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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2004

or

For the transition period from              to             

Commission file number 0-27914

SIRNA THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

2950 Wilderness Place

Boulder, Colorado 80301

(Address of principal executive offices)

Registrant’s telephone number: (303) 449-6500

N/A

Former name, if changed since last report

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of November 12, 2004 was 37,867,559.

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SIRNA THERAPEUTICS, INC.

INDEX TO FORM 10-Q

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

SIRNA THERAPEUTICS, INC.

CONDENSED BALANCE SHEETS

(in thousands)

See notes to condensed financial statements

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SIRNA THERAPEUTICS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share related amounts)

See notes to condensed financial statements

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SIRNA THERAPEUTICS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

See notes to condensed financial statements.

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SIRNA THERAPEUTICS, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

September 30, 2004

Note 1: Description of Business

Sirna Therapeutics, Inc., (formerly known as Ribozyme Pharmaceuticals, Inc.), was previously engaged in research to engineer RNA-based molecules for therapeutic and diagnostic purposes. Until recently, Sirna (the Company) focused on developing therapeutics based on ribozymes (a type of RNA). In 2003, the Company discontinued its efforts on ribozymes and redirected its focus to the development of a new type of nucleic acid-based therapeutic based on RNA interference (RNAi). The Company is using its considerable expertise to design, manufacture and deliver stabilized short interfering nucleic acids (siRNAs) that activate selectively the process of RNA interference, and is in research, preclinical and/or clinical development with product candidates in the following areas: Age-related Macular Degeneration (AMD), (Hepatitis C Virus (HCV), and Huntington’s Disease (HD). The Company is also evaluating other disease targets and indications for the development of RNA interference-based therapeutics on its own and in collaboration with academic research institutions and commercial enterprises. In addition, the Company manufactures and sells oligonucleotides in order to generate revenue for the purpose of supporting its ongoing operations.

Development of the Company’s products has required substantial funds (including both private and public financings), and will continue to require substantial funds to conduct the costly and time-consuming research, preclinical and clinical testing necessary to bring its proposed products to market. The Company’s ability to raise funds in the future will depend on many factors, including, among others, the progress of the Company’s research, development and drug delivery efforts, the ability of the Company to establish collaborative arrangements for clinical testing, progress with preclinical studies and clinical trials, the time and cost involved in obtaining regulatory approvals, the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims, competing technological and market developments, the determination as to the commercial potential of the Company’s potential products, and the cost and availability of third-party financing.

Note 2: Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the financial statements and disclosures thereto included in our annual report on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission.

Note 3: Private Placement Financings

On May 4, 2004, pursuant to Common Stock Purchase Agreements, the Company completed the sale of 5,760,000 shares of its common stock to institutional investors for aggregate gross proceeds of approximately $18.7 million. The common stock was sold at a price per share of $3.25. Costs related to the sale were approximately $1.5 million, resulting in net proceeds of $17.2 million.

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On April 21, 2003, pursuant to a Stock Purchase Agreement, the Company completed the sale of 24,242,425 shares of its common stock and warrants to purchase 5,015,152 shares of its common stock to the Sprout Group, Venrock Associates, Oxford Bioscience Partners IV, TVM V Life Science Ventures GmbH & Co. KG, and Granite Global Ventures for an aggregate gross consideration of approximately $48 million. The common stock was sold in a private placement at a price per share of $1.98 and the warrants are exercisable at any time over the five-year period measured from the date of issuance at a price per share of $2.52. Costs related to the sale of common stock and warrants were approximately $3.0 million.

Note 4: Accounting for Stock-Based Compensation

Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation defined a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. As provided for in SFAS No. 123, the Company has elected to apply Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock-based compensation plans. Under APB 25, if the exercise prices of the options issued to the Company’s employees and directors equal or exceed the fair value of the underlying stock on the date of grant, no compensation expense is recognized. However, the Company will continue to evaluate its approach to accounting for stock options in light of ongoing industry and regulatory developments, which at this time will likely require recognition of compensation expense under the fair value method in 2005.

The following is a reconciliation of net loss per weighted average share had the Company adopted the fair value measurement provisions of SFAS No. 123 (in thousands, except per share amounts).

