavigne, Jr.
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By:
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/s/ Tina S. Nova
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Director
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Tina S. Nova, Ph.D.
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By:
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/s/ Robert L. Toms
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Director
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Robert L. Toms
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EXHIBIT INDEX
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EXHIBIT
NO.
|
|
DESCRIPTION
|
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3.1
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Fifth Amended and Restated
Certificate of Incorporation of Arena Pharmaceuticals, Inc.
(incorporated by reference to Exhibit 3.1 to Arena’s quarterly report on
Form 10-Q for the period ended June 30, 2002, filed with the Securities
and Exchange Commission on August 14, 2002, Commission File No.
000-31161)
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3.2
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Amended and Restated
By-Laws of Arena (incorporated by reference to Exhibit 3.2 to Arena’s report
on Form
8-K filed with the Securities and Exchange Commission on January 21,
2003, Commission File No. 000-31161)
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3.3
|
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Certificate of
Designations of Series A Junior Participating Preferred Stock of Arena, dated
November 4, 2002 (incorporated by reference to Exhibit 3.3 to Arena’s
quarterly report on Form 10-Q for the period ended September 30, 2002,
filed with the Securities and Exchange Commission on September 30, 2002,
Commission File No. 000-31161)
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3.4
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Certificate of
Designations of the Series B Convertible Preferred Stock of Arena, dated
December 24, 2003 (incorporated by reference to Exhibit 3.1 to Arena’s
8-K filed with the Securities and Exchange Commission on December 30,
2003, Commission File No. 000-31161)
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4.1
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Rights Agreement, dated
October 30, 2002, between Arena and Computershare Trust Company, Inc.
(incorporated by reference to Exhibit 4.1 to Arena’s 8-K filed with the
Securities and Exchange Commission on November 1, 2002, Commission File
No. 000-31161)
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4.2
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Amendment
No. 1, December 24, 2003, to Rights Agreement dated
October 30, 2002, between Arena and Computershare Trust Company, Inc. (incorporated
by reference to Exhibit 4.1 to Arena’s 8-K filed with the Securities and
Exchange Commission on December 30, 2003, Commission File No. 000-31161)
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4.3
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Form of common stock
certificates (incorporated by reference to Exhibit 4.2 to Arena’s
registration statement on Form S-1, as amended, filed with the
Securities and Exchange Commission on July 19, 2000, Commission File No.
333-3594)
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10.1
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1998 Equity Compensation
Plan (incorporated by reference to Exhibit 10.1 to Arena’s registration
statement on Form S-1, as amended, filed with the Securities and
Exchange Commission on June 22, 2000, Commission File No. 333-3594)
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10.2
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Amended and Restated 2000
Equity Compensation Plan (incorporated by reference to Exhibit 10.2 to
Arena’s report on Form 10-K for the year ended December 31, 2001, filed
with the Securities and Exchange Commission on March 15, 2002,
Commission File No. 000-31161)
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10.3
|
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Lease, dated
March 1998, by and between ARE 6166 Nancy Ridge, LLC and
Arena, as amended by First Amendment to Lease dated as of June 30, 1998
(incorporated by reference to Exhibit 10.6 to Arena’s registration
statement on Form S-1, as amended, filed with the Securities and
Exchange Commission on June 22, 2000, Commission File No. 333-3594)
|
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10.4+
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Research Collaboration and
License Agreement, effective as of April 14, 2000, by and between Arena
and Eli Lilly and Company (incorporated by reference to Exhibit 10.9 to
Arena’s registration statement on Form S-1, as amended, filed with the
Securities and Exchange Commission on July 19, 2000, Commission File No.
