ITEM 1.
BUSINESS
Special Note Regarding Forward Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding the following: the timing and implications of obtaining regulatory approval of any of our product candidates; the progress of our research programs, including clinical testing; our ability to identify new product candidates; the potential of any product candidates to lead to the development of commercial products; our anticipated timing for initiation or completion of our clinical trials for any of our product candidates and expectations regarding future results of such trials; other statements regarding our future product development activities and plans to develop or acquire and commercialize product candidates, regulatory strategies and clinical strategies, including our intent to develop or seek regulatory approval for our product candidates in specific indications; our future expenditures for research and development and the conduct of clinical trials; the ability of our third-party manufacturing parties to support our requirements for drug supply; the extent to which our intellectual property rights may protect our technology and product candidates; the size and growth of the potential markets for our product candidates and our plans to develop our sales and marketing capabilities to serve those markets; the rate and degree of market acceptance of any future products; the success of competing drugs that are or become available; our plans and ability to enter into collaboration arrangements; any statements regarding our future financial performance, results of operations or sufficiency of capital resources to fund our operating requirements; and any other statements which are other than statements of historical fact. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part I, Item 1A
ITEM 1A.
RISK FACTORS
You should carefully consider the risks described below, which we believe are the material risks of our business. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained in our SEC filings, including our financial statements and related notes. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. We are relying upon the safe harbor for all forward-looking statements in this Report, and any such statements made by or on behalf of the Company are qualified by reference to the following cautionary statements, as well as to those set forth elsewhere in this Report.
Risks Related to our Business
We recently received a non-approvable letter from the FDA for our NDA for faropenem medoxomil, our lead product candidate, and we are currently evaluating our development program for faropenem medoxomil and do not currently know if faropenem medoxomil will ever receive regulatory approval, which is necessary before it can be commercialized.
If we do not receive regulatory approval for faropenem medoxomil and we are not able to commercialize faropenem medoxomil, we will not generate revenue for several years, if at all, and we may never generate sufficient revenue to achieve and sustain profitability. We need approval from the FDA prior to marketing our product candidates in the U.S. In December 2005, we submitted our first NDA to the FDA for use of faropenem medoxomil in four adult clinical indications. In October 2006, the FDA issued a non-approvable letter for all four indications in our NDA and recommended further clinical studies and microbiologic evaluation for all indications. We are in the planning stages of determining our next steps with respect to our faropenem medoxomil development program. Further clinical development of faropenem medoxomil for any indications will require us to complete additional and more extensive clinical trials, which will be costly and time consuming. The amount and timing of the increased costs related to our clinical trials is difficult to predict due to the uncertainty inherent in the timing of clinical trial initiations, the rate of patient enrollment and the detailed design of future trials. However, we expect that a minimum of two years will be required to complete additional clinical trials. If we continue our clinical development program for faropenem medoxomil, we may not obtain necessary approvals from the FDA even if our trials demonstrate the effectiveness of faropenem medoxomil for any indication. The data we collect from any additional clinical trials with larger patient populations may not demonstrate sufficient safety and efficacy to support regulatory approval of faropenem medoxomil, in which case we would experience potentially significant delays in, or be required to abandon, development of that product candidate. If we continue our clinical development program for faropenem medoxomil, we will have fewer resources to devote to the research and development of other potential product candidates and development stage programs. If we decide to terminate any further development of faropenem medoxomil, we will be dependent upon the success of the other product candidates in our pipeline or other compounds we may in-license and the size of the potential markets for such other product candidates may not be as significant as the potential markets for faropenem medoxomil. All of our other existing product candidates and development stage programs are in Phase I clinical development or preclinical development.
Even if we obtain FDA approval for faropenem medoxomil, it may not cover all of the clinical indications for which we seek approval. Also, an approval might contain significant limitations with respect to conditions of use in the form of narrow indications, incomplete activity against key bacterial pathogens, warnings, precautions or contra-indications. We cannot predict if or when we might again seek regulatory review of faropenem medoxomil for any indication or of any of our other product candidates.
The FDA has substantial discretion in the approval process and may either refuse to accept an application for substantive review or may conclude after review of our data that our application is insufficient to allow approval of a product candidate. If the FDA does not accept or approve our application, it may require that we conduct additional clinical, pre-clinical or manufacturing validation studies and submit that data before it will reconsider our application. Depending on the extent of these or any other studies, approval of any application
that we submit may be delayed by several years, or may require us to expend more resources than we have available. It is also possible that additional studies, if performed and completed, may not be considered sufficient by the FDA to approve our application for any particular indication for which we are seeking approval. If any of these outcomes occur, we may be forced to abandon our application for approval, which might cause us to cease operations.
Our lead product candidate, faropenem medoxomil, has been in-licensed from another pharmaceutical company, Daiichi Asubio Pharma Co., Ltd., or Daiichi Asubio. A previous licensee, Bayer AG, or Bayer, completed extensive pre-clinical studies and Phase II and Phase III clinical trials for a particular dosage of faropenem medoxomil. We may rely on some of the data from these pre-clinical studies and clinical trials in a future application or submission to the FDA for approval to market faropenem medoxomil. Any problems with these previous pre-clinical studies or clinical trials, including problems with the design or statistical analysis of such pre-clinical studies or clinical trials, could cause our application for regulatory approval to be delayed or rejected, in which case we might need to conduct additional trials.
Because of the termination of our collaboration with Forest Laboratories to develop and commercialize faropenem medoxomil, we plan to identify a new partner. If we do not obtain a new partner on acceptable terms, we likely will not be able to develop and commercialize faropenem medoxomil for adult indications and may not be able to develop faropenem medoxomil for pediatric indications or generate any future revenue from faropenem medoxomil.
On February 7, 2007, we announced the termination of our February 2006 agreement with Forest Laboratories. Under the collaboration agreement, Forest Laboratories had been granted an exclusive sublicense for the development and sale of faropenem medoxomil for all indications in the U.S. and a right of first refusal to extend the territory to include Canada. In connection with this agreement, Forest Laboratories paid us a non-refundable, non-creditable license fee of $50 million and in March 2006 we received a $10 million development milestone payment. The agreement contemplated up to an additional $190 million in development and commercial milestones for both adult and pediatric indications, which were to be reduced by $25 million if we had exercised our option to directly market and promote faropenem medoxomil directly to pediatricians. These milestone payments were largely dependent on the acceptance of additional NDA filings, FDA approvals and achieving certain sales levels of adult and pediatric formulations of faropenem medoxomil.
As a result of the termination we will reacquire all rights to faropenem medoxomil previously granted to Forest Laboratories.
We will seek another partner or partners, at an appropriate time, to assist us in the development and commercialization of faropenem medoxomil. We face competition in our search for partners with whom we may collaborate. Further, faropenem medoxomil has previously been licensed to other licensees who have opted not to develop and commercialize the product. As a result, we may not be successful in finding another collaboration partner on acceptable terms, or at all, and any failure to obtain a new collaboration partner on acceptable terms may adversely affect faropenem medoxomil development, commercialization and potential future sales. Identifying a new partner and entering into a collaboration agreement with it or developing the necessary infrastructure to commercialize, market and sell faropenem medoxomil to pediatricians ourselves could cause delays in obtaining regulatory approvals of faropenem medoxomil and commercializing faropenem, which would negatively impact our business. If we obtain regulatory approval of faropenem medoxomil for pediatric indications and we choose to commercialize, market and sell faropenem medoxomil to pediatricians ourselves, we will be required to substantially increase our internal sales, distribution and marketing capabilities. The development of the infrastructure necessary to commercialize, market and sell faropenem medoxomil to pediatricians will require substantial resources and may divert the attention of our management and key personnel and negatively impact our other product development efforts. Further, our current capital resources may not be sufficient to fund and support this type of infrastructure. Moreover, we may not be able to hire a sales force that is sufficient in size or has adequate expertise. It is unusual for the FDA to approve a drug for pediatric use which has not been approved for adult use. As a result, in the event that we are unable to pursue further development of faropenem medoxomil for adult use, it may be difficult to obtain FDA approval for a pediatric indication.
If we fail to enter into new strategic collaborations, we may have to reduce or delay our rate of product development and commercialization and/or increase our expenditures.
Our business model is based in part upon entering into strategic collaborations for discovery and/or development of some of our product candidates. Our strategy to develop and commercialize our products includes entering into various relationships with pharmaceutical or biotechnology companies to advance our programs. We may not be able to negotiate any of our collaborations on acceptable terms. If we are not able to establish collaborative arrangements, we may have to reduce or delay further development of some of our programs and/or increase our expenditures and undertake the development activities at our own expense. If we are not able to establish and maintain strategic collaborations on acceptable terms:
•
the development of our current or future product candidates may be reduced in scope, terminated or delayed;
•
our cash expenditures related to development of our current or future product candidates would increase significantly;
•
we may be required to hire additional employees or otherwise develop expertise, such as sales and marketing expertise, for which we have not budgeted;
•
we will bear all of the risk related to the development of each of our current and future product candidates; and
•
we may be unable to meet demand for any future products that we may develop.
In that event, we would likely be required to limit the size or scope of one or more of our programs.
Securing a strategic partner to develop and commercialize our product candidates may require us to relinquish valuable rights and will render us dependent on the efforts of any future collaboration partners, over which we would have limited control, and if our collaborations are unsuccessful, our potential to develop and commercialize product candidates and to generate future revenue from our product candidates would be significantly reduced.
In order to secure a strategic partner to develop and commercialize our product candidate, we may be required to relinquish valuable rights to our potential products or proprietary technologies. If we are able to identify and reach agreement with collaborators for our product candidates, those relationships will be subject to a number of risks, including:
•
collaborators may not pursue further development and commercialization of compounds resulting from collaborations or may elect not to renew research and development programs;
•
collaborators may delay clinical trials, under fund a clinical trial program, stop a clinical trial or abandon a product candidate, repeat or conduct new clinical trials, or require the development of a new formulation of a product candidate for clinical testing;
•
a collaborator with marketing and distribution rights to one or more of our product candidates may not commit sufficient resources to the marketing and distribution of any future products, limiting our potential revenues from the commercialization of these products;
•
disputes may arise delaying or terminating the research, development or commercialization of our product candidates, or result in significant litigation or arbitration;
•
strategic partners could develop drugs which compete with our future products, if any;
•
strategic partners could turn their focus away from anti-infective products and community respiratory tract infection indications;
•
strategic partners could fail to effectively manage manufacturing relationships with suppliers;
•
contracts with strategic partners may not provide significant protection or may be difficult to enforce if a strategic partner fails to perform; and
•
if an arrangement with a strategic partner expires or is terminated, we may not be able to replace it or the terms on which we replace it may be unacceptable.
If as a result of our financial condition or other factors we enter into a strategic collaboration while a drug candidate program is in early preclinical development, we may not generate as much near- or longer-term revenue from such program as we could have generated if we had the resources to further independently develop such program. In addition, if we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.
The type of trials that the FDA is recommending for faropenem medoxomil will be novel in design without historical formal guidance and may require alternative dosing regimens.
In the non-approval letter we received in October 2006, the FDA indicated that it recommends conducting additional large-scale clinical trials at alternate doses for all indications covered by our NDA, including superiority designed studies, which will be costly, difficult and time consuming to conduct. All efficacy studies upon which our NDA was based were designed as non-inferiority studies. In addition, dosages used in these studies were determined by the prior licensee of faropenem medoxomil, Bayer. Historically, the FDA and foreign regulatory authorities have not required superiority studies, such as placebo-controlled clinical trials, for approval of antibiotics but instead have relied on non-inferiority studies. In a non-inferiority study, a drug candidate is compared with an approved antibiotic and it must be shown that the drug product candidate is not less effective than the approved treatment. In a superiority study, a drug candidate is compared either with an approved antibiotic treatment or placebo and it must be shown that the drug candidate is more effective than the approved treatment or placebo, as the case may be. Although the FDA has indicated that superiority designed trials will be required for some indications, there is no existing formal guidance on the design of these studies and we are uncertain at this time as to exactly what types of trials will be required.
Conducting placebo-controlled trials for antibiotics can be time consuming and expensive and can be difficult to complete. Institutional review boards may not grant approval for placebo-controlled trials because of ethical concerns about denying some participating patients access to any antibiotic therapy during the course of the trial. It may be difficult to enroll patients in placebo-controlled trials even if institutional review board approval is obtained because certain patients would receive no therapy. Although we are currently conducting a placebo-controlled trial for acute exacerbation of chronic bronchitis, we have not completed any placebo-controlled trials for faropenem medoxomil for any indications. We may not be able to show a statistically significant advantage over placebo or another control treatment in any trials that we are able to complete. These factors could delay for several years or ultimately prevent commercialization of faropenem medoxomil for any indications for which the FDA requires superiority designed trials. Demonstration of superiority of a drug candidate over an approved antibiotic is likely to be difficult and require a large number of patients because clinical success rates for most approved antibiotics that would serve as appropriate comparisons are high, typically 70% to 90%.
If we choose, after discussion with the FDA, to pursue additional clinical trials in an effort to gain approval from the FDA for faropenem medoxomil, then our ongoing development programs for faropenem medoxomil will be lengthy and expensive. The amount of time and cost associated with these trials are difficult to predict due to the uncertainty inherent in the timing of clinical trial initiations, the rate of patient enrollment and details of future trial designs. In addition, the guidance we receive from the FDA in future meetings with them will influence the number, size and duration of planned and unplanned trials. Even if clinical trials show our product candidates to be safe and effective in treating their target conditions, we do not expect to be able to record commercial sales of any of our product candidates for at least two or three years. Even if we conduct these trials in accordance with FDA recommendations and achieve protocol defined end points, faropenem medoxomil may not be approved.
Further delays in clinical testing or approval could result in increased costs to us and delay our ability to generate revenue.
We may experience delays in clinical testing of our product candidates. We currently plan to limit our faropenem medoxomil adult clinical trial activities to completion of the ongoing Phase III placebo-controlled clinical trial for treatment of acute exacerbation of chronic bronchitis until we have a collaboration partner for the faropenem medoxomil adult program. Even in this trial, we temporarily stopped enrollment to exclude Ketek®. We had included Ketek as a comparator in the clinical trial to generate secondary data points versus a product projected to be a competitor product to faropenem. We based our decision to exclude Ketek on the findings of a joint Advisory Meeting of the FDA’s Anti-Infective Drug and Drug Safety and Risk Management committees held on December 14 and 15, 2006 that recommended to the FDA that the risks of using Ketek outweigh the benefits of using the drug for treatment of acute exacerbation of chronic bronchitis. This recommendation was adopted by the FDA on February 12, 2007. Following required communication with investigational review boards overseeing the clinical trial sites, we have re-initiated this trial without the Ketek comparator arm. We do not know whether planned clinical trials will begin on time, will need to be redesigned or will be completed on schedule, if at all. Clinical trials can be delayed for a variety of reasons, including delays in obtaining regulatory approval to commence a trial, in reaching agreement on acceptable clinical trial terms with prospective sites, in obtaining institutional review board or ministry of health approval at each site or country in which we seek to conduct clinical trials, in recruiting patients to participate in a trial, or in obtaining sufficient supplies of clinical trial materials. Many factors affect patient enrollment, including the size and nature of the patient population, the proximity of patients to clinical sites, the eligibility criteria for the trial, the design of the clinical trial, competing clinical trials, clinicians’ and patients’ perceptions as to the potential advantages of the drug being studied in relation to other available therapies, including any new drugs that may be approved for the indications we are investigating, and whether the clinical trial design involves comparison to placebo. Our antibiotics treat bacterial infections which tend to be seasonal in nature. As a result, during certain times of the year, it is difficult to find patients to enroll in our trials. Prescribing physicians would also face ethical issues associated with enrolling patients in clinical trials of our product candidates over existing antibiotics that have established safety and efficacy profiles or in placebo-controlled trials. These ethical issues may be even more pronounced in conducting clinical trials of antibiotics in children. Any delays in completing our clinical trials will increase our costs, slow down our product development and approval process and delay our ability to generate revenue or seek approval of faropenem medoxomil.
The success of our current business strategy will depend in part on our ability to obtain FDA approval of faropenem medoxomil for pediatric use and, if FDA approval is obtained, to successfully market an oral liquid formulation for the pediatric market.
The development of faropenem medoxomil for pediatric use is an important part of our current business strategy. We have developed a prototype oral liquid formulation, completed a Phase II trial in acute otitis media (middle ear infection) and are considering conducting future studies in acute otitis media and tonsillitis/pharyngitis. Our ability to successfully develop and market this product candidate for pediatric use is subject to various risks, including the following:
•
It is unusual for the FDA to approve a drug for pediatric use that has not been approved for adult use. As a result, in the event that we abandon further development of faropenem medoxomil for adult use, it may be difficult to obtain FDA approval for a pediatric indication.
•
Pre-clinical testing and clinical trials are protracted, expensive and uncertain processes. It may take us and any future collaboration partner several years to complete the testing and trials and failure can occur at any stage of the process. Success in pre-clinical testing and early clinical trials does not ensure that later clinical trials will be successful. These risks are potentially more pronounced in clinical tests involving children.
•
We have completed only one Phase II clinical trial in children with acute otitis media to date. A clinical trial conducted by Bayer for tonsillitis/pharyngitis in adults did not meet its primary endpoint.
•
Any NDA or other marketing authorization applications that we may file might be denied by the FDA and analogous foreign regulators.
•
Any regulatory approval we ultimately obtain may be limited or subject to post-approval commitments that render the product not commercially viable.
•
This product candidate, even if found to be safe and effective, might be difficult to develop into a commercially viable drug or to manufacture on a large scale, It may also prove to be economically unfeasible to market commercially.
•
Competitors may develop and market superior drugs or be more effective in marketing equivalent drugs.
•
Even if this product candidate is successfully developed and effectively marketed, the size of the market may be smaller than expected or may decrease over time, such that our sales revenue is less than initially contemplated.
Any failure to obtain regulatory approval of faropenem medoxomil for pediatric use would have a material and adverse impact on our ability to successfully execute our current business strategy and would significantly reduce the revenues that we might generate from faropenem medoxomil.
All of the Phase III clinical trials of faropenem medoxomil included in our NDA filed in December 2005 were conducted using a 300 mg, twice per day, dose. We expect that future clinical trials will be conducted at the alternate 600 mg, twice per day, dose. If the incidence of adverse events from use of faropenem medoxomil at the 600 mg, twice per day dose is significantly higher than that observed in completed clinical studies at the 300 mg, twice per day we may not be able to generate future revenue from faropenem medoxomil.
The Phase III clinical trials included in our December 2005 NDA were all conducted using a 300 mg, twice per day, dose. The dose was selected by the previous licensee of faropenem. We expect that future clinical trials will be conducted at the alternate 600 mg, twice per day, dose. In January 2006, we initiated a Phase III clinical trial for the acute exacerbation of chronic bronchitis indication using the higher dose. We have previously evaluated the potential for adverse events with the 600 mg, twice per day, dose in a Phase I study and a Phase II study conducted in 2005. In the Phase I study, the 600 mg, twice per day, dose was directly compared to a 300 mg, twice per day, dose, both administered for seven days. In the Phase II study, a 600 mg, twice per day, dose was compared to a 300 mg, twice per day, dose seven day treatment course in patients with acute bacterial sinusitis. In both trials, the adverse events were similar in both type and frequency. If there is an increased level of adverse events observed for faropenem medoxomil 600mg, twice per day as compared to 300mg twice per day, it will reduce future potential product revenue from faropenem medoxomil.
We have limited experience in acquiring or in-licensing product candidates, and integrating third parties’ products, businesses and technologies into our current infrastructure. If we determine that future acquisition or in-licensing opportunities are desirable and do not successfully execute on and integrate such targets, we may incur costs and disruptions to our business and we may be unable to grow our business.
A key element of our strategy is to commercialize a portfolio of new anti-infective products in addition to faropenem medoxomil. These efforts include potential licensing and acquisition transactions. To date, we have in-licensed rights to each of our product candidates. In addition to our internal drug development efforts, we may seek to expand our product pipeline and technologies by acquiring or in-licensing products, businesses or technologies that we believe are a strategic fit with our business and complement our existing product candidates, research programs and technologies.
If we decide not to pursue the development of faropenem medoxomil for any or all indications, then we may devote substantial additional time and energy to the pursuit of strategic opportunities, including potential licensing and acquisition transactions. These transactions may include new anti-infective products or product
candidates as well as products or product candidates outside of the anti-infective area. The success of this strategy depends upon our ability to identify, select and acquire the right pharmaceutical product candidates and products on terms that are acceptable to us. Proposing, negotiating and implementing an economically viable product acquisition or license is a lengthy and complex process. Other companies, including those with substantially greater financial, marketing and sales resources, may compete with us for the acquisition or license of product candidates and approved products. We may not be able to acquire or license the rights to additional product candidates and approved products on terms that we find acceptable, or at all.
Any product candidate we license or acquire may require additional development efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to the risks of failure inherent in pharmaceutical product development, including the possibility that the product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot ensure that any such products that are approved will be manufactured or produced economically, successfully commercialized or widely accepted in the marketplace.
In addition, future acquisitions may entail numerous operational and financial risks including:
•
exposure to unknown liabilities;
•
disruption of our business and diversion of our management’s time and attention to the development of acquired products or technologies;
•
incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;
•
higher than expected acquisition and integration costs;
•
difficulties in and costs of combining the operations and personnel of any acquired businesses with our operations and personnel;
•
impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and
•
inability to retain key employees of any acquired businesses.
Finally, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed or fail to realize the anticipated benefits of such efforts.
Our drug discovery approach and technologies and our product candidates other than faropenem medoxomil are unproven and in very early stages of development, which may not allow us to establish or maintain a clinical development pipeline or successful collaborations, and may never result in the discovery or development of commercially viable products.
