RDYN Replidyne (MM)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

 

Commission file number: 000-52082

 

REPLIDYNE, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

303-996-5500

 

Registrant’s telephone number, including area code:

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ   No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

TABLE OF CONTENTS

 

 

 

REPLIDYNE, INC.

 

CONDENSED BALANCE SHEETS

(unaudited)

(in thousands, except par value)

 

 

The accompanying notes are an integral part of the condensed financial statements.

REPLIDYNE, INC.

 

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share amounts)

 

 

The accompanying notes are an integral part of the condensed financial statements.

REPLIDYNE, INC.

 

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

 

The accompanying notes are an integral part of the condensed financial statements.

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

 

 

Replidyne, Inc. (Replidyne or the Company) is a biopharmaceutical company focused on discovering, developing and in-licensing anti-infective products. The Company’s lead product candidate is REP3123, an investigational narrow-spectrum antibacterial agent for the treatment of Clostridium difficile ( C. difficile ) bacteria and C. difficile infection (CDI). Replidyne is also pursuing the development of other novel anti-infective programs based on its bacterial DNA replication inhibitor technology. The Company’s operating strategy is directed to pursuing strategic alternatives, the consummation of which cannot be assured. The Company is considering strategic alternatives that include the merger or acquisition of some or all of its assets, and could reduce or change its current focus on the development of anti-infective product candidates.

 

 

Unaudited Interim Financial Statements

 

The condensed balance sheet as of June 30, 2008, condensed statements of operations for the three and six months ended June 30, 2008 and 2007, and cash flows for the six months ended June 30, 2008 and 2007 and related disclosures, respectively, have been prepared by the Company, without an audit, in accordance with generally accepted accounting principles for interim information. Accordingly, they do not contain all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All disclosures as of June 30, 2008 and for the three and six months ended June 30, 2008 and 2007, presented in the notes to the condensed financial statements are unaudited. In the opinion of management, all adjustments, which include only normal recurring adjustments, considered necessary to present fairly the financial condition as of June 30, 2008 and results of operations for the three and six months ended June 30, 2008 and 2007 and cash flows for the six months ended June 30, 2008 and 2007 have been made. These interim results of operations for the three and six months ended June 30, 2008 are not indicative of the results that may be expected for the full year ended December 31, 2008. The December 31, 2007 balance sheet and related disclosures were derived from audited financial statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

 

Fair Value of Financial Instruments

 

Statement of financial accounting standards (SFAS) No. 157, Fair Value Measurements (SFAS 157) establishes a fair value hierarchy that requires companies to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. SFAS 157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. SFAS 157 classifies these inputs into the following hierarchy:

 

Level 1 Inputs  — Quoted prices for identical instruments in active markets.

 

Level 2 Inputs  — Quoted prices for similar instruments in active markets; and quoted prices for identical or similar instruments in markets that are not active.

 

Level 3 Inputs  — Instruments with primarily unobservable value drivers.

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

As of June 30, 2008, those assets and liabilities that are measured at fair value on a recurring basis consisted of the Company’s short-term securities it classifies as available-for-sale. The Company believes that the carrying amounts of its other financial instruments, including cash and cash equivalents and accounts payable and accrued expenses, approximate their fair value due to the short-term maturities of these instruments. At June 30, 2008, the Company’s fair value hierarchies for its financial assets, which require fair value measurement on a recurring basis under SFAS 157 and include cash equivalents, are as follows, in thousands:

 

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments purchased with initial maturities of three months or less to be cash equivalents. Cash equivalents are carried at amortized cost, which approximates market value.

 

Short-Term Investments

 

Short-term investments are investments with a maturity of more than three months when purchased. At June 30, 2008, initial contractual maturities of the Company’s short-term investments were less than two years for investments classified as available-for-sale and less than nine months for investments classified as held-to-maturity. At June 30, 2008, the weighted average days to maturity was less than one year for investments classified as available-for-sale and less than two months for investments classified as held-to-maturity.

 

Management determines the classification of securities at purchase based on its intent. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities , the Company classifies its securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Available-for-sale securities are those the Company may decide to sell if needed for liquidity, asset/liability management, or other reasons.

 

Available-for-sale securities are recorded at estimated fair value. The estimated fair value amounts are determined by the Company using available market information. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive loss until realized. Cost is adjusted for amortization of premiums and accretion of discounts from the date of purchase to maturity. Such amortization is included in investment income and other. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are also included in investment income and other. The cost of securities sold is based on the specific-identification method. Any decline in the market value of any available-for-sale security results in a reduction in carrying amount as these securities are reported at fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other than temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period end, and forecasted performance of the investee. No impairments were recorded as a result of this analysis during the three and six months ended

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

June 30, 2008 or 2007. The Company’s investments were classified as follows at June 30, 2008 and December 31, 2007 (in thousands):

 

 

The following is a summary of the types of short-term investments classified as available-for-sale securities (in thousands):

 

 

Unrealized holding gains and losses on available-for-sale securities as of June 30, 2008 were $0.1 million and $29 thousand, respectively. Unrealized holding gains and losses on available-for-sale securities as of December 31, 2007 were $0.1 million and $7 thousand, respectively. Net unrealized holding gains or losses are recorded in accumulated other comprehensive income.

 

The following is a summary of short-term investments classified as held-to-maturity securities (in thousands):

 

 

Unrealized holding gains and losses on held-to-maturity investments as of June 30, 2008 were $4 thousand and $1 thousand, respectively. Unrealized holding gains and losses on held-to-maturity investments as of December 31, 2007 were $10 thousand and $3 thousand, respectively.

 

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. Cash, cash equivalents and investments consist of commercial paper, corporate and bank notes, U.S. government securities and money market funds all held with financial institutions.

 

Property and Equipment

 

Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are amortized over the shorter of the life of the lease or the estimated useful life of the assets. Repairs and maintenance costs are expensed as incurred.

 

Long-Lived Assets and Impairments

 

The Company periodically evaluates the recoverability of its long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , and, if appropriate, reduces the

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

carrying value whenever events or changes in business conditions indicate the carrying amount of the assets may not be fully recoverable. SFAS No. 144 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the fair value, and in the case of assets classified as held-for-sale, fair value is adjusted for costs to sell such assets. The Company has not yet generated positive cash flows from operations on a sustained basis, and such cash flows may not materialize for a significant period in the future, if ever. Additionally, the Company may make changes to its business plan that will result in changes to the expected cash flows from long-lived assets. As a result, it is reasonably possible that future evaluations of long-lived assets may result in impairment.

 

Accrued Expenses

 

As part of the process of preparing its financial statements, the Company is required to estimate accrued expenses. This process involves identifying services that third parties have performed on the Company’s behalf and estimating the level of service performed and the associated cost incurred on these services as of each balance sheet date in the Company’s financial statements. Examples of estimated accrued expenses include contract service fees, such as amounts due to clinical research organizations, professional service fees, such as attorneys and independent accountants, and investigators in conjunction with preclinical and clinical trials, and fees payable to contract manufacturers in connection with the production of materials related to product candidates. Estimates are most affected by the Company’s understanding of the status and timing of services provided relative to the actual level of services incurred by the service providers. The date on which certain services commence, the level of services performed on or before a given date, and the cost of services is often subject to judgment. The Company is also party to agreements which include provisions that require payments to the counterparty under certain circumstances. Additionally, the Company may be required to estimate and accrue for certain loss contingencies related to litigation or arbitration claims. The Company develops estimates of liabilities using its judgment based upon the facts and circumstances known and accounts for these estimates in accordance with accounting principles involving accrued expenses generally accepted in the U.S.

 

Restructuring Liabilities

 

The Company has and may continue to restructure its operations to better align its resources with its operating and strategic plans. Restructuring charges can include amounts related to employee severance, employee benefits, property impairment and other costs. The Company is often required to use estimates and assumptions when determining the amount and in which period to record charges and obligations related to restructuring activities.

 

Segments

 

The Company operates in one segment. Management uses one measure of profitability and does not segment its business for internal reporting purposes.

 

Clinical Trial Expenses

 

The Company records clinical trial expenses based on estimates of the services received and efforts expended pursuant to contracts with clinical research organizations (CROs) and other third party vendors associated with its clinical trials. The Company contracts with third parties to perform a range of clinical trial activities in the ongoing development of its product candidates. The terms of these agreements vary and may result in uneven payments. Payments under these contracts depend on factors such as the achievement of certain defined milestones, the successful enrollment of patients and other events. The objective of the Company’s clinical trial accrual policy is to match the recording of expenses in its financial statements to the actual services received and efforts expended. In doing so, the Company relies on information from CROs and

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

its clinical operations group regarding the status of its clinical trials to calculate the accrual for clinical expenses at the end of each reporting period.

 

Share-Based Compensation

 

The Company accounts for share-based compensation in accordance with SFAS No. 123(R), Share-Based Payment , which was adopted on January 1, 2006 under the prospective transition method. The Company selected the Black-Scholes option pricing model as the most appropriate valuation method for option grants with service and/or performance conditions. The Black-Scholes model requires inputs for risk-free interest rate, dividend yield, volatility and expected lives of the options. Since the Company has a limited history of stock purchase and sale activity, expected volatility is based on historical data from several public companies similar in size and nature of operations to the Company. The Company will continue to use historical volatility and other similar public entity volatility information until its historical volatility is relevant to measure expected volatility for option grants. The Company estimates forfeitures based upon historical forfeiture rates and assumptions regarding future forfeitures. The Company will adjust its estimate of forfeitures if actual forfeitures differ, or are expected to differ, from such estimates. Based on an analysis of historical forfeiture rates and assumptions regarding future forfeitures, the Company applied an annual forfeiture rate of 20% and 4.33% during the six months ended June 30, 2008 and 2007, respectively. The increase in the forfeiture rate during 2008 is primarily attributable to the Company’s recent organizational restructurings and future expectations. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant for a period commensurate with the expected term of the grant. The expected term (without regard to forfeitures) for options granted represents the period of time that options granted are expected to be outstanding and is derived from the contractual terms of the options granted and historical and expected option exercise behaviors.

 

During the three months ended June 30, 2008 and 2007, the fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes option pricing model and the following weighted average assumptions:

 

 

Stock options granted by the Company to its employees are generally structured to qualify as “incentive stock options” (ISOs). Under current tax regulations, the Company does not receive a tax deduction for the issuance, exercise or disposition of ISOs if the employee meets certain holding requirements. If the employee does not meet the holding requirements, a disqualifying disposition occurs, at which time the Company will receive a tax deduction. The Company does not record tax benefits related to ISOs unless and until a disqualifying disposition occurs. In the event of a disqualifying disposition, the entire tax benefit is recorded as a reduction of income tax expense. The Company has not recognized any income tax benefit or related tax asset for share-based compensation arrangements as the Company does not believe, based on its history of operating losses, that it is more likely than not it will realize any future tax benefit from such tax deductions.

 

Under SFAS 123(R), the estimated fair value of share-based compensation, including stock options granted under the Company’s Equity Incentive Plan and discounted purchases of common stock by employees under the Employee Stock Purchase Plan, is recognized as compensation expense. The estimated fair value of stock options is expensed over the requisite service period as discussed above. Compensation expense under the Company’s Employee Stock Purchase Plan is calculated based on participant elected contributions and

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

estimated fair values of the common stock and the purchase discount at the date of the offering. See Note 9 for further information on share-based compensation under these plans. Share-based compensation included in the Company’s statements of operations was as follows (in thousands):

 

 

The decrease in share-based compensation expense in 2008 was primarily related to a change in the Company’ s estimate of expected forfeitures. As noted above, the Company bases its estimate of expected forfeitures on historical forfeiture rates and assumptions regarding future forfeitures. During the six months ended June 30, 2008, the Company applied an expected annual forfeiture rate of 20% as compared to an expected forfeiture rate of 4.33% applied during the six months ended June 30, 2007. The increase in the expected forfeiture rate is primarily attributable to increased forfeitures as a result of the Company’s recent organizational restructurings and future expectations.

 

SFAS No. 123(R) is applied only to awards granted or modified after the required effective date of January 1, 2006. Awards granted prior to the Company’s implementation of SFAS No. 123(R) are accounted for under the recognition and measurement provisions of APB Opinion No. 25 and related interpretations.

 

For stock options granted as consideration for services rendered by nonemployees and for options that continue to vest upon a change in status from employee to nonemployee, the Company recognizes compensation expense in accordance with the requirements of SFAS 123(R), Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services and EITF No. 00-18, Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees , as amended. The Company has estimated the fair value of share-based payments issued to nonemployees based on the estimated fair value of the stock options granted. The Company has historically determined that this basis was more reliably determinable than estimating the fair value of the services received. The estimated fair value of options granted to nonemployees is expensed over the service period (which is generally equal to the period over which the options vest) and remeasured each reporting date until the options vest or performance is complete.

 

If an employee becomes a nonemployee and continues to vest in an option grant under its original terms, the option is treated as an option granted to a nonemployee prospectively, provided the individual is required to continue providing services. The option is accounted for prospectively under EITF No. 96-18 such that the fair value of the option is remeasured at each reporting date until the earlier of i) the performance commitment date or ii) the date the services have been completed. Only the portion of the newly measured cost attributable to the remaining requisite service period is recognized as compensation cost prospectively from the date of the change in status.

 

The fair value of share-based payments issued to nonemployees during the three months ended June 30, 2008 was estimated using the Black-Scholes option pricing model and the following weighted average assumptions: i) risk-free interest rate of 4.05%, ii) contractual life of 10 years, iii) volatility of 75% and iv) no expected dividends. The Company recognized share-based compensation expense relating to nonemployee options of $0.1 million for the three and six months ended June 30, 2008. No amounts were recognized in 2007.

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Comprehensive Income (Loss)

 

The Company applies the provisions of SFAS No. 130, Reporting Comprehensive Income , which establishes standards for reporting comprehensive loss and its components in financial statements. The Company’s comprehensive income (loss) is comprised of its net income (loss) and unrealized gains and losses on securities available-for-sale. For the three months ended June 30, 2008 and 2007, comprehensive income (loss) was $(18.9) million and $45.4 million, respectively. For the six months ended June 30, 2008 and 2007, comprehensive income (loss) was $(27.7) million and $36.9 million, respectively.

 

Income Taxes

 

The Company accounts for income taxes pursuant to SFAS No. 109, Accounting for Income Taxes , which requires the use of the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to the extent it is more likely than not that a deferred tax asset will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date.

 

Based on an analysis of historical equity transactions under the provisions of Section 382 of the Internal Revenue Code, the Company believes that ownership changes have occurred at two points since its inception. These ownership changes limit the annual utilization of the Company’s net operating losses in future periods. The Company’s only significant deferred tax assets are its net operating loss carryforwards. The Company has provided a valuation allowance for its entire net deferred tax asset since its inception as, due to uncertainty as to future utilization of its net operating loss carryforwards, due primarily to its history of operating losses, the Company has concluded that it is more likely than not that its deferred tax asset will not be realized.

 

FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 , defines a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. At the adoption date of January 1, 2007, the Company had no unrecognized tax benefits which would affect its effective tax rate if recognized. At June 30, 2008, the Company had no unrecognized tax benefits. The Company classifies interest and penalties arising from the underpayment of income taxes in the statements of operations as general and administrative expenses. At June 30, 2008, the Company has no accrued interest or penalties related to uncertain tax positions. The tax years 2003 to 2006 federal returns remain open to examination, and the tax years 2002 to 2006 remain open to examination by other taxing jurisdictions to which the Company is subject.

 

Net Income (Loss) Per Share

 

Net income (loss) per share is computed using the weighted average number of shares of common stock outstanding and is presented for basic and diluted net income (loss) per share. Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period, excluding common stock subject to vesting provisions. Diluted net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding if the potential common shares had been issued or restrictions lifted on restricted stock. The dilutive effect of

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

common stock equivalents such as outstanding stock options, warrants and restricted stock is reflected in diluted net loss per share by application of the treasury stock method.

 

Potentially dilutive securities representing approximately 4.0 million and 1.7 million shares of common stock for the three months ended June 30, 2008 and 2007, respectively, and 4.0 million and 1.3 million shares of common stock for the six months ended June 30, 2008 and 2007, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been antidilutive. Potentially dilutive securities include stock options, warrants, shares to be purchased under the employee stock purchase plan and restricted stock.

 

Research and Development

 

Research and development costs are expensed as incurred. These costs consist primarily of salaries and benefits, licenses to technology, supplies and contract services relating to the development of new products and technologies, allocated overhead, clinical trial and related clinical manufacturing costs, and other external costs.

 

The Company has historically produced clinical and commercial grade product in its Colorado facility and through third parties. Prior to filing for regulatory approval of its products for commercial sale, and such regulatory approval being assessed as probable, these costs are expensed when incurred as research and development expense.

 

Recent Accounting Pronouncements

 

In September 2006, the FASB issued SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, but the FASB provided a one year deferral for implementation of the standard for non-financial assets and liabilities. The Company adopted SFAS 157 effective January 1, 2008 for all financial assets and liabilities. The adoption did not have a material impact on the Company’s financial statements. The Company does not expect that the remaining provisions of SFAS 157, when adopted, will have a material impact on its financial statements.

 

 

Property and equipment at June 30, 2008 and December 31, 2007 consists of the following (in thousands):

 

 

Depreciation and amortization expense was $0.4 million for each of the three month periods ended June 30, 2008 and 2007. During the six months ended June 30, 2008 and 2007, depreciation and amortization expense was $0.6 million and $0.8 million, respectively.

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

Accounts payable and accrued expenses at June 30, 2008 and December 31, 2007 consist of the following (in thousands):

 

 

 

Indemnifications

 

The Company has agreements whereby it indemnifies directors and officers for certain events or occurrences while the director or officer is, or was, serving in such capacity at the Company’s request. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited.

 

Employment Agreements

 

The Company has entered into employment agreements with its chief executive officer and certain other executive officers that provide for base salary, eligibility for bonuses and other generally available benefits. The employment agreements provide that the Company may terminate the employment of the executive at any time with or without cause. If an executive is terminated by the Company without cause or such executive resigns for good reason, as defined, then such executive is entitled to receive a severance package consisting of salary continuation for a period of twelve months (or eighteen months with respect to its chief executive officer) from the date of termination among other benefits. If such termination occurs one month before or thirteen months following a change of control, then the executive is entitled to: i) salary continuation for a period of twelve months (or eighteen months with respect to its chief executive officer and chief scientific officer) from the date of termination, ii) a bonus equal to the average of such executive’s annual bonuses for the two years prior to the change in control termination (or one and a half times the average with respect to the chief executive officer), iii) acceleration of vesting of all of the executive’s outstanding unvested options to purchase the Company’s common stock, iv) and other benefits.

 

In addition, the Company has entered into retention bonus agreements with its chief financial officer and senior vice president of corporate development. The agreements provide that each such executive is eligible to receive both: i) a cash bonus in the amount of $0.1 million (Retention Bonuses), provided that the executive remains employed by the Company through September 30, 2008, and ii) a cash bonus in an amount of not less than $0.1 million and not greater than $0.2 million (Transaction Bonuses), which final amount will be determined by the Company’s board of directors in its sole discretion, provided that such executive remains employed by the Company through the consummation of a strategic transaction. In the event that the executive is terminated by the Company without cause or such executive resigns for good reason prior to September 30, 2008, such executive will become entitled to the Retention Bonus. The Retention Bonuses are amortized to expense over the expected six month service period. Management evaluates the probability of triggering the

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Transaction Bonuses each quarter and, when the bonuses are deemed to be probable of being incurred, the Company will begin expensing the Transaction Bonuses accordingly. To date, no amounts related to the Transaction Bonuses have been recorded in the Company’ s financial statements.

 

During 2007 the Company established a severance benefit plan that defines termination benefits for eligible employees. The severance plan does not apply to employees who have entered into separate employment agreements with the Company. Under the severance plan, employees whose employment is terminated without cause are provided a severance benefit of between nine and eighteen weeks pay, based on their employee grade level as defined by the Company, plus an additional two weeks pay for each year of service. Employees are also entitled to receive other benefits such as health insurance during the period of severance under the plan.

 

Asubio Pharma License Agreement

 

On June 20, 2008, the Company notified Asubio Pharma Co., Ltd., or Asubio Pharma, of its decision to terminate the license agreement with Asubio Pharma to develop and commercialize faropenem medoxomil in the U.S. and Canada. In accordance with the terms of the license agreement, the Company became obligated to pay Asubio Pharma a termination fee of ¥375 million ($3.6 million as paid in June 2008). During the three months ended June 30, 2008, the Company recorded the termination fee as research and development expense and paid this fee to Asubio Pharma.

 

Asubio Pharma and Nippon Soda Supply Agreement

 

On June 20, 2008 the Company notified Asubio Pharma, and Nippon Soda Company Ltd., or Nippon Soda, of its decision to terminate the supply agreement for the exclusive supply of the Company’s commercial requirements of the active pharmaceutical ingredient in faropenem medoxomil. Upon termination, the Company became obligated to pay Nippon Soda unpaid delay compensation fees totaling ¥99.2 million (approximately $0.9 million at June 30, 2008) through the effective date of termination of the supply agreement. In addition, the Company also became obligated to reimburse Nippon Soda for certain engineering costs totaling ¥64.4 million (approximately $0.6 million as of June 30, 2008). During the second quarter of 2008, the Company recorded as research and development expense the full amount of its obligation to reimburse Nippon Soda for engineering costs. The Company had previously accrued amounts due for delayed compensation through June 30, 2008. At June 30, 2008, the Company had an aggregate liability recorded in its financial statements for these amounts due to Nippon Soda totaling $1.5 million which was paid in full in July 2008.

 

MEDA Supply Agreement and Arbitration

 

In 2005, the Company and MEDA Manufacturing GmbH (formerly Tropon GmbH), or MEDA, entered into a supply agreement for production of 300 mg adult tablets of faropenem medoxomil, which was amended in 2006. Under the terms of the supply agreement, the Company was required to buy all of its requirements for 300 mg adult faropenem medoxomil tablets from MEDA until cumulative purchases exceeded €22 million (approximately $34.8 million at June 30, 2008). Beginning in 2006, the Company became obligated to make €2.3 million (approximately $3.6 million at June 30, 2008) in annual minimum purchases of 300 mg adult tablets from MEDA. If in any year the Company did not satisfy its minimum purchase commitments, the Company was required to pay MEDA the shortfall amount. Additionally, the agreement provided that, upon termination, the Company would be required to compensate MEDA for documented costs to decontaminate its facility up to a maximum of €1.7 million (approximately $2.7 million at June 30, 2008).

 

In 2006, the agreement was amended and the Company’s obligations for purchase commitments and facility decontamination costs were suspended and deemed satisfied by Forest Laboratories pursuant to an agreement between MEDA and Forest Laboratories. In February 2007, concurrent with Forest Laboratories’

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

termination of its supply agreement with MEDA, the previously suspended provisions in the Company’s agreement with MEDA were no longer suspended, and the Company’s obligations to MEDA with respect to purchase commitments and facility decontamination costs were no longer waived. Following this termination, in April 2007, the Company provided notice to MEDA of its termination of the supply agreement between MEDA and the Company in accordance with the termination provisions of the agreement as future clinical development of faropenem medoxomil adult tablets would use 600 mg dosing. As this notice occurred before the effective date of the termination of the Company’s collaboration agreement with Forest Laboratories, the Company believes that Forest Laboratories, under the terms of the collaboration agreement, is responsible for supply chain obligations related to faropenem medoxomil, including minimum purchase commitments and decontamination obligations under the MEDA agreement, through May 7, 2007 (the termination date of the collaboration agreement). In the fourth quarter of 2007, MEDA invoiced the Company for 2007 minimum purchase fees. In the first quarter of 2008, the Company paid the portion of minimum purchase fees incurred through May 11, 2007, the effective date of termination of the supply agreement, plus interest and has invoiced Forest Laboratories for the portion which pertained to the period through May 7, 2007.

 

In May 2008, MEDA filed a demand for arbitration and amended its demand in July 2008 after the Company terminated its license agreement with Asubio Pharma and relinquished all rights to the faropenem medoxomil program. In its amended demand, MEDA claims that the Company terminated the supply agreement in June 2008 when it returned the faropenem medoxomil program to Asubio Pharma and did not have the right to terminate the supply agreement in April 2007. The Company believes that it had the right to terminate the agreement in April 2007. However, if it is determined in arbitration that the agreement was not terminated until June 2008, the Company would be required to pay MEDA up to €2.7 million ($4.2 million at June 30, 2008) plus interest for additional minimum purchases fees and may not be able to recover amounts incurred (up to €1.7 million or $2.7 million at June 30, 2008) to reimburse MEDA for costs to decontaminate its facility from Forest Laboratories under the collaboration agreement. During the second quarter of 2008, the Company recorded as research and development expense €1.7 million ($2.7 million at June 30, 2008) related to its obligation to reimburse MEDA for costs to decontaminate its facility, representing the maximum amount of the Company’s obligation to MEDA for decontamination of the MEDA facility. The Company’s accrual is based on information provided by MEDA that they intend to decontaminate the facility and that actual decontamination costs are expected to exceed the limit specified in the agreement. In accordance with the Company’s agreement with Forest Laboratories in effect at the time of the termination of the MEDA agreement, upon receipt of documentation of decontamination costs from MEDA, the Company will invoice Forest Laboratories. At June 30, 2008, the Company also recorded as general and administrative expenses €1.1 million ($1.7 million at June 30, 2008) which represents the Company’s estimate of possible outcomes, within a range of possible outcomes, from the arbitration or as a result of a settlement reached between the parties. While the Company believes that it has acted in accordance with the terms of the supply agreement, estimates related to these matters are volatile and as such, it is reasonably possible that these estimates could change in the near term resulting in a future adjustment to the Company’s accrual of €2.8 million ($4.4 million at June 30, 2008). Based on the arbitration provisions of the contract, the Company expects the arbitration process to be completed in the second half of 2008.

 

Other

 

The Company entered into an arrangement with an investment bank to provide investment banking services. Under the terms of the agreement, the Company may incur transaction fees of at least $4 million and up to $6 million based on the value of a completed license or strategic transaction, as defined.

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

In the fourth quarter of 2007, the Company announced a restructuring of its operations to align its organization with its strategic priorities. As a result of this restructuring in the fourth quarter of 2007, the Company reduced its headcount, primarily in administrative, clinical, commercial and regulatory functions. The Company recognized expense related to this restructuring of $1.4 million in 2007, which was primarily for employee severance and related benefits.

 

The following table summarizes activity in the restructuring accrual for the first six months of 2008 related to the 2007 restructuring (in thousands):

 

 

In April and June 2008 the Company completed additional restructurings of its operations under which it recorded $2.5 million of expense in the second quarter of 2008. These restructurings of operations included the termination of 23 employees from the clinical, commercial, research and administrative functions of the Company and the closure of the Company’s office in Milford, Connecticut. In addition, the Company discontinued enrollment in its placebo-controlled Phase III clinical trial of faropenem medoxomil in patients with acute exacerbations of chronic bronchitis. The charges associated with the restructuring included approximately $2.1 million of cash expenditures for employee related severance benefits, $0.1 million of cash expenditures for facility related costs and $0.3 million for non-cash expenses related primarily to accelerated depreciation of certain property and equipment.

 

The following table summarizes activity in the restructuring accrual for the first six months of 2008 related to the 2008 restructurings (in thousands):

 

 

 

The Company has a 401(k) plan and matches an amount equal to 50 percent of employee contributions, limited to $2 thousand per participant annually. The Company provided matching contributions under this plan of $8 thousand and $29 thousand during the three months ended June 30, 2008 and 2007, respectively, and $0.1 million during each of the six months ended June 30, 2008 and 2007.

 

 

The Company’s Certificate of Incorporation, as amended and restated on July 3, 2006, authorizes the Company to issue 105,000,000 shares of $0.001 par value stock which is comprised of 100,000,000 shares of

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

common stock and 5,000,000 shares of preferred stock. Each share of common stock is entitled to one vote on each matter properly submitted to the stockholders of the Company for their vote. The holders of common stock are entitled to receive dividends when and as declared or paid by the board of directors, subject to prior rights of the preferred stockholders, if any.

 

Common Stock Warrants

 

In connection with the issuance of debt and convertible notes in 2002 and 2003, the Company issued warrants to certain lenders and investors to purchase shares of the Company’s then outstanding redeemable convertible preferred stock. The warrants were initially recorded as liabilities at their fair value. In July 2006, upon completion of the Company’s initial public offering, all outstanding preferred stock warrants were automatically converted into common stock warrants and reclassified to equity at the then current fair value. As of June 30, 2008 and December 31, 2007, warrants for the purchase of 53,012 shares of common stock were outstanding and exercisable with exercise prices in the range of $4.90 to $6.13 per share.

 

 

Stock Option Plan

 

The Company’s Equity Incentive Plan, as amended (the Option Plan), provides for issuances of up to 7,946,405 shares of common stock for stock option grants. Options granted under the Option Plan may be either incentive or nonqualified stock options. Incentive stock options may only be granted to Company employees. Nonqualified stock options may be granted by the Company to its employees, directors, and non-employee consultants. Generally, options granted under the Option Plan expire ten years from the date of grant and generally vest over four years. Options granted in prior years generally vest 25% on the first anniversary from the grant date and ratably in equal monthly installments over the remaining 36 months. Options granted in the current year generally vest in equal monthly installments over 48 months. This plan is considered a compensatory plan and subject to the provisions of SFAS No. 123(R).

 

Stock options outstanding at June 30, 2008, changes during the six months then ended and options exercisable at June 30, 2008 are presented below (share amounts in thousands):

 

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

The following table provides additional information regarding outstanding options to purchase the Company’s common stock at June 30, 2008 (shares presented in thousands):

 

 

The weighted average grant date fair value of options granted to employees during the three months ended June 30, 2008 and 2007 was $0.41 and $2.58 per share, respectively and during the six months ended June 30, 2008 and 2007 was $1.09 and $2.75 per share, respectively. The total intrinsic value of options exercised during the three months ended June 30, 2008 and 2007 was $13 thousand and $0.1 million, respectively and during the six months ended June 30, 2008 and 2007 was $21 thousand and $0.1 million, respectively.

 

Performance Options

 

In March 2008, the Company issued 400,000 options with performance conditions at an exercise price of $1.86 per share to certain of its executives. These options vest in full, subject to the sole discretion of the Board of Directors, immediately prior to the consummation of either: i) a strategic alliance or partnership with an unaffiliated third party that relates to the development and commercialization of faropenem medoxomil, which license was returned to Asubio Pharma in June 2008, or ii) another strategic transaction. Vested options continue to be exercisable three years following termination of the employee’s continued service with the

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Company. The Company evaluates the probability of meeting the performance objectives on a quarterly basis and has not recognized any share-based compensation expense associated with these awards to date.

 

Restricted Shares of Common Stock

 

The Company had granted to certain employees options to purchase shares of its common stock that were eligible to be exercised prior to vesting, provided that the shares issued upon such exercise are subject to restrictions which will be released consistent with the original option vesting period. In the event of termination of the service of an employee, the Company may repurchase all unvested shares from the optionee at the original issue price.

 

The table below provides a summary of restricted stock activity during the six months ended June 30, 2008 (in thousands):

 

 

Share-Based Compensation — Stock Options

 

During the three months ended June 30, 2008 and 2007, the Company recognized share-based compensation expense of $0.4 million and $0.9 million, respectively, and during the six months ended June 30, 2008 and 2007 recognized $44 thousand and $1.4 million, respectively. As of June 30, 2008, the Company had $2.3 million of total unrecognized compensation costs (or $1.2 million net of expected forfeitures) from options granted to employees under the Option Plan to be recognized over a weighted average remaining period of 1.74 years. Additionally, as of June 30, 2008, the Company had $0.1 million of total unrecognized share-based compensation costs (net of expected forefeitures) from options granted with performance conditions.

 

Nonemployee Options

 

During the three and six months ended June 30, 2008, the Company granted 100,000 stock options to certain former employees in their new capacity as consultants to the Company at exercise prices equal to the fair value of the underlying shares of common stock on the date of grant. The options vest over eight months and have a contractual life of ten years. Additionally, certain former employees who have changed their status with the Company from employee to nonemployee, have met the continued service requirements of the Company’s equity incentive plan and have continued to vest in options previously granted to them as employees. Vesting continues until their continued service to the Company ceases. The Company recorded $0.1 million in compensation expense during the three and six months ended June 30, 2008 related to the nonemployee options, and will re-measure compensation expense until these options vest. Under the current estimate of fair value, the Company expects to recognize the remaining expense related to nonemployee stock options of $0.2 million in 2008.

 

Employee Stock Purchase Plan

 

The Company has reserved approximately 306,000 shares of its common stock for issuance under its Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan allows eligible employees to purchase common stock of the Company at the lesser of 85% of its market value on the offering date or the purchase date as established by the board of directors. Employee purchases are funded through after-tax payroll deductions, which participants can elect from one percent to twenty percent of compensation, subject to the

 

REPLIDYNE, INC.

 

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

 

federal limit. The Purchase Plan is considered a compensatory plan and subject to the provisions of SFAS No. 123(R). To date, approximately 140,000 shares have been issued pursuant to the Purchase Plan. During the three months ended June 30, 2008 and 2007, the Company recognized $10 thousand and $0.1 million in share-based compensation expense, respectively and during the six months ended June 30, 2008 and 2007 recognized $26 thousand and $0.1 million, respectively.

 

 

SFAS No. 109 requires that a valuation allowance be provided if it is more likely than not that some portion or all of the Company’s deferred tax assets will not be realized. The Company’s ability to realize the benefit of its deferred tax assets will depend on the generation of future taxable income through profitable operations. Due to the uncertainty of future profitable operations, the Company has recorded a full valuation allowance against its net deferred tax assets.

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding the following: the timing and implications of our ongoing review of strategic alternatives; the outcome of our responses to the FDA with regard to the Warning Letter issued to us in February 2008 and subsequent related communications; the timing and implications of obtaining regulatory approval of any of our product candidates; the progress of our research programs, including clinical testing; our ability to identify new product candidates; the potential of any product candidates to lead to the development of commercial products; our anticipated timing for initiation or completion of our future clinical trials for any of our product candidates and expectations regarding future results of such trials; other statements regarding our future product development activities and plans to develop or acquire and commercialize product candidates, regulatory strategies and clinical strategies, including our intent to develop or seek regulatory approval for our product candidates in specific indications; our future expenditures for research and development and the conduct of clinical trials; the ability of our third-party manufacturing parties to support our requirements for drug supply; the extent to which our intellectual property rights may protect our technology and product candidates; the size and growth of the potential markets for our product candidates and our plans to develop our sales and marketing capabilities to serve those markets; the rate and degree of market acceptance of any future products; the success of competing drugs that are or become available; our plans and ability to enter into collaboration arrangements; any statements regarding our future financial performance, results of operations or sufficiency of capital resources to fund our operating requirements; and any other statements that are other than statements of historical fact. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Overview

 

We are a biopharmaceutical company focused on discovering, developing and in-licensing innovative anti-infective products. Our lead product candidate, REP3123, is an investigational narrow spectrum antibacterial agent for the treatment of Clostridium difficile , or C. difficile , bacteria and C. difficile -infection, or CDI, a healthcare concern for elderly and hospitalized patients. We are also pursuing the development of other novel compounds that inhibit bacterial DNA replication, which we believe represents a potentially promising drug target in antibiotic development.

 

Our operating strategy is directed to pursuing strategic alternatives, the consummation of which cannot be assured. We are considering strategic alternatives that include the merger or acquisition of some or all of our assets, and could reduce or change our current focus on the development of anti-infective product candidates.

 

In December 2005, we submitted a new drug application, or NDA, for faropenem medoxomil for the following adult indications: acute bacterial sinusitis; community-acquired pneumonia; acute exacerbation of

chronic bronchitis; and uncomplicated skin and skin structure infections. In October 2006, the FDA issued a non-approvable letter with respect to our NDA citing the need for further clinical studies for all indications, including studies using a superiority design for acute bacterial sinusitis and acute exacerbation of chronic bronchitis, more extensive microbiologic confirmation and consideration of alternate dosing regimens. A superiority design trial requires demonstrating that a product candidate is superior to placebo or an approved treatment. Historically, all of our trials were conducted using a non-inferiority design, which required these trials to demonstrate that a product candidate is not significantly less effective than an approved treatment. On January 22, 2008, we received a Warning Letter from the FDA related to our NDA filed in December 2005 for faropenem medoxomil citing certain conditions found by the FDA during their review of our role as the applicant of the NDA. Specifically, the Warning Letter noted that certain raw data, descriptions and analysis supporting clinical trials included in the NDA were not available for the FDA’s review and had not been obtained or reviewed by us prior to submission of the NDA. In March 2008, we formally responded to the FDA with regard to the Warning Letter. In a letter dated June 2008, the FDA made further inquiries of us related to our March 2008 response. In July 2008, we responded to the FDA’s further inquiry. Additionally, in July 2008, we withdrew our NDA and closed investigational new drug applications, or IND’s, for faropenem medoxomil and REP8839 with the FDA.

 

In April 2008, we discontinued enrollment in our Phase III placebo-controlled clinical trial for treatment of acute exacerbation of chronic bronchitis with faropenem medoxomil, which represented our only ongoing clinical trial with faropenem medoxomil, to conserve our cash.

 

In May 2008, we were served with a Demand for Arbitration (the “Demand”) from MEDA Manufacturing GmbH, or MEDA, alleging that we breached certain of our obligations under a Supply Agreement dated April 4, 2005, between us and MEDA (the “Supply Agreement”). MEDA amended the Demand in July 2008 following our termination of our license agreement for faropenem medoxomil with Asubio Pharma Co., Ltd, or Asubio Pharma. On April 27, 2007, we provided notice to MEDA of our termination of the Supply Agreement in accordance with the termination provisions of the Supply Agreement. We believe that we do not have obligations to MEDA under the Supply Agreement beyond May 11, 2007. The amended Demand seeks damages for breach of contract in the amount of €2.7 million (approximately $4.2 million at June 30, 2008) plus interest on such amounts and reimbursement of MEDA’s attorney fees and other costs incurred in the proceeding represented by the Demand. If the April 2007 termination of the Supply Agreement is determined to be ineffective, we would remain obligated for future decontamination fees of up to €1.7 million (approximately $2.7 million at June 30, 2008). We intend to vigorously defend ourselves against the allegations made in the amended Demand and, based on the arbitration provisions of the contract, we expect the arbitration process to be completed in the second half of 2008.

 

In June 2008, we announced our decision to terminate our license agreement with Asubio Pharma, Co., Ltd, or Asubio Pharma, for the development and commercialization of faropenem medoxomil in the U.S. and Canada. In conjunction with this decision, we also announced our decision to terminate our supply agreement with Asubio Pharma and Nippon Soda Co., Ltd, or Nippon Soda, for production of the active pharmaceutical ingredient in faropenem medoxomil. These decisions were made as a result of our being unable to secure a partner for the faropenem medoxomil program. As a result of these decisions, we incurred: i) a license termination fee of ¥375 million ($3.6 million) which was paid to Asubio Pharma in June 2008, ii) a charge of ¥64 million (approximately $0.6 million at June 30, 2008) to reimburse Nippon Soda for certain engineering costs and iii) a charge of ¥99 million (approximately $0.9 million at June 30, 2008) for the portion of annual delay compensation payable to Nippon Soda through the effective date of termination of the supply agreement. The delay compensation to Nippon Soda was accrued in 2007. Amounts due to Nippon Soda referred to above were paid in July 2008.

 

We are developing REP3123, our investigational narrow spectrum antibacterial agent to treat C. difficile bacteria and C. difficile -infection. C. difficile is a Gram-positive bacterium that causes diarrhea and other intestinal conditions, such as colitis, and is a major cause of morbidity among the elderly and hospitalized patients. People generally contract C. difficile -infections through the ingestion of C. difficile spores after coming into contact with a contaminated item or surface. These spores then germinate, grow and multiply in the digestive tract. In in vitro preclinical studies, REP3123 displayed an ability to inhibit growth of the

C. difficile bacterium and prevent the bacterium from forming the spores that allow it to be spread from person to person, but without inhibiting other key organisms that are essential for normal intestinal functioning. Also in preclinical studies, REP3123 exhibited signs it may be able to stop the production of destructive intestinal toxins caused by C. difficile bacteria. These results suggest that REP3123 has the potential to reduce C. difficile -infection outbreaks and relapse rates through reducing the presence of C. difficile spores and reduce the severity of, or possibly even prevent, C. difficile -infections through inhibiting the growth of or stopping production of toxins caused by C. difficile bacteria. We retain worldwide rights to REP3123.

 

We are also developing assays that identify compounds that inhibit bacterial DNA replication. The compounds may be useful to treat bacterial infections. We believe that bacterial DNA replication is an attractive target system for new antibacterial drugs because it is an essential cellular process and stalled DNA replication can trigger cell death. Our assays allow for efficient screening of large libraries of small molecules and are designed to mimic the bacterial DNA replication systems of numerous bacteria, with the goal of identifying novel inhibitors of bacterial DNA replication. We have identified compounds that are able to inhibit bacterial DNA replication in these assays. We believe that the novel mechanism of action of our technology may reduce the risk that bacteria will be resistant to drugs based on this technology. We are currently optimizing the initial inhibitors identified in the assays.

 

We have incurred significant operating losses since our inception on December 6, 2000, and, as of June 30, 2008, we had an accumulated deficit of $137 million. We have generated no revenue from product sales to date. We have funded our operations to date principally from the sale of our securities and amounts received from Forest Laboratories under our former collaboration and commercialization agreement. Although we reported net income during the second quarter of 2007 and for the year ended December 31, 2007 as a result of the termination of our agreement with Forest Laboratories, we expect to incur substantial operating losses for the next several years as we pursue the development of our programs.

 

Three Months Ended June 30, 2008 and 2007

 

Revenue

 

We reported no revenue during the second quarter of 2008 compared to $55.6 million for the second quarter of 2007. Revenue recognized during the second quarter of 2007 included $55.2 million of license revenue, representing amortization of $60 million in upfront and milestone payments recognized upon the termination of our former collaboration and commercialization agreement with Forest Laboratories in the second quarter of 2007. Revenue recognized during the second quarter of 2007 also included $0.4 million of contract revenue for activities funded under our agreement with Forest Laboratories.

 

Research and Development Expense

 

Research and development expenses were $14.4 million for the second quarter of 2008 as compared to $8.4 million for the second quarter of 2007. Research and development expenditures made to advance our product candidates and other research efforts were as follows (in thousands):

 

 

Costs to support our faropenem medoxomil program totaled $10.5 million in the second quarter of 2008 as compared to $4.8 million during the second quarter of 2007. In June 2008, we terminated our license agreement with Asubio Pharma, as well as our supply agreement with Asubio Pharma and Nippon Soda. As a result of these actions, we recorded charges of $4.2 million during the second quarter of 2008 related to

amounts due upon termination of these agreements. Additionally, we recorded a charge of $2.7 million during the second quarter of 2008 related to the obligation to reimburse MEDA for costs to decontaminate its facility. These increases were partially offset by a reduction of $1.0 million in internal and external clinical and non-clinical development costs. During the second quarter of 2008, our clinical activities related to faropenem medoxomil were limited to steps required to complete patient monitoring and database analysis for our Phase III clinical trial for the treatment of acute exacerbation of chronic bronchitis, which was discontinued in April 2008. We expect to incur additional costs for required patient monitoring and database analysis until the final clinical report is filed with the U.S. Food and Drug Administration, or FDA, which is expected in the third quarter of 2008.

 

In the second quarter of 2008, costs to support our REP8839 program were $0.1 million compared to $1.2 million in the second quarter of 2007. Costs related to this program have decreased significantly due to our decision to suspend this program in the fourth quarter of 2007.

 

In the second quarter of 2008, other research and development costs were $3.9 million compared to $2.4 million in the second quarter of 2007. Costs of external preclinical research increased by $1.2 million to advance our C. difficile , or REP3123, and DNA replication inhibition programs. Costs of internal research and development personnel in support of these programs also increased by $0.3 million during the second quarter of 2008.

 

During the second quarter ended June 30, 2008 we incurred approximately $1.2 million in restructuring charges which are included in the costs associated with our clinical programs as described above. These charges consisted primarily of severance payments due to impacted personnel.

 

Clinical development timelines, likelihood of success and associated costs are uncertain and therefore vary widely. On an on-going basis we make determinations as to which research and development projects to pursue and how much funding to direct toward each project. Due to the risks inherent in the clinical trial and research process, development completion dates and costs will vary significantly for each product candidate and are difficult to estimate. The lengthy regulatory approval process for our current and potential product candidates requires substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals for our product candidates could cause the costs of our research and development to increase and have a material adverse effect on our results of operations. We cannot be certain if and when any cash flows from our current product candidates will commence.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses were $4.7 million for the second quarter of 2008, compared to $3.3 million for the second quarter of 2007. The increase of $1.4 million is primarily the result €1.1 million ($1.7 million at June 30, 2008) recorded during the second quarter of 2008 related to our arbitration with MEDA. The amount represents our estimate of the outcome, within a range of possible outcomes, of the arbitration or as a result of a settlement reached between the parties. This increase was partially offset by $0.2 million in lower personnel related costs, excluding share-based compensation, following restructuring actions in the fourth quarter of 2007 and second quarter of 2008. Additionally, as a result of our restructured operations, actual and expected forfeitures of stock options increased, resulting in a decrease of $0.3 million in share-based compensation during the second quarter of 2008 as compared to the second quarter of 2007. During the remainder of 2008, we expect that selling, general and administrative expenses will be lower than 2007 levels.

 

Investment Income and Other, net

 

Investment income and other was $0.4 million for the second quarter of 2008, compared to $1.5 million for the second quarter of 2007. The decrease was primarily due to lower overall cash available for investing in 2008 compared to the second quarter of 2007.

Six Months Ended June 30, 2008 and 2007

 

Revenue

 

We reported no revenue during the six months ended June 30, 2008 compared to $58.6 million for the six months ended June 30, 2007. Revenue recognized during the six months ended June 30, 2007 included $56.2 million of license revenue, representing amortization of $60 million in upfront and milestone payments recognized upon the termination of our former collaboration and commercialization agreement with Forest Laboratories in the second quarter of 2007. Revenue recognized during the six months ended June 30, 2007 also included $2.4 million of contract revenue for activities funded under our agreement with Forest Laboratories.

 

Research and Development Expense

 

Research and development expenses were $22.1 million for the six months ended June 30, 2008 as compared to $17.8 million for the six months ended June 30, 2007. Research and development expenditures made to advance our product candidates and other research efforts were as follows (in thousands):

 

 

Costs to support our faropenem medoxomil program totaled $14.0 million in the six months ended June 30, 2008 compared to $10.9 million of costs incurred during the six months ended June 30, 2007. In June 2008, we terminated our license agreement with Asubio Pharma, as well as our supply agreement with Asubio Pharma and Nippon Soda. As a result of these actions, we recorded charges of $4.2 million during the six months ended June 30, 2008 related to amounts due under these agreements. Additionally, we recorded a charge of $2.7 million during the six months ended June 30, 2008 related to the obligation to reimburse MEDA for costs to decontaminate its facility. These increases were partially offset by a reduction of $3.1 million in internal and external clinical and non-clinical development costs incurred during the six months ended June 30, 2008. In 2008, our development activities were limited to one Phase III clinical trial for the treatment of acute exacerbation of chronic bronchitis. In April 2008, this trial was discontinued and our activities were reduced to completing steps required to complete patient monitoring and database analysis for the trial. We expect to incur additional costs for required patient monitoring and database analysis until the final clinical report is filed with the U.S. Food and Drug Administration, or FDA, which is expected in the third quarter of 2008.

 

In the six months ended June 30, 2008, costs to support our REP8839 program were $0.3 million compared to $2.6 million in the six months ended June 30, 2007. Costs related to this program have decreased significantly due to our decision to suspend this program in the fourth quarter of 2007.

 

In the six months ended June 30, 2008, other research and development costs were $7.8 million compared to $4.2 million in the six months ended June 30, 2007. Costs of external preclinical research increased by $2.7 million to advance our C. difficile , or REP3123, and DNA replication inhibition programs. Costs of internal research and development personnel in support of these programs also increased by $0.6 million during the six months ended June 30, 2008.

 

During the six months ended June 30, 2008 we incurred approximately $1.2 million in restructuring charges which are included in the costs associated with our clinical programs as described above. These charges consisted primarily of severance payments due to impacted personnel.

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses were $6.1 million for the six months ended June 30, 2008 compared to $6.8 million for the six months ended June 30, 2007. The decrease of $0.7 million is primarily the result of $0.9 million in lower personnel related costs, excluding share-based compensation, following several organizational restructurings. Additionally, as a result of our restructured operations, actual and expected forfeitures of stock options increased, resulting in a decrease of $0.8 million in share-based compensation during the six months ended June 30, 2008 compared to the six months ended June 30, 2007. These decreases were partially offset by €1.1 million ($1.7 million at June 30, 2008) recorded during the six months ended June 30, 2008 related to our arbitration with MEDA. The amount represents our estimate of the outcome, within a range of possible outcomes, of the arbitration or as a result of a settlement reached between the parties.

 

Investment Income and Other, net

 

Investment income and other was $1.0 million for the six months ended June 30, 2008, compared to $3.0 million for the six months ended June 30, 2007. The decrease was primarily due to lower overall cash available for investing in 2008 compared to the first half of 2007.

 

Liquidity and Capital Resources

 

At June 30, 2008, we had $64.7 million in cash, cash equivalents and short-term investments. We have accumulated significant aggregate operating losses since our inception and at June 30, 2008 we had an accumulated deficit of $136.5 million. We have funded our operations to date principally from private placements of equity securities and convertible notes totaling $121.5 million, amounts received from Forest Laboratories under our former collaboration and commercialization agreement totaling $74.6 million and net proceeds from the initial public offering of our common stock totaling $44.5 million.

 

In 2005, we entered into a supply agreement with MEDA for the production of 300 mg adult tablets of faropenem medoxomil, which was amended in 2006. We were required to buy all of our requirements for 300 mg adult faropenem medoxomil tablets from MEDA until cumulative purchases exceeded €22 million (approximately $34.8 million at June 30, 2008). Beginning in 2006, we became obligated to make €2.3 million (approximately $3.6 million at June 30, 2008) in annual minimum purchases of 300 mg adult tablets from MEDA. If in any year we did not satisfy our minimum purchase commitments, we were required to pay MEDA the shortfall amount. Additionally, the agreement provided that, upon termination, we would be required to compensate MEDA for documented costs to decontaminate its facility up to a maximum of €1.7 million (approximately $2.7 million at June 30, 2008). Based on the arbitration provisions of the contract, we expect the arbitration process to be completed in the second half of 2008.

 

In 2006, the supply agreement with MEDA was amended and our obligations for purchase commitments and facility decontamination costs were suspended and deemed satisfied by Forest Laboratories pursuant to an agreement between MEDA and Forest Laboratories. In February 2007, concurrent with Forest Laboratories’ termination of its supply agreement with MEDA, the previously suspended provisions in our agreement with MEDA were no longer suspended, and our obligations to MEDA with respect to purchase commitments and facility decontamination costs were no longer waived. Following this termination, in April 2007, we provided notice to MEDA of our termination of the supply agreement between us and MEDA in accordance with the termination provisions of the agreement as future clinical development of faropenem medoxomil adult tablets would use 600 mg dosing. As this notice occurred before the effective date of the termination of our collaboration agreement with Forest Laboratories, we believe that Forest Laboratories, under the terms of the collaboration agreement, is responsible for supply chain obligations related to faropenem medoxomil, including minimum purchase commitments through May 7, 2007 (the term of the collaboration agreement) and decontamination obligations under the MEDA agreement. In the fourth quarter of 2007, MEDA invoiced us for 2007 minimum purchase fees. In the first quarter of 2008, we paid the portion of minimum purchase fees incurred through May 11, 2007, the effective date of our termination of the supply agreement, plus interest.

In May 2008, MEDA filed a demand for arbitration and amended its demand in July 2008 shortly after we terminated our license agreement with Asubio Pharma and relinquished all rights to the faropenem medoxomil program. In its amended demand, MEDA claims that we terminated the supply agreement in June 2008 when we returned the faropenem medoxomil program to Asubio Pharma and did not have the right to terminate the supply agreement in April 2007. We believe that we had the right to terminate the agreement in April 2007. However, if it is determined in arbitration that the agreement was not terminated until June 2008, we would be required to pay MEDA up to €2.7 million ($4.2 million at June 30, 2008) plus interest for additional minimum purchases fees and may not be able to recover amounts incurred (up to €1.7 million or $2.7 million at June 30, 2008) to reimburse MEDA for costs to decontaminate its facility from Forest Laboratories under the collaboration agreement. During the second quarter of 2008, we recorded as research and development expense €1.7 million ($2.7 million at June 30, 2008) related to our obligation to reimburse MEDA for costs to decontaminate its facility, representing the maximum amount of our obligation to MEDA for decontamination of its facility. Our accrual is based on information provided by MEDA that they intend to decontaminate the facility and that actual decontamination costs are expected to exceed the limit specified in the agreement. In accordance with our agreement with Forest Laboratories in effect at the time of terminating the MEDA agreement, upon receipt of documentation of decontamination costs from MEDA, we will invoice Forest Laboratories. At June 30, 2008, we also recorded as general and administrative expenses €1.1 million ($1.7 million at June 30, 2008) which represents our estimate of possible outcomes, within a range of possible outcomes, from the arbitration or as a result of a settlement reached between the parties. While we believe that we have acted in accordance with the terms of the supply agreement, estimates related to these matters are volatile and as such, it is reasonably possible that these estimates could change in the near term resulting in a future adjustment to our accrual of €2.8 million ($4.4 million at June 30, 2008). Based on the arbitration provisions of the contract, we expect the arbitration process to be completed in the second half of 2008.

 

In May 2007, we entered into an arrangement with an investment bank to provide investment banking services. Under the terms of the agreement, we may incur transaction fees of at least $4 million and up to $6 million based on the value of a completed license or strategic transaction as defined.

 

We have entered into employment agreements with our chief executive officer and certain other executive officers that provide for base salary, eligibility for bonuses and other generally available benefits. The employment agreements provide that we may terminate the employment of the executive at any time with or without cause. If an executive is terminated without cause or such executive resigns for good reason, as defined, then the executive is entitled to receive a severance package consisting of salary continuation for a period of twelve months (or eighteen months with respect to our chief executive officer) from the date of termination among other benefits. If such termination occurs one month before or thirteen months following a change of control, then the executive is entitled to: i) salary continuation for a period of twelve months (or eighteen months with respect to our chief executive officer and chief scientific officer) from the date of termination, ii) a bonus equal to the average of the executive’s annual bonuses for the two years prior to the change in control termination (or one and a half times the average with respect to the chief executive officer), iii) acceleration of vesting of all of the executive’s outstanding unvested options to purchase our common stock, iv) and other benefits.

 

Additionally, we entered into retention bonus agreements with our chief financial officer and chief senior vice president of corporate development. The agreements provide that each such executive is eligible to receive both: i) a cash bonus in the amount of $0.1 million (Retention Bonus), provided that the officer remains employed by us through September 30, 2008, and ii) a cash bonus in an amount of not less than $0.1 million and not greater than $0.2 million, which final amount will be determined by our board of directors in its sole discretion, provided that such executive remains employed by us through the consummation of a strategic transaction. In the event that the executive is terminated without cause or such executive resigns for good reason prior to September 30, 2008, such executive will become entitled to the Retention Bonus.

 

During 2007 we established a severance benefit plan that defines termination benefits for all eligible employees, as defined, not under an employment contract, if the employee is terminated without cause. Under this plan, employees whose employment is terminated without cause are provided a severance benefit of

between nine and eighteen weeks pay, based on their employee grade level, as defined, plus an additional two weeks pay for each year of service.

 

We have not yet commercialized our product candidates or generated any revenue from product sales. We anticipate that we will continue to incur substantial net losses in the next several years as we develop our products, conduct and complete clinical trials, pursue additional product candidates, expand our clinical development team and corporate infrastructure and prepare for the potential commercial launch of our product candidates.

 

The pace and outcome of our discovery research program are difficult to predict. These projects may require several years and substantial expenditures to complete and may ultimately be unsuccessful. If we enter into third party collaborations or acquire new product candidates, the timing and amounts of any related licensing cash flows or expenses are likely to be highly variable. As a result, we anticipate that our quarterly results will fluctuate for the foreseeable future. In view of this variability and of our limited operating history, we believe that period-to-period comparisons of our operating results are not meaningful and you should not rely on them as indicative of our future performance.

 

Based on the current status of our product development and commercialization plans, we believe that our current cash, cash equivalents, short-term investments and interest earned on these balances will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures through at least the next 12 months. This forecast of the period in which our financial resources will be adequate to support operations is a forward-looking statement and involves risks, uncertainties and assumptions. Our actual results and the timing of selected events may differ materially from those anticipated as a result of many factors, including but not limited to those discussed under “Risk Factors” in Part II, Item 1A of this quarterly report.

 

Our future capital uses and requirements depend on a number of factors, including but not limited to the following:

 

 

If our available cash, cash equivalents, short-term investments and interest earned on these balances are insufficient to satisfy our liquidity requirements, or if we develop additional products or pursue additional applications for our products or conduct additional clinical trials beyond those currently contemplated, we may seek to sell additional equity or debt securities or acquire a credit facility. The sale of additional equity may result in additional dilution to our stockholders. If we raise additional funds through the issuance of debt securities, those securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to modify our planned research, development and commercialization strategy, which could adversely affect our business.

Critical Accounting Policies and Estimates

 

This discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these condensed financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, contingent assets and liabilities, revenues, expenses and related disclosures. Actual results may differ from these estimates. Our significant accounting policies are described in Note 2 of “Notes to Condensed Financial Statements” included elsewhere in this report. We believe the following accounting policies affect our more significant judgments and estimates used in the preparation of our condensed financial statements.

 

Clinical Trial and Other Accrued Expenses

 

As part of the process of preparing our financial statements, we are required to estimate accrued expenses. This process involves identifying services that third parties have performed on our behalf and estimating the level of service performed and the associated cost incurred on these services as of each balance sheet date in our financial statements. We are party to agreements which include provisions that require payments to the counterparty under certain circumstances. Additionally, we are required to asses and, if appropriate, accrue for certain loss contingencies related to litigation or arbitration claims. We develop estimates of liabilities using our judgment based upon the facts and circumstances known and account for these estimates in accordance with accounting principles involving accrued expenses generally accepted in the U.S. In regards to our clinical trials, we record expenses based on estimates of the services received and efforts expended pursuant to contracts with clinical research organizations (CROs) and other third party vendors associated with our clinical trials. We contract with third parties to perform a range of clinical trial activities in the ongoing development of our product candidates. The terms of these agreements vary and may result in uneven payments. Payments under these contracts depend on factors such as the achievement of certain defined milestones, the successful enrollment of patients and other events. The objective of our clinical trial accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. In doing so, we rely on information from CROs and our clinical operations group regarding the status of our clinical trials to calculate our accrual for clinical expenses at the end of each reporting period. Our estimates and assumptions could differ significantly from the amounts that we actually may incur.

 

Share-Based Compensation

 

We have adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment (SFAS 123(R)), which requires compensation costs related to share-based transactions, including employee stock options, to be recognized in the financial statements based on fair value. We adopted SFAS 123(R) using the prospective method. Under this method, compensation cost is recognized based on the fair value of all share-based awards granted or modified on or after January 1, 2006.

 

We selected the Black-Scholes option pricing model as the most appropriate valuation method for option grants with service and/or performance conditions. The Black-Scholes model requires inputs for risk-free interest rate, dividend yield, volatility and expected lives of the options. Since the Company has a limited history of stock activity, expected volatility is based on historical data from several public companies similar in size and value to us. We will continue to use a weighted average approach using historical volatility and other similar public entity volatility information until our historical volatility is sufficient for use to measure expected volatility for future option grants. We estimate the forfeiture rate based on historical data. Based on an analysis of historical forfeitures, we applied an annual forfeiture rate of 20% during the six months ended June 30, 2008. The forfeiture rate is re-evaluated on a quarterly basis. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected lives for options granted represents the period of time that options granted are expected to be outstanding and is derived from historical exercise behavior.

 

During the second quarter of 2008, we estimated the fair value of options granted to employees as of the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions.

Expected volatility was estimated to be 75%. The weighted average risk free interest rate was 1.91% and the dividend yield was 0.00%. The weighted average expected lives for each individual vesting tranche under the graded vesting attribution method discussed below was estimated to be 1.00 year.

 

For stock options granted as consideration for services rendered by nonemployees and for options that continue to vest upon a change in status from employee to nonemployee, the Company recognizes compensation expense in accordance with the requirements of SFAS 123(R), Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services and EITF 00-18, Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees , as amended.

 

We have estimated the fair value of share-based payments issued to nonemployees based on the estimated fair value of the stock options granted. We have historically determined that this basis was more reliably determinable than estimating the fair value of the services received. The estimated fair value of options granted to nonemployees is expensed over the service period (which is generally equal to the period over which the options vest) and remeasured each reporting date until the options vest or performance is complete.

 

If an employee becomes a nonemployee and continues to vest in an option grant under its original terms, the option is treated as an option granted to a nonemployee prospectively, provided the individual is required to continue providing services. The option is accounted for prospectively under EITF No. 96-18 such that the fair value of the option is remeasured at each reporting date until the earlier of i) the performance commitment date or ii) the date the services have been completed. Only the portion of the newly measured cost attributable to the remaining requisite service period is recognized as compensation cost prospectively from the date of the change in status.

 

The fair value of share-based payments issued to nonemployees during the quarter ended June 30, 2008 was estimated using the Black-Scholes option pricing model and the following weighted average assumptions: i) risk-free interest rate of 4.05%, ii) contractual life of 10 years, iii) volatility of 75% and iv) no expected dividends. We recognized share-based compensation expense relating to nonemployee options of $0.1 million for the three and six months ended June 30, 2008. No amounts were recognized in 2007.

 

Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007; however, the FASB provided a one year deferral for implementation of the standard for non-financial assets and liabilities. We adopted SFAS 157 effective January 1, 2008 for all financial assets and liabilities. The adoption did not have a material impact on our financial statements. We do not expect that the remaining provisions of SFAS 157, when adopted, will have a material impact on our financial statements.

 

 

Our exposure to market risk is primarily limited to our cash, cash equivalents, and short-term investments. We have attempted to minimize risk by investing in quality financial instruments, primarily money market funds, federal agency notes, commercial paper, bank and corporate debt securities and U.S. treasury notes, with no security having an effective duration in excess of two years. The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments in a variety of marketable securities, including U.S. government, money market funds and under certain circumstances, derivative financial instruments. Our cash and cash equivalents as of June 30, 2008 included a liquid

money market account. The securities in our investment portfolio are classified as available-for-sale or held-to-maturity and are, due to their short-term nature, subject to minimal interest rate risk.

 

 

Evaluation of Disclosure Controls and Procedures.   As of the end of the period covered by this report, our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”). Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2008, our chief executive officer and chief financial officer concluded that, as of such date, the Company’s disclosure controls and procedures are effective at providing reasonable assurance that all material information required to be included in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in 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.

 

Changes in Internal Controls over Financial Reporting.   No changes in our internal control over financial reporting occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

 

 

We are not currently a party to any legal proceedings. However, we are currently party to arbitration proceedings with MEDA Manufacturing GmbH, or MEDA. In May 2008, we were served with a Demand for Arbitration (the “Demand”), as filed by MEDA with the American Arbitration Association International Centre for Dispute Resolution, from alleging that we breached certain of our obligations under a Supply Agreement dated April 4, 2005, between us and MEDA (the “Supply Agreement”). MEDA amended its Demand in July 2008, following our termination of our license agreement for faropenem medoxomil with Asubio Pharma Co., Ltd, or Asubio Pharma. On April 27, 2007, we provided notice to MEDA of our termination of the Supply Agreement in accordance with the termination provisions of the Supply Agreement. We believe that we do not have obligations to MEDA under the Supply Agreement beyond May 11, 2007. The amended Demand seeks damages for breach of contract in the amount of €2.7 million (approximately $4.2 million at June 30, 2008) plus interest on such amounts and reimbursement of MEDA’s attorney fees and other costs incurred in the proceeding represented by the Demand. If the April 2007 termination of the Supply Agreement is determined to be ineffective, we would remain obligated for future decontamination fees of up to €1.7 million (approximately $2.7 million at June 30, 2008). We intend to vigorously defend ourselves against the allegations made in the amended Demand and based on the arbitration provisions of the contract, we expect the arbitration process to be completed in the second half of 2008.

 

 

You should carefully consider the risks described below, which we believe are the material risks of our business. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained in our SEC filings, including our financial statements and related notes. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. We are relying upon the safe harbor for all forward-looking statements in this Report, and any such statements made by or on behalf of the Company are qualified by reference to the following cautionary statements, as well as to those set forth elsewhere in this Report.

We are currently pursuing strategic alternatives that include the merger or acquisition of some or all of our assets, which may divert attention from the development of our current product candidates or cause us to shift our focus to other assets or product candidates that have not yet been identified. The failure to enter into a strategic transaction or entering into a strategic transaction may materially and adversely affect our business.

 

Our operating strategy includes pursuing strategic alternatives. The strategic alternatives that we consider may involve a merger or acquisition of some or all of our assets. Such a transaction could involve a complete divestment of our current product candidates or the addition of assets and product candidates to our research and development pipeline that are currently unknown and therefore cannot be evaluated today. We cannot assure you that any of such additional assets or product candidates will be profitable or well-received by the market. Our board of directors and management team have devoted and will need to devote substantial time and resources to the consideration and implementation of any such strategic alternatives. We have altered our product development strategy in an effort to maximize the strategic opportunities that may be available for us. In addition, the failure to enter into a strategic transaction or close an announced strategic transaction may materially and adversely affect our business. Further, upon review of the strategic transactions available to us, our board of directors and management may conclude that we enter into a plan of liquidation, and after settlement of all identified outstanding liabilities, distribute net cash proceeds to our then current shareholders. Our failure to enter into a strategic transaction could cause us to implement future restructurings that would result in the further downsizing of our operations and disruption to our business.

 

We have received a Warning Letter from the FDA for our NDA filed in December 2005 for faropenem medoxomil, our former product candidate that had been licensed from Asubio Pharma. Failure to resolve the matters addressed in the Warning Letter could negatively impact our ability to undertake clinical trials for our other product candidates or complete future IND and NDA submissions.

 

On January 22, 2008, we received a Warning Letter from the Division of Scientific Investigation of the FDA, or DSI, informing us of objectionable conditions found during its investigation of our role as applicant for our NDA for faropenem medoxomil. The FDA’s observations were based on its establishment inspection reports following on site inspections in conjunction with the FDA’s review of our NDA. Specifically DSI cited that we failed to make available the underlying raw data from the investigation for the FDA’s audit and failed to provide the FDA adequate descriptions and analyses of any other data or information relevant to the evaluation of the safety and effectiveness of faropenem medoxomil obtained or otherwise received by us from any source derived from clinical investigations. The clinical trials that supported our NDA were conducted by Bayer as a previous licensee of faropenem medoxomil. In June 2008, DSI made further inquires of us related to our previous responses to their observations in the Warning Letter. In July 2008, we communicated to the FDA our decision to terminate our license for faropenem medoxomil with Asubio Pharma and withdrew the NDA from consideration by the FDA. We also informed DSI of these actions. In a communication dated July 22, 2008 the FDA commented that since we have active Investigational New Drug applications, or IND’s, and ongoing clinical trials the issues raised in the Warning Letter remained open. Following receipt of this communication, we withdrew all of our open IND’s which relate to faropenem medoxomil and REP8839, and are closing out our remaining clinical trial reports in connection with our clinical trial using faropenem medoxomil for treatment of acute exacerbations of chronic bronchitis for which patient enrollment was stopped in April 2008. If we are unable to sufficiently establish to the FDA that future clinical trials conducted by us would be in accordance with FDA regulations, we may be subject to enforcement action by the FDA including being subject to the FDA’s Application Integrity Policy. This policy would require third party validation of the integrity of the raw data underlying any of our future filings to the FDA before those filings would be accepted for consideration. Such a requirement would be onerous and require significant additional time and expense for the clinical development and potential approval of our product candidates. Further, we could be subject to additional actions from the FDA that may negatively impact our ability to enter into clinical trials or submit an IND or NDA in the future.

If lawsuits or arbitration proceedings arising as a result of termination of collaboration or other commercial contracts are successfully brought against us, we may incur substantial liabilities and may be unable to commercialize our product candidates.

 

The interpretation of the terms of our collaboration and commercial agreements may be the subject of disagreement between us and our collaborators and other commercial partners that could result in lawsuits and/or arbitration proceedings. If former partners or other parties to our commercial contracts are successful in lawsuits or arbitration proceedings, we may incur judgments against us that could have a material impact on our financial position, limit our ability to complete development of and launch commercially our product candidates, and be a distraction to our business.

 

Between February 6, 2007 and May 7, 2007, we operated under the termination provisions of our collaboration agreement with Forest Laboratories. On April 27, 2007, under the termination provisions of our agreement with Forest Laboratories, we terminated our agreement with MEDA for the manufacture of 300 mg tablets of faropenem medoxomil. MEDA has disputed our right to terminate the agreement on the basis indicated in our notice of termination and contend that the agreement remained in place until the date we terminated our license agreement with Asubio Pharma, thereby terminating the entire faropenem medoxomil development program. We believe we have acted in accordance with the terms of these and other commercial agreements. MEDA has demanded an arbitration hearing to resolve this dispute. The result of an arbitration hearing is binding in accordance with the arbitration provisions of the agreement. If it is determined in an arbitration that we have obligations to MEDA under the agreement beyond May 11, 2007, then we may incur additional costs up to €2.7 million ($4.2 million as of June 30, 2008) plus interest. At June 30, 2008, we accrued for €1.1 million ($1.7 million at June 30, 2008) in amounts we may become obligated to pay as an outcome of the arbitration or as a result of a settlement reached between the parties.

 

Our drug discovery approach and technologies and our product candidates are unproven and in very early stages of development, which may not allow us to establish or maintain a clinical development pipeline or successful collaborations, and may never result in the discovery or development of commercially viable products.

 

Following our decision to terminate our license for faropenem medoxomil, we are dependent upon the success of the other product candidates in our pipeline or other compounds we may in-license. All of our existing product candidates and development stage programs are in preclinical development. We are dependent on the potential success of our internal discovery research programs and product candidates. Development of REP8839, one of our product candidates that has completed its Phase I clinical trials, was suspended by us due to the incremental investment that would be required to optimize the formulation of REP8839 and the niche initial target market being addressed by the product. As a significant part of our growth strategy, we intend to develop and commercialize additional products and product candidates through our discovery research program. A significant portion of the research that we are conducting involves new and unproven technologies, and may not result in the discovery or development of commercially viable products. Research programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development. The process of successfully discovering product candidates is expensive, time-consuming and unpredictable, and the historical rate of failure for drug candidates is extremely high. Data from our current research programs may not support the clinical development of our lead compounds or other compounds from these programs, and we may not identify any compounds suitable for recommendation for clinical development. Moreover, any compounds we recommend for clinical development may not be effective or safe for their designated use, which would prevent their advancement into clinical trials and impede our ability to maintain or expand our clinical development pipeline. If we are unable to identify new product candidates or advance our lead compounds into clinical development, we may not be able to establish or maintain a clinical development pipeline or generate product revenue. Our ability to identify new compounds and advance them into clinical development also depends upon our ability to fund our research and development operations, and we cannot be certain that additional funding will be available on acceptable terms, or at all. There is no

guarantee that we will be able to successfully advance any product candidates identified through our discovery research program into clinical trials or successfully develop any product candidate we advance into clinical trials for commercial sale. If we are unable to develop suitable potential product candidates through internal research programs or are not able to advance the development of our early stage product candidates REP3123 and DNA replication inhibition, our business will suffer and we may be unable to grow our business.

 

We are at an early stage of development as a company, with no current sources of revenue, and we may never generate future revenue or become profitable.

 

We are a biopharmaceutical company that emerged from the development stage in February 2006 and have a limited operating history. Currently, we have no products approved for commercial sale and, to date, we have not generated any revenue from product sales. Our ability to generate revenue depends heavily on:

 

 

Our existing product candidates and development programs will require extensive additional clinical evaluation, regulatory approval, significant marketing efforts and substantial investment before they can provide us with any revenue. If we do not receive regulatory approval for and successfully commercialize our product candidates, we will be unable to generate any royalty revenue from product sales for many years, if at all. If we are unable to generate revenue, we will not become profitable, and we may be unable to continue our operations.

 

We have incurred significant operating losses since inception and anticipate that we will incur continued losses for the foreseeable future.

 

We have experienced significant operating losses since our inception in December 2000. At June 30, 2008, we had an accumulated deficit of approximately $137 million. We have generated no revenue from product sales to date. We have funded our operations to date principally from the sale of our securities and payments by Forest Laboratories under our former collaboration agreement. As a result of the suspension of our clinical development of faropenem medoxomil, our prospects for near term future revenues are substantially uncertain. We expect to continue to incur substantial additional operating losses for the next several years as we pursue our clinical trials and research and development efforts. Because of the numerous risks and uncertainties associated with developing and commercializing antibiotics, we are unable to predict the extent of any future losses. We may never have any significant future revenue or become profitable on a sustainable basis.

 

If we fail to obtain additional financing, we may be unable to complete the development and commercialization of our product candidates, or continue our research and development programs.

 

Our operations have consumed substantial amounts of cash since inception. We currently expect to spend substantial amounts to:

 

 

We do not expect that our current capital resources will be sufficient to fund the complete development of our product candidates generated from our discovery research program. To date, our sources of cash have been limited primarily to the proceeds from the sale of our securities and payments by Forest Laboratories under our former collaboration agreement. As a result of the suspension of our clinical development of faropenem medoxomil, our prospects for near term future revenues are substantially uncertain. We are currently using our cash and cash equivalents, short-term investments and interest earned on these balances toward the funding necessary to support our planned activities. If the funds provided from existing resources

are insufficient to satisfy our future capital needs, or if we develop, in-license or acquire additional products or product candidates or pursue additional applications for our product candidates, we may seek to sell additional equity or debt securities. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional funds by issuing equity securities, our stockholders may experience significant dilution. Any debt financing, if available, may involve restrictive covenants, such as limitations on our ability to incur additional indebtedness, limitations on our ability to acquire or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If we are unable to raise additional capital when required or on acceptable terms, we may have to significantly delay, scale back or discontinue the development and/or commercialization of one or more of our product candidates. We also may be required to:

 

 

If we fail to enter into new strategic collaborations, we may have to reduce or delay our rate of product development and commercialization and/or increase our expenditures.

 

Our business model is based in part upon entering into strategic collaborations for discovery and/or development of some of our product candidates. Our strategy to develop and commercialize our products includes entering into various relationships with pharmaceutical or biotechnology companies to advance our programs. We may not be able to negotiate any of our collaborations on acceptable terms. If we are not able to establish collaborative arrangements, we may have to reduce or delay further development of some of our programs and/or increase our expenditures and undertake the development activities at our own expense. If we are not able to establish and maintain strategic collaborations on acceptable terms:

 

 

In this event, we would likely be required to limit the size or scope of one or more of our programs.

 

Securing a strategic partner to develop and commercialize our product candidates may require us to relinquish valuable rights and will render us dependent on the efforts of any future partners, over which we would have limited control, and if our collaborations are unsuccessful, our potential to develop and commercialize product candidates and to generate future revenue from our product candidates would be significantly reduced.

 

In order to secure a strategic partner to develop and commercialize our product candidates, we may be required to relinquish valuable rights to our potential products or proprietary technologies. If we are able to identify and reach agreement with collaborators for our product candidates, those relationships will be subject to a number of risks, including:

 

 

 

If as a result of our financial condition or other factors we enter into a strategic collaboration while a drug candidate program is in early preclinical development, we may not generate as much near or long-term revenue from such program as we could have generated if we had the resources to further independently develop such program. In addition, if we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

 

Any of our product candidates that we advance into clinical trials are subject to extensive regulation, which can be costly and time consuming, cause unanticipated delays, or prevent the receipt of the required approvals to commercialize our product candidates.

 

The clinical development, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution of any of our product candidates that we advance into clinical trials are subject to extensive regulation by the FDA in the U.S. and by comparable governmental authorities in foreign markets. Currently, we have completed preclinical testing of REP3123. In the U.S. and in many foreign jurisdictions, rigorous preclinical testing and clinical trials and an extensive regulatory review process must be successfully completed before a new drug can be sold. Satisfaction of these and other regulatory requirements is costly, time consuming, uncertain and subject to unanticipated delays. Clinical testing is expensive, can take many years to complete and its outcome is uncertain. Failure can occur at any time during the clinical trial process. The results of preclinical studies and early clinical trials of our product candidates may not be predictive of the results of later-stage clinical trials. Product candidates in later stages of clinical trials may fail to show the desired safety and efficacy traits despite having progressed through initial clinical testing. The time required to obtain approval by the FDA is unpredictable but typically takes many years following the commencement of clinical trials, depending upon numerous factors. In addition, approval policies, regulations, or the type and amount of clinical data necessary to gain approval may change. We have not obtained regulatory approval for any product candidate.

 

Our product candidates may fail to receive regulatory approval for many reasons, including the following:

 

 

 

The FDA or comparable foreign regulatory authorities might decide that our data is insufficient for approval and require additional clinical trials or other studies. Furthermore, even if we do receive regulatory approval to market a commercial product, any such approval may be subject to limitations on the indicated uses for which we may market the product. It is possible that none of our existing product candidates or any product candidates we may seek to develop in the future will ever obtain the appropriate regulatory approvals necessary for us or our collaborators to begin selling them.

 

Also, recent events have raised questions about the safety of marketed drugs and may result in increased cautiousness by the FDA in reviewing new drugs based on safety, efficacy or other regulatory considerations and may result in significant delays in obtaining regulatory approvals and more stringent product labeling requirements. Further, the FDA has been granted new authority to require additional clinical trials of license holders of pharmaceutical products, including post approval clinical trials, and modify previously approved product labels under the FDA Amendments Act of 2007 that was enacted September 2007. Any delay in obtaining, or inability to obtain, applicable regulatory approvals would prevent us from commercializing our product candidates.

 

If we fail to attract and keep senior management and key scientific personnel, we may be unable to successfully develop our product candidates, conduct our clinical trials and commercialize our product candidates.

 

Our success depends in part on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading academic institutions, clinicians and scientists. We are highly dependent upon our senior management and scientific staff, particularly Kenneth Collins, our President and Chief Executive Officer, Nebojsa Janjic, Ph.D., our Chief Scientific Officer, Mark Smith, our Chief Financial Officer, and Donald Morrissey, our Senior Vice President of Corporate Development. In May 2008 and April 2008, respectively, we eliminated the positions of Roger Echols, M.D., our Chief Medical Officer and Peter Letendre, PharmD., our Chief Commercial Officer, in conjunction with a restructuring of our operations. The loss of services of any of Mr. Collins, Dr. Janjic, Mr. Smith or Mr. Morrissey could delay or prevent the successful completion of our strategy or development of our product candidates.

 

Competition for qualified personnel in the biotechnology and pharmaceutical fields is intense. We will need to hire additional personnel should we expand our clinical development and commercial activities. In addition, we may be required to grant significant amounts of share-based compensation to certain individuals to attract them, which could increase the related non-cash compensation expense. We may not be able to attract and retain qualified personnel on acceptable terms. We do not carry “key person” insurance covering any members of our senior management. Each of our officers and key employees may terminate his or her employment at any time without notice and without cause or good reason.

 

We may need to modify the size of our organization, and we may experience difficulties in managing either growth or restructuring.

 

We are a small company with 27 full time employees as of June 30, 2008. As our development and commercialization plans and strategies develop, we may need to either reduce or expand the size of our employee base for managerial, operational, sales, financial and other reasons. In December 2007, we undertook

an organizational restructuring that reduced the number of employees in the clinical, commercial, administrative and research functions by 27 employees. In April and June 2008 we undertook further restructurings of our operations that reduced our commercial, clinical and administrative staff by a total of 23 employees. Future growth would impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Future restructuring activities may involve significant changes to our drug development and growth strategies, our commercialization plans and other operational matters, including a significant reduction in our employee base. Any future restructuring activity could result in disruption to our business, adversely affecting the morale of our employees and making it more difficult to retain qualified personnel. Also, our management may have to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing either growth or restructuring activities. Our future financial performance and our ability to commercialize our product candidates and to compete effectively will depend, in part, on our ability to effectively manage any future growth or restructuring, as the case may be. To that end, we must be able to:

 

 

We may not be able to accomplish these tasks, and our failure to accomplish any of them could harm our financial results.

 

We currently have no sales organization. If we are unable to establish a direct sales force in the U.S. to promote our product candidates, the commercial opportunity for our product candidates may be diminished.

 

We currently have no sales organization. If we elect to rely on third parties to sell our product candidates in the U.S., we may receive less revenue than if we sold our product candidates directly. In addition, we may have little or no control over the sales efforts of those third parties. In the event we are unable to develop our own sales force or collaborate with a third party to sell our product candidates, we may not be able to commercialize our product candidates which would negatively impact our ability to generate revenue.

 

The commercial success of our product candidates will depend upon attaining significant market acceptance of these products among physicians, patients, health care payors and the medical community.

 

None of our product candidates has been commercialized for any indication. Even if approved for sale by the appropriate regulatory authorities, physicians may not prescribe our product candidates, in which case we would not generate revenue or become profitable. Market acceptance of our product candidates by physicians, health care payors and patients will depend on a number of factors, including:

 

 

 

Even if our product candidates ultimately obtain regulatory approval, many of the above factors may be adversely impacted by the historical difficulty of obtaining any such approval and may create a negative perception among physicians and health care payors of the advantages or efficacy of our product candidates.

 

If product liability lawsuits are successfully brought against us or any future collaboration partners, we may incur substantial liabilities and may be required to limit commercialization of our product candidates.

 

We face an inherent risk of product liability lawsuits related to the testing of our product candidates, and will face an even greater risk if product candidates are introduced commercially. An individual may bring a liability claim against us if one of our product candidates causes, or merely appears to have caused, an injury. If we cannot successfully defend ourselves against the product liability claim, we may incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:

 

 

We are highly dependent upon consumer perceptions of us, and the safety and quality of our products. We could be adversely affected if we are subject to negative publicity. We could also be adversely affected if any of our products or any similar products distributed by other companies prove to be, or are asserted to be, harmful to consumers. Also, because of our dependence upon consumer perceptions, any adverse publicity associated with illness or other adverse effects resulting from consumers’ use or misuse of our products or any similar products distributed by other companies could have a material adverse impact on our results of operations.

 

We have global clinical trial liability insurance that covers our clinical trials up to a $10.0 million annual aggregate limit. Our current or future insurance coverage may prove insufficient to cover any liability claims brought against us. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for our product candidates. In addition, because of the increasing costs of insurance coverage, we may not be able to maintain insurance coverage at a reasonable cost or obtain insurance coverage that will be adequate to satisfy any liability that may arise.

 

We may be required to suspend or discontinue clinical trials due to side effects or other safety risks that could preclude approval of our product candidates.

 

Our clinical trials may be suspended at any time for a number of reasons. We may voluntarily suspend or terminate our clinical trials if at any time we believe that they present an unacceptable risk to participants. In addition, regulatory agencies may order the temporary or permanent discontinuation of our clinical trials at any time if they believe that the clinical trials are not being conducted in accordance with applicable regulatory requirements or that they present an unacceptable safety risk to participants.

 

Many antibiotics can produce significant side effects. Side effects associated with many current antibiotics include kidney and liver toxicities, heart rhythm abnormalities, photosensitivity, rash, and excessive flushing of the skin and central nervous system toxicities, such as seizures. Later clinical trials in a larger patient population could reveal other side effects. These or other side effects could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA or other regulatory authorities stopping further development of or denying approval of our product candidates for any or all targeted indications. Even if we

believe our product candidates are safe, our data is subject to review by the FDA, which may disagree with our conclusions. Moreover, we could be subject to significant liability if any volunteer or patient suffers, or appears to suffer, adverse health effects as a result of participating in our clinical trials.

 

We rely on third parties to conduct our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize our product candidates.

 

We have agreements with third-party contract research organizations to provide monitors for and to manage data for our clinical programs. We and our contract research organizations are required to comply with current Good Clinical Practices, or GCPs, regulations and guidelines enforced by the FDA for all of our products in clinical development. The FDA enforces GCPs through periodic inspections of trial sponsors, principal investigators and trial sites. If we or our contract research organizations fail to comply with applicable GCPs, the clinical data generated in our clinical trials may be deemed unreliable and the FDA may require us to perform additional clinical trials before approving our marketing applications. We cannot ensure that, upon inspection, the FDA will determine that any of our clinical trials comply with GCPs. In addition, our clinical trials must be conducted with product produced under cGMP regulations, and will require a large number of test subjects. Our failure to comply with these regulations may require us to repeat clinical trials, which would delay the regulatory approval process.

 

Our contract research organizations have the right to terminate their agreements with us in the event of an uncured material breach. In addition, some of our contract research organizations have an ability to terminate their respective agreements with us if it can be reasonably demonstrated that the safety of the subjects participating in our clinical trials warrants such termination, if we make a general assignment for the benefit of our creditors, or if we are liquidated. If any of our relationships with these third-party contract research organizations terminate, we may not be able to enter into arrangements with alternative contract research organizations. If contract research organizations do not successfully carry out their contractual duties or obligations or meet expected deadlines, if they need to be replaced, or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols, regulatory requirements, or for other reasons, our clinical trials may be extended, delayed or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates. As a result, our financial results and the commercial prospects for our product candidates would be harmed, our costs could increase and our ability to generate revenue could be delayed.

 

If we fail to gain and maintain approval for our product candidates in international markets, our market opportunities will be limited.

 

Sales of our product candidates outside of the U.S. will be subject to foreign regulatory requirements governing clinical trials and marketing approval. Even if the FDA grants marketing approval for a product candidate, comparable regulatory authorities of foreign countries must also approve the manufacturing or marketing of the product candidate in those countries. Approval in the U.S., or in any other jurisdiction, does not ensure approval in other jurisdictions. Obtaining foreign approvals could result in significant delays, difficulties and costs for us and require additional trials and additional expenses. Regulatory requirements can vary widely from country to country and could delay the introduction of our products in those countries. Clinical trials conducted in one country may not be accepted by other countries and regulatory approval in one country does not mean that regulatory approval will be obtained in any other country. None of our product candidates is approved for sale in international markets and we do not have experience in obtaining regulatory approval in international markets. If we fail to comply with these regulatory requirements or to obtain and maintain required approvals, our target market will be reduced and our ability to generate revenue will be diminished.

 

We may not be able to enter into acceptable agreements to market and commercialize our product candidates in international markets.

 

If appropriate regulatory approvals are obtained, we intend to commercialize our product candidates in international markets through collaboration arrangements with third parties. If we decide to sell our product candidates in international markets, we may not be able to enter into any arrangements on favorable terms or

at all. In addition, these arrangements could result in lower levels of income to us than if we marketed our product candidates entirely on our own. If we are unable to enter into a marketing arrangement for our product candidates in international markets, we may not be able to develop an effective international sales force to successfully commercialize those products in international markets. If we fail to enter into marketing arrangements for our products and are unable to develop an effective international sales force, our ability to generate revenue would be limited.

 

Even if we receive regulatory approval for our product candidates, we will be subject to ongoing significant regulatory obligations and oversight.

 

If we receive regulatory approval to sell our product candidates, the FDA and foreign regulatory authorities may impose significant restrictions on the indicated uses or marketing of such products, or impose ongoing requirements for post-approval studies. Following any regulatory approval of our product candidates, we will be subject to continuing regulatory obligations, such as safety reporting requirements, and additional post-marketing obligations, including regulatory oversight of the promotion and marketing of our products. If we become aware of previously unknown problems with any of our product candidates here or overseas or at our contract manufacturers’ facilities, a regulatory agency may impose restrictions on our products, our contract manufacturers or on us, including requiring us to reformulate our products, conduct additional clinical trials, make changes in the labeling of our products, implement changes to, or obtain re-approvals of, our contract manufacturers’ facilities, or withdraw the product from the market. In addition, we may experience a significant drop in the sales of the affected products, our reputation in the marketplace may suffer and we may become the target of lawsuits, including class action suits. Moreover, if we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution. Any of these events could harm or prevent sales of the affected products or could substantially increase the costs and expenses of commercializing and marketing these products.

 

Our corporate compliance program cannot guarantee that we are in compliance with all potentially applicable regulations.

 

The development, manufacturing, pricing, marketing, sales, and reimbursement of our product candidates, together with our general operations, are subject to extensive regulation by federal, state and other authorities within the U.S. and numerous entities outside of the U.S. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, including suspension or termination of clinical trials, the failure to approve a product candidate, restrictions on our product candidates or manufacturing processes, withdrawal of products from the market, significant fines, or other sanctions or litigation, and exclusion of our products from the Medicare/Medicaid payment system. As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002, some of which have only recently been adopted, and all of which are subject to change. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices and continue to update the program in response to newly implemented or changing regulatory requirements, we cannot ensure that we are or will be in compliance with all potentially applicable regulations. For example, we cannot assure that in the future our management will not find a material weakness in connection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot ensure that we could correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our annual reports filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year, when required. If we fail to comply with the Sarbanes-Oxley Act or any other regulations we could be subject to a range of consequences, including restrictions on our ability to sell equity or otherwise raise capital funds, significant fines, enforcement or other civil or criminal actions by the Securities and Exchange Commission or delisting by the NASDAQ Global Market or other sanctions or litigation. In addition, if we disclose any material weakness in our internal control over financial reporting or other consequence of failing to comply with applicable regulations, this may cause our stock price to decline.

Reimbursement may not be available for our product candidates, which could diminish our sales or affect our ability to sell any future products profitably.

 

Market acceptance and sales of our product candidates will depend on reimbursement policies and may be affected by future health care reform measures. Government authorities and third-party payors, such as private health insurers and health maintenance organizations, decide which drugs they will pay for and establish reimbursement levels. We cannot be sure that reimbursement will be available for any of our product candidates. Also, we cannot be sure that reimbursement amounts will not reduce the demand for, or the price of, our products. We have not commenced efforts to have our product candidates reimbursed by government or third-party payors. If reimbursement is not available or is available only to limited levels, we may not be able to commercialize our products.

 

In both the U.S. and certain foreign jurisdictions, there have been a number of legislative and regulatory changes to the health care system that could impact our ability to sell our products profitably. In particular, the Medicare Modernization Act of 2003 added an outpatient prescription drug benefit to Medicare, which became effective on January 1, 2006. Drug benefits under this provision are administered through private plans that negotiate price concessions from pharmaceutical manufacturers. We cannot be certain that our product candidates will successfully be placed on the list of drugs covered by particular health plans or plan formularies, nor can we predict the negotiated price for our product candidates, which will be determined by market factors. With respect to Medicaid, the Deficit Reduction Act of 2005 made several changes to the way pharmacies are reimbursed under Medicaid, most of which went into effect on January 1, 2007. These changes could lead to reduced drug prices. Many states have also created preferred drug lists and include drugs on those lists only when the manufacturers agree to pay a supplemental rebate. If our product candidates are not included on these preferred drug lists, physicians may not be inclined to prescribe them to their Medicaid patients.

 

As a result of legislative proposals and the trend towards managed health care in the U.S., third-party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement of new drugs. They may also refuse to provide any coverage of uses of approved products for medical indications other than those for which the FDA has granted market approvals. As a result, significant uncertainty exists as to whether and how much third-party payors will reimburse patients for their use of newly-approved drugs, which in turn will put pressure on the pricing of drugs. The availability of numerous generic antibiotics at lower prices than branded antibiotics can also be expected to substantially reduce the likelihood of reimbursement of branded antibiotic product candidates. We expect to experience pricing pressures in connection with the sale of our products due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals.

 

Risks Related to our Intellectual Property

 

It is difficult and costly to protect our proprietary rights, and we may not be able to ensure their protection.

 

Our commercial success will depend in part on obtaining and maintaining patent protection and trade secret protection of our product candidates, and the methods used to manufacture them, as well as successfully defending these patents against third-party challenges. Our ability to protect our product candidates from unauthorized making, using, selling, offering to sell or importation by third-parties is dependent upon the extent to which we have rights under valid and enforceable patents or trade secrets that cover these activities.

 

The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date in the U.S. The biotechnology patent situation outside the U.S. is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the U.S. and other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our licensed patents, our patents or in third-party patents.

The degree of future protection for our proprietary rights is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:

 

 

We also may rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third-party illegally obtained and is using any of our trade secrets is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the U.S. are sometimes less willing to protect trade secrets. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how.

 

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights and we may be unable to protect our rights to, or use, our technology.

 

If we choose to go to court to stop someone else from using the inventions claimed in our patents or our licensed patents, that individual or company has the right to ask the court to rule that these patents are invalid and/or should not be enforced against that third-party. These lawsuits are expensive and would consume time and other resources even if we were successful in stopping the infringement of these patents. In addition, there is a risk that the court will decide that these patents are not valid and that we do not have the right to stop the other party from using the inventions. There is also the risk that, even if the validity of these patents is upheld, the court will refuse to stop the other party on the ground that such other party’s activities do not infringe our rights to these patents.

 

Furthermore, a third-party may claim that we or our manufacturing or commercialization partners are using inventions covered by the third-party’s patent rights and may go to court to stop us from engaging in our normal operations and activities, including making or selling our product candidates. These lawsuits are costly and could affect our results of operations and divert the attention of managerial and technical personnel. There is a risk that a court would decide that we or our commercialization partners are infringing the third-party’s patents and would order us or our partners to stop the activities covered by the patents. In addition, there is a risk that a court will order us or our partners to pay the other party damages for having violated the other party’s patents. We have indemnified our commercial partners against patent infringement claims. The biotechnology industry has produced a proliferation of patents, and it is not always clear to industry participants, including us, which patents cover various types of products or methods of use. The coverage of patents is subject to interpretation by the courts, and the interpretation is not always uniform. If we are sued for patent infringement, we would need to demonstrate that our products or methods of use either do not infringe the patent claims of the relevant patent and/or that the patent claims are invalid, and we may not be able to do this. Proving invalidity, in particular, is difficult since it requires a showing of clear and convincing evidence to overcome the presumption of validity enjoyed by issued patents.

Because some patent applications in the U.S. may be maintained in secrecy until the patents are issued, because patent applications in the U.S. and many foreign jurisdictions are typically not published until eighteen months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our licensors’ issued patents or our pending applications or our licensors’ pending applications, or that we or our licensors were the first to invent the technology. Our competitors may have filed, and may in the future file, patent applications covering technology similar to ours. Any such patent application may have priority over our or our licensors’ patent applications and could further require us to obtain rights to issued patents covering such technologies. If another party has filed a U.S. patent application on inventions similar to ours, we may have to participate in an interference proceeding declared by the U.S. Patent and Trademark Office to determine priority of invention in the U.S. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful, resulting in a loss of our U.S. patent position with respect to such inventions.

 

Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.

 

Risks Related to Ownership of our Common Stock

 

The market price of our common stock is highly volatile.

 

Prior to June 28, 2006, there was no public market for our common stock. We cannot assure you that an active trading market for our common stock will exist at any time. You may not be able to sell your shares quickly or at the market price if trading in our common stock is not active. The trading price of our common stock has been highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

 

 

 

In addition, the stock market in general and the market for biotechnology and biopharmaceutical companies in particular have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market, securities class-action litigation has often been instituted against companies. Such litigation, if instituted against us, could result in substantial costs and diversion of management’s attention and resources, which could materially adversely affect our business and financial condition.

 

We are at risk of securities class action litigation or may become subject to stockholder activism efforts that each could cause material disruption to our business.

 

In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because biotechnology and biopharmaceutical companies have experienced significant stock price volatility in recent years. Further, certain influential institutional investors and hedge funds have taken steps to involve themselves in the governance and strategic direction of certain companies that were perceived to be operating sub-optimally due to governance or strategic related disagreements with such stockholders. Our stock price decreased significantly following our announcement that the FDA had issued a non-approvable letter for faropenem medoxomil, our former product candidate. If we face such litigation or stockholder activism efforts due to this development or any future development affecting us, it could result in substantial costs and a diversion of management’s attention and resources, which could harm our business.

 

Our principal stockholders and management own a significant percentage of our stock and are able to exercise significant influence over matters subject to stockholder approval.

 

Our executive officers, directors and principal stockholders, together with their respective affiliates, currently own a significant percentage of our voting stock, including shares subject to outstanding options and warrants, and we expect this group will continue to hold a significant percentage of our outstanding voting stock. Accordingly, these stockholders will likely be able to have a significant impact on the composition of our board of directors and continue to have significant influence over our operations. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material and adverse effect on the market value of our common stock.

 

We incur significant costs as a result of operating as a public company, and our management is required to devote substantial time to compliance initiatives.

 

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Global Market, have imposed various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have

increased our legal and financial compliance costs and made some activities more time-consuming and costly. For example, these rules and regulations have made it more difficult and more expensive for us to obtain director and officer liability insurance coverage.

 

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, when required, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 may require that we incur substantial accounting expense and expend significant management efforts. We currently do not have an internal audit group, and have had to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would require additional financial and management resources.

 

Substantial sales of our common stock in the public market could cause our stock price to fall.

 

Sales of a substantial number of shares of our common stock in the public market or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that sales may have on the prevailing market price of our common stock.

 

Certain holders of shares of our common stock and warrants to purchase shares of our common stock are entitled to rights with respect to the registration of their shares under the Securities Act. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares purchased by affiliates. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.

 

Future sales and issuances of our common stock or rights to purchase common stock, including pursuant to our equity incentive plans, could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to fall.

 

We expect that significant additional capital will be required in the future to continue our planned operations. To the extent we raise additional capital by issuing equity securities, our stockholders may experience substantial dilution. We may sell common stock in one or more transactions at prices and in a manner we determine from time to time. If we sell common stock in more than one transaction, stockholders who purchase stock may be materially diluted by subsequent sales. Such sales may also result in material dilution to our existing stockholders, and new investors could gain rights superior to existing stockholders. Pursuant to our 2006 Equity Incentive Plan, our management is authorized to grant stock options to our employees, directors and consultants, and our employees are eligible to participate in our 2006 Employee Stock Purchase Plan. The number of shares available for future grant under our 2006 Equity Incentive Plan can, subject to approval of our board of directors, increase each April 1 by the lesser of five percent of the number of total outstanding shares of our common stock on December 31 of the preceding year or 1,325,448 shares, subject to the ability of our board of directors to reduce such increase. Additionally, the number of shares reserved for issuance under our 2006 Employee Stock Purchase Plan can, subject to approval of our board of directors, increase each April 1 by the lesser of one percent of the number of total outstanding shares of our common stock on December 31 of the prior year or 101,957 shares, subject to the ability of our board of directors to reduce such increase. In addition, we also have warrants outstanding to purchase shares of our common stock. Our stockholders will incur dilution upon exercise of any outstanding stock options or warrants.

All of the shares of common stock sold in our initial public offering are freely tradable without restrictions or further registration under the Securities Act of 1933, as amended, except for any shares purchased by our affiliates as defined in Rule 144 under the Securities Act. Rule 144 defines an affiliate as a person who directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, us and would include persons such as our directors and executive officers.

 

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

 

Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes to offset its post-change income may be limited. We believe that, based on an analysis of historical equity transactions under the provisions of Section 382, ownership changes have occurred at two points since our inception. These ownership changes will limit the annual utilization of our net operating losses in future periods. We do not believe, however, that these ownership changes will result in the loss of any of our net operating loss carryforwards existing on the date of each of the ownership changes. We may also experience ownership changes in the future as a result of subsequent shifts in our stock ownership, and such changes may result in the loss of net operating loss carryforwards on such ownership change date.

 

Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders.

 

Provisions in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions include:

 

 

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with an interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder, unless such transactions are approved by our board of directors. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders.

 

 

Recent Sales of Unregistered Equity Securities

 

None.

 

Issuer Purchases Of Equity Securities

 

 

 

 

Not applicable.

 

 

Our annual meeting of stockholders was held on May 8, 2008. At the meeting, our stockholders voted to elect Daniel J. Mitchell and Geoffrey Duyk, M.D., Ph.D. to serve on the Board of Directors until the 2011 Annual Meeting of Stockholders and until their successors are elected and qualified and ratified the appointment of KPMG LLP as our independent auditors for the fiscal year ending December 31, 2008.

 

The results of voting from the stockholders who voted was as follows:

 

On the election of Daniel J. Mitchell our stockholders voted: For: 22,385,651, Against: None, Withheld: 411,647

 

On the election of Geoffrey Duyk, M.D., Ph.D. our stockholders voted: For: 21,973,775, Against: None, Withheld: 823,523.

 

On the ratification and approval of KPMG LLP our stockholders voted: For: 22,662,517 Against: 133,192, Abstain: 1,589.

 

In addition to the directors elected above, Kenneth J. Collins, Kirk K. Calhoun, Augustine Lawlor and Edward Brown continued to serve as directors after the annual meeting.

 

 

Not applicable.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

REPLIDYNE, INC.

 

Mark L. Smith

Chief Financial Officer, Treasurer

(Principal Financial and Accounting Officer)

 

Date: August 5, 2008

Exhibit Index

 

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