ITEM 1. Business
Company Overview
We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes and other central nervous system disorders. Specifically, our strategy involves acquiring or in-licensing central nervous system, or CNS, active compounds and developing them for novel and typically underserved indications. The term Functional Somatic Syndromes refers to several related syndromes characterized more by symptoms, suffering and disability than by disease-specific abnormalities that are found upon physical examination and include many overlapping pain and psychiatric conditions. We pursue opportunities to acquire or in-license CNS active compounds in the areas in which the brain and body overlap, where CNS mechanisms have a strong influence on somatic or bodily symptoms, and our two ongoing development programs are representative of this strategy. In pursuit of these opportunities, we evaluate various potential strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives.
Our goal is to be the first to commercialize a product approved in the United States for the treatment of Fibromyalgia Syndrome, or FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes. In January 2004, we entered into a collaboration agreement with Forest Laboratories, Inc., a leading marketer of CNS drugs with a strong franchise in the primary care and psychiatric markets, for the development and marketing of milnacipran. In July 2005, we completed the first Phase III trial for milnacipran, which was commenced in October 2003. We announced the top-line results from this first Phase III trial in September 2005. Although the results did not achieve statistical significance at the p<0.05 level, we believe the preliminary results support continuation of the development program and the planned development program for milnacipran is continuing. This development program includes an ongoing second Phase III study, that was commenced in October 2004, and an additional third Phase III study, that was initiated in the first quarter of 2006.
In June 2005, we announced the initiation of our second development program, wherein we are evaluating potential pharmaceutical treatments for Obstructive Sleep Apnea, or OSA. We entered into three licensing agreements to support and facilitate the program. Specifically, we licensed mirtazapine-related patents from Organon (Ireland) Ltd., and patents from two other parties that provide the opportunity to combine mirtazapine with a second approved agent with the goal of potentially
augmenting efficacy and improving tolerability. The series of licenses will allow Cypress to evaluate a number of potential OSA treatment modalities in proof of concept trials.
Cypress and Organon are each independently initiating Phase IIa trials that will serve as the basis for selecting the product candidate for further clinical development. The companies expect the Phase IIa trials and subsequent joint development and planning meetings to run through at least the first half of 2006, which is also the earliest a development candidate to be evaluated in further trials could be selected.
Milnacipran for the Treatment of FMS
Milnacipran
We are developing milnacipran for the treatment of FMS with our partner, Forest Laboratories. Milnacipran is the first of a new class of agents known as norepinephrine serotonin reuptake inhibitors, or NSRIs, which increase the level of norepinephrine more than they do serotonin. While milnacipran is similar to TCAs with regard to the relative ratio of norepinephrine and serotonin activity, milnacipran appears to lack the side effects associated with TCAs, as it does not interact with several classes of receptors that are responsible for many of the adverse effects of TCAs. Therefore, we believe that milnacipran may have efficacy similar to TCAs in treating FMS and related chronic pain conditions, without causing the side effects that limit the prescribing of TCAs by physicians, and compliance by patients. Milnacipran is approved for the treatment of depression in 32 countries and is currently a leading antidepressant in Japan. Since its commercial launch in 1997, milnacipran has been used by over 3,000,000 patients worldwide, with side effects typically limited to transient and mild nausea and a slight increase in heart rate, as well as the potential for urinary retention in older men with an enlarged prostate. Milnacipran has not been approved in the United States for any indication, and we are the first company conducting clinical trials of milnacipran in the United States for FMS. As a result of the favorable side effect profile of milnacipran compared to the TCAs and its ability to increase the level of norepinephrine more than serotonin in the brain, we believe that milnacipran may play a significant role in the treatment of FMS.
Milnacipran Development Status
Results of Phase II Trial
We completed a Phase II trial evaluating milnacipran for the treatment of FMS in the Fall of 2002. The Phase II trial was a three-month, randomized, placebo-controlled study involving 14 sites and 125 FMS patients who were randomized to either milnacipran treatment or placebo. The study evaluated the overall analgesic efficacy and safety of milnacipran in this population of FMS patients, with a primary endpoint based on improvement in patient-reported pain. Electronic diaries were provided to all patients for the purpose of recording daily pain assessments in real time. We believe that performing daily pain assessments using electronic diaries reduces bias involved with asking individuals to recall symptoms over time and improves compliance by prompting and time-date stamping each patient response. The pain measures obtained from the electronic diaries were chosen to be the primary variable for the measurement of pain improvement. Secondary objectives included assessment of the impact of dosing strategy (twice daily dosing versus once daily) and the impact of milnacipran on other symptoms of FMS including fatigue, mood, physical function and sleep disturbances. Based on tolerability, patients were allowed to double their dose every week, up to a maximum of 200 mg of milnacipran daily. In our Phase II trial, milnacipran was shown to provide statistically significant improvement in pain, the primary symptom of FMS. Thirty-seven percent of milnacipran-treated patients randomized to the twice a day dosing group reported at least a 50% reduction in pain intensity, which means that their reported pain was half as intense as it was at the beginning of the study, compared to 14% of patients in the placebo group. In this analysis, 51 patients received milnacipran and 28 patients received a placebo. The reduction in pain intensity was statistically
significant, with a p-value of 0.0395. A p-value is a statistical measure of probability of drawing an erroneous conclusion from an experimental result. A p-value of less than or equal to 0.05 is generally considered to signify a statistically significant result, which means a result is unlikely to occur by chance. Further, 75% of all milnacipran-treated patients reported an impression of overall improvement compared to 38% in the placebo group. In this analysis, 68 patients received milnacipran and 21 patients received a placebo. This reported impression of overall improvement was also statistically significant, with a p-value of 0.003. Twice daily milnacipran had significantly better analgesic properties than once daily milnacipran, although other outcomes (e.g. fatigue, mood, patient’s global impression) were equally impacted by the two dosing regimens. No unexpected safety concerns arose from this clinical trial and there were no serious adverse events. Milnacipran was generally well-tolerated, especially with twice daily dosing. The most common dose-related side effect reported by patients was nausea, particularly early in the study, as well as a slight increase in heart rate. Most adverse events were mild to moderate in intensity and only lasted for a short time.
Results of First Phase III Trial
To prepare for our Phase III clinical program, and before commencing the first pivotal clinical trial, we completed a special protocol assessment with the FDA. In the special protocol assessment process, the FDA reviews the design and size of a proposed Phase III program and provides comments regarding the adequacy of the clinical trial design to support a claim of effectiveness in an approvable NDA. The FDA’s comments are binding on its review decision, except in limited circumstances, such as when a substantial scientific issue essential to determining the safety or effectiveness of a drug is identified after the Phase III program commences. As generally is required by the FDA, two positive pivotal trials are required for an NDA approval of milnacipran for the treatment of FMS. As part of the Phase III program, we also need to evaluate patients for a time period consistent with the minimum safety guidelines of the International Conference on Harmonization of Technical Requirements for the Registration of Pharmaceuticals for Human Use, or ICH. Specifically, these ICH guidelines require that we evaluate 300 patients on the 200 mg dose of milnacipran for six months and 100 patients on the 200 mg dose of milnacipran for one year.
We completed our first Phase III trial evaluating milnacipran for the treatment of FMS in July 2005 and announced the top-line results in September 2005. The first Phase III trial was a six-month, randomized, double-blind, placebo-controlled pivotal Phase III study involving 50 sites and 888 patients with FMS who were randomized to either milnacipran treatment or placebo. The primary endpoint of this trial was a composite response rate of an assessment of pain as measured by the Patient Experience Diary (PED) and an assessment of overall impression of patient well-being as measured by the Patient Global Impression of Change (PGIC). The PED data are patient self-reported pain data collected via an electronic diary system which asks patients to document random, daily and weekly pain levels. The PGIC is a patient reported periodic assessment of their perception of the change in their condition.
Based on an analysis of the data at the three-month time point using the Last Observation Carry-forward analysis, or LOCF, the p-value for patients receiving 200 mg per day of milnacipran was 0.058. LOCF is a statistical analysis method that governs how missing data for patients who withdraw from the study before reaching the analysis time point is handled. Specifically, LOCF is an analysis in which observations measured when the patient withdraws from the study are carried forward to the last time point necessary in the analysis. The LOCF analysis treats the carried-forward data as if it were the observed data at the last time point. A p-value is a statistical measure of probability of drawing an erroneous conclusion from an experimental result. A p-value of less than or equal to 0.05 is generally considered to signify a statistically significant result, which means a result is unlikely to occur by chance. In an analysis of the data at the three-month time point using the FDA-recommended Baseline Observation Carry-forward (BOCF) analysis the p-value for patients receiving 200 mg per day of milnacipran was 0.048. BOCF is an alternative statistical analysis method that governs how missing data
for patients who withdraw from the study before reaching the analysis time point is handled. Specifically, BOCF is an analysis that requires the patient remain active in the trial to be evaluated for response. If a patient withdraws from the trial for any reason, they are classed as a non-responder regardless of their pain and global scores at the time of withdrawal. Although the BOCF analysis yielded statistically significant results, the FDA may not accept this as a registration study because the BOCF analysis was not the prospectively defined analysis method for handling data for those patients who withdrew from the study prior to the assessment time point. The magnitude of the treatment effect observed in the three-month study results was maintained at the six-month analysis (p=0.053 and 0.067 for LOCF and BOCF analyses, respectively), indicating a durable response to milnacipran treatment. An additional endpoint of fibromyalgia syndrome, which is a composite of the primary endpoint as well as a physical function assessment, which mean’s the patient’s ability to perform activities of daily living, was also evaluated. The results of this analysis were not statistically significant compared to placebo at either the three or six month timeframe. Milnacipran was well tolerated by a majority of the patients, with the majority of patient withdrawals occurring early in the trial. The adverse event profile was generally consistent with that seen in the previous worldwide experience with milnacipran, as well as in the Phase II trial. The most common adverse events leading to withdrawal among the milnacipran treated patients were nausea 6%, heart rate increase 2%, headache 2%, and depression 2%.
Ongoing Phase III Trials
While the results in our first Phase III trial did not achieve a p-value of less than or equal to 0.05, we believe the results support continued development of milnacipran as a treatment for FMS. The ongoing development program for milnacipran includes an ongoing second Phase III study and an additional third Phase III study.
We and Forest commenced our second Phase III trial evaluating milnacipran as a treatment for FMS in October 2004. The second Phase III trial is a six-month, randomized, double-blind, placebo-controlled pivotal Phase III study with planned enrollment of approximately 1,200 FMS patients. In the second Phase III trial, two milnacipran doses will be evaluated (200 mg, administered 100 mg twice daily, as well as a lower dose, also administered twice daily). Based on the anticipated time necessary to recruit the patients for this trial, we expect to announce initial results from the second Phase III trial no earlier than the middle of 2007. Additionally, we and Forest commenced our third Phase III trial evaluating milnacipran as a treatment for FMS in the first quarter of 2006.
Treatment of Obstructive Sleep Apnea
OSA Condition
Obstructive sleep apnea, or OSA, a breathing disorder that is not currently treatable with an approved drug, affects 15 - 20 million people in the United States alone (according to the National Institutes of Health National Center for Sleep Disorder Research) and another 10 to 20 million in Europe, a prevalence comparable to conditions such as diabetes or asthma. OSA is characterized by brief interruptions of breathing during sleep, typically caused by a blockage of the airway, usually when the soft tissue in the rear of the throat collapses, either partially or fully, during sleep. These interruptions in breathing are called, depending upon severity, apneic or hypopneic episodes, and people with OSA can have as many as 30 or more of these interruptions each hour. For many patients, OSA syndrome is characterized by these apneic episodes along with loud snoring and inappropriate daytime sleepiness.
Currently, there are no safe and effective medications indicated for the routine treatment of sleep apnea. However, the pathogenesis of the disorder suggests that patients with OSA syndrome may respond to drug therapy, including those that manipulate the brain neurotransmitter, serotonin.
OSA Development Status
Cypress and Organon have each independently initiated Phase IIa trials that will serve as the basis for selecting the product candidate, if any, for further clinical development. The companies expect the Phase IIa trials and subsequent joint development and planning meetings to run through at least the first half of 2006, which is also the earliest a development candidate to be evaluated in further trials could be selected.
Licenses and Collaborations
Milnacipran Agreements
Pierre Fabre Agreements
In January 2004, we amended and restated our existing license agreement with Pierre Fabre. Our license agreement with Pierre Fabre provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada. Milnacipran has been marketed outside of the United States since 1997 as an antidepressant and has been used by over 3,000,000 patients worldwide. We paid Pierre Fabre a total of $2.5 million, including upfront payments of $1.5 million in connection with the execution of the original license agreement in 2001 and a $1.0 million milestone payment in September 2003, and issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock in connection with an amendment to the agreement with Pierre Fabre. We are obligated to pay Pierre Fabre 5% of any upfront and milestone payments received from Forest Laboratories as a sublicense fee. A $1.25 million such payment has been made to date. After a total of $7.5 million has been paid, any additional sublicense fees are credited against any subsequent milestone and royalty payments owed by us to Pierre Fabre. If not used, these credits are carried forward to subsequent years. We also are obligated to pay Pierre Fabre up to $4.5 million in the aggregate upon achievement of defined clinical and regulatory objectives. Forest Laboratories assumed our obligation to pay royalties to Pierre Fabre and the transfer price for the active ingredient supplied by Pierre Fabre. Pierre Fabre retains the right to sell products in indications developed by us outside the United States and Canada, and will pay us a royalty based on net sales for such products. The license agreement also provides Pierre Fabre with certain rights to obtain a license outside the United States and Canada for new formulations and new salts developed by us.
The agreement is effective until the later of the expiration of the last-to-expire of certain patents held by Pierre Fabre relating to the development of milnacipran, or ten years after the first commercial sale of a licensed product, unless terminated earlier. Each party has the right to terminate the agreement upon 90 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if such breach is not cured within 90 days following such written notice. Additionally, Pierre Fabre has the right to terminate the agreement upon 90 days’ written notice if (i) we terminate all development activities, unless the termination of activities is subject to cure within 12 months and we are using commercially reasonable efforts to cure the termination of activities, (ii) we challenge the Pierre Fabre patents and (iii) we effect a change in control in which a third party acquiror controls an SNRI product and certain provisions of the agreement would be breached as a result of such SNRI product, and the breach is not cured within a specified time period.
In addition, in January 2004, we entered into a supply agreement with Pierre Fabre. If any product is commercialized under the license agreement, Pierre Fabre will have the exclusive right to manufacture the active ingredients used in the commercial product, and we will pay Pierre Fabre a transfer price and royalties based on net sales. Forest Laboratories has assumed both of these financial obligations. Our supply agreement with Pierre Fabre may be terminated for cause either by us or by Pierre Fabre upon 90 days’ prior
written notice to the other party upon a material breach of the agreement if the breach is not cured within 90 days following the written notice. In addition, Pierre Fabre may elect to terminate the agreement if we effect a change in control under specified circumstances.
Forest Laboratories Agreement
In January 2004, we entered into a collaboration agreement with Forest Laboratories for the development and marketing of milnacipran. We selected Forest Laboratories as our development and marketing collaborator based in part on its strong franchise in central nervous system drugs and in the primary care and psychiatric markets. Under our agreement with Forest Laboratories, we sublicensed our exclusive rights to develop and commercialize milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has an option for a specified time period to acquire an exclusive license from us in the United States, and potentially Canada, to any compounds developed under our agreement with Collegium Pharmaceutical, Inc. Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals, as well as a certain number of our employees. However, we agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only. In connection with this arrangement, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004, for the second Phase III trial only, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA. Forest Laboratories is funding the third Phase III clinical trial, including a specified number of our employees that are assisting with the conduct of that clinical trial. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, while we have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls. We share decision making authority with Forest Laboratories, through the joint development committee, with respect to the research, development and marketing of milnacipran. In the event that the joint development committee is unable to resolve any dispute, other than any marketing related issue, Forest Laboratories and we must jointly resolve such issue. With respect to any marketing related issue, Forest Laboratories has the final decision making authority. Under our agreement with Forest Laboratories and our agreement with Pierre Fabre, each party agreed to certain limitations on the development of products for FMS and on the development of SNRI products.
Under our agreement with Forest Laboratories, we received an upfront payment of $25.0 million, of which $1.25 million was paid to Pierre Fabre as a sublicense fee. The total upfront and milestone payments to us under the agreement could be approximately $205.0 million related to the development of milnacipran for the treatment of FMS, a large portion of which will depend upon achieving certain sales of milnacipran and an additional $45.0 million in the event that we and Forest Laboratories develop other indications for milnacipran, as well as potential royalty payments based on sales of licensed product under this agreement. In addition, Forest Laboratories assumed the royalty payments due to Pierre Fabre and the transfer price for the active ingredient used in milnacipran. The agreement with Forest Laboratories extends until the later of (i) the expiration of the last to expire of the applicable patents, (ii) 10 years after the first commercial sale of a product under the agreement or (iii) the last commercial sale of a generic product, unless terminated earlier. Each party has the right to terminate the agreement upon prior written notice of the bankruptcy or dissolution of the other party, or a breach of any material provision of the agreement if the breach has not been cured within the required time period following the written notice. Forest Laboratories may also terminate our agreement upon an agreed notice period in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of an NDA or to result in labeling or indications that would have a significant adverse affect on the marketing of any product developed under the agreement.
Collegium Agreement
In August 2002, we entered into a reformulation and new product agreement with Collegium pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. In January 2004, we exercised our option to acquire an exclusive license to technology developed under this agreement. In the event we commercialize any of the reformulations or new products developed under our agreement with Collegium, we will be obligated to pay Collegium milestone payments and royalty payments. The agreement with Collegium is effective until the expiration of the last-to-expire of the issued patents, if any, unless terminated earlier. Each party has the right to terminate the agreement upon 60 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if the breach has not been cured within the 60-day period following the written notice.
OSA Agreement
Organon Agreement
In June 2005, we entered into a license agreement with Organon in connection with the initiation of our second development program, wherein we are evaluating potential pharmaceutical treatments for OSA. We entered into three licensing agreements to support and facilitate the program. Specifically, we licensed mirtazapine-related patents from Organon and patents from two other parties that provide the opportunity to combine mirtazapine with a second approved agent with the goal of potentially augmenting efficacy and improving tolerability. The series of licenses will allow us to evaluate a number of potential OSA treatment modalities in proof of concept trials.