Because we do not currently know when or if we will continue clinical development of faropenem medoxomil for certain adult indications or any other indications, we are more dependent on the potential success of our internal discovery research programs and product candidates other than faropenem medoxomil. Our only other existing product candidate, REP8839, is in Phase I clinical development. As a significant part of our growth strategy, we intend to develop and commercialize additional products and product candidates through our discovery research program. A significant portion of the research that we are conducting involves new and unproven technologies, and may not result in the discovery or development of commercially viable products. Research programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development. The process of successfully discovering product candidates is expensive, time-consuming and unpredictable, and the historical rate of failure for drug candidates is extremely high. Data from our current research programs may not support the clinical development of our lead compounds or other compounds from these programs, and we may not identify any compounds suitable for recommendation for clinical development. Moreover, any compounds we recommend for clinical development may not be
effective or safe for their designated use, which would prevent their advancement into clinical trials and impede our ability to maintain or expand our clinical development pipeline. If we are unable to identify new product candidates or advance our lead compounds into clinical development, we may not be able to establish or maintain a clinical development pipeline or generate product revenue. Our ability to identify new compounds and advance them into clinical development also depends upon our ability to fund our research and development operations, and we cannot be certain that additional funding will be available on acceptable terms, or at all. If we continue our clinical development program for faropenem medoxomil for certain adult indications or any other indications we will have fewer resources to devote to the further research and development of other product candidates, such as REP8839, or potential product candidates identified through our discovery research program. There is no guarantee that we will be able to successfully advance any product candidates identified through our discovery research program into clinical trials or successfully develop any product candidate we advance into clinical trials for commercial sale. In addition, the size of the potential markets for such other product candidates may not be as attractive as the potential markets for faropenem medoxomil. If we are unable to develop suitable potential product candidates through internal research programs or are not able to advance the development of our early stage product candidates such as REP8839, our business will suffer and we may be unable to grow our business.
We are at an early stage of development as a company, with no current sources of revenue, and we may never generate future revenue or become profitable.
We are a biopharmaceutical company that emerged from the development stage in February 2006 and have a limited operating history. Currently, we have no products approved for commercial sale and, to date, we have not generated any revenue from product sales. Our ability to generate revenue depends heavily on:
•
our ability to obtain a new collaboration partner for faropenem medoxomil on acceptable terms;
•
obtaining U.S. and foreign regulatory approvals for our lead product candidate, faropenem medoxomil;
•
successfully developing and securing regulatory approval for our product candidate, REP8839; and
•
successfully commercializing any product candidates for which we receive FDA approval.
Our existing product candidates will require extensive additional clinical evaluation, regulatory approval, significant marketing efforts and substantial investment before they can provide us with any revenue. If we do not receive regulatory approval for and successfully commercialize faropenem medoxomil, we will be unable to generate any royalty revenue from product sales for many years, if at all. If we are unable to generate revenue, we will not become profitable, and we may be unable to continue our operations.
We have incurred significant operating losses since inception and anticipate that we will incur continued losses for the foreseeable future.
We have experienced significant operating losses since our inception in 2000. At December 31, 2006, we had an accumulated deficit of approximately $117 million. We have generated no revenue from product sales to date. We have funded our operations to date principally from the sale of our securities and from payments by Forest Laboratories under our former collaboration agreement. Due to the October 2006 FDA non-approval letter for our December 2005 NDA for faropenem medoxomil and the termination of our Forest Laboratories collaboration agreement announced in February 2007, our prospects for near term future revenues are substantially uncertain. We expect to continue to incur substantial additional operating losses for the next several years as we pursue our clinical trials and research and development efforts. Because of the numerous risks and uncertainties associated with developing and commercializing antibiotics, we are unable to predict the extent of any future losses. We may never have any significant future revenue or become profitable.
If we fail to obtain additional financing, we may be unable to complete the development and commercialization of faropenem medoxomil and other product candidates, or continue our research and development programs.
Our operations have consumed substantial amounts of cash since inception. We currently expect to spend substantial amounts to:
•
complete the clinical development of faropenem medoxomil and REP8839;
•
license or acquire additional product candidates;
•
launch and commercialize any product candidates for which we receive regulatory approval, including building our own sales force to address certain markets; and
•
continue our research and development programs.
We do not expect that our current capital resources will be sufficient to fund the complete development of our faropenem medoxomil and REP8839 product candidates and any product candidates generated from our discovery research program. To date, our sources of cash have been limited primarily to the proceeds from the sale of our securities and payments by Forest Laboratories under our former collaboration agreement. Due to the termination of our Forest Laboratories collaboration agreement announced in February 2007, our prospects for near term future revenues are substantially uncertain. We currently intend to seek a new collaboration partner for faropenem medoxomil and use our cash and cash equivalents, short-term investments and interest earned on these balances toward the funding necessary to support our planned activities. If we cannot find a new collaboration partner on acceptable terms or if the funds provided from existing resources are insufficient to satisfy our future capital needs, or if we develop, in-license or acquire additional products or product candidates or pursue additional applications for our product candidates, we may seek to sell additional equity or debt securities. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience significant dilution. Any debt financing, if available, may involve restrictive covenants, such as limitations on our ability to incur additional indebtedness, limitations on our ability to acquire or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If we are unable to raise additional capital when required or on acceptable terms, we may have to significantly delay, scale back or discontinue the development and/or commercialization of one or more of our product candidates. We also may be required to:
•
seek collaborators for our product candidates at an earlier stage than otherwise would be desirable and on terms that are less favorable than might otherwise be available; and
•
relinquish or license on unfavorable terms our rights to technologies or product candidates that we otherwise would seek to develop or commercialize ourselves.
We have limited manufacturing capabilities and will depend on third parties to manufacture faropenem medoxomil and future products. If these manufacturers fail to meet our requirements and strict regulatory standards, we may be unable to develop or commercialize our products.
We do not have the capability to manufacture commercial quantities of faropenem medoxomil drug substance. If we decide to pursue additional large scale clinical trials for faropenem medoxomil or if our other product candidates advance into full scale clinical trials, we may not have the capability to manufacture quantities of faropenem medoxomil or such other product candidates for our clinical trials. We originally engaged Nippon Soda and MEDA as our sole suppliers of faropenem medoxomil drug substance and faropenem medoxomil tablets, respectively. Pursuant to the terms of our former collaboration agreement with Forest Laboratories, Forest Laboratories had agreed to assume responsibility for supply chain management for faropenem medoxomil and entered into a direct relationship with both Nippon Soda and MEDA as its sole supplier of faropenem medoxomil drug substance. However, following termination of our agreement with Forest Laboratories, the Nippon Soda and MEDA obligations revert directly to us. We are contractually bound to purchase all of our requirements from these parties and we expect Nippon Soda and MEDA will be our and
a future collaboration partner’s sole suppliers of faropenem medoxomil drug substance and tablets for the foreseeable future. Nippon Soda and MEDA may terminate these supply agreements for a number of reasons, such as:
•
an uncured material breach of the supply agreement by us;
•
our liquidation or insolvency; or
•
in some circumstances, following a change of control.
MEDA and Nippon Soda will be subject to ongoing periodic unannounced inspections by the FDA and corresponding state agencies for compliance with good manufacturing practices regulations, or cGMPs, and similar foreign standards. We do not have control over compliance by MEDA and Nippon Soda with these regulations and standards.
Nippon Soda has only a single facility located in Nihongi, Japan that can readily manufacture commercial quantities of faropenem medoxomil. If that facility were to be damaged or destroyed, we would have no readily available source of supply. Nippon Soda has not yet manufactured faropenem medoxomil at commercial scale on a consistent basis, nor has Nippon Soda completed the manufacturing process validations that are part of the regulatory requirements prior to obtaining marketing approval for faropenem medoxomil.
Reliance on a third party manufacturer entails risk to which we would not be subject if we manufactured products ourselves, including:
•
reliance on the third party for regulatory compliance and quality assurance;
•
delays or failure to manufacture sufficient quantities needed for clinical trials in accordance with our specifications or to deliver such quantities on the dates we require;
•
the possible breach of the manufacturing agreement by the third party because of factors beyond our control; and
•
the possibility of termination or non-renewal of the agreement by the third party because of our breach of the manufacturing agreement or based on its own business priorities, and the non-approvable letter we recently received from the FDA for our NDA for faropenem medoxomil may adversely influence the business priorities of our current suppliers.
Any of these factors could cause delay or suspension of clinical trials, regulatory submissions, required approvals or commercialization of faropenem medoxomil and our other product candidates under development, cause us to incur higher costs and could prevent us from commercializing our product candidates successfully. If we obtain regulatory approval for faropenem medoxomil and our contract manufacturers fail to deliver the required commercial quantities of bulk drug substance or finished product on a timely basis and at commercially reasonable prices and we are unable to find one or more replacement manufacturers capable of production at a substantially equivalent cost, in substantially equivalent volumes and quality, and on a timely basis, we would likely be unable to meet demand for faropenem medoxomil and we would lose potential revenue. It may take several years to establish an alternative source of supply for faropenem medoxomil and to have any such new source approved by the FDA, especially because faropenem medoxomil requires dedicated manufacturing facilities.
If the FDA does not approve Nippon Soda’s facility, we may be unable to develop or commercialize faropenem medoxomil.
We rely on Nippon Soda to manufacture faropenem medoxomil drug substance and currently have no plans to develop our own manufacturing facility. The facilities used by our contract manufacturer to manufacture our product candidates must be approved by the FDA. Nippon Soda’s facility has undergone its initial inspection by the FDA as part of the faropenem medoxomil NDA review. Although no 483 observations were noted by the FDA site inspector, if Nippon Soda cannot successfully manufacture material that conforms to our specifications and strict regulatory requirements, Nippon Soda will not be able to maintain FDA approval for its manufacturing facility. If the FDA does not maintain approval of this facility for the
manufacture of faropenem medoxomil, we may need to find alternative manufacturing facilities, which would result in significant delay of up to several years in obtaining approval for and manufacturing faropenem medoxomil. In addition, our contract manufacturer will be subject to ongoing periodic unannounced inspections by the FDA and corresponding state and foreign agencies for compliance with cGMPs and similar regulatory requirements. These regulations cover all aspects of the manufacturing, testing, quality control and record keeping relating to our product candidates. We do not have control over Nippon Soda’s compliance with these regulations and standards. Failure by Nippon Soda to comply with applicable regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure to grant approval to market our product candidates, delays, suspension or withdrawals of approvals, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business. In addition, we have no control over Nippon Soda’s ability to maintain adequate quality control, quality assurance and qualified personnel. Failure by our contract manufacturer to comply with or maintain any of these standards could adversely affect our ability to develop, obtain regulatory approval for or market our product candidates.
Any of our product candidates that are in clinical trials or that we advance into clinical trials are subject to extensive regulation, which can be costly and time consuming, cause unanticipated delays, or prevent the receipt of the required approvals to commercialize our product candidates.
The clinical development, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution of any of our product candidates currently in clinical trials or that we advance into clinical trials are subject to extensive regulation by the FDA in the U.S. and by comparable governmental authorities in foreign markets. Currently, we are developing faropenem medoxomil for adult and pediatric use and we have commenced Phase I clinical testing of REP8839. In the U.S. and in many foreign jurisdictions, rigorous pre-clinical testing and clinical trials and an extensive regulatory review process must be successfully completed before a new drug can be sold. Satisfaction of these and other regulatory requirements is costly, time consuming, uncertain and subject to unanticipated delays. Clinical testing is expensive, can take many years to complete and its outcome is uncertain. Failure can occur at any time during the clinical trial process. The results of pre-clinical studies and early clinical trials of our product candidates may not be predictive of the results of later-stage clinical trials. Product candidates in later stages of clinical trials may fail to show the desired safety and efficacy traits despite having progressed through initial clinical testing. The time required to obtain approval by the FDA is unpredictable but typically takes many years following the commencement of clinical trials, depending upon numerous factors. In addition, approval policies, regulations, or the type and amount of clinical data necessary to gain approval may change. We have not obtained regulatory approval for any product candidate.
Our product candidates may fail to receive regulatory approval for many reasons, including the following:
•
we may be unable to demonstrate to the satisfaction of the FDA or comparable foreign regulatory authorities that a product candidate is safe and effective for a particular indication;
•
the results of clinical trials may not meet the level of statistical significance required by the FDA or other regulatory authorities for approval;
•
the FDA or other regulatory authorities may disagree with the design of our clinical trials;
•
we may be unable to demonstrate that a product candidate’s benefits outweigh its risks;
•
we may be unable to demonstrate that the product candidate presents an advantage over existing therapies, or over placebo in any indications for which the FDA requires a placebo-controlled trial;
•
the FDA or comparable foreign regulatory authorities may disagree with our interpretation of data from pre-clinical studies or clinical trials;
•
the data collected from clinical trials of our product candidates may not be sufficient to support the submission of a new drug application or to obtain regulatory approval in the U.S. or elsewhere;
•
the FDA or comparable foreign regulatory authorities may fail to approve the manufacturing processes or facilities of third-party manufacturers with which we contract for clinical and commercial supplies; and
•
the approval policies or regulations of the FDA or comparable foreign regulatory authorities may change.
The FDA or comparable foreign regulatory authorities might decide that our data is insufficient for approval and require additional clinical trials or other studies. Furthermore, even if we do receive regulatory approval to market a commercial product, any such approval may be subject to limitations on the indicated uses for which we may market the product. It is possible that none of our existing product candidates or any product candidates we may seek to develop in the future will ever obtain the appropriate regulatory approvals necessary for us or our collaborators to begin selling them.
Also, recent events have raised questions about the safety of marketed drugs and may result in increased cautiousness by the FDA in reviewing new drugs based on safety, efficacy or other regulatory considerations and may result in significant delays in obtaining regulatory approvals and more stringent product labeling requirements. Any delay in obtaining, or inability to obtain, applicable regulatory approvals would prevent us from commercializing our product candidates.
If we fail to attract and keep senior management and key scientific personnel, we may be unable to successfully develop our product candidates, conduct our clinical trials and commercialize our product candidates.
Our success depends in part on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading academic institutions, clinicians and scientists. We are highly dependent upon our senior management and scientific staff, particularly Kenneth Collins, our President and Chief Executive Officer, Roger Echols, M.D., our Chief Medical Officer, Peter Letendre, Pharm. D., our Chief Commercial Officer, and Nebojsa Janjic, Ph.D., our Chief Scientific Officer. The loss of services of any of Mr. Collins, Dr. Echols, Dr. Letendre or Dr. Janjic or one or more of our other members of senior management could delay or prevent the successful completion of our planned clinical trials or the commercialization of our product candidates. In addition, we only recently formed our clinical and regulatory group, which is based in Connecticut, the services of which we highly depend upon to conduct our clinical programs and obtain regulatory approvals.
Competition for qualified personnel in the biotechnology and pharmaceuticals field is intense. We will need to hire additional personnel as we expand our clinical development and commercial activities. In addition, we may be required to grant significant amounts of share-based compensation to certain individuals to attract them, which could increase the related non-cash compensation expense. We may not be able to attract and retain qualified personnel on acceptable terms. We do not carry “key person” insurance covering any members of our senior management. Each of our officers and key employees may terminate his or her employment at any time without notice and without cause or good reason.
We currently have no sales organization. If we are unable to establish a direct sales force in the U.S. to promote our product candidates, the commercial opportunity for our product candidates may be diminished.
We currently have no sales organization. If our lead product candidate, faropenem medoxomil, is approved by the FDA for adult use, we will require a collaboration partner to market the product. If faropenem medoxomil is approved by the FDA for pediatric use, we may opt to market and sell faropenem medoxomil to pediatricians in the U.S. We will incur significant additional expenses and commit significant additional management resources to establish a pediatric sales force. We may not be able to establish a pediatric specialty sales force in a cost effective manner or realize a positive return on this investment. We will also have to compete with other pharmaceutical and biotechnology companies to recruit, hire, train and retain sales and marketing personnel. If we elect to rely on third parties to sell our product candidates in the U.S., we may receive less revenue than if we sold our product candidates directly. In addition, we may have little or no
control over the sales efforts of those third parties. In the event we are unable to develop our own sales force or collaborate with a third party to sell our product candidates, we may not be able to commercialize our product candidates which would negatively impact our ability to generate revenue.
The commercial success of our product candidates will depend upon attaining significant market acceptance of these products among physicians, patients, health care payors and the medical community.
None of our product candidates has been commercialized for any indication. Even if approved for sale by the appropriate regulatory authorities, physicians may not prescribe our product candidates, in which case we would not generate revenue or become profitable. Market acceptance of our lead product candidate, faropenem medoxomil, and any future product candidates by physicians, healthcare payors and patients will depend on a number of factors, including:
•
the clinical indications for which the product candidate is approved;
•
acceptance by physicians and patients of each product candidate as a safe and effective treatment;
•
perceived advantages over alternative treatments;
•
the cost of treatment in relation to alternative treatments, including numerous generic antibiotics;
•
the extent to which the product candidate is approved for inclusion on formularies of hospitals and managed care organizations;
•
the extent to which bacteria develop resistance to the product candidate, thereby limiting its efficacy in treating or managing infections;
•
whether the product candidate is designated under physician treatment guidelines as a first-line therapy or as a second- or third-line therapy for particular infections;
•
the availability of adequate reimbursement by third parties;
•
relative convenience and ease of administration; and
•
prevalence and severity of side effects.
Even if faropenem medoxomil ultimately obtains regulatory approval, many of the above factors may be adversely impacted by the historical difficulty of obtaining any such approval and may create a negative perception among physicians and healthcare payors of the advantages or efficacy of faropenem medoxomil.
If our product candidates are unable to compete effectively with generic and branded antibiotics, our commercial opportunity will be reduced or eliminated.
If approved, our lead product candidate, faropenem medoxomil, will compete against both generic and branded community antibiotic therapies. The market for such products is very competitive and includes generic products, such as amoxicillin/clavulanate, and established branded products, such as Omnicef®, Zithromax®, Ketek® and Levaquin®, which are marketed by major pharmaceutical companies, all of which have significantly greater financial resources and expertise in research and development, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals, manufacturing and marketing approved products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large, established companies.
Over the next several years, our future products, if any, will face more competition in the form of generic versions of branded products of competitors that will lose their patent exclusivity. Many of the currently branded antibiotics will be sold as generics before we expect to be able to commercially launch faropenem medoxomil. Generic antibiotic therapies typically are sold at lower prices than branded antibiotics and are preferred by managed care providers of health services. As a result, managed care may place different constraints on formulary status and reimbursement at the time we expect to be able to commercially launch faropenem medoxomil. If we are unable to demonstrate to physicians that, based on experience, clinical data, side-effect profiles and other factors, our products are preferable to these generic antibiotic therapies, we may
have limited revenue potential due to formulary status. Our commercial opportunity will also be reduced or eliminated if our competitors develop and commercialize generic or branded antibiotics that are safer, more effective, have fewer side effects or are less expensive than our product candidates.
Daiichi Asubio owns a portfolio of patents related to faropenem compounds, including the faropenem parent compound, medoxomil and other faropenem prodrugs. We have licensed from Daiichi Asubio the patents to faropenem medoxomil and other faropenem prodrugs. These patents may not prevent competitors from developing other faropenem drugs that are not covered by the Daiichi Asubio patents. Beginning in 2008, when the Daiichi Asubio patents related to the faropenem parent compound expire, competitors may submit NDAs seeking approval of antibiotics containing the faropenem parent compound as the active ingredient. These applications would have to contain full reports of safety and efficacy data conducted by or for the applicants and could not in any way rely upon the safety and efficacy data utilized in the approval of faropenem medoxomil. In addition, as early as four years after the approval of a faropenem medoxomil NDA, if any, competitors could also file NDAs seeking approval of faropenem drugs that would likely require the applicant to conduct clinical trials in order to bring the product to market in the U.S., though the FDA may allow the applicant to rely in part on the FDA’s prior findings of safety and efficacy of faropenem medoxomil.
If product liability lawsuits are successfully brought against us or any future collaboration partners, we may incur substantial liabilities and may be required to limit commercialization of our product candidates.
We face an inherent risk of product liability lawsuits related to the testing of our product candidates, and will face an even greater risk if product candidates are introduced commercially. An individual may bring a liability claim against us if one of our product candidates causes, or merely appears to have caused, an injury. We have agreed to indemnify Nippon Soda from product liability claims under our commercial arrangement with it. If we cannot successfully defend ourselves against the product liability claim, we may incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:
•
decreased demand for our product candidates;
•
injury to our reputation;
•
withdrawal of clinical trial participants;
•
significant litigation costs;
•
substantial monetary awards to or costly settlement with patients;
•
product recalls;
•
loss of revenue; and
•
the inability to commercialize our product candidates.
We are highly dependent upon consumer perceptions of us, the faropenem medoxomil brand and the safety and quality of our products. We could be adversely affected if we or the faropenem medoxomil brand is subject to negative publicity. We could also be adversely affected if any of our products or any similar products distributed by other companies prove to be, or are asserted to be, harmful to consumers. Also, because of our dependence upon consumer perceptions, any adverse publicity associated with illness or other adverse effects resulting from consumers’ use or misuse of our products or any similar products distributed by other companies could have a material adverse impact on our results of operations.
We have global clinical trial liability insurance that covers our clinical trials up to a $5.0 million annual aggregate limit. Our current or future insurance coverage may prove insufficient to cover any liability claims brought against us. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for our product candidates. In addition, because of the increasing costs of insurance coverage, we may not be able to maintain insurance coverage at a reasonable cost or obtain insurance coverage that will be adequate to satisfy any liability that may arise.
We may be required to suspend or discontinue clinical trials due to side effects or other safety risks that could preclude approval of our product candidates.
Our clinical trials may be suspended at any time for a number of reasons. We may voluntarily suspend or terminate our clinical trials if at any time we believe that they present an unacceptable risk to participants. In addition, regulatory agencies may order the temporary or permanent discontinuation of our clinical trials at any time if they believe that the clinical trials are not being conducted in accordance with applicable regulatory requirements or that they present an unacceptable safety risk to participants.
Many antibiotics can produce significant side effects. Side effects associated with many current antibiotics include kidney and liver toxicities, heart rhythm abnormalities, photosensitivity, rash, and excessive flushing of the skin and central nervous system toxicities, such as seizures. In clinical trials, side effects of faropenem medoxomil have included gastrointestinal disorders (such as diarrhea, nausea and vomiting), nervous system disorders (such as dizziness and headaches), as well as infections and infestations (such as pneumonia and vaginal mycosis). Later clinical trials in a larger patient population could reveal other side effects. These or other side effects could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA or other regulatory authorities stopping further development of or denying approval of our product candidates for any or all targeted indications. Even if we believe our product candidates are safe, our data is subject to review by the FDA, which may disagree with our conclusions. Moreover, we could be subject to significant liability if any volunteer or patient suffers, or appears to suffer, adverse health effects as a result of participating in our clinical trials.
We rely on third parties to conduct 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 our product candidates.
We have agreements with third-party contract research organizations to provide monitors for and to manage data for our on-going clinical programs. We and our contract research organizations are required to comply with current Good Clinical Practices, or GCPs, regulations and guidelines enforced by the FDA for all of our products in clinical development. The FDA enforces GCPs through periodic inspections of trial sponsors, principal investigators and trial sites. If we or our contract research organizations fail to comply with applicable GCPs, the clinical data generated in our clinical trials may be deemed unreliable and the FDA may require us to perform additional clinical trials before approving our marketing applications. We cannot ensure that, upon inspection, the FDA will determine that any of our clinical trials comply with GCPs. In addition, our clinical trials must be conducted with product produced under cGMP regulations, and will require a large number of test subjects. Our failure to comply with these regulations may require us to repeat clinical trials, which would delay the regulatory approval process.
Our contract research organizations have the right to terminate their agreements with us in the event of an uncured material breach. In addition, some of our contract research organizations have an ability to terminate their respective agreements with us if it can be reasonably demonstrated that the safety of the subjects participating in our clinical trials warrants such termination, if we make a general assignment for the benefit of our creditors, or if we are liquidated. If any of our relationships with these third-party contract research organizations terminate, we may not be able to enter into arrangements with alternative contract research organizations. If contract research organizations do not successfully carry out their contractual duties or obligations or meet expected deadlines, if they need to be replaced, or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols, regulatory requirements, or for other reasons, our clinical trials may be extended, delayed or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates. As a result, our financial results and the commercial prospects for our product candidates would be harmed, our costs could increase and our ability to generate revenue could be delayed.
Our ability to pursue the development and commercialization of our product candidates depends upon the continuation of our licenses from third parties.
Our license agreement with Daiichi Asubio provides us with an exclusive license to develop and sell any products with the compound faropenem medoxomil as an active ingredient for any indication in the U.S. and Canada. Either we or Daiichi Asubio may terminate the license agreement immediately 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 60 days following written notice. We are currently in discussions with Daiichi Asubio regarding the future development plans for faropenem medoxomil. If there is any dispute between us and Daiichi Asubio regarding our rights or obligations under the license agreement, including diligence obligations, the achievement of milestones or interpretation of other material provisions, we risk litigation and our business may be adversely affected. If our license agreement with Daiichi Asubio were terminated, we would lose our rights to develop and commercialize faropenem medoxomil.
If we fail to gain and maintain approval for our product candidates in international markets, our market opportunities will be limited.
Sales of our product candidates outside of the U.S. will be subject to foreign regulatory requirements governing clinical trials and marketing approval. Even if the FDA grants marketing approval for a product candidate, comparable regulatory authorities of foreign countries must also approve the manufacturing or marketing of the product candidate in those countries. Approval in the U.S., or in any other jurisdiction, does not ensure approval in other jurisdictions. Obtaining foreign approvals could result in significant delays, difficulties and costs for us and require additional trials and additional expenses. Regulatory requirements can vary widely from country to country and could delay the introduction of our products in those countries. Clinical trials conducted in one country may not be accepted by other countries and regulatory approval in one country does not mean that regulatory approval will be obtained in any other country. None of our product candidates is approved for sale in international markets and we do not have experience in obtaining regulatory approval in international markets. If we fail to comply with these regulatory requirements or to obtain and maintain required approvals, our target market will be reduced and our ability to generate revenue will be diminished.
We may not be able to enter into acceptable agreements to market and commercialize our product candidates in international markets.
If appropriate regulatory approvals are obtained, we intend to commercialize our product candidates in international markets through collaboration arrangements with third parties. If we decide to sell our product candidates in international markets, we may not be able to enter into any arrangements on favorable terms or at all. In addition, these arrangements could result in lower levels of income to us than if we marketed our product candidates entirely on our own. If we are unable to enter into a marketing arrangement for our product candidates in international markets, we may not be able to develop an effective international sales force to successfully commercialize those products in international markets. If we fail to enter into marketing arrangements for our products and are unable to develop an effective international sales force, our ability to generate revenue would be limited.
Even if we receive regulatory approval for our product candidates, we will be subject to ongoing significant regulatory obligations and oversight.
If we receive regulatory approval to sell our product candidates, the FDA and foreign regulatory authorities may impose significant restrictions on the indicated uses or marketing of such products, or impose ongoing requirements for post-approval studies. Following any regulatory approval of our product candidates, we will be subject to continuing regulatory obligations, such as safety reporting requirements, and additional post-marketing obligations, including regulatory oversight of the promotion and marketing of our products. If we become aware of previously unknown problems with any of our product candidates here or overseas or at our contract manufacturers’ facilities, a regulatory agency may impose restrictions on our products, our contract manufacturers or on us, including requiring us to reformulate our products, conduct additional clinical
trials, make changes in the labeling of our products, implement changes to, or obtain re-approvals of, our contract manufacturers’ facilities, or withdraw the product from the market. In addition, we may experience a significant drop in the sales of the affected products, our reputation in the marketplace may suffer and we may become the target of lawsuits, including class action suits. Moreover, if we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. Any of these events could harm or prevent sales of the affected products or could substantially increase the costs and expenses of commercializing and marketing these products.
Our corporate compliance program cannot guarantee that we are in compliance with all potentially applicable regulations.
The development, manufacturing, pricing, marketing, sales, and reimbursement of our product candidates, together with our general operations, are subject to extensive regulation by federal, state and other authorities within the U.S. and numerous entities outside of the U.S. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, including suspension or termination of clinical trials, the failure to approve a product candidate, restrictions on our product candidates or manufacturing processes, withdrawal of products from the market, significant fines, or other sanctions or litigation, and exclusion of our products from the Medicare/Medicaid payment system. As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002, some of which have only recently been adopted, and all of which are subject to change. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices and continue to update the program in response to newly implemented or changing regulatory requirements, we cannot ensure that we are or will be in compliance with all potentially applicable regulations. For example, we cannot assure that in the future our management will not find a material weakness in connection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot ensure that we could correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our annual reports filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail to comply with the Sarbanes-Oxley Act or any other regulations we could be subject to a range of consequences, including restrictions on our ability to sell equity or otherwise raise capital funds, significant fines, enforcement or other civil or criminal actions by the Securities and Exchange Commission or delisting by the NASDAQ Global Market or other sanctions or litigation. In addition, if we disclose any material weakness in our internal control over financial reporting or other consequence of failing to comply with applicable regulations, this may cause our stock price to decline.
Reimbursement may not be available for our product candidates, which could diminish our sales or affect our ability to sell any future products profitably.
Market acceptance and sales of our product candidates will depend on reimbursement policies and may be affected by future health care reform measures. Government authorities and third-party payors, such as private health insurers and health maintenance organizations, decide which drugs they will pay for and establish reimbursement levels. We cannot be sure that reimbursement will be available for any of our product candidates. Also, we cannot be sure that reimbursement amounts will not reduce the demand for, or the price of, our products. We have not commenced efforts to have our product candidates reimbursed by government or third party payors. If reimbursement is not available or is available only to limited levels, we may not be able to commercialize our products.
In both the U.S. and certain foreign jurisdictions, there have been a number of legislative and regulatory changes to the health care system that could impact our ability to sell our products profitably. In particular, the Medicare Modernization Act of 2003 added an outpatient prescription drug benefit to Medicare, which became effective on January 1, 2006. Drug benefits under this provision are administered through private plans that negotiate price concessions from pharmaceutical manufacturers. We cannot be certain that faropenem
medoxomil will successfully be placed on the list of drugs covered by particular health plans or plan formularies, nor can we predict the negotiated price for faropenem medoxomil, which will be determined by market factors. With respect to Medicaid, the Deficit Reduction Act of 2005 made several changes to the way pharmacies are reimbursed under Medicaid, most of which went into effect on January 1, 2007. These changes could lead to reduced drug prices. Many states have also created preferred drug lists and include drugs on those lists only when the manufacturers agree to pay a supplemental rebate. If faropenem medoxomil or our other product candidates are not included on these preferred drug lists, physicians may not be inclined to prescribe them to their Medicaid patients.
As a result of legislative proposals and the trend towards managed health care in the U.S., third-party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement of new drugs. They may also refuse to provide any coverage of uses of approved products for medical indications other than those for which the FDA has granted market approvals. As a result, significant uncertainty exists as to whether and how much third-party payors will reimburse patients for their use of newly-approved drugs, which in turn will put pressure on the pricing of drugs. The availability of numerous generic antibiotics at lower prices than branded antibiotics, such as faropenem medoxomil, if it were approved for commercial introduction, can also be expected to substantially reduce the likelihood of reimbursement for faropenem medoxomil. We expect to experience pricing pressures in connection with the sale of our products due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals.
We may need to modify the size of our organization, and we may experience difficulties in managing either growth or restructuring.
We are a small company with 85 employees as of December 31, 2006. As our development and commercialization plans and strategies develop, we may need to either expand or reduce the size of our employee base for managerial, operational, sales, financial and other resources. Future growth would impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Future restructuring activities may involve significant changes to our drug development and growth strategies, our commercialization plans and other operational matters, including a significant reduction in our employee base. Any restructuring activity could result in disruption to our business, adversely affect the morale of our employees and make it more difficult to retain qualified personnel. Also, our management may have to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing either growth or restructuring activities. Our future financial performance and our ability to commercialize our product candidates and to compete effectively will depend, in part, on our ability to effectively manage any future growth or restructuring, as the case may be. To that end, we must be able to:
•
manage our development efforts effectively;
•
manage our clinical trials effectively;
•
integrate additional management, administrative, manufacturing and sales and marketing personnel, or reorganize these personnel;
•
maintain sufficient administrative, accounting and management information systems and controls; and
•
hire and train additional or replacement qualified personnel.
We may not be able to accomplish these tasks, and our failure to accomplish any of them could harm our financial results.
Risks Related to our Intellectual Property
It is difficult and costly to protect our proprietary rights, and we may not be able to ensure their protection.
Our commercial success will depend in part on obtaining and maintaining patent protection and trade secret protection of our product candidates, and the methods used to manufacture them, as well as successfully defending these patents against third-party challenges. Our ability to protect our product candidates from unauthorized making, using, selling, offering to sell or importation by third parties is dependent upon the extent to which we have rights under valid and enforceable patents or trade secrets that cover these activities.
As of December 31, 2006, we have exclusively licensed from Daiichi Asubio two issued U.S. patents, one issued foreign patent and one pending U.S. patent application covering faropenem medoxomil, a prodrug of faropenem. The two issued U.S. patents covering faropenem medoxomil also cover other potential prodrugs of faropenem but do not cover all potential faropenem-based antibiotic compounds. We do not and have not had any control over the filing or prosecution of these patents or patent applications. We cannot be certain that such prosecution efforts have been or will be conducted in compliance with applicable laws and regulations or will result in valid and enforceable patents. In addition, our enforcement of these faropenem medoxomil patents or defense of any claims asserting the invalidity of these patents would be subject to the cooperation of Daiichi Asubio. Although Daiichi Asubio has agreed to cooperate with us in such efforts, if requested, we cannot be assured that Daiichi Asubio would devote sufficient efforts to cooperate with us in these circumstances.
The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date in the U.S. The biotechnology patent situation outside the U.S. is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the U.S. and other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our licensed patents, our patents or in third-party patents.
Daiichi Asubio owns a portfolio of patents related to faropenem compounds, including the faropenem parent compound, faropenem medoxomil and other faropenem prodrugs. We have licensed from Daiichi Asubio the patents to faropenem medoxomil and other faropenem prodrugs. These patents may not prevent competitors from developing other faropenem drugs that are not covered by the Daiichi Asubio patents. Beginning in 2008, when the Daiichi Asubio patents expire, competitors may submit NDAs seeking approval of antibiotics containing the faropenem parent compound as the active ingredient. These applications would have to contain full reports of safety and efficacy data conducted by or for the applicants and could not in any way rely upon the safety and efficacy data utilized in the approval of faropenem medoxomil. In addition, as early as four years after the approval of a faropenem medoxomil NDA, if any, generic and branded competitors could also file NDAs seeking approval of faropenem drugs that would likely require the applicant to conduct clinical trials in order to bring the product to market in the U.S., though the FDA may allow the applicant to rely in part on the FDA’s prior findings of safety and efficacy of faropenem medoxomil. To the extent that any competitor relies on any of the findings of safety or efficacy with respect to faropenem medoxomil, the competitor will have to certify that its compound either does not infringe our patents or that our patents are invalid.
The degree of future protection for our proprietary rights is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:
•
others may be able to make compounds that are similar to our product candidates but that are not covered by the claims of our licensed patents, or for which we are not licensed under our license agreements;
•
we or our licensors might not have been the first to make the inventions covered by our pending patent application or the pending patent applications and issued patents of our licensors;
•
we or our licensors might not have been the first to file patent applications for these inventions;
•
others may independently develop similar or alternative technologies or duplicate any of our technologies;
•
it is possible that our pending patent applications will not result in issued patents;
•
our issued patents and the issued patents of our licensors may not provide us with any competitive advantages, or may be held invalid or unenforceable as a result of legal challenges by third parties;
•
we may not develop additional proprietary technologies that are patentable; or
•
the patents of others may have an adverse effect on our business.
We also may rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third party illegally obtained and is using any of our trade secrets is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the U.S. are sometimes less willing to protect trade secrets. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how.
We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights and we may be unable to protect our rights to, or use, our technology.
If we choose to go to court to stop someone else from using the inventions claimed in our patents or our licensed patents, that individual or company has the right to ask the court to rule that these patents are invalid and/or should not be enforced against that third party. These lawsuits are expensive and would consume time and other resources even if we were successful in stopping the infringement of these patents. In addition, there is a risk that the court will decide that these patents are not valid and that we do not have the right to stop the other party from using the inventions. There is also the risk that, even if the validity of these patents is upheld, the court will refuse to stop the other party on the ground that such other party’s activities do not infringe our rights to these patents.
Furthermore, a third party may claim that we or our manufacturing or commercialization partners are using inventions covered by the third party’s patent rights and may go to court to stop us from engaging in our normal operations and activities, including making or selling our product candidates. These lawsuits are costly and could affect our results of operations and divert the attention of managerial and technical personnel. There is a risk that a court would decide that we or our commercialization partners are infringing the third party’s patents and would order us or our partners to stop the activities covered by the patents. In addition, there is a risk that a court will order us or our partners to pay the other party damages for having violated the other party’s patents. We have indemnified our commercial partners against patent infringement claims. The biotechnology industry has produced a proliferation of patents, and it is not always clear to industry participants, including us, which patents cover various types of products or methods of use. The coverage of patents is subject to interpretation by the courts, and the interpretation is not always uniform. If we are sued for patent infringement, we would need to demonstrate that our products or methods of use either do not infringe the patent claims of the relevant patent and/or that the patent claims are invalid, and we may not be able to do this. Proving invalidity, in particular, is difficult since it requires a showing of clear and convincing evidence to overcome the presumption of validity enjoyed by issued patents.
Because some patent applications in the U.S. may be maintained in secrecy until the patents are issued, because patent applications in the U.S. and many foreign jurisdictions are typically not published until eighteen months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our licensors’ issued patents or our pending applications or our licensors’ pending applications, or that we or our licensors were the first to invent the technology. Our competitors may have filed, and may in the future file,
patent applications covering technology similar to ours. Any such patent application may have priority over our or our licensors’ patent applications and could further require us to obtain rights to issued patents covering such technologies. If another party has filed a U.S. patent application on inventions similar to ours, we may have to participate in an interference proceeding declared by the U.S. Patent and Trademark Office to determine priority of invention in the U.S. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful, resulting in a loss of our U.S. patent position with respect to such inventions.
Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.
Risks Related to Ownership of our Common Stock
The market price of our common stock is highly volatile.
Prior to June 28, 2006, there was no public market for our common stock. We cannot assure you that an active trading market for our common stock will exist at any time. You may not be able to sell your shares quickly or at the market price if trading in our common stock is not active. The trading price of our common stock has been highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:
•
announcement of FDA approval or non-approval of our product candidates, or specific label indications for their use, or delays in the FDA review process;
•
actions taken by regulatory agencies with respect to our product candidates, clinical trials, manufacturing process or sales and marketing activities;
•
termination of significant agreements;
•
changes in laws or regulations applicable to our products, including but not limited to clinical trial requirements for approvals;
•
the success of our development efforts and clinical trials;
•
the success of our efforts to acquire or in-license additional products or product candidates;
•
developments concerning our collaborations, including but not limited to those with our sources of manufacturing supply and our commercialization partners;
•
actual or anticipated variations in our quarterly operating results;
•
announcements of technological innovations by us, our collaborators or our competitors;
•
new products or services introduced or announced by us or our commercialization partners, or our competitors and the timing of these introductions or announcements;
•
actual or anticipated changes in earnings estimates or recommendations by securities analysts;
•
conditions or trends in the biotechnology and biopharmaceutical industries;
•
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
•
general economic and market conditions and other factors that may be unrelated to our operating performance or the operating performance of our competitors;
•
changes in the market valuations of similar companies;
•
sales of common stock or other securities by us or our stockholders in the future;
•
additions or departures of key scientific or management personnel;
•
developments relating to proprietary rights held by us or our competitors;
•
disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;
•
trading volume of our common stock; and
•
sales of our common stock by us or our stockholders.
In addition, the stock market in general and the market for biotechnology and biopharmaceutical companies in particular have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market, securities class-action litigation has often been instituted against companies. Such litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which could materially adversely affect our business and financial condition.
We are at risk of securities class action litigation or may become subject to stockholder activism efforts that each could cause material disruption to our business.
In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because biotechnology and biopharmaceutical companies have experienced significant stock price volatility in recent years. Further, certain influential institutional investors and hedge funds have taken steps to involve themselves in the governance and strategic direction of certain companies that were perceived to be operating sub-optimally due to governance or strategic related disagreements with such stockholders. Recently, our stock price decreased significantly following our announcement that the FDA had issued a non-approvable letter for our lead product candidate, faropenem medoxomil. If we face such litigation or stockholder activism efforts due to this recent development or any future development affecting us, it could result in substantial costs and a diversion of management’s attention and resources, which could harm our business.
Our principal stockholders and management own a significant percentage of our stock and are able to exercise significant influence over matters subject to stockholder approval.
Our executive officers, directors and principal stockholders, together with their respective affiliates, currently own approximately 49% of our voting stock, including shares subject to outstanding options and warrants, and we expect this group will continue to hold a significant percentage of our outstanding voting stock. Accordingly, these stockholders will likely be able to have a significant impact on the composition of our board of directors and continue to have significant influence over our operations. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material and adverse effect on the market value of our common stock.
We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Global Market, have imposed various new requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more
expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain the same or similar coverage.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, commencing in fiscal 2007, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management efforts. We currently do not have an internal audit group, and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would require additional financial and management resources.
Substantial sales of our common stock in the public market could cause our stock price to fall.
Sales of a substantial number of shares of our common stock in the public market or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that sales may have on the prevailing market price of our common stock.
Substantially all of our stockholders that owned shares prior to our initial public offering that was completed on July 3, 2006 were subject to lock-up agreements with the underwriters of the offering that restricted the stockholders’ ability to transfer shares of our common stock until December 25, 2006. Subject to certain limitations, a significant portion of our total outstanding shares became eligible for sale upon expiration of the lock-up period. In addition, shares issuable upon exercise of options and warrants vested as of December 25, 2006 became eligible for sale at that time. Sales of stock by these stockholders could have a material adverse effect on the trading price of our common stock.
Certain holders of shares of our common stock and warrants to purchase shares of our common stock are entitled to rights with respect to the registration of their shares under the Securities Act. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares purchased by affiliates. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.
Future sales and issuances of our common stock or rights to purchase common stock, including pursuant to our equity incentive plans, could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to fall.
We expect that significant additional capital will be required in the future to continue our planned operations. To the extent we raise additional capital by issuing equity securities, our stockholders may experience substantial dilution. We may sell common stock in one or more transactions at prices and in a manner we determine from time to time. If we sell common stock in more than one transaction, stockholders who purchase stock may be materially diluted by subsequent sales. Such sales may also result in material dilution to our existing stockholders, and new investors could gain rights superior to existing stockholders. Pursuant to our 2006 Equity Incentive Plan, our management is authorized to grant stock options to our employees, directors and consultants, and our employees are eligible to participate in our 2006 Employee Stock Purchase Plan. The number of shares available for future grant under our 2006 Equity Incentive Plan can, subject to approval of our board of directors, increase each April 1 by the lesser of five percent of the number of total outstanding shares of our common stock on December 31 of the preceding year or
1,325,448 shares, subject to the ability of our board of directors to reduce such increase. Additionally, the number of shares reserved for issuance under our 2006 Employee Stock Purchase Plan can, subject to approval of our board of directors, increase each April 1 by the lesser of one percent of the number of total outstanding shares of our common stock on December 31 of the prior year or 101,957 shares, subject to the ability of our board of directors to reduce such increase. In addition, we also have warrants outstanding to purchase shares of our common stock. Our stockholders will incur dilution upon exercise of any outstanding stock options or warrants.
All of the shares of common stock sold in our initial public offering are freely tradable without restrictions or further registration under the Securities Act of 1933, as amended, except for any shares purchased by our affiliates as defined in Rule 144 under the Securities Act. Rule 144 defines an affiliate as a person who directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, us and would include persons such as our directors and executive officers.
Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.
Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income may be limited. We believe, based on an analysis of historical equity transactions under the provisions of Section 382, that ownership changes have in fact occurred at two points since our inception. Such ownership changes can have the impact of limiting the utilization of net operating losses in future periods. We are finalizing our evaluation as to whether such ownership changes will result in the loss of our net operating loss carryforwards that existed on the date of the ownership change. We may also experience ownership change in the future as a result of subsequent shifts in our stock ownership.
Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders.
Provisions in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions include:
•
authorizing the issuance of “blank check” preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval;
•
limiting the removal of directors by the stockholders;
•
prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;
•
eliminating the ability of stockholders to call a special meeting of stockholders; and
•
establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at stockholder meetings.
In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with an interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder, unless such transactions are approved by our board of directors. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2.
PROPERTIES
Our facilities currently consist of approximately 52,000 square feet of laboratory and office facilities located at our headquarters in Louisville, Colorado, which is leased until September 2011, and approximately 8,000 square feet of office facilities for our clinical and regulatory group in Milford, Connecticut, which is leased until May 2010.