In February 2003, the Company, pursuant to its transition from Ribozyme Pharmaceuticals to Sirna Therapeutics and related recapitalization, granted options to purchase approximately 4.8 million shares of common stock to employees and consultants at an exercise price of $2.10 per share, subject to stockholder approval, which was granted on April 16, 2003. Related to the February 2003 grants, the Company recorded compensation expense of $149,000 and $562,000 for the three and nine-month periods ended September 30, 2004, respectively. As of September 30, 2004, $1.8 million of unearned compensation is deferred and will be expensed as the options vest, generally over the next three to four years.

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Note 5: Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reporting 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 materially differ from those estimates.

Note 6: Reclassifications

Certain amounts related to patent expense in the accompanying financial statements for the three and nine month periods ended September 30 2003 were reclassified. For the three and nine-month periods ended Sept 30, 2003, the Company reclassified patent expense of $356,000 and $745,000 respectively, from research and development to general and administrative expense.

Note 7: Write-Off of Patent Costs

As discussed in Note 1, in 2003, the Company changed its business strategy. As a result of finalizing this change in strategy direction, we undertook a detailed review of our existing patent portfolio. Based on this review, we wrote off $477,000 of costs related to patents that we abandoned in the second quarter of 2003. In addition, because we are no longer pursuing the development of ribozymes internally, we expensed approximately $4.9 million of capitalized patent costs related to the ribozyme technology. This expense is reflected as a separate line item in our statement of operations for the nine months ended September 30, 2003.

Note 8: Subsequent Event

In October, 2004, the Company entered into various agreements with a closely-held private corporation and related parties. Upon the successful completion of certain technical feasibility studies and other closing conditions, the Company will complete a transaction to acquire all of the issued and outstanding shares of the private corporation. Pursuant to an escrow agreement, the Company deposited 170,068 shares of its common stock into escrow, some or all of which shares are issuable to the related parties of the private corporation upon the consummation or termination of the contemplated acquisition. The Company has also entered into invention assignment, non-competition, and/or consulting agreements with the related parties.

Additionally, upon the consummation of the contemplated acquisition, the Company will issue to such parties an additional 510,204 of shares of common stock. Subject to the achievement of certain milestones and other conditions, the Company may issue additional shares of its common stock (some or all of which may be paid in cash in lieu of shares) plus additional shares of common stock based on possible future sales (some or all of which may be paid in cash in lieu of shares), the value of such stock will be based on the price of the stock as of future dates.

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained elsewhere in this report, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current events. Forward-looking statements use words such as “anticipate,” “estimate,” “expect,” “will,” “may,” “intend,” “plan,” “believe” and similar expressions in connection with discussion of future operating or financial performance. The forward-looking statements include statements relating to future actions, prospective products and product approvals, future performance or results of current and anticipated products, sales efforts, expenses and financial results. Forward-looking statements are not guarantees of future performance and they can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including, without limitation, those listed under “Risk Factors” in this Quarterly Report on Form 10-Q and under “Item 1. Business-Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2003. Except to fulfill our obligations under the federal securities laws, we undertake no obligation to update forward-looking statements to reflect events or circumstances after the date on which it is made.

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) with the company’s business overview to give you an understanding of the technology of our business and the direction in which our business and our product candidates are moving. This is followed by a discussion of the Critical Accounting Estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results. We then discuss our Results of Operations for the three and nine months ended September 30, 2004 compared to the same periods in 2003, separated by our functions. We then provide an analysis of changes in our balance sheet and cash flows, and discuss our financial commitments in the section entitled “Liquidity and Capital Resources.”

Business Overview

Sirna Therapeutics, Inc. (formerly known as Ribozyme Pharmaceuticals, Inc.), was previously engaged in research to engineer RNA-based molecules for therapeutic and diagnostic purposes. Until recently, Sirna (the Company) focused on developing therapeutics based on ribozymes (a type of RNA). In 2003, the Company discontinued its efforts in ribozymes and redirected its focus to the development of a new type of nucleic acid-based therapeutic based on RNA interference (RNAi). The Company is using its considerable expertise to design, stabilize, manufacture and deliver short interfering nucleic acids (siRNAs) that activate selectively the process of RNA interference, and is in research, preclinical and/or clinical development with product candidates in the following areas: Age-related Macular Degeneration (AMD), Hepatitis C Virus (HCV), and Huntington’s Disease (HD). The Company is also evaluating other disease targets and indications for the development of RNA interference-based therapeutics on its own and in collaboration with academic research institutions and commercial enterprises. In addition, the Company manufactures and sells oligonucleotides in order to generate revenue for the purpose of supporting its ongoing operations.

RNA Interference

RNA interference is an endogenous mechanism that generally relies on a sequence of double-stranded nucleic acid capable of reducing the expression of genes through the degradation of messenger

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RNA (mRNA) and viral RNA in a sequence-specific manner. We refer to such RNA molecules facilitating this process of RNAi as a short interfering RNA (siRNA). The RNAi mechanism induces the destruction of target RNA using naturally occurring cellular protein machinery.

Harnessing the natural phenomenon of RNAi through the production and targeted delivery of synthetic siRNAs holds potential for a new and important future class of drugs. Although there is widespread use of RNAi-based reagents for target validation, the development of RNAi-based pharmaceuticals for therapeutic uses to target disease is currently in an early stage of development.

Product Candidate Programs

The Company is seeking to develop a new class of drugs using siRNAs that address significant and unmet medical needs. Currently, we are in research, preclinical and clinical development with product candidates in the following areas:

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The Drug Discovery and Development Process

The new drug discovery and development process is generally considered a long (5 to 7 years or greater) and expensive (greater than $100 million) undertaking which is subject to many uncertainties and regulatory oversight. These generalized timelines and costs are estimates and as such involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from estimates. Research and development project costs, among others, include costs of salaries, benefits, clinical trial site costs, outside services, materials and supplies incurred to support the clinical programs. Indirect costs allocated to projects include facility and occupancy costs, license and royalty payments. The primary phases of new drug discovery and development include:

The most significant costs associated with clinical development are the Phase 3 trials, as they tend to be the longest and largest studies conducted during the drug development process. The FDA closely monitors the progress of each phase of clinical testing. The FDA may, at its discretion, re-evaluate, alter, suspend or terminate testing based upon the data accumulated to that point and the FDA’s assessment of the risk/benefit ratio to patients. If Phase 3 trials are successful, the final step in a drug approval timeline is submission of a New Drug Application (NDA) with the FDA. The NDA process may last several years.

In addition, development stage companies, like Sirna Therapeutics, often seek collaborations and/or partnerships with large, established pharmaceutical companies to assist in the cost and complexities of developing and marketing new drugs. At this time, the Company believes it may be too early to enter into such business arrangements as the full potential and value of its product candidate programs are unknown.

Intellectual Property

Protecting patents and other proprietary rights is crucial to developing our business. In addition to patents, we rely upon trade secrets, know-how and continuing technological innovations. As part of our overall intellectual property strategy, we selectively enter into agreements with third parties, such as academic institutions, either to license pre-existing technology or to support the development of new technologies. For example, in 2003 we entered into a worldwide licensing agreement with the University of

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Massachusetts (UMass) Medical School for its undivided interest in intellectual property relating to the seminal RNA interference technology covering siRNA for uses relating to human and veterinary therapeutic, prophylactic, diagnostic and health care applications. In June 2004, we entered into a worldwide exclusive license agreement with the University of Iowa Research Foundation for intellectual property relating to RNAi technology covering siRNA for targeting neurological disease indications, including Huntington’s Disease and Alzheimer’s Disease.

It is our policy to file patent applications when appropriate to protect technology, inventions and improvements that are considered important in the development of our business. We seek patent protection in the United States as well as in several key foreign countries. The following table summarizes the Company’s current intellectual property estate excluding ribozyme technology:

We believe our intellectual property holdings adequately enable the Company to pursue its business plans. We cannot however guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us or that such patents, if issued, will have scope sufficient to prevent competing products. In addition, the scope of our present or future patents may not be sufficiently broad to prevent competitive products. The Company, to the best of its ability, will defend its intellectual property estate from infringement. There is however inherent uncertainty in administrative proceedings and litigation relating to our patents that could cause us to incur substantial costs and delays in obtaining and enforcing our patents and other proprietary rights. The ultimate result of any patent litigation could be the loss of some or all protection for the patent involved. We may also decide to oppose or challenge third party patents. When prudent and for appropriate consideration, the Company is willing to out license its intellectual property. The manufacture, use or sale of our products may infringe on the patent rights of others. We may not have identified all United States and foreign patents and patent applications that pose a risk of infringement. We may be forced to in-license or litigate if an intellectual property dispute arises.

Licensing, Process Development and Pilot Manufacturing

In addition to our work with RNAi, we also have developed an extensive expertise in nucleic acid technologies. We intend to leverage our nucleic acid expertise through licensing, process development and pilot manufacturing opportunities. In July 2004, we entered into an exclusive four-year process development and manufacturing alliance with Archemix Corp. (Archemix), a privately held company. Archemix is currently developing ARC183, an anti-thrombin aptamer. Pursuant to the agreement, we will manufacture all of Archemix’s aptamers through Phase 2a clinical development. In addition, in 2003 we

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completed a collaboration with Geron Corporation, a biopharmaceutical company focused on oncology and regenerative medicine. Our first program, which began in 2001, was a process development collaboration with Geron for GRN163, a nucleic acid-based telomerase agonist for cancer. We successfully completed the program and renewed the agreement to manufacture GMP clinical-grade GRN163 for Geron’s Phase 1 clinical study. Delivery under the agreement was completed in June 2003.

Critical Accounting Estimates

The methods, estimates and judgments we use in applying our accounting policies may have an impact on the results we report in our financial statements, which we discuss under the heading “Results of Operations” following this section of our MD&A. Some of our accounting policies require us to make subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

Revenue Recognition

Revenues recorded from our collaborative agreements may consist of: research revenue, contract manufacturing revenue, milestone revenue and license or royalty revenue. We generally recognize revenue when we have satisfied all contractual obligations and we are reasonably assured of collecting the resulting receivable. Given the nature of our business and the infrastructure that we need to support, we often enter into collaborations where we receive nonrefundable up-front payments for prior or future expenditures. In compliance with current accounting rules, we recognize revenue related to up-front payments over the period of the contractual arrangements as we satisfy our performance obligations. Occasionally, we are required to estimate the period of a contractual arrangement or our performance obligation when the information is not clearly defined in the agreements we enter into. Should different estimates prevail, revenue recognized could be different. As of September 30, 2004, we evaluated our estimates for the periods of contractual arrangements and determined that our estimates are appropriate.

Patent Expenses

Due to the early stage of development of RNAi technology, we expense all legal costs directly incurred in connection with patent applications or patents until we determine that the estimated recoverability of such costs is sufficiently probable, at which time such costs are capitalized. If capitalized, such deferred patent costs are then amortized over the estimated economic life of the patent on a straight-line basis. We review all capitalized patent costs on a quarterly basis and, if we decide to abandon a patent or a patent application or determine that an issued patent or a patent application no longer has significant economic value, the unamortized balance in deferred patent costs related to that patent or patent application is immediately expensed.

In 2003, we changed our business strategy which focused on development of ribozyme-based therapeutics and diagnostics to developing a new class of nucleic acid-based therapeutics based on RNAi. As a result of finalizing this change in strategic direction during the quarter ended June 30, 2003, we undertook a detailed review of our existing patent portfolio. Based on this review, we wrote off $447,000 of patent costs related to patents or patents that we abandoned in the second quarter of 2003. In addition, because we are no longer pursuing the development of ribozymes internally, we expensed approximately $4.9 million of capitalized patent costs related to the ribozyme technology. This expense is reflected as a separate line item in our statement of operations for the year ended December 31, 2003. Legal expenses related to patents are included in general and administrative expenses.

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Results of Operations

Three and Nine Months Ended September 30, 2004 and 2003

Revenues

The following table sets forth information on revenues earned from our collaborations for the periods indicated (in thousands):

Generally, revenue fluctuations result from changes in the number of funded research projects as well as the timing and completion of contractual obligations. Our revenues for the three and nine months ended September 30, 2004 were $84,000 and $855,000, respectively, a decrease of $199,000 and $2.9 million compared to the same periods in 2003. The third quarter decrease is a result of our change in business strategy in 2003 and the subsequent termination of ribozyme-related programs and the associated revenues from Chiron, Fujirebio and atugen AG. Offsetting our loss in revenues in the ribozyme programs are revenues related to our Archemix manufacturing collaboration. Archemix revenues were $16,000 and $714,000 for the three and nine months ended September 30, 2004. In addition, during the first quarter of 2004, we entered into an eighteen-month collaboration with Lilly to jointly investigate our proprietary modified siRNAs against specific oncology targets provided by Lilly. Revenues recognized during the first half of 2004 are from Lilly’s access to a non-exclusive research license to certain of our technologies in oncology during the eighteen-month collaboration. The decrease of revenues year to date is primarily due to the completion of our process development and manufacturing scale-up for Geron’s anti-cancer drug, GRN163 in June 2003. During the second quarter of 2003, we completed our manufacturing contract with Geron, whereby we recognized $2.7 million upon the release of the product. We are actively pursuing new partnership and collaboration opportunities.