Upon execution of the license agreement with Organon, we issued to Organon as a license fee a warrant to purchase 62,656 shares of our common stock. These warrants, which have an exercise price of $15.96 per share and expire in June 2010, were valued at $615,000 and recorded as a non-cash compensation charge, classified as research and development expenses, during the second quarter of 2005 since the underlying technology still requires substantial development effort. Under the agreement with Organon, Cypress and Organon will jointly fund development activities in the event a candidate from the proof of concept trials has been selected for continued development. If we are able to select a development candidate, the following is the structure of our agreement with Organon. We will have operational control of the development activities and, depending on the candidate selected, will fund 40% or 50% of the development-related expenses. If the FDA approves this product, Organon will have operational control of sales and marketing activities, with Cypress having the opportunity to co-promote up to 25% of the physician promotion and details using its own sales force in the United States, Mexico and Canada. Expenses and revenue in the United States, Mexico and Canada are to be shared between Cypress and Organon based on the level of promotional effort each party contributes, with Cypress having the ability to share up to 40% or 50% depending on the candidate selected. Organon will be solely responsible for commercialization in the rest of the world and will pay us a royalty on net sales (as defined in the agreement).
Assuming the decision is made by Cypress and Organon to proceed with the commencement of the first Phase III clinical trial, at any time thereafter, either Cypress or Organon may elect to change the structure of the financial agreement to provide that the party that makes such election will no longer share in expenses and revenue, and instead will have the potential right to receive potential milestone and royalty payments in the event a product is commercialized.
In connection with our related licensing transactions with two other parties, Cypress paid the parties aggregate license payments totaling $2.5 million, with the potential for additional milestone
payments of up to $25.3 million related to our OSA program, as development progresses. The parties will also participate in royalties from any marketed products that may be developed under the respective agreements.
Other Potential Uses of Milnacipran
We also believe that milnacipran may be effective in the treatment of other Functional Somatic Syndromes, such as irritable bowel syndrome, or IBS. With our development and marketing partner Forest Laboratories, we may in the future investigate the use of milnacipran in the treatment of IBS or other disorders. Should we and Forest Laboratories choose to pursue additional indications beyond FMS and obtain FDA approval for such indications, we could receive up to an additional $45 million in milestone payments. Since we are entitled to royalty payments based on sales of any licensed product under the agreement with Forest Laboratories, we would receive royalty payments for any additional indications. The decision regarding which, if any, additional indications are pursued, is one that we make together with Forest Laboratories, through the joint development committee. Such decisions relate to the research and development of milnacipran, so in the event the joint development committee is unable to resolve any dispute regarding potential indications, Forest Laboratories and we must jointly resolve such issue.
Patents, Trademarks and Proprietary Technology
We believe that patents, trademarks, copyrights and other proprietary rights are important to our business. We also rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We seek to protect our intellectual property rights by a variety of means, including patents, maintaining trade secrets and proprietary know-how, and technological innovation to develop and maintain our competitive position. We actively seek patent protection both in the United States and internationally and have filed 8 patent applications related to FMS and milnacipran. It is possible that a patent application will not issue from any of our patent applications and the breadth or scope of protection allowed under any issued patents may not provide adequate protection to protect any of our future products. We intend to enforce our patents, trademarks and brand names. We have also obtained a license from Pierre Fabre to certain patents and patent applications related to milnacipran. Under the license, which we have sublicensed to Forest Laboratories, we have rights to a method of synthesis patent for milnacipran in the United States and Canada. Both the United States patent (U.S. Patent 5,034,541) and the Canadian patent (No. 2,006,464) terminate in December 2009. The composition of matter patent for milnacipran expired in June 2002. Pursuant to the terms of the license agreement, Pierre Fabre is responsible for the prosecution and maintenance of the patents and patent applications licensed thereunder at its sole expense. In addition, Pierre Fabre has the first right to take actions with respect to the infringement or potential infringement of such patents and patent applications, except for any action in connection with an abbreviated NDA filed by a third party, and provided that we may take appropriate actions with respect to the infringement of such patents and patent applications in the United States and Canada if Pierre Fabre fails to do so within a specified period of time. We or Forest Laboratories has the first right to take any action with respect to any proceeding in connection with an abbreviated NDA filed by a third party. Although we have filed use patents on milnacipran, three of which have issued (U.S. Patent 6,602,911, U.S. Patent 6,635,675, and U.S. Patent 6,992,110, all expiring in 2021), we may not be able to secure any additional patent protection and the existing patents may not ensure exclusivity through the patent term. As a new chemical entity in the United States, milnacipran also qualifies under the terms of the Hatch-Waxman Amendments to the Federal Food, Drug and Cosmetic Act, or Hatch-Waxman Amendments, under which it would receive five years of marketing exclusivity upon marketing approval, during which time a generic milnacipran may not be approved. Even so, recent amendments to the Hatch-Waxman Amendments have been proposed and it, therefore, may not apply to us in the future.
We have licensed the rights to two issued patents pertaining to the use of mirtazapine in the treatment of OSA. United States patent (U.S. Patent 6,303,595) related to the use of mirtazapine in the treatment of OSA expires in 2017. In addition, we have licensed the rights to two other patent application families that directly pertain to our treatment methodology that are being domestically and internationally prosecuted. Finally, we are pursuing two additional families, pertaining to OSA related patents invented at Cypress. It is possible that a patent application will not issue from any of our patent applications and the breadth or scope of protection allowed under any issued patents may not provide adequate protection to protect any of our future products. We intend to enforce our patents, trademarks and brand names. Pursuant to the terms of the license agreement, Organon is responsible for the prosecution and maintenance of the patents and patent applications licensed thereunder at its sole expense. We may not be able to secure any additional patent protection and the existing patents may not ensure exclusivity through the patent term.
Although patents are enforceable from the date of issuance and presumed to be valid, future litigation or reexamination proceedings regarding the enforcement or validity of our existing patents or future patents, if issued, could result in a ruling adverse to us that could invalidate such patents or substantially reduce the scope of protection afforded by such patents. Our patents may not afford commercially significant protection of our proprietary technology or have commercial application. There has been no judicial determination of the validity or scope of our proprietary rights. Moreover, the patent laws in foreign countries may differ from those of the United States, and the degree of protection afforded by foreign patents may be different.
Others have filed applications for, or have been issued, patents and may obtain additional patents and other proprietary rights relating to products or processes competitive with us. The scope and validity of such patents is presently unknown. If existing or future patents are upheld as valid by courts, we may be required to obtain licenses to use technology covered by such patents.
Competition
We are currently focusing on developing milnacipran to treat patients with FMS. Currently, there are no approved treatments specifically for FMS in the United States or elsewhere. As a result, the first option for treatment of FMS is physical therapy, followed by analgesics to attempt to alleviate the pain. If the analgesics do not alleviate the pain, then muscle relaxants and antidepressants are often prescribed. TCAs, which are available in inexpensive generic formulations, are currently viewed as the drugs of choice in treating FMS. We are also focusing on the development of products for the treatment of patients with Functional Somatic Syndromes.
Clinical trials have been conducted by other pharmaceutical companies for the treatment of FMS. In particular, Pfizer Inc. has publicly disclosed that it has conducted a Phase II clinical trial evaluating the efficacy and safety of its compound, pregabalin, as a treatment for FMS. In addition, Eli Lilly and Company has publicly disclosed that it has conducted two Phase II clinical trials evaluating the efficacy and safety of its compound, duloxetine, as a treatment for FMS. Both Pfizer and Eli Lilly and Company have also publicly disclosed that they are conducting Phase III clinical trials to evaluate the efficacy and safety of their respective compounds as a treatment for FMS. The market potential for Functional Somatic Syndromes, including FMS, is considerable and a number of pharmaceutical companies focused on therapies for alleviating pain or antidepressant therapies could decide to evaluate their current product candidates for the treatment of Functional Somatic Syndromes, including FMS, at any time. Due to the high incidence of Functional Somatic Syndromes, including FMS, we anticipate that most, if not all, of the major pharmaceutical companies will have significant research and product development programs in these areas. We expect to encounter significant competition both in the United States and in foreign markets for each of the drugs we seek to develop.
Currently, there are no safe and effective medications indicated for the routine treatment of sleep apnea. For those with moderate to severe OSA, the treatment approaches include surgery, or medical devices that keep the airway open during sleep through the use of air pressure. The type of surgery depends on the cause of the sleep apnea, and includes procedures to remove tonsils, adenoids, or other tissue in the airway, or to insert implants into a portion of the airway. However, in general, surgery has a limited success rate, estimated at 30% to 60%, in moderate to severe OSA.
Continuous Positive Airway Pressure, or CPAP, or similar devices represent the most common and most successful treatment for OSA. CPAP treatment involves a mask worn over the nose during sleep. The mask blows air into the airway in order to keep the throat open during sleep. CPAP has a 100% success rate in reducing AHI, the apnea-hypopnea index, or respiratory disturbance index, or RDI, which refers to the total number of apneas and hypopneas divided by the total amount of sleep during the sleep study) and associated nighttime oxygen desaturations, when the patient is compliant and utilizes the treatment each night for the entire night. However, CPAP devices are cumbersome and have achieved only moderate acceptance by patients, with compliance estimated to be between 50 - 70%.
Competitors for all of our potential products include fully-integrated pharmaceutical and biotechnology companies both in the United States and in foreign markets which have expertise in research and development, manufacturing processes, testing, obtaining regulatory clearances and marketing, and may have financial and other resources significantly greater than we do. Smaller companies may also prove to be significant competitors. Academic institutions, United States and foreign government agencies and other public and private research organizations conduct research relating to Functional Somatic Syndromes, including FMS and OSA, and may develop products for the treatment of these diseases that compete directly with any products we develop. Our competitors may compete with us for collaborations. These companies and institutions also compete with us in recruiting and retaining highly qualified scientific personnel.
Our competition will be partially determined by the potential indications that are ultimately cleared for marketing by regulatory authorities, the timing of any clearances and market introductions and whether any currently available drugs, or drugs under development by others, are effective in the same indications. Accordingly, the relative speed with which we can develop milnacipran or our product candidate for OSA, complete the clinical trials, receive regulatory clearance and supply commercial quantities of the products to the market is expected to be an important competitive factor. We expect that competition among products approved for sale will be based, among other things, on product efficacy, safety, reliability, availability and patent protection.
Manufacturing and Supply
Pursuant to the terms of our purchase and supply agreement with Pierre Fabre, Pierre Fabre is the exclusive supplier to us and Forest Laboratories of the active pharmaceutical ingredient for milnacipran in exchange for a transfer price. Forest Laboratories has assumed the obligation to pay the transfer price directly to Pierre Fabre. Currently, Pierre Fabre manufactures the active pharmaceutical ingredient for milnacipran in its facility located in Gaillac, France. This facility will need to be inspected by the FDA. Due to the projected commercial quantities of milnacipran that we may require and to provide a second manufacturing site, Pierre Fabre has agreed that within a certain time period after commercial launch of milnacipran, it will qualify an additional manufacturing facility. In addition, because Pierre Fabre is our sole supplier of the active pharmaceutical ingredient for milnacipran and is currently the only supplier of the active pharmaceutical ingredient for milnacipran in the world, we have the right, but not the obligation, to qualify us or Forest Laboratories as an additional manufacturing facility to manufacture the active pharmaceutical ingredient for milnacipran. We do not currently have this capability. In addition, we have the right to manufacture milnacipran if Pierre Fabre does not have the required buffer stock or in the event
that we terminate our license agreement with Pierre Fabre under certain circumstances. Currently, Forest Laboratories is responsible for encapsulating and packaging milnacipran for our clinical trials.
Pursuant to the terms of our License and Collaboration Agreement with Organon, Organon is responsible for manufacturing both clinical and commercial supplies of mirtazapine.
Government Regulation
Our research, preclinical testing, clinical trials, manufacturing and marketing activities are subject to extensive regulation by numerous governmental authorities in the United States and other countries. In the United States, pharmaceutical drugs are subject to rigorous FDA regulation under the Federal Food, Drug and Cosmetic Act and other federal and state statutes and regulations. These laws and regulations govern, among other things, the preclinical and clinical testing, manufacture, quality control, safety, efficacy, labeling, storage, record keeping, approval, marketing, advertising and promotion of our drug products and drug product candidates. The product development and regulatory approval process requires the commitment of substantial time, effort and financial resources.
The steps required before a pharmaceutical agent may be marketed in the United States generally include:
• completion of preclinical laboratory tests, animal pharmacology and toxicology studies and formulation studies performed in compliance with the FDA’s Good Laboratory Practice, or GLP regulations;
• the submission of an investigational new drug application, or IND, to the FDA for human clinical testing that must be accepted by the FDA before human clinical trials may commence;
• performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the product candidate for the proposed indication of use;
• the submission of an NDA to the FDA; and
• FDA approval of the NDA prior to any commercial sale or shipment of the drug.
Preclinical studies include the laboratory evaluation of in vitro pharmacology, product chemistry and formulation, as well as animal studies to assess the potential safety and efficacy of a product. Compounds must be formulated according to the FDA’s current good manufacturing practices, or cGMP, requirements and preclinical safety tests must be conducted by laboratories that comply with GLP requirements. The results of the preclinical tests, together with manufacturing information and analytical data, are submitted to the FDA as part of an IND application and are reviewed by the FDA before human clinical trials may begin. The IND must also contain protocols for any clinical trials that will be carried out. The IND automatically becomes effective 30 days after receipt by the FDA unless the FDA raises concerns or questions regarding the conduct of the proposed clinical trial during the 30-day waiting period. If the FDA objects to an IND application during this 30-day waiting period or at any time thereafter, the FDA may halt proposed or ongoing clinical trials or may authorize trials only under specified terms. Such a halt, called a clinical hold, continues in effect until and unless the FDA’s concerns are adequately addressed. In some cases, clinical holds are never lifted. Imposition by the FDA of a clinical hold can delay or preclude further product development. The IND process may be extremely costly and may substantially delay product development.
Clinical trials must be sponsored and conducted in accordance with good clinical practice, or GCP, requirements and under protocols and methodologies that, among other things:
• ensure receipt from participants of signed consents that inform them of risks;
• detail the protocol and objectives of the study;
• detail the parameters to be used to monitor safety; and
• detail the efficacy criteria to be evaluated.
Furthermore, each clinical study must be conducted under the supervision of a principal investigator operating under the auspices of an institutional review board, or IRB, at the institution where the study is conducted. The IRB must review and approve the plan for any clinical trial before it commences at that institution and it must monitor the study until it is completed. The IRB will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Sponsors, investigators and IRB members are obligated to avoid conflicts of interests and ensure compliance with all legal requirements. The FDA, the IRB or the sponsor may suspend or discontinue a clinical trial at any time on various grounds, including potential health risks to study subjects.
Clinical trials are conducted in accordance with protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part of the IND, and the FDA must grant permission before each clinical trial may begin. Clinical trials typically are conducted in three sequential phases that may overlap. In Phase I, the initial introduction of the drug into a small number of healthy volunteers, the drug is evaluated for safety by assessing the adverse effects, dosage tolerance, metabolism, distribution, excretion and clinical pharmacology. The Phase I trial must provide pharmacological data that is sufficient to devise the Phase II trials.
Phase II trials involve a limited patient population in order to:
• obtain initial indications of the efficacy of the drug for specific, targeted indications;
• determine dosage tolerance and optimal dosage; and
• identify possible adverse affects and safety risks.
When a compound is determined preliminarily to be effective and to have an acceptable safety profile in Phase II evaluation, Phase III trials-commonly referred to as pivotal studies-can be undertaken to evaluate safety and efficacy endpoints further in expanded and diverse patient populations at geographically dispersed clinical trial sites. Positive results in Phase I or II are not necessarily predictive of positive results in Phase III.
The results of the pharmaceutical development, preclinical studies and clinical trials, together with detailed information on the manufacture and composition of the product, are submitted to the FDA in the form of an NDA, which must be complete, accurate and in compliance with FDA regulations. Once the submission has been accepted for filing by the FDA, a process that may take up to 60 days after submission, by law the FDA has 180 days to review the application and respond to the applicant. The review process is often significantly extended by FDA requests for additional information or clarification. The FDA may deny an NDA filed by us or our collaborators if the applicable scientific and regulatory criteria are not satisfied, or it may require additional clinical data and/or an additional pivotal trial. Moreover, data obtained from
clinical trials are not always conclusive and may be susceptible to varying interpretations that could delay, limit or prevent regulatory approval. The approval of an NDA permits commercial-scale manufacturing, marketing, distribution and sale of the drug in the United States and, with some limitations, export from the United States. Upon approval, a drug may only be marketed in those dosage forms, for those indications and subject to those limitations approved in the NDA. Moreover, after approval, the FDA may require additional post-approval testing, surveillance and reporting to monitor the products. Thus, even if approval for a drug is granted, it can be limited or revoked if evidence subsequently emerges casting doubt on the safety or efficacy of a product, as has happened recently with respect to several high profile marketed drugs, or if the manufacturing facility, processes or controls do not comply with regulatory requirements. Finally, an approval may entail limitations on the uses, labeling, dosage forms, distribution and packaging of the product.
Among the conditions for new drug approval is the requirement that the prospective manufacturer’s quality control, record keeping, notifications and reporting and manufacturing systems conform to the FDA’s cGMP regulations. To obtain approval, the drug manufacturing facility must be registered with the FDA and must pass a pre-approval inspection demonstrating compliance with cGMP requirements. If milnacipran is commercialized in the United States, Pierre Fabre’s facility will need to be inspected by the FDA for compliance with cGMP requirements. Manufacturing establishments also are subject to periodic, ongoing compliance inspections. In complying with the standards contained in these regulations, manufacturers must continue to expend time, money, resources and effort in order to ensure compliance. Failure to comply with these requirements can result in legal or regulatory action, including warning letters, suspension of manufacture, product seizure or recalls, injunctive action or civil or criminal penalties.
The FDA closely regulates the post-approval marketing and promotion of drugs, including standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities and promotional activities involving the Internet. Failure to comply with these requirements can result in adverse publicity, warning letters, corrective advertising and potential civil and criminal penalties.
Outside the United States, including Canada, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authority. This foreign regulatory approval process includes many of the same steps associated with FDA approval described above.
In addition to regulations enforced by the FDA, we are and will be subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and future federal, state or local regulations. Our research and development activities involve the controlled use of hazardous materials, chemicals and various radioactive compounds. Although we believe that the safety procedures used by third parties for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be completely eliminated. In the event of an accident, we could be liable for any damages that result.
The approval process for milnacipran, mirtazapine or any of our future products is expensive, time consuming and uncertain, and any applicable regulatory agency may not grant marketing approval. We may not have sufficient resources to complete the required testing and regulatory review processes. Furthermore, we are unable to predict the extent of adverse governmental regulation, which might arise from future United States or foreign legislative or administrative action.
Employees
As of February 28, 2006, we employed 15 full-time employees. None of our employees are covered by a collective bargaining agreement. We believe that our relationship with our employees is good.
Available Information
Our website address is www.cypressbio.com. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission.
Item 1A.
Item 1A. Risk Factors
There are limited data regarding milnacipran as a treatment of FMS and it may not work for FMS, especially in light of the results from our first Phase III clinical trial, or there may be safety issues with its use in this patient population.
There are limited data supporting the use of milnacipran for the treatment of FMS and no data supporting the use of milnacipran for indications other than depression. In September 2005, we reported top line results from our first Phase III clinical trial for patients with FMS and our trial did not achieve statistical significance on our primary endpoint. These reported topline results from our first Phase III clinical trial have had a material negative impact on our stock price. Although milnacipran is currently being sold by Pierre Fabre outside North America as an antidepressant, it has only been tested as a treatment for FMS in our Phase II trial and one Phase III trial, which did not achieve its primary endpoint. We must conduct and obtain favorable results in at least two pivotal Phase III trials to support an application for FDA approval of the product candidate. Under our current agreement with the FDA, our first completed Phase III clinical trial may not qualify as one of the registration quality studies necessary to support an application to the FDA. Although we have disclosed that an alternative analysis than the one we agreed to with the FDA, the BOCF analysis, yielded statistically significant results, the FDA may not accept this as a registration study because the BOCF analysis was not the prospectively defined analysis method for handling data for those patients who withdrew from the study prior to the assessment time point. In light of the fact that our first Phase III clinical trial did not achieve statistical significance using the analysis we agreed to with the FDA, it is possible that our second and third trials will also not achieve statistical significance. We are experiencing higher patient drop out rates in our second Phase III trial than in our Phase II trial for milnacipran. Milnacipran may not prove to be effective to treat FMS in our ongoing Phase III trials or any future trial and although we believe based on our analysis of the data, that the effect was durable, further studies may prove that any positive effects from patients taking milnacipran may not be durable. Furthermore, even if we elect to pursue the development of milnacipran for any other Functional Somatic Syndromes, such as IBS, it may not prove to be effective.
In addition, all or any of our clinical trials may reveal that milnacipran is not safe. The FDA has never approved a drug for the treatment of FMS. If milnacipran is not demonstrated to be a safe and effective treatment for FMS to the satisfaction of the FDA or other regulatory agencies, including because we do not comply with the Special Protocol Assessment, we will not receive regulatory approval and our business would be materially harmed. Furthermore, the recent publicity related to safety issues in the market may make approval of any drug by the FDA more difficult.
We are dependent on our collaboration with Forest Laboratories to develop and commercialize milnacipran and to obtain regulatory approval. Events or circumstances may occur that delay or prevent the development and commercialization of milnacipran.
Pursuant to the terms of our collaboration agreement with Forest Laboratories, we granted Forest Laboratories an exclusive sublicense for the development and marketing of milnacipran, for all indications in the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has the option to acquire an exclusive license from us in the United States, and potentially Canada, to any compounds developed under our agreement with Collegium Pharmaceutical. Forest Laboratories is responsible for funding the development of milnacipran, including clinical trials and regulatory approval, other than the external costs of the second Phase III trial, which we have agreed to fund. If the FDA approves this product candidate, Forest Laboratories will also have primary responsibility for the marketing and sale of the approved product and will share responsibility for compliance with regulatory requirements. We have limited control over the amount and timing of resources that Forest Laboratories will dedicate to the development, approval and marketing of milnacipran. Although Forest has indicated that they intend to continue development of milnacipran, there is always the possibility that they may instead choose to terminate development and our license agreement with them. Even if they continue to develop milnacipran, they may do so on a slower timeline than originally predicted. Furthermore, because the size of the second Phase III clinical trial has been increased from 800 patients to 1,200 patients our original timeline for announcing our topline results has been extended, and may be extended even further. Our ability to generate milestone and royalty payments from Forest Laboratories depends on Forest Laboratories’ ability to establish the safety and efficacy of milnacipran, obtain regulatory approvals and achieve market acceptance of milnacipran for the treatment of FMS, all of which has been impacted by the reported results from our first Phase III clinical trial.
We are subject to a number of additional risks associated with our dependence on our collaboration with Forest Laboratories, including:
• Forest Laboratories could stop either or both of the ongoing phase III trials of milnacipran for the treatment of FMS \or any other clinical trials for milnacipran or abandon or underfund the development of milnacipran, repeat or conduct additional clinical trials or require a new formulation of milnacipran for clinical testing; or delay the commencement of any additional clinical trials for milnacipran for the treatment of FMS;
• We and Forest Laboratories could disagree as to development plans, including the number and timing of clinical trials or regulatory approval strategy, or as to which additional indications for milnacipran should be pursued, if any, and therefore milnacipran may never be developed for any indications other than FMS;
• Forest Laboratories could independently develop, develop with third parties or acquire products that could compete with milnacipran, including drugs approved for other indications used by physicians off-label for the treatment of FMS;
• Forest Laboratories could fail to devote sufficient resources to the development, approval, commercialization, or marketing and distribution of any products developed under our collaboration agreement, including by failing to develop specialty sales forces if such sales forces are necessary for the most effective distribution of any approved product; and
• Disputes regarding the collaboration agreement that delay or terminate the development, commercialization or receipt of regulatory approvals of milnacipran, may delay or prevent
the achievement of clinical or regulatory objectives that would result in the payment of milestone payments or result in significant litigation or arbitration.
Furthermore, Forest Laboratories may terminate our collaboration agreement upon our material breach or our bankruptcy and may also terminate our agreement upon 120 days’ notice in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of a NDA or to result in labeling or indications that would significantly adversely affect the marketing of any product developed under the agreement. If any of these events occur, we may not be able to find another collaborator for development or commercialization, especially given the existing Phase III clinical trial data as reported from our first Phase III trial, and even if we elected to pursue further development and commercialization of milnacipran, we would experience substantially increased capital requirements that we might not be able to fund.
We rely upon an exclusive license from Pierre Fabre in order to develop and sell our milnacipran product candidate, and our ability to pursue the development and commercialization of milnacipran for the treatment of FMS depends upon the continuation of our license from Pierre Fabre.
Our license agreement with Pierre Fabre provides us with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada, with a right to sublicense certain rights to Forest Laboratories under our collaboration with Forest Laboratories. Either we or Pierre Fabre may terminate the license agreement for cause upon 90 days’ prior written notice to the other party upon the bankruptcy or dissolution of the other party, or upon a breach of any material provision of the agreement if the breach is not cured within 90 days following the written notice. Furthermore, Pierre Fabre has the right to terminate the agreement upon 90 days’ prior notice to us if we and Forest terminate our development and marketing activities with respect to milnacipran, if we challenge certain patent rights of Pierre Fabre and under specified other circumstances. If our license agreement with Pierre Fabre were terminated, we would lose our rights to develop and commercialize products using the compound milnacipran as an active ingredient, as the compound is manufactured under Pierre Fabre patents and using Pierre Fabre know-how and trade secrets, and it would be unlikely that we could obtain the active ingredient in milnacipran from any other source.
We rely upon Pierre Fabre as our exclusive supplier of the compound used as the active ingredient in our milnacipran product candidate and if Pierre Fabre fails to supply us sufficient quantities of the active ingredient it may delay or prevent us from developing and commercializing milnacipran.
Pursuant to our purchase and supply agreement with Pierre Fabre, Pierre Fabre is the exclusive supplier to us and Forest Laboratories of the compound used as the active pharmaceutical ingredient in our milnacipran product candidate. Neither we nor Forest Laboratories have facilities for the manufacture of the product candidate. Currently, Pierre Fabre manufactures the active ingredient of milnacipran in its facility in Gaillac, France and Pierre Fabre is the only worldwide supplier of the active ingredient of milnacipran that is currently approved for sale as an antidepressant outside the United States, but is not approved for sale in the United States. If any product is commercialized under the agreement, Pierre Fabre will have the exclusive right to manufacture the active ingredient used in our commercial product. If milnacipran is commercialized in the United States, Pierre Fabre’s facility will need to be inspected by the FDA for compliance with current good manufacturing practices, or cGMP, requirements. Due to the projected commercial quantities of milnacipran that we may require and to provide a second manufacturing site, Pierre Fabre has agreed that within a certain time period after commercial launch of milnacipran, it will qualify an additional manufacturing facility. We do not have control over Pierre Fabre’s compliance with cGMP requirements or Pierre Fabre’s compliance with its obligation to qualify a second manufacturing facility. If Pierre Fabre fails or is unable to provide, in a timely and economic manner, required quantities of the active ingredient that Forest Laboratories or we request for clinical purposes, our development program
could be delayed. In addition, if Pierre Fabre fails to timely and economically supply us sufficient quantities for commercial sale, if milnacipran is ever commercialized, our product sales and market acceptance of the product could be adversely affected.
Furthermore, our purchase and supply agreement may be terminated for cause either by us or by Pierre Fabre upon 90 days’ prior written notice to the other party upon a material breach of the agreement if the breach is not cured within 90 days following the written notice. We have the right to manufacture milnacipran if Pierre Fabre does not have a required buffer stock or in the event that we terminate our license agreement with Pierre Fabre under certain circumstances. If our purchase and supply agreement with Pierre Fabre is terminated, we are unlikely to be able to qualify another supplier of the active ingredient within a reasonable time period, and our ability to develop and commercialize milnacipran will be significantly impaired.
Our agreements with Pierre Fabre and Forest Laboratories restrict our ability to develop specified compounds, which limits how we can expand our product candidates.
Under our agreements with Pierre Fabre and Forest Laboratories, Forest Laboratories has agreed to pay Pierre Fabre and us a royalty, in the event that Forest Laboratories sells a product other than milnacipran for FMS for a specified period of time, which shall not be less than three years. We are, in turn, obligated to pay a portion of the royalty we receive from Forest Laboratories to Pierre Fabre. In addition, each of us is subject to limitations related to each party’s development of any serotonin norephinephrine reuptake inhibitors, or SNRI, products other than milnacipran. These limitations include: (i) a prohibition on developing an SNRI product for specified indications for which milnacipran is being developed; and (ii) a prohibition on developing an SNRI product for any indication for a specified time period, and after such specified time period, a requirement that if one of the parties launches and sells an SNRI product that is prescribed off-label for any indication for which milnacipran is being developed, the selling party must reimburse the other parties for lost sales due to the off-label use.
There are very limited data supporting the use of mirtazapine for the treatment of OSA and it may not work.
There are very limited data supporting the use of mirtazapine alone, and no data supporting the use of mirtazapine in combination with another compound, for the treatment of OSA. We have made certain assumptions about mirtazapine as a potential treatment for OSA based on our assumptions about OSA and its causes and the pharmacology of mirtazapine and other compounds that we intend to combine with mirtazapine. However, these assumptions may prove to be wrong. Although mirtazapine is currently being sold as an antidepressant, it has only been tested as a treatment for OSA in animals. Results obtained in animals are not highly predictive of results in humans and therefore, mirtazapine may not be effective in treating humans with OSA. Mirtazapine has been tested in 10 human patients in one study and has never been tested for the treatment of OSA in combination with any other drug. The results that were obtained in this very small human study may not be repeated in our study. We must conduct and obtain favorable results in at least two pivotal Phase III trials to support an application for FDA approval of any product candidate we develop using mirtazapine for the treatment of OSA. Our Phase IIa trials for mirtazapine, alone or in combination, may not work to treat OSA. The FDA has approved medical devices for the treatment of OSA but has never approved a drug for the treatment of OSA. Further, the medical device that has been approved is very effective when used and it is possible the FDA will require similar efficacy results for a drug, which would likely be impossible to achieve. In addition, our clinical trials may reveal that mirtazapine, alone or in combination with another compound, is not safe. If mirtazapine is not demonstrated to be a safe and effective treatment for OSA to the satisfaction of the FDA or other regulatory agencies, we will not receive regulatory approval and our business would be materially harmed.
We will rely upon an exclusive license from Organon in order to develop and sell mirtazapine for OSA, and our ability to pursue the development and commercialization of mirtazapine for the treatment of OSA depends upon the continuation of our license from Organon, and potentially two other third parties, depending upon whether or not a combination compound is selected.
Our license agreement with Organon provides us with a license to develop and sell any products with the compound mirtazapine as an active ingredient for OSA. Either we or Organon may terminate the license agreement for cause upon 60 days’ prior written notice to the other party upon the bankruptcy or dissolution of the other party, or upon a breach of any material provision of the agreement if the breach is not cured within 60 days, 45 days with respect to payments, following the written notice. Furthermore, either party has the right to terminate the agreement upon 60 days’ prior notice if we and Organon determine to cease all development under the agreement. If our license agreement with Organon were terminated, we would lose our rights to develop and commercialize mirtazapine for OSA.
We have also entered into two other license agreements that provide us with the flexibility to develop mirtazapine in combination with other compounds. These agreements may also be terminated by either party under similar circumstances to those under our agreement with Organon.
Provisions in our collaboration agreement with Forest Laboratories, our license agreement with Pierre Fabre and our agreement with Organon may prevent or delay a change in control.
Our collaboration agreement with Forest Laboratories provides that Forest Laboratories may elect to terminate our co-promotion rights for milnacipran or any other product developed under the collaboration agreement and we may lose our decision making authority with respect to the development of milnacipran if we engage in a merger, consolidation or sale of all or substantially all of our assets, or if another person or entity acquires at least 50% of our voting capital stock. Our license agreement with Pierre Fabre provides that Pierre Fabre may elect to terminate the agreement upon a change in control transaction in which a third party acquiror of us controls an SNRI product, and the acquiror does not take certain actions (e.g., divestiture of such SNRI product) within a specified time period to cure the breach of certain restrictions in the agreement that results from such SNRI product. Our agreement with Organon provides that Organon may elect to cause Cypress to exercise its option to receive potential royalty and milestone payments instead of participating in the cost and revenue sharing arrangement upon a change in control in the event that an acquiring company has an approved product in the market or in a Phase III or later clinical development that would compete with mirtazapine as a potential treatment for OSA and the acquirer does not agree to divest such product within 12 months following the change in control.
These provisions may have the effect of delaying or preventing a change in control or a sale of all or substantially all of our assets, or may reduce the number of companies interested in acquiring us.
We have limited experience in identifying, completing and integrating acquisitions, including acquisitions of product candidates, and other targets, and we may incur unexpected costs and disruptions to our businesses if we make mistakes in our selection of future acquisitions or fail to integrate any future acquisitions.
As part of our strategy, we are continuing to evaluate potential strategic transactions, including potential acquisitions of products, technologies and companies, in order to expand our product pipeline. As we did with our in-licensing of milnacipran and mirtazapine, we may seek to in-license compounds or we may acquire products or businesses. Future acquisitions and licensing transactions would expose us to operational and financial risks, including:
• higher development costs than we anticipate;
• higher than expected licensing or acquisition and integration costs;
• exposure to liabilities of licensed or acquired intellectual property, compounds or products;
• disruption of our business and diversion of our management’s time and attention to developing licensed or acquired compounds or products;
• incurrence of dilutive issuances of securities or substantial debt to pay for licensing or acquisitions; and
• impairment of relationships with key collaborators, suppliers or customers of any acquired businesses due to changes in management or ownership.
We also may devote resources to potential strategic transactions that require several agreements and that we never complete or may fail to realize the anticipated benefit of any strategic transaction we do complete. Finally, we may incur unexpected costs in connection with the disposition of products or businesses, including our disposition of our PROSORBA column for which we indemnified Fresenius HemoCare for any losses related to patent or trademark infringement claims.
We are at an early stage of development and we do not have and may never develop any commercial drugs or other products that generate revenues.
We are at an early stage of development as a biotechnology company and do not have any commercial products. We have only two product candidates, milnacipran, which we sublicensed to Forest Laboratories in January 2004 and mirtazapine, which we partnered with Organon in June 2005. Milnacipran, our OSA candidate mirtazapine, or any future product candidates we may acquire or develop, will require significant additional development, clinical trials, regulatory approvals and additional investment before they can be commercialized. Our product development and product acquisition efforts may not lead to commercial drugs, either because the product candidates are not shown to be safe and effective in clinical trials, because we have inadequate financial or other resources to pursue clinical development of the product candidate, or because the FDA does not grant regulatory approval. We do not expect milnacipran to be marketed for a number of years, if at all, and mirtazapine as a potential treatment for OSA is at an even earlier stage of development. We may not achieve our internal timelines and the results from our second Phase III trial for milnacipran may not be available in mid 2007 and we may not be in a position to select a development candidate with Organon by mid 2006. If we and Forest Laboratories are unable to develop milnacipran or if we and Organon are unable to develop mirtazapine as a commercial drug in the United States, or if such development is delayed, we will be unable to generate revenues, may be unsuccessful in raising additional capital, and may cease our operations.
The FDA approval of milnacipran, mirtazapine, or any future product candidate is uncertain and will involve the commitment of substantial time and resources.
Even if our Phase III trials for milnacipran, our proof of concept trials for mirtazapine, or any future clinical trials are successful, we may not receive required regulatory approval from the FDA or any other regulatory body required for the commercial sale of milnacipran, mirtazapine, or any future products in the United States. In addition, even if we do obtain approval to market milnacipran or mirtazapine, the approval process by the FDA may take longer than we anticipate. The regulatory approval of a new drug typically takes many years and the outcome is uncertain. Despite the time and resources expended, regulatory approval is never guaranteed. If we fail to obtain regulatory approval for milnacipran, mirtazapine, or any future product candidates, we will be unable to market and sell any products and therefore may never generate any revenues from product sales or become profitable. In addition, our collaborators, or our third
party manufacturers’ failure to comply with the FDA and other applicable United States or foreign regulations may subject us to administrative or judicially imposed sanctions, including warning letters, civil and criminal penalties, injunctions, product seizure or detention, product recalls, total or partial suspension of production and refusal to approve new drug approval applications.