We believe that these facilities are adequate to meet our current needs. We believe that if additional space beyond the space currently under lease is needed in the future, such space will be available on commercially reasonable terms as needed.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are not currently subject to any material pending legal proceedings.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
Executive Officers of the Registrant
Our executive officers are as follows:
Kenneth J. Collins has served as our President, Chief Executive Officer and a member of the board of directors since January 2002. From 1997 to 2001, Mr. Collins served as President of Pegasus Technology Ventures, a firm that advised and raised seed capital for early stage life sciences companies. From 1995 to 1996, Mr. Collins served as Chief Financial Officer and a member of the board of directors of Quark, Inc., a developer of desktop publishing software. Mr. Collins served as an Executive Vice President from 1992 to 1994 and Chief Financial Officer from 1983 to 1994 of Synergen, Inc., a biotechnology company. Mr. Collins holds a B.S. from the University of Notre Dame and an M.B.A. from the Harvard Business School.
Roger M. Echols, M.D. has served as our Chief Medical Officer since January 2005. From 1997 to 2004, Dr. Echols served as Vice President of Infectious Disease Clinical Research and Development at Bristol Myers Squibb. He served as Medical Director at Immunex Corporation from 1996 to 1997 and as Medical Director at Bayer Corporation from 1989 to 1996. Prior to joining the pharmaceutical industry, Dr. Echols was Head of the Division of Infectious Diseases at Albany Medical College and an attending physician at Albany Medical College. Dr. Echols holds a B.A. from Yale University and an M.D. from Tufts University School of Medicine and trained in internal medicine and infectious diseases at the University of New Mexico.
Nebojsa Janjic, Ph.D. has served as our Secretary since December 2000 and as our Chief Scientific Officer since June 2005. Dr. Janjic joined us at inception and served as our Senior Vice President and Vice President, Research and Development until June 2005. From 1992 to 1999, Dr. Janjic held various positions at NeXstar Pharmaceuticals, Inc., a biotechnology company, most recently serving as Senior Director, Drug Discovery. Dr. Janjic holds B.S. and Ph.D. degrees from the University of Washington and completed postdoctoral training at the Scripps Research Institute.
Peter W. Letendre, Pharm.D. has served as our Chief Commercial Officer since March 2005. From October 2002 until February 2005, Dr. Letendre held various positions at Abbott Laboratories, most recently as Vice President and General Manager of the anti-infective division from October 2002 until July 2004. From
August 1990 to September 2002, Dr. Letendre held a number of marketing positions with SmithKline Beecham and GlaxoSmithKline Pharmaceuticals, including Marketing Director for the diabetes and metabolism division from 1998 to 2000. From 1988 to 1990, Dr. Letendre served as the Associate Dean of Clinical Practice at Southeastern University of the Health Sciences. Dr. Letendre holds B.S. and Doctor of Pharmacy degrees from the Massachusetts College of Pharmacy and Allied Health Sciences.
Donald J. Morrissey, Jr. has served as our Senior Vice President, Corporate Development since March 2006 and, prior to that, as Vice President, Corporate Development since 2002. From 1997 to 2002, Mr. Morrissey held various positions with Caliper Technologies, most recently as Vice President, Legal Affairs and Business Development from September 2001 to November 2002. From 1992 to 1997, Mr. Morrissey was a business attorney with Cooley Godward LLP. Mr. Morrissey holds a B.A. from the University of Colorado and a J.D. from the University of Southern California Law School.
Mark L. Smith has served as our Chief Financial Officer and Treasurer since March 2006. From August 1999 to March 2006, Mr. Smith held financial executive capacities at Nabi Biopharmaceuticals, including serving as Senior Vice President, Finance, Chief Financial Officer and Chief Accounting Officer from 2001 to March 2006. From 1998 to 1999, Mr. Smith served as Vice President of Finance and Administration and Chief Financial Officer of Neuromedical Systems, Inc. From 1996 to 1998, Mr. Smith served in various financial executive capacities at Genzyme Corporation. From 1991 to 1996, Mr. Smith held various positions at Genetrix, Inc., most recently as its Chief Financial Officer. Before joining Genetrix, Inc., Mr. Smith practiced with the accounting firm of PricewaterhouseCoopers LLP in both the U.S. and Australia. Mr. Smith holds a B.A. in Accounting from the Canberra College of Advanced Education in Australia.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock and Dividend Policy
Our common stock began trading on the Nasdaq Global Market under the symbol RDYN on June 28, 2006. The following table sets forth the high and low sales prices for our common stock (based upon intra-day trading) as reported by the Nasdaq Global market since June 28, 2006:
The number of record holders of our common stock on March 15, 2007 was approximately 1,256. No cash dividends have been previously paid on our common stock and none are anticipated in 2007.
Recent Sales of Unregistered Securities
None
Use of Proceeds from the Sale of Registered Securities
After deducting expenses of the initial public offering of our common stock in 2006 pursuant to our Registration Statement on Form S-1 (Reg. No. 333-133021) declared effective by the Securities and Exchange Commission on June 28, 2006 (the “Offering”), we received net offering proceeds of approximately $44.5 million. As of December 31, 2006, we have used approximately $20.7 million of the net proceeds of the Offering to fund our operations, including clinical trials related to faropenem medoxomil, clinical trials related to REP8839, activities related to the development of our preclinical product candidates, and general corporate
purposes. The remainder of the net proceeds from the Offering are invested in various interest-bearing instruments and accounts or marketable securities. We plan to allocate more proceeds from the Offering to our faropenem development activities and discovery research programs than was originally contemplated by the use of proceeds from the Offering as described in our final prospectus filed with the SEC pursuant to Rule 424(b) with respect to the Offering.
No payments were made to directors, officers or persons owning ten percent or more of our common stock or to their associates, or to our affiliates, other than payments in the ordinary course of business to officers for salaries and to non-employee directors as compensation for board or board committee service.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA (In Thousands, Except for Net Loss Per Share) (1)
The following selected financial data should be read together with our financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report. The selected financial data in this section is not intended to replace our financial statements and the accompanying notes. Historical results are not necessarily indicative of operating results to be expected in the future. All amounts in the following table are expressed in thousands, except for per share data.
The selected financial data presented below for each year in the four years ended December 31, 2006, are derived from our financial statements, which have been audited for 2006, 2005, 2004 and 2003 by KPMG LLP registered public accounting firm, and are qualified by reference to such Financial Statements and Notes thereto. The financial data for 2002 is derived from our unaudited financial statements. The statements of operations data for the years ended December 31, 2006, 2005 and 2004 and the balance sheet data as of December 31, 2006 and 2005 are derived from our audited financial statements appearing elsewhere in this Annual Report on Form 10-K. The statements of operations data for the year ended December 31, 2003 and the balance sheet data as of December 31, 2004 and 2003 are derived from our audited financial statements not included in this Annual Report. The statements of operations data for the year ended December 31, 2002 and balance sheet data as of December 31, 2002 are derived from our unaudited financial statements also not included in this Annual Report. We adopted the provisions of SFAS 123(R) on January 1, 2006, and our results for the year ended December 31, 2006 reflect $1.2 million of stock-based compensation expense.
(1)
Please see Note 2 to our financial statements for an explanation of the method used to calculate the net loss attributable to common stockholders per share and the number of shares used in the computation of the per share amounts.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with our financial statements and the notes to those statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under Part I, Item 1A and elsewhere in this report, our actual results may differ materially from those anticipated in these forward-looking statements. See “Special Note Regarding Forward-Looking Statements” under Part I, Item 1.
Overview
We are a biopharmaceutical company initially focused on discovering, developing, in-licensing and commercializing innovative anti-infective products. Our lead product candidate, faropenem medoxomil, is a novel oral community antibiotic. Since our inception, we have focused on the in-license and acquisition of technology acquired as in-process research and development, the selection of product candidates for pre-clinical testing, and the manufacture of clinical trial materials. The majority of our activities have been in support of the development of faropenem medoxomil and REP8839. On February 10, 2006, upon entering into a collaboration and commercialization agreement with Forest Laboratories, we were no longer considered a development stage company.
We submitted a new drug application, or NDA, in December 2005 for faropenem medoxomil based on 11 Phase III studies for the following adult indications: acute bacterial sinusitis; community-acquired pneumonia; acute exacerbation of chronic bronchitis; and uncomplicated skin and skin structure infections. This submission included safety data for over 5,000 patients who have been treated with faropenem medoxomil. In October 2006, the FDA issued a non-approvable letter with respect to this NDA citing the need for further clinical trials for all indications, including clinical trials using a superiority design versus placebo or an active comparator drug for acute bacterial sinusitis and acute exacerbation of chronic bronchitis, more extensive microbiologic confirmation and consideration of alternate dosing regimens. Since then, we have engaged in ongoing discussions with the FDA directed at determining the specific clinical trial designs required to obtain approval for the community respiratory tract infection indications of acute bacterial sinusitis, acute exacerbation of chronic bronchitis and community acquired pneumonia. Although a future partner may pursue the indication for uncomplicated skin and skin structure infections, the focus of our current activities is to clarify the approval process for faropenem medoxomil in the treatment of community respiratory tract infections. Based on the FDA’s recommendations in the non-approvable letter, as well as our ongoing discussions, we anticipate that comparator studies demonstrating that faropenem medoxomil is not inferior to
currently approved products for the treatment of community acquired pneumonia will be required for approval in this indication. If we seek approval for faropenem medoxomil to treat acute bacterial sinusitis and acute exacerbation of chronic bronchitis in addition to community acquired pneumonia, the faropenem medoxomil adult program may be anchored on at least two clinical trials for the treatment of community acquired pneumonia with single clinical trials using a superiority clinical trial design in acute bacterial sinusitis and acute exacerbation of chronic bronchitis. We anticipate that we will conduct superiority studies comparing treatment with faropenem medoxomil to placebo for acute bacterial sinusitis and continue our ongoing Phase III clinical trial for treatment of acute exacerbation of chronic bronchitis comparing treatment with faropenem medoxomil to placebo, which design is intended to meet the FDA’s new requirements. We further understand that clinical trials for community respiratory indications will include a requirement for minimum levels of microbiologic confirmation of physician assessed clinical outcomes. Future clinical trials of faropenem medoxomil will be conducted using the 600 mg, twice per day, dose. The clinical trials included in the NDA submitted in December 2005 were conducted using a 300 mg, twice per day, dose. We believe that this higher dose may offer the potential for even greater efficacy than the lower dose.
In February 2006, we entered into a collaboration and commercialization agreement with Forest Laboratories to co-develop and co-market faropenem medoxomil in the U.S. Under this agreement, we received upfront and milestone payments totaling $60 million in 2006. On February 6, 2007, we announced that our collaboration and commercialization agreement with Forest Laboratories would terminate. As a result, we will reacquire all rights to faropenem medoxomil previously granted to Forest Laboratories. There are no penalty fees incurred by either us or Forest Laboratories in connection with the termination of the agreement and all amounts received by us under the agreement are non-refundable. Due to the termination of our Forest Laboratories collaboration agreement, our prospects for near term future revenues are substantially uncertain. We currently intend to seek a new partner for faropenem medoxomil and use our cash, cash equivalents, short-term investments and interest earned on these balances toward the funding necessary to support our planned activities. We currently plan to limit our faropenem medoxomil adult clinical trial activities to the completion of the ongoing Phase III placebo-controlled clinical trial for the treatment of acute exacerbation of chronic bronchitis until we have a partner for the faropenem medoxomil adult program.
Our second product candidate, REP8839, has exhibited promising activity in pre-clinical studies against S. aureus, including MRSA and mupirocin resistant strains of S. aureus. We are developing REP8839 for topical treatment of skin and wound infections. Our initial target indication will be impetigo, one of the most common skin infections among children. We submitted an investigational new drug, or IND, application for the clinical development of a REP8839/mupirocin combination product in May 2006 and commenced Phase I clinical testing in August 2006. Mupirocin is a widely used topical antibiotic. We will initially pursue development of REP8839 as a stand alone compound due to its activity against key pathogens in the treatment of skin and wound infections and a more straightforward regulatory approval process for the development of single drug products as compared to combination drug products. We retain worldwide rights to REP8839.
We are also pursuing the development of other novel anti-infective products based on our own research efforts. We have developed assays that identify compounds that inhibit bacterial DNA replication. The compounds may be useful to treat bacterial infections. We have also selected from a proprietary library several potential compounds for development to treat infections in hospital settings caused by Clostridium difficile (C. difficile) and are in advanced pre-clinical testing.
We completed our initial public offering on July 3, 2006. In connection with this offering, we issued 4,500,000 shares of common stock at an offering price of $10 per common share. On August 2, 2006, in accordance with the terms of our agreement with the underwriters of the initial public offering, we sold an additional 506,000 common shares at $10 per share, representing a partial exercise of their over-allotment options. Including the exercise of the over-allotment options, we issued a total of 5,006,000 shares of common stock in our initial public offering. Total proceeds received from the initial public offering, including exercise of the over-allotment allocation, were $44.5 million, net of underwriters’ discount and offering costs.
We have incurred significant operating losses since our inception on December 6, 2000, and, as of December 31, 2006, we had an aggregate net loss of $100.4 million and accumulated net loss attributable to
common stockholders of $118.7 million. We have generated no revenue from product sales to date. We have funded our operations to date principally from the sale of our securities and payments received from Forest Laboratories under our former collaboration and commercialization agreement. We expect to continue to incur substantial operating losses for the next several years as we pursue our clinical trials and research and development efforts.
Former Collaboration with Forest Laboratories
In February 2006, we entered into a collaboration and commercialization agreement with Forest Laboratories to be our exclusive partner for the development and marketing of faropenem medoxomil in the U.S. On February 6, 2007, we announced that our collaboration and commercialization agreement with Forest Laboratories would terminate. This termination follows the issuance in October 2006 of a non-approvable letter by the FDA for our NDA for faropenem medoxomil that was submitted to the FDA in December 2005. As a result, we will reacquire all rights to faropenem medoxomil previously granted to Forest Laboratories. There are no penalty fees incurred by either us or Forest Laboratories in connection with the termination of the agreement and no amounts previously received by us under the agreement are refundable. We received $60 million in upfront and milestone payments from Forest Laboratories during the period of our collaboration. In accordance with the termination provisions of the collaboration agreement, Forest Laboratories is obligated to cooperate with us to assure a smooth transition of the faropenem medoxomil programs for a period of up to six months. For the initial 90 days of the transition period, the terms and conditions of the collaboration agreement remain in effect, including reimbursement of the majority of ongoing direct development costs for faropenem medoxomil, as defined. We have agreed with Forest Laboratories that such reimbursement would exclude costs incurred to reinitiate our clinical trial among patients with acute exacerbation of chronic bronchitis.
In accordance with our revenue recognition policy for upfront and milestone payments received under collaboration and commercialization agreements, we have recognized revenue for the payments received to date on a straight-line basis over a period of approximately 14 years, which was the estimated period of benefit. These upfront and milestone payments received are non-refundable. As no further obligations exist beyond a termination period in 2007, we anticipate recognizing the remaining unamortized deferred upfront and milestone fees as revenue in 2007. We also received reimbursements from Forest Laboratories for research and development and sales and marketing activities. These amounts have been recorded as revenue. This treatment reflected our role as principal in these transactions whereby we were responsible for selecting vendors, performing significant duties and bearing credit risk.
Comparison of Years Ended December 31, 2006 and 2005
Revenue. Revenue was $16 million for the year ended December 31, 2006, as compared to $0.4 million for the year ended December 31, 2005. The increase was due to revenue generated from our collaboration and commercialization agreement with Forest Laboratories which began in 2006. Revenue recognized during 2006 includes $3.8 million of license revenue, representing a portion of the upfront and milestone payments totaling $60 million, which was being recognized in our financial statements as of December 31, 2006 as revenue over the estimated period of performance of approximately 14 years, and $12.2 million of contract revenue for funded activity under our collaboration and commercialization agreement with Forest Laboratories. Revenue recognized in 2005 consists solely of license revenue generated from a research and development project that was completed in 2005. Based on the termination of our collaboration with Forest Laboratories and there being no further obligations beyond a termination period in 2007, we anticipate recognizing the remaining unamortized deferred revenue balance in 2007. Thus, increased revenues to be recognized in 2007 due to this acceleration of recognition of the Forest Laboratories payments are not indicative of a change in operating results, but the application of this accounting policy in light of the termination of our collaboration with Forest Laboratories. Due to the termination of this collaboration relationship, our prospects for other near term future revenues are substantially uncertain. Our ability to generate future revenue depends heavily on our ability to obtain a new collaboration partner for faropenem medoxomil on acceptable terms.
Research and Development Expense. Research and development expenses were $38.3 million for the year ended December 31, 2006 compared to $29.2 million for the year ended December 31, 2005. Research and development expenditures made to advance our product candidates and other research efforts during 2006 and 2005 were as follows (in thousands):
Costs incurred for the development of faropenem medoxomil were lower in 2006 compared to 2005 primarily reflecting decreased external clinical trial activity of $2.5 million, a $1.6 million decrease in costs of our internal research and development personnel and related costs and a $1 million decrease in expense incurred under our license agreement with Daiichi Asubio. These decreases were partially offset by $2.9 million of supply agreement contingencies that were recognized on October 20, 2006 when the FDA issued a non-approvable letter for the NDA we filed for faropenem medoxomil. During 2006, we continued to support our ongoing placebo controlled Phase III trial among patients with acute exacerbation of chronic bronchitis and our Phase II dose ranging clinical trial among pediatric patients with acute otitis media. During 2005, in addition to the thorough QT study completed for faropenem medoxomil in connection with our NDA submission we incurred significant external clinical research organization expenses supporting preparation of the NDA for faropenem medoxomil that was filed with the FDA in December 2005.
In 2006, costs to support our REP8839 program increased by $4.8 million compared to 2005 following initiation of our Phase I clinical trials program for this compound in July 2006, which resulted in increased external clinical trial costs of $1.9 million and internal personnel costs of $0.7 million. In 2006 we also incurred $1.5 million under our June 2003 purchase agreement with GlaxoSmithKline PLC, or GSK, due upon filing of our IND related to REP8839 with the FDA that was accounted for as research and development expense. We have no further financial obligations due to GSK under this agreement.
In 2006, other research and development costs increased by $5.8 million compared to 2005. Costs of internal research and development personnel and related costs increased by $2.2 million as we increased our research and development personnel in support of our expanded development activities specifically related to our C. difficile and DNA replication inhibitors programs. Other costs in support of these activities included external pre-clinical research, consulting, services and chemicals, compounds and laboratory costs that increased by $2 million.
Clinical development timelines, likelihood of success and associated costs are uncertain and therefore vary widely. Although we are currently focused primarily on faropenem medoxomil for the treatment of community-acquired respiratory tract infections and have commenced the clinical trials program for an oral liquid formulation of faropenem medoxomil for treatment of acute otitis media in pediatric patients, we anticipate that we will make determinations as to which research and development projects to pursue and how much funding to direct toward each project on an on-going basis in response to the guidance we receive through meetings with the FDA regarding each intended indication for faropenem medoxomil and the scientific and clinical success of each of our product candidates.
Due to the risks inherent in the clinical trial process, development completion dates and costs will vary significantly for each product candidate and are difficult to estimate. The lengthy regulatory approval process requires substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals for our product candidates could cause the costs of our research and development to increase and have a material adverse effect on our results of operations. We cannot be certain when any cash flows from our current product candidates will commence.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $12.2 million for the year ended December 31, 2006, as compared to $5.3 million for the year ended December 31, 2005. The increase was primarily due to increased personnel and related costs of $4.3 million which resulted from additional staff required to support our commercial organization and administrative and finance personnel, costs of recruiting and relocating personnel, costs associated with the initial adoption of SFAS 123(R), Share-based Payment, of $0.8 million, as well as $0.8 million in additional legal, accounting, insurance and other professional costs related to compliance obligations associated with being a public company. Market research expenses also increased by $1 million, principally related to market research associated with faropenem medoxomil and REP8839. We expect that selling, general and administrative expenses will remain relatively the same in 2007.
Investment Income, net. Investment income was $6 million for the year ended December 31, 2006, as compared to $0.7 million for the year ended December 31, 2005. The increase was primarily due to higher overall cash available for investing following receipt of $60 million under our collaboration and commercialization agreement with Forest Laboratories in the first quarter of 2006 and $44.5 million in net proceeds from our initial public offering completed in the third quarter of 2006.
Interest Expense. Interest expense was $14 thousand for the year ended December 31, 2006, as compared to $0.1 million for the year ended December 31, 2005. The decrease was due to payment in full of our equipment loan and security agreement during the first quarter of 2006.
Other Expense, net. Other expense was $0.7 million for the year ended December 31, 2006, as compared to $0.2 million for the year ended December 31, 2005. The increase was primarily due to the recognition of approximately $0.4 million in foreign currency losses associated with our foreign currency denominated payables.
Comparison of Years Ended December 31, 2005 and 2004
Revenue. Revenue was $0.4 million for the year ended December 31, 2005, as compared to $0.8 million for the year ended December 31, 2004. The decrease was primarily due to the completion of a research and development project in 2005.
Research and Development Expense. Research and development expenses were $29.2 million for the year ended December 31, 2005 compared to $16.3 million for the year ended December 31, 2004. Research and development expenditures made to advance our product candidates and other research efforts during 2005 and 2004 were as follows (in thousands):
Costs incurred for the development of faropenem medoxomil were $12.1 million higher in 2005 compared to 2004 primarily reflecting increases in external clinical trial activity of $7 million and pre-clinical trial activity of $0.7 million. During 2005, we commenced clinical trials for our placebo controlled Phase III trial among patients with acute exacerbation of chronic bronchitis and our Phase II dose ranging clinical trial among pediatric patients with acute otitis media. The cost of our internal research and development personnel increased by $3.3 million in 2005 compared to 2004 as we increased our clinical and regulatory head count in support of our clinical development activities. During 2004, our clinical and pre-clinical efforts were focused primarily on preparing to file our NDA for faropenem medoxomil in 2005 and designing clinical studies on faropenem medoxomil in additional areas, including a placebo controlled Phase III study for treatment of acute exacerbation of chronic bronchitis.
In 2005, costs to support our REP8839 program increased by $1 million compared to 2004 following initiation of our Phase I clinical trials program for this compound, which contributed to increased clinical and pre-clinical trial costs of $0.7 million and internal personnel costs of $0.3 million.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $5.3 million for the year ended December 31, 2005, as compared to $3 million for the year ended December 31, 2004. The increase was primarily due to increased personnel and related costs of $0.8 million related to staffing necessary to support our growth, costs of recruiting and relocating personnel and conducting market research of $0.7 million, as well as professional service expenses of $0.4 million, principally legal expenses related to patent filings and general corporate and licensing activities.
Investment Income, net. Investment income was $0.7 million for the year ended December 31, 2005, as compared to $0.2 million for the year ended December 31, 2004. The increase was due to higher overall cash available for investing throughout 2005 as compared to 2004. We sold shares of our Series C redeemable convertible preferred stock in preferred stock financings that were completed in April, August, September and November 2004 with net proceeds of $38.8 million and therefore did not have a full year of interest and other income on the proceeds from that financing in 2004. We sold shares of our Series D redeemable convertible preferred stock in a preferred stock financing that we completed in August 2005 with net proceeds of $60.2 million, which increased our average cash balance available for investment in 2005 compared to 2004.
Interest Expense. Interest expense was $0.1 million for the year ended December 31, 2005, as compared to $0.5 million for the year ended December 31, 2004. The decrease was due to a lower overall debt balance throughout 2004 as compared to 2005. Additionally, we no longer incurred interest expense on our convertible notes payable when these notes were converted to Series C redeemable convertible preferred stock in 2004.
Loss on Extinguishment of Convertible Notes Payable. In 2004, our convertible notes payable were converted into Series C redeemable convertible preferred stock. We recorded a loss of $0.5 million, which amount is equal to the difference between the carrying value of the convertible notes payable and the fair value of the Series C redeemable convertible preferred stock received on conversion.
Other Expense, net. Other expense was $0.2 million for the year ended December 31, 2005, as compared to no other expenses for the year ended December 31, 2005. The increase was primarily due to expenses associated with the initial measurement of preferred stock warrants as a liability in 2005 and subsequent adjustments to fair value.
Liquidity and Capital Resources
As of December 31, 2006, we had a total of $125.6 million in cash, cash equivalents and short-term investments. We have incurred losses since our inception and as of December 31, 2006, we had an accumulated deficit of $117 million. We have funded our operations to date principally from private placements of equity securities and convertible notes totaling $121.5 million, receipt of payments from Forest Laboratories under our collaboration and commercialization agreement totaling $67.5 million and from net proceeds received from our initial public offering of $44.5 million.
We completed an initial public offering of our common stock on July 3, 2006. In connection with this offering, we issued 4,500,000 shares of common stock at an offering price of $10 per share. On August 2, 2006, in accordance with the terms of our agreement with the underwriters of the initial public offering, we sold an additional 506,000 common shares at $10 per share, representing a partial exercise of their over-allotment options. Including the exercise of the over-allotment options, we issued a total of 5,006,000 shares of common stock in the initial public offering. Total proceeds received from the initial public offering, including exercise of the over-allotment allocation, were $44.5 million, net of underwriters’ discount and offering costs.
In February 2006, we entered into a collaboration and commercialization agreement with Forest Laboratories to be our exclusive partner for the development and marketing of faropenem medoxomil in the U.S. Under our agreement, in February 2006 we received an up-front payment of $50 million and in March 2006 we received a $10 million development milestone payment from Forest Laboratories. On February 6
2007, we announced that our collaboration and commercialization agreement with Forest Laboratories would terminate. There are no penalty fees incurred by either us or Forest Laboratories in connection with the termination of the agreement and no amounts previously received by us under the agreement are refundable. In accordance with the termination provisions of the collaboration agreement, Forest Laboratories is obligated to cooperate with us to assure a smooth transition of the faropenem medoxomil programs for a period of up to six months. For the initial 90 days of the transition period, the terms and conditions of the collaboration agreement remain in effect, including reimbursement of the majority of ongoing direct development costs for faropenem, as defined. Due to the termination of this collaboration relationship, our prospects for other near term future revenues are substantially uncertain. Our ability to generate future revenue depends heavily on our ability to obtain a new partner for faropenem medoxomil on acceptable terms.
In October 2006, the FDA issued a non-approvable letter for our December 2005 NDA for faropenem medoxomil. According to the non-approvable letter, the FDA recommends further clinical studies for all four indications that were the subject of the NDA including studies using superiority design for the indications of acute bacterial sinusitis and acute exacerbations of chronic bronchitis, additional microbiologic testing and consideration of alternate dosing regimens. We are discussing clinical plans with the FDA including the number of clinical trials needed for each indication, and currently expect that a minimum of two years will be required for completion of the clinical studies. We are evaluating the impact this FDA action will have on our liquidity and capital resources including costs of additional clinical trials and delays in product launch. As a result of this FDA action, in the fourth quarter of 2006 we recorded $2.9 million of expenses related to contingent obligations under our supply agreements as noted below.
In 2004, we entered into a license agreement with Daiichi Asubio to develop and commercialize faropenem medoxomil in the U.S. and Canada and we have the sole negotiation right to license such rights for the rest of the world except Japan. In consideration for the license, we paid an initial license fee of $3.8 million comprising $0.6 million paid in 2003 and $3.2 million paid in 2004. In December 2005, we recorded research and development expense for a milestone payable of $2.1 million in accordance with the terms of the license agreement following submission of an NDA for faropenem medoxomil to the FDA in December 2005. In February 2006, in conjunction with our entering into a license agreement with Forest Laboratories, this milestone payment was increased and we paid Daiichi Asubio an additional $1.1 million. The increased milestone amount was accounted for as research and development expense in 2006 when the modified terms of the license were finalized. Under the modified license agreement we are further obligated to future payments of up to ¥375 million (approximately $3.2 million as of December 31, 2006) upon filing of an NDA at a higher dose and up to ¥1,250 million (approximately $10.5 million as of December 31, 2006) in subsequent regulatory and commercial milestone payments for faropenem medoxomil. If we terminate our license agreement with Daiichi Asubio we will be obligated to pay a termination fee of up to ¥375 million (approximately $3.2 million as of December 31, 2006). Additionally, we are responsible for royalty payments to Daiichi Asubio based upon net sales of faropenem medoxomil. The license term extends to the later of: (i) the expiration of the last to expire of the licensed patents owned or controlled by Daiichi Asubio or (ii) 12 years after the first commercial launch of faropenem medoxomil. We have recorded payments made to date as research and development expense, as faropenem medoxomil has not been approved by the FDA.
Under a supply agreement entered into in December 2004 between Daiichi Asubio, Nippon Soda and us, we are obligated to purchase, and Nippon Soda is obligated to supply, all our commercial requirements of the faropenem medoxomil active pharmaceutical ingredient. During the three years following placement of an initial purchase order by us with Nippon Soda, we are obligated to make certain annual minimum purchase commitments to be determined initially by us and Nippon Soda at the time of a commercial launch. Since full commercial launch of an approved faropenem medoxomil drug has been delayed, we are obligated for certain delay compensation to Nippon Soda of up to ¥280 million (approximately $2.4 million as of December 31, 2006) per year. In September 2006, the supply agreement was amended concurrent with the execution of a new supply agreement between Forest Laboratories, Daiichi Asubio and Nippon Soda relating to the U.S. market for faropenem medoxomil. Under the amended supply agreement, certain of the Company’s obligations with respect to purchase commitments, delay compensation and other matters were waived and deemed satisfied by Forest Laboratories pursuant to its agreement. Under the February 2006 agreement with
Forest Laboratories, we were responsible for only the delay compensation that may accrue for any period ending on or prior to December 31, 2007. If we terminate the faropenem medoxomil program, under certain circumstances we may be obligated to reimburse Nippon Soda for up to ¥65 million (approximately $0.5 million as of December 31, 2006) in engineering costs. Additionally, in accordance with an agreement between Forest Laboratories and us signed in August 2006, we agreed to share equally in a ¥75 million (approximately $0.6 million) cancellation fee applicable to Forest Laboratories in its agreement with Daiichi Asubio and Nippon Soda Company. Based on the non-approvable letter we received from the FDA in October 2006, we incurred delay compensation and cancellation fees under these agreements totaling approximately $1.4 million in the fourth quarter of 2006. In 2007, following termination of our collaboration agreement with Forest Laboratories and the termination by Forest Laboratories of its supply agreements with Daiichi Asubio and Nippon Soda, previously suspended provisions in our direct agreements with Daiichi Asubio and Nippon Soda will no longer be suspended. Therefore, our obligations with respect to purchase commitments, delay compensation and other matters will no longer be waived.
In April 2005, we entered into a supply agreement for production of adult tablets of faropenem medoxomil with MEDA (formerly Tropon), which was amended in March 2006. Beginning in 2006, we became obligated to make annual minimum purchases of MEDA’s product of 2.3 million (approximately $3 million as of December 31, 2006). If in any year we have not satisfied this minimum purchase commitment, we are required to pay MEDA the shortfall amount. Fifty percent (50%) of the shortfall amount, if applicable, may be credited against future drug product purchases. We are required to buy all of our requirements for adult oral faropenem medoxomil tablets from MEDA until cumulative purchases exceed 22 million (approximately $29 million at December 31, 2006). If our agreement is terminated, under certain circumstances we may be obligated to pay up to 1.7 million (approximately $2.2 million as of December 31, 2006) in facility decontamination costs. In March 2006 when the agreement was amended, our obligations with respect to all purchase commitments and facility decontamination costs were suspended and deemed satisfied by Forest Laboratories pursuant to an agreement between MEDA and Forest Laboratories. Under our agreement with Forest Laboratories, we remained responsible for any shortfall amount in 2006 that may not be credited against future drug product purchases. Based on the non-approvable letter we received from the FDA in October 2006, we incurred expenses of $1.5 million under these agreements in the fourth quarter of 2006. In 2007, following termination of our collaboration agreement with Forest Laboratories and the termination by Forest Laboratories of its supply agreement with MEDA, all previously suspended provisions in our direct agreement with MEDA will no longer be suspended. Therefore our obligations with respect to purchase commitments and facility decontamination costs will no longer be waived.
In June 2003, we acquired certain intellectual property and supporting material from GSK in exchange for the issuance of 4,000,000 shares of our Series B convertible preferred stock at a fair value of $5 million. The acquisition was accounted for as a research and development expense. In June 2006, we paid GSK $1.5 million due upon filing of the IND for REP8839 under this agreement. We have no further financial obligations to GSK under this agreement.
We have not yet commercialized our product candidates or generated any revenue from product sales. We anticipate that we will continue to incur substantial net losses in the next several years as we develop our products, conduct and complete clinical trials, pursue additional product candidates, expand our clinical development team and corporate infrastructure and prepare for the potential commercial launch of our product candidates including faropenem medoxomil. We do not anticipate generating any product related revenue until we obtain FDA approval for faropenem medoxomil and we or a future partner launches the product, which may not occur.
The pace and outcome of our clinical development programs and the progress of our discovery research program are difficult to predict. These projects may require several years and substantial expenditures to complete and may ultimately be unsuccessful. If we enter into additional third party collaborations or acquire new product candidates, the timing and amounts of any related licensing cash flows or expenses are likely to be highly variable. As a result, we anticipate that our quarterly results will fluctuate for the foreseeable future. In the view of this variability and of our limited operating history, we believe that period-to-period
comparisons of our operating results are not meaningful and you should not rely on them as indicative of our future performance.
Based on the current status of our product development and commercialization plans, we believe that our current cash, cash equivalents, short-term investments and interest earned on these balances will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures through at least the next 12 months. This forecast of the period in which our financial resources will be adequate to support operations is a forward-looking statement and involves risks, uncertainties and assumptions. Our actual results and the timing of selected events may differ materially from those anticipated as a result of many factors, including but not limited to those discussed under “Risk Factors” in Part I, Item 1A of this report.
Our future capital uses and requirements depend on a number of factors, including but not limited to the following:
•
the rate of progress and cost of our pre-clinical studies, clinical trials and other research and development activities;
•
our ability to obtain a new partner for faropenem medoxomil on acceptable terms;
•
the scope and number of clinical development and research programs we pursue;
•
the costs, timing and outcomes of regulatory approvals;
•
the costs of establishing or contracting for marketing and sales capabilities, including the establishment of our own sales force;
•
the extent to which we acquire or in-license new products, technologies or businesses;
•
the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and
•
the terms and timing of any additional collaborative, strategic partnership or licensing agreements that we may establish.
If our available cash, cash equivalents, short-term investments and interest earned on these balances are insufficient to satisfy our liquidity requirements, or if we develop additional products or pursue additional applications for our products or conduct additional clinical trials beyond those currently contemplated, we may seek to sell additional equity or debt securities or acquire a credit facility. The sale of additional equity may result in additional dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to modify our planned research, development and commercialization strategy, which could adversely affect our business.
Our future contractual obligations, including financing costs, at December 31, 2006, include the following (in thousands):
(1)
Operating lease obligations represent future minimum rental commitments for non-cancelable operating leases for our office and laboratory facilities in Colorado and Connecticut.
(2)
Purchase obligations represent annual minimum purchase requirements of adult tablets of faropenem medoxomil with MEDA under our April 2005 supply agreement, equal to approximately $3 million per year through the initial 10 year term of the contract.
(3)
Delay compensation assumes, for this purpose only, that a full commercial launch of an approved faropenem medoxomil drug does not occur for three years.
The table above reflects only payment obligations that are fixed and determinable, based on certain of the assumptions described in the footnotes to the table. The table above does not include information with respect to the following contractual obligations because the amounts of the obligations are not currently determinable:
•
contractual obligations for clinical trials;
•
royalty obligations, which would be payable based on any future sales of faropenem medoxomil;
•
amounts due to Daiichi Asubio under our license agreement, which amounts are uncertain as to timing and dependent on the achievement of milestones; and
•
contingent amounts that may become due under supply agreements, including minimum purchase commitments not yet established and the extent of delay compensation amounts determined based on the timing of a commercial launch.
We enter into agreements with clinical research organizations and other vendors related to our clinical trials. Certain payments are made based upon the number of patients enrolled. For the years ended December 31, 2006 and 2005, we incurred external costs of approximately $11.4 million and $12.0 million, respectively, associated with conducting our clinical trials. At this time, due to the variability associated with these agreements, we are unable to estimate the future patient enrollment costs we will incur and therefore have excluded these costs from the table above.
Under our license agreement with Daiichi Asubio, we are obligated to future payments of (i) up to ¥375 million (approximately $3.2 million as of December 31, 2006) upon filing of an NDA at a higher dose and up to ¥1,250 million (approximately $10.5 million as of December 31, 2006) in subsequent regulatory and commercial milestone payments for faropenem medoxomil. Additionally, we are responsible for royalty payments to Daiichi Asubio based upon net sales of faropenem medoxomil.
Under our supply agreement with Nippon Soda, we are obligated to purchase, and Nippon Soda is obligated to supply, all our commercial requirements of the faropenem medoxomil active pharmaceutical ingredient. During the three years following placement of an initial purchase order by us with Nippon Soda, we are obligated to make certain annual minimum purchase commitments to be determined initially by us and Nippon Soda at the time of a commercial launch. Since full commercial launch of an approved faropenem drug has been delayed, we are obligated for certain annual delay compensation to Nippon Soda up to ¥280 million (approximately $2.4 million as of December 31, 2006). If we terminate the faropenem medoxomil program, under certain circumstances we may be obligated to reimburse Nippon Soda for up to ¥65 million (approximately $0.5 million as of December 31, 2006) in engineering costs.
Under our supply agreement with MEDA, beginning in 2006, we are obligated to make annual minimum purchases of MEDA’s product of 2.3 million (approximately $3.0 million as of December 31, 2006). If in any year we have not satisfied the minimum purchase commitments, we are required to pay MEDA the shortfall amount. Fifty percent (50%) of the shortfall amount, if applicable, may be credited against future drug product purchases. We are required to buy all of our requirements for adult oral faropenem medoxomil tablets from MEDA until cumulative purchases exceed 22 million (approximately $29.0 million at December 31, 2006). If the agreement is terminated, under certain circumstances we may be obligated to pay up to 1.7 million (approximately $2.2 million as of December 31, 2006) in facility decontamination costs.
Redeemable Convertible Preferred Stock
Our redeemable convertible preferred stock was classified on the balance sheet between liabilities and stockholders’ equity (deficit) as the holders of the redeemable convertible preferred stock had the right to request redemption in the future if certain classes of stockholders voted in favor of such redemption. Our
Series B convertible preferred stock was also classified on the balance sheet between liabilities and stockholders’ equity (deficit) as the holders of Series B convertible preferred stock had certain rights in liquidation. On July 3, 2006, all of our outstanding shares of preferred stock were converted into shares of common stock concurrent with the completion of our initial public offering and the redemption right and rights in liquidation terminated.
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Actual results may differ from these estimates. Our significant accounting policies are described in the Note 2 of Notes to Financial Statements included elsewhere in this annual report. We believe the following accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition. We generate revenue through research, license, collaboration and commercialization agreements. These agreements may contain multiple elements, including non-refundable upfront fees, payments for reimbursement of research and commercialization costs, non-refundable payments associated with achieving specific milestones, and royalties based on specified percentages of net product sales.
In determining when to recognize revenue related to upfront and milestone payments under these agreements we apply the revenue recognition criteria as outlined in EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). In applying these criteria, we consider a variety of factors to determine the appropriate method of revenue recognition, including whether the elements of the agreement are separable, whether payments received are subject to refund or forfeiture, whether there are determinable fair values and whether there is a unique earnings process associated with each element of an agreement.
When a payment is specifically tied to a separate earnings process and the amount to be received is fixed and determinable, revenue is recognized when the performance obligation associated with the payment is completed. Performance obligations typically consist of significant and substantive milestones. Revenues from milestone payments may be considered separable from funding for research, development or commercial activities because of the uncertainty surrounding the achievement of the milestones. Accordingly, these payments could be recognized as revenue when the performance milestone is achieved as described in EITF 00-21. In circumstances where we cannot identify a separate earnings process related to an upfront or milestone payment, we record deferred revenue and recognize revenue ratably over the period of expected benefit, which is generally the unexpired contract term.
Revenues derived from reimbursement of expenses for research, development and commercial activities under our collaboration and commercialization agreements are recorded in compliance with EITF Issue 99-19, Reporting Revenue Gross as Principal Versus Net as an Agent (EITF 99-19). In accordance with the criteria established by EITF 99-19, in transactions where we act as principal, with discretion to choose suppliers, bear credit risk and perform a substantive part of the services, revenue is recorded at the gross amount of the reimbursement. Costs associated with these reimbursements are reflected as a component of operating expenses in our statements of operations.
Under our former agreement with Forest Laboratories entered into in February 2006, we have recorded the initial $50 million upfront payment received in February 2006 as deferred revenue and recognize this amount into revenue ratably over the expected term of the agreement. In addition, we received a development milestone payment of $10 million in March 2006. Due to this milestone being achieved within one month of entering into the collaboration and commercialization agreement with Forest Laboratories, we could not identify a separate earnings process related to this milestone payment and are recognizing revenue related to this payment over the expected term of the agreement. The expected term of the agreement was originally estimated in February 2006 to be 13.5 years. In October 2006, when the FDA issued a non-approvable letter for our NDA for faropenem medoxomil we revised our estimate of the expected term of the agreement from 13.5 years to 14.7 years, due to the estimated additional time that would be required to achieve approval. In
February 2007, we and Forest Laboratories announced that our agreement would terminate, and as a result, we will reacquire all U.S. adult and pediatric rights previously granted to Forest Laboratories. No further obligations exist beyond a termination period that will conclude on May 7, 2007, and accordingly, we anticipate recognizing the remaining unamortized deferred revenue balance in 2007.
We have also received amounts from Forest Laboratories as reimbursement for certain research and development and expect to receive additional amounts as reimbursement for certain future research and development activities under our agreement related to qualifying activities through the 90 day period following the February 6, 2007 announcement that our agreement with Forest Laboratories would terminate. We believe that, as it relates to these activities, we act as the principal, performing a substantive part of the services directly, having the discretion to choose our suppliers and bearing all credit risk associated with the performance of these activities. We therefore have recorded these amounts as revenue in accordance with our revenue recognition policy. See Note 2 to our financial statements for more information about our revenue recognition policies.
Stock-Based Compensation. Through December 31, 2005, we accounted for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (APB), Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting Standards Board (FASB), Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB No. 25, and related interpretations. For periods prior to January 1, 2006, we adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS), No. 123, Accounting for Stock-Based Compensation, as amended.
Under APB No. 25, we recognized stock-based compensation expense, which is a non-cash charge, when we issued employee stock option grants at exercise prices that, for financial reporting purposes, are deemed to be below the estimated fair value of the underlying common stock on the date of grant. Because shares of our common stock were not publicly traded, prior to June 28, 2006, the fair value of our common stock for financial accounting purposes prior to that time was determined by our board of directors on the dates of grant after consideration of several factors, each of which have a significant impact on valuation of the common stock, including:
•
pricing of private sales of our convertible preferred stock;
•
relative rights and preferences of our common stock compared to the rights and preferences of our other outstanding equity securities;
•
our progress towards clinical and product development milestones;
•
the risks and uncertainties of obtaining FDA approval for faropenem medoxomil;
•
progress towards establishing a collaborative development and commercialization partnership for faropenem medoxomil, and evaluation of the alternatives available to us if a commercialization partnership was not obtained;
•
the status of our efforts to build our management team;
•
changes in valuations of comparable publicly-traded companies and acquisitions of companies similar to ours;
•
the likelihood of achieving a liquidity event such as an initial public offering or sale of our company, and the proceeds that would be allocated to holders of our common stock given the amounts contractually due to the holders of preferred stock in preference to, and participating with, the common shareholder;
•
the inherent risks associated with the Company’s business at the time; and
•
overall equity market conditions and economic trends.
Based on these factors, during 2005, we valued our common stock and set exercise prices for common stock options at each date of grant within the range of $0.61 to $1.32. During 2005, we granted options to
purchase a total of 569,541 shares of our common stock. If our estimates of the deemed fair value of these equity instruments were too low, it would have the effect of understating our expenses. For example, a 100% increase in the deemed fair value of our common stock for financial accounting purposes associated with option grants made from August 2005 through December 2005 would result in an increase in stock-based compensation expense for fiscal years 2005 and 2006 of approximately $12 thousand and $49 thousand, respectively.
