ITEM 1. Business
Company Overview
We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes and other central nervous system disorders. Functional Somatic Syndromes refer to several related syndromes characterized more by symptoms, suffering and disability than by disease-specific abnormalities that are found upon physical examination and include many overlapping pain and psychiatric conditions such as Fibromyalgia Syndrome, or FMS, irritable bowel syndrome, non-cardiac chest pain and interstitial cystitis, or chronic pelvic pain. Our goal is to be the first to commercialize a product approved in the United States for the treatment of FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes. In January 2004, we entered into a collaboration agreement with Forest Laboratories, Inc., a leading marketer of central nervous system drugs with a strong franchise in the primary care and psychiatric markets, for the development and marketing of milnacipran. We are currently running the first Phase III trial for milnacipran, which was commenced in October 2003. Enrollment in this trial was completed in December 2004, with results expected to be available in the Fall of 2005. In October 2004, Forest Laboratories initiated the second Phase III trial evaluating milnacipran for the treatment of FMS. These two Phase III trials and any additional studies needed for regulatory approval could possibly be completed in 2006 and, if successful, a New Drug Application, or NDA, for FMS could possibly be submitted later in that year at the earliest.
We completed a Phase II trial evaluating milnacipran for the treatment of FMS in the Fall of 2002. The Phase II trial was a three-month, randomized, placebo-controlled study involving 14 sites and 125 FMS patients who were randomized to either milnacipran treatment or placebo. In this clinical trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS. No unexpected safety concerns arose from this trial and there were no serious adverse events.
We obtained an exclusive license for milnacipran from Pierre Fabre Medicament in 2001. Milnacipran has been marketed outside of the United States since 1997 as an antidepressant and has been used by over 3,000,000 patients worldwide. We have paid Pierre Fabre a total of $2.5 million, including upfront payments of $1.5 million in connection with the execution of the original license agreement in 2001 and a $1.0 million milestone payment in September 2003, and issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock in connection with an amendment to the agreement with Pierre Fabre. Additional payments to Pierre Fabre of up to a total of $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones. Under our agreement with Forest Laboratories, we sublicensed our rights to milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. Additionally, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approval, as well as a specified number of our employees. However, in light of
the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with these discussions, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, while we have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls.
We are continuing to evaluate various potential strategic transactions, including the acquisitions of products, technologies and companies and other alternatives that we believe may enhance stockholder value.
Fibromyalgia Syndrome Background
FMS is a chronic and debilitating condition characterized by widespread pain and stiffness throughout the body, accompanied by severe fatigue, insomnia and mood symptoms. Unlike arthritis and other debilitating rheumatological disorders, FMS produces serious and chronic pain that is not the result of inflammation. Pain associated with FMS is of a “head-to-toe” nature, and is described as a diffuse aching or burning. Pain can vary in severity and location from day to day and, in some people, it can be so intense that it interferes with the performance of even simple tasks, while in others it may cause only moderate, ongoing discomfort. By some measures, patients with FMS have at least comparable disability, more pain and lower quality of life than patients with rheumatoid arthritis or osteoarthritis. Although FMS has been medically recognized for many years, it was only in 1990 that medical specialists agreed on the signs and symptoms that must be present to make the diagnosis. The American College of Rheumatology, or ACR, diagnosis criteria for FMS include a history of widespread and longstanding pain, as measured by pain upon application of pressure in 11 of 18 designated tender points. Specialists in the field of FMS have concluded that FMS is a result of a generalized and heightened perception of sensory stimuli resulting from abnormal pain processing within the central nervous system, and in most instances, is triggered by physical trauma, emotional stress or infection.
As reported by the ACR, FMS affects an estimated 2-4% of the population worldwide, including an estimated 6-12 million patients in the United States. A recent scientific article suggests that because the ACR criteria were designed for clinical research purposes and therefore limit the FMS diagnosis, the 2-4% prevalence may under-represent the actual prevalence of chronic widespread pain in the population. Most FMS patients are middle-aged women, although the ailment can strike children, the elderly and men. According to the ACR, FMS is diagnosed four times more frequently in women than in men and once symptoms appear, most patients can expect to suffer the condition throughout their entire life. As a result of the diversity of symptoms, there are numerous physician specialties involved in the treatment and management of FMS. FMS is most often treated in the primary care setting. The leading specialty group treating FMS patients is rheumatologists, for whom FMS is the second most common diagnosis made after osteoarthritis.
Despite the high prevalence and severity of this syndrome, there are no treatments specifically approved for FMS in the United States or elsewhere. Current treatments consist of a regimen that includes medication to diminish pain and improve sleep, exercise programs that stretch muscles and improve cardiovascular fitness and physical therapy and relaxation techniques to ease muscle tension. Antidepressants are often prescribed for FMS patients, as low doses of these medications appear to relieve
pain associated with FMS. Tricyclic antidepressants, or TCAs, a class of compounds that are known to be effective analgesics, or pain-reducing drugs, in multiple chronic pain conditions, including FMS, are currently viewed as the drugs of choice in treating FMS. TCAs act by increasing serotonin and norepinephrine. Serotonin and norepinephrine are chemicals in the brain that are thought to be involved in controlling “centrally mediated pain”-that is, pain that originates at the central nervous system level, as opposed to pain that is caused by an injury, such as a cut or an arthritic swollen joint. Some TCAs are distinguished from most other antidepressants, specifically from the selective serotonin reuptake inhibitors, or SSRIs, and the serotonin norepinephrine reuptake inhibitors, or SNRIs, because some TCAs preferentially block the reuptake of norepinephrine as compared to serotonin, which means that these TCAs increase the level of norepinephrine more than they do the serotonin levels. We believe that these characteristics of TCAs make them more suited to the treatment of the pain associated with FMS than SSRIs and SNRIs. TCAs, however, are severely limited in their use for the treatment of FMS because they have been linked with side effects such as arrhythmias, the risk of fatal overdose, as well as contributing to weight gain and drowsiness, which is particularly problematic because individuals with FMS are already suffering from fatigue.
Milnacipran for the Treatment of FMS
Milnacipran
We are developing milnacipran for the treatment of FMS. Milnacipran is the first of a new class of agents known as norepinephrine serotonin reuptake inhibitors, or NSRIs, which increase the level of norepinephrine more than they do serotonin. While milnacipran is similar to TCAs with regard to the relative ratio of norepinephrine and serotonin activity, milnacipran appears to lack the side effects associated with TCAs, as it does not interact with several classes of receptors that are responsible for many of the adverse effects of TCAs. Therefore, we believe that milnacipran may have efficacy similar to TCAs in treating FMS and related chronic pain conditions, without causing the side effects that limit the prescribing of TCAs by physicians, and compliance by patients. Milnacipran is approved for the treatment of depression in 32 countries and is currently a leading antidepressant in Japan. Since its commercial launch in 1997, milnacipran has been used by over 3,000,000 patients worldwide, with side effects typically limited to transient and mild nausea and a slight increase in heart rate, as well as the potential for urinary retention in older men with an enlarged prostate. Milnacipran has not been approved in the United States for any indication, and we are the first company conducting clinical trials of milnacipran in the United States for FMS. As a result of the favorable side effect profile of milnacipran and its ability to increase the level of norepinephrine more than serotonin in the brain, we believe that milnacipran may play a significant role in the treatment of FMS.
Milnacipran Development Status
Phase II Results
We completed a Phase II trial evaluating milnacipran for the treatment of FMS in the Fall of 2002. The Phase II trial was a three-month, randomized, placebo-controlled study involving 14 sites and 125 FMS patients who were randomized to either milnacipran treatment or placebo. The study evaluated the overall analgesic efficacy and safety of milnacipran in this population of FMS patients, with a primary endpoint based on improvement in patient-reported pain. Electronic diaries were provided to all patients for the purpose of recording daily pain assessments in real time. We believe that performing daily pain assessments using electronic diaries reduces bias involved with asking individuals to recall symptoms over time and improves compliance by prompting and time-date stamping each patient response. The pain measures obtained from the electronic diaries were chosen to be the primary variable for the measurement of pain improvement. Secondary objectives included assessment of the impact of dosing strategy (twice daily dosing versus once daily) and the impact of milnacipran on other symptoms of FMS including fatigue,
mood, physical function and sleep disturbances. Based on tolerability, patients were allowed to double their dose every week, up to a maximum of 200 mg of milnacipran daily. In our Phase II trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS. Thirty-seven percent of milnacipran-treated patients randomized to the twice a day dosing group reported at least a 50% reduction in pain intensity, which means that their reported pain was half as intense as it was at the beginning of the study, compared to 14% of patients in the placebo group. In this analysis, 51 patients received milnacipran and 28 patients received a placebo. The reduction in pain intensity was statistically significant, with a p-value of 0.0395. A p-value is a statistical measure of probability of drawing an erroneous conclusion from an experimental result. A p-value of less than or equal to 0.05 is generally considered to signify a statistically significant result, which means a result is unlikely to occur by chance. Further, 75% of all milnacipran-treated patients reported an impression of overall improvement compared to 38% in the placebo group. In this analysis, 68 patients received milnacipran and 21 patients received a placebo. This reported impression of overall improvement was also statistically significant, with a p-value of 0.003. Twice daily milnacipran had significantly better analgesic properties than once daily milnacipran, although other outcomes (e.g. fatigue, mood, patient’s global impression) were equally impacted by the two dosing regimens. No unexpected safety concerns arose from this clinical trial and there were no serious adverse events. Milnacipran was generally well-tolerated, especially with twice daily dosing. The most common dose-related side effect reported by patients was nausea, particularly early in the study, as well as a slight increase in heart rate. Most adverse events were mild to moderate in intensity and only lasted for a short time.
Phase III Trials
We commenced the first of our planned Phase III trials in October 2003. We and Forest commenced the second of our planned Phase III trials in October 2004. To prepare for our Phase III clinical program, and before commencing the first pivotal clinical trial, we completed a special protocol assessment with the FDA. In the special protocol assessment process, the FDA reviews the design and size of a proposed Phase III program and provides comments regarding the adequacy of the clinical trial design to support a claim of effectiveness in an approvable NDA. The FDA’s comments are binding on its review decision, except in limited circumstances, such as when a substantial scientific issue essential to determining the safety or effectiveness of a drug is identified after the Phase III program commences. In response to our Phase II results, and based on modeling of the outcome measures used in our Phase II trial, we have mutually agreed with the FDA on a Phase III program. As generally is required by the FDA, two positive pivotal trials are required for an NDA approval of milnacipran for the treatment of FMS. Both of the required trials are similar in design to the Phase II trial-they require that participants in the trial cease taking any drugs they are taking for FMS, have virtually identical inclusion and exclusion criteria, will rely on the use of the electronic diary to assess pain and are utilizing qualitative assessment methodologies. We plan on enrolling over 1,000 patients in total in our first two Phase III trials. Per the stipulations in the special protocol assessment, the first pivotal trial will include a six-month evaluation phase once a patient has reached his or her stable treatment dose. The second trial could have an evaluation phase as short as three-months once a patient has reached his or her stable dose. In these clinical trials, two milnacipran doses will be evaluated (200 mg, administered 100 mg twice daily, as well as a lower dose, also administered twice daily), and the endpoint will be a composite responder analysis. This new endpoint is a composite incorporating pain, the patient’s global impression of change and physical function, which means the patient’s ability to perform functions of daily living. As part of the Phase III program, we also need to evaluate patients for a time period consistent with the minimum safety guidelines of the International Conference on Harmonization of Technical Requirements for the Registration of Pharmaceuticals for Human Use, or ICH. Specifically, these ICH guidelines require that we evaluate 300 patients on the 200 mg dose of milnacipran for six months and 100 patients on the 200 mg dose of milnacipran for one year. The entire Phase III program could possibly be completed in 2006 and, if
successful, an NDA for FMS could possibly be submitted later in that year at the earliest. We do not believe that patient enrollment will be a time-limiting factor due to the current lack of approved treatments for FMS, and our historical FMS enrollment rates have met our expectations.
Licenses and Collaborations
Pierre Fabre Agreements
In January 2004, we amended and restated our existing license agreement with Pierre Fabre. Our license agreement with Pierre Fabre provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada. We are obligated to pay Pierre Fabre 5% of any upfront and milestone payments received from Forest Laboratories as a sublicense fee. After a total of $7.5 million has been paid, any additional sublicense fees are credited against any subsequent milestone and royalty payments owed by us to Pierre Fabre. If not used, these credits are carried forward to subsequent years. We also are obligated to pay Pierre Fabre up to $4.5 million in the aggregate upon achievement of defined clinical and regulatory objectives. Forest Laboratories assumed our obligation to pay royalties to Pierre Fabre and the transfer price for the active ingredient supplied by Pierre Fabre. Pierre Fabre retains the right to sell products in indications developed by us outside the United States and Canada, and will pay us a royalty based on net sales for such products. The license agreement also provides Pierre Fabre with certain rights to obtain a license outside the United States and Canada for new formulations and new salts developed by us.
The agreement is effective until the later of the expiration of the last-to-expire of certain patents held by Pierre Fabre relating to the development of milnacipran, or ten years after the first commercial sale of a licensed product, unless terminated earlier. Each party has the right to terminate the agreement upon 90 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if such breach is not cured within 90 days following such written notice. Additionally, Pierre Fabre has the right to terminate the agreement upon 90 days’ written notice if (i) we terminate all development activities, unless the termination of activities is subject to cure within 12 months and we are using commercially reasonable efforts to cure the termination of activities, (ii) we challenge the Pierre Fabre patents and (iii) we effect a change in control in which a third party acquiror controls an SNRI product and certain provisions of the agreement would be breached as a result of such SNRI product, and the breach is not cured within a specified time period.
In addition, in January 2004, we entered into a supply agreement with Pierre Fabre. If any product is commercialized under the license agreement, Pierre Fabre will have the exclusive right to manufacture the active ingredients used in the commercial product, and we will pay Pierre Fabre a transfer price and royalties based on net sales. Forest Laboratories has assumed both of these financial obligations. Our supply agreement with Pierre Fabre may be terminated for cause either by us or by Pierre Fabre upon 90 days’ prior written notice to the other party upon a material breach of the agreement if the breach is not cured within 90 days following the written notice. In addition, Pierre Fabre may elect to terminate the agreement if we effect a change in control under specified circumstances.
Forest Laboratories Agreement
In January 2004, we entered into a collaboration agreement with Forest Laboratories for the development and marketing of milnacipran. We selected Forest Laboratories as our development and marketing collaborator based in part on its strong franchise in central nervous system drugs and in the primary care and psychiatric markets. Under our agreement with Forest Laboratories, we sublicensed our exclusive rights to develop and commercialize milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has an option for a specified time period to acquire an exclusive license from us in the United States, and potentially
Canada, to any compounds developed under our agreement with Collegium Pharmaceutical, Inc. Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals, as well as a certain number of our employees. However, in light of the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with these discussions, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, and we will have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls. We share decision making authority with Forest Laboratories, through the joint development committee, with respect to the research, development and marketing of milnacipran. In the event that the joint development committee is unable to resolve any dispute, other than any marketing related issue, Forest Laboratories and we must jointly resolve such issue. With respect to any marketing related issue, Forest Laboratories has the final decision making authority. Under our agreement with Forest Laboratories and our agreement with Pierre Fabre, each party agreed to certain limitations on the development of products for FMS and on the development of SNRI products.
Under our agreement with Forest Laboratories, we received an upfront payment of $25.0 million, of which $1.25 million was paid to Pierre Fabre as a sublicense fee. The total upfront and milestone payments to us under the agreement could be approximately $205.0 million related to the development of milnacipran for the treatment of FMS, a large portion of which will depend upon achieving certain sales of milnacipran and an additional $45.0 million in the event that we and Forest Laboratories develop other indications for milnacipran, as well as potential royalty payments based on sales of licensed product under this agreement. In addition, Forest Laboratories assumed the royalty payments due to Pierre Fabre and the transfer price for the active ingredient used in milnacipran. The agreement with Forest Laboratories extends until the later of (i) the expiration of the last to expire of the applicable patents, (ii) 10 years after the first commercial sale of a product under the agreement or (iii) the last commercial sale of a generic product, unless terminated earlier. Each party has the right to terminate the agreement upon prior written notice of the bankruptcy or dissolution of the other party, or a breach of any material provision of the agreement if the breach has not been cured within the required time period following the written notice. Forest Laboratories may also terminate our agreement upon an agreed notice period in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of an NDA or to result in labeling or indications that would have a significant adverse affect on the marketing of any product developed under the agreement.
Collegium Agreement
In August 2002, we entered into a reformulation and new product agreement with Collegium pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. Collegium is led by a management team with significant expertise in developing novel formulations of currently marketed or soon-to-be marketed products for both the brand and generic industries. In January 2004, we exercised our option to acquire an exclusive license to technology developed under this agreement. In the event we commercialize any of the reformulations or new products developed under our agreement with Collegium, we will be obligated to pay Collegium milestone payments and royalty payments. The agreement with Collegium is effective until the expiration of the last-to-expire
of the issued patents, if any, unless terminated earlier. Each party has the right to terminate the agreement upon 60 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if the breach has not been cured within the 60-day period following the written notice.
Other Potential Uses of Milnacipran
We also believe that milnacipran may be effective in the treatment of other Functional Somatic Syndromes, such as irritable bowel syndrome, or IBS. With our development and marketing partner Forest Laboratories, we may in the future investigate the use of milnacipran in the treatment of IBS or other disorders. Should we and Forest Laboratories choose to pursue additional indications beyond FMS and obtain FDA approval for such indications, we could receive up to an additional $45 million in milestone payments. Since we are entitled to royalty payments based on sales of any licensed product under the agreement with Forest Laboratories, we would receive royalty payments for any additional indications. The decision regarding which, if any, additional indications are pursued, is one that we make together with Forest Laboratories, through the joint development committee. Such decisions relate to the research and development of milnacipran, so in the event the joint development committee is unable to resolve any dispute regarding potential indications, Forest Laboratories and we must jointly resolve such issue.
Patents, Trademarks and Proprietary Technology
We believe that patents, trademarks, copyrights and other proprietary rights are important to our business. We also rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We seek to protect our intellectual property rights by a variety of means, including patents, maintaining trade secrets and proprietary know-how, and technological innovation to develop and maintain our competitive position. We actively seek patent protection both in the United States and internationally and have filed 10 patent applications related to FMS and milnacipran. It is possible that a patent application will not issue from any of our patent applications and the breadth or scope of protection allowed under any issued patents may not provide adequate protection to protect any of our future products. We intend to enforce our patents, trademarks and brand names. We have also obtained a license from Pierre Fabre to certain patents and patent applications related to milnacipran, our only product candidate. Under the license, which we have sublicensed to Forest Laboratories, we have rights to a method of synthesis patent for milnacipran in the United States and Canada. Both the United States patent (U.S. Patent 5,034,541) and the Canadian patent (No. 2,006,464) terminate in December 2009. The composition of matter patent for milnacipran expired in June 2002. Pursuant to the terms of the license agreement, Pierre Fabre is responsible for the prosecution and maintenance of the patents and patent applications licensed thereunder at its sole expense. In addition, Pierre Fabre has the first right to take actions with respect to the infringement or potential infringement of such patents and patent applications, except for any action in connection with an abbreviated NDA filed by a third party, and provided that we may take appropriate actions with respect to the infringement of such patents and patent applications in the United States and Canada if Pierre Fabre fails to do so within a specified period of time. We or Forest Laboratories has the first right to take any action with respect to any proceeding in connection with an abbreviated NDA filed by a third party. Although we have filed use patents on milnacipran, two of which have issued (U.S. Patent 6,602,911 and U.S. Patent 6,635,675, both expiring in 2021), we may not be able to secure any additional patent protection and the existing patents may not ensure exclusivity through the patent term. As a new chemical entity in the United States, milnacipran also qualifies under the terms of the Hatch-Waxman Amendments to the Federal Food, Drug and Cosmetic Act, or Hatch-Waxman Amendments, under which it would receive five years of marketing exclusivity upon marketing approval, during which time a generic milnacipran may not be approved. Even so, recent amendments to the Hatch-Waxman Amendments have been proposed and it, therefore, may not apply to us in the future.
Although patents are enforceable from the date of issuance and presumed to be valid, future litigation or reexamination proceedings regarding the enforcement or validity of our existing patents or future patents, if issued, could result in a ruling adverse to us that could invalidate such patents or substantially reduce the scope of protection afforded by such patents. Our patents may not afford commercially significant protection of our proprietary technology or have commercial application. There has been no judicial determination of the validity or scope of our proprietary rights. Moreover, the patent laws in foreign countries may differ from those of the United States, and the degree of protection afforded by foreign patents may be different.
Others have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights relating to products or processes competitive with us. The scope and validity of such patents is presently unknown. If existing or future patents are upheld as valid by courts, we may be required to obtain licenses to use technology covered by such patents.
Government Regulation
Our research, preclinical testing, clinical trials, manufacturing and marketing activities are subject to extensive regulation by numerous governmental authorities in the United States and other countries. In the United States, pharmaceutical drugs are subject to rigorous FDA regulation under the Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations. These laws and regulations govern, among other things, the preclinical and clinical testing, manufacture, quality control, safety, efficacy, labeling, storage, record keeping, approval, marketing, advertising and promotion of our drug products and drug product candidates. The product development and regulatory approval process requires the commitment of substantial time, effort and financial resources.
The steps required before a pharmaceutical agent may be marketed in the United States generally include:
· completion of preclinical laboratory tests, animal pharmacology and toxicology studies and formulation studies performed in compliance with the FDA’s Good Laboratory Practice, or GLP regulations;
· the submission of an investigational new drug application, or IND, to the FDA for human clinical testing that must be accepted by the FDA before human clinical trials may commence;
· performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the product candidate for the proposed indication of use;
· the submission of an NDA to the FDA; and
· FDA approval of the NDA prior to any commercial sale or shipment of the drug.
Preclinical studies include the laboratory evaluation of in vitro pharmacology, product chemistry and formulation, as well as animal studies to assess the potential safety and efficacy of a product. Compounds must be formulated according to the FDA’s current good manufacturing practices, or cGMP, requirements and preclinical safety tests must be conducted by laboratories that comply with GLP requirements. The results of the preclinical tests, together with manufacturing information and analytical data, are submitted to the FDA as part of an IND application and are reviewed by the FDA before human clinical trials may begin. The IND must also contain protocols for any clinical trials that will be carried out. The IND automatically becomes effective 30 days after receipt by the FDA unless the FDA raises concerns or questions regarding the conduct of the proposed clinical trial during the 30-day waiting period. If the FDA objects to an IND application during this 30-day waiting period or at any time thereafter, the FDA may halt proposed or ongoing clinical trials or may authorize trials only under specified terms. Such a halt, called a clinical hold, continues in effect until and unless the FDA’s concerns are adequately addressed. In
some cases, clinical holds are never lifted. Imposition by the FDA of a clinical hold can delay or preclude further product development. The IND process may be extremely costly and may substantially delay product development.
Clinical trials must be sponsored and conducted in accordance with good clinical practice, or GCP, requirements and under protocols and methodologies that, among other things:
· ensure receipt from participants of signed consents that inform them of risks;
· detail the protocol and objectives of the study;
· detail the parameters to be used to monitor safety; and
· detail the efficacy criteria to be evaluated.
Furthermore, each clinical study must be conducted under the supervision of a principal investigator operating under the auspices of an institutional review board, or IRB, at the institution where the study is conducted. The IRB must review and approve the plan for any clinical trial before it commences at that institution and it must monitor the study until it is completed. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Sponsors, investigators and IRB members are obligated to avoid conflicts of interests and ensure compliance with all legal requirements. The FDA, the IRB or the sponsor may suspend or discontinue a clinical trial at any time on various grounds, including potential health risks to study subjects.
Clinical trials are conducted in accordance with protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part of the IND, and the FDA must grant permission before each clinical trial may begin. Clinical trials typically are conducted in three sequential phases that may overlap. In Phase I, the initial introduction of the drug into a small number of healthy volunteers, the drug is evaluated for safety by assessing the adverse effects, dosage tolerance, metabolism, distribution, excretion and clinical pharmacology. The Phase I trial must provide pharmacological data that is sufficient to devise the Phase II trials.
Phase II trials involve a limited patient population in order to:
· obtain initial indications of the efficacy of the drug for specific, targeted indications;
· determine dosage tolerance and optimal dosage; and
· identify possible adverse affects and safety risks.
When a compound is determined preliminarily to be effective and to have an acceptable safety profile in Phase II evaluation, Phase III trials-commonly referred to as pivotal studies-can be undertaken to evaluate safety and efficacy endpoints further in expanded and diverse patient populations at geographically dispersed clinical trial sites. Positive results in Phase I or II are not necessarily predictive of positive results in Phase III. In our case, our positive results from the Phase II clinical trial of milnacipran are no guarantee of positive results in our current or future Phase III trials. To prepare for our Phase III clinical program and before commencing the first pivotal clinical trial, we completed a special protocol assessment, or SPA, with the FDA. During the SPA process, the FDA requested that we provide additional information, including information regarding our statistical analysis plan. We have responded to the FDA’s request. In the SPA process, the FDA reviews the proposed Phase III program and provides comments regarding the adequacy of the design and size of a proposed clinical trial to support claims of effectiveness in an approvable NDA. These FDA comments are binding on the review decision of the FDA, except in limited circumstances, such as when a substantial scientific issue essential to determining the safety or effectiveness of a drug is identified after the Phase III program subject to the SPA commences.
The results of the pharmaceutical development, preclinical studies and clinical trials, together with detailed information on the manufacture and composition of the product, are submitted to the FDA in the form of an NDA, which must be complete, accurate and in compliance with FDA regulations. Once the submission has been accepted for filing by the FDA, a process that may take up to 60 days after submission, by law the FDA has 180 days to review the application and respond to the applicant. The review process is often significantly extended by FDA requests for additional information or clarification. The FDA may deny an NDA filed by us or our collaborators if the applicable scientific and regulatory criteria are not satisfied, or it may require additional clinical data and/or an additional pivotal trial. Moreover, data obtained from clinical trials are not always conclusive and may be susceptible to varying interpretations that could delay, limit or prevent regulatory approval. The approval of an NDA permits commercial-scale manufacturing, marketing, distribution and sale of the drug in the United States and, with some limitations, export from the United States. Upon approval, a drug may only be marketed in those dosage forms, for those indications and subject to those limitations approved in the NDA. Moreover, after approval, the FDA may require additional post-approval testing, surveillance and reporting to monitor the products. Thus, even if approval for a drug is granted, it can be limited or revoked if evidence subsequently emerges casting doubt on the safety or efficacy of a product or if the manufacturing facility, processes or controls do not comply with regulatory requirements. Finally, an approval may entail limitations on the uses, labeling, dosage forms, distribution and packaging of the product.
Among the conditions for new drug approval is the requirement that the prospective manufacturer’s quality control, record keeping, notifications and reporting and manufacturing systems conform to the FDA’s cGMP regulations. To obtain approval, the drug manufacturing facility must be registered with the FDA and must pass a pre-approval inspection demonstrating compliance with cGMP requirements. If milnacipran is commercialized in the United States, Pierre Fabre’s facility will need to be inspected by the FDA for compliance with cGMP requirements. Manufacturing establishments also are subject to periodic, ongoing compliance inspections. In complying with the standards contained in these regulations, manufacturers must continue to expend time, money, resources and effort in order to ensure compliance. Failure to comply with these requirements can result in legal or regulatory action, including warning letters, suspension of manufacture, product seizure or recalls, injunctive action or civil or criminal penalties.
The FDA closely regulates the post-approval marketing and promotion of drugs, including standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities and promotional activities involving the Internet. Failure to comply with these requirements can result in adverse publicity, warning letters, corrective advertising and potential civil and criminal penalties.
Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authority. This foreign regulatory approval process includes many of the same steps associated with FDA approval described above.
In addition to regulations enforced by the FDA, we are and will be 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 and other present and future federal, state or local regulations. Our research and development activities involve the controlled use of hazardous materials, chemicals and various radioactive compounds. Although we believe that the safety procedures used by third parties for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be liable for any damages that result.
The approval process for milnacipran or any of our future products is expensive, time consuming and uncertain, and any applicable regulatory agency may not grant marketing approval. We may not have
sufficient resources to complete the required testing and regulatory review processes. Furthermore, we are unable to predict the extent of adverse governmental regulation, which might arise from future United States or foreign legislative or administrative action.
Competition
We are currently focusing on developing milnacipran to treat patients with FMS. Currently, there are no approved treatments specifically for FMS in the United States or elsewhere. As a result, the first option for treatment of FMS is physical therapy, followed by analgesics to attempt to alleviate the pain. If the analgesics do not alleviate the pain, then muscle relaxants and antidepressants are often prescribed. TCAs, which are available in inexpensive generic formulations, are currently viewed as the drugs of choice in treating FMS. We are also focusing on the development of products for the treatment of patients with Functional Somatic Syndromes.
Preliminary clinical trials have been conducted by other pharmaceutical companies for the treatment of FMS. In particular, Pfizer Inc. has publicly disclosed that it has conducted a Phase II clinical trial evaluating the efficacy and safety of its compound, pregabalin, as a treatment for FMS. In addition, Eli Lilly and Company has publicly disclosed that it has conducted two Phase II clinical trials evaluating the efficacy and safety of its compound, duloxetine, as a treatment for FMS. The market potential for Functional Somatic Syndromes, including FMS, is considerable and a number of pharmaceutical companies focused on therapies for alleviating pain or antidepressant therapies could decide to evaluate their current product candidates for the treatment of Functional Somatic Syndromes, including FMS, at any time. Due to the high incidence of Functional Somatic Syndromes, including FMS, we anticipate that most, if not all, of the major pharmaceutical companies will have significant research and product development programs in these areas. We expect to encounter significant competition both in the United States and in foreign markets for each of the drugs we seek to develop.
Our competitors include fully-integrated pharmaceutical and biotechnology companies both in the United States and in foreign markets which have expertise in research and development, manufacturing processes, testing, obtaining regulatory clearances and marketing, and may have financial and other resources significantly greater than we do. Smaller companies may also prove to be significant competitors. Academic institutions, United States and foreign government agencies and other public and private research organizations conduct research relating to Functional Somatic Syndromes, including FMS, and may develop products for the treatment of these diseases that compete directly with any products we develop. Our competitors may compete with us for collaborations. These companies and institutions also compete with us in recruiting and retaining highly qualified scientific personnel.
Our competition will be partially determined by the potential indications that are ultimately cleared for marketing by regulatory authorities, the timing of any clearances and market introductions and whether any currently available drugs, or drugs under development by others, are effective in the same indications. Accordingly, the relative speed with which we can develop milnacipran or any of our future product candidates, complete the clinical trials, receive regulatory clearance and supply commercial quantities of the products to the market is expected to be an important competitive factor. We expect that competition among products approved for sale will be based, among other things, on product efficacy, safety, reliability, availability and patent protection.
Manufacturing and Supply
Pursuant to the terms of our purchase and supply agreement with Pierre Fabre, Pierre Fabre is the exclusive supplier to us and Forest Laboratories of the active pharmaceutical ingredient for milnacipran in exchange for a transfer price. Forest Laboratories has assumed the obligation to pay the transfer price directly to Pierre Fabre. Currently, Pierre Fabre manufactures the active pharmaceutical ingredient for
milnacipran in its facility located in Gaillac, France. This facility will need to be inspected by the FDA. Due to the projected commercial quantities of milnacipran that we may require and to provide a second manufacturing site, Pierre Fabre has agreed that within a certain time period after commercial launch of milnacipran, it will qualify an additional manufacturing facility. In addition, because Pierre Fabre is our sole supplier of the active pharmaceutical ingredient for milnacipran and is currently the only supplier of the active pharmaceutical ingredient for milnacipran in the world, we have the right, but not the obligation, to qualify us or Forest Laboratories as an additional manufacturing facility to manufacture the active pharmaceutical ingredient for milnacipran. We do not currently have this capability. In addition, we have the right to manufacture milnacipran if Pierre Fabre does not have the required buffer stock or in the event that we terminate our license agreement with Pierre Fabre under certain circumstances. Currently, we have contracted with Patheon Inc. to complete the manufacture process by encapsulating and packaging milnacipran for our clinical trials. Forest Laboratories will be responsible for future encapsulating and packaging at their Forest Ireland facility.
Employees
As of February 28, 2005, we employed 14 full-time employees. None of our employees are covered by a collective bargaining agreement. We believe that our relationship with our employees is good.