As part of the regulatory approval process, we must conduct, at our own expense, preclinical research and clinical trials for each product candidate sufficient to demonstrate its safety and efficacy to the satisfaction of the FDA and other regulatory agencies in the United States and other countries where the product candidate will be marketed if approved. The number of preclinical studies and clinical trials that will be required varies depending on the product, the disease or condition that the product is in development for and the regulations applicable to any particular product. The regulatory process typically also includes a review of the manufacturing process to ensure compliance with applicable regulations and standards, including the cGMP requirements. The FDA can delay, limit or decline to grant approval for many reasons, including:
• a product candidate may not be safe or effective;
• we may not achieve statistical significance for the primary endpoint;
• FDA officials may interpret data from preclinical testing and clinical trials in different ways than we interpret such data;
• the FDA might not approve our manufacturing processes or facilities, or the processes or facilities of any future collaborators or contract manufacturers, including Pierre Fabre’s facility for the manufacture of the active ingredient in milnacipran; and
• the FDA may change its approval policies or adopt new regulations.
We have agreed to pay certain external expenses associated with our second Phase III clinical trial evaluating milnacipran for FMS, currently being run by Forest Laboratories, and we may never be reimbursed for these amounts.
The amounts we are funding for external expenses for the second Phase III clinical trial evaluating milnacipran, which will now be increased because we have increased the number of patients to be enrolled, are only reimbursed to us by Forest Laboratories under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA. The second Phase III trial may not be utilized as one of the pivotal trials in the NDA submission, and, in such event, we will not be reimbursed by Forest Laboratories for the external expenses that we fund in connection with the second Phase III clinical trial. It is also possible that Forest could alter the development plan for milnacipran or even terminate our collaboration agreement plan, which would prevent us from ever being reimbursed for our funding of the external expenses for the second Phase III trial for milnacipran.
If we receive regulatory approval for milnacipran, mirtazapine or any other future product candidate, we will be subject to ongoing FDA obligations and continuing regulatory review.
Any regulatory approvals that we or our collaborators receive for milnacipran, mirtazapine, or any future product candidates will be limited to the indications, dosages and restrictions on the product label. We currently intend to seek approval for milnacipran in the treatment of FMS and mirtazapine for the treatment of OSA. The FDA may not approve milnacipran or mirtazapine for our preferred indications at all, may approve milnacipran or mirtazapine for a more limited indication, or may impose additional limitations on the indicated uses or contain requirements for post-marketing surveillance or the performance of potentially
costly post-marketing studies. Even if we receive FDA and other regulatory approvals, as we have seen with other products on the market for pain, milnacipran, or mirtazapine or any of our other future product candidates may later exhibit adverse effects that limit or prevent their widespread use or that force us to withdraw those product candidates from the market. In our Phase II trial evaluating milnacipran for the treatment of FMS, the most common dose-related side effects reported by patients were nausea, particularly early in the study, as well as a slight increase in heart rate. In our first Phase III trial the most common adverse events leading to withdrawal among the milnacipran treated patients were nausea 6%, heart rate increase 2%, headache 2%, and depression 2%. Mirtazapine has a side effect profile that includes both sedation and weight gain, both of which could be significant in patients with OSA. Any marketed product and its manufacturer continue to be subject to strict FDA regulation after approval, including regulation of product labeling and packaging, adverse event reporting, manufacture, storage, advertising, promotion and recordkeeping. Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market.
We rely on third parties to conduct all of our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize milnacipran, mirtazapine, or any of our other future product candidates.
As of February 28, 2006, we had only 15 full-time employees. We have in the past and expect to continue to rely on third parties to conduct all of our clinical trials. We and Forest Laboratories used the services of Scirex, a contract research organization, to conduct the first Phase III trial with respect to milnacipran, and have used Scirex to assist in the conduct of the second Phase III trial with respect to milnacipran. We are also using a contract research organization to conduct our Phase IIa trials for mirtazapine, alone and in combination with other compounds. Because we do not conduct our own clinical trials, we must rely on the efforts of others and cannot always control or predict accurately the timing of such trials, the costs associated with such trials or the procedures that are followed for such trials. We do not plan on significantly increasing our personnel in the foreseeable future and therefore, expect to continue to rely on third parties to conduct all of our future clinical trials. If these third parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols or for other reasons, or if they fail to maintain compliance with applicable government regulations and standards, our clinical trials may be extended, delayed or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize milnacipran, mirtazapine, or any of our other future product candidates.
Even if our product candidates are approved, the market may not accept these products.
Even if our product development efforts are successful and even if the requisite regulatory approvals are obtained, milnacipran, mirtazapine, or any future product candidates that we may develop may not gain market acceptance among physicians, patients, healthcare payors and the medical community. The FDA has never approved a drug for the treatment of FMS and has only approved medical devices for the treatment of OSA, and we cannot predict whether milnacipran or mirtazapine, if approved for these indications, will gain market acceptance. A number of additional factors may limit the market acceptance of products including the following:
• timing of market entry relative to competitive products;
• extent of marketing efforts by us and third-party distributors or agents retained by us;
• rate of adoption by healthcare practitioners;
• rate of a product’s acceptance by the target community;
• availability of alternative therapies;
• price of our product relative to alternative therapies;
• availability of third-party reimbursement; and
• the prevalence or severity of side effects or unfavorable publicity concerning our products or similar products.
If milnacipran, mirtazapine, or any future product candidates that we may develop do not achieve market acceptance, we may lose our investment in that product candidate, which may cause our stock price to decline.
Our competitors may develop and market products that are less expensive, more effective or safer, which may diminish or eliminate the commercial success of any products we may commercialize.
The biotechnology market is highly competitive. Large pharmaceutical and biotechnology companies have developed or are attempting to develop products that will compete with any products we may develop to target Functional Somatic Syndromes, such as FMS, or other central nervous system disorders, including OSA. With respect to our FMS program, Pfizer, Inc. has publicly disclosed that it has conducted a Phase II clinical trial evaluating the efficacy and safety of its compound, pregabalin, as a treatment for FMS. In addition, Eli Lilly and Company has publicly disclosed that it has conducted two Phase II clinical trials evaluating the efficacy and safety of its compound, duloxetine, as a treatment for FMS. Both companies have also publicly disclosed they are currently conducting Phase III programs with their compounds in FMS. Duloxetine is a serotonin norepinephrine reuptake inhibitor, and as a dual reuptake inhibitor is therefore similar in pharmacology to milnacipran, which is a norepinephrine serotonin reuptake inhibitor. Based on the similar pharmacology, it is anticipated that duloxetine, which is currently approved for the treatment of depression, is receiving some off-label use for the treatment of FMS. Tricyclic antidepressants, or TCAs, which are inexpensive generic formulations, are currently viewed as the drugs of choice in treating FMS.
It is possible that our competitors will develop and market products for FMS and OSA prior to us, especially in light of our recent milnacipran Phase III clinical trial in FMS that did not achieve statistical significance at the p<0.05 level, and that our competitors will market products that are less expensive and more effective than milnacipran or mirtazapine or any of our future products or that will render any of our products obsolete. With respect to OSA, there is already competition from medical device companies. We also expect that, in the treatment of Functional Somatic Syndromes and other central nervous system disorders, competition from other biopharmaceutical companies, pharmaceutical companies, universities and public and private research institutions will increase. Many of these competitors have substantially greater financial resources, technical expertise, research capabilities and other resources than we do. We may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully.
We have the right to co-promote milnacipran and mirtazapine, but we do not have the marketing, sales or distribution experience or capabilities.
Our ability to co-promote any product developed under our agreements with Forest Laboratories and Organon is subject to our building our own marketing and sales capabilities, and we currently do not have the ability to directly sell, market or distribute any product. In addition, in the event our agreement with Forest Laboratories or our agreement with Organon is terminated or with respect to any other product we may develop that is not covered by our collaborations with Forest Laboratories or Organon, we would have
to obtain the assistance of a pharmaceutical company or other entity with a large distribution system and a large direct sales force or build a substantial marketing and sales force with appropriate technical expertise and supporting distribution capabilities. We may not be able to enter into such arrangements with third parties in a timely manner or on acceptable terms or establish sales, marketing and distribution capabilities of our own. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful.
We are subject to uncertainty relating to health care reform measures and reimbursement policies which, if not favorable to our product candidates, could hinder or prevent our product candidate’s commercialization success.
The continuing efforts of the government, insurance and management care organizations and other health care payors to contain or reduce prescription drug costs may adversely affect:
• our ability to set a price we believe is fair for our products;
• our ability to generate revenues and achieve or maintain profitability;
• the future revenues and profitability of our potential customers, suppliers and collaborators; and
• the availability of capital.
Successful commercialization of milnacipran and mirtazapine in the United States will depend in part on the extent to which government, insurance and management care organizations and other health care payors establish appropriate coverage and reimbursement levels for the cost of our products and related treatments. Third-party payors are increasingly challenging the prices charged for prescription drugs. Third-party payors are also encouraging the use of generic drugs. These trends could influence health care purchases, as well as legislative proposals to reform health care or reduce government insurance programs and result in the exclusion of our product candidates from coverage and reimbursement programs or lower the prices of our product candidates. Our revenues from the sale of any approved products could be significantly reduced as a result of these cost containment measures and reforms.
We rely on our employees and consultants for their scientific and technical expertise in connection with our business operations.
We rely significantly on the scientific and technical expertise of our employees and consultants to conduct our business. As of February 28, 2006, we had only 15 full time employees and therefore, we rely heavily on our employees. In addition, because we have a small number of employees, we rely much more on consultants than do other companies. If any of our relationships with our employees or consultants are terminated, we may lose access to scientific knowledge and expertise necessary for the research, development and commercialization of milnacipran, mirtazapine, or any further products. We do not anticipate significantly increasing our personnel in the foreseeable future and therefore, we expect to continue to rely on consultants and our current employees for scientific and technical knowledge and expertise essential to our business.
Our employment agreement with our chief executive officer provides for “at will” employment, which means that he may terminate his services to us at any time. In addition, our scientific advisors may terminate their services to us at any time.
We may be subject to product liability claims that could cause us to incur liabilities beyond our insurance coverage.
We plan to continue conducting clinical trials on humans using milnacipran and mirtazapine, and the use of milnacipran and mirtazapine may result in adverse effects. Although we are aware that there are side effects associated with both milnacipran and mirtazapine, we cannot predict all possible harm or side effects that may result from the treatment of patients with milnacipran, mirtazapine, or any of our future products, and the amount of insurance coverage we currently hold may not be adequate to protect us from any liabilities. We currently maintain $10,000,000 in insurance for product liability claims. We may not have sufficient resources to pay any liability resulting from such a claim beyond our insurance coverage.
We have a history of operating losses and we may never be profitable.
We have incurred substantial losses during our history. For the years ended December 31, 2005, 2004 and 2003, we incurred net losses of $8.6 million, $11.2 million and $21.7 million, respectively. As of December 31, 2005, we had an accumulated deficit of $146.1 million. Our ability to become profitable will depend upon our and Forest Laboratories’ ability to develop, market and commercialize milnacipran and our and Organon’s ability to develop, market and commercialize mirtazapine with sufficient sales volumes, and our ability to develop, market and commercialize any other products. We do not expect to generate revenue from the sale of products for the next several years or become profitable in the foreseeable future and may never achieve profitability.
We will need substantial additional funding and may be unable to raise capital when needed, which could force us to scale back or discontinue the completion of any proposed acquisitions or adversely affect our ability to realize the expected benefits of any completed acquisitions.
We agreed to pay certain expenses in connection with the second Phase III clinical trial for milnacipran in FMS. In addition, we will incur certain non-reimbursable expenses in connection with the development of milnacipran. We are funding our current Phase IIa clinical trials for mirtazapine, which is being tested alone and in combination with other compounds, and in the event a candidate is selected to be developed for OSA, we will share development costs with Organon. We are also incurring expenses in connection with the evaluation of potential acquisitions or other strategic transactions and will incur additional expenses in the event we close any such transactions. We do not have any committed external sources of funding and we will likely need to raise additional capital through the sale of equity or debt. The amount of capital we will require will depend upon many factors, including but not limited to, our OSA program, the evaluation and potential closing of any strategic transactions and the development strategy for milnacipran. If we are unable to raise capital when we need it, we may have to scale back or discontinue the evaluation or completion of any proposed acquisitions or strategic transaction(s).
Raising additional funds by issuing securities or through collaboration and licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish propriety rights.
We will likely attempt to raise additional funds through public or private equity offerings, including through our shelf registration statement, debt financings or corporate collaborations and licensing arrangements. To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership percentage will be diluted. In addition, if we raise additional funds through collaborations and licensing arrangements, it may be necessary to relinquish potential valuable rights to our potential products on terms that are not favorable to us.
We may lose our net operating loss carryforwards, which could prevent us from offsetting future taxable income.
We have incurred substantial losses during our history and do not expect to become profitable in the foreseeable future and may never achieve profitability. To the extent that we continue to generate taxable losses, unused losses will carry forward to offset future taxable income, if any, until such unused losses expire. All unused federal net operating losses will expire 15 or 20 years after any year in which they were generated. The carryforward period is 15 years for losses incurred prior to 1996 and 20 years for losses incurred subsequent to 1997. Our federal net operating losses will begin to expire in 2008, and our California tax loss carryforwards will begin to expire in 2007.
Our stock price has been very volatile and will likely continue to be volatile.
The market prices of the stock of technology companies, particularly biotechnology companies, have been highly volatile. For the period from January 1, 2003 through December 31, 2005, the high and low closing sales prices for our common stock ranged from $2.20 to $16.05. The negative results of our first Phase III clinical trial for milnacipran had a very material impact on our stock price. Our stock price has been and will likely continue to be affected by market volatility, as well as by our own performance. We do not expect our stock price to increase in the near future, if at all. The following factors, among other risk factors, may have a significant effect on the market price of our common stock:
• the results of our second Phase III clinical trial for milnacipran and any other clinical trials for milnacipran;
• developments in our relationship with Forest Laboratories, including the termination of our agreement;
• developments in our relationship with Pierre Fabre, including the termination of our agreement;
• the results and timing of our and Organon’s Phase IIa trials for mirtazapine;
• developments in our relationship with Organon, including the termination of our agreement;
• our entering into, or failing to enter into, an agreement for the acquisition of any products or companies, or an agreement with any corporate collaborator;
• our available cash;
• announcements of technological innovations or new products by us or our competitors;
• developments in our patent or other proprietary rights;
• fluctuations in our operating results;
• litigation initiated by or against us;
• developments in domestic and international governmental policy or regulation; and
• economic and other external factors or other disaster or crisis.
The concentration of ownership among our existing officers, directors and principal stockholders may result in the entrenchment of management, prevent other stockholders from influencing significant corporate decisions and depress our stock price.
As of January 31, 2006, our executive officers, directors and stockholders who hold at least 5% of our stock beneficially owned and controlled approximately 44% of our outstanding common stock. If these officers, directors and principal stockholders act together, they will be able to help entrench management and to influence significantly and possibly control matters requiring approval by our stockholders, including a financing in which we sell more than 20% of our voting stock at a discount to the market price, the removal of any directors up for election, the election of the members of our board of directors, mergers, a sale of all or substantially all of our assets, going private transactions and other fundamental transactions. This concentration of ownership could also depress our stock price.
We expect to continue incurring significant costs as a result of enacted and proposed changes in laws and regulations relating to corporate governance matters.
Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted by the Securities and Exchange Commission and by the Nasdaq National Market, have and we expect will continue to result in significant costs to us. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant financial resources and management time related to compliance activities. Additionally, these laws and regulations could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
Risks Related to Our Intellectual Property
We rely primarily on method of use patents to protect our proprietary technology for the development of milnacipran and mirtazapine, and our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology.
Our ability to compete may decrease or be eliminated if we are not able to protect our proprietary technology. The composition of matter patent for milnacipran (U.S. Patent 4,478,836) expired in June 2002. Accordingly, we rely on the patent for the method of synthesis of milnacipran (U.S. Patent 5,034,541), which expires on December 27, 2009 and was assigned to Pierre Fabre and licensed to us and on patents on the method of use of milnacipran to treat symptoms of FMS (U.S. Patent 6,602,911 and U.S. Patent 6,992,110) and the method of use of milnacipran to treat symptoms of chronic fatigue syndrome (U.S. Patent 6,635,675) issued to us, to protect our proprietary technology with respect to the development of milnacipran. We have also filed additional patent applications related to milnacipran and to the use of milnacipran for FMS (and other related pain syndromes and disorders), although no patents have issued on these patent applications. Because there is very limited patent protection for the composition of matter of milnacipran, other companies may be able to sell milnacipran in competition with us and Forest Laboratories unless we and Forest Laboratories are able to obtain additional protection through milnacipran-related patents or additional use patents that may issue from our pending patent applications or other regulatory exclusivity. It may be more difficult to establish infringement of methods of synthesis, formulation or use patents as compared to a patent on a compound. If we or Forest Laboratories are not able
to obtain and enforce these patents, a competitor could use milnacipran for a treatment or use not covered by any of our patents.
We also will rely on method of use patents to protect our proprietary technology for the development of mirtazapine for OSA. The composition of matter patent for mirtazapine has expired. United States patent (U.S. Patent 6,303,595) related to the use of mirtazapine in the treatment of OSA expires in 2017. Because mirtazapine is sold as a generic drug, other companies may be able to sell mirtazapine for indications other than OSA in competition with us unless we, Organon and other license partners, depending upon which combination compound is selected, are able to obtain additional patent protection under the various patent applications that have been filed.
We also expect to rely on the United States Drug Price Competition and Patent Term Restoration Act, commonly known as the Hatch-Waxman Amendments, for protection of milnacipran and our other future products. The Hatch-Waxman Amendments provide data exclusivity for new molecular entities, such as that in milnacipran. Once a drug containing a new molecule is approved by the FDA, the FDA cannot accept an abbreviated NDA for a generic drug containing that molecule for five years, although the FDA may accept and approve a drug containing the molecule pursuant to an NDA supported by independent clinical data. Recent amendments have been proposed that would narrow the scope of Hatch-Waxman exclusivity and permit generic drugs to compete with our drug. After the Hatch-Waxman exclusivity period expires, assuming our patents are valid, we still expect to rely on our method of use patents to protect our proprietary technology with respect to the development of milnacipran. The patent positions of pharmaceutical companies are uncertain and may involve complex legal and factual questions. We may incur significant expense in protecting our intellectual property and defending or assessing claims with respect to intellectual property owned by others. Any patent or other infringement litigation by or against us could result in significant expense to us, including diversion of the resources of management.
Others may file patent applications or obtain patents on similar technology or compounds that compete with milnacipran for the treatment of FMS or mirtazapine in the treatment of OSA. We cannot predict the breadth of claims that will be allowed and issued in patent applications. Once patents have issued, we cannot predict how the claims will be construed or enforced. We may infringe on intellectual property rights of others without being aware of the infringement. If another party claims we are infringing their technology, we could have to defend an expensive and time consuming lawsuit, pay a large sum if we are found to be infringing, or be prohibited from selling or licensing our products unless we obtain a license or redesign our product, which may not be possible.
We also rely on trade secrets and proprietary know-how to develop and maintain our competitive position. Some of our current or former employees, consultants or scientific advisors, or current or prospective corporate collaborators, may unintentionally or willfully disclose our confidential information to competitors or use our proprietary technology for their own benefit. Furthermore, enforcing a claim alleging the infringement of our trade secrets would be expensive and difficult to prove, making the outcome uncertain. Our competitors may also independently develop similar knowledge, methods and know-how or gain access to our proprietary information through some other means.
Our ability to compete may decline if we do not adequately protect our proprietary rights.
Our commercial success depends on obtaining and maintaining proprietary rights to our product candidates and technologies and their uses as well as successfully defending these rights against third party challenges. We will only be able to protect our product candidates, proprietary technologies and their uses from unauthorized use by third parties to the extent that valid and enforceable patents or effectively-protected trade secrets cover them.
Our ability to obtain patent protection for our products and technologies is uncertain due to a number of factors, including:
• we may not have been the first to make the inventions covered by our pending patent applications or issued patents;
• we may not have been the first to file patent applications for our product candidates or the technologies we rely upon;
• others may independently develop similar or alternative technologies or duplicate any of our technologies;
• our disclosures in patent applications may not be sufficient to meet the statutory requirements for patentability;
• any or all of our pending patent applications may not result in issued patents;
• we may not seek or obtain patent protection in all countries that will eventually provide a significant business opportunity;
• any patents issued to us or our collaborators may not provide a basis for commercially viable products, may not provide us with any competitive advantages or may be challenged by third parties;
• some of our proprietary technologies may not be patentable;
• others may design around our patent claims to produce competitive products which fall outside of the scope of our patents; or
• others may identify prior art which could invalidate our patents.
Even if we obtain patents covering our product candidates or technologies, we may still be barred from making, using and selling our product candidates or technologies because of the patent rights of others. Others may have filed and in the future are likely to file patent applications covering compounds, assays, genes, gene products or therapeutic products that are similar or identical to ours. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the area of central nervous system disorders and the other fields in which we are developing products. These could materially affect our ability to develop our product candidates or sell our products. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or technologies may infringe. These patent applications may have priority over patent applications filed by us. Disputes may arise regarding the ownership or inventorship of our inventions. It is difficult to determine how such disputes will be resolved. Others may challenge the validity of our patents. If our patents are found to be invalid we will lose the ability to exclude others from making, using or selling the inventions claimed therein.
Some of our research collaborators and scientific advisors have rights to publish data and information to which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, then our ability to receive patent protection or protect our proprietary information will be impaired. In addition, in-licensed technology is important to our business. We generally will not control the patent prosecution, maintenance or enforcement of in-licensed technology.
A dispute concerning the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be time consuming and costly and an unfavorable outcome could harm our business.
There is significant litigation in the industry regarding patent and other intellectual property rights. We may be exposed to future litigation by third parties based on claims that our product candidates, technologies or activities infringe the intellectual property rights of others. If our drug development activities are found to infringe any such patents, we may have to pay significant damages. There are many patents relating to chemical compounds and the uses thereof. If our compounds are found to infringe any such patents, we may have to pay significant damages. A patentee could prevent us from making, using or selling the patented compounds. We may need to resort to litigation to enforce a patent issued to us, protect our trade secrets or determine the scope and validity of third party proprietary rights. From time to time, we may hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities conducted by us. Either we or these individuals may be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. If we become involved in litigation, it could consume a substantial portion of our managerial and financial resources, whether we win or lose. We may not be able to afford the costs of litigation. Any legal action against our company or our collaborators could lead to:
• payment of damages, potentially treble damages, if we are found to have willfully infringed such parties’ patent rights;
• injunctive or other equitable relief that may effectively block our ability to further develop, commercialize and sell products; or
• we or our collaborators having to enter into license arrangements that may not be available on commercially acceptable terms, if at all.
As a result, we could be prevented from commercializing current or future products.
The patent applications of pharmaceutical and biotechnology companies involve highly complex legal and factual questions, which could negatively impact our patent position.
The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. The United States Patent and Trademark Office’s standards are uncertain and could change in the future. Consequently, the issuance and scope of patents cannot be predicted with certainty. Patents, if issued, may be challenged, invalidated or circumvented. United States patents and patent applications may also be subject to interference proceedings and United States patents may be subject to reexamination proceedings in the United States Patent and Trademark Office (and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent office), which proceedings could result in either loss of the patent or denial of the patent application or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Accordingly, rights under any issued patents may not provide us with sufficient protection against competitive products or processes.
In addition, changes in or different interpretations of patent laws in the United States and foreign countries may permit others to use our discoveries or to develop and commercialize our technology and products without providing any compensation to us. The laws of some countries do not protect intellectual property rights to the same extent as United States laws and those countries may lack adequate rules and procedures for defending our intellectual property rights. For example, some countries, including many in
Europe, do not grant patent claims directed to methods of treating humans, and in these countries patent protection may not be available at all to protect our product candidates.
If we fail to obtain and maintain patent protection and trade secret protection of our product candidates, proprietary technologies and their uses, we could lose our competitive advantage and competition we face would increase, reducing our potential revenues and adversely affecting our ability to attain or maintain profitability.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
We currently occupy approximately 5,200 square feet of leased office space in San Diego, California. The San Diego facility houses our executive and administrative offices. The lease for this facility expires in July 2007 and contains monthly rental payments ranging from $13,465 to $15,753 over the lease term.
ITEM 3.
ITEM 3. Legal Proceedings
From time to time, in the normal course of business, we are involved in litigation arising out of our operations. We are not currently engaged in any legal proceedings that we expect would materially harm our business or financial condition.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.
Executive Officers
Our executive officers are as follows:
JAY D. KRANZLER, M.D., Ph.D., was appointed as our Chief Executive Officer and Vice-Chairman in December 1995. In April 1998, Dr. Kranzler was appointed as Chairman of the Board. From January 1989 until August 1995, Dr. Kranzler served as President, Chief Executive Officer and a director of Cytel Corporation, a publicly held biotechnology company. Dr. Kranzler has been an adjunct member of the Research Institute of Scripps Clinic since January 1989. Before joining Cytel, from 1985 to January 1989, Dr. Kranzler was employed by McKinsey & Company, a management-consulting firm, as a consultant specializing in the pharmaceutical industry. Dr. Kranzler has an M.D. with a concentration in psychiatry and a Ph.D. in pharmacology from Yale University. He graduated summa cum laude from Yeshiva University.
SABRINA MARTUCCI JOHNSON was appointed as our interim Chief Financial Officer in February 2002 and in April 2002, she was appointed as our Vice President and Chief Financial Officer. In April 2005, she was promoted to Senior Vice President. Ms. Johnson served as our Vice President of Marketing from March 2001 to April 2002. Ms. Johnson joined us in August of 1998 and held various positions from 1998 through 2000, including Product Director, Executive Director of Marketing and Sales, and Vice President of Marketing and Sales. From 1993 to 1998, Ms. Johnson held marketing and sales positions with Advanced Tissue Sciences and Clonetics. Ms. Johnson began her career in the biotechnology industry in 1990 as a research scientist with Baxter Healthcare, Hyland Division. Ms. Johnson has an MBA from the American Graduate School of International Management (Thunderbird), a MSc. in Biochemical Engineering from the University of London and a BSc. in biomedical engineering from Tulane University.
R. MICHAEL GENDREAU, M.D., Ph.D., was appointed as our Vice President of Research and Development and Chief Medical Officer in December 1996 and is currently serving as the Vice President of Clinical Development and Chief Medical Officer. Dr. Gendreau joined us in 1994 and held various positions from 1994 through 1996, including Executive Director of Scientific Affairs. From 1991 to 1994, Dr. Gendreau was Vice President of Research and Development and Chief Medical Officer for MicroProbe Corporation, a developer and manufacturer of DNA probe-based diagnostic equipment. Dr. Gendreau has a B.S. in chemistry from Ohio University and an M.D./Ph.D. in medicine and pharmacology from the Ohio State University.
DENISE L. WHEELER was appointed as our Vice President of Business and Legal Affairs and Corporate Secretary in February 2004. Prior to joining us, from September 1997 until January 2004, Ms. Wheeler worked as a corporate attorney at the law firm of Cooley Godward LLP. Ms. Wheeler has a B.A. from Old Dominion University and a J.D. from the University of San Diego, School of Law.
PART II
ITEM 5.
ITEM 5. Market for our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq National Market under the symbol “CYPB”. Prior to March 1, 2004, our stock was traded on the Nasdaq SmallCap Market. Set forth below are the high and low closing sales prices for our common stock for the periods indicated as reported on the Nasdaq National Market and the Nasdaq SmallCap Market, as applicable.
As of March 1, 2006, there were approximately 725 holders of record of our common stock. On March 1, 2006, the last reported sale price of our common stock on the Nasdaq National Market was $6.02 per share. We have never paid any cash dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future as we intend to retain any earnings for use in our business.
Equity Compensation Plan Information
The following table summarizes the securities authorized for issuance under our equity compensation plans as of December 31, 2005:
(a) Includes our 1996 Equity Incentive Plan and our 2000 Equity Incentive Plan.
(b) In February 2001, the shareholders of the Company approved a provision to amend the 2000 Equity Incentive Plan, whereby the total number of shares reserved for issuance under the 2000 Equity Incentive Plan and the 1996 Equity Incentive Plan, in the aggregate, may be increased quarterly such that the number equals 21.1% of the number of shares of the Company’s common stock issued and outstanding as of the end of that day.
ITEM 6.
ITEM 6. Selected Financial Data
The following table presents our selected financial data, which is derived from our audited financial statements. The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes and other central nervous system disorders. Specifically, our strategy involves acquiring or in-licensing central nervous system, or CNS, active compounds and developing them for novel and typically underserved indications. The term Functional Somatic Syndromes refers to several related syndromes characterized more by symptoms, suffering and disability than by disease-specific abnormalities that are found upon physical examination and include many overlapping pain and psychiatric conditions. We pursue opportunities to acquire or in-license CNS active compounds in the areas in which the brain and body overlap, where CNS mechanisms have a strong influence on somatic or bodily symptoms, and our two ongoing development programs are representative of this strategy.
Our goal is to be the first to commercialize a product approved in the United States for the treatment of Fibromyalgia Syndrome, or FMS, the focus of our initial efforts in the area of Functional Somatic Syndromes. In January 2004, we entered into a collaboration agreement with Forest Laboratories, Inc., a leading marketer of CNS drugs with a strong franchise in the primary care and psychiatric markets, for the development and marketing of milnacipran. In July 2005, we completed the first Phase III trial for milnacipran, which was commenced in October 2003. We announced the top-line results from this first Phase III trial in September 2005. Although the results did not achieve statistical significance at the p<0.05 level, we believe the preliminary results support continuation of the development program and the planned development program for milnacipran is continuing. This development program includes an ongoing second Phase III study and an additional third Phase III study that was initiated in the first quarter of 2006.
We obtained an exclusive license for milnacipran from Pierre Fabre Medicament in 2001. Milnacipran has been marketed outside of the United States since 1997 as an antidepressant and has been used by over 3,000,000 patients worldwide. We have paid Pierre Fabre a total of $2.5 million, including upfront payments of $1.5 million in connection with the execution of the original license agreement in 2001 and a $1.0 million milestone payment in September 2003, and issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock in connection with an amendment to the agreement with Pierre Fabre. We are obligated to pay Pierre Fabre 5% of any upfront and milestone payments received from Forest Laboratories as a sublicense fee. A $1.25 million such payment has been made to date. After a total of $7.5 million has been paid, any additional sublicense fees are credited against any subsequent milestone and royalty payments owed by us to Pierre Fabre. If not used, these credits are carried forward to subsequent years. Additional payments to Pierre Fabre of up to a total of $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones. Under our agreement with Forest Laboratories, we sublicensed our rights to milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. Additionally, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approval, as well as a specified number of our employees. However, in light of the increased expense and risk associated with running two parallel trials, we have agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only. In connection with this arrangement, the amount of funding that we receive from Forest Laboratories for certain of our employees has been eliminated as of the fourth quarter in 2004 for the second Phase III trial only, and we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under
specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA. Forest Laboratories is funding the third Phase III clinical trial, including a specified number of our employees that are assisting with the conduct of that clinical trial. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, while we have the option to co-promote using our own sales force up to 25% of the total physician details and would be reimbursed by Forest in an amount equal to Forest’s cost of providing the equivalent detailing calls.
In June 2005, we announced the initiation of our second development program, wherein we are evaluating potential pharmaceutical treatments for Obstructive Sleep Apnea, or OSA. We entered into three licensing agreements to support and facilitate the program. Specifically, we licensed mirtazapine-related patents from Organon (Ireland) Ltd., and patents from two other parties that provide the opportunity to combine mirtazapine with a second approved agent with the goal of potentially augmenting efficacy and improving tolerability. The series of licenses will allow Cypress to evaluate a number of potential OSA treatment modalities in proof of concept trials.
Upon execution of the license agreement with Organon, we issued to Organon as a license fee a warrant to purchase 62,656 shares of our common stock at an exercise price of $15.96. Under the agreement with Organon, Cypress and Organon will jointly fund development activities in the event a candidate from the proof of concept trials has been selected for continued development. If we are able to select a development candidate, the following is the structure of our agreement with Organon. We will have operational control of the development activities and, depending on the candidate selected, will fund 40% or 50% of the development-related expenses. If the FDA approves this product, Organon will have operational control of sales and marketing activities, with Cypress having the opportunity to co-promote up to 25% of the physician promotion and details using its own sales force in the United States, Mexico and Canada. Expenses and revenue in the United States, Mexico and Canada are to be shared between Cypress and Organon based on the level of promotional effort each party contributes, with Cypress having the ability to share up to 40% or 50% depending on the candidate selected. Organon will be solely responsible for commercialization in the rest of the world and will pay Cypress a royalty on net sales.
Assuming the decision is made by Cypress and Organon to proceed with the commencement of the first Phase III clinical trial, at any time thereafter, either Cypress or Organon may elect to change the structure of the financial agreement to provide that the party that makes such election will no longer share in expenses and revenue, and instead will have the potential right to receive potential milestone and royalty payments in the event a product is commercialized.
In connection with our related licensing transactions with two other parties, Cypress paid the parties aggregate license payments totaling $2.5 million, with the potential for additional milestone payments of up to $25.3 million related to our OSA program, as development progresses. The parties will also participate in royalties from any marketed products that may be developed under the respective agreements.
Cypress and Organon have each independently initiated Phase IIa trials that will serve as the basis for selecting the product candidate, if any, for further clinical development. The companies expect the Phase IIa trials and subsequent joint development and planning meetings to run through at least the first half of 2006, which is also the earliest a development candidate to be evaluated in further trials could be selected.
We are continuing to evaluate other various potential strategic transactions, including the potential acquisitions of products, technologies and companies, and other alternatives.
As of December 31, 2005, we had working capital of approximately $105.5 million and an accumulated deficit of approximately $146.1 million. Our future success depends on our ability to develop and market new products for the treatment of Functional Somatic Syndromes, such as FMS, and other central nervous system disorders.
Results of Operations
Comparison of Years Ended December 31, 2005 and 2004
Revenues
We recognized revenues under our collaborative agreement of $8.4 million for the year ended December 31, 2005 compared to $14.4 million for the year ended December 31, 2004. The decrease in revenues under our collaborative agreement is due to a decrease in sponsored development reimbursements during 2005 for costs incurred in connection with the first Phase III trial, which was completed during the second half of 2005, and the elimination of funding from Forest Laboratories for certain of our employees devoted to the development of milnacipran as of the fourth quarter in 2004. This decrease in revenues under our collaborative agreement was partially offset by an increase in sponsored development reimbursements during 2005 for costs incurred in connection with the extension trial to our first Phase III trial, which commenced during the third quarter of 2004 and had a full year of activity during 2005. The revenues recorded during 2005 and 2004 consist solely of amounts earned pursuant to our collaboration agreement with Forest Laboratories for the development and marketing of milnacipran, entered into in January 2004. Such revenues include the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, sponsored development reimbursements and funding received from Forest Laboratories during 2004 for certain of our employees devoted to the development of milnacipran.
We currently are not generating any revenues from product sales and we do not expect to generate revenues from product sales for at least the next several years, if at all. Unless and until we generate revenues from product sales, we expect our revenues to consist of the continued recognition on a straight-line basis of the upfront payment of $25.0 million and sponsored development reimbursements. We may also recognize future milestone payments under our agreement with Forest Laboratories, which are contingent upon the achievement of agreed upon objectives and which are not guaranteed payments. In connection with our arrangement with Forest Laboratories regarding cost sharing arrangements for the second Phase III trial only, the amount of funding that we receive from Forest Laboratories for certain of our employees was eliminated as of the fourth quarter in 2004. Additionally, the amount of sponsored development reimbursements from Forest Laboratories may change periodically based on the level of development activity. Our collaboration agreement is subject to early termination by Forest Laboratories upon specified events, including breach of the agreement.
Research and Development
Research and development expenses for the year ended December 31, 2005 were $15.5 million compared to $15.2 million for the year ended December 31, 2004. The increase in research and development expenses is primarily attributable to costs incurred during 2005 in connection with the extension trial to our first Phase III trial, which commenced during the third quarter of 2004 and had a full year of activity during 2005, and our second Phase III trial for milnacipran, which commenced during the fourth quarter of 2004 and had a full year of activity during 2005, payment of license fees of $2.5 million and a non-cash charge of $0.6 million incurred due to the issuance of a warrant to Organon in connection with the licensing agreement related to our OSA program and costs incurred in connection with various proof of concept studies for our sleep apnea program. This increase in research and development
expenses during 2005 was partially offset by several non-recurring expenses incurred in 2004, including a $1.25 million sublicense fee paid to Pierre Fabre recorded during the first quarter of 2004 in connection with our collaboration agreement with Forest Laboratories and a payment for the exercise of our option in January 2004 to acquire an exclusive license to technology developed under our reformulation and new product agreement with Collegium, and a decrease during 2005 in costs incurred in connection with the first Phase III trial, which was completed during the second half of 2005. During 2005, we incurred total costs of $8.3 million in connection with our Phase III programs compared to a total of $12.9 million (including the $1.25 million sublicense fee to Pierre Fabre) during 2004. The costs for the first Phase III clinical trial and extension trial are being reimbursed by Forest Laboratories as noted below.
Effective January 9, 2004, pursuant to our collaboration agreement with Forest Laboratories, Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals. This funding received from Forest Laboratories for sponsored development reimbursements is included as a component of our revenue under collaborative agreement on the statement of operations. We agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only. In connection with this arrangement, we will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing us under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the NDA submission to the FDA.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $320,000 and $449,000 related to research and development expenses for the years ended December 31, 2005 and 2004, respectively, and as discussed below in “Compensation Benefit-Variable Stock Options,” we recognized a compensation benefit for variable stock options of $0 and $180,000 related to research and development expenses for the years ended December 31, 2005 and 2004, respectively.
General and Administrative
General and administrative expenses for the year ended December 31, 2005 were $4.8 million compared to $5.7 million for the year ended December 31, 2004. The decrease in general and administrative expenses is primarily due to non-recurring costs incurred during 2004, consisting of a success-based fee paid to our investment bankers in connection with the closing of our collaboration agreement with Forest Laboratories in January 2004 and a one-time fee associated with our being listed during the first quarter of 2004 on the Nasdaq National Market, and lower consulting fees and travel expenses during 2005 in connection with business development activities. This decrease in general and administrative expenses during 2005 was partially offset by a success-based fee paid to advisors during the second quarter of 2005 in connection with the closing of our licensing agreement with Organon.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $678,000 and $6.0 million related to general and administrative expenses for the years ended December 31, 2005 and 2004, respectively, and as discussed below in “Compensation Benefit-Variable Stock Options,” we recognized a compensation benefit for variable stock options of $1.7 million and $519,000 related to general and administrative expenses for the years ended December 31, 2005 and 2004, respectively.
Non-Cash Compensation Charges
Non-cash compensation charges for the year ended December 31, 2005 were $998,000, consisting of approximately $320,000 related to research and development expenses and $678,000 related
to general and administrative expenses, compared to $6.5 million, consisting of approximately $449,000 related to research and development expenses and $6.0 million related to general and administrative expenses, for the year ended December 31, 2004. The decrease in non-cash compensation charges is primarily due to non-recurring, non-cash compensation charges recorded during the first quarter of 2004, consisting of $2.4 million related to stock options previously granted to consultants and two former board members for services that vested upon the completion of the collaboration agreement with Forest Laboratories and $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members to roles as consultants during the first quarter of 2004, as well as a decrease in the Black-Scholes valuation for stock options granted to consultants due to the overall decrease in our stock price experienced during 2005.
Compensation Benefit - Variable Stock Options
In June 2001, we implemented an option cancel and re-grant program, which resulted in variable accounting for the newly issued options under Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”), Accounting for Certain Transaction Involving Stock Compensation - An Interpretation of APB 25. During the year ended December 31, 2005, as the intrinsic value of the common stock underlying the options declined due to a decrease in our stock price during the period, we recognized a compensation benefit of $1.7 million, consisting of $0 related to research and development expenses and $1.7 million related to general and administrative expenses. Similarly, due to a decrease in our stock price during the year ended December 31, 2004, we recognized a compensation benefit of $699,000, consisting of $180,000 related to research and development expenses and $519,000 related to general and administrative expenses. In the event our stock price is above $5.78 (closing price on December 31, 2005) on March 31, 2006, we will record additional compensation charges (however, we cannot predict what our stock price will be in the future and it may be substantially lower than $5.78).
Interest Income
Interest income for the year ended December 31, 2005 was $2.5 million compared to $1.1 million for the year ended December 31, 2004. The increase in interest income for the year ended December 31, 2005 compared to the corresponding period in 2004 is due to higher cash and investment balances during 2005 and a general increase in interest rates and related yields experienced during 2005.
Comparison of Years Ended December 31, 2004 and 2003
Revenues
We recognized revenues under our collaborative agreement of $14.4 million for the year ended December 31, 2004 compared to no revenue for the year ended December 31, 2003. The revenues recorded during 2004 consist solely of amounts earned pursuant to our collaboration agreement with Forest Laboratories for the development and marketing of milnacipran, entered into in January 2004. Such revenues include the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, funding received from Forest Laboratories for certain of our employees devoted to the development of milnacipran and sponsored development reimbursements.
Research and Development
Research and development expenses for the year ended December 31, 2004 were $15.2 million compared to $11.4 million for the year ended December 31, 2003. The increase in research and development expenses is primarily attributable to increased costs in connection with our first Phase III clinical trial for milnacipran due to a full year of activity during 2004 and costs incurred during 2004 in
connection with the extension trial and our second Phase III trial for milnacipran. During 2004, we incurred total costs of $12.9 million in connection with our Phase III programs compared to a total of $3.3 million during 2003. Research and development expenses during 2003 included a non-cash charge in the amount of $5.0 million recognized during the second quarter of 2003 in connection with the issuance of 1,000,000 shares of our common stock and warrants to purchase 300,000 shares of our common stock to Pierre Fabre under the Restated Pierre Fabre Agreement and costs incurred during the first quarter of 2003 related to the Phase II clinical trial for milnacipran, which was in its final completion stage during the first quarter of 2003. The costs for the first Phase III clinical trial and extension trial incurred during 2004 are being reimbursed by Forest Laboratories.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $449,000 and $201,000 related to research and development expenses for the years ended December 31, 2004 and 2003, respectively, and as discussed below in “Compensation Expense (Benefit)-Variable Stock Options,” we recognized a compensation (benefit) for variable stock options of $(180,000) and compensation expense for variable stock options of $646,000 related to research and development expenses for the years ended December 31, 2004 and 2003, respectively.
General and Administrative
General and administrative expenses for the year ended December 31, 2004 were $5.7 million compared to $4.1 million for the year ended December 31, 2003. The increase in general and administrative expenses is primarily due to a success-based fee paid to our investment bankers in connection with the closing of our collaboration agreement with Forest Laboratories, a one-time fee associated with our being listed during the first quarter of 2004 on the Nasdaq National Market, increased wages and benefits expense associated with an increase in headcount, increased consulting fees and travel expenses in connection with business development activities surrounding potential strategic transactions and increased business insurance costs.
In addition, as discussed below in “Non-Cash Compensation Charges,” we recognized non-cash compensation expense of $6.0 million and $216,000 related to general and administrative expenses for the years ended December 31, 2004 and 2003, respectively, and as discussed below in “Compensation Expense (Benefit)-Variable Stock Options,” we recognized a compensation (benefit) for variable stock options of $(519,000) and compensation expense for variable stock options of $5.2 million related to general and administrative expenses for the years ended December 31, 2004 and 2003, respectively.
Non-Cash Compensation Charges
Non-cash compensation charges for the year ended December 31, 2004 were $6.5 million, consisting of approximately $449,000 related to research and development expenses and $6.0 million related to general and administrative expenses, compared to $417,000, consisting of approximately $201,000 related to research and development expenses and $216,000 related to general and administrative expenses, for the year ended December 31, 2003. The increase in non-cash compensation charges is primarily due to: (i) non-recurring, non-cash compensation charges recognized during the first quarter of 2004, consisting of $2.4 million related to stock options previously granted to consultants and two former board members for services that vested upon the execution of the collaboration agreement with Forest Laboratories and $2.8 million related to the accounting treatment for stock options in connection with the resignation of certain board members to roles as consultants during the first quarter of 2004; (ii) a non-recurring, non-cash compensation charge in the amount of $385,000 recognized during the second quarter of 2004 related to the issuance of warrants to purchase 50,000 shares of our common stock to an outside consultant as compensation for services provided; and (iii) an increase in the Black-Scholes
valuation for stock options previously granted to consultants due to the overall average increase in our stock price. These options are being expensed over their related vesting period.
Compensation Expense (Benefit) - Variable Stock Options
In connection with the option cancel and re-grant program implemented in 2001, which resulted in variable accounting for the newly issued options under FIN 44, we recognized a compensation (benefit) of $(699,000), consisting of $(180,000) related to research and development expenses and $(519,000) related to general and administrative expenses, during the year ended December 31, 2004 as the intrinsic value of the common stock underlying the options declined due to a decrease in our stock price during the period. In contrast, due to an increase in our stock price during the year ended December 31, 2003, we recognized compensation expense of $5.9 million, consisting of $646,000 related to research and development expenses and $5.2 million related to general and administrative expenses.
Interest Income
Interest income for the year ended December 31, 2004 was $1.1 million compared to $122,000 for the year ended December 31, 2003. The increase in interest income for the year ended December 31, 2004 compared to the corresponding period in 2003 is due to higher cash and investment balances during 2004 achieved primarily through the upfront payment received from Forest Laboratories in January 2004 and the proceeds from our secondary offering completed in April 2004, and a general increase in interest rates and related yields experienced during 2004.
Liquidity and Capital Resources
At December 31, 2005, we had cash, cash equivalents and short-term investments of $109.6 million compared to cash, cash equivalents and short-term investments of $112.0 million at December 31, 2004. Working capital at December 31, 2005 totaled $105.5 million compared to $112.8 million at December 31, 2004. We have invested a substantial portion of our available cash in high quality marketable debt instruments of governmental agencies and certificates of deposit, which are within federally insured limits. We have established guidelines relating to our investments to preserve principal and maintain liquidity.
Net cash used in operating activities totaled $6.9 million for the year ended December 31, 2005 compared to net cash provided by operating activities of $11.1 million for the year ended December 31, 2004. The primary use of cash during 2005 were actual expenditures to fund our operating activities during the period, offset by net collections of amounts due from Forest Laboratories. The primary source of cash from operations during 2004 was the upfront payment of $25.0 million received from Forest Laboratories, offset by cash used in operations of approximately $13.9 million.
Net cash provided by investing activities was $18,000 for the year ended December 31, 2005 compared to net cash used in investing activities of $81.0 million for the year ended December 31, 2004. The much smaller amount in net cash from investing activities during 2005 compared to 2004 was primarily a result of the purchase of short-term securities during 2004 with the proceeds from the secondary offering of our common stock completed during April 2004.
Net cash provided by financing activities was $3.8 million for the year ended December 31, 2005 compared to $77.4 million for the year ended December 31, 2004. The decrease in net cash provided by financing activities during 2005 compared 2004 was primarily the result of proceeds of approximately $3.8 million from the exercise of stock options and warrants during 2005 compared to proceeds of approximately
$74.2 million from the completion of our public offering of common stock during April 2004 and proceeds of approximately $3.0 million from the exercise of stock options and warrants during 2004.
The following table summarizes our long-term contractual obligations at December 31, 2005:
(1) Purchase obligations include agreements to purchase goods or services, including consulting services, that are enforceable and legally binding on us and that specify all significant terms. This includes contracts that are cancelable with notice and the payment of an early termination penalty. Purchase obligations exclude agreements that are cancelable without penalty and also exclude liabilities to the extent presented on the balance sheet as of December 31, 2005.
Other commercial commitments include certain potential milestone, sublicense and royalty payments to Pierre Fabre and other parties from whom we licensed patents in connection with our OSA program as discussed in the “Overview” section and milestone payments of up to $5.4 million to Collegium Pharmaceutical, Inc. in connection with the reformulation and new product agreement entered into with Collegium. Contractual obligations for which we will be reimbursed by Forest Laboratories are not included in the table above. The above also does not include the external costs of the second Phase III trial for FMS that we have agreed to fund.
Unless and until we can consistently generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources that were primarily generated from the proceeds of offerings of our equity securities and from revenue under our collaboration agreement with Forest and if available to us, cash from financings. We currently have a shelf registration statement on file that would allow us to issue up to $100 million in shares but we do not have any current intentions to engage in a financing and no current intended purchasers. Additionally, in connection with the sale of most of our assets related to the PROSORBA column to Fresenius Hemocare in January 2001, a contingent payment is due to us on January 30, 2008 in the amount of $1 million if sales during the first seven years exceed 35,000 units, $2 million if they exceed 50,000 units and none if the sales are less than 35,000 units.
Our current expected primary cash needs on both a short term and long-term basis are for the development of current products, working capital and other general corporate purposes and the identification, acquisition or license, and development of potential future products. In addition to the amounts required to pay any amounts payable under our agreements with Pierre Fabre and Collegium, the costs of in-licensing or acquiring additional compounds or companies and funding clinical development for any product (other than our FMS or OSA product) that we may in-license or acquire, we estimate that based on our current business plan, which now includes the development of a candidate for OSA, we will require approximately $16 million to fund our operations for the year 2006. One of our ongoing goals is to identify and in-license new products. In the event we acquire, license or develop any new products, the amount to fund our operations for 2006 would increase, possibly materially. Our net losses will continue for at least the next several years as we seek to acquire, license or develop additional products for the treatment of
Functional Somatic Syndromes and other central nervous system disorders. Such losses may fluctuate, and the fluctuations may be substantial.
Based on our current business plan, we believe our cash and cash equivalents and short-term investments balances at December 31, 2005 are sufficient to fund operations for at least the next year. However, we are actively continuing to evaluate various potential strategic transactions, including the potential acquisitions of products and companies, and other alternatives. In order to acquire or develop additional products, we will require additional capital. The amount of capital we require is dependent upon many forward-looking factors that could significantly increase our capital requirements, including the following:
• the extent to which we acquire or invest in other products and businesses;
• the costs of in-licensing drug candidates;
• the ability of Forest Laboratories and us to reach milestones, and other events or developments under our collaboration agreement;
• the ability of Organon and our other OSA related collaborators to reach milestones, and other events or developments under our collaboration agreements;
• the costs and timing of development and regulatory approvals for milnacipran and our OSA product candidate; and
• the costs of commercialization of any future products.
Because we are unable to predict the outcome of the foregoing factors, some of which are beyond our control, we are unable to estimate with certainty our mid to long-term capital needs. Unless and until we can generate a sufficient amount of product revenue, if ever, we expect to finance future capital needs through public or private debt or equity offerings or collaboration and licensing arrangements, as well as interest income earned on cash balances. We do not currently have any commitments or specific plans for future external funding. We may not be able to raise additional capital and the funds we raise, if any, may not allow us to maintain our current and planned operations. If we are unable to obtain additional capital, we may be required to delay, scale back or eliminate some or all of our development of existing or future product candidates.
To date, we have not had any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, research and development expenses and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following are the
critical accounting policies that affect the significant judgments and estimates used in the preparation of our financial statements (see also the notes to our financial statements).
Revenue Recognition
In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (as amended by SAB 104), revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Amounts received for upfront license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Accordingly, the upfront payment of $25.0 million from Forest Laboratories is being recognized over a period of 8 years, which represents the estimated period of significant on-going services and performance, including the development period, under our agreement with Forest Laboratories. Amounts received for sponsored development activities, including funding received for certain of our employees, are recognized as research costs are incurred over the period specified in the related agreement or as the services are performed. Amounts received for milestones are recognized upon achievement of the milestone, which requires substantive effort and was not readily assured at the inception of the agreement. Any amounts received prior to satisfying revenue recognition criteria will be recorded as deferred revenue.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related personnel expenses for our research and development personnel, fees paid to external service providers to conduct clinical trials, patient enrollment costs, fees and milestone payments under our license and development agreements and costs for facilities, supplies, materials and equipment. All such costs are charged to research and development expenses as incurred. Clinical trial costs are a significant component of research and development expenses and include costs associated with third-party contractors. We accrue clinical trial expenses based on work performed, which relies on estimates of total costs incurred based on completion of patient studies and other events. Actual clinical trial costs may differ from estimated clinical trial costs and are adjusted for in the period in which they become known. Historically, adjustments have not resulted in material changes to research and development expenses; however, a modification in the protocol of a clinical trial or cancellation of a trial could result in a charge to our results of operations.
Stock Based Compensation
We grant stock options for a fixed number of shares to employees in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, as amended by SFAS No. 123, Accounting for Stock Based Compensation. Accordingly, we ordinarily recognize no compensation expense for stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of grant. The value of options or stock awards issued to non-employees has been determined in accordance with SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring or in Conjunction with selling Goods and Services, and is periodically re-measured as the options vest. For the years ended December 31, 2005 and 2004, we recorded compensation expense of $864,000 and $3.1 million (including $2.4 million related to stock options that vested upon the execution of the collaboration agreement with Forest Laboratories), respectively, related to options issued to consultants. Additionally, during the year ended December 31, 2004, we recorded compensation expense of $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members during the first quarter of 2004 and compensation expense of $385,000 in connection with the
issuance of warrants to purchase 50,000 shares of our common stock to an outside consultant as compensation for services provided.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which is a revision of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). SFAS 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends Statement of Financial Accounting Standards No. 95, Statement of Cash Flows (SFAS 95). Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123R must be adopted no later than January 1, 2006. Early adoption will be permitted in periods in which financial statements have not yet been issued. The Company will adopt SFAS 123R on January 1, 2006.
As permitted by SFAS 123, we currently account for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. Determining the exact impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the assumptions for the variables which affect the computation. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in Note 1 to our financial statements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosure about Market Risk
We have invested our excess cash in United States government securities, certificates of deposit and money market funds with strong credit ratings. As a result, our interest income is most sensitive to changes in the general level of United States interest rates. We do not use derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, we believe that, while the investment-grade securities we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. A hypothetical 1% adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our financial instruments that are exposed to changes in interest rates.