The fair value of the common stock underlying grants of options for common stock issued to employees prior to our consideration of a public offering of securities had historically been determined by our board of directors based upon information available to it on the grant dates. However, in December 2005 and early 2006, we performed retrospective analyses to determine the deemed fair value of our common stock for accounting purposes at various points in time in 2005. These retrospective analyses addressed the deemed fair value of our common stock utilizing a probability-weighted expected return method (PWERM), as detailed in a practice aid issued by the American Institute of Certified Public Accountants entitled “Valuation of Privately Held Company Equity Securities Issued as Compensation” (AICPA Guide). This valuation methodology evaluates the probability of various potential liquidity events and the value of the common stock in each scenario. At each valuation date, we specifically considered changes in the factors described above, which resulted in changes to the probabilities of various possible liquidity events, and the resulting impact to the valuations of the common stock. The resulting valuations supported the fair value of our common stock established by our board of directors during the year ended December 31, 2005. In 2006 through the date of our initial public offering, we obtained multiple contemporaneous valuations utilizing the same valuation methodology to determine the fair value of our common stock for accounting purposes at various points in time in 2006 prior to the closing of our initial public offering.
Information on stock options granted during 2005 is summarized as follows (in thousands, except exercise price, estimated fair value and intrinsic values per share):
Information on stock options granted during 2006 prior to our initial public offering is summarized as follows (in thousands, except exercise price, estimated fair value and intrinsic values per share):
The chart below indicates how our estimates of likely liquidity events changed over time, as we evaluated the significant valuation drivers noted above:
In evaluating these events, the following factors are significant:
•
In March 2005 and May 2005, the estimated fair value of our common stock was determined by our board of directors to be $0.61 per share. At this time, we had not sufficiently developed our product to a point in which we believed we could reasonably be considered for acquisition and we needed additional funding to support that development effort;
•
In August 2005, the estimated fair value of our common stock was determined to be $0.93 per share. At that time, we had just completed a significant funding through issuance of Series D preferred stock in August 2005 for aggregate proceeds of $62.5 million. Our ability to secure this funding was based in significant part upon our determination shortly prior to that time that we would likely be able to file an NDA for faropenem medoxomil with the FDA based on our existing clinical trials. Obtaining a collaboration partner with an appropriate distribution channel for faropenem medoxomil was a critical factor in achieving value for our stockholders, both preferred and common. Consummating a collaboration partnership would allow us to focus on drug development without the need to expend significant costs, at significant risk, to distribute faropenem medoxomil ourselves. As such, we determined the value of our common stock under a scenario in which we were successful in obtaining a collaboration partner and a scenario without a collaboration partner. In August 2005, we considered the fact that we had spoken with numerous potential collaboration partners for faropenem medoxomil, including several major pharmaceutical companies, without successfully securing a partner due to the fact that these companies had a competing product already in their portfolio, did not believe that the product was
compatible with their other products or for other reasons. Further, the number of remaining potential collaboration partners was limited and the risk was high that we would not be successful in obtaining a suitable collaboration partner. Accordingly, we determined that the probability was high that we would not be able to find such a collaboration partner and that the resulting possible liquidity events were limited. We also noted that the consensus among industry analysts was that an initial public offering without a collaboration partner would be unlikely;
•
In November 2005, the estimated fair value of our common stock was increased to $1.32 per share, primarily based on the initiation of partnership discussions with Forest Laboratories, who we believed to be one of the few remaining appropriate potential collaboration partners. Following the initiation of partnership discussions, we considered the concerns raised by Forest Laboratories, including supply risks related to faropenem medoxomil drug substance being manufactured at a single site with limited experience manufacturing in an FDA regulated environment and risks surrounding our ability to file an NDA for faropenem medoxomil with the FDA that would be accepted for review, and ultimately approved by the FDA for sufficient indications to make the product commercially viable for us and for Forest Laboratories;
•
In January 2006, the estimated fair value of our common stock was increased to $3.19 per share, primarily based on the filing of our NDA for faropenem medoxomil on December 20, 2005 and continuing progress in our discussions with Forest Laboratories regarding a possible partnership and specifically addressing significant concerns raised by Forest Laboratories that threatened the possible partnership;
•
On February 10, 2006, we signed the collaboration agreement with Forest Laboratories. It was only at this time that we believe we became a candidate for an initial public offering that would meet the valuation requirements of our preferred stockholders. Further, on February 17, 2006, our NDA for faropenem medoxomil was accepted for review by the FDA. Accordingly, on the date that we next granted options for our common stock, March 9, 2006, the estimated fair value of our common stock was increased to $5.20 per share. Also at this time, our board of directors approved our proceeding with an initial public offering and investment bankers were retained; and
•
On April 5, 2006, we filed our initial registration statement for the initial public offering of our common stock.
The above table summarizes the specific probabilities assigned to certain liquidity events using PWERM, based on assessments of company-specific risks and the timing and probability of anticipated liquidity events, including:
•
the potential of an initial public offering at various market capitalizations;
•
a sale of us or our assets in a merger or acquisition; or
•
a transaction resulting in no value to the holders of common stock.
In addition to these potential liquidation events, we also incorporated an option-pricing method under which each class of our stock was considered as a series of call options that were then valued using the option-pricing method. Under this approach, a hypothetical payoff representing each class of stock as a series of call options was utilized. As our enterprise value increased beyond the liquidation preferences of our preferred stock, all further benefits accrued to both the holders of preferred and common stock. Our total derived enterprise value was applied to this liquidation analysis to derive a total value of our common stock evaluated on a weighted average basis with the potential liquidation events as illustrated in the table above.
Based on discussions with potential underwriters, we believed that our ability to pursue an initial public offering would depend on our securing a suitable collaboration partner for commercialization of faropenem medoxomil in the U.S. As a result, the probabilities assigned to a specific liquidity event were affected by the probability assigned to the successful completion of a collaboration arrangement. Without a collaboration partner, we believed that we would not have been able to pursue a public offering and thus that the most likely outcome would have been a sale or merger. This consideration impacted the valuation of our common
stock in periods prior to securing a collaboration partner because of the significant liquidation preferences of the preferred stock.
We considered in each liquidity scenario that the holders of preferred stock are entitled to liquidation preferences equal to their initial purchase prices plus dividends that accrue at a rate of 8% per year. Following the issuance of our Series D preferred stock in August 2005, dividends accrued at the rate of approximately $0.8 million per month. Under all scenarios other than an initial public offering, payments of these liquidation preferences are senior to any claims of our common stockholders and, in the event that there are any available funds remaining after distribution to preferred stockholders in accordance with their liquidation preferences, such funds would have been distributed among the common stockholders and preferred stockholders on a pro rata basis. In initial public offerings, accrued dividends are converted to common stock at the initial public offering price.
The assessment of probabilities at each valuation date considered the probability of successfully completing an initial public offering, taking into account that:
•
historically, 22% of proposed initial public offerings have been withdrawn after filing;
•
historically, initial public offerings that have not been withdrawn have been priced at approximately a 27% discount from the mid-point of the initial filing range; and
•
of the 14 initial public offerings completed in 2006 through the date of our evaluation for biotechnology and pharmaceutical companies that may be considered comparable to us, 12 of those offerings were priced below the low point of the initial filing range.
At each date of value, our valuations incorporate a discount rate, also known as required return or cost of capital, based on the risk-adjusted rate of return an investor would require given the circumstances of the Company at that time, which reflects the risk associated with the Company, risks and uncertainty regarding the achievement of potential liquidity events and consideration of observed rates of return on comparable investments. The selected discount rates were decreased from 40% in September 2005, to 30% in January 2006 and to 25% in February and April 2006, reflecting changes in the risks and uncertainties related to securing a collaboration partner, the FDA review process and our ability to access the public markets. We believe that our selected discount rates are consistent with required rates of return as outlined in the AICPA Guide, which provides that the cost of equity capital for a private enterprise prior to its initial public offering generally ranges from 20% to 35%. We also note that discount rates are expected to be higher for biotechnology companies without an approved product. By contrast, the cost of equity capital for a newly public enterprise generally ranges from 15% to 25%.
Additionally, we adjusted the indicated value of our common stock to reflect reductions for lack of control, potential dilution and the lack of liquidity and a trading market for our common stock at each valuation date. The weighted average reduction that reflects these factors decreased from 40% in September 2005, to 20% in February 2006 to 15% in April 2006, as we progressed toward significant events that could provide liquidity for our stockholders in the public markets. Although many of the economic factors of control were incorporated in our valuation analyses, our common stockholders did not share the same control over the enterprise as our preferred stockholders. In February 2006, we executed the collaboration agreement with Forest Laboratories and, in April 2006, we filed our initial registration statement. In determining the appropriate adjustment at the time, we considered the following factors as outlined in the AICPA Guide:
•
prospects for liquidity, including the expectation of an initial public offering in the future;
•
restrictions on the transferability of our common and preferred stock;
•
risk and volatility associated with us, our industry and our peers;
•
uncertainty of our value; and
•
concentration and control of our ownership.
The lack of marketability discount is based on qualitative and quantitative analysis, as well as subjective judgment of these factors. Published restricted stock studies indicate these discounts may fall within the range of 9% to 45%. For the valuations performed in September 2005 through January 2006, we used one combined discount of 40% to reflect the impact of all these factors on the value of our common stock. For the February and April 2006 valuations, we performed the valuations in two steps as follows:
•
we calculated the anticipated dilution to the common stockholders in each initial public offering scenario that we estimated based on available market data to be within the range of 25% to 35%; and
•
then utilized a probability weighted average lack of marketability discount of 20% in February 2006, which was further reduced to 15% in April 2006 at the time we filed our initial registration statement.
We believe that we have applied reasonable valuation methodologies, including the application of the discounts noted above, to properly reflect the risks and uncertainties in our common stock as of each date of value.
While our financial statements through December 31, 2005 account for stock option grants pursuant to APB No. 25, in accordance with SFAS No. 123, we disclose in the notes to our financial statements the pro forma impact on our net loss had we accounted for stock option grants using the fair value method of accounting. This information is presented as if we had accounted for our employee stock options at fair value using the minimum value option-pricing model. Our use of the minimum value model was primarily due to our determination as to its appropriateness as well as its general acceptance as an option valuation technique for private companies. We no longer utilize the minimum value method subsequent to our adoption of SFAS 123(R) on January 1, 2006, and the fair values of our options are higher as a result. Stock-based compensation expense under APB No. 25 for stock options granted to employees and directors has been determined as the difference between the exercise price and the fair value of our common stock on the date of grant, as estimated by us for financial reporting purposes, on the date those options were granted. It also includes stock-based compensation for options granted to consultants that has been determined in accordance with SFAS No. 123, and Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods and Services, as the fair value of the equity instruments issued and is periodically revalued as the options vest. Stock-based compensation expense depends on the amount of stock options and other equity compensation awards we grant to our employees, consultants and directors and the exercise price of those options. See Notes 2 and 11 to our financial statements.
Adoption of SFAS No. 123(R)
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS 123(R)), which requires compensation costs related to share-based transactions, including employee stock options, to be recognized in the financial statements based on fair value. SFAS 123(R) revises SFAS 123, as amended, Accounting for Stock-Based Compensation (SFAS 123), and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). We adopted SFAS 123(R) using the prospective method. Under this method, compensation cost is recognized for all share-based awards granted or modified on or after January 1, 2006.
We selected the Black-Scholes option pricing model as the most appropriate valuation method for option grants with service and/or performance conditions. The Black-Scholes model requires inputs for risk-free interest rate, dividend yield, volatility and expected lives of the options. Since the Company has a limited history of stock activity, expected volatility is based on historical data from several public companies similar in size and value to us. We will continue to use a weighted average approach using historical volatility and other similar public entity volatility information until our historical volatility is relevant to measure expected volatility for future option grants. We estimate the forfeiture rate based on historical data. Based on an analysis of historical forfeitures, we applied an annual forfeiture rate of 6.97% to all options granted in 2006. The forfeiture rate is re-evaluated on a quarterly basis. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected lives (net
of forfeitures) for options granted represents the period of time that options granted are expected to be outstanding and is derived from the contractual terms of the options granted.
During 2006, we estimated the fair value of option grants as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions. We separated optionees into two groups: grants with early exercise provisions and grants without early exercise provisions. We have determined that the exercise behavior of the two option groups is distinct and, therefore, the assumptions are different for purposes of valuing the options. The weighted average expected lives for each individual vesting tranche under the graded vesting attribution method discussed below for options with and without early exercise provisions were estimated to be 2.05 years and 2.57 years, respectively. Expected volatility for the two groups was estimated to be 75%. The weighted average risk free interest rate was 4.58% for both groups and the dividend yield was 0%.
During 2006, we also issued options which vest over the earlier to be achieved of service or market conditions. In determining the estimated fair value of these option awards on the date of grant, we elected to use a binomial lattice option pricing model together with Monte Carlo simulation techniques using the following weighted average assumptions during 2006: risk-free interest rate of 5.08%, expected dividend yield of 0%, expected volatility of 75%, forfeiture rate of 6.97%, suboptimal exercise factor of 2, and post-vesting exit rate of 6.97%. An expected life of 7.01 years was derived from the model.
The lattice model requires inputs for risk-free interest rate, dividend yield, volatility, contract term, average vesting period, post-vest exit rate and suboptimal exercise factor. Both the fair value and expected life are outputs from the model. The risk-free interest rate was determined based on the yield available on U.S. Treasury Securities over the life of the option. The dividend yield and volatility factor was determined in the same manner as described above for the Black-Scholes model. The lattice model assumes that employees’ exercise behavior is a function of the option’s remaining vested life and the extent to which the option is in-the-money. The lattice model estimates the probability of exercise as a function of the suboptimal exercise factor and the post-vesting exit rate. The suboptimal exercise factor and post-vesting exit rate were based on actual historical exercise behavior.
We had a choice of two attribution methods for allocating compensation costs under SFAS No. 123(R): the “straight-line” method, which allocates expense on a straight-line basis over the requisite service period of the last separately vesting portion of an award, or the “graded vesting attribution method”, which allocates expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. We chose the graded vesting attribution method and accordingly, amortize the fair value of each option over each option’s vesting period (requisite service period).
Deferred Tax Asset Valuation Allowance. In establishing an allowance on the valuation of our deferred tax assets we are required to make significant estimates and judgments about our future operating results. Our ability to realize deferred tax assets depends on our future taxable income as well as limitations on utilization primarily of net operating losses and tax credits. We are required to reduce our deferred tax assets by a valuation allowance if it is more likely than not that some portion or all of our deferred tax asset will not be realized. As we have historically incurred significant operating losses, it is difficult to conclude with certainty that any of our deferred tax assets will be realized. Accordingly, we have recorded a full valuation allowance on our net deferred tax assets since inception due to uncertainties related to our ability to realize deferred tax assets in the foreseeable future. See Note 12 to our financial statements.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS No. 157) which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective as of the beginning of our 2008 fiscal year. We are currently evaluating the impact of adopting SFAS No. 157 on our financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159
permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS No. 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We will assess the impact the adoption of SFAS No. 159 will have on our financial position and results of operations during 2007.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is primarily limited to our cash, cash equivalents, and short-term investments. We have attempted to minimize risk by investing in quality financial instruments primarily money market funds, federal agency notes, asset backed securities, corporate debt securities and U.S. treasury notes, with no security having an effective duration in excess of one year. The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments in a variety of marketable securities, including U.S. government and mortgage backed securities, money market funds and under certain circumstances, derivative financial instruments. Our cash and cash equivalents as of December 31, 2006 included a liquid money market account. The securities in our investment portfolio are classified as available-for-sale or held-to-maturity and are, due to their short-term nature, subject to minimal interest rate risk.
Most of our transactions are conducted in U.S. dollars, although we do have certain contractual obligations and conduct a number of clinical trials, and manufacture active pharmaceutical product with vendors located outside the U.S. Some of these expenses are paid in U.S. dollars, and some are paid in the local foreign currency. We have attempted to hedge our exposure to foreign currency fluctuations on certain forecasted expenses denominated in Japanese Yen. The risk that counterparties to our derivative contracts will default and not settle according to the terms of the agreements is a credit risk. Although these instruments are considered derivatives, their economic risks and fair value have historically been insignificant and managed on the same basis as risks of other securities we hold.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS
Replidyne, Inc.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Replidyne, Inc.:
We have audited the accompanying balance sheets of Replidyne, Inc. as of December 31, 2006 and 2005, and the related statements of operations, preferred stock, stockholders’ equity (deficit) and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Replidyne, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in note 2 to the accompanying financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, effective January 1, 2006.
KPMG LLP
Boulder, Colorado
March 26, 2007
REPLIDYNE, INC.
BALANCE SHEETS
(in thousands, except for share and per share amounts)
See accompanying notes to financial statements.
REPLIDYNE, INC.
STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
See accompanying notes to financial statements.
REPLIDYNE, INC.
STATEMENTS OF PREFERRED STOCK, STOCKHOLDERS’ EQUITY (DEFICIT), AND
COMPREHENSIVE LOSS
(in thousands, except share and per share amounts)
See accompanying notes to financial statements.
REPLIDYNE, INC.
STATEMENTS OF PREFERRED STOCK, STOCKHOLDERS’ EQUITY (DEFICIT), AND
COMPREHENSIVE LOSS - (continued)
(in thousands, except share and per share amounts)
See accompanying notes to financial statements.
REPLIDYNE, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to financial statements.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS
(1) Business and Organization
Replidyne, Inc. (Replidyne or the Company) is a biopharmaceutical company focused on discovering, developing, in-licensing and commercializing anti-infective products. The Company’s lead product candidate, faropenem medoxomil, is a novel oral community antibiotic for which the Company submitted a New Drug Application (NDA) with the U.S. Food and Drug Administration (FDA) in December 2005 for treatment of acute bacterial sinusitis, community acquired pneumonia, acute exacerbation of chronic bronchitis, and uncomplicated skin and skin structure infections in adults. In October 2006, the FDA issued a non-approvable letter for the NDA. According to the non-approvable letter, the FDA recommends further clinical studies for all indications included in the NDA, additional Microbiologic confirmation and consideration of alternate dosing of faropenem medoxomil.
The Company’s research and development product pipeline also includes REP8839, a drug candidate being developed for topical use for treatment of skin and wound infections, including methicillin-resistant Staphylococcus aureus (MRSA) infections in hospital settings. The Company is also pursuing the development of other novel anti-infective products based on an in-house library of proprietary compounds and its bacterial DNA replication technology.
In February 2006, the Company entered into a collaboration and commercialization agreement with Forest Laboratories Holding Limited (Forest Laboratories) for the commercialization, development and distribution of faropenem medoxomil in the U.S. Under this agreement, in February 2006 the Company received an upfront payment of $50 million and in March 2006 a $10 million development milestone payment (see Notes 4 and 14). On February 6, 2007, the Company announced that its collaboration and commercialization agreement with Forest Laboratories would terminate. This termination follows the issuance in October 2006 of the non-approvable letter by the FDA for the Company’s NDA for faropenem medoxomil that was submitted to the FDA in December 2005. As a result, the Company will reacquire all rights to faropenem medoxomil previously granted to Forest Laboratories and all amounts received under the collaboration and commercialization agreement are non-refundable.
The Company completed an initial public offering of its common stock on July 3, 2006. In connection with this offering, the Company issued 4,500,000 shares of common stock at an offering price of $10 per share. On August 2, 2006, in accordance with the terms of its agreement with the underwriters of the initial public offering, the Company sold an additional 506,000 common shares at $10 per share, representing a partial exercise of their over-allotment options. Including the exercise of the over-allotment options, the Company issued a total of 5,006,000 shares of its common stock in its initial public offering. Total proceeds received from the initial public offering, including exercise of the over-allotment allocation, were $44.5 million, net of underwriters’ discount and $2 million of offering costs.
Prior to and in connection with the initial public offering, on June 26, 2006, all issued and outstanding common shares and options to purchase the Company’s common shares were subject to a 1-for-4.904 reverse stock split. Upon completion of the initial public offering on July 3, 2006, and in accordance with the terms of the preferred stock purchase agreements, each outstanding share of the Company’s preferred stock automatically converted into 0.204 common shares. Additionally, each outstanding warrant to purchase the Company’s preferred stock automatically converted into a warrant to purchase 0.204 shares of common stock.
On July 3, 2006, also in accordance with the terms of the preferred stock purchase agreements, with the conversion of preferred stock into common stock, unpaid accumulated dividends on preferred stock were settled through issuance of 1,781,826 shares of common stock.
(2) Summary of Significant Accounting Policies
Basis of Presentation. Through December 31, 2005, the Company had generated limited revenue and its activities consisted primarily of research and development, clinical trials and regulatory filings, initial sales
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
and marketing development, raising capital, and recruiting personnel. Accordingly, at December 31, 2005, the Company was considered to be in the development stage as defined in Statement of Financial Accounting Standards (SFAS) No. 7, Accounting and Reporting by Development Stage Enterprises. During 2006, the Company began generating revenue from its planned principal operations as a result of its agreement with Forest Laboratories. As such, the Company was no longer considered to be in the development stage, effective February 10, 2006.
Reverse Stock Split. In May 2006, the Company authorized a 1-for-4.904 reverse stock split, effective June 26, 2006. All common stock data and shares issuable upon the conversion of preferred stock presented herein have been restated to retroactively reflect the reverse stock split.
Accounting Estimates in the Preparation of Financial Statements. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. 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 revenue and expenses during the reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents. The Company considers all highly liquid investments purchased with maturities of 90 days or less when acquired to be cash equivalents. All cash equivalents are carried at amortized cost, which approximates fair value.
Short-Term Investments. Short-term investments are investments purchased with maturities of longer than 90 days, but less than one year, held at a financial institution. At December 31, 2006 and 2005, the contractual maturities of the Company’s short-term investments are twelve months or less.
Management determines the classification of securities at purchase. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company classifies its securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Available-for-sale securities are those the Company may decide to sell if needed for liquidity, asset/liability management, or other reasons.
Available-for-sale securities are recorded at fair value. The estimated fair value amounts are determined by the Company using available market information. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income or loss until realized. Cost is adjusted for amortization of premiums and accretion of discounts from the date of purchase to maturity. Such amortization is included in interest and other income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are also included in interest and other income. The cost of securities sold is based on the specific-identification method. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other than temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period end, and forecasted performance of the investee. No impairments were recorded as a result of this analysis in 2006, 2005 or 2004.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
The Company’s short-term investments are classified as follows at December 31, 2006 and 2005 (in thousands):
The following is a summary of short-term investments classified as available-for-sale securities (in thousands):
Total unrealized holding gains and losses on available-for-sale securities as of December 31, 2006 were $5 and $12 thousand, respectively. Net unrealized holding losses on available-for-sale securities included in accumulated other comprehensive loss at December 31, 2006 was $7 thousand. Total and net unrealized holding gains on available-for-sale securities as of December 31, 2005 were $0.5 million and included in accumulated other comprehensive income at December 31, 2005.
The following is a summary of short-term investments classified as held-to-maturity securities (in thousands):
Total unrealized holding gains and losses on held-to-maturity investments as of December 31, 2006 were $3 and $18 thousand, respectively.
Concentrations of Credit Risk. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments, receivables from Forest Laboratories and derivative instruments. 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 making investments with maturities that maintain safety and liquidity.
Derivative Instruments. The Company recognizes derivative instruments as either assets or liabilities in its balance sheet and measures those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
For a derivative instrument designated as a fair value hedge, the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the risk being hedged. For a derivative instrument designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of other comprehensive income (loss) and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. For derivative instruments that are not designated as accounting hedges, changes in fair value are recognized in earnings in the period of change.
The fair values of the Company’s derivative instruments as of December 31, 2006 and 2005 was $6 thousand and $0.2 million, respectively. These derivative instruments have not been designated as hedges for accounting purposes. Changes in fair value are included in the Company’s earnings and have been immaterial to date.
Property and Equipment. Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are amortized over the shorter of the life of the lease or the estimated useful life of the assets. Repairs and maintenance costs are expensed as incurred.
Long-Lived Assets and Impairments. The Company periodically evaluates the recoverability of its long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and, accordingly, reduces the carrying value whenever events or changes in business conditions indicate the carrying amount of the assets may not be fully recoverable. SFAS No. 144 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the fair value less costs to sell such assets. The Company has not yet generated positive cash flows from operations, and such cash flows may not materialize for a significant period in the future, if ever. Additionally, the Company may make changes to its business plan that will result in changes to the expected cash flows from long-lived assets. As a result, it is possible that future evaluations of long-lived assets may result in impairment.
Accrued Liabilities. As part of the process of preparing our financial statements, the Company is required to estimate accrued liabilities. This process involves identifying services that third parties have performed on the Company’s behalf and estimating the level of service performed and the associated cost incurred on these services as of each balance sheet date in the Company’s financial statements. Examples of estimated accrued expenses include contract service fees, such as amounts due to clinical research organizations, professional service fees, such as attorneys and accountants, and investigators in conjunction with preclinical and clinical trials, and fees paid to contract manufacturers in connection with the production of materials related to product candidates. Accruals for amounts due to clinical research organizations are among our most significant estimates. In connection with these service fees, estimates are most affected by the Company’s understanding of the status and timing of services provided relative to the actual level of services incurred by the service providers. The date on which certain services commence, the level of services performed on or before a given date, and the cost of services is often subject to judgment. The Company makes these judgments based upon the facts and circumstances known and accounts for these estimates in accordance with accounting principles involving accrued liabilities generally accepted in the U.S.
Segments. The Company operates in one segment. Management uses one measure of profitability and does not segment its business for internal reporting purposes.
Stock-Based Compensation under APB No. 25. Prior to January 1, 2006, the Company applied the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, including Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, in accounting for its employee stock options. Under this method, compensation expense is generally recorded on the date of grant only if the estimated fair value of
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
the underlying stock exceeds the exercise price. Given the absence of an active market for the Company’s common stock, prior to its initial public offering the board of directors historically determined the estimated fair value of common stock on the dates of grant based on several factors, including progress against regulatory, clinical and product development milestones; sales of redeemable convertible preferred stock and the related liquidation preference associated with such preferred stock; progress toward establishing a collaborative development and commercialization partnership for faropenem medoxomil; changes in valuation of comparable publicly-traded companies; overall equity market conditions; and the likelihood of achieving a liquidity event such as an initial public offering or sale of the Company. The Company also considered the guidance set forth in the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately Held-Company Equity Securities Issued As Compensation. In addition, the Company obtained independent valuations of its common stock at September, November and December 2005. These independent valuations supported the fair value of the Company’s common stock established by the board of directors in 2005. Based on these factors, during 2005 the Company valued its common stock and set exercises prices for common stock options at each date of grant within the range of $0.61 to $1.32 per share.
SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As permitted by existing accounting standards, the Company elected to continue to apply the intrinsic-value-based method of accounting described above, for options granted through December 31, 2005. The following table illustrates the effect on net loss as if the fair-value-based method had been applied to all outstanding and unvested awards in each period prior to the adoption of SFAS 123(R) Share-Based Payment, on January 1, 2006 (in thousands, except per share data):
Prior to January 1, 2006, the fair value of each employee stock option award was estimated on the date of grant based on the minimum value method using the Black-Scholes option pricing valuation model with the following weighted average assumptions:
Stock Based Compensation under SFAS No. 123(R). Effective January 1, 2006, the Company adopted SFAS No. 123(R) using the prospective method of transition. Under that transition method, compensation cost
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
recognized in the year ended December 31, 2006 includes: (a) compensation costs for all share-based payments granted prior to January 1, 2006, based on the intrinsic value method prescribed by APB Opinion No. 25, and (b) compensation cost for all share-based payments granted or modified subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).
The Company selected the Black-Scholes option pricing model as the most appropriate valuation method for option grants with service and/or performance conditions. The Black-Scholes model requires inputs for risk-free interest rate, dividend yield, volatility and expected lives of the options. Since the Company has a limited history of stock activity, expected volatility is based on historical data from several public companies similar in size and value to the Company. The Company will continue to use a weighted average approach using historical volatility and other similar public entity volatility information until its historical volatility is relevant to measure expected volatility for future option grants. The Company estimates the forfeiture rate based on historical data. Based on an analysis of historical forfeitures, the Company applied an annual forfeiture rate of 6.97% to all options granted in 2006. The forfeiture rate is re-evaluated on a quarterly basis. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant for a period commensurate with the expected term of the grant. The expected term (without regard to forfeitures) for options granted represents the period of time that options granted are expected to be outstanding and is derived from the contractual terms of the options granted and historical option exercise behaviors.
During 2006, the Company estimated the fair value of option grants as of the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions. The Company separated optionees into two groups: grants with early exercise provisions and grants without early exercise provisions. The Company determined that the exercise behavior of the two option groups is distinct and, therefore, the assumptions are different for purposes of valuing the options. The weighted average expected lives for each individual vesting tranche under the graded vesting attribution method discussed below for options with and without early exercise provisions are estimated to be 2.05 years and 2.57 years, respectively. Expected volatility for the two groups was estimated to be 75%. The weighted average risk free interest rate was 4.58% for both groups, and the dividend yield was 0%.
During 2006, the Company also issued options which vest over the earlier to be achieved service or market condition. In determining the estimated fair value of these option awards on the date of grant, the Company elected to use a binomial lattice option pricing model together with Monte Carlo simulation techniques using the following weighted average assumptions during 2006: risk-free interest rate of 5.08%, expected dividend yield of 0%, expected volatility of 75%, forfeiture rate of 6.97%, suboptimal exercise factor of 2, and post-vesting exit rate of 6.97%. An expected life of 7.01 years was derived from the model.
The lattice model requires inputs for risk-free interest rate, dividend yield, volatility, contract term, average vesting period, post-vest exit rate and suboptimal exercise factor. Both the fair value and expected life are outputs from the model. The risk-free interest rate was determined based on the yield available on U.S. Treasury Securities over the life of the option. The dividend yield and volatility factor was determined in the same manner as described above for the Black-Scholes model. The lattice model assumes that employees’ exercise behavior is a function of the option’s remaining vested life and the extent to which the option is in-the-money. The lattice model estimates the probability of exercise as a function of the suboptimal exercise factor and the post-vesting exit rate. The suboptimal exercise factor and post-vesting exit rate were based on actual historical exercise behavior.
The Company had a choice of two attribution methods for allocating compensation costs under SFAS No. 123(R): the “straight-line” method, which allocates expense on a straight-line basis over the requisite service period of the last separately vesting portion of an award, or the “graded vesting attribution method”, which allocates expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. The Company chose the
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
graded vesting attribution method and accordingly, amortizes the fair value of each option over each option’s vesting period (requisite service period).
As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company’s net loss for the year ended December 31, 2006 was $1.1 million higher than if it had continued to account for share-based compensation under APB Opinion No. 25.
Employee stock options granted by the Company are generally structured to qualify as “incentive stock options” (ISOs). Under current tax regulations, the Company does not receive a tax deduction for the issuance, exercise or disposition of ISOs if the employee meets certain holding requirements. If the employee does not meet the holding requirements, a disqualifying disposition occurs, at which time the Company will receive a tax deduction. The Company does not record tax benefits related to ISOs unless and until a disqualifying disposition occurs. In the event of a disqualifying disposition, the entire tax benefit is recorded as a reduction of income tax expense. The Company has not recognized any income tax benefit or related tax asset for share-based compensation arrangements due to the fact that the Company does not believe it is more likely than not it will recognize any future tax benefit from such compensation cost recognized since inception of the Company.
The Company’s net loss for the year ended December 31, 2006 includes $1.2 million of compensation costs and no income tax benefit related to the Company’s stock-based compensation arrangements. Stock based compensation included in the Company’s statement of operations for the year ended December 31, 2006 was (in thousands):
SFAS No. 123(R) was applied only to awards granted or modified after the required effective date of January 1, 2006. Awards granted prior to the Company’s implementation of SFAS No. 123(R) are accounted for under the recognition and measurement provisions of APB Opinion No. 25 and related interpretations.
The Company accounts for stock options issued to nonemployees in accordance with the provisions of SFAS No. 123, as amended by SFAS 123(R)and Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees, or in Conjunction with Selling Goods or Services, which requires valuing the stock options using a Black-Scholes option pricing model and re-measuring such stock options to the current fair value until the performance date has been reached. Awards granted to nonemployees were valued using the Black-Scholes option pricing valuation model using the following weighted average assumptions for awards granted during the years ended December 31, 2006, 2005, and 2004.
The Company recognized $1 thousand, $1 thousand, and $6 thousand of stock-based compensation related to option grants to nonemployees for the years ended December 31, 2006, 2005 and 2004.
Net Loss Per Share. Net loss per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted net loss per share. Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
common shares outstanding during the period, excluding common stock subject to vesting provisions. Diluted net loss per share is computed by dividing net loss attributable to common stockholders 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 net loss per share by application of the treasury stock method. The Company has excluded all outstanding stock options, restricted common stock, warrants, and shares which would be issued under convertible preferred stock from the calculation of diluted net loss per share for the years ended December 31, 2006, 2005 and 2004 because such securities are anti-dilutive for these periods. Potentially dilutive securities total 2,519,356, 19,410,281 and 12,326,842 at December 31, 2006, 2005, and 2004, respectively.
Fair Value of Financial Instruments. The carrying amounts of financial instruments, including cash and cash equivalents, receivables from Forest Laboratories, notes receivable from officers, and accounts payable approximate fair value due to their short-term maturities. Based on borrowing rates available to the Company, the carrying value of the Company’s debt obligations as of December 31, 2005 approximated fair value.
In conjunction with entering into debt agreements, as disclosed in Note 6, the Company issued warrants to purchase shares of its Series A and C redeemable convertible preferred stock that were considered liabilities pursuant to SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, and related FASB Staff Position 150-5, Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Investments on Shares That Are Redeemable (FSP 150-5). The warrants were reported as liabilities at their estimated fair value, and any changes in fair value were reflected in the statements of operations during the period of the change in value. On July 3, 2006, the warrants were automatically converted into warrants exercisable for common shares and have been reclassified to equity as they are no longer considered liabilities pursuant to SFAS No. 150, FSP 150-5 and EITF 00-19 Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock.
Revenue Recognition. The Company’s commercial collaboration agreements contain multiple elements, including nonrefundable upfront fees, payments for reimbursement of research costs, payments for ongoing research, payments associated with achieving specific milestones and royalties based on specified percentages of net product sales, if any. The Company applies the revenue recognition criteria outlined in EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21), in accounting for up-front and milestone payments under the agreement. In applying the revenue recognition criteria within EITF 00-21, the Company considers a variety of factors in determining the appropriate method of revenue recognition under these arrangements, such as whether the elements are separable, whether there are determinable fair values and whether there is a unique earnings process associated with each element of a contract.
Where the Company does not believe that an upfront fee or milestone payment is specifically tied to a separate earnings process, revenues are recognized ratably over the estimated term of the agreement. When the Company’s obligations under such arrangements are completed, any remaining deferred revenue is recognized.
Payments received by the Company for the reimbursement of expenses for research, development and commercial activities under commercial collaboration and commercialization agreements are recorded in accordance with EITF Issue 99-19, Reporting Revenue Gross as Principal Versus Net as an Agent (EITF 99-19). Per EITF 99-19, in transactions where the Company acts as principal, with discretion to choose suppliers, bears credit risk and performs a substantive part of the services, revenue is recorded at the gross amount of the reimbursement. Costs associated with these reimbursements are reflected as a component of operating expenses in the Company’s statements of operations.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
Research and Development. Research and development costs are expensed as incurred. These costs consist primarily of salaries and benefits, licenses to technology, supplies and contract services relating to the development of new products and technologies, allocated overhead, clinical trial and related clinical manufacturing costs, and other outside costs.
The Company is currently producing clinical and commercial grade product in its facilities and through third parties. Prior to the receipt of approval of its products for commercial sale, these costs are expensed as incurred to research and development.
As discussed in Note 9, in June 2003, the Company acquired program intellectual property, in exchange for Series B convertible preferred stock, which was reflected as research and development expense.
In 2006, 2005 and 2004 the Company expensed $1.1 million, $2.1 million and $3.2 million, respectively, as research and development for payments required under faropenem medoxomil license agreements. In 2006, the Company expensed $1.5 million as research and development for payments required under its REP8839 license agreement.
Comprehensive Loss. The Company applies the provisions of SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting comprehensive income or loss and its components in financial statements. The Company’s comprehensive loss is comprised of its net loss and unrealized gains and losses on securities available for sale. For the years ended December 31, 2006, 2005 and 2004 comprehensive loss was $29.7 million, $33.2 million and $19.2 million, respectively.
Income Taxes. The Company accounts for income taxes pursuant to SFAS No. 109, Accounting for Income Taxes, which requires the use of the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to the extent it is more likely than not that a deferred tax asset will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date.
At December 31, 2006, for income tax purposes, the Company had net operating loss carryforwards of approximately $96 million, which are available to offset future taxable income, if any, and tax credit carryforwards of approximately $2.4 million. The loss carryforwards expire in various amounts from 2020 through 2026, and the tax credit carryforwards begin expiring in 2022. The Company believes, based on an analysis of historical equity transactions under the provisions of Section 382, that ownership changes have in fact occurred at two points since its inception. Such ownership changes can have the impact of limiting the utilization of net operating losses in future periods. The Company is finalizing its evaluation as to whether such ownership changes will result in the loss of its net operating loss carryforwards existing on the date of the ownership change. The Company’s only significant deferred tax assets are its net operating loss carryforwards. The Company has provided a valuation allowance for its entire net deferred tax asset at December 31, 2006 and 2005 as it is more likely than not that a deferred tax asset will not be realized due to uncertainty as to future utilization of its net operating loss carryforwards, due primarily to its history of operating losses.
Recent Accounting Pronouncements. In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective as of the beginning of our 2008 fiscal year. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS No. 159 is to provide opportunities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company will assess the impact the adoption of SFAS No. 159 will have on its financial statements during 2007.
(3) Property and Equipment
Property and equipment at December 31, 2006 and 2005 consist of the following (in thousands):
For the years ended December 31, 2006, 2005 and 2004 depreciation and amortization expense was $1.4 million, $1.3 million and $1 million, respectively.
(4) Agreement with Forest Laboratories Holdings Limited
In February 2006, the Company entered into a collaboration and commercialization agreement with Forest Laboratories for the commercialization, development and distribution of faropenem medoxomil in the U.S.
Under the terms of the agreement, in February 2006 Forest Laboratories made a $50 million initial payment to the Company and an additional $10 million milestone payment in March 2006, which are being recognized as revenue ratably over the expected term of the agreement. In February 2007, Forest Laboratories provided notice to the Company of its intent to terminate the collaboration and commercialization agreement at the end of the 90 day termination period. As a result, Replidyne will reacquire all U.S. adult and pediatric rights previously granted to Forest Laboratories. Forest Laboratories is obligated under the agreement to cooperate with the Company to assure a smooth transition of the faropenem medoxomil programs for a period of up to six months. For the initial 90 days of the transition period, the terms and conditions of the collaboration agreement remain in effect, including reimbursement of the majority of ongoing direct development costs for faropenem medoxomil, as defined. As no further obligations exist beyond the termination period in 2007, we anticipate recognizing the remaining unamortized deferred upfront and milestone fees as revenue in 2007.
Through termination in 2007, Forest Laboratories is required under the agreement to reimburse the Company for certain research and development and sales and marketing activities. The Company believes that, as it relates to these activities, it acts as the principal, performing a substantive part of the services directly, has the discretion to choose its suppliers and bears all credit risk associated with the performance of these
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
activities. The Company therefore has recorded these amounts as revenue in accordance with our revenue recognition policy.
(5) Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities at December 31, 2006 and 2005 consist of the following (in thousands):
(6) Long-Term Debt
Equipment Loan and Security Agreement. On July 31, 2002, the Company entered into an Equipment Loan and Security Agreement (the Agreement) providing the Company with an available line of credit of up to $3.5 million. Pursuant to the terms of the Agreement, amounts borrowed are restricted solely for the purchase of eligible equipment (computer equipment, networking equipment, laboratory equipment, test and measurement equipment, office equipment and furnishings) and other equipment (certain accepted tenant improvements and build-out costs, software, software licenses, tooling, and equipment specially manufactured for the Company). The Company borrowed $3.4 million under this arrangement. At December 31, 2005, $0.2 million was due to the lenders and no additional borrowings were available. Borrowings under this agreement were paid in full in the first quarter of 2006, and no balance is outstanding at December 31, 2006.
In conjunction with the Agreement, the Company issued warrants to the lenders to purchase 140,000 shares of the Company’s Series A redeemable convertible preferred stock, with an exercise price of $1.00 per share. The Company accounted for the warrants in accordance with APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants (APB Opinion No. 14). Accordingly, the warrants were valued at $0.91 per share, based upon the Black-Scholes option pricing valuation model with the following assumptions: fair value of Series A preferred stock of $1.00; risk-free interest rate of 4.65%; 100% volatility; term equal to the maximum contractual life of the warrants of 10 years; and no dividend yield. The relative fair value of the warrants of $0.1 million was recorded as a debt discount and was amortized to interest expense over the life of the debt. As noted above, in conjunction with the initial public offering in July 2006, all outstanding warrants for preferred stock were automatically converted into warrants to acquire common stock, at a ratio of 0.204 shares of common stock for each share of preferred stock.
Convertible Promissory Notes. In December 2003, the Company entered into an agreement to borrow an aggregate principal amount of $2 million, which amount was subsequently amended to $7 million. The Company had borrowed $0.7 million at December 31, 2003, and through April 28, 2004, had borrowed the remaining $6.3 million. The borrowings were from existing stockholders in the form of convertible notes payable (the Convertible Notes). The Convertible Notes matured on June 19, 2004, or earlier if a financing that met specified criteria (a Qualified Financing) was closed, and bore interest at a stated rate of 6% per annum.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
The Convertible Notes were convertible into Series A redeemable convertible preferred stock (Series A) if a financing was not closed by June 19, 2004, or were automatically converted to the class of equity securities issued upon a Qualified Financing on or prior to June 19, 2004.
In connection with these borrowings, the Company agreed to issue detachable warrants that were exercisable for 700,000 shares of Series A with an exercise price of $1.00 per share or the class of securities issued in a Qualified Financing, if a Qualified Financing occurred on or before June 19, 2004 with an exercise price equal to the per-share price paid for such securities. The Company estimated the value of such warrants using the Black-Scholes option pricing model, and the following assumptions: risk-free interest rate of 4.11%; 100% volatility; maximum contractual life of 10 years; and no dividend yield.
The Company recorded the proceeds from the Convertible Notes based on the relative fair value of the warrants and the debt, and as such, recorded a debt discount of $0.7 million for the allocated value of the warrants. This debt discount was recorded as additional interest expense of $0.3 million, through April 28, 2004, the date that the Convertible Notes were converted to 5,600,000 shares of Series C Redeemable Convertible Preferred Stock (Series C) at $1.25 per share. The carrying amount of the debt for accounting purposes was $6.5 million on the conversion date, and accordingly, the Company recorded a loss upon the extinguishment of $0.5 million, equal to the difference between the carrying value and the fair value of the Series C which extinguished the Convertible Notes.
Also, in connection with the conversion of the Convertible Notes into Series C in 2004, the holders of warrants for 500,000 shares of Series C issued with the Convertible Notes canceled their warrants. The cancellation of the warrants was accounted for as a capital contribution in the accompanying financial statements.
(7) Related-Party Transactions
Clinical Trials Service Agreement with Quintiles, Inc. During 2004 and 2005, the Company entered into a consulting agreement and a five year master service agreement with one of its investors, Quintiles, Inc. (Quintiles), for regulatory and documentation consulting services associated with the Company’s faropenem medoxomil program. Under these agreements with Quintiles, the Company is required to pay service fees, expenses and pass-through costs in accordance with established clinical trial budgets. During the years ended December 31, 2006 and 2005, the Company incurred fees of $3.5 million and $0.8 million, respectively, under these agreements, and, as of December 31, 2006 and 2005, $0.4 million and $0.5 million, respectively, was due to Quintiles for services performed. These amounts are included in accounts payable and accrued expenses in the accompanying financial statements. Additionally, the Company has made certain payments to Quintiles for future clinical trial related expenses under its agreements. At December 31, 2006, $0.3 million was included in prepaid expenses and other current assets in the accompanying condensed financial statements. No prepaid amounts related to these agreements existed as of December 31, 2005.
Notes Receivable from Officers. In 2005, the Company entered into interest-bearing note receivable agreements with two of its officers for the purpose of early exercising stock options in accordance with the Company’s Long-Term Incentive Plan and their option agreements. The loans, totaling $0.4 million, were secured by the underlying restricted common stock received upon exercise, and the Company had full recourse to all assets of the officers to satisfy the notes. The notes receivable bore interest at a rate that was determined to be a market rate. On February 28, 2006, the principal amount of the notes, together with accrued interest, was paid in full in cash.
(8) Commitments and Contingencies
Operating Leases. In August and March 2005, the Company entered into a 74-month sub-lease agreement for its Colorado corporate office and laboratory facility and a 60-month lease agreement for its
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
Connecticut office facility, respectively. In August 2006, the Company leased additional office facilities in Colorado from its existing landlord on terms consistent with the existing lease. These lease agreements include rent concessions and escalating rent payments throughout the term of the lease. The rent expense related to these leases is recorded monthly on a straight-line basis in accordance with U.S. generally accepted accounting principles. Additionally, the Company received leasehold incentives which have been recorded as a deferred credit and are being amortized monthly on a straight-line basis to rent expense over the term of the lease.
At December 31, 2006, future minimum lease payments under the Company’s noncancelable operating leases are as follows (in thousands):
During the years ended December 31, 2006, 2005 and 2004 the Company recognized $0.6 million, $0.6 million, $0.4 million in rent expense, respectively.
Indemnifications. The Company has agreements whereby it indemnifies directors and officers for certain events or occurrences while the director or officer is, or was, serving in such capacity at the Company’s request. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited.
Daiichi Asubio License Agreement. In 2003, the Company made payments, totaling $0.6 million, under a letter of intent to secure certain in-process research and development. In March 2004, the Company entered into a license agreement with Daiichi Asubio to develop and commercialize faropenem medoxomil in the U.S. and Canada for adult and pediatric use. The Company has an exclusive option to license rights to faropenem medoxomil for the rest of the world excluding Japan. The Company bears the cost of and manages development, regulatory approvals and commercialization efforts. Daiichi Asubio is entitled to up-front fees, milestone payments and royalties. Under certain circumstances, the Company may be required to make certain payments to Daiichi Asubio upon termination of the agreement or abandonment of certain products. In February 2006, the Company and Daiichi Asubio amended certain terms of this agreement. These amended terms have been reflected below.
In consideration for the license, in 2004 the Company paid Daiichi Asubio an initial license fee of ¥400 million ($3.8 million) less amounts previously paid in 2003. In December 2005, the Company submitted its first NDA for adult use of faropenem medoxomil and, at that time, recorded an accrual in the amount of ¥250 million (approximately $2.1 million) for the first milestone due to Daiichi Asubio under this agreement. This amount was expensed to research and development in 2005, and paid in 2006. In February 2006, this milestone payment was increased to ¥375 million (approximately $3.2 million). The increased milestone amount of ¥125 million (approximately $1.1 million) was accounted for as research and development expense in the quarter ended March 31, 2006 when the modified terms of the license were finalized. Under the modified license agreement the Company is further obligated to make future payments of up to ¥375 million (approximately $3.2 million at December 31, 2006) upon filing of an NDA at a higher dose and up to ¥1,250 million (approximately $10.5 million at December 31, 2006) in subsequent regulatory and commercial milestone payments for faropenem medoxomil. If we terminate our license agreement with Daiichi Asubio we will be obligated to pay a termination fee of up to ¥375 million (approximately $3.2 million as of December 31, 2006). Additionally, the Company is responsible for royalty payments to Daiichi Asubio based
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
upon net sales of faropenem medoxomil. The license term extends to the later of: (i) the expiration of the last to expire of the licensed patents owned or controlled by Daiichi Asubio or (ii) 12 years after the first commercial launch of faropenem medoxomil. The Company has recorded payments made to date as a research and development expense, as faropenem medoxomil has not been approved by the FDA.
Daiichi Asubio and Nippon Soda Supply Agreement. Under a separate supply agreement entered into in December 2004 among Daiichi Asubio, Nippon Soda and the Company, the Company is obligated to purchase, and Nippon Soda is obligated to supply, all of the Company’s commercial requirements for faropenem medoxomil for the U.S. and Canadian markets. At the time of full commercial launch, the Company becomes obligated to purchase minimum quantities of drug substance to be determined initially by the Company and Nippon Soda. If the full commercial launch is delayed, the Company may be obligated to pay annual delay compensation of up to ¥280 million (approximately $2.4 million at December 31, 2006) to Nippon Soda beginning on July 1, 2007. In September 2006 the supply agreement was amended concurrent with the execution of a new supply agreement between Forest Laboratories, Daiichi Asubio and Nippon Soda relating to the U.S. market for faropenem medoxomil. Under the amended supply agreement, certain of the Company’s obligations with respect to purchase commitments, delay compensation and other matters were waived and deemed satisfied by Forest Laboratories pursuant to its agreement. The Company’s supply agreement continued to apply for potential supply of faropenem medoxomil for the Canadian market.
Under an agreement with Forest Laboratories Holdings Limited (Forest Laboratories) entered into in February 2006, the Company remained responsible for only the delay compensation that accrued for any period ending on or prior to December 31, 2007. Thereafter, Forest Laboratories was primarily responsible for any delay compensation. After consideration of the agreement with Forest Laboratories, the Company’s maximum potential delay compensation obligation in 2006 was ¥105 million (approximately $0.9 million at December 31, 2006). If the Company terminates this Agreement by material breach, bankruptcy, abandonment of the development or commercialization of faropenem medoxomil or significant delay in launch, as defined in the agreement, and fails to launch faropenem medoxomil, it is obligated to reimburse Nippon Soda for up to ¥65 million (approximately $0.5 million at December 31, 2006) in engineering costs. Additionally, in accordance with an agreement between Forest Laboratories and the Company signed in August 2006, the Company agreed to share equally in a cancellation fee applicable to Forest Laboratories in its agreement with Daiichi Asubio and Nippon Soda. Upon Forest Laboratories cancellation of its initial purchase order of a specified amount, the Company’s share of the cancellation fee was ¥75 million (approximately $0.6 million at December 31, 2006) which was accounted for a research and development expense in 2006. In 2006, upon receiving the non-approvable letter from the FDA, the Company accrued delay compensation and cancellation fees under these agreements totaling $1.5 million. These amounts were expensed as research and development in 2006. In February 2007, concurrent with Forest Laboratories termination of its supply agreements with Daiichi Asubio and Nippon Soda, the previously suspended provisions in the Company’s agreements with Daiichi Asubio and Nippon Soda are no longer suspended and therefore the Company’s obligations with respect to purchase commitments, delay compensation and other matters are no longer waived. As a result, the Company may incur additional contingent fees under these agreements in future periods.
MEDA Supply Agreement. In April 2005, the Company and MEDA (formerly Tropon) entered into a supply agreement for production of adult tablets of faropenem medoxomil, which was amended as to certain terms in March 2006. Beginning in 2006, the Company became obligated to make annual minimum purchases of MEDA product of 2.3 million (approximately $3 million at December 31, 2006). If in any year the Company has not satisfied its minimum purchase commitments, the Company is required to pay MEDA the shortfall amount. Fifty percent (50%) of the shortfall amount, if applicable, may be credited against future drug product purchases. The Company is required to buy all of its requirements for adult oral faropenem medoxomil tablets from MEDA until cumulative purchases exceed 22 million (approximately $29 million at December 31, 2006). If the agreement is terminated, under certain circumstances the Company may be
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
obligated to pay up to 1.7 million (approximately $2.2 million at December 31, 2006) in facility decontamination costs.
In March 2006 when the agreement was amended, the Company’s obligations with respect to all purchase commitments and facility decontamination costs were suspended and deemed satisfied by Forest Laboratories pursuant to an agreement between MEDA and Forest Laboratories. Under its agreement with Forest Laboratories, the Company remained liable for any shortfall amount in 2006 that may not have been credited against future drug product purchases. In 2006, the Company incurred $1.5 million relating to its portion of the 2006 shortfall in minimum purchases under these agreements. The amount was expensed as research and development in 2006. In 2007, concurrent with Forest Laboratories termination of its supply agreements with MEDA, the previously suspended provisions in the Company’s agreements with MEDA are no longer suspended and therefore the Company’s obligations with respect to purchase commitments and facility decontamination costs are no longer waived. As a result, the Company may incur additional contingent fees under this agreement in future periods.
Derivative Instruments. The Company has used derivative instruments to minimize the impact of foreign currency fluctuations on current and forecasted payables, denominated in Japanese Yen. As discussed above, the Company is obligated to pay amounts in accordance with its license agreement with Daiichi Asubio in Japanese Yen. These forecasted payments expose the Company’s earnings and cash flows to adverse movements in foreign currency exchange rates. To reduce the effects of foreign currency fluctuations the Company has entered into foreign exchange option contracts with maturities of less than 12 months.
The Company does not enter into foreign exchange option contracts for trading purposes. Gains and losses on the contracts are included in earnings. The Company does not expect gains or losses on these derivative instruments to have a material impact on its financial results.
(9) Preferred Stock
In May 2006, the Company authorized a 1-for-4.904 reverse stock split effective June 26, 2006. The stock split applied to all common stock and options to purchase the Company’s common stock outstanding as of June 26, 2006. All common shares and amounts included in these financial statements have been adjusted to reflect this reverse stock split.
In conjunction with the reverse stock split, on June 26, 2006 the preferred stock conversion to common stock ratio was adjusted from 1-for-1 to 0.204-for-1. On July 3, 2006 when the Company’s initial public offering closed, all of the Company’s preferred stock and warrants to purchase the Company’s preferred stock automatically converted into common stock and warrants to purchase common stock, respectively.
Common shares issued upon the conversion of outstanding preferred stock on July 3, 2006 are presented below (in thousands):
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
Original Issuances of Preferred Stock. In February 2002, the Company issued 13,000,000 shares of $0.01 par value Series A redeemable convertible preferred stock (Series A) at $1.00 per share. Total proceeds from Series A were $12.8 million, net of $0.2 million in issuance costs.
In June 2003, the Company issued 4,000,000 shares of $0.01 par value Series B convertible preferred stock (Series B) for $1.25 per share to GlaxoSmithKline (GSK) in exchange for certain program intellectual property, supporting material and license rights, which was recorded as research and development expense in the year ended December 31, 2003. The fair value of Series B was $5 million. In accordance with the terms of the asset purchase agreement, the Company paid GSK an additional $1.5 million in June 2006 following filing of the Company’s Investigational New Drug application (IND) for REP8839, the related drug. The amount was recorded as research and development expense in 2006. The Company is not obligated to make any additional payments to GSK under this agreement.
In April, August, September, and November 2004, the Company issued an aggregate of 36,800,000 shares of $0.01 par value Series C redeemable convertible preferred stock (Series C) at $1.25 per share. Total proceeds from Series C were $38.8 million, net of $0.2 million in issuance costs, and the conversion of $7.0 million of bridge notes payable.
In August 2005, the Company issued 34,722,222 shares of $0.001 par value Series D redeemable convertible preferred stock (Series D) at $1.80 per share. Total proceeds from Series D were $60.2 million, net of $2.3 million in issuance costs.
Redeemable Convertible Preferred Stock Warrants. In connection with the issuance of debt and convertible notes, the Company issued 140,000 and 200,004 warrants to certain lenders and investors to purchase shares of the Company’s Series A and Series C redeemable convertible preferred stock, respectively. In 2006, warrants for 80,001 shares of Series C redeemable convertible preferred stock were exercised for proceeds of $0.1 million.
The warrants were recorded as liabilities at their fair value pursuant to SFAS No. 150 and FSP 150-5. In July 2006, upon completion of the Company’s initial public offering, all outstanding preferred stock warrants were automatically converted into common stock warrants at a conversion rate of 0.204-to-1 and reclassified to equity at the then current fair value. As of December 31, 2006, warrants for the purchase of 53,012 shares of common stock were outstanding with exercise prices in the range of $4.90 to $6.13 per share.
Preferred Stockholder Rights and Preferences. Prior to the conversion of the Company’s preferred stock upon completion of its initial public offering on July 3, 2006, holders of the Company’s preferred stock had certain rights and preferences. Preferred stockholders were entitled to receive, when and as declared or paid by the board of directors, dividends at the rate of 8% per annum of the applicable original purchase price, accrued on a daily basis. Holders of Series A, B and D preferred stock had certain redemption rights, which included accrued and unpaid dividends, whether or not declared. Additionally, preferred stockholders had rights and preferences in liquidation, voting and conversion.
(10) Common Stock
The Company’s Certificate of Incorporation, as amended and restated on July 3, 2006, authorizes the Company to issue 100,000,000 shares of $0.001 par value common stock. Each share of common stock is entitled to one vote on each matter properly submitted to the stockholders of the Company for their vote. The holders of common stock are entitled to receive dividends when and as declared or paid by the board of directors, subject to prior rights of the Preferred Stockholders, if any.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
(11) Share-Based Compensation
Stock Option Plan. The Company’s Equity Incentive Plan, as amended in 2006 (the Option Plan), provides for up to 7,137,030 shares of common stock for stock option grants. Options granted under the Option Plan may be either incentive or nonqualified stock options. Incentive stock options may only be granted to Company employees, including its officers. Nonqualified stock options may be granted to Company employees, which includes its officers, directors, and consultants of the Company. Generally, options granted under the Option Plan expire ten years from the date of grant and vest over four years: 25% on the first anniversary from the grant date and ratably in equal monthly installments over the remaining 36 months. This plan is considered a compensatory plan and subject to the provisions of SFAS No. 123(R).
The total intrinsic value of options exercised during the year ended December 31, 2006, 2005 and 2004 was $0.5 million, $0.2 million and $2 thousand, respectively.
In 2005, following the death of one of its employees, the Company accelerated and re-priced to zero 24,468 stock options. As a result, in 2005 the Company recorded additional stock based compensation expense of approximately $0.1 million.
In 2006, the Company issued 16,313 stock options to an employee with an exercise price of $5.20 per share which was based on a previous independent valuation and deemed to be fair value at the date of grant. Subsequently, the Company completed a valuation with an independent third party and determined that the grant date fair value was $8.98 per share. In 2006, the Company re-priced all 16,313 shares from $5.20 to $8.98. In consideration for this upward adjustment to exercise price, in 2007 the Company issued the employee 12,727 shares of restricted stock. As a result of this modification, the Company will record additional stock based compensation expense of $34 thousand over the requisite service period.
Stock options outstanding at December 31, 2006, changes during the year then ended, and options exercisable are presented below (in thousands, except weighted average data and intrinsic value):
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
Additional information regarding outstanding stock options as of December 31, 2006 is presented below (in thousands, except for exercise price and weighted average data):
The weighted average grant date fair value of options granted under the Equity Incentive Plan during the years ended December 31, 2006, 2005, and 2004 was $2.52, $0.15 and $0.10, per share respectively.
In preparing for its IPO, the Company obtained a retrospective valuation from an independent valuation specialist as of September 8, 2005 and November 30, 2005. Thereafter, the Company obtained contemporaneous valuations from an independent valuation specialist as of December 30, 2005, January 19, 2006, February 10, 2006 and April 5, 2006. The Company selected the period from September 8, 2005 for obtaining independent valuations because the Company issued shares of Series D convertible preferred shares to unrelated parties in an arms length transaction in August 2005. The significant factors considered in the independent valuations included financial position following completion of offerings of the Company’s Series A, Series C and Series D convertible preferred shares for cash, the potential for filing an NDA for faropenem medoxomil with the FDA, the opportunity to obtain a collaboration and commercial partner for faropenem medoxomil and the potential for an IPO. The independent valuation firm calculated the fair value of the Company’s common stock using the Probability-Weighted Expected Return Method in accordance with guidelines established in the AICPA Practice Aid on Valuation of Privately-Held-Company Equity Securities.
Non-vested Shares. During the years ended December 31, 2006, 2005 and 2004 the Company granted options for 1,283,316, 525,081, and 905,587 shares of common stock, respectively, that are eligible to be exercised prior to vesting, provided that the shares issued upon such exercise are subject to restrictions which will be released consistent with the original option vesting period. Of these shares, restrictions on 145,288 shares will be released at an accelerated rate if a new drug application for faropenem medoxomil is approved by the FDA. In the event of termination of the service of an employee, the Company may repurchase all unvested shares from the optionee at the original issue price. Options granted under the Option Plan expire no more than 10 years from the date of grant.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
A summary of the changes in restricted shares is presented below (in thousands):
The fair value of restricted shares vested during 2006 and 2005 was $0.2 million in each period.
Stock Based Compensation - Stock Options. Awards granted to employees prior to the adoption of SFAS No. 123(R) were valued using the intrinsic value method. The Company recognized $0.1 million and $3 thousand of stock-based compensation in the years ended December 31, 2005 and 2004, respectively, for employee awards. As discussed in Note 2, the Company has applied SFAS No. 123(R) to awards granted after January 1, 2006. During the year ended December 31, 2006, the Company recognized $1.2 million of stock based compensation for employee awards. As of December 31, 2006, there was $2.3 million of total unrecognized compensation costs (net of expected forfeitures) from options granted under the Plan to be recognized over a weighted average remaining period of 2.88 years.
Employee Stock Purchase Plan. The Company has reserved 305,872 shares of common stock for issuance under its Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan allows eligible employees to purchase common stock of the Company at the lesser of 85% of its market value on the offering date or the purchase date as established by the Board of Directors. Employee purchases are funded through after-tax payroll deductions, which participants can elect from one percent to twenty percent of compensation, subject to the federal limit. During the initial six month offering period, which commenced on June 28, 2006, employees were permitted to make retroactive elections to increase contributions through cash infusions until ten days before the end of the initial offering period. These retroactive elections to increase contributions through cash infusions are no longer available to employees in subsequent offering periods. This plan is considered a compensatory plan and subject to the provisions of SFAS No. 123(R). As of December 31, 2006, 43,482 shares had been issued pursuant to the Purchase Plan. The Company recognized approximately $39 thousand in share-based compensation expense under SFAS No. 123(R) related to the Purchase Plan during the year ended December 31, 2006.
(12) Income Taxes
SFAS No. 109 requires that a valuation allowance be provided if it is more likely than not that some portion or all deferred tax assets will not be realized. The Company’s ability to realize the benefit of its deferred tax assets will depend on the generation of future taxable income through profitable operations. Due to the uncertainty of future profitable operations, the Company has recorded a full valuation allowance against its net deferred tax assets.
The Company has had no provision for income taxes since inception due to its net operating losses.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
The income tax effects of temporary differences that give rise to significant portions of the Company’s net deferred tax assets are as follows (in thousands):
The benefit for income taxes differs from the amount computed by applying the United States of America federal income tax rate of 35% to the loss before income taxes as follows (in thousands):
At December 31, 2006, the Company had approximately $96 million of net operating loss carryforwards and approximately $2.4 million of research and experimentation credits which may be used to offset future taxable income. The carryforwards will expire in 2020 through 2026. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carryforwards that can be utilized if certain changes in the Company’s ownership occur. The Company believes, based on an analysis of historical equity transactions under the provisions of Section 382, that ownership changes have in fact occurred at two points since its inception. Such ownership changes can have the impact of limiting the utilization of net operating losses in future periods. The Company is finalizing its evaluation as to whether such ownership changes will result in the loss of its net operating loss carryforwards existing on the date of the ownership change.
REPLIDYNE, INC.
NOTES TO FINANCIAL STATEMENTS - (continued)
(13)
Selected Quarterly Financial Data (unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2006 and 2005 (unaudited, in thousands, except for loss per share data):
Basic and diluted net loss attributable to common stockholders per share are identical since common equivalent shares are excluded from the calculation as their effect is antidilutive.
(14) Subsequent Event
Agreement with Forest Laboratories
In February 2007, the Company received notice from Forest Laboratories of its intent to terminate the Commercialization and Collaboration agreement entered into in February 2006. As a result of this termination, the Company will reacquire all faropenem medoxomil U.S. adult and pediatric rights previously granted to Forest Laboratories. Forest Laboratories is obligated under the agreement to cooperate with the Company to assure a smooth transition of the faropenem medoxomil programs for a period of up to six months. For the initial 90 days of the transition period, the terms and conditions of the collaboration agreement remain in effect, including reimbursement of the majority of ongoing direct development costs for faropenem medoxomil, as defined. The Company has agreed with Forest Laboratories that such reimbursement would exclude costs incurred to reinitiate the clinical trial among patients with acute exacerbation of chronic bronchitis. In 2007, the Company will accelerate the recognition of certain upfront and milestone payments previously received and being amortized over the former expected term of the agreement. Accordingly, the Company has classified the remaining unamortized deferred license revenue as current in its balance sheet as of December 31, 2006.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.
No Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
We have adopted a Code of Business Conduct and Ethics (the “Code”) that applies to all of our employees (including executive officers) and directors. The Code is available on our website at www.replidyne.com under the heading “Investor Information”. We intend to satisfy the disclosure requirement regarding any waiver of a provision of the Code applicable to any executive officer or director, by posting such information on such website. We shall provide to any person without charge, upon request, a copy of the Code. Any such request must be made in writing to Replidyne, Inc., c/o Investor Relations, 1450 Infinite Drive, Louisville, CO 80027.
Except for information relating to executive officers under the heading “Executive Officers of the Registrant,” which can be found in Part I following Item 4, all additional information required by this item will be contained in our definitive Proxy Statement (“Proxy Statement”) for our 2007 Annual Meeting of Stockholders to be held on May 10, 2007 under the headings “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this item will be contained in the Proxy Statement under the headings “Compensation of Directors” and “Compensation of Executive Officers” and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will be contained in the Proxy Statement under the headings “Compensation of Executive Officers - Securities Authorized for Issuance under Equity Compensation Plans” and “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be contained in the Proxy Statement under the heading “Certain Relationships and Related Transactions” and is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item will be contained in the Proxy Statement under the heading “Ratification of Selection of Independent Registered Public Accounting Firm” and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a. Financial Statements. The following financial statements are submitted as part of this report:
Report of Registered Independent Public Accounting Firm
Balance Sheets at December 31, 2006 and 2005
Statements of Operations for 2006, 2005 and 2004
Statements of Preferred Stock, Stockholders’ Equity (Deficit) and Comprehensive Loss
for 2006, 2005 and 2004
Statements of Cash Flows for 2006, 2005 and 2004
Notes to Financial Statements
b. Financial Statement Schedules
No financial statement schedules are included because they are not required or the information is included in the financial statements or notes thereto.
c. Exhibits
+
Indicates management contract or compensatory plan.
*
Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
(1)
Incorporated by reference to the same numbered exhibit filed with our Registration Statement on Form S-1 (File No. 333-133021), as amended, declared effective June 29, 2006.
(2)
Incorporated by reference to our Current Report on Form 8-K filed on March 9, 2007.
SIGNATURES
Pursuant to the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
REPLIDYNE, INC.
By:
/s/ Kenneth Collins
Kenneth Collins
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated and on the dates indicated.
+
Indicates management contract or compensatory plan.
*
Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
(1)
Incorporated by reference to the same numbered exhibit filed with our Registration Statement on Form S-1 (File No. 333-133021), as amended, declared effective June 29, 2006.
(2)
Incorporated by reference to our Current Report on Form 8-K filed on March 9, 2007.