UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No. 000-27409
AKESIS PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
| Nevada | 84-1409219 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
888 Prospect Street Suite 320 La Jolla, California | 92037 | |
| (Address of principal executive offices) | (Zip Code) | |
(858) 454-4311
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock ($0.001 Par Value)
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act of 1933. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act of 1934. Yes ¨ No x
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 x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ¨ No x
The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2006 was approximately $6.4 million. For purposes of this calculation, all executive officers and directors of the registrant and all beneficial owners of more than ten percent or more of the registrant’s common stock were considered affiliates.
As of January 31, 2007, the registrant had outstanding 22,580,884 shares of common stock.
Explanatory Note
Restatement of Consolidated Financial Statements
On May 11, 2007, following consultation with, and upon the recommendation of, the management of Akesis Pharmaceuticals, Inc. (“we” or the “Company”), the board of directors of the Company determined that it was necessary to restate the Company’s previously issued consolidated financial statements for the fiscal quarter and year ended December 31, 2006 in order to correct the amount of stock-based compensation expense recorded by the Company for those periods. As a result, this Amendment on Form 10-K/A (the “Amendment” or “Form 10-K/A”) is being filed to reflect the restatement of the previously issued consolidated financial statements for the fiscal quarter and year ended December 31, 2006, which were included in our Form 10-K as originally filed with the Securities and Exchange Commission (the “SEC”) on February 9, 2007 (the “Form 10-K”).
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) requires all share-based payments to employees, including stock awards, to be recognized as expenses in the issuer’s financial statements based on the fair values of those payments, reduced as appropriate based on any estimated forfeitures. In the case of stock-based compensation, the estimation of the number of stock awards that will ultimately be forfeited requires significant judgment and is based on the issuer’s determination of an appropriate rate of estimated forfeitures calculated by reference to a variety of data and assumptions. SFAS No. 123(R) also requires issuers to periodically review their estimated forfeiture rates and, to the extent necessary based on differences between estimated and actual results, to revise such estimated forfeiture rates. In the event of such a revision, any differences between estimated and actual results are required by SFAS No. 123(R) to be recorded as a cumulative adjustment in the period in which the estimated forfeiture rate is revised.
In May 2007, the Company conducted a review of its estimated forfeiture rate, taking into account, among other things, the types of awards typically granted by the Company, the types of employees who typically receive such awards and the Company’s historical forfeiture rate. As a result of this review, the Company determined that, due to the resignation of the Company’s former chief executive officer in October 2006 and the corresponding forfeiture by such former chief executive officer of a large number of stock awards, the Company’s estimated rate of forfeitures should have been materially revised during the fiscal quarter ended December 31, 2006. Accordingly, as required by SFAS No. 123(R), the Company revised its estimated forfeiture rate based on the differences between its estimated and actual results. However, because the Company determined that it should have revised its estimated forfeiture rate concurrently with the resignation of the Company’s former chief executive officer in the fiscal quarter ended December 31, 2006, the Company likewise concluded that the cumulative adjustment required by SFAS No. 123(R) should have been recorded in that period as opposed to the period during which the Company conducted the review.
The Company has calculated the amount of the necessary cumulative adjustment to be equal to $1,047,575, which amount should have been recorded as a reduction of non-cash stock-based compensation expense within the Company’s operating expenses in the fiscal quarter ended December 31, 2006. Previously, in the Form 10-K, the Company reported a non-cash stock-based compensation expense of $1,150,961 for the fiscal year ended December 31, 2006. As a result, after applying the necessary cumulative adjustment referenced above, this Amendment reflects the restatement of the Company’s non-cash stock-based compensation expense for the fiscal year ended December 31, 2006 as being equal to $103,386.
The restatement reflected in this Amendment does not result in a change in the Company’s previously reported revenues, cash flow from operations or total cash and cash equivalents shown in its financial statements for the fiscal quarter and year ended December 31, 2006. Instead, the resulting reduction in non-cash stock-based compensation expense effects a decrease of $1,047,575 in the Company’s net loss for the fiscal quarter and year ended December 31, 2006. In addition, because the amount of the reduction in non-cash stock-based compensation expense decreased both the Company’s accumulated deficit and paid-in capital, there was no net effect on the Company’s balance sheet at December 31, 2006. Likewise, the restatement has no impact on the Company’s operating results for any periods prior to the fiscal quarter ended December 31, 2006.
For further discussion regarding the restatement, see Note 1 to our consolidated financial statements for the fiscal quarter and year ended December 31, 2006, included in Item 8 in this Amendment.