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Expenses

Research and Development

The following table sets forth information on research and development expenses for the periods indicated (in thousands):

Our research and development expenses for the three and nine months ended September 30, 2004 were $6.1 million and $15.9 million, respectively, a decrease of $3.9 million and $1.8 million compared to the same periods in 2003. The decrease is primarily due to the acquisition of a license to the University of Massachusetts’ rights in RNAi technology for $6.0 million in September 2003. Under the terms of the license agreement, we paid $3.0 million in cash and issued 579,150 shares of our common stock, valued at $3.0 million, to its Medical School in exchange for the license. The purchase price was expensed as in-process research and development due to the uncertainty of both the technological feasibility and alternative future uses of the technology as of the acquisition date. The $6.0 million decrease was offset by increases in 2004 due to the scale up of our research and outside services costs as we progress in our preclinical activities for Sirna-027, our RNAi drug candidate targeting AMD.

General and Administrative

The following table sets forth information on general and administrative expenses for the periods indicated (in thousands):

General and administrative expenses for the three and nine months ended September 30, 2004 were $1.8 million and $5.1 million, respectively, an increase of $582,000 and $819,000 for the same periods in 2003. The increase in 2004 compared to 2003 is primarily due to increased activity in patent expense and related applications in RNAi technology. Until we can determine that the estimated recoverability of patent

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costs is sufficiently probable, we expense all legal costs directly incurred in connection with patent applications or patents. Increases in other costs for the three and nine month periods compared to 2003 are due to the scale-up of our business development efforts.

Interest Income, Expense and Other Expense

Interest income was $126,000 and $346,000 for the three and nine months ended September 30, 2004, respectively, compared to $101,000 and $312,000 for the same periods in 2003. The fluctuations are due to changes in average balances in our cash, cash equivalents and securities available-for-sale. Interest expense was $75,000 and $259,000 for the three and nine month periods ended September 30, 2004, respectively, compared to $105,000 and $313,000 during the same periods in 2003. The reduction in interest expense is a result of paying off a $1.0 million loan that we carried through a credit institution in February 2004.

Equity in Loss of Unconsolidated Affiliate - Medizyme

Equity in loss of unconsolidated affiliate was zero for the three and nine months ended September 30, 2004, compared to zero and $209,000 for the same periods in 2003. The losses recognized in 2003 were our share of Medizyme’s net losses. Medizyme was a joint venture with Elan Corporation which terminated in April 2003, thus accounting for the decrease in losses from equity in unconsolidated subsidiaries in 2004 compared to 2003. As of September 30, 2004, all material expenses incurred with Medizyme have been recognized.

Liquidity and Capital Resources

We had cash, cash equivalents and securities available-for-sale of $35.1 million at September 30, 2004 compared with $36.6 million at December 31, 2003. The $1.5 million decrease in cash, cash equivalents and securities available-for-sale is primarily the result of $17.5 million received in net proceeds from the private placement of common stock; $17.3 million (net of $855,000 in revenues) used for operations; $555,000 used for investments in equipment, leasehold improvements and patents; and $1.2 million paid for debt obligations.

We invest our securities available-for-sale in interest bearing, investment-grade securities.

Accounts receivable at September 30, 2004 were $12,000 compared to $156,000 at December 31, 2003. Accounts receivable at September 30, 2004 were primarily due from Archemix under our manufacturing agreement.

Total additions for property, plant and equipment for the nine months ended September 30, 2004 were $339,000. In February 2004, we paid off a loan of $1.0 million that we carried through a credit institution. We anticipate future property, plant and equipment needs to be financed either through credit facilities, equity sales or revenues, all of which are yet to be determined.

Schering AG - At September 30, 2004, we had an outstanding convertible loan, including accrued interest, of $3.06 million from Schering AG. Accrued interest is paid on a quarterly basis. The $3.0 million principal is due in January 2005.

Going Concern - We have financed our operations through sales of equity securities in public offerings, private placements of preferred and common stock, funds received under our collaborative agreements and financing under equipment and tenant improvement loans. We anticipate that, with the consummation of our private placements in April 2003 and May 2004, our existing financial resources and

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expected revenues from collaborations, our cash should be sufficient to meet our anticipated operating and capital requirements through 2005. We expect to incur substantial additional costs, including costs related to:

We will continue to need to raise additional capital through any or all of the following: public or private financing, merger or acquisition, new collaborative relationships, new credit facilities and/or other sources. If we raise funds by issuing and selling more stock, your ownership in us will be diluted. We may grant future investors rights superior to those of existing stockholders. In addition, we do not know if additional funding will be available or available on acceptable terms when needed.

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Risk Factors

Risks Relating to our Business, Industry and Common Stock

We are a biotechnology company in the early stage of development and have only a limited operating history for you to review in evaluating our current business and its prospects.

Our focus is directed towards RNAi technology, which is in an early stage of development and will require substantial further testing before we can begin any clinical development of RNA-based therapeutic product candidates. There can be no assurance that our technologies will enable us to discover and develop therapeutic products.

All of our product candidates are in early stages of development, have never generated any sales and require extensive testing before commercialization. Our RNAi-based drugs, which are the focus of our business, will require more than five years to bring to market, and may never reach the market. You must consider, based on our limited history, our ability to:

We have a history of losses, expect future losses, a continuing need to raise additional capital, and cannot assure you that we will ever become or remain profitable.

We have incurred significant losses and have had negative cash flows from operations since inception. To date, we have dedicated most of our financial resources to research and development and general and administrative expenses. We have funded our activities primarily from sales of our stock, revenues we receive under contract manufacturing of oligonucleotides, research and development agreements, and lines of credit. We will continue to need to raise additional capital through any or all of the following: public or private financing, merger or acquisition, new collaborative relationships, new credit facilities and/or other sources. We do not know if additional funding will be available or available on acceptable terms when needed.

As of September 30, 2004, our accumulated deficit was approximately $244.3 million. We expect that the ability to use our net operating loss as a tax benefit will be significantly restricted in the future as a result of the change of control associated with the 2003 private placement transaction with the Sprout Group, Venrock Associates, Oxford Bioscience Partners IV, TVM V Life Science Ventures GmbH & Co. KG and Granite Global Ventures (collectively, the “Investors”).

We expect to incur losses for at least the next several years because we plan to spend substantial amounts on research and development of our product candidates, including preclinical studies and clinical trials.

There is inherent uncertainty in administrative proceedings and litigation relating to our patents that could cause us to incur substantial costs and delays in obtaining and enforcing our patents and other proprietary rights. The ultimate result of any patent litigation could be the loss of some or all protection for the patent involved. We may also decide to oppose or challenge third party patents.

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We have filed patent applications on various aspects of RNAi technology that have not yet been approved. We cannot guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us or that such patents, if issued, will have scope sufficient to prevent competing products. In addition, the scope of our present or future patents may not be sufficiently broad to prevent competitive products. We have received issuance of some additional patent applications covering various aspects of basic RNA and other oligonucleotide technology, and we have filed patent applications for other technology improvements and modifications that have not yet been approved.

We are involved in a re-examination proceeding involving one of our patents in the United States that relates to oligonucleotides. Additionally, we have filed documents in opposition to two RNAi-related patents granted to a potential competitor in Europe.

Additionally, we cannot be certain that the named inventors or assignees of subject matter claimed by our owned or licensed patents or patent applications were the first to invent or the first to file patent applications or are proper assignees for these inventions.

The manufacture, use or sale of our products may infringe on the patent rights of others. We may not have identified all United States and foreign patents and patent applications that pose a risk of infringement. We may be forced to in-license or litigate if an intellectual property dispute arises.

If we infringe or are alleged to have infringed another party’s patent rights, we may be required to seek a license, defend an infringement action or challenge the validity of the patents in court. Patent litigation is costly and time consuming. We may not have sufficient resources to bring these actions to a successful conclusion. In addition, if we do not obtain a license, do not successfully defend an infringement action or are unable to have infringed patents declared invalid, we may:

In addition, we regularly enter into agreements to license technologies and patent rights. Should we fail to comply with the terms of those license agreements, including payment of any required maintenance fees or royalties, or should the licensors fail to maintain their licensed interest in the licensed patents, we could lose the rights to those technologies and patents.

We are aware of a number of issued patents and patent applications that are owned by third parties and that purport to cover chemically modified oligonucleotides as well as their manufacture and use. We have investigated the breadth and validity of these patents to determine their impact upon the company’s programs in the field of RNAi. Based on our review of these patents and advice of outside patent counsel, we believe that our technology does not infringe any valid claims of such patents and that these patents are not likely to impede the advancement of the company’s programs. There can be no assurance, however, that third parties will not assert infringement claims against the company’s programs with respect to these patents or otherwise, or that any such assertions will not result in costly litigation or require the company to obtain a license to intellectual property rights of such parties. There can be no assurance that any such licenses would be available on terms acceptable to us, if at all. Parties making such claims may be able to obtain injunctive relief that could effectively block the company’s ability to further develop or commercialize our products in the United States and abroad and could result in the award of substantial

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damages. Defense of any lawsuit or failure to obtain any such license could substantially harm the company. Litigation, regardless of outcome, could result in substantial cost to and a diversion of efforts by the company.

To develop, market or sell RNAi-based drugs, we may need to find partners for collaboration.

Engaging corporate partners and other third parties to help develop, manufacture and market our RNAi-based products may be a requirement of a successful business strategy. Our partnership with Lilly is focused on developing novel RNAi therapeutics in oncology. During the eighteen-month collaboration, the companies will jointly investigate Sirna’s proprietary modified small interfering RNAs against Lilly’s specific oncology targets. There can be no assurances that Lilly will extend the collaboration beyond the eighteen-month period or that we will be able to engage other partners.

Generally, if a partner were to terminate its funding of the development of a particular product candidate from our collaboration, we may not have the right or resources to continue development of that product candidate on our own. Similarly, if we are unable to attract partners for particular product candidates, then we may be unable to develop those candidates.

In addition, there are many aspects of our collaborations that have been and will continue to be outside of our control, including:

We currently lack sales and marketing experience and may need to rely upon third parties to market our products which will result in a loss of control over the marketing process. These third parties, if engaged, may have significant control over important aspects of the commercialization of our products, including market identification, marketing methods, pricing, sales force recruitment and management and promotional activities. We may be unable to control the actions of these third parties. We may be unable to make or maintain arrangements with third parties to perform these activities on favorable terms.

Because we must obtain regulatory approval to market our products in the United States and foreign jurisdictions, we cannot predict whether or when we will be permitted to commercialize our products.

The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether regulatory clearance will be obtained for any product we develop. A pharmaceutical product cannot be marketed in the United States until it has completed rigorous preclinical testing and clinical trials and an extensive regulatory clearance process implemented by the Food and Drug Administration, the FDA. Satisfaction of regulatory requirements typically takes many years, depends upon the type, complexity and novelty of the product, and requires the expenditure of substantial resources. Of particular significance are the requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use.

Before commencing clinical trials in human beings, we must submit and receive approval from the FDA for an investigational new drug, or IND. In addition to the FDA regulations, clinical trials are subject to oversight by institutional review boards at the universities or research institutions where we plan to carry out our clinical trials. The clinical trials:

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Before receiving FDA clearance to market a product, we must demonstrate that the product is safe and effective on the patient population that would be treated. Data obtained from preclinical and clinical activities are susceptible to varying interpretations that could delay, limit or prevent regulatory clearances. In addition, delays or rejections may be encountered based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review.

Failure to comply with applicable FDA or other applicable regulatory requirements may result in criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory action against our potential products or us. Additionally, we have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval.

If regulatory clearance for a product is granted, this clearance will be limited to those disease states and conditions for which the product is demonstrated through clinical trials to be safe and efficacious. We cannot ensure that any compound developed by us, alone or with others, will prove to be safe and efficacious in clinical trials and will meet all the applicable regulatory requirements needed to receive marketing clearance.

Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process includes all of the risks associated with FDA clearance described above.

Our products require materials that may not be readily available or cost effective, which may reduce our competitiveness or reduce our profitability.