ITEM 8.
ITEM 8. Financial Statements
Refer to the Index on Page of the Financial Report included herein.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A. Controls and Procedures
Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
There has been no change in our internal controls over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.
Our management’s assessment of and on the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders
Cypress Bioscience, Inc.
We have audited management’s assessment, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting” that Cypress Bioscience, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Cypress Bioscience, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Cypress Bioscience, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Cypress Bioscience, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets of Cypress Bioscience, Inc. as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005 of Cypress Bioscience, Inc. and our report dated March 3, 2006 expressed an unqualified opinion thereon.
Item 9B.
Item 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers
Information required by this item will be contained in our Definitive Proxy Statement for our 2006 Annual Meeting of Stockholders (except that information pertaining to executive officers of the Registrant is contained in Part I of this report). Such information is incorporated herein by reference.
We have adopted a Code of Business Conduct and Ethics, which covers all employees, including our principal executive, financial and accounting officers. A copy of our Code of Business Conduct and Ethics is posted on our website, www.cypressbio.com. We also will post on our website any waiver or amendment (other than technical, administrative and other non-substantive amendments) to our Code of Business Conduct and Ethics that is granted to or affects the duties of any of our directors or our principal executive, financial and accounting officers. Such posting will be made within five business days after the date of the waiver or amendment and will remain on the website for at least twelve months.
ITEM 11.
ITEM 11. Executive Compensation
Information required by this item will be contained in our Definitive Proxy Statement for our 2006 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item will be contained in our Definitive Proxy Statement for our 2006 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions
Information required by this item will be contained in our Definitive Proxy Statement for our 2006 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 14.
ITEM 14. Accounting Fees and Services
Information required by this item will be contained in our Definitive Proxy Statement for our 2006 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules
(a) Financial Statements
Our financial statements are included herein as required under Item 8 of this Annual Report on Form 10-K. See Index on page.
Financial statement schedules have been omitted since they are either not required, not applicable or the information is otherwise included.
(b) Exhibits
Exhibit
No.
Description
Incorporated by Reference to
3.1
Second Amended and Restated Certificate of Incorporation
Appendix C to Definitive Proxy Statement filed with the Securities and Exchange Commission on August 11, 2003
3.2
Second Amended and Restated By-Laws
Appendix D to Definitive Proxy Statement filed with the Securities and Exchange Commission on August 11, 2003
4.1
Form of Stock Certificate
Exhibit 4.1 to Form S-1 Registration Statement No. 33-41225
10.1
1996 Equity Incentive Plan (the “1996 Plan”)()
Exhibit 99.2 to Form 10-Q for the quarter ended March 31, 1996 (File No. 0-12943)
10.2
Form of Incentive Stock Option Agreement under the 1996 Plan()
Exhibit 99.3 to Form 10-Q for the quarter ended March 31, 1996 (File No. 0-12943)
10.3
Form of Non-Statutory Stock Option Agreement under 1996 Equity Incentive Plan()
Exhibit 99.4 to Form 10-Q for the quarter ended March 31, 1996 (File No. 0-12943)
10.4
Incentive Stock Option and Appreciation Plan, as amended June 29, 1992()
Exhibit 99.4 to Form S-8 Registration Statement No. 333-06771
10.5
Form of Stock Option Agreement for issuances of all non-plan options()
Exhibit 99.8 to Form S-8 Registration Statement No. 333-06771
10.7
Sublease dated February 1, 1999 between the Registrant and Cardia Pacemakers, Inc. and related lease dated August 1991 between Michael R. Mastro and Redmond East Associates and Incontrol, Inc. and Amendments One through Ten
Exhibit 10.41 to Form 10-K for the year ended December 31, 1998
10.8
Amended and Restated License and Distribution Agreement dated January 19, 2001 among the Registrant, Fresenius HemoCare, Inc. and Fresenius HemoCare GmbH(*)
Exhibit 2.2 to Form 8-K filed on January 23,
10.9
2000 Equity Incentive Plan()
Exhibit 10.25 to Form 10-K for the year ended December 31, 2000
10.10
Form of Stock Option Agreement for use with the 2000 Equity Incentive Plan()
Exhibit 10.26 to Form 10-K for the year ended December 31, 2000
10.11
Letter Amendment dated February 1, 2002 to the Amended and Restated License Agreement dated January 19, 2001 among the Registrant, Fresenius HemoCare, Inc. and Fresenius HemoCare GmbH
Exhibit 10.24 to Form 10-K for the year ended December 31, 2001
10.12
Reformulation and New Product Agreement dated August 22, 2002 between the Registrant and Collegium Pharmaceuticals, Inc.(*)
Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 2002
10.13
Common Stock Issuance Agreement dated October 31, 2002 between the Registrant and Collegium Pharmaceuticals, Inc.(*)
Exhibit 10.3 to Form 10-Q for the quarter ended September 30, 2002
10.14
Equity Investment Agreement dated June 6, 2003 between the Registrant and Pierre Fabre Medicament
Exhibit 10.2 to Form 10-Q for the quarter ended June 30, 2003
10.15
Warrant to purchase Common Stock of the Registrant issued to Pierre Fabre Medicament on June 6, 2003
Exhibit 10.3 to Form 10-Q for the quarter ended June 30, 2003
10.16
Amended and Restated Employment Agreement dated August 11, 2003 between the Registrant and Jay D. Kranzler, M.D., Ph.D()
Exhibit 10.4 to Form 10-Q for the quarter ended June 30, 2003
10.17
Employment Agreement dated February 4, 2004 between the Registrant and Denise Woolard()
Exhibit 10.22 to the Form 10-K for the year ended December 31, 2003.
10.18
Third Restated License Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.23 to the Form 10-K for the year ended December 31, 2003.
10.19
First Restated Trademark Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.24 to the Form 10-K for the year ended December 31, 2003.
10.20
Purchase and Supply Agreement dated January 9, 2004 between the Registrant and Pierre Fabre Medicament(*)
Exhibit 10.25 to the Form 10-K for the year ended December 31, 2003.
10.21
License and Collaboration Agreement dated January 9, 2004 between the Registrant and Forest Laboratories(*)
Exhibit 10.26 to the Form 10-K for the year ended December 31, 2003.
10.22
Side Letter dated January 9, 2004 among the Registrant, Forest Laboratories and Pierre Fabre Medicament(*)
Exhibit 10.27 to the Form 10-K for the year ended December 31, 2003.
10.23
Letter Agreement dated January 9, 2004 among the Registrant, Forest Laboratories and Pierre Fabre Medicament(*)
Exhibit 10.28 to the Form 10-K for the year ended December 31, 2003.
10.24
2005 Bonus Plan()
Exhibit 10.24 to the Form 10-K for the year ended December 31, 2004
10.25
Amendment to Forest Agreement(**)
Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 2005
10.26
License and Collaboration Agreement dated June 29, 2005 between Organon (Ireland) Ltd. and Cypress(**)
Exhibit 10.1 to Form 10-Q for the quarter ended September 30, 2005
10.27
2006 Bonus Plan()
21.1
Subsidiaries of the registrant
The registrant has no subsidiaries
23.1
Consent of Independent Registered Public Accounting Firm
24.1
Power of Attorney
Reference is made to page 52
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Act of 2002 (18 U.S.C. §1350, as adopted)
* Confidential Treatment has been granted to certain portions of this agreement.
** Confidential Treatment has been requested for certain portions of this agreement.
 Indicates management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jay D. Kranzler, M.D., Ph.D. and Sabrina Martucci Johnson, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to intents and purposes as he or she might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their substitute or resubstitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated.
CYPRESS BIOSCIENCE, INC.
Report of Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2005 and 2004
Statements of Operations for the years ended December 31, 2005, 2004 and 2003
Statements of Stockholders’ Equity for the years ended December 31, 2005, 2004 and
Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Cypress Bioscience, Inc.
We have audited the accompanying balance sheets of Cypress Bioscience, Inc. as of December 31, 2005 and 2004, and the related statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based upon our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cypress Bioscience, Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with generally accepted accounting principles in the United States.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Cypress Bioscience’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2006 expressed an unqualified opinion thereon.
CYPRESS BIOSCIENCE, INC.
BALANCE SHEETS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF OPERATIONS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
STATEMENTS OF CASH FLOWS
See accompanying notes to the financial statements.
CYPRESS BIOSCIENCE, INC.
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
The Company
Cypress Bioscience, Inc. (the “Company”) is committed to being the innovator and leader in providing products for the treatment of patients with Functional Somatic Syndromes, such as Fibromyalgia Syndrome, or FMS, and other central nervous system disorders, such as Obstructive Sleep Apnea, or OSA. Specifically, the Company’s strategy involves acquiring or in-licensing central nervous system, or CNS, active compounds and developing them for novel and typically underserved indications.
Accounting Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers cash equivalents to be those investments which are highly liquid, readily convertible into cash and which mature within three months from the date of purchase.
Short-Term Investments
The Company’s short-term investments consist of securities of the U.S. government or its agencies and certificates of deposit with maturities ranging from one to twelve months. The Company has classified its short-term investments as “available-for-sale” and carries them at fair value with unrealized gains and losses, if any, reported as a separate component of stockholders’ equity and included in comprehensive loss. Realized gains and losses are calculated on the specific identification method and recorded as interest income. Realized gains on the sale of available for sale securities during the years ended December 31, 2005, 2004 and 2003 were $1,814,189, $615,872 and $79,837, respectively. There were no realized losses.
At December 31, 2005 and 2004, short-term investments consisted of the following:
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company has established guidelines to limit its exposure to credit risk by placing investments with high credit quality financial institutions, diversifying its investment portfolio and placing investments with maturities that maintain safety and liquidity.
Property and Equipment
Property and equipment, including assets acquired under capital leases, are recorded at cost and depreciated or amortized over the estimated useful lives of the assets (three to five years) or the lease term using the straight-line method.
Long-Lived Assets
The Company evaluates the carrying value of its long-lived assets when events or changes in circumstances indicate that an asset’s carrying value may not be recoverable. An impairment loss is recognized when the sum of the expected future undiscounted net cash flows is less than the carrying value of the asset. To date, the Company has not identified any indicators of impairment or recorded any impairment of long-lived assets.
Fair Value of Financial Instruments
The carrying amounts of financial instruments, including cash and cash equivalents, prepaid expenses, receivables, accounts payable, accrued compensation and accrued liabilities, approximate fair value due to the nature of their short-term maturities.
Revenue Recognition
In accordance with Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (as amended by SAB 104), revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Amounts received for upfront license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Amounts received for sponsored development activities, including funding received for certain of the Company’s employees, are recognized as research costs are incurred over the period specified in the related agreement or as the services are performed. Amounts received for milestones are recognized upon achievement of the milestone, which requires substantive effort and was not readily assured at the inception of the agreement. Any amounts received prior to satisfying revenue recognition criteria will be recorded as deferred revenue.
Research and Development
Research and development expenses consist primarily of salaries and related personnel expenses for the Company’s research and development personnel, fees paid to external service providers to conduct clinical trials, patient enrollment costs, fees and milestone payments under the Company’s license and development agreements
and costs for facilities, supplies, materials and equipment. All such costs are charged to research and development expenses as incurred. Clinical trial costs are a significant component of research and development expenses and include costs associated with third-party contractors. The Company accrues clinical trial expenses based on work performed, which relies on estimates of total costs incurred based on completion of patient studies and other events. Actual clinical trial costs may differ from estimated clinical trial costs and are adjusted for in the period in which they become known.
Research and development expenses also include costs incurred in connection with the first Phase III clinical trial and extension trial for milnacipran, for which such costs are reimbursed by Forest Laboratories pursuant to the collaboration agreement.
Stock-Based Compensation
The Company measures compensation costs related to stock option plans using the intrinsic value method and provides pro forma disclosures of net loss per common share as if the fair value based method had been applied in measuring compensation costs. Accordingly, no compensation expense is recognized if the exercise price of stock options equals the fair value of the underlying stock at the date of grant.
Compensation expense for options granted to non-employees has been determined at the grant date in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, and Emerging Issues Task Force (“EITF”) No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services, and has been recorded at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Such compensation is recognized over the related vesting period of the underlying option.
Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, the Company’s net loss and net loss per share would have been adjusted to the pro forma amounts presented below:
The fair value of each option grant was estimated as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants during the years ended December 31, 2005, 2004 and 2003: no dividend yield; a risk-free interest rate of 3.5%, 2.6% and 2.9%, respectively; an expected term of 4.0 years for all years presented; and an expected volatility of 95%, 112% and 117%, respectively. The weighted average fair value of options granted during the years ended December 31, 2005, 2004 and 2003 was $9.13, $9.45 and $2.68, respectively.
Earnings (Loss) Per Share
Earnings (loss) per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted earnings (loss) per share. Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued. The dilutive effect of outstanding stock options and warrants is reflected in diluted earnings (loss) per share by application of the treasury stock method. The Company has excluded all outstanding stock options and warrants from the calculation of diluted loss per share for the years ended December 31, 2005, 2004 and 2003 because such securities are antidilutive for these periods. The total number of potential common shares excluded from the calculation of diluted loss per common share for the years ended December 31, 2005, 2004 and 2003 was 2,146,976, 3,444,888 and 2,718,175, respectively.
Comprehensive Income (Loss)
Comprehensive income (loss) is calculated in accordance with SFAS No. 130, Comprehensive Income. SFAS No. 130 requires the disclosure of all components of comprehensive income (loss), including net income (loss) and changes in equity during a period from transactions and other events and circumstances generated from non-owner sources. The Company’s other comprehensive income (loss) consisted of gains and losses on short-term investments and is reported in the statements of stockholders’ equity.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which is a revision of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). SFAS 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends Statement of Financial Accounting Standards No. 95, Statement of Cash Flows (SFAS 95). Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123R must be adopted no later than January 1, 2006. Early adoption will be permitted in periods in which financial statements have not yet been issued. The Company will adopt SFAS 123R on January 1, 2006.
As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R’s fair value method will have a significant impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. Determining the exact impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future and the assumptions for the variables which affect the computation. However, had the Company adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in the Stock Based Compensation section of Note 1 above.
2. STOCKHOLDERS’ EQUITY
Authorized Shares
The Company is authorized to issue up to 60,000,000 shares of common stock and 15,000,000 shares of preferred stock.
Public Offering of Shares of Common Stock
On April 7, 2004, the Company completed a public offering of 6,900,000 shares of common stock, including the underwriters’ purchase of an additional 900,000 shares to cover over-allotments, at $11.50 per share resulting in proceeds of approximately $74.2 million, net of placement costs.
Shelf Registration
On May 10, 2005, the Company filed a Form S-3 with the Securities and Exchange Commission (“SEC”) to issue and sell up to a total dollar amount of $100 million of the Company’s common stock to the public in a registered offering or offerings. The Form S-3 was declared effective by the SEC on July 6, 2005. As of December 31, 2005, no shares of common stock had been issued pursuant to this shelf registration.
Warrants
In June 2005, upon execution of the license agreement with Organon, the Company issued Organon warrants to purchase 62,656 shares of common stock as a license fee. These warrants, which have an exercise price of $15.96 per share and expire in June 2010, were valued at $615,000 using the Black-Scholes valuation model and recorded as a non-cash compensation charge, classified as research and development expenses, during the second quarter of 2005 since the underlying technology still requires substantial development effort.
In May 2004, the Company issued an outside consultant warrants to purchase 50,000 shares of common stock as compensation for services provided. These warrants, which have an exercise price of $13.23 per share and expire in May 2007, were valued at $385,000 using the Black-Scholes valuation model and recorded as a non-cash compensation charge during the second quarter of 2004.
Private Placement of Common Stock and Warrants to Purchase Common Stock
During April 2003, the Company completed a private placement of 4,029,342 shares of common stock and warrants to purchase 1,007,333 shares of common stock for proceeds of approximately $9.5 million, net of placement costs and fees of approximately $0.8 million. The purchase price of each security, which is the combination of one share of common stock and a warrant to purchase 25% of one share of the Company’s common stock, was priced at the market value of $2.56. Each warrant has an exercise price equal to $3.84 and expires in April 2008. In addition, in connection with the private placement, the Company issued warrants to purchase 380,908 shares of common stock to various placement agents. These warrants have an exercise price of $2.82 and expire in April 2008. One of the placement agents in the financing, who received warrants to purchase 283,301 shares of common stock and cash commission of $508,000, is affiliated with a stockholder of the Company. As of December 31, 2005, none of these warrants remain outstanding.
In March 2002, in connection with a private placement, the Company issued warrants to purchase 889,575 shares of common stock to various placement agents. These warrants have exercise prices ranging from $2.72 to $2.96 and expire in March and April of 2007. As of December 31, 2005, 8,936 of the warrants issued to various placement agents remain outstanding.
Call for Redemption of Outstanding Warrants
During October 2003, the Company called for redemption of the outstanding warrants to purchase common stock of the Company issued in connection with the Company’s private placement in March 2002. As of October 1, 2003, there were warrants to purchase 2,167,962 shares of common stock outstanding at an exercise price of $3.09 out of 3,435,726 warrants originally issued. Pursuant to the terms of the warrant agreements, the Company had the right to call for redemption of the warrants if the closing price of the Company’s common stock exceeded 200% of the warrant purchase price for 20 consecutive trading days, or $6.18, which occurred on September 26, 2003. All outstanding warrants from the private placement in March 2002 were exercised prior to the redemption date of October 20, 2003 resulting in gross proceeds to the Company of $6.7 million.
3. BENEFIT PLANS
401(k) Plan
The Company has a savings plan under Section 401(k) of the Internal Revenue Code under which all employees over the age of twenty-one are eligible to participate on the first entry date (January 1, April 1, July 1 and October 1) following their hire date. The plan allows for a matching contribution in the Company’s common stock (valued as of the contribution date) equal to 100% of the amount of the salary contributed for the preceding six- month period. Employees vest in the matching contribution made on the last day of June of the plan year provided they are employed on the last day of December of the plan year and vest in the matching contribution made on the last day of December of the plan year provided that they are employed on the last day of June of the following plan year. After five years of vesting service, the matching contribution is 100% vested immediately. During the years ended December 31, 2005, 2004 and 2003, the charge to operations for the matching contribution was $133,402, $123,763 and $65,500, respectively.
Stock Options
2000 EQUITY INCENTIVE PLAN In May 2000, the Company adopted the 2000 Equity Incentive Plan (the “2000 Plan”) providing for the grant to employees, directors and consultants of the Company of incentive and non-qualified stock options to purchase the Company’s common stock, as well as the granting of stock bonuses and rights to purchase restricted stock. The exercise price of all incentive stock options granted under the 2000 Plan shall not be less than the fair market value of the Company’s common stock on the date of grant. The exercise price of non-qualified stock options granted under the 2000 Plan shall not be less than 85% of the fair market value of the Company’s common stock on the date of grant. Options granted under the 2000 Plan have a term of up to ten years and generally vest over four years. In February 2001, the shareholders of the Company approved a provision to amend the 2000 Plan, whereby the total number of shares reserved for issuance under the 2000 Plan and the 1996 Equity Incentive Plan, in the aggregate, may be increased quarterly such that the number equals 21.1% of the number of shares of the Company’s common stock issued and outstanding as of the end of that day. Additionally, in September 2003, the shareholders of the Company approved an amendment to the 2000 Plan to increase the number of shares of common stock available for issuance as incentive stock options from 875,000 shares to 5,600,000 shares. This amendment does not alter the total number of shares available for issuance under the 2000 Plan; it only increases the total number of shares that may be issued under the 2000 Plan as incentive stock options. As of December 31, 2005, 3,399,190 shares of the Company’s common stock are available for future grant under the 2000 Plan.
1996 EQUITY INCENTIVE PLAN In January 1996, the Company adopted the 1996 Equity Incentive Plan (the “1996 Plan”) providing for the grant to employees, directors and consultants of the Company of incentive and non-qualified stock options to purchase the Company’s common stock, as well as the granting of stock bonuses and rights to purchase restricted stock. The exercise price of all incentive stock options granted under the 1996 Plan shall not be less than the fair market value of the Company’s common stock on the date of grant. The exercise price of non-qualified stock options granted under the 1996 Plan shall not be less than 85% of the fair market value of the Company’s common stock on the date of grant. Options granted under the 1996 Plan have a term of up to ten years and vest as determined by the Board but in no event less than twenty percent per year. As of December 31, 2005, 16,873 shares of the Company’s common stock are available for future grant under the 1996 Plan.
STOCK OPTION CANCEL AND RE-GRANT PROGRAM In June 2001, the Company implemented an option cancel and re-grant program. Pursuant to the program, the exercise price of certain options held by certain of the Company’s executive officers and directors were exchanged for options with an exercise price of $2.50, the fair market value of the Company’s common stock on June 27, 2001, the date the option cancel and re-grant program was effected. As a condition to participating in the option cancel and re-grant program, optionees who elected to surrender their old options for the replacement options had to exercise at least twenty percent of the replacement options on June 27, 2001. In addition, the replacement options expire no later than the earlier of the expiration date of the original option grant or June 27, 2006. The Company’s chief executive officer exercised his options to purchase 101,319 shares of common stock pursuant to a promissory note that was issued by the Company and was secured by his stock. The outstanding principal amount of the promissory note was due on June 27, 2006, with interest payable annually. The principal
amount of the loan was $189,973 and the interest rate was variable, adjusted monthly and was two points above the federal funds rate. In January 2004, the principal amount of the loan and related interest was paid in full.
As a result of the program, the Company granted options to purchase 618,738 shares of its common stock. In accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation-An Interpretation of APB Opinion No. 25, the shares underlying the options are accounted for as variable, and the intrinsic value of the options to purchase common stock are re-measured at the end of each period for the term of the option and amortized over the vesting period. During the years ended December 31, 2005 and 2004, the Company recorded a compensation benefit of $1,749,135 and $699,033, respectively, as the intrinsic value of the common stock underlying the options declined due to a decline in the Company’s stock price. The Company recorded stock compensation expense of $5,879,277 for the year ended December 31, 2003 to reflect in an increase in the intrinsic value of the common stock underlying the options due to an increase in the Company’s stock price during this period.
The following table summarizes the activity of the Company’s stock options and warrants for the periods presented:
The following table summarizes information regarding stock options outstanding at December 31, 2005:
The weighted average exercise prices for stock option activity are as follows:
4. SIGNIFICANT LICENSING AND COLLABORATION AGREEMENTS
License and Collaboration Agreement with Organon
In June 2005, the Company entered into a license agreement with Organon in connection with the initiation of its second development program, wherein the Company is evaluating potential pharmaceutical treatments for OSA. The Company entered into three licensing agreements to support and facilitate the program. Specifically, the Company licensed mirtazapine-related patents from Organon and patents from two other parties that provide the opportunity to combine mirtazapine with a second approved agent with the goal of potentially augmenting efficacy and improving tolerability. The series of licenses will allow the Company to evaluate a number of potential OSA treatment modalities in proof of concept trials.
Upon execution of the license agreement with Organon, the Company issued to Organon as a license fee a warrant to purchase 62,656 shares of common stock. These warrants, which have an exercise price of $15.96 per share and expire in June 2010, were valued at $615,000 and recorded as a non-cash compensation charge, classified as research and development expenses, during the second quarter of 2005 since the underlying technology still requires substantial development effort. Under the agreement with Organon, the Company and Organon will jointly fund development activities in the event a candidate from the proof of concept trials has been selected for continued development. If the Company is able to select a development candidate, the following is the structure of the agreement with Organon. The Company will have operational control of the development activities and, depending on the candidate selected, will fund 40% or 50% of the development-related expenses. If the FDA approves this product, Organon will have operational control of sales and marketing activities, with the Company having the opportunity to co-promote up to 25% of the physician promotion and details using its own sales force in the United States, Mexico and Canada. Expenses and revenue in the United States, Mexico and Canada are to be shared between the Company and Organon based on the level of promotional effort each party contributes, with the Company having the ability to share up to 40% or 50% depending on the candidate selected. Organon will be solely responsible for commercialization in the rest of the world and will pay the Company a royalty on net sales (as defined in the agreement).
Assuming the decision is made by the Company and Organon to proceed with the commencement of the first Phase III clinical trial, at any time thereafter, either the Company or Organon may elect to change the structure of the financial agreement to provide that the party that makes such election will no longer share in expenses and revenue, and instead will have the potential right to receive potential milestone and royalty payments in the event a product is commercialized.
In connection with the Company’s related licensing transactions with the two other parties (one of which is a related party as discussed in Note 6), the Company paid the parties aggregate license payments totaling $2.5 million, included in research and development expenses, with the potential for additional milestone payments of up to $25.3 million related to the Company’s OSA program, as development progresses. The parties will also participate in royalties from any marketed products that may be developed under the respective agreements.
License and Collaboration Agreement with Forest Laboratories
In January 2004, the Company entered into a collaboration agreement with Forest Laboratories for the development and marketing of milnacipran. Under the agreement with Forest Laboratories, the Company sublicensed its exclusive rights to develop and commercialize milnacipran to Forest Laboratories for the United States, with an option to extend the territory to include Canada. In addition, Forest Laboratories has an option to acquire an exclusive license from the Company in the United States, and potentially Canada, to any compounds developed under the Company’s agreement with Collegium Pharmaceutical, Inc. Forest Laboratories assumed responsibility for funding all continuing development of milnacipran, including the funding of clinical trials and regulatory approvals, as well as a certain number of the Company’s employees. However, in light of the increased expense and risk associated with running two parallel trials, the Company has agreed upon an alternative cost sharing arrangement with Forest Laboratories for the second Phase III trial only. In connection with this arrangement, the amount of funding that the Company receives from Forest Laboratories for certain of its employees has been eliminated as of the fourth quarter in 2004 for the second Phase III trial only, and the Company will pay for a majority of the external costs of the second Phase III trial only, with Forest reimbursing the Company under specific scenarios where the second Phase III trial is used as one of the two required pivotal trials in the New Drug Application (NDA) submission to the FDA. Forest Laboratories is funding the third Phase III trial, including a specified number of our employees that are assisting with the conduct of that trial. Forest Laboratories will also be responsible for sales and marketing activities related to any product developed under the agreement, and the Company will have the option to co-promote using its own sales force up to 25% of the total physician details and would be reimbursed by Forest Laboratories in an amount equal to Forest Laboratories’ cost of providing the equivalent detailing calls.
Under the agreement with Forest Laboratories, the Company received an upfront, non-refundable payment of $25.0 million, of which $1.25 million, classified as research and development expenses, was paid to Pierre Fabre as a sublicense fee. The total upfront and milestone payments to the Company under the agreement could total approximately $205.0 million related to the development of milnacipran for the treatment of FMS, a large portion of which will depend upon achieving certain sales of milnacipran and an additional $45.0 million in the event that the
Company and Forest Laboratories develop other indications for milnacipran. In addition, the Company has the potential to receive royalty payments based on sales of licensed product under this agreement. Forest Laboratories also assumed the future royalty payments due to Pierre Fabre and the transfer price for the active ingredient used in milnacipran. The agreement with Forest Laboratories extends until the later of (i) the expiration of the last to expire of the applicable patents, (ii) 10 years after the first commercial sale of a product under the agreement or (iii) the last commercial sale of a generic product, unless terminated earlier. Each party has the right to terminate the agreement upon prior written notice of the bankruptcy or dissolution of the other party, or a breach of any material provision of the agreement if such breach has not been cured within the required time period following such written notice. Forest Laboratories may also terminate the agreement upon an agreed notice period in the event Forest Laboratories reasonably determines that the development program indicates issues of safety or efficacy that are likely to prevent or significantly delay the filing or approval of a new drug application or to result in labeling or indications that would have a significant adverse affect on the marketing of any product developed under the agreement.
For the years ended December 31, 2005 and 2004, the Company recognized revenues of $8.4 million and $14.4 million, respectively, under its collaboration agreement with Forest Laboratories, consisting of the recognition of the upfront payment of $25.0 million from Forest Laboratories on a straight-line basis over a period of 8 years, sponsored development reimbursements and funding received from Forest Laboratories during 2004 for certain of the Company’s employees devoted to the development of milnacipran.
Licensing Agreement with Pierre Fabre
In August 2001, the Company entered into a license agreement and a trademark agreement with Pierre Fabre. Pursuant to the terms of the license agreement, the Company paid Pierre Fabre $1.5 million upon execution of the agreement and a $1.0 million milestone payment in September 2003. The upfront payment of $1.5 million and $1.0 million milestone payment have been expensed pursuant to SFAS No. 2, Accounting for Research and Development Costs, as the ultimate commercialization of the related products is uncertain and the technology has no alternative uses. Additional payments of up to $4.5 million will be due to Pierre Fabre based on meeting certain clinical and regulatory milestones.
The license agreement was amended and restated in November 2001 and subsequently in May 2003. In connection with the second amended and restated agreement in May 2003, the Company issued Pierre Fabre 1,000,000 shares of common stock and warrants to purchase 300,000 shares of common stock. These warrants have an exercise price of $4.91 per share and expire in June 2008. Pursuant to SFAS No. 2, the additional license consideration in the form of the equity instruments has been expensed as the ultimate commercialization of the related product is uncertain and the technology has no alternative uses. Accordingly, during the second quarter of 2003, the Company recognized a non-cash charge of $5.0 million classified as research and development expense based on the fair value of the stock and warrants issued to Pierre Fabre.
In January 2004, in connection with the Company’s transaction with Forest Laboratories, the Company’s license agreement and trademark agreement with Pierre Fabre were further amended. The third amended and restated license agreement with Pierre Fabre provides the Company with an exclusive license to develop and sell any products with the compound milnacipran as an active ingredient for any indication in the United States and Canada. Simultaneous to the third amended and restated license agreement, the Company also entered into a purchase and supply agreement with Pierre Fabre for the active pharmaceutical ingredient in milnacipran. If any product is commercialized, Pierre Fabre will have the exclusive right to manufacture the active ingredients used in the commercial product for a specified time period (subject to compliance with certain provisions in the agreement), and Pierre Fabre will be paid a transfer price for each product manufactured and royalties based on net sales, both obligations which have been assumed by Forest Laboratories. Additionally, the Company is obligated to pay Pierre Fabre a 5% sublicense fee on upfront and milestone payments received from Forest Laboratories. Once a total of $7.5 million has been paid to Pierre Fabre, such additional sublicense payments due to Pierre Fabre shall be credited against any royalties or milestones owed by the Company to Pierre Fabre, which shall be carried forward to any subsequent years as applicable. Pierre Fabre also retains the right to sell products in indications developed by the Company outside the United States and Canada and will pay the Company a royalty based on net sales for such products. The license agreement also provides Pierre Fabre with certain rights to obtain a license outside the United States and Canada for new formulations and new salts developed by the Company. The agreement is effective until the later of the expiration of the last-to-expire of certain patents held by Pierre Fabre relating to the development of
milnacipran or ten years after the first commercial sale of a licensed product, unless terminated earlier. Each party has the right to terminate the agreement upon 90 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if the breach is not cured within 90 days following the written notice. Additionally, Pierre Fabre has the right to terminate the agreement upon 90 days’ prior notice to the Company if the Company takes certain actions.
Reformulation and New Product Agreement
In August 2002, the Company entered into a Reformulation and New Product Agreement (“Agreement”) with Collegium Pharmaceutical, Inc., or Collegium, pursuant to which Collegium is attempting to develop new formulations of milnacipran and new products that are analogs of milnacipran. In January 2004, the Company exercised its option to acquire an exclusive license to technology developed under this agreement. In the event the Company commercializes any of the reformulations or new products developed under the agreement with Collegium, the Company will be obligated to pay Collegium milestone payments, which amount to $5.4 million in the aggregate, as well as potential royalty payments based on the net sales of reformulated or new products. Additionally, in October 2002, the Company entered into a Common Stock Issuance Agreement with Collegium, pursuant to which Collegium may elect to be issued shares of the Company’s common stock, subject to certain conditions, in lieu of cash, for milestone payments. The Company has authorized the issuance of up to 1,800,000 shares of common stock as milestone payments. The agreement with Collegium is effective until the expiration of the last-to-expire of the issued patents, if any, unless terminated earlier. Each party has the right to terminate the agreement upon 60 days’ prior written notice of the bankruptcy or dissolution of the other party or a breach of any material provision of the agreement if the breach has not been cured within the 60-day period following the written notice.
5. INCOME TAXES
Significant components of the Company’s net deferred income tax assets as of December 31, 2005 and 2004 are shown below. A valuation allowance has been established to offset the net deferred tax asset as of December 31, 2005 and 2004, respectively, as the realization of such assets is uncertain.
As of December 31, 2005, the Company has accumulated federal and California net operating loss carryforwards of approximately $81,200,000 and $22,600,000, respectively. The federal tax loss carryforwards will begin to expire in 2008, and the California tax loss carryforwards will begin to expire in 2007. Additionally, the Company has federal and California research and development tax credit carryforwards of approximately $1,899,000 and $549,000, respectively, which will begin expiring in 2006 unless previously utilized.
The Company has determined that “ownership changes” within the meaning of Internal Revenue Code Section 382 have occurred in prior years. However, the Company has determined based on an analysis completed in 2004 that those limitations on the future utilization of net operating loss carryforwards will not have a material impact on such utilization. Future financings may cause additional changes in ownership and cause further limitation on the use of net operating loss carryforwards.
6. RELATED PARTY TRANSACTIONS
A member of the Company’s board of directors accepted the position of Chief Executive Officer of a biotechnology company in April 2005. The Company entered into an agreement with this company in January 2005 with respect to the in-license of certain patents. Under this agreement, the Company paid an aggregate of $1.5 million, included in research and development expenses, to such biotechnology company. In the event the Company moves forward with development of a product or products under this agreement, the Company would be obligated to pay certain milestone and royalty payments.
In conjunction with the signing of the collaboration agreement with Forest Laboratories in the first quarter of 2004, options to purchase 200,000 shares of common stock at $2.51 per share became fully vested. Such options were previously granted to outside consultants and two former board members for services provided in connection with corporate partner negotiations and were to become fully vested upon the execution of a significant strategic collaboration within two years of the date of grant. The Company recorded a non-cash compensation charge of $2.4 million, determined using the Black-Scholes valuation model, in the first quarter of 2004 in connection with this transaction.
During March 2004, the Company entered into consulting agreements with certain board members in connection with their resignation from the Company’s board of directors to roles as consultants. Pursuant to such consulting agreements, the Company is committed to pay each consultant a fee of $50,000 per year for services provided over a two-year term. Additionally, each consultant will vest in all unvested shares under outstanding option grants in equal monthly installments over a period of two years from the effective date of the agreements. In connection with the consulting agreements, the Company recorded a non-cash compensation charge of $2.8 million during the first quarter of 2004 related to the accounting for the stock options previously granted to such former board members.
The Company employs the services of a consultant, whose husband is an officer of the Company. Such consultant provided consulting services to the Company in the amount of approximately $147,000, $144,000 and $70,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
7. COMMITMENTS AND CONTINGENCIES
The Company currently occupies approximately 5,200 square feet of leased office space in San Diego, California. The San Diego facility houses the Company’s executive and administrative offices. The lease for this facility expires in July 2007.
Future annual minimum lease payments due under noncancelable capital and operating leases consists of the following at December 31, 2005:
Total rent expense was approximately $176,000, $191,000 and $171,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
8. QUARTERLY INFORMATION (UNAUDITED)
The following quarterly information includes all adjustments which management considers necessary for a fair statement of such information.
(1) During the first, second, third and fourth quarters, the Company recognized non-cash compensation expense (benefit) for variable stock options of $(1,392,060), $1,148,732, $(1,580,894) and $75,087, respectively, related to the variable accounting treatment for options issued pursuant to the cancel and re-grant program in June 2001.
(1) During the first, second, third and fourth quarters, the Company recognized non-cash compensation expense (benefit) for variable stock options of $(1,442,933), $847,025, $(782,454) and $679,329, respectively, related to the variable accounting treatment for options issued pursuant to the cancel and re-grant program in June 2001.
(2) During the first quarter, the Company recognized non-cash charges of $2.4 million related to stock options that vested upon the execution of the collaboration agreement with Forest Laboratories and $2.8 million in connection with the accounting treatment for stock options related to the resignation of certain board members during the first quarter of 2004.