333-3594)
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10.5
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2001 Arena Employee Stock
Purchase Plan (incorporated by reference to Exhibit B of Arena’s Proxy
Statement regarding Arena’s May 8, 2001, Annual Stockholders Meeting,
filed with the Securities and Exchange Commission on March 21, 2001,
Commission File No. 000-31161)
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10.6
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Arena Pharmaceuticals,
Inc. 2002 Equity Compensation Plan (incorporated by reference to Exhibit A to
Arena’s Proxy Statement regarding Arena’s June 11, 2002, Annual
Stockholders Meeting, filed with the Securities and Exchange Commission on
April 23, 2002, Commission File No. 000-31161)
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10.7
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Stockholders Agreement
dated as of January 17, 2003, by and among Arena, Biotechnology Value
Fund, L.P., Biotechnology Value Fund II, L.P., BVF
Investments, L.L.C., BVF Partners L.P., BVF Inc. and
Investment 10, L.L.C. (incorporated by reference to Exhibit 10 to
Arena’s report on Form 8-K filed with the Securities and Exchange Commission
on January 21, 2003, Commission File No. 000-31161)
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10.8+
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Research Collaboration and
License Agreement, dated effective as of October 21, 2002, by and
between Arena and Merck & Co., Inc., a New Jersey corporation
(incorporated by reference to Exhibit 10.20 to Arena’s annual report on Form
10-K for the period ended December 30, 2003, filed with the Securities
and Exchange Commission on March 28, 2003)
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10.9*
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Form of Termination
Protection Agreement, dated December 20, 2002, by and among Arena and
the employees listed on Schedule 1 thereto (incorporated by reference to
Exhibit 10.1 to Arena’s quarterly report on Form 10-Q for period ended
June 30, 2003, filed with the Securities and Exchange Commission on
August 13, 2003)
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10.10*
|
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Form of Termination
Protection Agreement, dated December 20, 2002, by and among Arena and
the
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employees listed on
Schedule 1 thereto (incorporated by reference to Exhibit 10.1 to Arena’s
quarterly report on Form 10-Q for the June 30, 2003, filed with the
Securities and Exchange Commission on August 13, 2003)
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10.11
|
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Securities Purchase
Agreement for Arena’s Series B Convertible Preferred Stock and warrants dated
December 24, 2003, among Arena and the investor signatories thereto
(incorporated by reference to Exhibit 10.1 to Arena’s 8-K filed with the
Securities and Exchange Commission on December 30, 2003, Commission File
No. 000-31161)
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10.12
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Registration Rights
Agreement dated December 24, 2003, among Arena and the investor
signatories thereto (incorporated by reference to Exhibit 10.2 to
Arena’s 8-K filed with the Securities and Exchange Commission on
December 30, 2003, Commission File No. 000-31161)
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10.13
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Form of Warrant dated
December 24, 2003 (incorporated by reference to Exhibit 10.3 to
Arena’s 8-K filed with the Securities and Exchange Commission on December 30,
2003, Commission File No. 000-31161)
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10.14
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Form of Unit Warrant dated
December 24, 2003 (incorporated by reference to Exhibit 10.4 to Arena’s
8-K filed with the Securities and Exchange Commission on December 30,
2003, Commission File No. 000-31161)
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10.15
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Purchase and Sale
Agreement and Joint Escrow Instructions, dated December 22, 2003,
between Arena and ARE — Nancy Ridge No. 3, LLC (incorporated by reference to
Exhibit 10.1 to Arena’s 8-K filed with the Securities and Exchange Commission
on January 6, 2004, Commission File No. 000-31161)
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10.16
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Lease Agreement, dated
December 30, 2003, between Arena and ARE — Nancy Ridge No. 3, LLC
(incorporated by reference to Exhibit 10.2 to Arena’s 8-K filed with the
Securities and Exchange Commission on January 6, 2004, Commission File
No. 000-31161)
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10.17*
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Arena’s Deferred
Compensation Plan, effective November 11, 2003, between Arena and
participating executive officers (incorporated by reference to Exhibit 10.29
to Arena’s 10-K filed with the Securities and Exchange Commission on March 1,
2004, Commission File No. 000-31161)
|
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10.18
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|
Letter Agreement, dated
February 5, 2004, by and between Arena and William R. Shanahan, Jr., M.D.,
J.D. (incorporated by reference to Exhibit 10.1 to Arena’s 10-Q filed with the
Securities and Exchange Commission on May 7, 2004, Commission File No.
000-31161)
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10.19++
|
|
First Amendment to
Research Collaboration and License Agreement, dated as of October 20, 2004,
by and between Arena and Merck
|
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10.20++
|
|
Collaboration and License
Agreement, dated as of December 20, 2004, by and between Arena and
Ortho-McNeil Pharmaceutical, Inc., a New Jersey corporation
|
|
10.21*
|
|
Summary of
2005 compensation for non-employee directors (incorporated by reference to
the description of such compensation in Arena’s 8-K filed with the
Securities and Exchange Commission on January 21, 2005, Commission File No.
000-31161)
|
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10.22*
|
|
Form of
stock option grant for non-employee directors (incorporated by reference to
Exhibit 10.1 to Arena’s 8-K filed with the Securities and Exchange
Commission on January 21, 2005, Commission File No. 000-31161)
|
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21.1
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Subsidiaries of the
registrant-None
|
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23.1
|
|
Consent of Independent
Registered Public Accounting Firm
|
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31.1
|
|
Section 302
Certification by Arena’s chief executive officer
|
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31.2
|
|
Section 302
Certification by Arena’s principal financial officer
|
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32.1
|
|
Section 906
Certification by Arena’s chief executive officer and principal financial
officer
|
+ Confidential treatment has been granted for portions of this
document.
++ Confidential treatment has been requested for portions of this
document.
* This is an agreement with management.
Searchable text section of graphics
shown above
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Product /
Indication
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Lead
Optimization
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Preclinical
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Phase 1
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Phase 2
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Phase 3
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Metabolic
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APD356
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Obesity
|
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Arena
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19AJ
/ 1
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Diabetes
|
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Ortho-McNeil
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19AJ
/ 2
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Diabetes
|
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Ortho-McNeil
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20PO
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Diabetes
|
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Arena
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CNS
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APD125
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Insomnia
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Arena
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Cardiovascular
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Niacin GPCR [GRAPHIC]
|
HDL
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Merck
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5-HT2A
|
Thrombosis
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Arena
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Inflammation
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19GJ
|
RA
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Arena
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21BW
|
MS
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Arena
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