ARADIGM CORP (ARDM)Quarterly Report (SEC form 10-Q)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The discussion below contains forward-looking statements that are based on the beliefs of management, as well as assumptions made by, and information currently available to, management. Our future results, performance or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements as a result of certain factors, including, but not limited to, those discussed in this section as well as in the section entitled “Risk Factors” and elsewhere in the Company’s most recent Form 10-K and Form 10-Q filed with the Securities and Exchange Commission.
The business is subject to significant risks including, but not limited to, the success of research and development efforts, dependence on corporate partners for marketing and distribution resources, obtaining and enforcing patents important to the business, clearing the lengthy and expensive regulatory process and
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possible competition from other products. Even if the products appear promising at various stages of development, they may not reach the market or may not be commercially successful for a number of reasons. Such reasons include, but are not limited to, the possibilities that the potential products may be found to be ineffective during clinical trials, fail to receive necessary regulatory approvals, are difficult to manufacture on a large scale, are uneconomical to market, are precluded from commercialization by proprietary rights of third parties or may not gain acceptance from health care professionals and patients. Readers are cautioned not to place undue reliance on the forward-looking statements contained herein. We undertake no obligation to publicly release the results of any revision to these forward-looking statements, which may be made to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.
Overview
Since our inception in 1991, we have been engaged in the development of innovative drug delivery systems. Beginning with our AERx pulmonary delivery system and more recently with the Intraject subcutaneous delivery technology acquired in May 2003 from Weston, we are building a solid platform in needle-free drug delivery. As of June 30, 2003, we had an accumulated deficit of $205 million. We have not been profitable since inception and expect to incur additional operating losses over the next several years as research and development efforts, preclinical and clinical testing activities and manufacturing scale-up efforts expand and as we plan and build our late-stage clinical and early commercial production capabilities. To date, we have not had any material product sales and do not anticipate receiving any revenue from the sale of products during 2003. Our sources of working capital have been equity financings, equipment lease financings, contract revenues and interest earned on investments.
We have performed initial feasibility work on a number of compounds with the AERx system and have been compensated for expenses incurred while performing this work in several cases pursuant to feasibility study agreements with third parties. Once feasibility is demonstrated with respect to a potential product, we seek to enter into development contracts with pharmaceutical corporate partners. We currently have an agreement pursuant to which we are developing pulmonary delivery systems with Novo Nordisk A/S, to manage diabetes using insulin and other blood glucose regulating compounds, and with GlaxoSmithKline plc, to manage acute and breakthrough pain using opioid analgesics.
We expect to perform various studies evaluating our Intraject subcutaneous delivery platform for both existing and future partnerships. The Intraject technology is currently licensed for various compounds to GlaxoSmithKline, Roche Laboratories and Abbott Laboratories, as well as several smaller companies. We are planning to enter into renegotiated replacement license agreements with these companies, but we may elect to assume the existing licenses, depending on the circumstances. In some cases, a partnership may not be disclosed until a long-term development agreement has been established.
The collaborative agreement with Novo Nordisk provides for reimbursement of research and development expenses as well as additional payments to us as we achieve certain significant milestones. We also expect to receive royalties from this development partner based on revenues from product sales and to receive revenue from the manufacturing of unit dose packets and hand-held devices. We recognize revenues under the terms of our collaborative agreement as the research and development expenses are incurred, to the extent they are reimbursable. For the six months ended June 30, 2003, this partner-funded program has contributed approximately 99% of our total contract revenues. At June 30, 2003, Novo Nordisk and its affiliate Novo Nordisk Pharmaceuticals, Inc. own approximately 13% of our total outstanding common stock (on an as-converted basis) and are considered a related party.
During December 2000, GlaxoSmithKline and we amended the product development and commercialization agreement covering the use of the AERx Pain Management System for the delivery of narcotic analgesics whereby we assumed full control and responsibility for conducting and financing the remainder of all development activities. Under the amendment, unless GlaxoSmithKline or we have terminated the agreement, GlaxoSmithKline can restore its rights to participate in the development and commercialization of the product under the amended agreement upon payment of a restoration fee to us. GlaxoSmithKline has been in a position to exercise its restoration election since delivery of Phase 2b trial results, which were made available to them during the second quarter of 2002. Since they have not done so and it appears unlikely that they will do so in the future, we are currently in discussions with several alternate partners for this product. There can be no assurance that we will successfully enter into an alternative partnership agreement for this product if GlaxoSmithKline does not elect to restore its rights.
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No product development or milestone payments were received from GlaxoSmithKline during 2002 or in the first half of 2003.
In addition to the diabetes, morphine and fentanyl programs, we have four additional AERx programs in development, three of which are partner funded. It is our policy not to disclose the partner and/or the drug until a long-term development agreement has been established; both parties agree to highlight a clinical advancement in the program or under special circumstances in which both parties agree to disclosure. In 2002, we announced successful clinical results from one partnered trial with interferon alpha when an abstract was accepted at a leading scientific session, in which the partner was not disclosed. In addition, a gene therapy collaboration with geneRx+ was disclosed in which we hold certain potentially beneficial licensing rights.
Critical Accounting Policies
We consider certain accounting policies related to revenue recognition and the use of estimates to be critical accounting policies that require the use of significant judgments and estimates relating to matters that are inherently uncertain and may result in materially different results under different assumptions and conditions.
Revenue Recognition
Contract revenues consist of revenue from collaboration agreements and feasibility studies. We recognize revenue under the agreements as costs are incurred. Deferred revenue represents the portion of all refundable and nonrefundable research payments received that have not been earned. In accordance with contract terms, milestone payments from collaborative research agreements are considered reimbursements for costs incurred under the agreements and, accordingly, are generally recognized as revenue either upon the completion of the milestone effort when payments are contingent upon completion of the effort or are based on actual efforts expended over the remaining term of the agreements when payments precede the required efforts. Costs of contract revenues are approximate or are greater than such revenue and are included in research and development expenses. Refundable development and license fee payments are deferred until the specified performance criteria are achieved. Refundable development and license fee payments are generally not refundable once the specific performance criteria are achieved and such payments are no longer refundable.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. These estimates include useful lives for property and equipment and related depreciation calculations, estimated amortization period for payments received from product development and license agreements as they relate to the revenue recognition of deferred revenue and assumptions for valuing options and warrants. Actual results could differ from these estimates.
Three Months Ended June 30, 2003 and 2002
Contract and License Revenues: Contract revenues for the three months ended June 30, 2003 increased to $9.4 million from $7.3 million for the same period in 2002. Revenue from Novo Nordisk was $9.3 million for the three months ended June 30, 2003 and $6.6 million for the same period in 2002. The increase in revenue is related to increased reimbursement by Novo Nordisk for clinical supply and product development activities for the ongoing phase 3 clinical program and offset by lower revenue from other funded programs. Costs associated with collaborative agreements are included in research and development expenses. The Company expects that the revenue from Novo Nordisk may trend down over the coming quarter(s) due to the expected level of activity in support of the ongoing phase 3 clinical program.
Research and Development Expenses: Research and development expenses for the three months ended June 30, 2003 decreased to $14.0 million from $14.6 million for the same period in 2002. The decrease in research and development expenses is primarily due to a reduction in unfunded development efforts and cost reduction programs.
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These expenses represent proprietary research expenses as well as costs related to contract revenues and include salaries and benefits of scientific and development personnel, laboratory supplies, consulting services and expenses associated with the development of manufacturing processes. We expect research and development spending to increase over the next few years as we continue to expand our development activities to support current and potential future collaborations and initiate commercial manufacturing of the AERx systems. The increase in research and development expenditures cannot be predicted accurately as it depends in part upon the future success of, and funding levels supported by, our existing development collaborations, as well as obtaining new collaborative agreements.
Our lead development program is developing pulmonary delivery systems to manage diabetes using insulin and other blood glucose regulating compounds with our partner Novo Nordisk. Since Novo Nordisk and we successfully initiated Phase 3 clinical trials in September 2002, we have been focused on supporting our partner in the existing and planned additional Phase 3 clinical trials that will be needed for their regulatory submission and commercial scale-up activities.
Our next program has been conducted to date with our partner GlaxoSmithKline pursuant to our development agreement, as amended, which covers the use of the AERx Pain Management System for the delivery of narcotic analgesics. Activity in this program has been limited since delivery to GlaxoSmithKline of data from the Phase 2b clinical trials in the second quarter of 2002. We are in a position to move forward with this program and start Phase 3 trials within a year; however, future progress for this program is contingent on either GlaxoSmithKline recommitting to this program or our entering into another development agreement with a new partner.
We have four additional programs, three of which are partner-funded programs, including two gene therapy programs. Future research and development efforts for these partner-funded programs are difficult to predict at this time due to their early stage of development.
General and Administrative Expenses: General and administrative expenses were $2.8 million for both of the three month periods ended June 30, 2003 and June 30, 2002.
Interest Income: Interest income for the three months ended June 30, 2003 decreased to $86,000 from $210,000 for the same period in 2002. The decrease is due to lower invested balances and lower interest rates.
Interest Expense and Other: Interest expense for the three months ended June 30, 2003 decreased to $39,000 from $84,000 for the same period in 2002. The decrease is primarily due to lower outstanding capital lease and equipment loan balances under various equipment and lease lines of credit.
Net Loss: Net loss for the three months ended June 30, 2003 of $7.4 million was lower compared to the $10.0 million loss for the same period in 2002, reflecting higher Novo Nordisk contract revenues and reduced expenses for unfunded projects.
Six Months Ended June 30, 2003 and 2002
Contract Revenues: Contract revenues for the six months ended June 30, 2003 increased to $17.1 million from $15.4 million for the same period in 2002. Revenue from Novo Nordisk was $16.8 million for the six months ended June 30, 2003 and $14.2 million for the same period in 2002. The increase in revenue is related to increased reimbursement by Novo Nordisk for clinical supply and product development activities for the ongoing phase 3 clinical program offset by lower revenue from other funded programs. Costs associated with collaborative agreements are included in research and development expenses. The Company expects that the revenue from Novo Nordisk may trend down over the coming quarter(s) due to the expected level of activity in support of the ongoing phase 3 clinical program.
Research and Development Expenses: Research and development expenses for the six months ended June 30, 2003 decreased to $27.0 million from $28.9 million for the same period in 2002. The decrease in research and development expenses is primarily due to a reduction in unfunded development efforts and cost reduction programs.
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General and Administrative Expenses: General and administrative expenses for the six months ended June 30, 2003 increased to $5.5 million from $5.3 million for the same period in 2002. The increase is primarily due to higher business development and investor relations’ expenses and higher facility support costs.
Interest Income: Interest income for the six months ended June 30, 2003 decreased to $194,000 from $501,000 for the same period in 2002. The decrease is due to lower invested balances and lower interest rates.
Interest Expense and Other: Interest expense for the six months ended June 30, 2003 decreased to $95,000 from $250,000 for the same period in 2002. The decrease is primarily due to lower outstanding capital lease and equipment loan balances under various equipment and lease lines of credit.
Net Loss: Net loss for the six months ended June 30, 2003 decreased to $15.3 million from $18.5 million for the same period in 2002 reflecting our focus on the Novo Nordisk funded project and cost reduction efforts in other area.
Liquidity and Capital Resources
We have financed our operations since inception primarily through private placements and public offerings of capital stock, proceeds from equipment lease financing, contract revenues and interest earned on investments. As of June 30, 2003, we had cash, cash equivalents and investments of approximately $28.2 million.
In March 2003, we raised approximately $15.0 million through the sale of 18,992,391 shares of common stock at a price of $0.79 per share and warrants to purchase 4,273,272 shares of common stock at $1.07 per share to certain investors in a private placement.
In June 2003, the Company received net proceeds of approximately $2.3 million and issued an aggregate of 2,171,964 shares of Common Stock in connection with the exercise of warrants by three investors.
Net cash used in operating activities for the six months ended June 30, 2003 decreased to $14.3 million from $24.3 million for the same period in 2002. Net cash used was substantially higher in 2002 due to the greater operating loss, payments of accrued accounts payable and accrued liabilities and greater recognition of deferred revenue carried over from 2001.
Investing activities for the six months ended June 30, 2003 provided cash $641,000 in contrast to the use of cash of $9.3 million for the same period in 2002. Higher capital expenditures in 2002 related to the acquisition of manufacturing production equipment for commercial production. The majority of the capital expenditures in 2003 relate to the acquisition of the Intraject assets and intellectual property.
On May 12, 2003, we completed the purchase of certain assets from Weston, a UK public company currently in bankruptcy. Weston’s business involved the design, development, manufacture and exploitation of drug delivery technologies, including a proprietary needle-free injection technology known as “Intraject.” We acquired test and production equipment, intellectual property and other assets associated with Weston’s drug delivery technologies for a cash consideration of $2.0 million. The acquisition was funded out of our working capital. We will continue the development of Weston’s technologies and drug delivery systems at our existing US facilities. We will continue development of Intraject by re-allocating existing resources and we are not anticipating more than a small increase in our current cash burn rate.
Net cash provided by financing activities for the six months ended June 30, 2003 was $15.2 million compared to a use of $1.4 million for the same period in 2002. The increase in cash provided is the result of the completion of the private placement in March 2003.
The development of our technology and proposed products, including the Intraject development program, will require a commitment of substantial funds to conduct the costly and time-consuming research, preclinical studies and clinical trial activities necessary to develop and refine the technology and proposed products and bring such products to market. Our future capital requirements will depend on many factors, including continued progress and results from research and development for the technology and
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drug delivery systems, the ability to establish and maintain favorable collaborative arrangements with others, progress with preclinical studies and clinical trials and the results thereof, the time and costs involved in obtaining regulatory approvals, the cost of development and the rate of scale-up for the required production technologies, the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and the need to acquire licenses or other rights to new technology.
We continue to review our planned operations through the end of 2003 and beyond. We particularly focus on capital spending requirements to ensure that capital outlays are not expended sooner than necessary. We expect our total annual capital outlays for 2003 not to exceed $10 million. Other than in connection with the acquisition of the Intraject related assets, since December 31, 2002, there have been no material changes in our contractual obligations or commitments. We believe that our existing cash balances at June 30, 2003, together with the $20.0 million unused common stock purchase commitment from Novo Nordisk A/S, research and development funding commitments from corporate development partners and interest earned on our investments should be sufficient to meet our needs for at least the next 24 months. The sale of additional common stock to Novo Nordisk A/S is subject to certain conditions and there can be no assurance that our funding commitments from corporate development partners will not be amended or terminated. If we cannot exercise our option to sell additional shares of common stock to Novo Nordisk or if our current funding commitments from corporate development partners are amended or terminated, we will need to obtain additional sources of capital sooner than would otherwise be the case.
If our development programs, including the Intraject development program, continue to progress, we would expect our cash requirements for capital spending and operations to increase in future periods. We will need to raise additional capital to fund our capital spending and operations before we become profitable. We may seek additional funding through collaborations, borrowing arrangements or through public or private equity financings. There can be no assurance that additional financing can be obtained on acceptable terms, or at all. Dilution to shareholders may result if funds are raised by issuing additional equity securities. If adequate funds are not available, we may be required to delay, to reduce the scope of, or to eliminate one or more of our research and development programs, or to obtain funds through arrangements with collaborative partners or other sources that may require us to relinquish rights to certain of our technologies or products that we would not otherwise relinquish.
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