All information in this Amendment is as of February 9, 2007, the filing date of the Form 10-K, and does not reflect any subsequent information or events other than the restatement and adjustments discussed in this Explanatory Note and in Note 1 to our consolidated financial statements. In particular, we have not updated or amended the disclosures contained herein to reflect events that have occurred since the filing of the Form 10-K, nor have we modified or updated those disclosures in any way other than as described in the following paragraph. In addition, this Amendment does not attempt to restate all of the information contained in the
Form 10-K that has not been specifically affected by the restatement. Accordingly, this Amendment should be read in conjunction with the Form 10-K and our filings made with the SEC subsequent to the filing of the Form 10-K on February 9, 2007. Without limiting the generality of the foregoing, please note that certain capitalized terms used in this Amendment have previously been defined or explained in the Form 10-K, and such definitions and/or explanations have not been duplicated in this Amendment.
This Amendment updates the following information, and only the following information, from the Form 10-K in order to reflect the effects of the restatement and miscellaneous related adjustments:
Part I – Item 1A – Risk Factors
Part II – Item 6 – Selected Financial Data
Part II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Part II – Item 8 – Financial Statements and Supplementary Data
Part II – Item 9A – Controls and Procedures
Part IV – Item 15 – Exhibits
FORM 10-K/A
Year Ended December 31, 2006
INDEX
| Page | ||||
Item 1A. | Risk Factors | 1 | ||
Item 6. | Selected Financial Data | 8 | ||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 9 | ||
Item 8. | Financial Statements and Supplementary Data | 14 | ||
Item 9A. | Controls and Procedures | 33 | ||
Item 15. | Exhibits and Financial Statement Schedules | 34 | ||
| 36 | ||||
| Item 1A. | Risk Factors |
Our future operating results may vary substantially from anticipated results due to a number of factors, many of which are beyond our control. The following discussion highlights some of these factors and the possible impact of these factors on future results of operations. You should carefully consider these factors before making an investment decision. If any of the following factors actually occur, our business, financial condition or results of operations could be harmed. In that case, the price of our common stock could decline, and you could experience losses on your investment.
We have a history of operating losses, anticipate future losses, may not generate revenues from product sales and may never become profitable.
We have experienced significant operating losses in each period since our inception. As of December 31, 2006 (as restated), we have incurred total losses of $7.2 million. We expect these losses to continue and it is uncertain when, if ever, we will become profitable. These losses have resulted principally from costs incurred in conducting the initial open-label clinical trials, stock-based compensation for our executive officers and from general and administrative costs associated with operations. We expect to incur increasing operating losses in the future as a result of expenses associated with clinical trials (see the Liquidity and Capital Resources section of this report below) as well as general and administrative costs. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.
We will require additional capital in the future to fund our expected operations, and if this additional capital is not available or not available on acceptable terms, we may have to reduce the size of our operations.
As of December 31, 2006, we have no long-term financial commitments. However, we are planning to proceed with additional feasibility clinical trials of our proposed products, which will require extensive additional funding (see the Liquidity and Capital Resources section of this report below). There can be no assurance that we will be able to raise additional financing. If we are unable to raise any additional required financing, our current cash resources would only enable us to continue operations based on our current level of commitments into the second half of 2008.
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We may require substantial additional capital to finance future growth and fund ongoing operations beyond the second half of 2008. In particular, we may issue a substantial number of additional shares and warrants to raise additional financing and we have little control over the timing of any resales of such shares. As a result, the market price of our common stock may fall if a large portion of those shares is sold in the public market. We may raise additional funds through public or private financing, strategic relationships or other arrangements. We cannot be certain that the funding will be available on attractive terms, or at all. Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. Strategic arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies or products. If we fail to raise capital when needed, our business will be negatively affected, which could cause the price of our common stock to decline.
We are currently assessing various prospective product combinations. We will require additional capital to fund the development and commercialization of our specific combinations. Our future capital requirements will depend on many factors, including:
| • | progress with our preclinical studies and toxicity studies; |
| • | the time and costs involved in obtaining regulatory approvals for the marketing of any of our specific combinations; |
| • | the costs of manufacturing any of our specific combinations; |
| • | our ability, and the ability of any partner, to effectively market, sell and distribute product, subject to obtaining regulatory approval; |
| • | our ability to establish one or more marketing, distribution or other commercialization arrangements; |
| • | the cost of any potential licenses or acquisitions; and |
| • | the costs involved in preparing, filing, prosecuting, maintaining and enforcing patents or defending ourselves against competing technological and market developments. |
If adequate funds are not available when required, we may have to delay, scale back or eliminate one or more of our development programs, or obtain funds by entering into more arrangements with collaborative partners or others that may require us to relinquish rights to certain of our specific combinations or technologies that we would not otherwise relinquish.
We may be unable to obtain regulatory clearance to market our proprietary combinations in the United States or foreign countries on a timely basis, or at all.
Our proprietary combinations are subject to extensive government regulations related to development, clinical trials, manufacturing and commercialization. The process of obtaining FDA and other regulatory approvals is costly, time consuming, uncertain and subject to unanticipated delays. The FDA may refuse to approve an application for approval of a specific combination if it believes that applicable regulatory criteria are not satisfied. The FDA may also require additional testing for safety and efficacy. Moreover, if the FDA grants regulatory approval of a product, the approval may be limited to specific indications or limited with respect to its distribution, which could limit our revenues. Foreign regulatory authorities may apply similar limitations or may refuse to grant any approval.
No diabetes product using our technologies has been approved for marketing. Consequently there is no precedent for the successful commercialization of products based on our technologies. This may impede our ability to obtain timely approvals from the FDA or foreign regulatory agencies. We will not be able to commercialize our proprietary products until we obtain regulatory approval, and consequently any delay in obtaining, or inability to obtain regulatory approvals could harm our business.
If we violate regulatory requirements at any stage, whether before or after marketing approval is obtained, we may be fined, forced to remove a product from the market or experience other adverse consequences, including delay, which would materially harm our financial results. Additionally, we may not be able to obtain the labeling claims necessary or desirable for product promotion.
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Moreover, manufacturing facilities operated by the third-party manufacturers with whom we may contract to manufacture our proprietary combinations may not pass an FDA or other regulatory authority pre-approval inspection. Any failure or delay in obtaining these approvals could prohibit or delay us or any of our business partners from marketing our combinations.
Delays in the conduct or completion of our clinical trials, the analysis of the data from our clinical trials, or our manufacturing scale-up activities may result in delays in our planned filings for regulatory approvals, and may adversely affect our ability to enter into new collaborative arrangements.
We cannot predict whether we will encounter problems with any of our completed or planned clinical studies that will cause us or regulatory authorities to delay or suspend planned clinical studies.
Any of the following could delay the completion of our planned clinical studies:
| • | failure of the FDA or comparable foreign authorities to approve the scope or design of our clinical trials; |
| • | delays in enrolling volunteers; |
| • | insufficient supply or deficient quality of specific combination materials or other materials necessary for the performance of clinical trials; |
| • | negative results of clinical studies; or |
| • | serious side effects experienced by study participants relating to a specific combination. |
If the results of our planned clinical studies for our proprietary combinations are not available when we expect or if we encounter any delay in the analysis of data from our clinical studies or if we encounter delays in our ability to scale-up our manufacturing processes, we may have to delay our planned filings seeking regulatory approval of our proprietary combinations. Additionally we may not have the financial resources to continue research and development of any of our proprietary combinations; and we may not be able to enter into additional collaborative arrangements relating to any proprietary combinations subject to delay in clinical studies or delay in regulatory filings.
We have not commenced FDA trials and may not ever commence FDA trials.
We have not commenced FDA trials for any of our product combinations. There are a number of requirements that we must satisfy in order to begin FDA trials. These requirements will require substantial time, effort and financial resources. There can be no assurance that we will complete the steps necessary to reach FDA trials.
We currently have no internal sales and marketing resources and may have to rely on third parties in the event that we successfully develop our product candidates into commercial drug products.
To market any of our products in the United States or elsewhere, we must develop internally or obtain access to sales and marketing forces with technical expertise and with supporting distribution capability in the relevant geographic territory.
We may not be able to enter into marketing and distribution arrangements or find a corporate partner for our specific combination or our other specific combinations, and we are not likely to be able to market and distribute our products ourselves. If we are not able to enter into a marketing or distribution arrangement or find a corporate partner who can provide support for commercialization of our specific combinations as we deem necessary, we may not be able to commercialize our products successfully. Moreover, any new marketer or distributor or corporate partner for our specific combinations, with whom we choose to contract may not establish adequate sales and distribution capabilities or gain market acceptance for our products, if any.
Our ability to generate revenues will be diminished if we fail to obtain acceptable prices or an adequate level of reimbursement for our products from third-party payors.
The requirements governing product licensing, pricing and reimbursement vary widely from country to country. Some countries require approval of the sale price of a drug before it can be marketed. In many countries, the pricing review period begins after product licensing approval is granted. As a result, we may obtain regulatory approval for a product in a particular country, but then
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be subject to price regulations that reduce our revenues from the sale of the product. Also, in some foreign markets, pricing of prescription pharmaceuticals is subject to continuing governmental control even after initial marketing approval. If we succeed in bringing a specific combination to market, we cannot be certain that the products will be considered cost effective and that reimbursement will be available or, if available, will be sufficient to allow us to sell the products on a competitive basis.
The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means, including efforts to increase the amount of patient co-pay obligations, may limit our commercial opportunity. For example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be a number of federal and state proposals to implement similar government control. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the rate of adoption and pricing of pharmaceutical products. Cost control initiatives could decrease the price that any of our collaborators or we would receive for any products in the future. