ITEM 1. BUSINESS
FORWARD-LOOKING STATEMENTS
This Report on Form 10-K contains forward-looking statements regarding us and our business, financial condition, results of operations and prospects within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements. These forward-looking statements include statements about the following:
•our plans to develop PS433540, a Phase 2 product candidate from our DARA program;
•our existing and proposed Phase 2 and Phase 1 clinical studies with respect to PS433540, including timing and expected outcomes of such studies;
•our ability to raise additional funds;
•our plans to develop PS178990, a Phase 1 product candidate from our SARM program;
•our plans to develop PS031291, a preclinical development product candidate from our chemokine receptor CCR1 program;
•our estimates of the market opportunity for our product candidates, including PS433540, PS178990 and PS031291;
•our ability to successfully perform under our agreements with Bristol-Myers Squibb Company, GlaxoSmithKline, Wyeth, Cephalon and Organon;
•our ability to build our pipeline of novel drug candidates through our own internally-funded drug discovery and development programs, third party collaborations, in-licensing and acquisitions;
•our expectations concerning the development priorities of our collaborators, their ability to successfully develop compounds and our receipt of milestones and royalties;
•our anticipated operating results, financial condition, liquidity and capital resources;
•our expectations concerning the legal protections afforded by U.S. and international patent laws;
•our ability to pursue the development of new compounds and other business matters without infringing the patent rights of others;
•our ability to acquire or invest in complementary businesses or technologies; and
•additional competition and changes in economic conditions.
In some cases, you can identify forward-looking statements by terminology, such as "goals," or "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," or the negative of such terms or other similar expressions. You are urged not to place undue reliance on any such forward-looking statements, any of which may turn out to be wrong due to inaccurate assumptions, unknown risks, uncertainties or other factors. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed elsewhere in this Report in Part I, Item 1A.
ITEM 1A. RISK FACTORS
As further described herein, our performance and financial results are subject to risks and uncertainties including, but not limited to, the following specific risks:
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
If we consume cash more quickly than expected, and if we are unable to raise additional capital, we may be forced to curtail operations.
As of December 31, 2007, we had cash, cash equivalents and marketable securities of approximately $71.3 million. In addition, as of December 31, 2007, we had deferred revenue of approximately $47.2 million relating to research and development activities that are to be performed by us subsequent to December 31, 2007. Our cash used in operating activities for the year ended December 31, 2007 was approximately $11.1 million, which included $25.0 million in upfront payments from collaborators. Excluding these receipts, our cash used in operating activities would have been $36.1 million. As the clinical programs we are developing progress, we expect this amount to increase in the future. Clinical and preclinical development of drug candidates is a long, expensive and uncertain process that requires us to raise funds from time to time to support our internal development programs. We expect to raise funds from one or a combination of approaches, which could include public and/or private financing, sale and/or partnering of one or more of our internal programs, and partnering of our internal drug discovery capabilities.
We believe that our capital resources will be adequate to fund our operations at their current levels at least through December 31, 2008. However, changes may occur that would cause us to consume available capital resources before that time. Examples of relevant potential changes that could impact our capital resources include:
•the costs associated with our drug research and development activities, including the costs associated with our Phase 2 and Phase 1 clinical development programs for our product candidates PS433540 and PS178990 and additional costs we may incur if our development programs are delayed or are more expensive to implement than we currently anticipate;
•changes in existing collaborative relationships, including the funding we receive in connection with those relationships;
•the progress of our milestone and royalty producing activities;
•acquisitions of other businesses or technologies;
•the purchase of additional capital equipment;
•cash refunds we may be required to make to GSK if, prior to March 24, 2011, we exercise our discretionary termination right under the GSK Agreement;
•cash payments we may be required to make to Organon relating to a termination fee if, prior to August 2010, we exercise our discretionary termination right under the Organon Agreement;
•cash payments we may be required to make to BMS if we fail to deliver certain compound libraries under the license agreement for the DARA program;
•competing technological and market developments; and
•the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, and the outcome of related litigation.
In May 2007, we raised capital through a public underwritten offering of common stock. Our issuance of approximately 8.1 million shares of common stock in connection with that financing resulted in significant dilution in the percentage ownership of our stockholders that owned stock prior to the financing. We expect to raise funds from one or a combination of approaches, which could include public or private financing, sale and/or partnering of one or more of our internal programs, and partnering of our internal drug discovery capabilities. Capital could be raised through public or private financings involving debt or common stock or other classes of our equity. As of February 29, 2008, we had only approximately 12.9 million shares of common stock authorized and available for issuance to raise additional capital under our amended and restated certificate of incorporation. Our failure to secure stockholder approval of an amendment of our amended and restated certificate of incorporation to authorize additional shares of common stock would make it more difficult for us to raise additional capital through the issuance of our common stock. Further issuances of equity securities will further dilute our stockholders' percentage ownership.
As of February 29, 2008, there were approximately 4,802,000 stock options outstanding granted under our various equity compensation plans and approximately 1,626,000 warrants outstanding, which includes approximately 176,000 warrants issued in connection with the GSK Agreement and approximately 1,450,000 warrants issued in connection with our October 2006 financing transaction. These equity instruments represent approximately 22% of our shares outstanding at February 29, 2008. The significant dilution represented by our outstanding warrants and equity compensation awards may make it more difficult for us to raise additional capital.
Additional capital may not be available on favorable terms, or at all. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into arrangements with partners or others that may require us to relinquish rights to certain of our technologies, products or potential markets that we would not otherwise relinquish.
Because PS433540 is in Phase 2 clinical development and PS178990 is in Phase 1 clinical development, there is a high risk that further development and testing will demonstrate that neither compound is suitable for commercialization. In addition, because we exclusively licensed each of PS433540 and PS178990 from BMS, any dispute with BMS may adversely affect our ability to develop and commercialize those product candidates.
We have no products that have received regulatory approval for commercial sale. PS433540 is in Phase 2 clinical development and PS178990 is in Phase 1 clinical development. We face the substantial risks of failure inherent in developing drugs based on new technologies.
Both PS433540 and PS178990 must satisfy rigorous standards of safety and efficacy before the FDA and foreign regulatory authorities will approve either product candidate for commercial use. Phase 1 clinical trials with PS178990 may not demonstrate that the product candidate is sufficiently safe
to warrant our continued development of it, and Phase 2 clinical trials with PS433540 may not demonstrate that it is safe or efficacious with respect to the clinical indications for which we seek to develop it. We will need to conduct significant additional clinical trials to demonstrate the safety and efficacy of PS433540 and PS178990 to the satisfaction of the FDA and foreign regulatory authorities to obtain product approval.
Clinical development is a long, expensive and uncertain process. It may take us many years to complete clinical trials, and failure can occur at any stage of trials. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. We may suffer significant setbacks in advanced clinical trials, even after promising results in earlier trials. We may not be able to enroll a sufficient number of patients to complete our clinical trials in a timely manner. Based on results at any stage of preclinical testing or clinical trials, we may decide to discontinue development of PS433540 and PS178990.
We do not know whether any future clinical trials of PS433540 or PS178990 will demonstrate sufficient safety and efficacy necessary to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately demonstrate the safety and efficacy of PS433540 or PS178990 in their respective development programs will prevent receipt of FDA and foreign regulatory approvals and, ultimately, commercialization.
If there is any dispute between us and BMS regarding our rights under the DARA License Agreement, our ability to develop and commercialize PS433540 may be adversely affected. Any loss of our rights from BMS could delay or completely terminate our product development efforts for PS433540 and other DARA compounds licensed from BMS. Similarly, if there is any dispute between us and BMS regarding our rights under the SARM License Agreement and/or performance under the discovery collaboration agreement, our ability to develop and commercialize PS178990 may be adversely affected. Any loss of our rights from BMS could delay or completely terminate our product development efforts for PS178990 and other SARM compounds licensed from BMS.
Our development of PS433540 may be adversely impacted if our clinical trials show certain adverse effects reported by other companies in connection with clinical trials of their ERA and ARB product candidates.
Abnormal liver function test (LFT) results, which are indicative of potential liver toxicity, have been reported by other companies as complications in their clinical trials of ERA product candidates. Approval of PS433540 may be delayed or ultimately blocked by such concerns. If the results of any of our PS433540 clinical trials indicate abnormal LFTs, we may not receive regulatory approval to market the product candidate and our product candidate, if approved for marketing, may not be able to compete with other products. There can be no assurance that the lack of LFT abnormalities seen with respect to PS433540 prior to now will be confirmed by subsequent clinical trial results.
As developed by other companies, ERAs and ARBs have been teratogenic in animals. If approved for marketing, we assume that PS433450 will be subject to a black box warning regarding teratogenicity and therefore may not be able to compete with other products that do not have a similar warning.
Prior clinical trials by other companies have also indicated that the ERA therapeutic class may cause peripheral edema (fluid retention) in some patients. Consequently, PS433540 may not be successfully developed as a treatment for heart failure or for use in patients at risk for heart failure and may therefore have a more limited market potential than antihypertensives that are approved for the treatment of heart failure.
Our development of PS178990 may be adversely impacted if our clinical trials show certain adverse effects reported in connection with testosterone and other anabolic steroids.
Testosterone and other anabolic steroids may cause serious unwanted side effects, including stimulating prostate cancer growth in men and masculinization in women. Approval of PS178990 may be delayed or ultimately blocked by such concerns. If the results of any of our PS178990 clinical trials indicate such stimulation of prostate cancer growth or masculinization, we may not receive regulatory approval to market the product candidate and our product candidate, if approved for marketing, may not be able to compete with other products.
We had net losses in recent years and our future profitability is uncertain.
During the year ended December 31, 2007, we had a net loss of approximately $47.9 million. The net loss was primarily due to costs incurred in our internal product development efforts, including the costs of developing PS433540, which is currently in Phase 2 clinical trials, and the research and development of our other product candidates.
In connection with the acquisition of the SARM program, we recorded a non-cash charge of $9.2 million to proprietary research and development expense. The amount of this charge approximates the fair value of the chemistry resources we are to provide to BMS under the discovery collaboration agreement.
We expect to incur losses in future periods and these losses are expected to increase as compared to prior periods as a result of the increased level of investment we plan to make in our internal programs, including our DARA program and our SARM program, in the future.
Our adoption of SFAS No. 123 (revised 2004) "Share-Based Payment" (SFAS 123R), which was effective January 1, 2006, increased our compensation costs and will continue to have a significant impact on our results of operations. In addition, under Emerging Issues Task Force (EITF) No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" (EITF 00-19), the accounting treatment of the warrants that we issued in our October 2006 equity financing may have a significant impact on our results of operations, depending on the volatility of the market price of our common stock and the assumptions used in calculating the fair value of the warrants.
On a quarterly basis, our future operating results are likely to be highly volatile depending upon our receipt, if any, of milestone payments from our collaborators. We may not receive milestone payments on a regular basis or at all. Our ability to achieve profitability, if ever, will be significantly impacted by the level of investment we plan to make in our internal proprietary programs in the future, as well as the results of those programs.
Continuing net losses may limit our ability to fund our operations and we may not generate income from operations in the future.
Our current revenue stream is highly dependent upon the extent to which the pharmaceutical and biotechnology industries collaborate with drug discovery and development companies for one or more aspects of their drug discovery and development process.
Our revenue depends to a large extent on research and development expenditures by the pharmaceutical and biotechnology industries. Our capabilities include aspects of the drug discovery and development process that pharmaceutical companies have traditionally performed internally. Although there is a history among pharmaceutical and biotechnology companies of outsourcing drug research and development functions, this practice may not continue.
The willingness of these companies to expand or continue collaborations to enhance their research and development activities is based on certain factors that are beyond our control. While we are unaware of a specific reason that any of the following factors will have a material impact on the willingness of current or potential collaborators to expand or continue collaborations, examples of
relevant factors include collaborators' changing spending priorities among various types of research activities, the increased presence of offshore companies that conduct research and have lower full-time equivalent costs than ours, their ability to hire and retain qualified scientists, their approach regarding expenditures during recessionary periods and their policies regarding the balance of research expenditures versus cost containment. Also, general economic downturns in our collaborators' industries, adverse changes in the regulatory environment, the adverse impact of product litigation on our collaborators' businesses or any decrease in our research and development expenditures could harm our operations, as could increased popularity of management theories, which counsel against outsourcing of critical business functions.
Continued consolidation in the pharmaceutical and biotechnology industries may further decrease the number of potential collaborators for us or may alter the priorities of our current collaborators. For example, in 2007, subsequent to our entering into the Organon Agreement, Schering-Plough acquired our collaborator Organon.
In addition, the popularity of scientific thinking that disfavors elements of our technology platform, such as large diverse libraries, could negatively impact our business. Any decrease in drug discovery spending by pharmaceutical and biotechnology companies could cause our revenue to decline.
Our ability to collaborate with large pharmaceutical and biotechnology companies will depend on many factors, including our ability to:
•discover and develop high-quality drug candidates;
•identify and utilize scientists and technologies that are of the highest caliber; and
•achieve results in a timely fashion, with acceptable quality and at an acceptable cost.
The importance of these factors varies from collaborator to collaborator, and we may be unable to meet any or all of them for some or all of our collaborators in the future.
If third parties do not manufacture PS433540 in sufficient quantities and at an acceptable cost, clinical development of PS433540 would be delayed.
We do not currently own or operate manufacturing facilities, and we rely, and expect to continue to rely, on third parties for the production of clinical quantities of our product candidates. Our current and anticipated future dependence upon others for the manufacture of our product candidates may adversely affect our future profit margins and our ability to develop product candidates and commercialize any product candidates on a timely and competitive basis.
We have relied on third party vendors for the manufacture of clinical quantities of PS433540, and we are currently assessing our manufacturing needs for additional clinical trial supply of PS433540 as we review our clinical strategy for PS433540. We will evaluate whether to continue to rely on the manufacturing capabilities of our current third party vendors or whether some or all of the manufacturing process should be transferred to other contract manufacturers as we plan for our additional clinical trials. If our current supply of PS433540 becomes unusable, if our PS433540 supply is not sufficient to complete our clinical trials, or if we are unsuccessful in identifying a contract manufacturer or negotiating a manufacturing agreement on a timely basis for our additional clinical trials, we could experience a delay in receiving an adequate supply of PS433540.
We may not be able to maintain or renew our existing or any other third-party manufacturing arrangements on acceptable terms, if at all. If we are unable to continue relationships for PS433540, or to do so at an acceptable cost, or if these or other suppliers fail to meet our requirements for PS433540 for any reason, we would be required to obtain alternate suppliers. Any inability to obtain alternate suppliers, including an inability to obtain approval from the FDA of an alternate supplier, would delay or prevent the clinical development of these product candidates.
Use of third-party manufacturers may increase the risk that we will not have adequate supplies of our product candidates.
Reliance on third-party manufacturers entails risks to which we would not be subject if we manufactured product candidates or products ourselves, including:
•Reliance on the third party for regulatory compliance and quality assurance;
•The possible breach of the manufacturing agreement by the third party because of factors beyond our control; and
•The possible termination or non-renewal of the agreement by the third party, based on its own business priorities, at a time that is costly or inconvenient for us.
If we are not able to obtain adequate supplies of our product candidates, it will be more difficult for us to develop our product candidates and compete effectively. Our product candidates and any products that we may develop may compete with other product candidates and products for access to manufacturing facilities.
Our present or future manufacturing partners may not be able to comply with FDA-mandated current Good Manufacturing Practice regulations, other FDA regulatory requirements or similar regulatory requirements outside the United States. Failure of our third-party manufacturers or us to comply with applicable regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our product candidates, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of product candidates or products, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect supplies of our product candidates.
We are dependent on our collaborations, and events involving these collaborations or any future collaborations could prevent us from developing or commercializing product candidates.
The success of our current business strategy will depend in part on our ability to successfully perform under and manage strategic collaborations. Since we do not currently possess the resources necessary to independently develop and commercialize all of the product candidates that may be discovered through our drug discovery technology, we may need to enter into additional collaborative agreements to assist in the development and commercialization of some of these product candidates or in certain markets for a particular product candidate. Establishing strategic collaborations is difficult and time-consuming. Potential collaborators may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position, and our discussions with potential collaborators may not lead to the establishment of new collaborations on acceptable terms.
We and our present and future collaborators may fail to develop or effectively commercialize products covered by our present and future collaborations if:
•we do not achieve our objectives under our collaboration agreements;
•we or our collaborators are unable to obtain patent protection for the product candidates or proprietary technologies we discover in our collaborations;
•we are unable to manage multiple simultaneous product discovery and development collaborations;
•our potential collaborators are less willing to expend their resources on our programs due to their focus on other programs or as a result of general market conditions;
•our collaborators become competitors of ours or enter into agreements with our competitors;
•we or our collaborators encounter regulatory hurdles that prevent commercialization of our product candidates;
•we develop products and processes or enter into additional collaborations that conflict with the business objectives of our other collaborators; or
•our collaborators elect to terminate our partnerships under the permitted circumstances.
If we or our collaborators are unable to develop or commercialize products as a result of the occurrence of any one or a combination of these events, we will be prevented from developing and commercializing such product candidates. Moreover, disputes may arise with respect to the ownership of rights to any technology or products developed with any current or future partner. Lengthy negotiations with potential new partners or disagreements between us and our partners may lead to delays or termination in the research, development or commercialization of product candidates. If we are not able to establish additional partnerships on terms that are favorable to us or if a significant number of our existing partnerships are terminated and we cannot replace them, we may be required to increase our internal product development and commercialization efforts. Any of the foregoing may materially harm our business, financial condition and results of operations.
The development of our internal and collaborative products is at an early stage and is uncertain.
Drug development is a highly uncertain process. Our approach and technology may never result in a commercial drug. None of our programs has resulted in products that have received regulatory approval for commercial sale. Our most advanced internal compound, PS433540, is in Phase 2 clinical trials. Currently our collaborators have advanced six programs into active clinical trials. All of our therapeutic candidates, including these clinical candidates, face the substantial risks of failure inherent in the drug development process. Any potential pharmaceutical product emanating from one of our internal or collaborative programs must satisfy rigorous standards of safety and efficacy before the FDA and foreign regulatory authorities will approve them for commercial use. To satisfy these standards, significant additional research, preclinical studies and clinical trials will be required.
Our internal and collaborative programs are in early stages relative to generating a commercial product. Therefore, we and our collaborators must engage in significant, time-consuming and costly research and development efforts followed by our and our collaborators' applications for and receipt of, regulatory approvals. Consequently, we do not expect compounds from these development activities to result in commercially available products for many years, if at all.
If our collaborators are not able to successfully develop our existing clinical candidates, our business will be harmed.
Our collaborators Schering-Plough, BMS and Celgene, currently are undertaking active clinical trials of prospective pharmaceutical products containing our proprietary compounds.
In each case, the collaborator is responsible for the development of these potential products, the level of resources devoted to such development and the decision as to when, or whether, such development should cease. Numerous additional studies are necessary to support the further development of these product candidates. Results from preclinical and clinical studies conducted to date on these product candidates are not necessarily indicative of the results that may be obtained in clinical studies. Clinical results could cause our collaborators to discontinue or limit development of these product candidates. For example, in each of August 2007 and November 2005, Schering-Plough informed us that it had discontinued Phase 1 clinical trials for the respective clinical compounds developed from leads from our collaboration with Schering-Plough. There can be no assurance that Schering-Plough, BMS and Celgene will continue to develop the current clinical programs.
In addition, our collaborators may pursue alternative technologies or drug candidates, either on their own or in collaboration with others, that compete with the clinical candidates on which they collaborate with us. If our collaborators do not continue their development efforts or if such efforts do not result in positive clinical results, we will not receive additional milestone and royalty payments from those efforts, and our business will be harmed.
Our stock price may be volatile and your investment in our stock could decline in value.
The market price for our common stock has been highly volatile and may continue to be highly volatile in the future. During the year ended December 31, 2007, the closing market price of our common stock ranged from $4.02 per share at its low point in January 2007 to $6.59 per share at its high point in April 2007. Results from our development programs, especially the DARA program, our quarterly operating results, changes in general conditions in the economy or the financial markets, and other developments affecting our competitors or us could cause the market price of our common stock to fluctuate substantially. In recent years, the stock market has experienced significant price and volume fluctuations.
While we are unaware of a specific reason that any of the following factors will have a material impact on our stock price, the following factors, in addition to the factors described in the other risk factors contained in this report, may have a significant impact on the market price of our common stock:
•publicity concerning the status of potential drug products under development by us or our collaborators or our competitors and their partners;
•reduction, termination or expiration of our collaborations;
•announcements by us or our competitors of significant acquisitions, strategic partnerships or joint ventures;
•announcements of technological innovations or new commercial products by our competitors or us;
•developments concerning proprietary rights, including patents;
•litigation;
•economic and other external factors or other disasters or crises;
•actual or anticipated period-to-period fluctuations in our financial results;
•changes in financial estimates prepared by securities analysts;
•differences in the valuations assigned by the equity markets and, in particular, the biopharmaceutical sector of the equity markets, to biopharmaceutical companies like us that have more drug discovery than drug development capabilities; and
•the general performance of the equity markets and, in particular, the biopharmaceutical sector of the equity markets.
Disputes may arise between our partners and us as to royalties and milestones to which we believe we are entitled.
The compound basis for drugs developed by a partner may be a derivative or optimized version of the compound screened or optimized by us.
While our existing collaborative agreements provide that we will receive milestone payments and royalties with respect to certain products developed from certain derivative compounds, there can be no assurance that disputes will not arise over the application of payment provisions to such products.
There can be no assurance that current or future partners will not pursue alternative technologies, or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments based on the targets which are the subject of the collaborative arrangements with us.
In addition, many of our agreements that provide for potential royalty payments to us also contain provisions that reduce our expected royalty if a partner is also required to pay a royalty on a product to a third party.
The drug research and development industry is highly competitive and subject to technological change, and we may not have the resources necessary to compete successfully.
Many of our competitors have access to greater financial, technical, research, marketing, sales, distribution, service and other resources than we do. Moreover, the pharmaceutical and biotechnology industries are characterized by continuous technological innovation. We anticipate that we will face increased competition in the future as new companies enter the market and our competitors make advanced technologies available. Technological advances or entirely different approaches that we or one or more of our competitors develop may render our products, services and expertise obsolete or uneconomical. Additionally, the existing approaches of our competitors or new approaches or technologies that our competitors develop may be more effective than those we develop. We may not be able to compete successfully with existing or future competitors.
If we cannot manage the multiple relationships and interests involved in our collaborative arrangements and internal programs, our business, financial condition and results of operations may be materially adversely affected.
We need to successfully structure and manage multiple internal programs and collaborative relationships, including maintaining confidentiality of the research being performed for multiple collaborators. We may be unable to successfully manage conflicts between competing drug development programs of third parties to which we offer services. From time to time, more than one of our collaborators may want to perform research concerning the same or molecularly similar disease targets.
Because of that, we may be required to reconcile our relationships with those collaborators, particularly if both want to establish exclusive relationships with us with respect to that target or if one collaborator has an existing arrangement with us and the other would like us to perform services regarding a target restricted by that arrangement.
Further, if we are working with a collaborator regarding a particular target, another of our collaborators may be researching the same target in one of its internal programs of which we have no knowledge. As a result, potential conflicts involving us may arise due to this competition between collaborators in a particular disease field of interest.
Conflicts also may arise between our collaborators as to proprietary rights to particular compounds in our libraries or as to proprietary rights to biological targets such as receptors or enzymes against which we screen compounds in our libraries. The occurrence of conflicts, or the perception of conflicts, could have a material adverse effect on our business, financial condition and results of operations.
If we use hazardous materials in a manner that causes injury or violates laws, we may be liable for damages.
Our activities involve the use of potentially harmful hazardous materials, chemicals and various radioactive compounds. These materials are utilized in the performance of our assay development, high-throughput screening and chemistry optimization services, and include common organic solvents, such as acetone, hexane, methylene chloride, acetonitrile, and isopropyl and methyl alcohol, as well as common acids and bases. The waste from utilization of these solvents and other materials is disposed of through licensed third-party contractors. Further, we utilize an extremely wide variety of chemicals in
the performance of our assay development, screening and optimization services. These chemicals, such as reagents, buffers and inorganic salts, typically are employed in extremely small amounts in connection with the work performed in our laboratories.
We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result.
We maintain insurance coverage against environmental hazards arising from the storage and disposal of the materials utilized in our business. Although our management believes that such insurance has terms, including coverage limits, which are appropriate for our business, liabilities arising from the use, storage, handling or disposal of these materials could exceed our insurance coverage, as well as our resources. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant. To our knowledge, we have not been, and currently are not, the subject of any governmental investigation concerning the violation of these federal, state and local laws and regulations. There can be no assurance that we will not be the subject of future investigations by governmental authorities.
We and our products are subject to strict government regulation, which may limit the development of products by us or our collaborators.
Regulation by governmental entities in the United States and other countries will be a significant factor in the production and marketing of any pharmaceutical products our collaborators or we may develop. The nature and the extent to which government regulation may apply to our collaborators and us will vary depending on the nature of the pharmaceutical products, if any. Virtually all pharmaceutical products require regulatory approval prior to commercialization.
If we or our collaborators or licensees fail to obtain, or encounter delays in obtaining or maintaining, regulatory approvals, our financial results could be adversely affected. Similar regulatory procedures are required in countries outside the United States.
In addition, new legislation related to health care could reduce the prices pharmaceutical and biotechnology companies can charge for drugs they sell which, in turn, could reduce the amounts that they have available for collaborative relationships with us. If pharmaceutical and biotechnology companies decrease the resources they devote to the research and development of new drugs, the number of collaborations we conclude could be adversely impacted and our revenue and profitability reduced. If prices that pharmaceutical and biotechnology companies can charge for drugs they sell decrease, the royalties, if any, we receive from the sale of products would also decrease, which would reduce our revenue and profitability.
Failure to attract and retain skilled personnel could materially and adversely affect us.
We are a small company and our success depends in part on the continued service of key scientific and management personnel, including our president and chief executive officer, Leslie J. Browne, Ph.D., and our ability to identify, hire and retain additional personnel. There is intense competition for qualified personnel. Immigration laws may further restrict our ability to attract or hire qualified personnel. We may not be able to continue to attract and retain the personnel necessary for our growth and development. Failure to attract and retain key personnel could have a material adverse effect on our business, financial condition and results of operations. Further, we are highly dependent on the principal members of our scientific and management staff. One or more of these key employees could retire or otherwise leave our employ within the foreseeable future and the loss of any of these people could have a material adverse effect on our business, financial condition and results of operations. We do not, and do not intend to, maintain key person life insurance on the life of any employee.
If third parties on whom we rely do not perform as contractually required or expected, we may not be able to obtain regulatory approval for or to commercialize our product candidates.
We do not have the ability to independently conduct clinical trials for our product candidates, and we must rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to conduct our clinical trials. In addition, we rely on third parties to assist with our preclinical development of product candidates. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if the third parties need to be replaced, or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our preclinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for, or successfully commercialize, our product candidates.
In addition, we continue to depend heavily upon the expertise and dedication of sufficient resources by partners to develop and commercialize products primarily based on lead compounds discovered by us. If a partner fails to develop or commercialize a compound or product with respect to which it has rights from us, we may not receive any future milestone payments or royalties associated with that compound or product.
Similarly, while we are unaware of a specific reason that any of the following factors will be experienced by our partners, because we rely heavily on them, our revenue could be adversely affected if our partners:
•fail to select a target or product candidate we have identified for subsequent development;
•fail to gain the requisite regulatory approvals for product candidates;
•do not successfully commercialize products based on the compounds that we originate;
•do not conduct their collaborative activities in a timely manner;
•do not devote sufficient time or resources to our partnered programs or potential products;
•terminate their alliances or arrangements with us;
•develop, either alone or with others, products that may compete with our product candidates;
•dispute our respective allocations of rights to any products or technology developed during our collaborations; or
•merge with or are acquired by a third party that seeks to terminate our collaboration.
Our operations may be interrupted by the occurrence of a natural disaster or other catastrophic event at our primary facilities.
We depend on our laboratories and equipment for the continued operation of our business. Our research and development operations and administrative functions are primarily conducted at our facilities in the Princeton, New Jersey area. Although we have contingency plans in effect for natural disasters or other catastrophic events, catastrophic events could still disrupt our operations.
Even though we carry business interruption insurance policies, we may suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies. Any natural disaster or catastrophic event in our facilities or the areas in which they are located could have a significant negative impact on our operations.
Because we do not intend to pay dividends, you will benefit from an investment in our common stock only if it appreciates in value.
We have never declared or paid any cash dividend on common stock. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of your investment in our common stock will depend entirely upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain its price.
Anti-takeover provisions under Section 203 of the Delaware General Corporation Law, provisions in our amended and restated certificate of incorporation and amended and restated bylaws, and our adoption of a stockholder rights plan may render more difficult the accomplishment of mergers or the assumption of control by a principal stockholder, making more difficult the removal of management.
Section 203 of the Delaware General Corporation Law may delay or deter attempts to secure control of our company without the consent of our management. In general, Section 203 prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years following the date the person becomes an interested stockholder, unless certain conditions are met.
Our amended and restated certificate of incorporation and amended and restated bylaws contain several provisions that could delay or make more difficult the acquisition of our company through a hostile tender offer, open market purchases, proxy contest, merger or other takeover attempt that a stockholder might consider in his or her best interest, including those attempts that might result in a premium over the market price of our common stock. Such provisions include the issuance of preferred stock without approval of the holders of our common stock, the classification of our board of directors, the election and removal of directors, restrictions on the ability of stockholders to take action without a meeting, restrictions on stockholders' ability to call a special meeting and advance notice procedures regarding any proposal of stockholder business to be discussed at a stockholders meeting.
We have adopted a stockholder rights plan, which is triggered upon commencement or announcement of a hostile tender offer or when any one person or group acquires 15% or more of our common stock. The rights plan, once triggered, enables stockholders to purchase our common stock at reduced prices. These provisions of our governing documents, stockholder rights plan and Delaware law could have the effect of delaying, deferring or preventing a change of control, including without limitation a proxy contest, making more difficult the acquisition of a substantial block of our common stock. The provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. Further, the existence of these anti-takeover measures may cause potential bidders to look elsewhere, rather than initiating acquisition discussions with us.
If we engage in an acquisition or business combination, we will incur a variety of risks that could adversely affect our business operations or our stockholders.
From time to time we have considered, and we will continue to consider in the future, if and when any appropriate opportunities become available, strategic business initiatives intended to further the development of our business.
These initiatives may include acquiring businesses, technologies or products or entering into a business combination with another company. If we do pursue such a strategy, we could, among other things:
•issue equity securities that would dilute our current stockholders' percentage ownership;
•incur substantial debt that may place strains on our operations;
•spend substantial operational, financial and management resources in integrating new businesses, technologies and products;
•assume substantial actual or contingent liabilities; or
•merge with, or otherwise enter into a business combination with, another company in which our stockholders would receive cash or shares of the other company or a combination of both on terms that our stockholders may not deem desirable.
We are not in a position to predict what, if any, collaborations, alliances or other transactions may result or how, when or if these activities would have a material effect on us or the development of our business.
Accounting for our collaboration agreements, our in-licensing agreements, our revenues and costs, our warrants and share-based compensation and other significant transactions involve significant estimates which, if incorrect, could have a material adverse effect on our financial position, results of operations, and our ability to raise capital.
As further described in "Critical Accounting Policies and Estimates" under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," accounting for our collaborative, development, and other transactions in the course of our business require us to make a variety of significant estimates and assumptions. Although we believe we have sufficient experience and processes in place to enable us to formulate appropriate assumptions and produce reliable estimates, these assumptions and estimates may change significantly in the future and these changes could have a material adverse effect on our financial position, our results of operations, and our ability to raise capital.
CERTAIN RISKS RELATED TO INTELLECTUAL PROPERTY
Positions taken by the U.S. Patent and Trademark Office or non-U.S. patent and trademark officials may preclude us from obtaining sufficient or timely protection for our intellectual property.
The patent positions of pharmaceutical and biotechnology companies are uncertain and involve complex legal and factual questions. The coverage claimed in a patent application can be significantly reduced before the patent is issued. There is a significant risk that the scope of a patent may not be sufficient to prevent third parties from marketing other products or technologies with the same functionality of our products and technologies. Consequently, some or all of our patent applications may not issue into patents, and any issued patents may provide ineffective remedies or be challenged or circumvented.
Third parties may have filed patent applications of which we may or may not have knowledge, and which may adversely affect our business.
Patent applications in the United States are maintained in secrecy for 18 months from filing or until a patent issues. Under certain circumstances, patent applications are never published but remain in secrecy until issuance. As a result, others may have filed patent applications for products or technology covered by one or more pending patent applications upon which we are relying. If applications covering similar technologies were to be filed before our applications, our patent applications may not be granted. There may be third-party patents, patent applications and other intellectual property or information relevant to our chemical compositions and other technologies that are not known to us, that block us or compete with our chemical compositions or other technologies, or limit the scope of patent protection available to us. Moreover, from time to time, patents may issue which block or compete with our chemical compositions or other technologies, or limit the scope of patent protection available to us. Litigation may be necessary to enforce patents issued to us or to determine the scope and validity of the intellectual property rights of third parties.
We may not be able to protect adequately the trade secrets and confidential information that we disclose to our employees.
We rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. Competitors through their independent discovery (or improper means, such as unauthorized disclosure or industrial espionage) may come to know our proprietary information. We generally require employees and consultants to execute confidentiality and assignment-of-inventions agreements. These agreements typically provide that all materials and confidential information developed by or made known to the employee or consultant during his, her or its relationship with us are to be kept confidential, and that all inventions arising out of the employee's relationship with us are our exclusive property. Our employees and consultants may breach these agreements, and in some instances we may not have an adequate remedy. Additionally, in some instances, we may have failed to require that employees and consultants execute confidentiality and assignment-of-inventions agreements.
Foreign laws may not afford us sufficient protections for our intellectual property, and we may not seek patent protection outside the United States.
We believe that our success depends, in part, upon our ability to obtain international protection for our intellectual property. However, the laws of some foreign countries may not be as comprehensive as those of the United States and may not be sufficient to protect our proprietary rights abroad. In addition, we may decide not to pursue patent protection outside the United States because of cost and confidentiality concerns. Accordingly, our international competitors could obtain foreign patent protection for, and market overseas, products and technologies for which we are seeking U.S. patent protection and they may be able to use these products and technologies to compete against us.
We may not be able to adequately defend our intellectual property from third party infringement, and third party challenges to our intellectual property may adversely affect our rights and be costly and time consuming.
Some of our competitors have, or are affiliated with companies having, substantially greater resources than we have, and those competitors may be able to sustain the costs of complex patent litigation to a greater degree and for longer periods of time than us. Uncertainties resulting from the initiation and continuation of any patent or related litigation could have a material adverse effect on our ability to compete in the marketplace pending resolution of the disputed matters. If our competitors prepare and file patent applications in the United States that claim technology also claimed by us, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of invention, which could result in substantial costs to us, even if the outcome is favorable to us. Similarly, opposition proceedings may occur overseas, which may result in the loss or narrowing of the scope of claims or legal rights. Such proceedings will at least result in delay in the issuance of enforceable claims. An adverse outcome could subject us to significant liabilities to third parties and require us to license disputed rights from third parties or cease using the technology.
A patent issued to us may not be sufficiently broad to protect adequately our rights in intellectual property to which the patent relates.
Even if patents are issued to us, these patents may not sufficiently protect our interest in our chemical compositions or other technologies because the scope of protection provided by any patents issued to or licensed by us are subject to the uncertainties inherent in patent law. Third parties may be able to design around these patents or develop unique products providing effects similar to our products. In addition, others may discover uses for our chemical compositions or technologies other than those uses covered in our patents and these other uses may be separately patentable. A number of pharmaceutical and biotechnology companies, and research and academic institutions, have developed
technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, patent applications or patents may conflict with our technologies, patent applications or patents. These conflicts could also limit the scope of patents, if any, that we may be able to obtain, or result in the denial of our patent applications. We are not currently aware of any such patent applications or patents that could have a material adverse effect on our business.
We may be subject to claims of infringement by third parties.