The PROSORBA Column
Prior to December 31, 2000, we were engaged in the product development and marketing of the PROSORBA column, a medical device, which was marketed for the treatment of rheumatoid arthritis and idiopathic thrombocytopenia purpura. In January 2001, Fresenius HemoCare, or Fresenius, purchased most of our assets related to the PROSORBA column. In February 2002, we amended certain provisions of our license and distribution agreement with Fresenius. Under the terms of the amendment, the initial $8 million payment we received in January 2001 was made non-refundable under any circumstances. The amendment also eliminated the payment from Fresenius to us of royalties on column sales in excess of 10,000 units in any of the first five years of the agreement and eliminated all royalties on sales beyond five years. A contingent payment is due to us on January 30, 2008 in the amount of $1 million if sales during the first seven years exceed 35,000 units, $2 million if they exceed 50,000 units and none if the sales are less than 35,000 units. We are responsible for prosecuting and maintaining the patents and trademarks related to the PROSORBA column. In addition, we agreed to indemnify Fresenius for any losses related to patent or trademark infringement claims.
Available Information
Our website address is www.cypressbio.com. We make available free of charge through our website 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 as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission.
Risk Factors
There are limited data regarding milnacipran as a treatment of FMS and it may not work for FMS or there may be safety issues with its use in this patient population.
There are limited data supporting the use of milnacipran, our only product candidate, for the treatment of FMS. Although milnacipran is currently being sold by Pierre Fabre outside North America as an antidepressant, it has only been tested as a treatment for FMS in our Phase II trial, during which milnacipran was administered to only 97 individuals with FMS. We must conduct and obtain favorable results in at least two pivotal Phase III trials to support an application for FDA approval of the product candidate. We cannot predict whether the results of our Phase II trial will be repeated in our Phase III clinical trials which have larger patient populations and are being conducted for longer time periods. The FDA has never approved a drug for the treatment of FMS. In addition, our future clinical trials may reveal that milnacipran is not safe or that it is not effective for the treatment of FMS. If milnacipran is not demonstrated to be a safe and effective treatment for FMS to the satisfaction of the FDA or other regulatory agencies, we will not receive regulatory approval and our business would be materially harmed.
We are dependent on our collaboration with Forest Laboratories to develop and commercialize milnacipran, our only product candidate, and to obtain regulatory approval. Events or circumstances may occur that delay or prevent the development and commercialization of milnacipran.
Pursuant to the terms of our collaboration agreement with Forest Laboratories, we granted Forest Laboratories an exclusive sublicense for the development and marketing of milnacipran, our only product candidate, for all indications in the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has the option to acquire an exclusive license from us in the United States, and potentially Canada, to any compounds developed under our agreement with Collegium Pharmaceutical. Forest Laboratories is responsible for funding the development of milnacipran, including clinical trials and regulatory approval. In light of the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. If the FDA approves this product candidate, Forest Laboratories will also have primary responsibility for the marketing and sale of the approved product and will share responsibility for compliance with regulatory requirements. We have limited control over the amount and timing of resources that Forest Laboratories will dedicate to the development, approval and marketing of milnacipran. Our ability to generate milestone and royalty payments from Forest Laboratories depends on Forest Laboratories’ ability to establish the safety and efficacy of milnacipran, obtain regulatory approvals and achieve market acceptance of milnacipran for the treatment of FMS.
We are subject to a number of additional risks associated with our dependence on our collaboration with Forest Laboratories, including:
· Forest Laboratories could delay the commencement of any additional clinical trials for milnacipran for the treatment of FMS, extend the timeframe of any clinical trials, including the second Phase III clinical trial for milnacipran, underfund such clinical trials, stop either phase III trial or any other clinical trials for milnacipran or abandon development of milnacipran, repeat or conduct additional clinical trials or require a new formulation of milnacipran for clinical testing;
· We and Forest Laboratories could disagree as to development plans, including the number and timing of clinical trials or regulatory approval strategy, or as to which additional indications for milnacipran should be pursued, if any and therefore, milnacipran may never be developed for any indications other than FMS;
· Forest Laboratories could independently develop, develop with third parties or acquire products that could compete with milnacipran, including drugs approved for other indications used by physicians off-label for the treatment of FMS;
· Forest Laboratories could fail to devote sufficient resources to the development, approval, commercialization, or marketing and distribution of any products developed under our collaboration agreement, including by failing to develop specialty sales forces if such sales forces are necessary for the most effective distribution of any approved product; and
· Disputes regarding the collaboration agreement that delay or terminate the development, commercialization or receipt of regulatory approvals of milnacipran, delay or prevent the achievement of clinical or regulatory objectives that would result in the payment of milestone payments or result in significant litigation or arbitration.
Furthermore, Forest Laboratories may terminate our collaboration agreement upon our material breach or our bankruptcy and may also terminate our agreement upon 120 days’ notice in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of a new drug application or to result in labeling or indications that would significantly adversely affect the marketing of any product developed under the agreement. If any of these events occur, we may not be able to find another collaborator for development or commercialization, and if we elected to pursue further development and commercialization of milnacipran, we would experience substantially increased capital requirements that we might not be able to fund.
We rely upon an exclusive license from Pierre Fabre in order to develop and sell our milnacipran product candidate, and our ability to pursue the development and commercialization of milnacipran for the treatment of FMS depends upon the continuation of our license from Pierre Fabre.
Our license agreement with Pierre Fabre provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada, with a right to sublicense certain rights to Forest Laboratories under our collaboration with Forest Laboratories. Either we or Pierre Fabre may terminate the license agreement for cause upon 90 days’ prior written notice to the other party upon the bankruptcy or dissolution of the other party, or upon a breach of any material provision of the agreement if the breach is not cured within 90 days following the written notice. Furthermore, Pierre Fabre has the right to terminate the agreement upon 90 days’ prior notice to us if we and our sub-licensees terminate our development and marketing activities with respect to milnacipran, if we challenge certain patent rights of Pierre Fabre and under specified other circumstances. If our license agreement with Pierre Fabre were terminated, we would lose our rights to develop and commercialize products using the compound milnacipran as an active ingredient, as the compound is manufactured under Pierre Fabre patents and using Pierre Fabre know-how and trade secrets, and it would be unlikely that we could obtain the active ingredient in milnacipran from any other source.
We rely upon Pierre Fabre as our exclusive supplier of the compound used as the active ingredient in our milnacipran product candidate and if Pierre Fabre fails to supply us sufficient quantities of the active ingredient it may delay or prevent us from developing and commercializing our only product candidate.
Pursuant to our purchase and supply agreement with Pierre Fabre, Pierre Fabre is the exclusive supplier to us and Forest Laboratories of the compound used as the active pharmaceutical ingredient in our milnacipran product candidate. Neither we nor Forest Laboratories have facilities for the manufacture of the product candidate. Currently, Pierre Fabre manufactures the active ingredient of milnacipran in its facility in Gaillac, France and Pierre Fabre is the only worldwide supplier of the active ingredient of
milnacipran that is currently approved for sale as an antidepressant and sold in 32 countries, but is not approved for sale in the United States. If any product is commercialized under the agreement, Pierre Fabre will have the exclusive right to manufacture the active ingredient used in our commercial product. If milnacipran is commercialized in the United States, Pierre Fabre’s facility will need to be inspected by the FDA for compliance with current good manufacturing practices, or cGMP, requirements. Due to the projected commercial quantities of milnacipran that we may require and to provide a second manufacturing site, Pierre Fabre has agreed that within a certain time period after commercial launch of milnacipran, it will qualify an additional manufacturing facility. We do not have control over Pierre Fabre’s compliance with cGMP requirements or Pierre Fabre’s compliance with its obligation to qualify a second manufacturing facility. If Pierre Fabre fails or is unable to provide, in a timely and economic manner, required quantities of the active ingredient that Forest Laboratories or we request for clinical purposes, our development program could be delayed. In addition, if Pierre Fabre fails to timely and economically supply us sufficient quantities for commercial sale, our product sales and market acceptance of the product could be adversely affected.
Furthermore, our purchase and supply agreement may be terminated for cause either by us or by Pierre Fabre upon 90 days’ prior written notice to the other party upon a material breach of the agreement if the breach is not cured within 90 days following the written notice. We have the right to manufacture milnacipran if Pierre Fabre does not have a required buffer stock or in the event that we terminate our license agreement with Pierre Fabre under certain circumstances. If our purchase and supply agreement with Pierre Fabre is terminated, we are unlikely to be able to qualify another supplier of the active ingredient within a reasonable time period, and our ability to develop and commercialize milnacipran will be significantly impaired.
Our agreements with Pierre Fabre and Forest Laboratories restrict our ability to develop specified compounds, which limits how we can expand our product candidates.
Under our agreements with Pierre Fabre and Forest Laboratories, Forest Laboratories has agreed to pay Pierre Fabre and us a royalty, in the event that Forest Laboratories sells a product other than milnacipran for FMS for a specified period of time, which shall not be less than three years. We are, in turn, obligated to pay a portion of the royalty we receive from Forest Laboratories to Pierre Fabre. In addition, each of us is subject to limitations related to each party’s development of any serotonin norephinephrine reuptake inhibitors, or SNRI, products other than milnacipran. These limitations include: (i) a prohibition on developing an SNRI product for specified indications for which milnacipran is being developed; and (ii) a prohibition on developing an SNRI product for any indication for a specified time period, and after such specified time period, a requirement that if one of the parties launches and sells an SNRI product that is prescribed off-label for any indication for which milnacipran is being developed, the selling party must reimburse the other parties for lost sales due to the off-label use.
Provisions in our collaboration agreement with Forest Laboratories and our license agreement with Pierre Fabre may prevent or delay a change in control.
Our collaboration agreement with Forest Laboratories provides that Forest Laboratories may elect to terminate our co-promotion rights for milnacipran or any other product developed under the collaboration agreement and we may lose our decision making authority with respect to the development and marketing of milnacipran if we engage in a merger, consolidation or sale of all or substantially all of our assets, or if another person or entity acquires at least 50% of our voting capital stock. Our license agreement with Pierre Fabre provides that Pierre Fabre may elect to terminate the agreement upon a change in control transaction in which a third party acquiror of us controls an SNRI product, and the acquiror does not take certain actions (e.g., divestiture of such SNRI product) within a specified time period to cure the breach of certain restrictions in the agreement that results from such SNRI product.
If Forest Laboratories and/or Pierre Fabre elected to exercise these termination rights, we or our successor could lose the ability to develop, commercialize and market milnacipran. These provisions may have the effect of delaying or preventing a change in control or a sale of all or substantially all of our assets, or may reduce the number of companies interested in acquiring us.
We are at an early stage of development and we do not have and may never develop any commercial drugs or other products that generate revenues.
We are at an early stage of development as a biotechnology company and do not have any commercial products. We have only one product candidate, milnacipran, which we sublicensed to Forest Laboratories in January 2004. Milnacipran, or any future product candidates we may acquire or develop, will require significant additional development, clinical trials, regulatory approvals and additional investment before they can be commercialized. Our product development and product acquisition efforts may not lead to commercial drugs, either because the product candidates are not shown to be safe and effective in clinical trials, because we have inadequate financial or other resources to pursue clinical development of the product candidate, or because the FDA does not grant regulatory approval. We do not expect milnacipran to be marketed for a number of years, if at all. If we and Forest Laboratories are unable to develop milnacipran as a commercial drug in the United States and Canada, or if such development is delayed, we will be unable to generate revenues, may be unsuccessful in raising additional capital, and may cease our operations.
The FDA approval of milnacipran or any future product candidate is uncertain and will involve the commitment of substantial time and resources.
Even if our Phase III trials or any future clinical trials are successful, we may not receive required regulatory approval from the FDA or any other regulatory body required for the commercial sale of milnacipran in the United States. In addition, even if we do obtain approval to market milnacipran, the approval process by the FDA may take longer than we anticipate. The regulatory approval of a new drug typically takes many years and the outcome is uncertain. Despite the time and resources expended, regulatory approval is never guaranteed. If we fail to obtain regulatory approval for milnacipran or any future product candidates, we will be unable to market and sell any products and therefore may never generate any revenues from product sales or become profitable. In addition, our collaborators, or our third party manufacturers’ failure to comply with the FDA and other applicable United States or foreign regulations may subject us to administrative or judicially imposed sanctions, including warning letters, civil and criminal penalties, injunctions, product seizure or detention, product recalls, total or partial suspension of production and refusal to approve new drug approval applications.
As part of the regulatory approval process, we must conduct, at our own expense, preclinical research and clinical trials for each product candidate sufficient to demonstrate its safety and efficacy to the satisfaction of the FDA and other regulatory agencies in the United States and other countries where the product candidate will be marketed if approved. The number of preclinical studies and clinical trials that will be required varies depending on the product, the disease or condition that the product is in development for and the regulations applicable to any particular product. The regulatory process typically also includes a review of the manufacturing process to ensure compliance with applicable regulations and standards, including the cGMP requirements. The FDA can delay, limit or decline to grant approval for many reasons, including:
· a product candidate may not be safe or effective;
· we may not achieve statistical significance for the primary endpoint;
· FDA officials may interpret data from preclinical testing and clinical trials in different ways than we interpret such data;
· the FDA might not approve our manufacturing processes or facilities, or the processes or facilities of any future collaborators or contract manufacturers, including Pierre Fabre’s facility for the manufacture of the active ingredient in milnacipran; and
· the FDA may change its approval policies or adopt new regulations.
We have agreed to pay certain external expenses associated with our second Phase III clinical trial evaluating milnacipran for FMS, currently being run by Forest Laboratories, and we may never be reimbursed for these amounts.
The amounts we are funding for external expenses for the second Phase III clinical trial evaluating milnacipran are only reimbursed to us by Forest Laboratories under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA. It is possible that the second Phase III trial may not be utilized as one of the pivotal trials in the NDA submission, and, in such event, we will not be reimbursed by Forest Laboratories for certain costs incurred in connection with the second Phase III clinical trial.
If we receive regulatory approval for milnacipran or any other future product candidate, we will be subject to ongoing FDA obligations and continuing regulatory review.
Any regulatory approvals that we or our collaborators receive for milnacipran or any future product candidates will be limited to the indications, dosages and restrictions on the product label. We currently intend to seek approval for milnacipran in the treatment of FMS. The FDA may not approve milnacipran for this indication at all, may approve milnacipran for a more limited indication, or may impose additional limitations on the indicated uses or contain requirements for post-marketing surveillance or the performance of potentially costly post-marketing studies. Even if we receive FDA and other regulatory approvals, milnacipran or any of our other future product candidates may later exhibit adverse effects that limit or prevent their widespread use or that force us to withdraw those product candidates from the market. In our Phase II trial evaluating milnacipran for the treatment of FMS, the most common dose-related side effects reported by patients were nausea, particularly early in the study, as well as a slight increase in heart rate. Any marketed product and its manufacturer continue to be subject to strict FDA regulation after approval, including regulation of product labeling and packaging, adverse event reporting, manufacture, storage, advertising, promotion and recordkeeping. Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market.
We rely on third parties to conduct all of our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize milnacipran or any of our other future product candidates.
As of February 28, 2005, we have only 14 full-time employees. We have in the past and expect to continue to rely on third parties to conduct all of our clinical trials. We and Forest Laboratories are using the services of Scirex, a contract research organization, to conduct the first Phase III trial with respect to milnacipran, and to assist in the conduct of the second Phase III trial with respect to milnacipran. Because we do not conduct our own clinical trials, we must rely on the efforts of others and cannot always control or predict accurately the timing of such trials, the costs associated with such trials or the procedures that are followed for such trials. We do not anticipate significantly increasing our personnel in the foreseeable future and therefore, expect to continue to rely on third parties to conduct all of our future clinical trials. If these third parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols or for other reasons, or if they fail to maintain compliance with applicable government regulations and standards, our clinical trials may be extended, delayed or
terminated, and we may not be able to obtain regulatory approval for or successfully commercialize milnacipran or any of our other future product candidates.
Even if our product candidates are approved, the market may not accept these products.
Even if our product development efforts are successful and even if the requisite regulatory approvals are obtained, milnacipran or any future product candidates that we may develop may not gain market acceptance among physicians, patients, healthcare payors and the medical community. The FDA has never approved a drug for the treatment of FMS and we cannot predict whether milnacipran, if approved for this indication, will gain market acceptance. A number of additional factors may limit the market acceptance of products including the following:
· timing of market entry relative to competitive products;
· extent of marketing efforts by us and third-party distributors or agents retained by us;
· rate of adoption by healthcare practitioners;
· rate of a product’s acceptance by the target community;
· availability of alternative therapies;
· price of our product relative to alternative therapies;
· availability of third-party reimbursement; and
· the prevalence or severity of side effects or unfavorable publicity concerning our products or similar products.
If milnacipran or any future product candidates that we may develop do not achieve market acceptance, we may lose our investment in that product candidate, which may cause our stock price to decline.
Our competitors may develop and market products that are less expensive, more effective or safer, which may diminish or eliminate the commercial success of any products we may commercialize.
The biotechnology market is highly competitive. Large pharmaceutical and biotechnology companies have developed or are attempting to develop products that will compete with any products we may develop to target Functional Somatic Syndromes, such as FMS, or other central nervous system disorders. In particular, Pfizer, Inc. has publicly disclosed that it has conducted a Phase II clinical trial evaluating the efficacy and safety of its compound, pregabalin, as a treatment for FMS. In addition, Eli Lilly and Company has publicly disclosed that it has conducted two Phase II clinical trials evaluating the efficacy and safety of its compound, duloxetine, as a treatment for FMS. Duloxetine is a serotonin norepinephrine reuptake inhibitor, and as a dual reuptake inhibitor is therefore similar in pharmacology to milnacipran, which is a norepinephrine serotonin reuptake inhibitor. Based on the similar pharmacology, it is anticipated that duloxetine, which is currently approved but not yet available for the treatment of depression, will receive some off-label use for the treatment of FMS. TCAs, which are inexpensive generic formulations, are currently viewed as the drugs of choice in treating FMS.
It is possible that our competitors will develop and market products for FMS prior to us and that are less expensive and more effective than milnacipran or any of our future products or that will render milnacipran or any other of our products obsolete. We also expect that, in the treatment of Functional Somatic Syndromes and other central nervous system disorders, competition from other biopharmaceutical companies, pharmaceutical companies, universities and public and private research institutions will increase. Many of these competitors have substantially greater financial resources, technical expertise, research capabilities and other resources than we do. We may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully.
We have the right to co-promote milnacipran, but we do not have the marketing, sales or distribution experience or capabilities.
Our ability to co-promote any product developed under our agreement with Forest Laboratories is subject to our building our own marketing and sales capabilities, and we currently do not have the ability to directly sell, market or distribute any product. In addition, in the event our agreement with Forest Laboratories is terminated or with respect to any other product we may develop that is not covered by our collaboration with Forest Laboratories, we would have to obtain the assistance of a pharmaceutical company or other entity with a large distribution system and a large direct sales force or build a substantial marketing and sales force with appropriate technical expertise and supporting distribution capabilities. We may not be able to enter into such arrangements with third parties in a timely manner or on acceptable terms or establish sales, marketing and distribution capabilities of our own. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful.
We are subject to uncertainty relating to health care reform measures and reimbursement policies which, if not favorable to our product candidates, could hinder or prevent our product candidate’s commercialization success.
The continuing efforts of the government, insurance and management care organizations and other health care payors to contain or reduce prescription drug costs may adversely affect:
· our ability to set a price we believe is fair for our products;
· our ability to generate revenues and achieve or maintain profitability;
· the future revenues and profitability of our potential customers, suppliers and collaborators; and
· the availability of capital.
Successful commercialization of milnacipran in the United States will depend in part on the extent to which government, insurance and management care organizations and other health care payors establish appropriate coverage and reimbursement levels for the cost of our products and related treatments. Third-party payors are increasingly challenging the prices charged for prescription drugs. Third-party payors are also encouraging the use of generic drugs. These trends could influence health care purchases, as well as legislative proposals to reform health care or reduce government insurance programs and result in the exclusion of our product candidates from coverage and reimbursement programs or lower the prices of our product candidates. Our revenues from the sale of any approved products could be significantly reduced as a result of these cost containment measures and reforms.
We rely on our employees and consultants for their scientific and technical expertise in connection with our business operations.
We rely significantly on the scientific and technical expertise of our employees and consultants to conduct our business. As of February 28, 2005, we have only 14 full time employees and therefore, we rely heavily on our employees. In addition, because we have a small number of employees, we rely more on consultants than do other companies. If any of our relationships with our employees or consultants are terminated, we may lose access to scientific knowledge and expertise necessary for the research, development and commercialization of milnacipran or any further products. We do not anticipate significantly increasing our personnel in the foreseeable future and therefore, we expect to continue to rely on consultants and our current employees for scientific and technical knowledge and expertise essential to our business.
Our employment agreement with our chief executive officer provides for “at will” employment, which means that he may terminate his services to us at any time. In addition, our scientific advisors may terminate their services to us at any time.
We have limited experience in identifying, completing and integrating acquisitions, including acquisitions of product candidates, and other targets, and we may incur unexpected costs and disruptions to our businesses if we make mistakes in our selection of future acquisitions or fail to integrate any future acquisitions.
As part of our strategy, we are continuing to evaluate potential strategic transactions, including potential acquisitions of products, technologies and companies, in order to expand our product pipeline. As we did with our in-licensing of milnacipran, we may seek to in-license compounds or acquire products or businesses. We have no agreements or understandings with respect to any acquisitions. Future acquisitions, however, may expose us to operational and financial risks, including:
· higher development costs than we anticipate;
· higher than expected acquisition and integration costs;
· exposure to unknown liabilities of acquired intellectual property, compounds or products;
· disruption of our business and diversion of our management’s time and attention to developing acquired compounds or products;
· incurrence of dilutive issuances of securities or substantial debt to pay for acquisitions; and
· impairment of relationships with key collaborators, suppliers or customers of any acquired businesses due to changes in management or ownership.
We also may devote resources to potential strategic transactions that we never complete or may fail to realize the anticipated benefit of any strategic transaction we do complete. Finally, we may incur unexpected costs in connection with the disposition of products or businesses, including our disposition of our PROSORBA column for which we indemnified Fresenius HemoCare for any losses related to patent or trademark infringement claims.
We may be subject to product liability claims that could cause us to incur liabilities beyond our insurance coverage.
We plan to continue conducting clinical trials on humans using milnacipran, and the use of milnacipran may result in adverse effects. We cannot predict all possible harm or side effects that may result from the treatment of patients with milnacipran or any of our future products, and the amount of insurance coverage we currently hold may not be adequate to protect us from any liabilities. We currently maintain $10,000,000 in insurance for product liability claims. We may not have sufficient resources to pay any liability resulting from such a claim beyond our insurance coverage.
We have a history of operating losses and we may never be profitable.
We have incurred substantial losses during our history. For the years ended December 31, 2004, 2003 and 2002, we incurred net losses of $11.2 million, $21.7 million and $1.0 million, respectively. As of December 31, 2004, we had an accumulated deficit of $137.5 million. Our ability to become profitable will depend upon our and Forest Laboratories’ ability to develop, market and commercialize milnacipran with sufficient sales volumes, and our ability to develop, market and commercialize any other products. We do not expect to generate revenue from the sale of products for the next several years or become profitable in the foreseeable future and may never achieve profitability.
We will need substantial additional funding and may be unable to raise capital when needed, which could force us to scale back or discontinue the completion of any proposed acquisitions or adversely affect our ability to realize the expected benefits of any completed acquisitions.
We agreed to pay certain expenses in connection with the second Phase III clinical trial for milnacipran in FMS. In addition, we will incur certain non-reimbursable expenses in connection with the development of milnacipran. We will incur expenses in connection with the evaluation of potential acquisitions or other strategic transactions and additional expenses in the event we close any such transactions. We do not have any committed external sources of funding and we will likely need to raise additional capital through the sale of equity or debt. The amount of capital we will require will depend upon many factors, including but not limited to, the evaluation and potential closing of any strategic transactions and the development strategy for milnacipran. If we are unable to raise capital when we need it, we may have to scale back or discontinue the evaluation or completion of any proposed acquisitions or strategic transaction(s).
Raising additional funds by issuing securities or through collaboration and licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish propriety rights.
We will likely raise additional funds through public or private equity offerings, debt financings or corporate collaborations and licensing arrangements. To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership percentage will be diluted. In addition, if we raise additional funds through collaborations and licensing arrangements, it may be necessary to relinquish potential valuable rights to our potential products on terms that are not favorable to us.
We may lose our net operating loss carryforwards, which could prevent us from offsetting future taxable income.
We have incurred substantial losses during our history and do not expect to become profitable in the foreseeable future and may never achieve profitability. To the extent that we continue to generate taxable losses, unused losses will carry forward to offset future taxable income, if any, until such unused losses expire. All unused federal net operating losses will expire 15 or 20 years after any year in which they were generated. The carryforward period is 15 years for losses incurred prior to 1998 and 20 years for losses incurred subsequent to 1997. Approximately $1.2 million in federal net operating losses expired in 2004. Our California tax loss carryforwards will begin to expire in 2006.
Our stock price will likely be volatile.
The market prices of the stock of technology companies, particularly biotechnology companies, have been highly volatile. For the period from January 1, 2002 through December 31, 2004, the high and low closing sales prices for our common stock ranged from $1.00 to $16.05. Our stock price has been and will likely continue to be affected by this type of market volatility, as well as by our own performance. The following factors, among other risk factors, may have a significant effect on the market price of our common stock:
· the results and timing of clinical trials for milnacipran;
· developments in our relationship with Forest Laboratories;
· developments in our relationship with Pierre Fabre;
· our entering into, or failing to enter into, an agreement for the acquisition of any products or companies, or an agreement with any corporate collaborator;
· our available cash;
· announcements of technological innovations or new products by us or our competitors;
· developments in patent or other proprietary rights;
· fluctuations in our operating results;
· litigation initiated by or against us;
· developments in domestic and international governmental policy or regulation; and
· economic and other external factors or other disaster or crisis.
The concentration of ownership among our existing officers, directors and principal stockholders may result in the entrenchment of management, prevent other stockholders from influencing significant corporate decisions and depress our stock price.
As of February 28, 2005, our executive officers, directors and stockholders who hold at least 5% of our stock beneficially owned and controlled approximately 35% of our outstanding common stock. If these officers, directors and principal stockholders act together, they will be able to help entrench management and to influence significantly and possibly control matters requiring approval by our stockholders, including a financing in which we sell more than 20% of our voting stock at a discount to the market price, the removal of any directors up for election, the election of the members of our board of directors, mergers, a sale of all or substantially all of our assets, going private transactions and other fundamental transactions. This concentration of ownership could also depress our stock price.
We expect to continue incurring increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance matters.
Recently enacted 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, have and we expect will continue to result in increased costs to us as we evaluate the implications of these laws and regulations and respond to their requirements. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant financial resources and management time related to compliance activities. Additionally, these laws 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.
Risks Related to Our Intellectual Property
We rely primarily on a method patent to protect our proprietary technology for the development of milnacipran, and our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology.
Our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology. The composition of matter patent for milnacipran (U.S. Patent 4,478,836) expired in June 2002. Accordingly, we rely on the patent for the method of synthesis of milnacipran (U.S. Patent 5,034,541), which expires on December 27, 2009 and was assigned to Pierre Fabre and licensed to us and on patents on the method of use of milnacipran to treat symptoms of FMS (U.S. Patent 6,602,911) and the method of use of milnacipran to treat symptoms of chronic fatigue syndrome (U.S. Patent 6,635,675) issued to us, to protect our proprietary technology with respect to the development of milnacipran. We
have also filed additional patent applications related to milnacipran and to the use of milnacipran for FMS (and other related pain syndromes and disorders), although no patents have issued on these patent applications. Because there is limited patent protection for the composition of matter of milnacipran, other companies may be able to sell milnacipran in competition with us and Forest Laboratories unless we and Forest Laboratories are able to obtain additional protection through milnacipran-related patents or additional use patents that may issue from our pending patent applications or other regulatory exclusivity. It may be more difficult to establish infringement of methods of synthesis, formulation or use patents as compared to a patent on a compound. If we or Forest Laboratories are not able to obtain and enforce these patents, a competitor could use milnacipran for a treatment or use not covered by any of our patents.
We also expect to rely on the United States Drug Price Competition and Patent Term Restoration Act, commonly known as the Hatch-Waxman Amendments, for protection of milnacipran or our other future products. The Hatch-Waxman Amendments provide data exclusivity for new molecular entities, such as that in milnacipran. Once a drug containing a new molecule is approved by the FDA, the FDA cannot accept an abbreviated NDA for a generic drug containing that molecule for five years, although the FDA may accept and approve a drug containing the molecule pursuant to an NDA supported by independent clinical data. Recent amendments have been proposed that would narrow the scope of Hatch-Waxman exclusivity and permit generic drugs to compete with our drug. After the Hatch-Waxman exclusivity period expires, assuming our patents are valid, we still expect to rely on our method of use patents to protect our proprietary technology with respect to the development of milnacipran. The patent positions of pharmaceutical companies are uncertain and may involve complex legal and factual questions. We may incur significant expense in protecting our intellectual property and defending or assessing claims with respect to intellectual property owned by others. Any patent or other infringement litigation by or against us could result in significant expense to us, including diversion of the resources of management.
Others may file patent applications or obtain patents on similar technology or compounds that compete with milnacipran for the treatment of FMS. We cannot predict the breadth of claims that will be allowed and issued in patent applications. Once patents have issued, we cannot predict how the claims will be construed or enforced. We may infringe on intellectual property rights of others without being aware of the infringement. If another party claims we are infringing their technology, we could have to defend an expensive and time consuming lawsuit, pay a large sum if we are found to be infringing, or be prohibited from selling or licensing our products unless we obtain a license or redesign our product, which may not be possible.
We also rely on trade secrets and proprietary know-how to develop and maintain our competitive position. Some of our current or former employees, consultants or scientific advisors, or current or prospective corporate collaborators, may unintentionally or willfully disclose our confidential information to competitors or use our proprietary technology for their own benefit. Furthermore, enforcing a claim alleging the infringement of our trade secrets would be expensive and difficult to prove, making the outcome uncertain. Our competitors may also independently develop similar knowledge, methods and know-how or gain access to our proprietary information through some other means.
Our ability to compete may decline if we do not adequately protect our proprietary rights.
Our commercial success depends on obtaining and maintaining proprietary rights to our product candidates and technologies and their uses as well as successfully defending these rights against third party challenges. We will only be able to protect our product candidates, proprietary technologies and their uses from unauthorized use by third parties to the extent that valid and enforceable patents or effectively-protected trade secrets cover them.
Our ability to obtain patent protection for our products and technologies is uncertain due to a number of factors, including:
· we may not have been the first to make the inventions covered by our pending patent applications or issued patents;
· we may not have been the first to file patent applications for our product candidates or the technologies we rely upon;
· others may independently develop similar or alternative technologies or duplicate any of our technologies;
· our disclosures in patent applications may not be sufficient to meet the statutory requirements for patentability;
· any or all of our pending patent applications may not result in issued patents;
· we may not seek or obtain patent protection in all countries that will eventually provide a significant business opportunity;
· any patents issued to us or our collaborators may not provide a basis for commercially viable products, may not provide us with any competitive advantages or may be challenged by third parties;
· some of our proprietary technologies may not be patentable;
· others may design around our patent claims to produce competitive products which fall outside of the scope of our patents; or
· others may identify prior art which could invalidate our patents.
Even if we obtain patents covering our product candidates or technologies, we may still be barred from making, using and selling our product candidates or technologies because of the patent rights of others. Others may have filed and in the future are likely to file patent applications covering compounds, assays, genes, gene products or therapeutic products that are similar or identical to ours. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the area of central nervous system disorders and the other fields in which we are developing products. These could materially affect our ability to develop our product candidates or sell our products. 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. These patent applications may have priority over patent applications filed by us. Disputes may arise regarding the ownership or inventorship of our inventions. It is difficult to determine how such disputes will be resolved. Others may challenge the validity of our patents. If our patents are found to be invalid we will lose the ability to exclude others from making, using or selling the inventions claimed therein.
Some of our research collaborators and scientific advisors have rights to publish data and information to which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, then our ability to receive patent protection or protect our proprietary information will be impaired. In addition, in-licensed technology is important to our business. We generally will not control the patent prosecution, maintenance or enforcement of in-licensed technology.
A dispute concerning the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be time consuming and costly and an unfavorable outcome could harm our business.
There is significant litigation in the industry regarding patent and other intellectual property rights. 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. If our drug development activities are found to infringe any such patents, we may have to pay significant damages. There are many patents relating to chemical compounds and the uses thereof. If our compounds are found to infringe any such patents, we may have to pay significant damages. A patentee could prevent us from making, using or selling the patented compounds. We may need to resort to litigation to enforce a patent issued to us, protect our trade secrets or determine the scope and validity of third party proprietary rights. From time to time, we may hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities conducted by us. Either we or these individuals may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. If we become involved in litigation, it could consume a substantial portion of our managerial and financial resources, whether we win or lose. We may not be able to afford the costs of litigation. Any legal action against our company or our collaborators could lead to:
· payment of damages, potentially treble damages, if we are found to have willfully infringed such parties’ patent rights;
· injunctive or other equitable relief that may effectively block our ability to further develop, commercialize and sell products; or
· we or our collaborators having to enter into license arrangements that may not be available on commercially acceptable terms, if at all.
As a result, we could be prevented from commercializing current or future products.
The patent applications of pharmaceutical and biotechnology companies involve highly complex legal and factual questions, which could negatively impact our patent position.
The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. The United States Patent and Trademark Office’s standards are uncertain and could change in the future. Consequently, the issuance and scope of patents cannot be predicted with certainty. Patents, if issued, may be challenged, invalidated or circumvented. United States patents and patent applications may also be subject to interference proceedings and United States patents may be subject to reexamination proceedings in the United States Patent and Trademark Office (and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent office), which proceedings could result in either loss of the patent or denial of the patent application or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Accordingly, rights under any issued patents may not provide us with sufficient protection against competitive products or processes.
In addition, changes in or different interpretations of patent laws in the United States and foreign countries may permit others to use our discoveries or to develop and commercialize our technology and products without providing any compensation to us. The laws of some countries do not protect intellectual property rights to the same extent as United States laws and those countries may lack adequate rules and procedures for defending our intellectual property rights. For example, some countries, including many in Europe, do not grant patent claims directed to methods of treating humans, and in these countries patent protection may not be available at all to protect our product candidates.
If we fail to obtain and maintain patent protection and trade secret protection of our product candidates, proprietary technologies and their uses, we could lose our competitive advantage and competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.
ITEM 2.
ITEM 2. Properties
We currently occupy approximately 5,200 square feet of leased office space in San Diego, California. The San Diego facility houses our executive and administrative offices. The lease for this facility expires in July 2007 and contains monthly rental payments ranging from $13,465 to $15,753 over the lease term.
ITEM 3.
ITEM 3. Legal Proceedings
From time to time, in the normal course of business, we are involved in litigation arising out of our operations. We are not currently engaged in any legal proceedings that we expect would materially harm our business or financial condition.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2004.
Our executive officers are as follows:
JAY D. KRANZLER, M.D., Ph.D., was appointed as our Chief Executive Officer and Vice-Chairman in December 1995. In April 1998, Dr. Kranzler was appointed as Chairman of the Board. From January 1989 until August 1995, Dr. Kranzler served as President, Chief Executive Officer and a director of Cytel Corporation, a publicly held biotechnology company. Dr. Kranzler has been an adjunct member of the Research Institute of Scripps Clinic since January 1989. Before joining Cytel, from 1985 to January 1989, Dr. Kranzler was employed by McKinsey & Company, a management-consulting firm, as a consultant specializing in the pharmaceutical industry. Dr. Kranzler has an M.D. with a concentration in psychiatry and a Ph.D. in pharmacology from Yale University. He graduated summa cum laude from Yeshiva University.
SABRINA MARTUCCI JOHNSON was appointed as our interim Chief Financial Officer in February 2002 and in April 2002, she was appointed as our Vice President and Chief Financial Officer. Ms. Johnson served as our Vice President of Marketing from March 2001 to April 2002. Ms. Johnson joined us in August of 1998 and held various positions from 1998 through 2000, including Product Director, Executive Director of Marketing and Sales, and Vice President of Marketing and Sales. From 1993 to 1998, Ms. Johnson held marketing and sales positions with Advanced Tissue Sciences and Clonetics. Ms. Johnson began her career in the biotechnology industry in 1990 as a research scientist with Baxter Healthcare, Hyland Division. Ms. Johnson has an MBA from the American Graduate School of International Management (Thunderbird), a MSc. in Biochemical Engineering from the University of London and a BSc. in biomedical engineering from Tulane University.
R. MICHAEL GENDREAU, M.D., Ph.D., was appointed as our Vice President of Research and Development and Chief Medical Officer in December 1996 and is currently serving as the Vice President of Clinical Development and Chief Medical Officer. Dr. Gendreau joined us in 1994 and held various positions from 1994 through 1996, including Executive Director of Scientific Affairs. From 1991 to 1994, Dr. Gendreau was Vice President of Research and Development and Chief Medical Officer for MicroProbe Corporation, a developer and manufacturer of DNA probe-based diagnostic equipment. Dr. Gendreau has a B.S. in chemistry from Ohio University and an M.D./Ph.D. in medicine and pharmacology from the Ohio State University.
DENISE L. WOOLARD was appointed as our Vice President of Business and Legal Affairs and Corporate Secretary in February 2004. Prior to joining us, from September 1997 until January 2004, Ms. Woolard worked as a corporate attorney at the law firm of Cooley Godward LLP. Ms. Woolard has a B.A. from Old Dominion University and a J.D. from the University of San Diego, School of Law.
PART II
ITEM 5.
ITEM 5. Market for our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq National Market under the symbol “CYPB”. Prior to March 1, 2004, our stock was traded on the Nasdaq SmallCap Market. Set forth below are the high and low closing sales prices for our common stock for the periods indicated as reported on the Nasdaq National Market and the Nasdaq SmallCap Market, as applicable.
As of March 1, 2005, there were approximately 750 holders of record of our common stock. On March 10, 2005, the last reported sale price of our common stock on the Nasdaq National Market was $10.10 per share. We have never paid any cash dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future as we intend to retain any earnings for use in our business.
ITEM 6.
ITEM 6. Selected Financial Data
The following table presents our selected financial data, which is derived from our audited financial statements. The information set forth below is not indicative of the results of future operations, particularly because we changed our business focus in 2001, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes and other central nervous system disorders. Functional Somatic Syndromes refer to several related syndromes characterized more by symptoms, suffering and disability than by disease-specific abnormalities that are found upon physical examination and include many overlapping pain and psychiatric conditions such as Fibromyalgia Syndrome, or FMS, irritable bowel syndrome, non-cardiac chest pain and interstitial cystitis, or chronic pelvic pain. Our goal is to be the first to commercialize a product approved in the United States for the treatment of FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes. In January 2004, we entered into a collaboration agreement with Forest Laboratories, Inc., a leading marketer of central nervous system drugs with a strong franchise in the primary care and psychiatric markets, for the development and marketing of milnacipran. We are currently running the first Phase III trial for milnacipran, which was commenced in October 2003. Enrollment in this trial was completed in December 2004, with results expected to be available in the Fall of 2005. In October 2004, Forest Laboratories initiated the second Phase III trial evaluating milnacipran for the treatment of FMS. These two Phase III trials and any additional studies needed for regulatory approval could possibly be completed in 2006 and, if successful, a New Drug Application, or NDA, for FMS could possibly be submitted later in that year at the earliest.
We completed a Phase II trial evaluating milnacipran for the treatment of FMS in the Fall of 2002. The Phase II trial was a three-month, randomized, placebo-controlled study involving 14 sites and 125 FMS patients who were randomized to either milnacipran treatment or placebo. In this clinical trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS. No unexpected safety concerns arose from this trial and there were no serious adverse events.
We obtained an exclusive license for milnacipran from Pierre Fabre Medicament in 2001. Milnacipran has been marketed outside of the United States since 1997 as an antidepressant and has been used by over 3,000,000 patients worldwide. We have paid Pierre Fabre a total of $2.5 million, including upfront payments of $1.5 million in connection with the execution of the original license agreement in 2001 and a $1.0 million milestone payment in September 2003, and issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock in connection with an amendment to the agreement with Pierre Fabre. Additional payments to Pierre Fabre of up to a total of $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones. Under our agreement with Forest Laboratories, we sublicensed our rights to milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. Additionally, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approval, as well as a specified number of our employees. However, in light of the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with these discussions, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, while we have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls.
In August 2002, we entered into a reformulation and new product agreement with Collegium Pharmaceutical, Inc. pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. In January 2004, we exercised our option to acquire an exclusive license to technology developed under this agreement. In the event we commercialize any of the reformulations or new products developed under our agreement with Collegium, we will be obligated to pay Collegium milestone payments of up to $5.4 million in the aggregate upon achievement of defined clinical and regulatory objectives, as well as potential royalty payments based on the net sales of reformulated or new products. In October 2002, we also entered into a common stock issuance agreement with Collegium, pursuant to which Collegium may elect to be issued shares of our common stock, subject to certain conditions, in lieu of cash, for milestone payments.
We are continuing to evaluate other various potential strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives that we believe may enhance stockholder value.
As of December 31, 2004, we had working capital of approximately $112.9 million and an accumulated deficit of approximately $137.5 million. Our future success depends on our ability to develop and market new products for the treatment of Functional Somatic Syndromes, such as FMS, and other central nervous system disorders.
Results of Operations
Comparison of Years Ended December 31, 2004 and
Revenues
We recognized revenues under our collaborative agreement of $14.4 million for the year ended December 31, 2004 compared to no revenue for the year ended December 31, 2003. The revenues recorded during 2004 consist solely of amounts earned pursuant to our collaboration agreement with Forest Laboratories for the development and marketing of milnacipran, entered into in January 2004. Such revenues include the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, funding received from Forest Laboratories for certain of our employees devoted to the development of milnacipran and sponsored development reimbursements.
We currently are not generating any revenues from product sales and we do not expect to generate revenues from product sales for at least the next several years, if at all. Until we generate revenues from product sales, we expect our revenues to consist of the continued recognition on a straight-line basis of the upfront payment of $25.0 million, sponsored development reimbursements and possible future milestone payments under our agreement with Forest Laboratories, which are contingent upon the achievement of agreed upon objectives. In connection with discussions with Forest Laboratories regarding cost sharing arrangements for the second Phase III trial only, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004. Additionally, the amount of sponsored development reimbursements from Forest Laboratories may change periodically based on the level of development activity. Our collaboration agreement is subject to early termination by Forest Laboratories upon specified events, including breach of the agreement.
Research and Development
Research and development expenses for the year ended December 31, 2004 were $15.2 million compared to $11.4 million for the year ended December 31, 2003. The increase in research and development expenses is primarily attributable to increased costs in connection with our first Phase III clinical trial for milnacipran due to a full year of activity during 2004 and costs incurred during 2004 in connection with the extension trial and our second Phase III trial for milnacipran. During 2004, we
incurred total costs of $12.9 million in connection with our Phase III programs compared to a total of $3.3 million during 2003. Research and development expenses during 2003 included a non-cash charge in the amount of $5.0 million recognized during the second quarter of 2003 in connection with the issuance of 1,000,000 shares of our common stock and warrants to purchase 300,000 shares of our common stock to Pierre Fabre under the Restated Pierre Fabre Agreement and costs incurred during the first quarter of 2003 related to the Phase II clinical trial for milnacipran, which was in its final completion stage during the first quarter of 2003. The costs for the first Phase III clinical trial and extension trial incurred during 2004 are being reimbursed by Forest Laboratories as noted below.
Effective January 9, 2004, pursuant to our collaboration agreement with Forest Laboratories, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals. This funding received from Forest Laboratories for sponsored development reimbursements is included as a component of our revenue under collaborative agreement on the statement of operations. However, in light of the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with these discussions, we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA and with a premium under certain additional circumstances.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $449,000 and $201,000 related to research and development expenses for the years ended December 31, 2004 and 2003, respectively, and as discussed below in “Compensation Expense (Benefit)-Variable Stock Options,” we recognized a compensation (benefit) for variable stock options of $(180,000) and compensation expense for variable stock options of $646,000 related to research and development expenses for the years ended December 31, 2004 and 2003, respectively.
General and Administrative
General and administrative expenses for the year ended December 31, 2004 were $5.7 million compared to $4.1 million for the year ended December 31, 2003. The increase in general and administrative expenses is primarily due to a success-based fee paid to our investment bankers in connection with the closing of our collaboration agreement with Forest Laboratories, a one-time fee associated with our being listed during the first quarter of 2004 on the Nasdaq National Market, increased wages and benefits expense associated with an increase in headcount, increased consulting costs and travel expenses in connection with business development activities surrounding potential strategic transactions and increased business insurance costs.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $6.0 million and $216,000 related to general and administrative expenses for the years ended December 31, 2004 and 2003, respectively, and as discussed below in “Compensation Expense (Benefit)-Variable Stock Options,” we recognized a compensation (benefit) for variable stock options of $(519,000) and compensation expense for variable stock options of $5.2 million related to general and administrative expenses for the years ended December 31, 2004 and 2003, respectively.
Non-Cash Compensation Charges
Non-cash compensation charges for the year ended December 31, 2004 were $6.5 million, consisting of approximately $449,000 related to research and development expenses and $6.0 million related to general and administrative expenses, compared to $417,000, consisting of approximately $201,000 related to research and development expenses and $216,000 related to general and administrative expenses, for
the year ended December 31, 2003. The increase in non-cash compensation charges is primarily due to: (i) non-recurring, non-cash compensation charges recognized during the first quarter of 2004, consisting of $2.4 million related to stock options previously granted to consultants and two former board members for services that vested upon the execution of the collaboration agreement with Forest Laboratories and $2.8 million related to the accounting treatment for stock options in connection with the resignation of certain board members to roles as consultants during the first quarter of 2004; (ii) a non-recurring, non-cash compensation charge in the amount of $385,000 recognized during the second quarter of 2004 related to the issuance of warrants to purchase 50,000 shares of our common stock to an outside consultant as compensation for services provided; and (iii) an increase in the Black-Scholes valuation for stock options previously granted to consultants due to the overall average increase in our stock price. These options are being expensed over their related vesting period.
Compensation Expense (Benefit)-Variable Stock Options
In June 2001, we implemented an option cancel and re-grant program, which resulted in variable accounting for the newly issued options under Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transaction Involving Stock Compensation-An Interpretation of APB 25. During the year ended December 31, 2004, as the intrinsic value of the common stock underlying the options declined due to a decrease in our stock price during the period, we recognized a compensation (benefit) of $(699,000), consisting of $(180,000) related to research and development expenses and $(519,000) related to general and administrative expenses. In contrast, due to an increase in our stock price during the year ended December 31, 2003, we recognized compensation expense of $5.9 million, consisting of $646,000 related to research and development expenses and $5.2 million related to general and administrative expenses. In the event our stock price is above $14.06 (closing price on December 31, 2004) on March 31, 2005, we will record additional compensation charges (however, we cannot predict what our stock price will be in the future and it may be substantially lower than $14.06).
Interest Income
Interest income for the year ended December 31, 2004 was $1.1 million compared to $122,000 for the year ended December 31, 2003. The increase in interest income for the year ended December 31, 2004 compared to the corresponding period in 2003 is due to higher cash and investment balances during 2004 achieved primarily through the upfront payment received from Forest Laboratories in January 2004 and the proceeds from our secondary offering completed in April 2004, and a general increase in interest rates and related yields experienced during 2004.
Comparison of Years Ended December 31, 2003 and
Revenues
We had no revenue for the year ended December 31, 2003 compared to revenue of $6.4 million for the year ended December 31, 2002. Pursuant to the Second Restructured Agreement with Fresenius, the agreement was modified to clarify that the $8.0 million upfront fee received under the First Restructured Agreement was not refundable under any circumstances and therefore, the entire $6.4 million of remaining deferred revenue as of December 31, 2001 was recognized as revenue in the first quarter of 2002.
As a result of the modification to our agreement with Fresenius reflected in the Second Restructured Agreement, the 2003 and 2002 revenues are not comparable. In addition, as a result of this modification, we will not recognize additional revenue, if any, under our agreement with Fresenius until at the earliest, January 30, 2008, when we may receive a one-time payment of $1.0 million, $2.0 million or no payment at all.
Research and Development
Research and development expenses were $11.4 million for the year ended December 31, 2003 compared to $5.1 million for the year ended December 31, 2002. The increase in research and development expenses is primarily attributable to the non-cash charge in the amount of $5.0 million recognized during the second quarter of 2003 in connection with the issuance of 1,000,000 shares of our common stock and warrants to purchase 300,000 shares of our common stock to Pierre Fabre under the Restated Pierre Fabre Agreement, costs incurred during 2003 of approximately $3.3 million in connection with our Phase III clinical trials for milnacipran, including expenses for clinical research organization and trial consultants, and higher bonuses for research and development executives accrued in the fourth quarter of 2003 following commencement of the Phase III clinical trial of milnacipran. During the year ended December 31, 2002, we incurred costs of approximately $2.9 million related to the Phase II clinical trial for milnacipran compared to corresponding costs of $0.4 million during 2003, as all costs associated with the Phase II trial were substantially completed by the first quarter of 2003.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $201,000 and $85,000 related to research and development expenses for the years ended December 31, 2003 and 2002, respectively, and as discussed below in "Compensation Expense (Benefit)-Variable Stock Options," we recognized compensation expense for variable stock options of $646,000 and a compensation (benefit) for variable stock options of $(74,000) related to research and development expenses for the years ended December 31, 2003 and 2002, respectively.
General and Administrative
General and administrative expenses were $4.1 million for the year ended December 31, 2003 compared to $3.0 million for the year ended December 31, 2002. The increase in general and administrative expenses is primarily due to executive bonuses accrued in the fourth quarter of 2003 and increased legal, consulting and travel costs related to business development activities in 2003, including costs incurred in connection with our collaboration agreement with Forest Laboratories. During 2002, we incurred initial set-up costs related to the implementation of a database for our physician and patient registries focused on patients with FMS and physicians that treat patients with FMS that were not incurred during 2003.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $216,000 and $138,000 related to general and administrative expenses for the years ended December 31, 2003 and 2002, respectively, and as discussed below in "Compensation Expense (Benefit)-Variable Stock Options," we recognized compensation expense for variable stock options of $5.2 million and a compensation (benefit) for variable stock options of $(614,000) related to general and administrative expenses for the years ended December 31, 2003 and 2002, respectively.
Non-Cash Compensation Charges
Non-cash compensation charges for the year ended December 31, 2003 were $417,000, consisting of approximately $201,000 related to research and development expenses and $216,000 related to general and administrative expenses, compared to $222,000, consisting of approximately $85,000 related to research and development expenses and $138,000 related to general and administrative expenses, for the year ended December 31, 2002. The increase in non-cash compensation charges is primarily due to an increase in the Black-Scholes value for stock options granted to consultants due to the increase experienced in our stock price during 2003 and an increase in the number of consultant options that vested during 2003. These options are being expensed over their related vesting period.
Compensation Expense (Benefit)-Variable Stock Options
In connection with the option cancel and re-grant program implemented in June 2001, which resulted in variable accounting for the newly issued options under FIN 44, we recognized compensation expense of $5.9 million for the year ended December 31, 2003 compared to a compensation (benefit) of $(688,000) for the year ended December 31, 2002. During the year ended December 31, 2003, as the intrinsic value of the common stock underlying the options increased due to an increase in our stock price during the period, we recognized compensation expense of $5.9 million, consisting of $646,000 related to research and development expenses and $5.2 million related to general and administrative expenses. In contrast, as our stock price decreased during the year ended December 31, 2002, we recognized a compensation (benefit) of $(688,000), consisting of $(74,000) related to research and development expenses and $(614,000) related to general and administrative expenses.
Interest Income
Interest income for the year ended December 31, 2003 was $122,000 compared to $200,000 for the year ended December 31, 2002. The decrease in interest income during 2003 is primarily due to a change in the composition of our cash and cash equivalents balance and lower rates offered for our cash investments. During the year ended December 31, 2003, a majority of our cash balance was invested in short-term investments classified as “available-for-sale” whereby unrealized gains or losses are recorded as a component of stockholders’ equity, compared to the corresponding period in 2002, during which our cash balance was invested in money market accounts.
Liquidity and Capital Resources
At December 31, 2004, we had cash, cash equivalents and short-term investments of $112.0 million compared to cash, cash equivalents and short-term investments of $23.5 million at December 31, 2003. Working capital at December 31, 2004 totaled $112.9 million compared to $22.0 million at December 31, 2003. We have invested a substantial portion of our available cash in high quality marketable debt instruments of governmental agencies and certificates of deposit, which are within federally insured limits. We have established guidelines relating to our investments to preserve principal and maintain liquidity.
Net cash provided by operating activities totaled $11.1 million for the year ended December 31, 2004 compared to net cash used in operating activities of $9.4 million for the year ended December 31, 2003. The primary source of cash from operations during 2004 was the upfront payment of $25.0 million received from Forest Laboratories, offset by cash used in operations of approximately $13.9 million. The primary use of cash during 2003 was to fund our operating activities during the period.
Net cash used in investing activities was $81.0 million for the year ended December 31, 2004 compared to $17.7 million for the year ended December 31, 2003. The increase in net cash used in investing activities during 2004 compared to 2003 was primarily a result of the increase in the level of activity related to the purchase of short-term investments, net of the proceeds from the sale of short-term investments.
Net cash provided by financing activities was $77.4 million for the year ended December 31, 2004 compared to $20.7 million for the year ended December 31, 2003. The increase in net cash provided by financing activities during 2004 compared 2003 was primarily the result of proceeds of approximately $74.2 million from the completion of our public offering of common stock during April 2004 and proceeds of approximately $3.0 million from the exercise of stock options and warrants during 2004, compared to net proceeds of approximately $9.5 million from the private placement of our common stock and warrants to purchase our common stock completed in April 2003 and proceeds of approximately $11.2 million from the exercise of stock options and warrants during 2003.
The following table summarizes our long-term contractual obligations at December 31, 2004:
(1) Purchase obligations include agreements to purchase goods or services, including consulting services, that are enforceable and legally binding on us and that specify all significant terms. This includes contracts that are cancelable with notice and the payment of an early termination penalty. Purchase obligations exclude agreements that are cancelable without penalty and also exclude liabilities to the extent presented on the balance sheet as of December 31, 2004.
Other commercial commitments include certain potential milestone, sublicense and royalty payments to Pierre Fabre and Collegium discussed in the “Overview” section. Contractual obligations for which we will be reimbursed by Forest Laboratories are not included in the table above. In light of the increased expense and risk associated with running two parallel trials, we are discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to our agreement with Forest Laboratories. In connection with these discussions, we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA with a premium under certain additional circumstances.
Until we can consistently generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and from revenue from our collaboration agreement. Our current expected primary cash needs on both a short term and long-term basis are for the identification, acquisition or license, and development of potential future products, development of current products, working capital and other general corporate purposes. In addition to the amounts required to pay any amounts payable under our agreements with Pierre Fabre and Collegium, costs of in-licensing or acquiring additional compounds or companies, funding external research and funding clinical development for any product that we may in-license or acquire, we estimate that based on our current business plan, we will require approximately $12 million to fund our operations for the year 2005. One of our goals for 2005 is to identify and in-license a new product. In the event we acquire, license or develop any new products, the amount to fund our operations for 2005 would increase, possibly materially. We expect the current trend of net losses to continue for at least the next several years as we seek to acquire, license or develop additional products for the treatment of Functional Somatic Syndromes and other central nervous system disorders. Such losses may fluctuate, and the fluctuations may be substantial.
Based on our current business plan, we believe our cash and cash equivalents and short-term investments balances at December 31, 2004 are sufficient to fund operations for the next several years. We are actively continuing to evaluate various potential strategic transactions, including the potential acquisitions of products and companies, and other alternatives that we believe may enhance stockholder value. In order to acquire or develop additional products, we will require additional capital. The amount of capital we require is dependent upon many forward-looking factors that could significantly increase our capital requirements, including the following:
· the extent to which we acquire or invest in other products and businesses;
· the costs of in-licensing drug candidates;
· the ability of Forest Laboratories and us to reach milestones, and other events or developments under our collaboration agreement;
· the costs and timing of development and regulatory approvals for milnacipran; and
· the costs of commercialization of any future products.
Because we are unable to predict the outcome of the foregoing factors, some of which are beyond our control, we are unable to estimate with certainty our mid to long-term capital needs. Until we can generate a sufficient amount of product revenue, if ever, we expect to finance future capital needs through public or private debt or equity offerings or collaboration and licensing arrangements, as well as interest income earned on cash balances. We do not currently have any commitments for future external funding. We may not be able to raise additional capital through such sources and the funds we raise, if any, may not allow us to maintain our current and planned operations. If we are unable to obtain additional capital, we may be required to delay, scale back or eliminate some or all of our development of future additional product candidates.
To date, we have not had any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, research and development expenses and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be 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 these estimates under different assumptions or conditions. We believe the following are some of the more critical accounting policies that affect the significant judgments and estimates used in the preparation of our financial statements (see also the notes to our financial statements).
Revenue Recognition
In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (as amended by SAB 104), revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Amounts received for upfront license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Accordingly, the upfront payment of $25.0 million from Forest Laboratories is being recognized over a period of 8 years, which represents the estimated period of significant on-going services and performance, including the development period, under our agreement with Forest Laboratories. Amounts received for sponsored development activities, including funding received for certain of our employees, are recognized as research costs are incurred over the period specified in the related agreement or as the services are performed. Amounts received for milestones are recognized upon achievement of the milestone, which requires
substantive effort and was not readily assured at the inception of the agreement. Any amounts received prior to satisfying revenue recognition criteria will be recorded as deferred revenue.
Research and Development Expenses
We expense research and development costs as they are incurred pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 2, Accounting for Research and Development Costs, as the ultimate commercialization of the related products is uncertain and the technology has no alternative uses. In connection with our agreement with Pierre Fabre, we have paid certain upfront and milestone payments and are also obligated to make additional payments based on meeting certain clinical and regulatory milestones. Such upfront and milestone payments are expensed as incurred pursuant to SFAS 2. We also issued Pierre Fabre 1,000,000 shares of our common stock and warrants to purchase 300,000 shares of our common stock in the second quarter of 2003 in connection with the Restated Pierre Fabre Agreement. Pursuant to SFAS 2, the additional license consideration in the form of these equity instruments has been expensed as the ultimate commercialization of the related product is uncertain and the technology has no alternative uses.
Stock Based Compensation
We grant stock options for a fixed number of shares to employees in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, as amended by SFAS No. 123, Accounting for Stock Based Compensation. Accordingly, we ordinarily recognize no compensation expense for stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of grant. The value of options or stock awards issued to non-employees has been determined in accordance with SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with selling Goods and Services, and is periodically re-measured as the options vest. For the years ended December 31, 2004 and 2003, we recorded compensation expense of $3.1 million (including $2.4 million related to stock options that vested upon the execution of the collaboration agreement with Forest Laboratories) and $351,000, respectively, related to options issued to consultants. Additionally, during the year ended December 31, 2004, we recorded compensation expense of $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members during the first quarter of 2004 and compensation expense of $385,000 in connection with the issuance of warrants to purchase 50,000 shares of our common stock to an outside consultant as compensation for services provided.
In June 2001, we implemented an option cancel and re-grant program, which resulted in variable accounting for the newly issued options under Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transaction Involving Stock Compensation-An Interpretation of APB 25. Pursuant to FIN 44, the intrinsic value of the options to purchase common stock will be re-measured at the end of each period for the term of the option and amortized over the vesting period. During the year ended December 31, 2004, as the intrinsic value of the common stock underlying the options declined due to a decrease in our stock price during the period, we recognized a compensation benefit of $699,000. During the year ended December 31, 2003, as the intrinsic value of the common stock underlying the options increased due to an increase in our stock price during the period, we recognized compensation expense of $5.9 million. In the event our stock price is above $14.06 (closing price on December 31, 2004) on March 31, 2005, we will record additional compensation charges (however, we cannot predict what our stock price will be in the future and it may be substantially lower than $14.06). Pursuant to the option cancel and re-grant program, options with certain exercise prices held by certain of our employees, including executive officers, and directors were exchanged for options with an exercise
price of $2.50, the fair market value of our common stock on June 27, 2001, the date the program was effected.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share Based Payment (“SFAS 123R”), which is a revision of SFAS 123, Accounting for Stock-Based Compensation. This statement supercedes APB Opinion 25, Accounting for Stock Issued to Employees (“APB 25”), and amends SFAS 95, Statement of Cash Flows. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123, however, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.
SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements for SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but also permits companies to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. We currently utilize the Black-Scholes model to measure the fair value of stock options granted to employees. While SFAS 123R permits companies to continue to use such model, it also permits the use of a “lattice” model. We have not yet determined which model we will use to measure the fair value of employee stock options under the adoption for SFAS 123R. The new standard is effective for periods beginning after June 15, 2005 and we expect to adopt SFAS 123R on July 1,2005.
We currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, recognize no compensation cost for employee stock options granted with exercise prices equal to or greater than the fair value of our common stock on the date of the grant. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on the level of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in the notes to the financial statements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk
We have invested our excess cash in United States government securities, certificates of deposit and money market funds with strong credit ratings. As a result, our interest income is most sensitive to changes in the general level of United States interest rates. We do not use derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, we believe that, while the investment-grade 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. A hypothetical 1% adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.
ITEM 8.
ITEM 8. Financial Statements
Refer to the Index on Page of the Financial Report included herein.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A. Controls and Procedures
Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the year covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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 Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial 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.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Cypress Bioscience, Inc.
We have audited management’s assessment, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting” that Cypress Bioscience, 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). Cypress Bioscience, 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 Cypress Bioscience, 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, Cypress Bioscience, 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 balance sheets of Cypress Bioscience, Inc. as of December 31, 2004 and 2003, and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004 of Cypress Bioscience, Inc. and our report dated February 25, 2005 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
San Diego, California
February 25, 2005
Item 9B.
Item 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers
Information required by this item will be contained in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2004 (except that information pertaining to executive officers of the Registrant is contained in Part I of this report). Such information is incorporated herein by reference.
We have adopted a Code of Business Conduct and Ethics, which covers all employees, including our principal executive, financial and accounting officers. A copy of our Code of Business Conduct and Ethics is posted on our website, www.cypressbio.com. We also will post on our website any waiver or amendment (other than technical, administrative and other non-substantive amendments) to our Code of Business Conduct and Ethics that is granted to or affects the duties of any of our directors or our principal executive, financial and accounting officers. Such posting will be made within five business days after the date of the waiver or amendment and will remain on the website for at least twelve months.
ITEM 11.
ITEM 11. Executive Compensation
Information required by this item will be contained in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2004. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item will be contained in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2004. Such information is incorporated herein by reference.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
Information required by this item will be contained in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2004. Such information is incorporated herein by reference.
ITEM 14.
ITEM 14. Accounting Fees and Services
Information required by this item will be contained in our Definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2004. Such information is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules
(a) Financial Statements
Our financial statements are included herein as required under Item 8 of this Annual Report on Form 10-K. See Index on page.
Financial statement schedules have been omitted since they are either not required, not applicable or the information is otherwise included.
(b) Exhibits
10.11
Letter Amendment dated February 1, 2002 to the Amended and Restated License Agreement dated January 19, 2001 among the Registrant, Fresenius HemoCare, Inc. and Fresenius HemoCare GmbH
Exhibit 10.24 to Form 10-K for the year ended December 31, 2001
10.12
Reformulation and New Product Agreement dated August 22, 2002 between the Registrant and Collegium Pharmaceuticals, Inc.(*)
Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 2002
10.13
Common Stock Issuance Agreement dated October 31, 2002 between the Registrant and Collegium Pharmaceuticals, Inc.(*)
Exhibit 10.3 to Form 10-Q for the quarter ended September 30, 2002
10.14
Equity Investment Agreement dated June 6, 2003 between the Registrant and Pierre Fabre Medicament
Exhibit 10.2 to Form 10-Q for the quarter ended June 30, 2003
10.15
Warrant to purchase Common Stock of the Registrant issued to Pierre Fabre Medicament on June 6, 2003
Exhibit 10.3 to Form 10-Q for the quarter ended June 30, 2003
10.16
Amended and Restated Employment Agreement dated August 11, 2003 between the Registrant and Jay D. Kranzler, M.D., Ph.D()
Exhibit 10.4 to Form 10-Q for the quarter ended June 30, 2003
10.17
Employment Agreement dated February 4, 2004 between the Registrant and Denise Woolard()
Exhibit 10.22 to the Form 10-K for the year ended December 31, 2003.
10.18
Third Restated License Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.23 to the Form 10-K for the year ended December 31, 2003.
10.19
First Restated Trademark Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.24 to the Form 10-K for the year ended December 31, 2003.
10.20
Purchase and Supply Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.25 to the Form 10-K for the year ended December 31, 2003.
10.21
License and Collaboration Agreement dated January 9, 2004 between the Registrant and Forest Laboratories(*)
Exhibit 10.26 to the Form 10-K for the year ended December 31, 2003.
10.22
Side Letter dated January 9, 2004 among the Registrant, Forest Laboratories and Pierre Fabre Medicament(*)
Exhibit 10.27 to the Form 10-K for the year ended December 31, 2003.
10.23
Letter Agreement dated January 9, 2004 among the Registrant, Forest Laboratories and Pierre Fabre Medicament(*)
Exhibit 10.28 to the Form 10-K for the year ended December 31, 2003.
10.24
2005 Bonus Plan
21.1
Subsidiaries of the registrant
The registrant has no subsidiaries
23.1
Consent of Independent Registered Public Accounting Firm
24.1
Power of Attorney
Reference is made to page 47
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
* Confidential Treatment has been granted to certain portions of this agreement.
** Confidential Treatment has been requested for certain portions of this agreement.
 Indicates management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jay D. Kranzler, M.D., Ph.D. and Sabrina Martucci Johnson, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and full power and authority to do and performance each and every act and thing requisite and necessary to be done in connection therewith, as fully to intents and purposes as he or she might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their substitute or resubstitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ PERRY B. MOLINOFF
Director
March 16, 2005
Perry B. Molinoff
/s/ DANIEL H. PETREE
Director
March 16,
Daniel H. Petree
/s/ GARY D. TOLLEFSON
Director
March 16,
Gary D. Tollefson
/s/ JACK H. VAUGHN
Director
March 16,
Jack H. Vaughn
CYPRESS BIOSCIENCE, INC.
Report of Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2004 and 2003
Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Statements of Stockholders’ Equity for the years ended December 31, 2004, 2003 and 2002
Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Cypress Bioscience, Inc.
We have audited the accompanying balance sheets of Cypress Bioscience, Inc. as of December 31, 2004 and 2003, and the related 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 upon 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 Cypress Bioscience, 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 Cypress Bioscience’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
CYPRESS BIOSCIENCE, INC.
BALANCE SHEETS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF OPERATIONS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF CASH FLOWS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
The Company
Cypress Bioscience, Inc. (the “Company”) is committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes, such as Fibromyalgia Syndrome, or FMS, and other central nervous system disorders. The Company in-licensed its first clinical candidate for clinical development, milnacipran, in August of 2001 from Pierre Fabre Médicament, or Pierre Fabre. The Company completed its Phase II trial to evaluate milnacipran in the potential treatment of FMS in the fall of 2002, and the final results were announced in the first quarter of 2003. The Company initiated its first Phase III clinical trial evaluating the use of milnacipran as a potential treatment for FMS in the fourth quarter of 2003. In January 2004, the Company entered into an agreement with Forest Laboratories, Inc. (“Forest Laboratories”) for the development and marketing of milnacipran (Note 5). In October 2004, the Company and Forest Laboratories initiated the second Phase III clinical trial evaluating milnacipran for the treatment of FMS.
Prior to December 31, 2000, the Company was engaged in the product development and marketing of the PROSORBA® column, a medical device, which was marketed for the treatment of rheumatoid arthritis and idiopathic thrombocytopenia purpura.
Basis of Presentation
Effective October 2002, the Company merged its wholly-owned subsidiary, PRP, Inc. (“PRP”), with and into the Company. Upon the effectiveness of the merger, each outstanding share of capital stock of PRP ceased to be outstanding, without any payment being made, and the Company remained as the surviving corporation. As PRP was an inactive subsidiary, the merger of PRP into the Company had no financial statement impact.
Accounting Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles 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
The Company considers cash equivalents to be those investments which are highly liquid, readily convertible into cash and which mature within three months from the date of purchase.
Short-Term Investments
The Company’s short-term investments consist of securities of the U.S. government or its agencies and certificates of deposit with maturities ranging from one to twelve months. The Company has classified its short-term investments as “available-for-sale” and carries them at fair value with unrealized gains and losses, if any, reported as a separate component of stockholders’ equity and included in comprehensive loss. Realized gains and losses are calculated on the specific identification method and recorded as interest income. Realized gains on the sale of available for sale securities during the years ended December 31,
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES (Continued)
2004 and 2003 were $615,872 and $79,837, respectively. There were no realized gains or losses during the year ended December 31, 2002.
At December 31, 2004 and 2003, short-term investments consisted of the following:
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company has established guidelines to limit its exposure to credit risk by placing investments with high credit quality financial institutions, diversifying its investment portfolio and placing investments with maturities that maintain safety and liquidity.
Property and Equipment
Property and equipment, including assets acquired under capital leases, are recorded at cost and depreciated or amortized over the estimated useful lives of the assets (three to five years) or the lease term using the straight-line method.
Long-Lived Assets
The Company evaluates the carrying value of its long-lived assets when events or changes in circumstances indicate that an asset’s carrying value may not be recoverable. An impairment loss is recognized when the sum of the expected future undiscounted net cash flows is less than the carrying value of the asset. To date, the Company has not identified any indicators of impairment or recorded any impairment of long-lived assets.
Accrued Clinical Trial Costs
The Company enrolls patients in various clinical trial sites, which are located in the United States. The Company records the cost of such studies as the clinical work is performed by the respective research entities. The Company accrues costs related to clinical trials in the period incurred.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash and cash equivalents, prepaid expenses, receivables, accounts payable, accrued compensation and accrued liabilities, approximate fair value due to the nature of their short-term maturities. The Company believes the carrying amount of its capital lease obligations approximates fair value because the interest rate on these instruments are at market rates.
Revenue Recognition
In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (as amended by SAB 104), revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Amounts received for upfront license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Amounts received for sponsored development activities, including funding received for certain of the Company’s employees, are recognized as research costs are incurred over the period specified in the related agreement or as the services are performed. Amounts received for milestones are recognized upon achievement of the milestone, which requires substantive effort and was not readily assured at the inception of the agreement. Any amounts received prior to satisfying revenue recognition criteria will be recorded as deferred revenue.
Revenue from the Fresenius agreement (Note 6) for the year ended December 31, 2002 related to an $8.0 million upfront payment that the Company received in January 2001, which was originally recognized ratably over 5 years. The agreement with Fresenius was restructured in February 2002, whereby the Company and Fresenius agreed that the $8.0 million payment would cover all sales of the PROSORBA column in the seven-year period commencing January 2001 and that it was non-refundable. As of a result of this modification and the fact that the Company had no further performance obligations, the Company recognized the remaining deferred revenue, which amounted to $6.4 million at December 31, 2001, as revenue in the first quarter of 2002.
Research and Development
Research and development expenses are expensed as incurred and consist primarily of salaries and related personnel expenses for the Company’s research and development personnel, fees paid to external service providers, patient enrollment costs, fees and milestone payments under the Company’s license and development agreements and costs for facilities, supplies, materials and equipment. All such costs are charged to research and development expenses as incurred. Such costs also include research and development expenses incurred in connection with the first Phase III clinical trial for milnacipran which are reimbursed by Forest Laboratories pursuant to the collaboration agreement, as well as expenses incurred in connection with the second Phase III trial for milnacipran which commenced in October 2004. The Company is discussing with Forest Laboratories an arrangement whereby the costs of the second Phase III trial will be reimbursed in the future at a premium under certain circumstances.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation
The Company measures compensation costs related to stock option plans using the intrinsic value method and provides pro forma disclosures of net loss per common share as if the fair value based method had been applied in measuring compensation costs. Accordingly, no compensation expense is recognized if the exercise price of stock options equals the fair value of the underlying stock at the date of grant.
Compensation expense for options granted to non-employees has been determined at the grant date in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force (“EITF”) No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services, and has been recorded at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Such compensation is recognized over the related vesting period of the underlying option.
Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, the Company’s net loss and net loss per share would have been adjusted to the pro forma amounts presented below:
The fair value of each option grant was estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants during the years ended December 31, 2004, 2003 and 2002: no dividend yield; a risk-free interest rate of 2.6%, 2.9% and 4%, respectively; an expected term of 4.0 years for all years presented; and an expected volatility of 112.0%, 116.6% and 115.8%, respectively. The weighted average fair value of options granted during the years ended December 31, 2004, 2003 and 2002 was $9.45, $2.68 and $2.52, respectively.
Earnings (Loss) Per Share
Earnings (loss) per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued. The dilutive effect of outstanding stock options and warrants is reflected in diluted earnings (loss) per share by application of the treasury stock method. The Company has excluded all
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES (Continued)
outstanding stock options and warrants from the calculation of diluted loss per share for the years ended December 31, 2004, 2003 and 2002 because such securities are antidilutive for these periods. The total number of potential common shares excluded from the calculation of diluted loss per common share for the years ended December 31, 2004, 2003 and 2002 was 3,444,888, 2,718,175 and 120,106, respectively.
Comprehensive Income (Loss)
Comprehensive income (loss) is calculated in accordance with SFAS No. 130, Comprehensive Income. SFAS No. 130 requires the disclosure of all components of comprehensive income (loss), including net income (loss) and changes in equity during a period from transactions and other events and circumstances generated from non-owner sources. The Company’s other comprehensive income (loss) consisted of gains and losses on short-term investments and is reported in the statements of stockholders’ equity.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share Based Payment (SFAS 123R), which is a revision of SFAS 123, Accounting for Stock-Based Compensation. This statement supercedes APB Opinion 25, Accounting for Stock Issued to Employees (APB 25), and amends SFAS 95, Statement of Cash Flows. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123, however, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.
SFAS 123R permits companies to adopt its requirements using either a “modified prospective” method or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all share-based payments granted after that date, and based on the requirements for SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but also permits companies to restate financial statements of previous periods based on proforma disclosures made in accordance with SFAS 123. The Company currently utilizes the Black-Scholes model to measure the fair value of stock options granted to employees. While SFAS 123R permits companies to continue to use such model, it also permits the use of a “lattice” model. The Company has not yet determined which model it will use to measure the fair value of employee stock options under the adoption for SFAS 123R. The new standard is effective for periods beginning after June 15, 2005 and the Company expects to adopt SFAS 123R on July 1, 2005.
The Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options granted with exercise prices equal to or greater than the fair value of the Company’s common stock on the date of the grant. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on the Company’s results of operations, although it will have no impact on its overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on the level of share-based payments granted in the future. However, had the Company adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share above.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
2. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
Property and Equipment
Property and equipment are comprised of the following as of December 31:
Depreciation and amortization expense for the years ended December 31, 2004, 2003 and 2002 was $45,653, $56,793 and $80,856, respectively, including assets under capital leases. The cost for assets acquired under capital leases totaled $75,000 at December 31, 2004 and 2003 with accumulation amortization of $41,250 and $26,250 at December 31, 2004 and 2003, respectively.
Accrued Liabilities
Accrued liabilities are comprised of the following as of December 31:
3. STOCKHOLDERS’ EQUITY
Authorized Shares
The Company is authorized to issue up to 60,000,000 shares of common stock and 15,000,000 shares of preferred stock.
Public Offering of Shares of Common Stock
On April 7, 2004, the Company completed a public offering of 6,900,000 shares of common stock, including the underwriters’ purchase of an additional 900,000 shares to cover over-allotments, at $11.50 per share resulting in proceeds of approximately $74.2 million, net of placement costs.
Shelf Registration
On October 31, 2003, the Company filed a Form S-3 with the Securities and Exchange Commission (“SEC”) to issue and sell up to a total dollar amount of $60 million of the Company’s common stock to the public in a registered offering or offerings. The Form S-3 was subsequently amended on January 13, 2004 to increase the total dollar amount of the offering or offerings to $100 million of the Company’s common
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
3. STOCKHOLDERS’ EQUITY (Continued)
stock, comprised of up to $88 million that the Company may sell and up to $12 million that selling stockholders may sell, and was declared effective by the SEC on January 16, 2004. During April 2004, the Company issued $79.4 million of common stock pursuant to this shelf registration.
Warrants
On May 21, 2004, the Company issued an outside consultant warrants to purchase 50,000 shares of common stock as compensation for services provided. These warrants, which have an exercise price of $13.23 per share and expire in May 2007, were valued at $385,000 using the Black-Scholes valuation model and recorded as a non-cash compensation charge during the second quarter of 2004.
Private Placement of Common Stock and Warrants to Purchase Common Stock
During April 2003, the Company completed a private placement of 4,029,342 shares of common stock and warrants to purchase 1,007,333 shares of common stock for proceeds of approximately $9.5 million, net of placement costs and fees of approximately $0.8 million. The purchase price of each security, which is the combination of one share of common stock and a warrant to purchase 25% of one share of the Company’s common stock, was priced at the market value of $2.56. Each warrant has an exercise price equal to $3.84 and expires in April 2008. In addition, in connection with the private placement, the Company issued warrants to purchase 380,908 shares of common stock to various placement agents. These warrants have an exercise price of $2.82 and expire in April 2008. One of the placement agents in the financing, who received warrants to purchase 283,301 shares of common stock and cash commission of $508,000, is affiliated with a stockholder of the Company.
During March 2002, the Company completed a private placement of 6,871,467 shares of common stock and warrants to purchase 3,435,726 shares of common stock. For each two shares of common stock bought, the purchaser received a warrant to acquire one share of common stock at $3.09 per share, a premium to the then-current market price. Such warrants expire in March 2007. The purchase price for the combined security was $2.47. The Company received proceeds of approximately $15.3 million, net of placement costs and fees of approximately $1.6 million. In addition, in March 2002, in connection with the private placement, the Company issued warrants to purchase 889,575 shares of common stock to various placement agents. These warrants have exercise prices ranging from $2.72 to $2.96 and expire in March and April of 2007.
Call for Redemption of Outstanding Warrants
During October 2003, the Company called for redemption of the outstanding warrants to purchase common stock of the Company issued in connection with the Company’s private placement in March 2002. As of October 1, 2003, there were warrants to purchase 2,167,962 shares of common stock outstanding at an exercise price of $3.09 out of 3,435,726 warrants originally issued. Pursuant to the terms of the warrant agreements, the Company had the right to call for redemption of the warrants if the closing price of the Company’s common stock exceeded 200% of the warrant purchase price for 20 consecutive trading days, or $6.18, which occurred on September 26, 2003. All outstanding warrants from the private placement in March 2002 were exercised prior to the redemption date of October 20, 2003 resulting in gross proceeds to the Company of $6.7 million.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
4. BENEFIT PLANS
401(k) Plan
The Company has a savings plan under Section 401(k) of the Internal Revenue Code under which all employees over the age of twenty-one are eligible to participate on the first entry date (January 1, April 1, July 1 and October 1) following their hire date. The plan allows for a matching contribution in the Company’s common stock (valued as of the contribution date) equal to 100% of the amount of the salary contributed for the preceding six- month period. Employees vest in the matching contribution made on the last day of June of the plan year provided they are employed on the last day of December of the plan year and vest in the matching contribution made on the last day of December of the plan year provided that they are employed on the last day of June of the following plan year. After five years of vesting service, the matching contribution is 100% vested immediately. During the years ended December 31, 2004, 2003 and 2002, the charge to operations for the matching contribution was $123,763, $65,500 and $79,014, respectively.
Stock Options
2000 EQUITY INCENTIVE PLAN In May 2000, the Company adopted the 2000 Equity Incentive Plan (the “2000 Plan”) providing for the grant to employees, directors and consultants of the Company of incentive and non-qualified stock options to purchase the Company’s common stock, as well as the granting of stock bonuses and rights to purchase restricted stock. The exercise price of all incentive stock options granted under the 2000 Plan shall not be less than the fair market value of the Company’s common stock on the date of grant. The exercise price of non-qualified stock options granted under the 2000 Plan shall not be less than 85% of the fair market value of the Company’s common stock on the date of grant. Options granted under the 2000 Plan have a term of up to ten years and generally vest over four years. In February 2001, the shareholders of the Company approved a provision to amend the 2000 Plan, whereby the total number of shares reserved for issuance under the 2000 Plan and the 1996 Equity Incentive Plan, in the aggregate, may be increased quarterly such that the number equals 21.1% of the number of shares of the Company’s common stock issued and outstanding as of the end of that day. Additionally, in September 2003, the shareholders of the Company approved an amendment to the 2000 Plan to increase the number of shares of common stock available for issuance as incentive stock options from 875,000 shares to 5,600,000 shares. This amendment does not alter the total number of shares available for issuance under the 2000 Plan; it only increases the total number of shares that may be issued under the 2000 Plan as incentive stock options. As of December 31, 2004, 3,538,907 shares of the Company’s common stock are available for future grant under the 2000 Plan.
1996 EQUITY INCENTIVE PLAN In January 1996, the Company adopted the 1996 Equity Incentive Plan (the “1996 Plan”) providing for the grant to employees, directors and consultants of the Company of incentive and non-qualified stock options to purchase the Company’s common stock, as well as the granting of stock bonuses and rights to purchase restricted stock. The exercise price of all incentive stock options granted under the 1996 Plan shall not be less than the fair market value of the Company’s common stock on the date of grant. The exercise price of non-qualified stock options granted under the 1996 Plan shall not be less than 85% of the fair market value of the Company’s common stock on the date of grant. Options granted under the 1996 Plan have a term of up to ten years and vest as determined by the Board but in no event less than twenty percent per year. As of December 31, 2004, 16,873 shares of the Company’s common stock are available for future grant under the 1996 Plan.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
4. BENEFIT PLANS (Continued)
STOCK OPTION CANCEL AND RE-GRANT PROGRAM In June 2001, the Company implemented an option cancel and re-grant program. Pursuant to the program, the exercise price of certain options held by certain of the Company’s executive officers and directors were exchanged for options with an exercise price of $2.50, the fair market value of the Company’s common stock on June 27, 2001, the date the option cancel and re-grant program was effected. As a condition to participating in the option cancel and re-grant program, optionees who elected to surrender their old options for the replacement options had to exercise at least twenty percent of the replacement options on June 27, 2001. In addition, the replacement options expire no later than the earlier of the expiration date of the original option grant or June 27, 2006. The Company’s chief executive officer exercised his options to purchase 101,319 shares of common stock pursuant to a promissory note that was issued by the Company and was secured by his stock. The outstanding principal amount of the promissory note was due on June 27, 2006, with interest payable annually. The principal amount of the loan was $189,973 and the interest rate was variable, adjusted monthly and was two points above the federal funds rate. In January 2004, the principal amount of the loan and related interest was paid in full.
As a result of the program, the Company granted options to purchase 618,738 shares of its common stock. In accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation-An Interpretation of APB Opinion No. 25, the shares underlying the options are accounted for as variable, and the intrinsic value of the options to purchase common stock are re-measured at the end of each period for the term of the option and amortized over the vesting period. During the years ended December 31, 2004 and 2002, the Company recorded a compensation benefit of $699,033 and $688,376, respectively, as the intrinsic value of the common stock underlying the options declined due to a decline in the Company’s stock price. In contrast, the Company recorded stock compensation expense of $5,879,277 for the year ended December 31, 2003 to reflect in an increase in the intrinsic value of the common stock underlying the options due to an increase in the Company’s stock price during this period.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
4. BENEFIT PLANS (Continued)
The following table summarizes the activity of the Company’s stock options and warrants for the periods presented:
The following table summarizes information regarding stock options outstanding at December 31, 2004:
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
4. BENEFIT PLANS (Continued)
The weighted average exercise prices for stock option activity are as follows:
5. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS
License and Collaboration Agreement with Forest Laboratories
In January 2004, the Company entered into a collaboration agreement with Forest Laboratories for the development and marketing of milnacipran. Under the agreement with Forest Laboratories, the Company sublicensed its exclusive rights to develop and commercialize milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has an option to acquire an exclusive license from the Company in the United States, and potentially Canada, to any compounds developed under the Company’s agreement with Collegium Pharmaceutical, Inc. Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals, as well as a certain number of the Company’s employees. However, in light of the increased expense and risk associated with running two parallel trials, the Company is discussing an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only and are currently working towards formalizing an amendment to the agreement with Forest Laboratories. In connection with these discussions, the amount of funding that the Company receives from Forest Laboratories for certain of its employees has been eliminated as of the fourth quarter in 2004, and the Company will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing the Company under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA and with a premium under certain additional circumstances. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, and the Company will have the option to co-promote using its own sales force up to 25% of the total physician
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
5. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS (Continued)
details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls.
Under the agreement with Forest Laboratories, the Company received an upfront, non-refundable payment of $25.0 million, of which $1.25 million, classified as research and development expenses, was paid to Pierre Fabre as a sublicense fee. The total upfront and milestone payments to the Company under the agreement could total approximately $205.0 million related to the development of milnacipran for the treatment of FMS, a large portion of which will depend upon achieving certain sales of milnacipran and an additional $45.0 million in the event that the Company and Forest Laboratories develop other indications for milnacipran. In addition, the Company has the potential to receive royalty payments based on sales of licensed product under this agreement. Forest Laboratories also assumed the future royalty payments due to Pierre Fabre and the transfer price for the active ingredient used in milnacipran. The agreement with Forest Laboratories extends until the later of (i) the expiration of the last to expire of the applicable patents, (ii) 10 years after the first commercial sale of a product under the agreement or (iii) the last commercial sale of a generic product, unless terminated earlier. Each party has the right to terminate the agreement upon prior written notice of the bankruptcy or dissolution of the other party, or a breach of any material provision of the agreement if such breach has not been cured within the required time period following such written notice. Forest Laboratories may also terminate the agreement upon an agreed notice period in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of a new drug application or to result in labeling or indications that would have a significant adverse affect on the marketing of any product developed under the agreement.
For the year ended December 31, 2004, the Company recognized revenue of $14.4 million under its collaboration agreement with Forest Laboratories, consisting of the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, funding received from Forest Laboratories for certain of the Company’s employees devoted to the development of milnacipran and sponsored development reimbursements.
Licensing Agreement with Pierre Fabre
In August 2001, the Company entered into a license agreement and a trademark agreement with Pierre Fabre. Pursuant to the terms of the license agreement, the Company paid Pierre Fabre $1.5 million upon execution of the agreement and a $1.0 million milestone payment in September 2003. The upfront payment of $1.5 million and $1.0 million milestone payment have been expensed pursuant to SFAS No. 2, Accounting for Research and Development Costs, as the ultimate commercialization of the related products is uncertain and the technology has no alternative uses. Additional payments of up to $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones.
The license agreement was amended and restated in November 2001 and subsequently in May 2003. In connection with the second amended and restated agreement in May 2003, the Company issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock. These warrants have an exercise price of $4.91 per share and expire in June 2008. Pursuant to SFAS No. 2, the additional license consideration in the form of the equity instruments has been expensed as the ultimate commercialization of the related product is uncertain and the technology has no alternative uses. Accordingly, during the second quarter of 2003, the Company recognized a non-cash charge of $5.0 million
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
5. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS (Continued)
classified as research and development expense based on the fair value of the stock and warrants issued to Pierre Fabre.
In January 2004, in connection with the Company’s transaction with Forest Laboratories, the Company’s license agreement and trademark agreement with Pierre Fabre were further amended. The third amended and restated license agreement with Pierre Fabre provides the Company with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada. Simultaneous to the third amended and restated license agreement, the Company also entered into a purchase and supply agreement with Pierre Fabre for the active pharmaceutical ingredient in milnacipran. If any product is commercialized, Pierre Fabre will have the exclusive right to manufacture the active ingredients used in the commercial product for a specified time period (subject to compliance with certain provisions in the agreement), and Pierre Fabre will be paid a transfer price for each product manufactured and royalties based on net sales, both obligations which have been assumed by Forest Laboratories. Additionally, the Company is obligated to pay Pierre Fabre a 5% sublicense fee on upfront and milestone payments received from Forest Laboratories. Once a total of $7.5 million has been paid to Pierre Fabre, such additional sublicense payments due to Pierre Fabre shall be credited against any royalties or milestones owed by the Company to Pierre Fabre, which shall be carried forward to any subsequent years as applicable. Pierre Fabre also retains the right to sell products in indications developed by the Company outside the United States and Canada and will pay the Company a royalty based on net sales for such products. The license agreement also provides Pierre Fabre with certain rights to obtain a license outside the United States and Canada for new formulations and new salts developed by the Company. The agreement is effective until the later of the expiration of the last-to-expire of certain patents held by Pierre Fabre relating to the development of milnacipran or ten years after the first commercial sale of a licensed product, unless terminated earlier. Each party has the right to terminate the agreement upon 90 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if the breach is not cured within 90 days following the written notice. Additionally, Pierre Fabre has the right to terminate the agreement upon 90 days’ prior notice to the Company if the Company takes certain actions.
Reformulation and New Product Agreement
In August 2002, the Company entered into a Reformulation and New Product Agreement (“Agreement”) with Collegium Pharmaceutical, Inc., or Collegium, pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. In January 2004, the Company exercised its option to acquire an exclusive license to technology developed under this agreement. In the event the Company commercializes any of the reformulations or new products developed under the agreement with Collegium, the Company will be obligated to pay Collegium milestone payments, which amount to $5.4 million in the aggregate, as well as potential royalty payments based on the net sales of reformulated or new products. Additionally, in October 2002, the Company entered into a Common Stock Issuance Agreement with Collegium, pursuant to which Collegium may elect to be issued shares of the Company’s common stock, subject to certain conditions, in lieu of cash, for milestone payments. The Company has authorized the issuance of up to 1,800,000 shares of common stock as milestone payments. The agreement with Collegium is effective until the expiration of the last-to-expire of the issued patents, if any, unless terminated earlier. Each party has the right to terminate the agreement upon 60 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any
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NOTES TO FINANCIAL STATEMENTS (Continued)
5. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS (Continued)
material provision of the agreement if the breach has not been cured within the 60-day period following the written notice.
6. FRESENIUS AGREEMENT
In March 1999, the Company entered into an agreement with Fresenius HemoCare, or Fresenius, providing Fresenius with an exclusive license to distribute the PROSORBA column in the United States, Europe and Latin America and, subject to certain conditions, Japan and select Asian countries, referred to as the Original Fresenius Agreement. The Original Fresenius Agreement contemplated joint efforts to introduce and market the PROSORBA column in the United States, with us bearing the responsibility for sales, marketing and clinical research associated with the product in the United States. The Original Fresenius Agreement included a 50/50 profit split in countries other than the United States, and a 50/50 profit split in the United States until the revenue from sales of the PROSORBA column reached a pre-determined sales threshold, after which time the Company would receive 60% of the profits.
On January 19, 2001, the Company restructured its agreement with Fresenius, referred to as the First Restructured Agreement. Pursuant to the terms of the First Restructured Agreement, Fresenius assumed all of the sales, marketing and clinical efforts associated with the PROSORBA column worldwide. The Company received an upfront payment of $8.0 million, a portion of which reflected prepaid royalties on the sales of 10,000 PROSORBA columns in any year during the initial five years of the agreement. The First Restructured Agreement eliminated certain profit sharing and expense sharing provisions, and the Company was entitled to receive additional royalties for any sales in excess of the 10,000 PROSORBA columns. Pursuant to the First Restructured Agreement, the Company also transferred to Fresenius certain assets associated with the PROSORBA column, including the Food and Drug Administration Pre-Market Approval. In addition, Fresenius assumed the liability under a lease for a facility in Redmond, Washington and obligations under contracts relating to the PROSORBA column, including royalty obligations under assigned patent licenses. The Company also assigned a distribution agreement for the territory of Canada to Fresenius, but retained ownership of the patents and trademarks for the PROSORBA column.
In light of lower sales than the Company and Fresenius anticipated, the Company and Fresenius determined to implement a different set of economic terms. As a result, the agreement was further restructured on February 1, 2002, referred to as the Second Restructured Agreement. Under the Second Restructured Agreement, the Company agreed that the $8.0 million upfront fee would cover all sales of the PROSORBA column in the initial seven-year period commencing January 2001 and that it was non-refundable under any circumstances. The Company is not entitled to any additional royalty payments during the initial seven-year period of the agreement. In addition, whereas under the First Restructured Agreement, the Company was entitled to certain royalty payments on sales of the PROSORBA column after January 2006, pursuant to the terms of the Second Restructured Agreement, a contingent payment is due to us in the amount of $1 million if sales during the first seven years exceed 35,000 units, $2 million if they exceed 50,000 units and none if the sales are less than 35,000 units. Such payment, if any, will be due on January 30, 2008 and is non-refundable. Prior to these modifications, the Company had accounted for the initial $8.0 million payment as deferred revenue, and had amortized this amount on a straight-line basis over five years, at the rate of $400,000 per quarter. As a result of these modifications, the Company
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NOTES TO FINANCIAL STATEMENTS (Continued)
6. FRESENIUS AGREEMENT (Continued)
recognized the remaining deferred revenue, which amounted to $6.4 million at December 31, 2001, as revenue in the first quarter of 2002.
7. INCOME TAXES
Significant components of the Company’s net deferred income tax assets as of December 31, 2004 and 2003 are shown below. A valuation allowance has been established to offset the net deferred tax asset as of December 31, 2004 and 2003, respectively, as the realization of such assets is uncertain.
As of December 31, 2004, the Company has accumulated federal and California net operating loss carryforwards of approximately $87,100,000 and $26,000,000, respectively. Approximately $1,200,000 of the federal net operating loss expired in 2004. The federal tax loss carryforwards will continue to expire in 2005. The California tax loss carryforwards will begin to expire in 2006. Additionally, the Company has federal and California research and development tax credit carryforwards of approximately $1,927,000 and $549,000, respectively, which will begin expiring in 2006 unless previously utilized.
The Company has determined that “ownership changes” within the meaning of Internal Revenue Code Section 382 have occurred in prior years. However, the Company has determined based on an analysis completed in 2004 that those limitations on the future utilization of net operating loss carryforwards will not have a material impact on such utilization. Future financings may cause additional changes in ownership and cause further limitation on the use of net operating loss carryforwards.
8. RELATED PARTY TRANSACTIONS
In conjunction with the signing of the collaboration agreement with Forest Laboratories, options to purchase 200,000 shares of common stock at $2.51 per share became fully vested. Such options were previously granted to outside consultants and two former board members for services provided in connection with corporate partner negotiations and were to become fully vested upon the execution of a significant strategic collaboration within two years of the date of grant. The Company recorded a non-cash compensation charge of $2.4 million, determined using the Black-Scholes valuation model, in the first quarter of 2004 in connection with this transaction.
During March 2004, the Company entered into consulting agreements with certain board members in connection with their resignation from the Company’s board of directors to roles as consultants. Pursuant to such consulting agreements, the Company is committed to pay each consultant a fee of $50,000 per year for services provided over a two-year term. Additionally, each consultant will vest in all unvested shares
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NOTES TO FINANCIAL STATEMENTS (Continued)
8. RELATED PARTY TRANSACTIONS (Continued)
under outstanding option grants in equal monthly installments over a period of two years from the effective date of the agreements. In connection with the consulting agreements, the Company recorded a non-cash compensation charge of $2.8 million during the first quarter of 2004 related to the accounting for the stock options previously granted to such former board members.
9. COMMITMENTS AND CONTINGENCIES
The Company currently occupies approximately 5,200 square feet of leased office space in San Diego, California. The San Diego facility houses the Company’s executive and administrative offices. The lease for this facility expires in July 2007.
Future annual minimum lease payments due under noncancelable capital and operating leases consists of the following at December 31, 2004:
Total rent expense was approximately $191,000, $171,000 and $189,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
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NOTES TO FINANCIAL STATEMENTS (Continued)
10. QUARTERLY INFORMATION (UNAUDITED)
The following quarterly information includes all adjustments which management considers necessary for a fair statement of such information.
(1) During the first, second, third and fourth quarters, the Company recognized non-cash compensation expense (benefit) for variable stock options of $(1,442,933), $847,025, $(782,454) and $679,329, respectively, related to the variable accounting treatment for options issued pursuant to the cancel and re-grant program in June 2001.
(2) During the first quarter, the Company recognized non-cash charges of $2.4 million related to stock options that vested upon the execution of the collaboration agreement with Forest Laboratories and $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members during the first quarter of 2004.
(1) During the first, second, third and fourth quarters, the Company recognized non-cash compensation expense (benefit) for variable stock options of $(96,498), $882,956, $1,616,342 and $3,476,477, respectively, related to the variable accounting treatment for options issued pursuant to the cancel and re-grant program in June 2001.
(2) During the second quarter, the Company recognized a non-cash charge of $5.0 million related to common stock and warrants issued to Pierre Fabre in connection with the second amended and restated agreement.