The products we are developing are new chemical entities that are not yet available in commercial quantities. Raw materials necessary for the manufacture of our products may not be available in sufficient quantities or at a reasonable cost in the future. Therefore, our products may not be available at a reasonable cost in the future.

Disclosure of our trade secrets could reduce our competitiveness.

Because trade secrets and other unpatented proprietary information are critical to our business, we attempt to protect our trade secrets by entering into confidentiality agreements with third parties, employees and consultants. However, these agreements can be breached and, if they are, there may not be an adequate remedy available to us. In addition, third parties may independently discover trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights.

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Our success may depend on third party reimbursement of patients’ costs for our products that could result in price pressure or reduced demand for our products.

Our ability to market products successfully will depend in part on the extent to which various third parties are willing to reimburse patients for the costs of our products and related treatments. These third parties include government authorities, private health insurers and other organizations, such as health maintenance organizations. Third party payors are increasingly challenging the prices charged for medical products and services. Accordingly, if less costly drugs are available, third party payors may not authorize or may limit reimbursement for our products, even if our products are safer or more effective than the alternatives. In addition, the trend toward managed healthcare and government insurance programs could result in lower prices and reduced demand for our products. Cost containment measures instituted by healthcare providers and any general healthcare reform could affect our ability to sell our products and may have a material adverse effect on us. We cannot predict the effect of future legislation or regulation concerning the healthcare industry and third party coverage and reimbursement on our business.

Our common stock has limited trading volume and a history of volatility, which could impair your investment.

You may be unable to sell securities you purchase from us at the time or price desired. The market price of our common stock has fluctuated dramatically in recent years. The trading price of our common stock may continue to fluctuate substantially due to:

These fluctuations are not necessarily related to our operating performance. As a result, the value of your shares could vary significantly from time to time. The historical trading volume of our common stock has been limited.

A small number of investors can control the company.

As of September 30, 2004 the Investors in our April 2003 private placement collectively own approximately 68.2% (after giving effect to the exercise of their warrants issued in connection with the private placement, but prior to giving effect to exercise of any stock options) of our outstanding common stock. In addition, some of the Investors currently have the right to select four of seven members of our Board of Directors. In connection with the private placement transaction, our stockholders agreed to amend our certificate of incorporation to permit stockholder action to be taken by written consent in addition to by means of an actual meeting. As a result, our Investors (if they acted together) are now able to take any action

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without the need for a stockholders’ meeting. For example, if our Investors were to act in concert, they could decide to take us private, to sell some or all of our assets, or to effect a merger without holding a stockholders’ meeting. If the Investors were to act in concert, they would have sufficient voting power to affect these types of transactions, although they have not indicated any present intent to do so.

Both our charter documents and Delaware law have anti-takeover provisions that may discourage transactions involving actual or potential changes of control at premium prices.

Our corporate documents and provisions of Delaware law applicable to us include provisions that discourage change of control transactions. For example, our charter documents authorize our board of directors to issue up to 5,000,000 shares of preferred stock without stockholder approval and to set the rights, preferences and other designations of preferred stock, including the voting rights, at its discretion.

In addition, we are subject to provisions of Delaware General Corporation Law that may make some business combinations more difficult. As a result, transactions that otherwise could involve a premium over prevailing market prices to holders of our common stock may be discouraged or may be more difficult for us to effect as compared to companies organized in other jurisdictions.

The personal liability of our directors is limited.

Our charter documents limit the liability of our directors for breach of their fiduciary duty or duty of care to our company. The effect is to eliminate liability of directors for monetary damages arising out of negligent or grossly negligent conduct. However, liability of directors under the federal securities laws will not be affected.

Any of our stockholders would be able to institute an action against a director for monetary damages only if he, she or it can show a breach of the individual director’s duty of loyalty, a failure to act in good faith, intentional misconduct, a knowing violation of the law, an improper personal benefit, or an illegal dividend or stock purchase, and not for such director’s negligence or gross negligence in satisfying his duty of care.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to changes in interest rates primarily from our investments in certain short-term investments. We invest our excess cash in highly liquid short-term investments that are typically held for the duration of the term of the respective instrument. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments to manage exposure to interest rate changes. Accordingly, we believe that, while the securities we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we have carried out an evaluation, under the supervision and with the participation of our principal executive officer and our principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon the evaluation, our principal executive officer and principal financial officer concluded as of the end of the period covered by this report that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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Exhibit Index

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