Third parties may claim infringement by us of their intellectual property rights. In addition, to the extent our employees are involved in research areas similar to those areas in which they were involved at their former employers, we may be subject to claims that one of our employees, or we, have inadvertently or otherwise used or disclosed the alleged trade secrets or other proprietary information of a former employer. From time to time, we have received letters claiming or suggesting that our products or activities may infringe third party patents or other intellectual property rights. Our products may infringe patent or other intellectual property rights of third parties. A number of patents may have been issued or may be issued in the future that could cover certain aspects of our technology and that could prevent us from using technology that we use or expect to use. We may be required to seek licenses for, or otherwise acquire rights to, technology as a result of claims of infringement. We may not possess proper ownership or access rights to the intellectual property we use. Third parties or other companies may bring infringement suits against us. Any claims, with or without merit, could be time consuming to defend, result in costly litigation, divert management's attention and resources or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event of a successful claim of product infringement against us, our failure or inability to license or design around the infringed technology could have a material adverse effect on our business, financial condition and results of operations. We are not currently involved in actions of this type that are material to our business.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We currently lease and occupy approximately 99,000 square feet in two facilities near Princeton, New Jersey. We pay approximately $206,000 per month under these leases and they expire in 2016.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a party to any legal proceedings the negative outcome of which would have a material adverse effect on our business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2007.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
MARKET FOR COMMON STOCK
Our common stock trades on the NASDAQ Global Market under the ticker symbol "PCOP". The following table sets forth for the periods indicated the range of high and low closing sale prices of the Common Stock.
HOLDERS OF RECORD
As of February 29, 2008 there were approximately 374 holders of record of our Common Stock.
DIVIDENDS
No cash dividends have been paid on our Common Stock to date. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data have been derived from our audited Financial Statements. This data should be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements and related notes thereto included elsewhere in this Annual Report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the Financial Statements and related disclosures included elsewhere in this Report. The following discussion may contain forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.
In some cases, you can identify forward-looking statements by terminology, such as "goals," or "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," or the negative of such terms or other similar expressions. You are urged not to place undue reliance on any such forward-
looking statements, any of which may turn out to be wrong due to inaccurate assumptions, unknown risks, uncertainties or other factors. Factors that could cause or contribute to differences in results and outcomes from those in our forward-looking statements include, without limitation, those discussed elsewhere in this Report in Part I, Item 1A. "Risk Factors" and in Item 1 "Business-Forward-Looking Statements," as well as those discussed in our other Securities and Exchange Commission (SEC) filings.
Business Overview
We are a clinical development stage biopharmaceutical company dedicated to discovering and developing novel small molecule therapeutics to address significant medical needs. We have a broad portfolio of clinical and preclinical candidates under development internally or by partners, including eight clinical compounds in Phase 2 or Phase 1 development addressing multiple indications including hypertension, diabetic nephropathy, muscle wasting, inflammation and respiratory disease.
Executive Overview of Financial Results
Our cash, cash equivalents and marketable securities balance increased from $46.1 million at December 31, 2006 to $71.3 million at December 31, 2007. Our net cash used in operating activities increased from $5.9 million during the year ended December 31, 2006 to $11.1 million during year ended December 31, 2007. Excluding up-front payments totaling $25.0 million in 2007 and $20.0 million in 2006, cash used in operating activities would have been $36.1 million and $25.9 million during the years ended December 31, 2007 and 2006, respectively.
Our deferred revenue increased from $24.3 million at December 31, 2006 to $47.2 million at December 31, 2007. The increase is primarily attributable to up-front payments we received from our new alliances with Wyeth and Organon, additional research funding we received from GSK, and chemistry resources we have committed to BMS as consideration for our in licensing of our SARM program.
In May 2007, we raised net proceeds of $37.1 million through a public financing of common stock. The shares of common stock were sold through a prospectus supplement pursuant to one of our effective shelf registration statements.
Net revenue increased to $21.4 million from $16.9 million, an increase of 26%. This increase was due to revenue recognized under our new alliance with Wyeth, coupled with increased revenue from our alliances with Cephalon and GSK. These increases were offset by the completion of our collaborations with Schering-Plough in April 2007, and decreased milestone revenue from our collaborations with Organon.
Our collaborative research and development expense increased from $13.6 million in 2006 to $23.7 million in 2007. This increase related primarily to an increase in resources allocated to our alliances with GSK, Cephalon and Wyeth, offset by decreased resources allocated to our Schering-Plough collaborations.
Our proprietary research and development expense increased from $23.5 million in 2006 to $39.3 million in 2007, an increase of 67%. This increase was partially due to our licensing of the SARM program from BMS, for which we recorded a $9.2 million charge. Exclusive of this charge, our proprietary research and development expenditures increased 28%. This increase related primarily to increased costs associated with our most advanced internal compound, PS433540 from our DARA program, which entered Phase 2 clinical trials in September 2007.
We recognized a net loss of $47.9 million during the year ended December 31, 2007, compared to $27.8 million during the year ended December 31, 2006.
Liquidity and Capital Resources
As of December 31, 2007, we had cash, cash equivalents and marketable securities of $71.3 million compared to $46.1 million at December 31, 2006, representing 79% and 70% of our total assets, respectively. We make investments in highly liquid investment-grade marketable securities, including corporate bonds, United States government and agency securities, and auction rate securities. In addition, as of December 31, 2007, we had deferred revenue of $47.2 million relating to research and development activities that are to be performed by us subsequent to December 31, 2007.
The following is a summary of selected cash flow information for the years ended December 31, 2007 and 2006:
Net cash used in operating activities
Net cash used in operating activities for the year ended December 31, 2007 was primarily due to cash used to fund both our proprietary internal drug research and development efforts, including our Phase 2 and Phase 1 clinical trials for PS433540, and the fulfillment of our research and development performance obligations under our collaborations, offset by the receipt of a $5.0 million up-front non-refundable payment received in January 2007 relating to the Wyeth Agreement, a $15.0 million up-front non-refundable payment received in March 2007 in connection with the Organon Agreement, and a $5.0 million payment received in June 2007 related to the additional research funding under the GSK Agreement. Absent the receipt of the $25.0 million from Wyeth, Organon and GSK, our net cash used in operating activities would have been approximately $36.1 million.
Net cash used in operating activities for the year ended December 31, 2006 was primarily due to cash used to fund both our proprietary internal drug research and preclinical development efforts and the fulfillment of our research and development performance obligations under our collaborations, as well as the payment of restructuring expenses related to the 2004 consolidation of our facilities, offset by receipt of a $5.0 million up-front payment received in April 2006 relating to the GSK Agreement and a $15.0 million up-front non-refundable payment received in June 2006 relating to the Cephalon Agreement. Absent the receipt of the $20.0 million from GSK and Cephalon, our net cash used in operating activities would have been approximately $25.9 million.
Net cash (used in) provided by investing activities
Net cash used in investing activities for the year ended December 31, 2007 related primarily to the purchase of marketable securities. Net cash used in investing activities also included capital expenditures related to the expansion of our facilities and capital expenditures for research and development and information technology equipment and software, partially offset by net proceeds from maturities of marketable securities.
Net cash provided by investing activities for the year ended December 31, 2006 related primarily to the net sales and maturities of marketable securities, partially offset by capital expenditures for research and development and information technology equipment and software.
Net cash provided by financing activities
In May 2007, we issued and sold approximately 8.1 million shares of our common stock at a purchase price per share of $5.00 as part of a public underwritten offering. The aggregate gross proceeds of the transaction were approximately $40.3 million. The proceeds we received from the transaction, net of transaction costs, were approximately $37.1 million. The shares of common stock were sold through a prospectus supplement pursuant to one of our effective shelf registration statements. Net cash provided by financing activities for year ended December 31, 2007 also included proceeds, net of repayments, of approximately $4.1 million received from loans originated under our line of credit and proceeds of $0.8 million from the issuance of common stock in connection with exercises of stock options.
Net cash provided by financing activities for year ended December 31, 2006 related primarily to our sale of approximately 5.8 million shares of our common stock at a purchase price per share of $4.28 in October 2006. In connection with that sale of stock, we sold warrants to purchase approximately 1.45 million shares of our common stock at a purchase price of $0.125 per warrant, with an exercise price of $5.14 per share. The aggregate gross proceeds of the transaction were approximately $25.0 million. We received proceeds of approximately $23.0 million from the transaction, net of transaction costs. The shares and warrants were offered through a prospectus supplement pursuant to our effective shelf registration statement on Form S-3. We accounted for the warrants as a liability at their fair value using a Black-Scholes option-pricing model and remeasure the fair value at each reporting date until the warrants are exercised or have expired. Net cash provided by financing activities for the year ended December 31, 2006 also consisted of approximately $1.3 million in proceeds from the issuance of common stock in connection with exercises of stock options.
Contractual Obligations
The following table and discussions summarize our contractual obligations as of December 31, 2007:
Operating Leases
We are obligated to pay approximately $2.5 million annually in costs in connection with the facilities we currently occupy. The leases on these facilities expire in 2016.
Product Manufacturing Contracts
We have entered into contracts with third parties related to the manufacturing of materials that are to be used in connection with our clinical trials for PS433450. The termination provisions for these contracts are such that, as of December 31, 2007, we had commitments totaling approximately $5.2 million, which are expected to be fulfilled during the year ended December 31, 2008.
Contract Research Organizations (CROs)
In connection with toxicology studies for PS433540, we have made certain commitments with CROs totaling approximately $1.0 million, which we expect to be fulfilled during the year ended December 31, 2008.
From time to time in connection with the development studies we sponsor, we enter into contractual relationships with CROs to perform services for those studies.
Columbia University and Cold Spring Laboratory
We have a license agreement with Columbia University, or Columbia, and Cold Spring Harbor Laboratory, or Cold Spring, that grants us an exclusive, worldwide license to certain technology for making and using combinatorial chemical libraries for the development of human pharmaceutical products. The term of the agreement is the later of (i) July 16, 2013 or (ii) the expiration of the last patent relating to the technology, at which time we will have a fully paid license to the technology. The license granted under this agreement may be terminated by Columbia and Cold Spring (i) upon 30 days written notice to us if we do not expend certain amount of money developing and commercializing the combinatorial chemical libraries, (ii) upon 30 days written notice to us if we materially breach the agreement and fail to cure the material breach, or (iii) if we commit any act of bankruptcy, become insolvent, file a petition under any bankruptcy or insolvency act or have a petition filed against us that is not dismissed within 60 days. This agreement requires us to pay minimum annual fees and certain royalties of at least $100 thousand per year. Due to the uncertainty of our future payment obligations, we have included only the minimum annual fee required by the agreement in the table above. In 2007, 2006 and 2005 we paid related royalties and license fees of approximately $110 thousand, $129 thousand and $126 thousand, respectively.
Contractual obligations under our collaborations
Product Development and Commercialization Agreement with GSK
Under the terms of the GSK Agreement, we and GSK each have the right to terminate the GSK Agreement in our sole discretion under certain specified circumstances at any time during the term of the GSK Agreement. In addition, we and GSK each have the right to terminate the GSK Agreement under other circumstances that are customary in these types of agreements. If we exercise our discretionary termination right at any time during the first five years of the term, under certain circumstances, we could be required to refund to GSK a portion of the up to $15.0 million related to initial discovery activities we will conduct. The amount of any such refund will be calculated based upon when during the term of the GSK Agreement that termination occurs. Further, should GSK exercise its discretionary termination rights, there are no provisions in the GSK Agreement that would require us to refund payments received relating to our performance of initial discovery activities under the GSK Agreement.
Our role in our alliance with GSK is to (i) identify and (ii) advance molecules in chosen therapeutic programs to development stage and (iii) subject to certain provisions in the GSK Agreement, further develop the candidates to clinical "proof of concept" (a demonstration of efficacy in humans). As of December 31, 2007, we had approximately $9.1 million of deferred revenue related to services that we are to provide under the GSK Agreement after December 31, 2007.
Research and License Agreement with Wyeth
Under the Wyeth Agreement, we received an up-front, non-refundable payment of $5.0 million in January 2007 to support the Company's research efforts. As of December 31, 2007, we had approximately $3.3 million of deferred revenue related to services that we are to provide under the Wyeth Agreement after December 31, 2007.
Collaboration Agreement with Cephalon
Under the terms of the Cephalon Agreement, we received an up-front, non-refundable payment of $15.0 million in June 2006 to support our research efforts. We are principally responsible for performing medicinal chemistry research over the alliance term. As of December 31, 2007, we had approximately $7.1 million of deferred revenue related to services that we are to provide under the Cephalon Agreement after December 31, 2007.
Collaboration and License Agreement with Organon
Under the Organon Agreement, if we exercise our discretionary termination right, under certain circumstances, we could be subject to a termination fee of $5.0 million. Whether or not we are subject to the termination fee is based upon when during the term of the Organon Agreement we exercise our discretionary termination right. However, until such time as we are no longer subject to the termination fee, there will be no instances where the deferred revenue associated with the Organon Agreement would be amortized below $5.0 million.
In addition, we have received $20.0 million since February 2007 to support our research efforts. As of December 31, 2007, we had approximately $17.0 million of deferred revenue related to services that we are to provide under the Organon Agreement after December 31, 2007.
DARA License Agreement with BMS
Under the terms of the DARA License Agreement with BMS, in lieu of an up-front cash payment, we are providing BMS a set of compound libraries, over a period of approximately three years following the execution of the agreement. We recorded deferred revenue of $2.0 million representing the estimated fair value of the compound library services to be provided. As of December 31, 2007 the balance of this deferred revenue was approximately $1.2 million. In the event we fail to deliver the aforementioned libraries to BMS, the Company would be required to make cash payments on a pro rata basis of up to approximately $1.2 million as of December 31, 2007.
We are obligated to pay BMS additional milestone payments upon the achievement, if any, of further successive clinical and regulatory events in the United States and certain other jurisdictions, and royalties on sales of products, if any, resulting from the DARA program.
SARM License Agreement with BMS
In consideration for the licenses to the SARM program, in October 2007, we also entered into a discovery collaboration agreement (the Discovery Collaboration Agreement) with BMS. The Discovery Collaboration Agreement provides that we will apply a portion of our medicinal chemistry resources to a BMS discovery program that is unrelated to the SARM program for up to three years. In addition, we will pay BMS milestone payments associated with submission and approval of a therapeutic product for marketing and a stepped royalty on net sales of therapeutic products, if any, resulting from the SARM program. We recorded deferred revenue of $9.2 million which approximates the fair value of the chemistry resources that we are to provide to BMS after December 31, 2007.
Milestones and Royalty Commitments
Under the terms of certain agreements to which we are a party, it is possible that we may become obligated to pay aggregate milestone payments totaling up to $287 million upon the achievement of
successive clinical and regulatory events and royalties on sales of products, if any, resulting from programs for which we have development responsibility under such agreements. We will not be responsible for the payment of future milestone and/or royalty payments in the event that development of such a program is discontinued. Preclinical and clinical development of drug candidates is a long, expensive and uncertain process. At any stage of the preclinical or clinical development process, we may decide to discontinue the development of our product candidates. To date, none of the compounds to which we hold complete or partial rights has reached the stage of commercial product. We expect that our product candidates will not be commercially available for many years, if ever.
Deferred Compensation Plan
We maintain a deferred compensation plan for certain officers and members of our Board of Directors. Under the employee matters agreement entered into at the time of our spin-off from Accelrys, effective as of April 30, 2004, we assumed all liabilities of its current and former employees under the deferred compensation plan. The total deferred compensation plan obligation as of December 31, 2007 was approximately $2.1 million. This amount has not been included in the table above, as the obligation dates are governed by the applicable employee's termination or retirement, and therefore the timing of such payments is indeterminable.
Off-Balance Sheet Arrangements
Our significant off-balance sheet arrangements relate to operating lease obligations for the facilities we currently occupy, product manufacturing commitments to certain third parties, commitments to certain CROs related to the clinical development of PS433540, and other contractual obligations related to minimum contractual payments due to Columbia and Cold Spring. All of these obligations are included in the Contractual Obligations schedule above.
Liquidity and Capital Resources Outlook
As of December 31, 2007, we had cash, cash equivalents and marketable securities of approximately $71.3 million. In addition, as of December 31, 2007, we had deferred revenue of approximately $47.2 million relating to research and development activities that are to be performed by us subsequent to December 31, 2007. Our cash used in operating activities for the year ended December 31, 2007 was approximately $11.1 million, which included $25.0 million in upfront payments from collaborators. Excluding these receipts, our cash used in operating activities would have been $36.1 million. We expect that our research and development expenditures will continue to increase in the future as we increase our internal drug research and development efforts. Clinical and preclinical development of drug candidates is a long, expensive and uncertain process that requires us to raise funds from time to time to support our internal development programs. We expect to raise funds from one or a combination of approaches, which could include public and/or private financing, sale and/or partnering of one or more of our internal programs, and partnering of our internal drug discovery capabilities.
Conducting our own drug research and development is a key component of our business model. We are currently conducting Phase 2 and Phase 1 clinical trials for PS433540, a product candidate from our DARA program that we are developing internally. In September 2007, we announced the initiation of a Phase 2a clinical trial of PS433540 in subjects with Stage I and Stage II hypertension. In March 2008, we initiated a Phase 2b clinical trial designed to further evaluate safety and efficacy in subjects with Stage I and Stage II hypertension. Conducting these Phase 2 clinical trials, in addition to other Phase 1 clinical trials that will need to be conducted, will significantly increase our proprietary research and development costs.
In October 2007, we acquired the development and commercialization rights to the SARM program from BMS, including PS178990, a product candidate in Phase 1 clinical development for which we intend to conduct further clinical trials. In consideration for the licenses to the SARM program, we
entered into the Discovery Collaboration Agreement with BMS to provide a portion of our medicinal chemistry resources to a BMS discovery program unrelated to the SARM program for a period up to three years. Additionally, progressing the SARM program, specifically our product candidate PS178990, through clinical trials is expected to further increase our proprietary research and development costs.
As part of our other collaborative agreements with GSK, Wyeth, Cephalon and Organon, we have received up-front cash payments. In connection with these agreements, we are obligated to perform significant research and development activities over multiple years and as such, expect to incur significant costs performing such activities.
Since February 2007, under the Organon Agreement, we received $20.0 million (the $15.0 million up-front payment, $1.0 million for the transfer of rights to certain programs from the 2002 Collaboration, and four quarterly research payments of $1.0 million each). We may receive up to an additional $16.0 million of research and development funding over the remaining portion of the five-year research term, which began in February 2007.
Since January 2007, we received $8.0 million in connection with our research and license agreement with Wyeth (a $5.0 million up-front payment and $3.0 million in research funding). We may receive an additional $6.0 million of research and development funding over the remaining portion of the three-year research term, which began in January 2007.
In connection with the GSK Agreement, we may receive up to an additional $5.0 million from GSK, should we fulfill certain conditions related to initial discovery activities that we expect to perform.
As of December 31, 2007, we had borrowings associated with our line of credit of approximately $4.1 million, which have repayment terms ranging from 36 to 48 months, including approximately $1.1 million that is due in 2008. We also had approximately $0.6 million available for borrowings under our line of credit as of December 31, 2007 and we expect that we will continue to draw on this line of credit for capital expenditures in the future.
We anticipate that our capital resources will be adequate to fund our operations at their current levels at least through December 31, 2008. However, there can be no assurance that changes will not occur that would consume available capital resources before then.
Our capital requirements depend on competing technological and market developments, changes in our existing collaborative relationships, progress of PS433540 and PS178990 in clinical trials, the cost of filing, prosecuting, defending, and enforcing patent claims and other intellectual property rights and the outcome of related litigation, the purchase of additional capital equipment, acquisitions of other businesses or technologies, and the progress of our collaborators' milestone and royalty producing activities. Prior to exhausting our current capital resources, we will need to raise additional funds to finance our operating activities or enter into strategic initiatives intended to further the development of our business. There can be no assurance that additional funding, if necessary, will be available to us on favorable terms, if at all. Our forecasts of the period of time through which our financial resources will be adequate to support our operations are forward-looking information and actual results could vary. The factors described earlier in this section will impact our future capital requirements and the adequacy of our available funds.
Results of Operations
This section should be read in conjunction with the discussion above under "Liquidity and Capital Resources".
2007 Compared to 2006
Our net revenue increased 26% to $21.4 million in the year ended December 31, 2007 compared to $16.9 million in the year ended December 31, 2006. Net revenue consists of revenue recorded in connection with research and development efforts we perform under our various collaborative
agreements, as well as our earning of milestones, success fees and license revenue if and as our research and development progress through our collaborators' development processes. Net revenue for the years ended December 31, 2007 and 2006 is summarized as follows:
Revenue recognized from our collaborative relationships for the years ended December 31, 2007 and 2006, respectively was as follows:
(1)Revenue from our Schering-Plough collaborations includes $3.0 million and $2.0 million in milestone revenue for the years ended December 31, 2007 and 2006, respectively. Our research activities under our collaborations with Schering-Plough were completed in April 2007.
(2)Revenue from our Organon collaborations includes $2.0 million in milestone revenue for the year ended December 31, 2006.
(3)Revenue from our Biovitrum collaborations includes $1.2 million in milestone revenue for the year ended December 31, 2007. The increase in collaborative research revenue in the year ended December 31, 2007 was largely due to our alliances with Cephalon, Wyeth and GSK, partially offset by decreased research revenue that resulted from the completion of our research activities under our collaborations with Schering-Plough in April 2007 and lower milestone revenue from Organon in 2007.
Collaborative research and development expense includes the labor, material, equipment and allocated facilities cost of our scientific staff that is working on collaborative partnerships. Collaborative research and development expenses increased 75% to $23.7 million in the year ended December 31, 2007 compared to $13.6 million in the year ended December 31, 2006. This increase primarily related to an increase in resources allocated to our alliances with GSK, Cephalon and Wyeth. In December 2006, we entered into the Wyeth agreement under which we licensed certain rights to our JAK3 program to Wyeth. Prior to January 2007, the resources that were deployed on the JAK3 program were accounted for in proprietary research and development expense. Resources now deployed on our JAK3 program, except as they relate to programs for employing topical administration for ocular and dermatological diseases, are accounted for in collaborative research and development. This increase was offset by decreased resources allocated to our collaborations with Schering-Plough that resulted from
the completion of our research activities in April 2007. Share-based compensation costs associated with our adoption of SFAS 123R for the years ended December 31, 2007 and 2006 were $594 thousand and $329 thousand, respectively.
Proprietary research and development expense includes research and development acquisition costs, clinical trial and preclinical study costs, and labor, material, equipment and allocated facilities cost of scientific staff working on self-funded internal drug discovery and development programs. Our most advanced internal program is our DARA program, which is in Phase 2 clinical trials. We licensed our DARA program from BMS in March 2006. In addition, we in-licensed our SARM program from BMS in October 2007. The most advanced compound in our SARM program is our product candidate PS178990, which is in Phase 1 clinical trials. We also currently have several internal programs in advanced preclinical discovery. Proprietary research and development expenses increased 67% to $39.3 million in the year ended December 31, 2007 compared to $23.5 million in the year ended December 31, 2006. This increase was partially due to our in-licensing of our SARM program, for which we incurred a charge to earnings of approximately $9.2 million. Exclusive of this charge, proprietary research and development expense increased 28% This increase was primarily attributable to costs relating to clinical trials for PS433540, including milestone payments of $1.0 million and $2.0 million made to BMS for the initiation of Phase 1 and Phase 2 clinical trials, respectively. The increase in proprietary research and development expense also related to increased costs expended on our CCR1 discovery program. The increase was offset by a decrease in costs related to our JAK3 program. As previously mentioned, certain aspects of our JAK3 program were partnered with Wyeth in December 2006. The majority of the costs related to this program, previously recorded in proprietary research and development expense in prior periods, are now categorized as collaborative research and development. Costs for our JAK3 program as they relate to the employment of topical administration for ocular and dermatological diseases continue to be accounted for in proprietary research and development expense as we retain all rights to these programs. Share-based compensation costs associated with our adoption of SFAS 123R for the years ended December 31, 2007 and 2006 were $327 thousand and $371 thousand, respectively. Because of the speculative nature of these internal drug discovery and development projects, it is not possible to estimate completion dates or costs of completion. Additionally, from time to time, certain staff and other research and development resources may be temporarily redirected from one project to another, which redirection may also delay or impact the cost of internal drug discovery and development projects.
General and administrative expense increased by 12% to $11.0 million in the year ended December 31, 2007 compared to $9.8 million in the year ended December 31, 2006. The increase in general and administrative expense was attributable to increased consulting costs, including costs related to our compliance with section 404 of the Sarbanes-Oxley Act, and recruiting costs during the years ended December 31, 2007. Share-based compensation costs associated with our adoption of SFAS 123R for the years ended December 31, 2007 and 2006 were $1.3 million and $1.2 million, respectively.
Interest and other income, net increased to $3.8 million in the year ended December 31, 2007 compared to $1.6 million in the year ended December 31, 2006. This increase was primarily due to higher yields on our increased cash, cash equivalents, and marketable securities balances during the years ended December 31, 2007 as compared to the year ended December 31, 2006.
Interest expense of approximately $78 thousand was incurred in the year ended December 31, 2007, and related to our borrowings under our line of credit during the period. During the corresponding period in 2006, we did not have any borrowings under our credit facility.
Non-operating income associated with the decrease in warrant liability was $173 thousand for the year ended December 31, 2007 compared to $89 thousand for the year ended December 31, 2006. This increase represents the change in the fair value of the warrants that were issued in connection with our equity financing in October 2006, from December 31, 2006 to December 31, 2007. The fair value of the warrants was determined using the Black-Scholes option-pricing model and is remeasured at each reporting period.
We recorded an income tax benefit of $823 thousand and $478 thousand in the years ended December 31, 2007 and 2006, respectively. This increase in income tax benefit relates primarily to an increase in the amount of New Jersey net operating losses sold in 2007. In addition, we recorded no income tax provision for the year ended December 31, 2007 as the minimum state income taxes that we previously were subject to no longer apply due to state legislative changes. For the year ended December 31, 2006, we recorded an income tax provision of $37 thousand related to these minimum state income taxes.
As a result of the net revenues and expenses described above, we generated a net loss of $47.9 million ($1.79 per basic and diluted share) in the year ended December 31, 2007, compared to a net loss of $27.8 million ($1.69 per basic and diluted share) in the year ended December 31, 2006.
2006 Compared to 2005
Our net revenue decreased 17% to $16.9 million in the year ended December 31, 2006 compared to $20.4 million in the year ended December 31, 2005. Net revenue consists of revenue recorded in connection with research and development efforts we perform under our various collaborative agreements, as well as our earning of milestones, success fees and license revenue if and as our research and development progress through our collaborators' development processes. Net revenue for the years ended December 31, 2006 and 2005 is summarized as follows:
Revenue recognized from our collaborative relationships for the years ended December 31, 2006 and 2005, respectively was as follows:
(1)Revenue from our Schering-Plough collaborations includes $2.0 million and $1.0 million in milestone revenue for the years ended December 31, 2006 and 2005, respectively.
(2)Revenue from our Organon collaborations includes $2.0 million in milestone revenue for each of the years ended December 31, 2006 and 2005, respectively. The decrease in collaborative research funding in 2006 was largely due to reductions in funding from our collaboration with Schering-Plough and the expiration of other collaborative research and development agreements. The decrease in revenue was partially offset by revenue recognized under our new alliances with Cephalon and GSK.
Collaborative research and development expense includes the labor, material, equipment and allocated facilities cost of our scientific staff working on collaborative partnerships. Collaborative research and development expenses decreased 24% to $13.6 million in the year ended December 31, 2006 compared to $17.7 million in the year ended December 31, 2005. This decrease was due to decreased resources allocated to our collaborative partnerships largely due to the further reduction in staffing on our collaboration with Schering-Plough and the expiration of other collaborative research and development agreements. This decrease was offset by costs associated with research and development activities relating to our new alliances with Cephalon and GSK, and the recognition of share-based compensation costs of $329 thousand associated with our adoption of SFAS 123R in January 2006.
Proprietary research and development expense includes research and development acquisition costs, labor, material, equipment and allocated facilities cost of scientific staff working on self-funded internal drug discovery and development programs. Proprietary research and development expenses increased 115% to $23.5 million in the year ended December 31, 2006 compared to $11.0 million in the year ended December 31, 2005. This increase was partially due to our licensing of the DARA program in March 2006, for which we recorded a $2.0 million charge. Exclusive of this charge, proprietary research and development expenditures increased 96%. This increase was primarily attributable to costs relating to preclinical development studies for our DARA program, resources expended on our JAK3 program, our CCR1 program, our Adenosine A2a program, and our recognition of share-based compensation costs of $371 thousand associated with our adoption of SFAS 123R in January 2006. Because of the speculative nature of these internal drug discovery and development projects, it is not possible to estimate completion dates or costs of completion. Additionally, from time to time, certain staff and other research and development resources may be temporarily redirected from one project to another, which redirection may also delay or impact the cost of internal drug discovery and development projects.
General and administrative expense decreased by 3% to $9.8 million in the year ended December 31, 2006 compared to $10.2 million in the year ended December 31, 2005. The decrease in general and administrative expense was attributable to approximately $1.5 million in severance costs incurred in the year ended December 31, 2005, and lower consulting, recruiting, travel and certain compensation costs offset by the recognition of share-based compensation costs of $1.0 million associated with our adoption of SFAS 123R in January 2006 and approximately $182 thousand in severance costs, which includes $79 thousand relating to the acceleration of vesting of certain stock options under SFAS 123R, in the year ended December 31, 2006.
Interest and other income, net increased to $1.6 million in the year ended December 31, 2006 compared to $1.1 million in the year ended December 31, 2005. This increase was due to higher yields on our investments.
The decrease in the warrant liability for the year ended December 31, 2006 was approximately $89 thousand, and represented the change in fair value of the warrants that we issued in October 2006, as of December 31, 2006 from the initial measurement date of October 19, 2006.
Restructuring and other charges decreased by approximately $88 thousand in the year ended December 31, 2006 compared to the year ended December 31, 2005, which related to an adjustment to our restructuring cost estimate to reflect our actual restructuring costs.
We recorded an income tax benefit of $478 thousand and $234 thousand in the years ended December 31, 2006 and 2005, respectively, related to the sale of some of our state net operating losses offset by minimum state income taxes.
As a result of the net revenues and expenses described above, we generated a net loss of $27.8 million ($1.69 per basic and diluted share) in the year ended December 31, 2006, compared to a net loss of $17.1 million ($1.27 per basic and diluted share) in the year ended December 31, 2005.
Net Loss Outlook
We have had net losses in recent years and we expect to incur losses in future periods These losses are expected to increase as compared to prior periods as a result of the increased level of investment we plan to make in our internal proprietary programs in the future, as well as the results of those programs. Our internal proprietary research and development costs are expected to continue to increase due to our efforts to progress the DARA and SARM programs through clinical trials.
Our net loss is highly dependent on the continued funding and success of our research and development programs with our existing and potential collaborators. Our collaborations with Schering-Plough ceased in April 2007. We will continue to be entitled to payments resulting from the successful achievement by Schering-Plough, if any, of clinical milestones, as well as royalty payments from sales, if any, of products resulting from compounds already delivered by us and accepted by Schering-Plough under the collaborations.
In connection with the acquisition of the licenses to the SARM program in October 2007, we also entered into the Discovery Collaboration Agreement with BMS, which provides that we will apply a portion of our medicinal chemistry resources to a BMS discovery program that is unrelated to the SARM program for up to three years. We recorded deferred revenue of approximately $9.2 million in the fourth quarter of 2007. The amount of this charge approximates the fair value of the chemistry resources we are to provide to BMS under the Discovery Collaboration Agreement. The increase in our expected future losses may be partially offset by revenue we recognize associated with providing these resources to BMS.
Our adoption of SFAS 123R, which was effective January 1, 2006, increased our compensation costs and will continue to have a significant impact on our results of operations. Changes in the fair value of the warrants we issued in October 2006 are reported in the statements of operations as income or expense. As such, changes to the market price of our common stock or to the assumptions used in calculating the fair value of the warrants may cause significant increases or decreases to our results of operations. However, neither the impact of share-based compensation costs, nor the impact of changes in the fair value of the warrant liability will have an impact on our cash flows.
There is no assurance that we will ever achieve profitable operations, or that profitable operations, if achieved, could be sustained on a continuing basis.
Critical Accounting Policies and Estimates
The preparation of our financial statements and disclosures involve the use of judgments and estimates. We believe the following critical accounting policies which we follow involve significant judgments and use estimates.
Revenue Recognition
Contract revenue is generally recognized either (i) on a proportional performance basis, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement for contracts specifying payment on a full-time employee basis.
Revenue earned related to up-front product and technology license fees is recognized in accordance with Staff Accounting Bulletin (SAB) 104 issued by the SEC and EITF 00-21, "Revenue Arrangements with Multiple Deliverables" issued by the FASB. Accordingly, amounts received under multiple-element arrangements requiring ongoing services or performance by us are recognized over the period of such services or performance.
Revenue from milestones is recognized when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive, its achievability was not reasonably assured at the inception of the agreement, and we have no further performance obligations relating to that event, and (ii) collectibility is reasonably assured. If these criteria are not met, the milestone payment is recognized over the remaining minimum period of our performance obligations under the arrangement. Royalties are recognized as earned in accordance with the terms of various research and collaboration agreements.
Share-based Compensation
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R, using the modified-prospective transition method. This statement is a revision to SFAS 123, supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and amends SFAS No. 95, "Statement of Cash Flows." Under this transition method, compensation cost recognized includes compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation cost for all share-based payments granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with provisions of SFAS 123R. Results for prior periods have not been restated.
Under SFAS 123R, we use the Black-Scholes option pricing model to estimate the fair value of the share-based awards as of the grant date. The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are the estimated lives of the share-based awards and the estimated volatility of our stock price. The Black-Scholes model is sensitive to changes in these two data inputs. Beginning in fiscal year 2006, we calculated the estimated life of stock options granted using a "simplified" method, which is based on the average of the vesting term and the actual term of the option, as a result of guidance from the SEC as contained in SAB 107 permitting the initial use of this method through 2007. In December 2007, the SEC issued SAB 110, which is effective January 1, 2008, expressing the expectation that companies should be employing information from internal or external sources about employee stock option exercise behavior when developing estimates of expected term as they relate to stock option valuations. SAB 110 states that the SEC will continue to accept the use of the "simplified" method, under certain circumstances, beyond December 31, 2007. We are still evaluating the method that we will use to develop our expected term assumption in 2008. Expected stock price volatility is typically based on the daily historical trading data from an appropriate point in time through the last day of the applicable period. Because our historical trading data only dates back to May 3, 2004, the date of our spin-off from Accelrys, we have determined expected volatility for fiscal year 2007 using an analysis of the stock price volatility of companies comparable to ours in our industry.
Warrant Liability
We follow EITF 00-19 in accounting for our warrants which provides guidance for distinguishing between permanent equity, temporary equity and assets and liabilities. Under EITF 00-19, to qualify as permanent equity, the equity derivative must permit us to settle in unregistered shares. Under securities law, if the warrants were issued in connection with a public offering and have a cash settlement feature at the holder's option, we do not have the ability to settle in unregistered shares. Therefore, the warrants cannot be classified as permanent equity and are instead classified as a liability. The approximately 1,450,000 warrants that we issued as part of our equity financing in October 2006 meet this criteria, and have been recorded as a liability in the accompanying balance sheets. Other warrants we had previously issued qualify as permanent equity and do not require remeasurement.
We record our warrant liabilities at fair value using a Black-Scholes option-pricing model and remeasure at each reporting date until the warrants are exercised or have expired. Changes in the fair value of the warrants are reported in the statements of operations as income or expense. The fair value of the warrants could be subject to significant fluctuation based on changes in our stock price, expected volatility, expected life, the risk-free interest rate and dividend yield. The market price for our common stock has been and may continue to be volatile. Consequently, future fluctuations in the price of our common stock may cause significant increases or decreases in the fair value of the warrants issued in October 2006.
Long-Lived Assets
We review long-lived assets, including leasehold improvements, property and equipment, and acquired technology rights, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. This requires us to estimate future cash flows related to these assets. Actual results could differ from these estimates, which may affect the carrying amount of assets and the actual amortization expense. As of December 31, 2007, we had long-lived assets with a net book value of $14.8 million.
Accounting for Uncertain Tax Positions
We have adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FAS Statement No. 109" (FIN 48). FIN 48 applies to all uncertain tax positions accounted for in accordance with SFAS No. 109, "Accounting for Income Taxes" and is intended to result in increased relevance and comparability in financial reporting of income taxes and to provide more information about the uncertainty in income tax assets and liabilities. We will recognize potential interest and penalties related to income tax positions as a component of the benefit or provision for income taxes on the consolidated statements of operations in any future periods in which we must record a liability. Because we have not recorded a liability at December 31, 2007, there is no impact to our effective tax rate. We do not anticipate that total unrecognized tax benefits will significantly change during the next twelve months.
New Accounting Pronouncements
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," (SFAS 157). SFAS 157 establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position (FSP) 157-2 which delays the effective date of SFAS 157 for one year for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 and FSP 157-2 are effective for financial statements issued for fiscal years beginning after November 15, 2007. We
have elected a partial deferral of Statement 157 under the provisions of FSP 157-2. We are currently evaluating the impact that this partial adoption of SFAS 157, which is effective January 1, 2008, will have on our consolidated financial statements.
Fair Value Option for Financial Assets and Liabilities
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Liabilities Including an Amendment of FASB Statement No. 115" (SFAS 159). SFAS 159 permits reporting entities to choose to measure eligible financial assets or liabilities, which include marketable securities available-for-sale and equity method investments, at fair value at specified election dates, or according to a pre-existing policy for specific types of eligible items. Unrealized gains and losses for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that SFAS 159 will have on our consolidated financial statements.
Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities
In June 2007, the EITF of the FASB reached a consensus on Issue No. 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities" (EITF 07-3). EITF 07-3 requires that non-refundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. As the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided, the deferred amounts would be recognized as an expense. EITF 07-3 is effective for financial statements issued for fiscal years beginning after December 15, 2007. Our adoption of EITF 07-3 is not expected to have a material effect on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our international revenue is generally denominated in United States Dollars, and are, therefore, not exposed to changes in foreign currency exchange rates. Additionally, certain of our preclinical and clinical development expenses are denominated in foreign currencies. We believe that the foreign currency risk arising from these expenses is minimal to these financial instruments.
We do not use derivative financial instruments for trading or speculative purposes. However, we regularly make investments in overnight repurchase agreements that are subject to changes in short-term interest rates. We believe that the market risk arising from holding these financial instruments is minimal.
Our exposure to market risks associated with changes in interest rates relates primarily to the increase or decrease in the amount of interest income earned on our investment portfolio since we have minimal debt. We ensure the safety and preservation of invested funds by limiting default risks, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not have materially affected the fair value of our interest sensitive financial instruments at December 31, 2007.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of Pharmacopeia, Inc.
We have audited the accompanying consolidated balance sheets of Pharmacopeia, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2007. 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 consolidated financial position of Pharmacopeia, Inc. at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the Financial Statements, in 2006 the Company adopted SFAS No. 123 (revised 2004), "Share-Based Payments" applying the modified prospective method at the beginning of fiscal year 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Pharmacopeia, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2008 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
February 29, 2008
Pharmacopeia, Inc.
Consolidated Balance Sheets
(Amounts in thousands, except share and per share data)
See accompanying notes to these consolidated financial statements.
Pharmacopeia, Inc.
Consolidated Statements of Operations
(Amounts in thousands, except share and per share data)
See accompanying notes to these consolidated financial statements.
Pharmacopeia, Inc.
Consolidated Statements of Stockholders' Equity
(Amounts in thousands)
See accompanying notes to these consolidated financial statements.
Pharmacopeia, Inc.
Consolidated Statements of Cash Flows
(Amounts in thousands)
Noncash transactions for the year ended December 31, 2006 were as follows:
•The Company recorded the fair value of two warrants issued as part of its Product Development and Commercialization Agreement with GSK as an increase to additional paid-in capital and a decrease to deferred revenue. The fair value of the warrants amounted to approximately $505 thousand.
•The Company recorded the fair value of the warrants it issued in October 2006 as part of its equity financing as a decrease to additional paid-in capital and an increase to warrant liability. The fair value of the warrants amounted to approximately $4.5 million on October 19, 2006. See accompanying notes to these consolidated financial statements.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements
1. Background and Basis of Presentation
Pharmacopeia, Inc. (Pharmacopeia or the Company) was incorporated in 2002 as Pharmacopeia Drug Discovery, Inc., a wholly owned subsidiary of Accelrys, Inc. (Accelrys). On April 30, 2004 (the distribution date), Accelrys spun-off 100 percent of the shares of Pharmacopeia Drug Discovery, Inc. in a pro rata tax-free distribution and distributed to its stockholders of record one share of Pharmacopeia Drug Discovery, Inc. common stock for every two shares of Accelrys common stock held. Effective May 3, 2007, Pharmacopeia Drug Discovery, Inc. changed its name to Pharmacopeia, Inc.
Pharmacopeia is a clinical development stage biopharmaceutical company dedicated to discovering and developing novel small molecule therapeutics to address significant medical needs. Using proprietary technologies and processes, the Company seeks to identify, optimize and develop novel drug candidates through its own internally-funded drug discovery and development programs and in collaborations with major pharmaceutical and biotechnology companies. The Company has a broad portfolio of clinical and preclinical candidates under development internally or by partners, including eight compounds in Phase 2 or Phase 1 development, addressing multiple indications including hypertension, diabetic nephropathy, muscle wasting, inflammation and respiratory disease.
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary Pharmacopeia UK Holdings Limited (Pharmacopeia UK), which was formed in March 2007. All significant intercompany accounts and transactions have been eliminated in consolidation.
2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with U.S generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual future results could differ from those estimates.
Revenue Recognition
Contract revenue is generally recognized either (i) on a proportional performance basis, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement for contracts specifying payment on a full-time employee basis.
Revenue earned related to up-front product and technology license fees is recognized in accordance with SAB 104 issued by the SEC and EITF 00-21, "Revenue Arrangements with Multiple Deliverables" issued by the FASB. Accordingly, amounts received under multiple-element arrangements requiring ongoing services or performance by us are recognized over the period of such services or performance.
Revenue from milestones is recognized when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive, its achievability was not reasonably assured at the inception of the agreement, and the Company has no further performance obligations relating to that event, and (ii) collectibility is reasonably assured. If these criteria are not met, the milestone payment is recognized over the remaining period of our performance obligations under the arrangement. Royalties are recognized as earned in accordance with the terms of various research and collaboration agreements.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
Share-based Compensation
Prior to January 1, 2006 and as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company elected to follow APB 25 and related interpretations in accounting for its employee stock option plans. Under APB 25, the Company did not recognize share-based compensation expense at the time of option grant because the exercise price of the stock option equaled the fair market value of the underlying common stock on the date of grant.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified-prospective transition method. This statement is a revision to SFAS 123, supersedes APB 25 and amends SFAS No. 95, "Statement of Cash Flows." Under this transition method, compensation cost recognized includes compensation costs for all share-based payments granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation cost for all share-based payments granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with provisions of SFAS 123R. Results for prior periods have not been restated.
Under SFAS 123R, the Company uses the Black-Scholes option pricing model to estimate the fair value of the share-based awards as of the grant date. The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are the estimated lives of the share-based awards and the estimated volatility of our stock price. The Black-Scholes model is sensitive to changes in these two data inputs. Beginning in fiscal year 2006, the Company calculated the estimated life of stock options granted using a "simplified" method, which is based on the average of the vesting term and the actual term of the option, as a result of guidance from the SEC as contained in SAB 107 permitting the initial use of this method through 2007. In December 2007, the SEC issued SAB 110, which is effective January 1, 2008, expressing the expectation that companies should be employing information from internal or external sources, about employee stock option exercise behavior when developing estimates of expected term, as they relate to stock option valuations. SAB 110 states that the SEC will continue to accept the use of the "simplified" method beyond December 31, 2007 under certain circumstances. The Company is still evaluating the method it will use to develop its expected term assumption in 2008. Expected stock price volatility is typically based on the daily historical trading data from an appropriate point in time through the last day of the applicable period. Because the Company's historical trading data only dates back to May 3, 2004, the date of its spin-off from Accelrys, the Company has determined expected volatility for fiscal year 2007 using an analysis of the stock price volatility of comparable companies in its industry.
The fair value of these equity awards were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for the years ended December 31, 2007, 2006 and 2005, respectively:
As a result of adopting SFAS 123R, the Company's net loss and basic and diluted loss per share for the years ended December 31, 2007 and 2006 were approximately $2.2 million, or $0.8 per share, and $1.8 million, or $0.11 per share, respectively, higher than if the Company had continued to account
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
for its share-based compensation under APB 25. As of December 31, 2007, there was approximately $4.2 million of unrecognized compensation costs, net of estimated forfeitures, related to share-based payments which are expected to be recognized over a weighted average period of 2.7 years. The cash proceeds from options exercised during the years ended December 31, 2007, 2006 and 2005 were approximately $0.8 million, $1.3 million and $0.1 million, respectively. The aggregate intrinsic value of options exercised during the years ended December 31, 2007, 2006, and 2005 was approximately $433 thousand, $497 thousand, and $155 thousand, respectively. In addition to the expense incurred related to stock option grants, during the years ended December 31, 2007 and 2006, the Company also incurred share-based compensation costs of approximately $13 thousand and $68 thousand, respectively, relating to the vesting of restricted stock awards, and $35 thousand and $258 thousand, respectively, relating to stock options granted to consultants.
The following table illustrates the effect on operating results and per share information had the Company accounted for its share-based compensation in accordance with SFAS 123 for the year ended December 31, 2005 (in thousands, except per share data):
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company invests its cash with major financial institutions in money market funds, US Treasury securities and other investment grade securities such as prime-rated commercial paper.
Marketable Securities
Marketable securities consist of fixed-income investments with an original maturity of greater than three months such as US Treasury securities, obligations of US Government agencies and other investment grade securities such as prime-rated commercial paper and corporate bonds. The Company applies SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115) in accordance with its investments in marketable securities. The Company's marketable securities are classified as available-for sale and are recorded at estimated fair value with unrealized gains or losses reported in accumulated other comprehensive income (loss) in stockholders' equity.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
Marketable securities consisted of the following (in thousands):
Amortized cost and market value in the table above included accrued interest of $311 thousand and $40 thousand as of December 31, 2007 and 2006, respectively.
Available-for-sale marketable securities by contractual maturity at December 31, 2007 were as follows (in thousands):
As of February 1, 2008, the Company had re-invested its entire auction rate securities portfolio into U.S. government agency securities. The Company did not recognize any gain or loss with respect to the settlement of these securities.
Property and Equipment
Property and equipment, which consists of laboratory equipment, computers and software, furniture, fixtures and other equipment, is stated at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the related assets, which range from three to five years. Assets under capital leases are amortized over their estimated useful life or the applicable lease period, whichever period is shorter. The Company amortizes leasehold improvements over the shorter of their estimated useful lives or the remaining term of the related lease. Repair and maintenance costs are charged to expense as incurred.
Warrant Liability
The Company, in accounting for its warrants, follows EITF 00-19 which provides guidance for distinguishing between permanent equity, temporary equity and assets and liabilities. Under EITF 00-19, to qualify as permanent equity, an equity derivative, including warrants, must permit the Company to settle in unregistered shares. Under securities law, if the warrants were issued in connection with a public offering and have a cash settlement feature at the holder's option, the Company does not have the ability to settle in unregistered shares. Therefore, the warrants cannot be classified as permanent equity and are instead classified as a liability. The approximately 1,450,000 warrants that the Company issued as part of its equity financing in October 2006 meet this criteria, and their fair value has been recorded as a liability in the accompanying balance sheets. Other warrants the Company had previously issued qualify as permanent equity and do not require remeasurement.
The Company records its warrant liabilities at fair value using a Black-Scholes option-pricing model and remeasures at each reporting date until the warrants are exercised or have expired. Changes in the fair value of the warrants are reported in the statements of operations as income or expense.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
The fair value of the warrants is subject to significant fluctuation based on changes in the Company's stock price, expected volatility, expected life, the risk-free interest rate and dividend yield. The market price for the Company's common stock has been and may continue to be volatile. Consequently, future fluctuations in the price of the Company's common stock may cause significant increases or decreases in the fair value of the warrants issued in October 2006. During the year ended December 31, 2007, the fair value of the warrant liability decreased and as such, approximately $173 thousand was recorded as income.
Research and Development Expense
Research and development expense consists of intellectual property in-licensing costs, labor, materials, contracted services, and allocated facility costs that are incurred in connection with internally funded and partnered drug discovery and development programs. All research and development costs are charged to operations as incurred.
Impairment of Long-Lived Assets
The Company reviews the recoverability of the carrying value of long-lived assets, primarily property, plant and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.
Should indicators of impairment exist, the carrying values of the assets are evaluated in relation to the operating performance and future undiscounted cash flows of the underlying business. The net book value of an asset is adjusted to fair value if its expected future undiscounted cash flow is less than its book value. The Company identified no such impairment losses during the years ended December 31, 2007, 2006 and 2005.
Leases
The Company accounts for its operating leases in accordance with SFAS No. 13, "Accounting for Leases, as amended" and FASB Technical Bulletin 85-3, "Accounting for Operating Leases with Scheduled Rent Increases". As such, the Company records the total determinable rental payments due under the lease on a straight-line basis over the lease term. Leasehold improvements are amortized over the shorter of their estimated useful lives or the remaining term of the related lease. Common area maintenance costs are charged to expense as incurred.
Accounting for Uncertain Tax Positions
The Company adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FAS Statement No. 109" (FIN 48). FIN 48 applies to all uncertain tax positions accounted for in accordance with SFAS No. 109, "Accounting for Income Taxes" and is intended to result in increased relevance and comparability in financial reporting of income taxes and to provide more information about the uncertainty in income tax assets and liabilities. The Company will recognize potential interest and penalties related to income tax positions as a component of the benefit or provision for income taxes on the consolidated statements of operations in any future periods in which the Company must record a liability. Because the Company has not recorded a liability at December 31, 2007, there is no impact to the Company's effective tax rate. The Company does not anticipate that total unrecognized tax benefits will significantly change during the next twelve months.
Concentrations of Risk
See Note 3 to the Financial Statements regarding Concentrations of Risk as they relate to our significant collaborations.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
Net Loss Per Share
The Company computes net loss per share in accordance with SFAS No. 128, "Earnings Per Share" (SFAS 128). Under the provisions of SFAS 128, basic net loss per share is computed by dividing the net loss for the period by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted-average number of common and dilutive common equivalent shares outstanding during the period.
The following table sets forth the computation of basic and diluted net loss per share as follows (in thousands, except per share amounts):
Dilutive common stock equivalents would include the dilutive effects of common stock options, warrants for common stock equivalents, and restricted stock that has not yet fully vested. Potentially dilutive common stock equivalents totaled approximately 4.8 million, 3.7 million and 3.4 million, shares for the years ended December 31, 2007, 2006 and 2005, respectively.
Reclassifications
Certain accounts in the consolidated balance sheet as of December 31, 2006, the consolidated statement of stockholders equity as of December 31, 2006 and the consolidated statement of cash flows for the years ended December 31, 2006 and 2005 have been reclassified for comparative purposes to conform with the presentation of the consolidated financial statements as of and for the year ended December 31, 2007.
New Accounting Pronouncements
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," (SFAS 157). SFAS 157 establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position (FSP) 157-2 which delays the effective date of SFAS 157 for one year for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 and FSP 157-2 are effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has elected a partial deferral of Statement 157 under the provisions of FSP 157-2. The
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
2. Significant Accounting Policies (Continued)
Company is currently evaluating the impact that this partial adoption of SFAS 157, which is effective January 1, 2008, will have its consolidated financial statements.
Fair Value Option for Financial Assets and Liabilities
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Liabilities Including an Amendment of FASB Statement No. 115" (SFAS 159). SFAS 159 permits reporting entities to choose to measure eligible financial assets or liabilities, which include marketable securities available-for-sale and equity method investments, at fair value at specified election dates, or according to a pre-existing policy for specific types of eligible items. Unrealized gains and losses for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact, if any, that SFAS 159 will have on its consolidated financial statements.
Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities
In June 2007, the EITF of the FASB reached a consensus on Issue No. 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities" (EITF 07-3). EITF 07-3 requires that non-refundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. As the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided, the deferred amounts would be recognized as an expense. EITF 07-3 is effective for financial statements issued for fiscal years beginning after December 15, 2007. The Company's adoption of EITF 07-3 is not expected to have a material effect on its consolidated financial statements.
3. Significant Collaborations
Product Development and Commercialization Agreement with GSK
In March 2006, the Company and GSK entered into a product development and commercialization agreement. Under the terms of the GSK Agreement, the Company may receive up to $15.0 million in cash payments from GSK related to the initial discovery activities to be conducted by the Company, including $5.0 million that the Company received in April 2006 and $5.0 million that the Company received in June 2007. The remaining $5.0 million will be payable to the Company upon its fulfillment of certain conditions related to the initial discovery activities to be conducted by the Company. The Company's role in the alliance is to (i) identify and (ii) advance molecules in chosen therapeutic programs to development stage and (iii) subject to certain provisions in the GSK Agreement, further develop the candidates to clinical "proof of concept" (a demonstration of efficacy in humans). The Company has agreed that it will not screen its compound library for other collaborators, or for its own account, against any target it screens under the GSK Agreement for a specified period.
The GSK Agreement provides GSK an exclusive option, exercisable at defined points during the development process for each program (up to the point of clinical proof of concept), to license that program. Upon licensing a program, GSK is obligated to conduct preclinical development and/or clinical trials and commercialize pharmaceutical products resulting from such licensed programs on a worldwide basis. In addition to the cash payments above, the Company is entitled to receive success-
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Collaborations (Continued)
based milestone payments, starting in preclinical research, from GSK for each drug development program under the alliance and the potential for double-digit royalties upon the successful commercialization by GSK of any product resulting there from.
In the event that GSK does not exercise its option to license a program, the Company will retain all rights to that program and may continue to develop the program and commercialize any products resulting from the program, or it may elect to cease progressing the program and/or seek other partners for further development and commercialization. Should the Company develop or partner such a program and commercialize any products resulting from that program, the Company will be obligated to pay GSK success-based milestone payments and royalties upon successful commercialization, if any.
Since the inception of the GSK Agreement, the Company has received $10.0 million ($5.0 million in April 2006 and $5.0 million in June 2007) in connection with initial discovery and research activities the Company is obligated to perform under the GSK Agreement. The Company recorded deferred revenue of approximately $9.5 million associated with these payments, net of the fair value of the warrants described below. In the year ended December 31, 2007, the Company also received non-refundable milestone payments totaling $1.5 million from GSK related to the identification of three lead compounds, which were also recorded as deferred revenue due to the Company's continuing performance obligations under the GSK Agreement. Included in deferred revenue as of December 31, 2007 was $9.1 million, of which $4.9 million was classified as long-term. The Company recognizes revenue on a proportional performance basis as it performs the required discovery activities in an amount from time to time less than or equal to the non-refundable portion of payments received in connection with the GSK Agreement. The Company's revenue under the GSK Agreement accounted for $1.6 million and $0.3 million of net revenue for the years ended December 31, 2007 and 2006, respectively. The research activities under the GSK Agreement commenced in April 2006.
In connection with the GSK Agreement, the Company issued two warrants to GSK for the purchase of up to an aggregate of 176,367 shares of its common stock at an exercise price of $5.67 per share, which was a 25% premium over the trailing 30-day closing price average preceding March 24, 2006. The warrants are exercisable at any time before the earlier to occur of (i) March 24, 2011 and (ii) the effective date of certain types of terminations of the GSK Agreement. These warrants were issued in a transaction not involving a public offering under Section 4(2) of the Securities Act of 1933, as amended. The fair value of the warrants at the time of the execution of the GSK Agreement was determined to be $505 thousand. This amount was calculated using the Black-Scholes pricing model with the following assumptions: 80% volatility; expected term of 5 years; 4.66% risk-free rate; and 0% dividend.
The Company and GSK each have the right to terminate the GSK Agreement in its sole discretion under certain specified circumstances at any time during the term of the GSK Agreement. In addition, the Company and GSK each have the right to terminate the GSK Agreement under other circumstances that are customary in these types of agreements. If the Company exercises its discretionary termination right at any time during the first five years of the term, under certain circumstances, it could be required to refund to GSK a portion of the up to $15.0 million related to initial discovery activities to be conducted by the Company referred to above. The amount of any such refund will be calculated based upon when during the term of the GSK Agreement that termination occurs and the amount of research funding the Company had received prior to such termination. However, there are no instances where the deferred revenue would be amortized below the amount
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Collaborations (Continued)
that could be potentially refundable pursuant to the terms of the GSK Agreement. Further, should GSK exercise its discretionary termination rights, there are no provisions in the GSK Agreement that would require the Company to refund payments received relating to its performance of initial discovery activities or milestone payments received under the GSK Agreement.
Research and License Agreement with Wyeth
In December 2006, Pharmacopeia entered into a research and license agreement (the Wyeth Agreement) with Wyeth, acting through its Wyeth Pharmaceuticals Division, providing for the formation of a new alliance based on the Company's Janus Kinase-3 (JAK3) inhibitor program. The alliance's goal is to identify, develop and commercialize therapeutic products for the treatment of certain immunological conditions in humans.
The companies each have certain exclusive rights to develop and commercialize products resulting from the JAK3 program and the alliance. Pharmacopeia retains the right to develop and commercialize therapeutic products for the treatment of dermatological and ocular diseases employing topical administration and Wyeth has the right to develop human therapeutic products for all other indications and routes of delivery. Under the terms of the Wyeth Agreement, the Company received an up-front non-refundable $5.0 million cash payment, and $3.0 million in research funding in 2007. The Company may also receive an additional $6.0 million, over the remaining portion of the three-year research term that began in January 2007. In addition, the Company may receive up to $175.0 million if Wyeth achieves preclinical and clinical development and regulatory and commercialization milestones, as well as double-digit royalties on the net sales of any products commercialized by Wyeth under the alliance. Each company is responsible for all development, regulatory, manufacturing and commercialization activities for the products it develops and commercializes in its field.
In 2007, the Company received a $5.0 million up-front non-refundable payment and $3.0 million in research funding. The revenue for this research is recognized on a proportional performance basis, which is expected to approximate straight-line recognition of revenue over the initial three year term of the alliance. For the year ended December 31, 2007, the Company recognized approximately $4.7 million, or 22% of net revenue under the Wyeth Agreement. As of December 31, 2007, approximately $3.3 million was recorded in deferred revenue, of which $1.7 million was classified as long-term. The research term under the Wyeth Agreement commenced in January 2007. The Company may receive milestone payments upon the successful achievement, if any, of preclinical and clinical milestones.
Pharmacopeia and Wyeth each have the right to terminate the Wyeth Agreement under certain specified circumstances at any time during the term of the Wyeth Agreement. In addition, Wyeth has the right, upon six months' prior written notice provided to the Company, to terminate the research collaboration and/or the Wyeth Agreement in its entirety or in part. Such right to termination would not apply to Wyeth's obligations with respect to any program developed by the collaboration and licensed by Wyeth. No termination will require the Company to refund to Wyeth any or all of the cash payments described above.
Collaboration and License Agreement with Cephalon
In May 2006, the Company entered into a Collaboration and License Agreement (the Cephalon Agreement) with Cephalon, Inc. (Cephalon) providing for the formation of a new drug discovery,
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Collaborations (Continued)
development and commercialization alliance. Under the Cephalon Agreement, the Company received an up-front, non-refundable payment of $15.0 million in June 2006 to support the Company's research efforts.
Cephalon is responsible for identifying hit and lead compounds, which the Company and Cephalon will then work collaboratively to advance the lead compounds to clinical candidates. The Company is principally responsible for medicinal chemistry research and Cephalon provides biology support, including preclinical disease models, as required by the Cephalon Agreement. The Company has agreed that, for a specified period, it will not screen its compound library for other collaborators, or for its own account, against any target it works on under the Cephalon Agreement.
Upon the nomination of any clinical candidates by the alliance, Cephalon will be primarily responsible for their development and commercialization. The Company will retain an option to develop certain candidates from the alliance, subject to Cephalon's agreeing to such development. For any preclinical development candidate advanced under the alliance, the developing company will make clinical, regulatory and sales milestone payments to the non-developing company. In addition, the company commercializing any resulting product will pay the non-commercializing company up to double-digit royalties based on the sales level achieved.
As stated above, under the Cephalon Agreement, the Company received a non-refundable payment of $15.0 million and is principally responsible for performing medicinal chemistry research. The revenue for this research is recognized on a proportional performance basis, which is expected to approximate straight-line recognition of revenue over the initial three year term of the alliance. Included in deferred revenue at December 31, 2007 was approximately $7.1 million related to the Cephalon Agreement, of which $2.1 million was classified as long-term. For the years ended December 31, 2007, and 2006 the Company recognized $5.0 million, or 23%, and $2.9 million, or 17%, of net revenue, respectively, under the Cephalon Agreement. The research activities under the Cephalon Agreement commenced in June 2006.
The Company and Cephalon each have the right to terminate the Cephalon Agreement under certain specified circumstances at any time during the term of the Cephalon Agreement. In addition, Cephalon has the right to terminate the Cephalon Agreement in its sole discretion, upon ninety days written notice to the Company, during the initial three-year phase of the alliance, which phase may be extended by agreement of the parties. No such termination shall require the Company to refund to Cephalon any or all of the above research and development funding.
One of the Company's directors currently serves as the Chairman and Chief Executive Officer of Cephalon.
Collaboration and License Agreement with Organon
In February 2007, the Company entered into an amended and restated collaboration and license agreement (the Organon Agreement) with N.V. Organon (Organon), providing for the formation of a new alliance to discover, develop and commercialize therapeutic products across a broad range of therapeutic indications. The new alliance builds on the companies' past collaborations, including the February 2002 agreement between the Company and Organon (the 2002 Collaboration). In November 2007, Organon was acquired by and is now a part of Schering-Plough.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Collaborations (Continued)
Under the Organon Agreement, the Company received an up-front payment of $15.0 million, $1.0 million for the transfer of rights to certain programs from the 2002 collaboration and $4.0 million in quarterly research funding during 2007. The Organon Agreement provides that the Company may also receive up to an additional $4.0 million per year ($16.0 million aggregate) in research funding over the remaining portion of the five-year research term of the alliance, which began in February 2007. The Organon Agreement also provides that the Company waives its rights to receive further compensation (e.g., future milestone and royalty payments) with respect to programs resulting from lead series identified by the Company and delivered to Organon under the 2002 Collaboration and certain other programs from earlier agreements.
The Organon Agreement provides Pharmacopeia the option to purchase the right to co-develop and co-commercialize certain therapeutic candidates discovered through the alliance. For therapeutic candidates the Company does not elect to co-develop and co-commercialize, Organon will retain exclusive development and commercialization rights, and the Company will receive milestone payments as a result of Organon's successful advancement, if any, of each candidate through clinical development, and up to double-digit royalties based on commercialization of any resulting pharmaceutical products.
Since February 2007, the Company has received $20.0 million in connection with the Organon Agreement which the Company recorded as deferred revenue. Included in deferred revenue as of December 31, 2007 was approximately $17.0 million related to the Organon Agreement, of which approximately $10.0 million was classified in deferred revenue, long-term. The Company recognizes revenue on a proportional performance basis as it performs research activities as provided in the Organon Agreement. For the year ended December 31, 2007, the Company recognized approximately $3.0 million, or 14%, of revenue in connection with the Organon Agreement.
Under the 2002 Collaboration, the Company had received quarterly research funding to conduct its drug discovery activities to identify and optimize new drug candidates for multiple therapeutic targets provided by Organon. Funding received in advance was recorded as deferred revenue. Research funding from the 2002 Collaboration was recognized as revenue on a proportional performance basis, which approximated straight-line recognition over the term of the agreement. For the year ended December 31, 2007, the Company recognized as revenue approximately $0.5 million in connection with the 2002 Collaboration. The research term of the 2002 Collaboration ended in February 2007.
Under the Organon Agreement and the 2002 Collaboration, the Company recognized approximately $3.5 million, or 16%, and $5.5 million, or 32%, respectively, of net revenue for the years ended December 31, 2007 and 2006, including $2.0 million in milestones and success fees in the year ended December 31, 2006.
Both Pharmacopeia and Organon have the right to terminate the Organon Agreement under certain specified circumstances at any time during the term of the Organon Agreement. In addition, the Company and Organon each have the right to terminate the Organon Agreement under other circumstances that are customary in these types of agreements. Further, each party has the right, upon six months prior written notice provided to the other party at any time beginning two and one-half years after February 8, 2007, to terminate the research portion of the alliance and/or the Organon Agreement. Such a termination of the research portion of the alliance by Organon would not apply to Organon's obligations with respect to any program developed by the alliance that Organon is advancing or to therapeutic candidates with respect to which the Company has previously exercised its option to
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
3. Significant Collaborations (Continued)
purchase the right to co-develop and co-commercialize. Should Organon exercise its discretionary termination right, there are no provisions in the Organon Agreement that would require the Company to refund payments received under the Organon Agreement. If Pharmacopeia exercises its discretionary termination right, under certain circumstances, it could be subject to a termination fee of $5.0 million. Whether or not the Company is subject to the termination fee is based upon when during the term of the Organon Agreement the Company's discretionary termination right is exercised. However, until such time as we are no longer subject to the termination fee, there will be no instances where the deferred revenue associated with the Organon Agreement would be amortized below $5.0 million.
Collaboration and License Agreements with Schering-Plough
In April 2007, the Company's research activities under its agreements with Schering-Plough were completed. Under the terms of the Company's agreements with Schering-Plough, the cessation of the Company's research activities does not affect other areas of the collaborations, including the ongoing Phase 2 and Phase 1 clinical trials and multiple preclinical programs that Schering-Plough is conducting. The Company will continue to be entitled to payments resulting from the successful achievement by Schering-Plough, if any, of clinical milestones, as well as royalty payments from sales, if any, of products resulting from compounds already delivered by the Company and accepted by Schering-Plough under the collaborations. For the years ended 2007 and 2006, the Company's collaborations with Schering-Plough accounted for approximately $3.8 million, or 18%, and $6.6 million, or 39%, respectively, of net revenue in the period, including $3.0 million and $2.0 million in milestone revenue in 2007 and 2006, respectively
In 2007, subsequent to the Company entering into the Organon Agreement, Schering-Plough acquired Organon.
Other Items
No other collaborator accounted for more than 10% of total revenue in the years ended December 31, 2007, 2006 and 2005.
4. License Agreements with Bristol-Myers Squibb (DARA program and SARM program)
DARA License Agreement
In March 2006, the Company and BMS entered into an exclusive licensing agreement (the DARA License Agreement) providing the Company an exclusive license under certain BMS patents with respect to worldwide development and commercialization of certain compounds discovered by BMS that possess dual angiotensin and endothelin receptor antagonist (DARA) activity, including lead and backup DARA development candidates.
Under the terms of the DARA License Agreement, in lieu of an up-front cash payment, the Company is providing BMS a set of compound libraries, over a period of approximately three years following the execution of the agreement. In the event the Company fails to deliver the aforementioned libraries to BMS, the Company would be required to make cash payments to BMS on a pro rata basis of up to $1.2 million as of December 31, 2007.
The Company estimated that the fair value of the compound library services to be provided to BMS is approximately $2.0 million. In accordance with SFAS 2 "Accounting for Research and
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
4. License Agreements with Bristol-Myers Squibb (DARA program and SARM program) (Continued)
Development Costs," the Company recorded a non-cash charge of $2.0 million to proprietary research and development expense related to the acquisition of the license to the DARA program during the year ended December 31, 2006. The Company also recorded deferred revenue for the estimated fair value of the compound library services to be provided. Included in deferred revenue as of December 31, 2007 was approximately $1.2 million, all of which was classified as deferred revenue, current portion. During the year ended December 31, 2007, the Company recognized approximately $765 thousand of revenue in connection with these compound library services.
During the year ended December 31, 2007, the Company paid BMS $3.0 million in milestone fees related to the achievement of clinical events by PS433540. The Company is obligated to pay BMS additional milestone payments upon the achievement, if any, of further successive clinical and regulatory events in the United States and certain other jurisdictions, and royalties on sales of products, if any, resulting from the DARA program. BMS has a limited right of first negotiation in the event that the Company desires to license compounds that are the subject of the DARA License Agreement to a third party other than BMS.
SARM License Agreement
In October 2007, Pharmacopeia acquired the development and commercialization rights to its SARM program from BMS, including PS178990, a product candidate in Phase 1 clinical development for which it intends to conduct further clinical trials. In consideration for the licenses to the SARM program, the Company entered into a discovery collaboration agreement with BMS to provide a portion of our medicinal chemistry resources to a BMS discovery program unrelated to the SARM program for a period up to three years.
The Company estimated that the fair value of the compound library services to be provided to BMS is approximately $9.2 million. In accordance with SFAS 2, the Company recorded a non-cash charge of $9.2 million to proprietary research and development expense related to the acquisition of the license to the SARM program during the year ended December 31, 2007. Included in deferred revenue as of December 31, 2007 was approximately $9.2 million, which represents the estimated fair value of the medicinal chemistry resources the Company is to provide to BMS, of which $6.2 million was classified as long-term revenue.
In addition, the Company will pay BMS milestone payments associated with submission and approval of a therapeutic product for marketing and a stepped royalty on net sales of therapeutic products, if any, resulting from the SARM development program. BMS has a limited right of first negotiation in the event that the Company desires to license compounds that are the subject of the SARM License Agreement to a third party other than BMS.
5. Related Party Transactions
A member of Pharmacopeia's board of directors currently serves as the Chairman and Chief Executive Officer of Cephalon. In connection with the Cephalon Agreement, in June 2006, the Company received an up-front non-refundable $15.0 million payment to support the Company's research efforts. The Company recognized revenue of approximately $5.0 million, or 23% of its total revenue, and $2.9 million, or 17% of its total revenue, relating to this alliance during the years ended December 31, 2007 and 2006, respectively. The alliance with Cephalon began in 2006 and thus, there was no revenue recognized in the year ended December 31, 2005.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
5. Related Party Transactions (Continued)
A member of Pharmacopeia's clinical advisory board also is affiliated with a contract research organization that the Company has contracted with to conduct one of it clinical trials. For the year ended December 31, 2007, the Company incurred expense of approximately $1.3 million related to the clinical trial this CRO is conducting for the Company. There was no such expense for the years ended December 31, 2006 and 2005, respectively.
A former member of Pharmacopeia's Board of Directors, who retired in May 2007, was also a partner in an outside law firm that provided legal services to Pharmacopeia during the years he served as director. For the years ended December 31, 2007, 2006, and 2005, Pharmacopeia expended a total of $510 thousand, $373 thousand, and $324 thousand, respectively, in fees related to services provided by such firm.
A member of Pharmacopeia's Board of Directors also serves as Chair of Pharmacopeia's Scientific Advisory Board. For the years ended December 31, 2007, 2006, and 2005, Pharmacopeia expended a total of $36 thousand, for each year, in fees related to his services as Chair.
The Company's Chairman is also Chairman of the Board of Directors of a collaborator. For the year ended December 31, 2005, the Company recorded revenue of approximately $1.0 million for collaborative research and development provided to that collaborator. For the years ended December 31, 2007, and 2006, there was no revenue recognized from that collaborator.
6. Composition of Certain Financial Captions
Property and equipment consist of the following (in thousands):
Depreciation and amortization expense for the years ended December 31, 2007, 2006 and 2005 was $2.4 million, $1.9 million and $2.2 million, respectively.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
6. Composition of Certain Financial Captions (Continued)
Accrued liabilities consist of the following (in thousands):
7. Income Taxes
The Company accounts for income taxes using the liability method. Under the liability method, deferred income taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the carrying amounts and the tax basis of existing assets and liabilities.
Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands):
As of December 31, 2007, the Company had U.S. federal net operating loss carryforwards of approximately $82.7 million. The U.S. federal net operating losses begin to expire in 2022, if not fully utilized. Realization is dependent on generating sufficient taxable income prior to expiration of the loss. For the years ended December 31, 2007, 2006 and 2005, $419 thousand, $497 thousand and, $54 thousand, respectively, of net operating losses related to stock option deductions, which will result in an increase to paid-in capital and a decrease in income taxes payable at such time as the tax benefit is realized. A valuation allowance has been established for the net deferred tax assets due to the Company's lack of earnings history.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
7. Income Taxes (Continued)
The benefit from income taxes consists of the following (in thousands):
The benefit from state income taxes for the years ended December 31, 2007, 2006 and 2005 represents the sale by the Company of a portion of its 2005, 2004 and 2003 state net operating losses and research and development credits, from which the Company realized $771 thousand, $532 thousand, and $267 thousand, respectively, offset by amounts recorded for state alternative minimum taxes.
The following reconciles income taxes computed at the US statutory federal tax rate to the Company's benefit from income taxes from continuing operations (in thousands):
The Tax Reform Act of 1986 contains provisions that limit the utilization of net operating loss and tax credit carryforwards if there has been a "change of ownership" as described in Section 382 of the Internal Revenue Code. The Company has not performed a detailed analysis to determine whether an ownership change has occurred. Such a change of ownership may limit the Company's utilization of its net operating loss and tax credit carryforwards, and could be triggered by subsequent sales of securities by the Company or its stockholders.
8. Line of Credit / Notes Payable
In December 2006, the Company entered into a Loan and Security Agreement (the Line of Credit) with a lending institution (the Lender). The Line of Credit is intended to provide the Company with funding, in exchange for a security interest in certain of the Company's equipment. The Line of Credit provides up to a total of $5.0 million in funding in the form of term loans, from time to time through December 2008. Term loans secured by laboratory equipment have a fixed term of 48 months. Term loans secured by all other collateral categories have a fixed term of 36 months.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
8. Line of Credit / Notes Payable (Continued)
The following table includes the aggregate future principal payments of the Company's long-term debt as of December 31, 2007:
As of December 31, 2007, the aggregate balance of loans originated under the Line of Credit was approximately $4.1 million, of which $3.0 million was classified as notes payable, long-term. Interest rates on these loans range from 10.08% to 10.28%. Additionally, the Company had approximately $0.6 million available for borrowings under the Line of Credit as of December 31, 2007.
9. Sale of Securities
In May 2007, we issued and sold approximately 8.1 million shares of our common stock at a purchase price per share of $5.00 as part of a public underwritten offering. The aggregate gross proceeds of the transaction were approximately $40.3 million. The proceeds we received from the transaction, net of transaction costs, were approximately $37.1 million. The shares of common stock were sold through a prospectus supplement pursuant to one of our effective shelf registration statements.
In October 2006, the Company sold approximately 5.8 million shares of its common stock at a purchase price per share of $4.28. In connection with that sale of stock, the Company sold warrants to purchase approximately 1.45 million shares of its common stock at a purchase price of $0.125 per warrant, with an exercise price of $5.14 per share. The warrants are exercisable from April 19, 2007 through April 19, 2012. The aggregate gross proceeds of the transaction were approximately $25.0 million. On October 18, 2006, the Company received proceeds of approximately $23.0 million from the transaction, net of transaction costs. The shares and warrants were offered through a prospectus supplement pursuant to the Company's effective shelf registration statement on Form S-3.
Under EITF 00-19, to qualify as permanent equity, an equity derivative must permit the issuer to settle in unregistered shares. Under securities law, if the warrants were issued in connection with a public offering and have a cash settlement feature at the holder's option, a company does not have the ability to settle in unregistered shares. Therefore, the warrants cannot be classified as permanent equity and are instead classified as a liability. The warrants that the Company issued as part of its equity financing in October 2006 meet this criteria, and have been recorded as a liability in the accompanying balance sheet. The fair value of the warrants was determined as of October 18, 2006 and the Company recorded a liability relating to the issuance of the warrants of approximately $4.5 million. Equity derivatives not qualifying for permanent equity accounting are recorded at fair value on the measurement date, and are remeasured at each reporting date until the warrants are exercised or have expired. Changes in the fair value of the warrants are reported in the statement of operations as income or expense. At December 31, 2006, the fair value of the warrants decreased to approximately $4.4 million. As a result of this decrease, the Company recorded approximately $0.1 million in income
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
9. Sale of Securities (Continued)
in the statement of operations for the year ended December 31, 2006. At December 31, 2007, the fair value of the warrants had decreased further to approximately $4.2 million. As a result of this decrease, the Company recorded approximately $0.2 million in income in the statement of operations for the year ended December 31, 2007.
The fair value of the warrants were calculated using the Black-Scholes option-pricing model with the following assumptions at the respective measurement dates:
10. Preferred Stock
The Company's amended and restated certificate of incorporation authorizes the issuance of up to 2,500,000 shares of preferred stock, $0.01 par value, per share. As of December 31, 2007 and 2006, no shares of preferred stock were outstanding.
The Company's amended and restated certificate of incorporation provides that its board of directors may by resolution establish one or more classes or series of preferred stock having the number of shares and relative voting rights, designation, dividend rates, liquidation, and other rights, preferences, and limitations as may be fixed by them without further stockholder approval. The holders of the Company's preferred stock may be entitled to preferences over common stockholders with respect to dividends, liquidation, dissolution or the Company winding up in such amounts as are established by the Company's board of directors resolutions issuing such shares.
The Company's board of directors adopted a stockholder rights plan (the rights plan) in April 2004. Under the rights plan, preferred stock purchase rights (each a "right) were distributed as a dividend at the rate of one right for each share of common stock outstanding as of the close of business on April 6, 2004 and automatically attach to shares issued thereafter. Each right entitles the holder to purchase one ten-thousandth of a share of newly created Series A Junior Participating Preferred Stock at an exercise price of $75.00 per right. In general, the rights will be exercisable if a person or group (Acquiring Person) becomes the beneficial owner of 15% or more of the Company's outstanding common stock or announces a tender offer for 15% or more of the Company's common stock. When the rights become exercisable, in lieu of Series A Junior Participating Preferred Stock, a holder, other than the Acquiring Person, will have the right to receive upon exercise common stock having a value equal to two times the exercise price of the right. In general the Company's board of directors will be entitled to redeem the rights for $0.0001 per right at any time prior to the occurrence of the stock acquisition events described above. If not redeemed, the rights will expire on April 5, 2014.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
11. Stock Plans
Pharmacopeia had two Stock Plans, the 2004 Stock Incentive Plan (the Plan), which was approved by the Company's Board of Directors on April 6, 2004, and the 2004 Employee Stock Purchase Plan (ESPP), which was approved by the Company's Board of Directors on May 1, 2004. Effective May 31, 2005 the Company terminated the ESPP.
In accordance with the Plan, Pharmacopeia may grant up to an aggregate of 3,400,000 shares of stock options, restricted stock, common stock, performance awards, deferred stock units and stock appreciation rights to officers, directors, employees, sales representatives and consultants of Pharmacopeia. All of the shares reserved under the Plan may be issuable as incentive stock options. The term of each incentive and non-qualified stock option is ten years. Vesting generally occurs over a period of not greater than five years, the expense for which is recorded on a straight-line basis for the requisite service basis. As of December 31, 2007, there were approximately 1,980,000 shares reserved underlying options granted under the Plan and approximately 1,375,000 shares available for future grants under the Plan.
In September 2007, the Company granted 300,000 options to two new executives, including 50,000 options that vest upon the achievement of certain enumerated objective performance criteria (performance-based vesting). These options were granted outside the Plan, and with provisions that are generally consistent with the provisions of the Plan.
Prior to the spin-off, the Company adopted the following Accelrys stock option plans: the 1994 Incentive Stock Plan, the 1995 Director's Option Plan and the 2000 Stock Option Plan under which grants of options and restricted stock had been made to Pharmacopeia employees. Generally, all outstanding options to purchase Accelrys common stock under these Accelrys Stock Option Plans were converted to options to purchase Pharmacopeia stock, in order to maintain the then existing intrinsic value and maintain the ratio of the then existing exercise price per share to the market value per share in accordance with applicable accounting standards. As of December 31, 2007, there were approximately 1,918,000 shares reserved underlying options made under these plans. No additional options may be granted to Pharmacopeia employees from these plans. A summary of the stock option activity and weighted average exercise prices follows (in thousands, except per share amounts):
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
11. Stock Plans (Continued)
A summary of stock options outstanding and exercisable as of December 31, 2007 is as follows (in thousands, except per share amounts):
As of December 31, 2007, there were approximately 4,108,000 options outstanding, net of estimated forfeitures, that had vested or are expected to vest. The weighted-average exercise price of these options was $6.45 per option; the weighted-average remaining contractual life of these options was 5.99 years; and the aggregate intrinsic value of these options was approximately $651 thousand.
12. Deferred Compensation and Retirement Savings Plans
The Company maintained a deferred compensation plan for certain officers and members of the Board of Directors. Effective December 31, 2004, participation in the deferred compensation plan was frozen and no further contributions may be made into the plan. The balance of the assets in the plan totaled approximately $2.1 million and $2.0 million as of December 31, 2007 and 2006.
The Company has an employee savings and retirement plan (the 401(k) Plan) that is intended to be a tax-qualified plan covering substantially all employees. Under the terms of the 401(k) Plan, employees may elect to contribute up to 20% of their compensation, or the statutory prescribed limit, if less. The Company may, at its discretion, match employee contributions up to a maximum of 3% of the employee's compensation, subject to certain plan limits. Employer contributions, made up entirely of Company common stock, totaled $448 thousand, $405 thousand and $390 thousand for the years ended December 31, 2007, 2006 and 2005, respectively.
13. Commitments and Contingencies
Operating Leases
The Company has several operating leases for office and laboratory space, which expire in 2016. The leases for the Company's facilities in New Jersey provide generally for scheduled rent increases, options to extend the leases with certain changes to the terms of the lease agreement, and refurbishment allowances. Rent and Common Area Maintenance expense under operating leases for the years ended December 31, 2007, 2006, and 2005 was approximately $2.2 million, $2.1 million, and $2.1 million, respectively.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
13. Commitments and Contingencies (Continued)
Future minimum lease commitments at December 31, 2007 are as follows (in thousands):
ECLiPS® Royalties
Under its license agreement with the Trustees of Columbia (Columbia) University and Cold Spring Harbor Laboratory (Cold Spring), the Company has an exclusive license for technology used in its proprietary combinatorial chemistry encoding technology, Encoded Combinatorial Libraries on Polymeric Support, or ECLiPS®. The Agreement obligates the Company to pay a minimum annual license fee of $100 thousand to Columbia and Cold Spring. In 2007, 2006, and 2005, the Company incurred related royalties and license fees totaling $110 thousand, $129 thousand and $126 thousand, respectively. The term of the Agreement is the later of (i) July 16, 2013 or (ii) the expiration of the last patent relating to the technology, at which time the Company will have a fully paid license to the technology. The license granted to the Company under the Agreement can be terminated by Columbia and Cold Spring (i) upon 30 days written notice to the Company if the Company materially breaches the Agreement and the Company fails to cure such material breach in accordance with the Agreement or (ii) if the Company commits any act of bankruptcy, becomes insolvent, files a petition under any bankruptcy or insolvency act or has any such petition filed against it that is not dismissed within 60 days. The Company is also obligated to pay royalties to Columbia and Cold Spring based on net sales of pharmaceutical products the Company develops, as well as a percentage of all other revenue the Company recognizes from collaborators that is derived from the technology licensed from Columbia and Cold Spring.
Product Development and Commercialization Agreement with GSK
Under the GSK Agreement, the Company and GSK each have the right to terminate the GSK Agreement in its sole discretion under certain specified circumstances at any time during the term of the GSK Agreement. In addition, the Company and GSK each have the right to terminate the GSK Agreement under circumstances that are customary in these types of agreements. If the Company exercises its discretionary termination right at any time during the first five years of the term, under certain circumstances, it could be required to refund to GSK a portion of the up to $15.0 million related to initial discovery activities to be conducted by the Company. The amount of any such refund will be calculated based upon when during the term of the GSK Agreement that termination occurs. However, there are no instances where the deferred revenue would be amortized below the amount that could be potentially refundable pursuant to the terms of the GSK Agreement. Further, should GSK exercise its discretionary termination rights, there are no provisions in the GSK Agreement that
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
13. Commitments and Contingencies (Continued)
would require the Company to refund payments received relating to its performance of initial discovery activities under the GSK Agreement.
The Company's role in the alliance is to (i) identify and (ii) advance molecules in chosen therapeutic programs to development stage and (iii) subject to certain provisions in the GSK Agreement, further develop the candidates to clinical "proof of concept" (a demonstration of efficacy in humans). As of December 31, 2007, the Company had approximately $9.1 million of deferred revenue related to services that are to be provided under the GSK Agreement by the Company after December 31, 2007.
Research and License Agreement with Wyeth
Under the Wyeth Agreement, in 2007 the Company received an up-front, non-refundable payment of $5.0 million and $3.0 million in research funding to support the Company's research efforts. As of December 31, 2007, the Company had approximately $3.3 million of deferred revenue related to services that we are to provide under the Wyeth Agreement after December 31, 2007.
Collaboration and License Agreement with Cephalon
Under the Cephalon Agreement, the Company received an up-front, non-refundable payment of $15.0 million in June 2006 to support the Company's research efforts. The Company is principally responsible for performing medicinal chemistry research over the alliance term, as required by the Cephalon Agreement. As of December 31, 2007, the Company had approximately $7.1 million of deferred revenue related to services that are to be provided under the Cephalon Agreement by the Company after December 31, 2007.
Collaboration and License Agreement with Organon
Under the Organon Agreement, the Company has received $20.0 million (the $15.0 million up-front payment, $1.0 million for the transfer of rights to certain programs from the 2002 Collaboration, and four quarterly research payments of $1.0 million each) since February 2007 to support our research efforts. As of December 31, 2007, The Company had approximately $17.0 million of deferred revenue related to services that it is to provide under the Organon Agreement after December 31, 2007.
In addition, if the Company exercises its discretionary termination right, under certain circumstances, the Company could be subject to a termination fee of $5.0 million. Whether or not the Company is subject to the termination fee is based upon when during the term of the Organon Agreement the Company exercise its discretionary termination right. However, until such time as the Company is no longer subject to the termination fee, the will be no instances where the deferred revenue associated with the Organon Agreement would be amortized below $5.0 million.
SARM License Agreement with BMS
In consideration for the licenses to the SARM program, in October 2007, the Company also entered into a discovery collaboration agreement (the Discovery Collaboration Agreement) with BMS. The Discovery Collaboration Agreement provides that the Company will apply a portion of its medicinal chemistry resources to a BMS discovery program that is unrelated to the SARM program for
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
13. Commitments and Contingencies (Continued)
up to three years. The Company recorded deferred revenue of $9.2 million which approximates the fair value of the chemistry resources that we are to provide to BMS subsequent to December 31, 2007.
In addition, the Company will pay BMS milestone payments associated with submission and approval of a therapeutic product for marketing and a stepped royalty on net sales of therapeutic products, if any, resulting from the SARM development program.
DARA License Agreement with BMS
Under the terms of the DARA License Agreement, in lieu of an up-front cash payment, the Company is providing BMS a set of compound libraries, over a period of approximately three years following the execution of the agreement. In the event the Company fails to deliver the aforementioned libraries to BMS, the Company would be required to make cash payments on a pro rata basis of up to $1.2 million.
In addition, the Company will pay BMS milestone payments upon the achievement of successive clinical and regulatory events in the United States and certain other jurisdictions, and royalties on sales of products, if any, resulting from the DARA program.
Milestone and Royalty Commitments
Under the terms of certain agreements to which the Company is a party, it is possible that the Company may become obligated to pay aggregate milestone payments totaling up to $287 million upon the achievement of successive clinical and regulatory events and royalties on sales of products, if any, resulting from programs for which the Company has development responsibility under such agreements. The Company will not be responsible for the payment of future milestone and/or royalty payments in the event that development of such a program is discontinued. Preclinical and clinical development of drug candidates is a long, expensive and uncertain process. At any stage of the preclinical or clinical development process, the Company may decide to discontinue the development of its product candidates. To date, none of the compounds to which the Company holds complete or partial rights has reached the stage of commercial product. The Company expects that its product candidates will not be commercially available for many years, if ever.
Product Manufacturing Contracts
The Company has entered into contracts with third parties related to the manufacturing of materials that are to be used in connection with our clinical trials for PS433450. The termination provisions for these contracts are such that, as of December 31, 2007, the Company had commitments totaling approximately $5.2 million, which are expected to be fulfilled during the year ended December 31, 2008.
Contract Research Organizations (CROs)
In connection with toxicology studies for PS433540, the Company has made certain commitments with contract research organizations totaling approximately $1.0 million, which it expects to be fulfilled during the year ended December 31, 2008.
Pharmacopeia, Inc.
Notes to Consolidated Financial Statements (Continued)
14. Business Segment and Geographical Information
The Company classifies its business operations in one operating segment. All of the Company's revenues are generated from this segment. Revenue was derived from collaborators located in the following geographic regions:
15. Restructuring and severance costs
During the year ended December 31, 2005, the Company incurred approximately $1.5 million of expense related to severance payable to two former executives of the Company. These charges consisted of $1.3 million in connection with cash payment obligations to these former executives, as well as a noncash charge of $0.2 million related to the accelerated vesting of their stock compensation. These expenses were classified as general and administrative expense in the Company's Consolidated Statement of Operations. Severance costs for year ended December 31, 2006 were approximately $182 thousand. The Company incurred no severance costs in the year ended December 31, 2007.
During the year ended December 31, 2006, the Company reduced its restructuring accrual by $88 thousand to reflect the final costs associated with its restructuring plan in 2004.
16. Selected Quarterly Financial Information (unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2007 and 2006 (in thousands, except per share amounts):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer and our Executive Vice President, Chief Financial Officer and Treasurer (our principal financial officer and chief accounting officer), of the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, or the Exchange Act, as of the end of the period covered by this report. Based upon this evaluation, our President and Chief Executive Officer and our Executive Vice President, Chief Financial Officer and Treasurer concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in reports filed under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Our management, including our President and Chief Executive Officer and our Executive Vice President, Chief Financial Officer and Treasurer, does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well designed and operated, cannot provide assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
Additionally, our President and Chief Executive Officer and our Executive Vice President, Chief Financial Officer and Treasurer determined that there were no changes in our internal control over financial reporting during the quarter ended December 31, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management's Report on Internal Controls Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Pharmacopeia, Inc.; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment and those criteria, our management has concluded we maintained effective internal control over financial reporting as of December 31, 2007. The effectiveness of our internal control over financial reporting as of December 31, 2007 has been
audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which appears below.
Attestation Report of Independent Registered Public Accounting Firm
Report of Independent Public Accounting Firm
The Board of Directors and Stockholders of Pharmacopeia, Inc.
We have audited Pharmacopeia, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Pharmacopeia, Inc.'s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Pharmacopeia, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Pharmacopeia, Inc. as of December 31, 2007 and 2006, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2007 and our report dated February 29, 2008 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
February 29, 2008
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item concerning the Company's directors and executive officers is incorporated by reference from the Sections entitled "Corporate Governance", "Director Compensation Table" and "Executive Officers of the Registrant" in the Company's Proxy Statement (the Proxy Statement) related to the Annual Meeting of Stockholders to be held on April 30, 2008.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the sections entitled "Compensation Discussion and Analysis", "Compensation Committee Interlocks and Insider Participation", "Executive Officers of the Registrant", "Compensation Table" and "Employment Agreements and Potential Payments Upon Termination or Change in Control" in the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Certain information required by this Item is incorporated by reference from the section entitled "Stock Ownership of Principal Stockholders and Management" in the Proxy Statement.
OTHER FORMS OF COMPENSATION
2007 Equity Compensation Plan Information
(1)Includes approximately 1,918,000 options outstanding from the following Accelrys stock option plans: the 1994 Incentive Stock Plan, the 1995 Director's Option Plan, and the 2000 Stock Option Plan, under which grants of options had been made to Pharmacopeia employees. Prior to the spin-off our Board of Directors resolved to adopt these Accelrys stock option plans. Generally, any outstanding options to purchase Accelrys common stock under these plans have been converted to maintain the then existing intrinsic value and maintain the ratio of the then existing exercise price per share to the market value per share in accordance with applicable accounting standards. No additional options may be granted to Pharmacopeia employees from these plans. The remaining approximately 1,980,000 shares reflects options outstanding under Pharmacopeia, Inc.'s Amended and Restated 2004 Stock Incentive Plan (the Plan).
(2)Represents 300,000 options outstanding that were issued in 2007 outside the Plan. The provisions of these options are generally consistent with the provisions of the Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference from the sections entitled "Certain Relationships and Related Transactions" and "Corporate Governance-Director Independence" in the Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference from the section entitled "Audit Committee Report and Payment of Fees to Auditors-Auditor Fees" in the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements The following Financial Statements are included:
Report of Ernst & Young LLP, Independent Registered Public Accounting
Firm
Balance Sheets as of December 31, 2007 and 2006
Statements of Operations for the years ended December 31, 2007, 2006 and 2005
Statements of Stockholders' Equity for the years ended December 31, 2007, 2006 and 2005.
Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005
Notes to Financial Statements
(a)(2) Exhibits:
EXHIBITS
NO.
DESCRIPTION
1.1
Underwriting Agreement, by and among Pharmacopeia, Inc., CIBC World Markets Corp., Canaccord Adams Inc. and Merriman Curhan Ford & Co., dated May 1, 2007 (incorporated by reference to Exhibit 1.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed on May 2, 2007).
2.1
Master Separation and Distribution Agreement between Pharmacopeia, Inc., Accelrys Inc. and Pharmacopeia, Inc., dated April 30, 2004 (incorporated by reference to Exhibit 2.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed May 3, 2004).
3.1
Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to Pharmacopeia, Inc.'s Report on Form 10-Q filed on May 10, 2007).
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to Pharmacopeia, Inc.'s Registration Statement on Form 10 (Reg. No. 000-50523)).
3.3
Amendment No. 1 to Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to Pharmacopeia, Inc.'s Report on Form 8-K filed on December 18, 2007).
3.3
Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock of Pharmacopeia, Inc. (incorporated by reference to Exhibit 3.3 to Pharmacopeia, Inc.'s Registration Statement on Form 10 (Reg. No. 000-50523)).
4.1
Form of Specimen Certificate for Pharmacopeia, Inc. Common Stock (incorporated by reference to Exhibit 4.3 to Pharmacopeia, Inc.'s Registration Statement on Form S-3 filed on August 13, 2007).
4.2
Form of Warrant to Purchase Common Stock issued in connection with Product Development and Commercialization Agreement among SmithKlineBeecham Corporation, doing business as GlaxoSmithKline, Glaxo Group Limited and Pharmacopeia, Inc., dated as of March 24, 2006 (incorporated by reference to Exhibit 4.1 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed May 12, 2006).
4.3
Form of Warrant issued in connection with the Underwriting Agreement, by and among Pharmacopeia, Inc., CIBC World Markets Corp. and Merriman Curhan Ford & Co., dated October 13, 2006 (incorporated by reference to Exhibit 4.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed October 17, 2006).
10.1
Tax Sharing and Indemnification Agreement between Pharmacopeia, Inc. and Pharmacopeia, Inc., dated April 30, 2004 (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 8-K, filed May 3, 2004).
10.2
Patent and Software License Agreement between Pharmacopeia, Inc., Accelrys Inc. and Pharmacopeia, Inc., dated April 30, 2004 (incorporated by reference to Exhibit 10.4 to Pharmacopeia, Inc.'s Report on Form 8-K, filed May 3, 2004).
10.3
Form of Pharmacopeia Drug Discovery, Inc. Amended and Restated 2004 Stock Incentive Plan (incorporated by reference to Exhibit 10.5 to Pharmacopeia, Inc.'s Form DEF 14A filed on March 26, 2007).(3)
10.4(a)
Amended 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by Reference to Exhibit 10.5 to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 1995).(3)
10.4(b)
Amendment No. 1 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(a) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(c)
Amendment No. 2 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.5(c) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(d)
Amendment No. 3 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.5(a) to Accelrys Inc.'s Report on Form 10-Q for the quarter ended June 30, 1997).(3)
10.4(e)
Amendment No. 4 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(d) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(f)
Amendment No. 5 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(e) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(g)
Amendment No. 6 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(f) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(h)
Amendment No. 7 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(g) to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.4(i)
Amendment No. 8 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.54 to Accelrys Inc.'s Report on Form 10-Q for the quarter ended June 30, 2000).(3)
10.4(j)
Amendment No. 9 to the 1994 Incentive Stock Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1(i) to Accelrys Inc.'s Report on Form 10-Q for the quarter ended March 31, 2002).(3)
10.4(k)
1995 Director Option Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.7 to the Accelrys Inc. Registration Statement on Form S-1 (Reg. No. 33-98246)).(3)
10.4(l)
Amendment No. 1 to 1995 Director Option Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.3(a) to Accelrys Inc.'s report on form 10-K for the year ended December 31, 2000).(3)
10.4(m)
Amendment No. 2 to the 1995 Director Option Plan of Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.3(b) to Accelrys Inc.'s report on Form 10-Q for the quarter ended March 31, 2001).(3)
10.4(n)
Pharmacopeia, Inc. 2000 Stock Option Plan (incorporated by reference to Accelrys Inc.'s Report on Form 10-K for the year ended December 31, 2000).(3)
10.5
Rights Agreement between Pharmacopeia, Inc. and American Stock Transfer & Trust Company, dated April 30, 2004 (incorporated by reference to Exhibit 10.5 to Pharmacopeia, Inc.'s Report on Form 8-K, filed May 3, 2004).
10.6
Collaboration and License Agreement, dated as of July 9, 2003 and effective August 8, 2003, between Pharmacopeia, Inc. and Schering- Plough Ltd. (incorporated by reference to Exhibit 10.32 to Accelrys, Inc.'s Report on Form 10-Q for the quarter ended September 30, 2003).(5)
10.7
Collaboration and License Agreement, dated as of July 9, 2003 and effective August 8, 2003, between Pharmacopeia, Inc. and Schering Corporation (incorporated by reference to Exhibit 10.33 to Accelrys, Inc.'s Report on Form 10-Q for the quarter ended September 30, 2003).(5)
10.8
Amendment No. 1, dated July 27, 2006, to the Collaboration and License Agreements, effective as of July 9, 2003, between (i) the Company and Schering Corporation and (ii) the Company and Schering-Plough Ltd. (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed August 2, 2006).
10.9
Amendment No. 2, dated September 25, 2006, to the Collaboration and License Agreements, effective as of July 9, 2003 (and as subsequently amended) between (i) the Company and Schering Corporation and (ii) the Company and Schering-Plough Ltd. (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed November 2, 2006).(4)
10.10
Lease, dated August 20, 2003, between Pharmacopeia, Inc. and Eastpark at 8A (Building 1000) (incorporated by reference to Exhibit 10.35 to Accelrys, Inc.'s Report on Form 10-Q for the quarter ended September 30, 2003).
10.11
Amendment to Lease, dated September 10, 2007, between Eastpark at 8A and Pharmacopeia, Inc. (Building 1000) (incorporated by reference to Exhibit 10.1 to Pharmacopeia Inc.'s Report on Form 10-Q filed on November 5, 2007).
10.12
Lease, dated August 20, 2003, between Pharmacopeia, Inc. and Eastpark at 8A (Building 3000) (incorporated by reference to Exhibit 10.36 to Accelrys, Inc.'s Report on Form 10-Q for the quarter ended September 30, 2003).
10.13
Amendment to Lease, dated April 18, 2007, between Eastpark at 8A and Pharmacopeia, Inc. (Building 3000) (incorporated by reference to Exhibit 10.2 to Pharmacopeia Inc.'s Report on Form 10-Q filed on November 5, 2007).
10.14
Product Development and Commercialization Agreement among SmithKlineBeecham Corporation, doing business as GlaxoSmithKline, Glaxo Group Limited and Pharmacopeia, Inc., dated as of March 24, 2006 (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed May 12, 2006).(5)
10.15
Amendment No. 1, dated August 10, 2006, to the Product Development and Commercialization Agreement among the Company, SmithKlineBeecham Corporation, doing business as GlaxoSmithKline, and Glaxo Group Limited (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed November 2, 2006).(5)
10.16
License Agreement, dated as of March 27, 2006, between Pharmacopeia, Inc. and Bristol-Myers Squibb Company (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed May 12, 2006).(5)
10.17
Collaboration and License Agreement between Pharmacopeia, Inc. and Cephalon, Inc., dated May 18, 2006 (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 10-Q, filed August 4, 2006).(5)
10.18
License Agreement, amended and restated as of July 1, 2003, among The Trustees of Columbia University in the City of New York, Cold Spring Harbor Laboratory and Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 10-Q for the quarter ended June 30, 2005).(5)
10.19
Form of Purchase Agreement dated July 27, 2005 between Pharmacopeia, Inc. and the Purchasers set forth therein (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed August 2, 2005).
10.20
Form of Indemnity Agreement between Pharmacopeia, Inc. and its directors and executive officers. (incorporated by reference to Exhibit 3.3 to Pharmacopeia, Inc.'s Registration Statement on Form 10 (Reg. No. 000-50523)).(3)
10.21
Employment Agreement between Pharmacopeia, Inc. and Leslie Johnston Browne, Ph.D., amended and restated as of March 5, 2008.(1)(3)
10.22
Letter Agreement, dated November 15, 2004, between Pharmacopeia, Inc. and Stephen C. Costalas (incorporated by reference to Exhibit 10.22 to Pharmacopeia, Inc.'s Report on Form 10-K for the year ended December 31, 2004).(3)
10.23
Amended and Restated Severance Agreement, dated December 18, 2007, between Pharmacopeia, Inc. and Stephen C. Costalas.(1)(3)
10.24
Letter Agreement, dated January 6, 2005, between Pharmacopeia, Inc. and David M. Floyd (incorporated by reference to Exhibit 10.24 to Pharmacopeia, Inc.'s Report on Form 10-K for the year ended December 31, 2004).(3)
10.25
Amended and Restated Severance Agreement, dated December 18, 2007, between Pharmacopeia, Inc. and David M. Floyd.(1)(3)
10.26
Letter Agreement, dated May 4, 2006, between Pharmacopeia, Inc. and Brian M. Posner (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed May 4, 2006).(3)
10.27
Amended and Restated Severance Agreement, dated December 18, 2007, between Pharmacopeia, Inc. and Brian M. Posner.(1)(3)
10.28
Letter Agreement, dated November 2, 2006, between Pharmacopeia, Inc. and Rene Belder (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K, filed November 7, 2006).(3)
10.29
Amended and Restated Severance Agreement, dated December 18, 2007, between Pharmacopeia, Inc. and Rene Belder.(1)(3)
10.30
Letter Agreement, effective September 6, 2007, between Pharmacopeia, Inc. and Eric J. Liebler (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K filed on September 7, 2007).(3)
10.31
Severance Agreement, dated September 6, 2007, between Pharmacopeia, Inc. and Eric J. Liebler (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 8-K filed on September 7, 2007).(3)
10.32
Letter Agreement, effective August 31, 2007, between Pharmacopeia, Inc. and S. David Kimball (incorporated by reference to Exhibit 10.3 to Pharmacopeia, Inc.'s Report on Form 8-K filed on September 7, 2007).(3)
10.33
Severance Agreement, dated August 31, 2007, between Pharmacopeia, Inc. and S. David Kimball (incorporated by reference to Exhibit 10.4 to Pharmacopeia, Inc.'s Report on Form 8-K filed on September 7, 2007).(3)
10.34
Amended and Restated Severance Agreement, dated December 18, 2007, between Pharmacopeia, Inc. and Maria L. Webb.(1)(3)
10.35
Letter Agreement, dated March 21, 2003, between Pharmacopeia, Inc. and Simon M. Tomlinson (incorporated by reference to Exhibit 10.31 to Pharmacopeia, Inc.'s Report on Form 10-K filed March 20, 2006).(3)
10.36
Form of Stock Option Agreement (incorporated by reference to Exhibit 10.2 to Pharmacopeia, Inc.'s Report on Form 8-K filed on February 27, 2006.(3)
10.37
Form of Stock Option Agreement (incorporated by reference to Exhibit 10.3 to Pharmacopeia, Inc.'s Report on Form 8-K filed on February 27, 2006.(3)
10.38
Form of Stock Option Agreement (incorporated by reference to Exhibit 10.3 to Pharmacopeia, Inc.'s Report on Form 10-Q filed on November 5, 2007.(3)
10.39
2007 Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 8-K filed on February 8, 2007).(3)
10.40
2008 Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report Form on 8-K filed on February 11, 2008).(3)
10.41
Executive Deferred Compensation Plan (incorporated by reference to Exhibit 10.29 to Pharmacopeia, Inc.'s Report on Form 10-K for the year ended December 31, 2004).(3)
10.42
Research and License Agreement, dated December 22, 2006, between Pharmacopeia, Inc. and Wyeth (incorporated by reference to Exhibit 10.43 to Pharmacopeia, Inc.'s Report on Form 10-K for the year ended December 31, 2006).(4).
10.43
Master Security Agreement, dated December 26, 2006, between Oxford Finance Corporation and Pharmacopeia, Inc. (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 10-Q filed on August 2, 2007).
10.44
Collaboration and License Agreement, amended and restated effective as of February 8, 2007, between Pharmacopeia, Inc. and N.V. Organon (incorporated by reference to Exhibit 10.1 to Pharmacopeia, Inc.'s Report on Form 10-Q filed on May 10, 2007).(2)
10.45
License Agreement, dated October 11, 2007, between Bristol-Myers Squibb Company and Pharmacopeia, Inc.(1)(2)
10.46
Discovery Collaboration Agreement, dated October 11, 2007, between Bristol-Myers Squibb Company and Pharmacopeia, Inc.(1)(2)
21.1
Subsidiaries of Pharmacopeia, Inc.(1)
23.1
Consent of Ernst & Young LLP.(1)
31.1
Certification of the Principal Executive Officer of Pharmacopeia, Inc. pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)
31.2
Certification of the Principal Financial Officer of Pharmacopeia, Inc. pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)
32.1
Certification of the Chief Executive Officer of Pharmacopeia, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)
32.2
Certification of the Principal Financial Officer of Pharmacopeia, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)
(1)Filed herewith.
(2)Confidential treatment of certain provisions of this exhibit has been requested.
(3)Compensation plan or arrangement in which directors and executive officers are eligible to participate.
(4)Confidential treatment of certain provisions of this exhibit has been granted.
(5)Accelrys, Inc. has been granted confidential treatment of certain provisions of this exhibit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
PHARMACOPEIA, INC.
By:
/s/ LESLIE J. BROWNE, PH.D. Leslie J. Browne, Ph.D.
President, Chief Executive Officer and Director
(Principal Executive Officer and Authorized Signatory)
Date:
March 6, 2008
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ LESLIE J. BROWNE Leslie J. Browne, Ph.D.
President and Chief Executive Officer and Director (Principal Executive Officer)
March 6, 2008
/s/ BRIAN M. POSNER Brian M. Posner
Executive Vice President, Chief Financial Officer and Treasurer (Principal Finance and Accounting Officer)
March 6, 2008
/s/ JOSEPH A. MOLLICA Joseph A Mollica, Ph.D.
Chairman of the Board
March 6, 2008
/s/ CAROL A. AMMON Carol A. Ammon
Director
March 6, 2008
/s/ FRANK BALDINO, JR. Frank Baldino, Jr., Ph.D.
Director
March 6, 2008
/s/ PAUL A. BARTLETT Paul A. Bartlett, Ph.D.
Director
March 6, 2008
/s/ STEVEN J. BURAKOFF Steven J. Burakoff, M.D.
Director
March 6, 2008
/s/ DENNIS H. LANGER Dennis H. Langer, M.D., J.D.
Director
March 6, 2008
/s/ BRUCE A. PEACOCK Bruce A. Peacock
Director
March 6, 2008
/s/ MARTIN H. SOETERS Martin H. Soeters
Director
March 6, 2008
Each person whose signature appears above in so signing also makes, constitutes and appoints each of Leslie J. Browne, Ph.D., President and Chief Executive Officer of the Registrant, and Brian M. Posner, Executive Vice President, Chief Financial Officer and Treasurer of the Registrant, his true and lawful attorney in-fact, in his or her name, place and stead to execute and cause to be filed with Securities and Exchange Commission any or all amendments to this Form 10-K.
DOCUMENTS INCORPORATED BY REFERENCE
Pharmacopeia, Inc. Report on Form 10-K Table of Contents
PART I
ITEM 1. BUSINESS
Internal Program Portfolio
ITEM 1A. RISK FACTORS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Pharmacopeia, Inc. Consolidated Balance Sheets (Amounts in thousands, except share and per share data)
Pharmacopeia, Inc. Consolidated Statements of Operations (Amounts in thousands, except share and per share data)
Pharmacopeia, Inc. Consolidated Statements of Stockholders' Equity (Amounts in thousands)
Pharmacopeia, Inc. Consolidated Statements of Cash Flows (Amounts in thousands)
Pharmacopeia, Inc. Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
OTHER FORMS OF COMPENSATION 2007 Equity Compensation Plan Information
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES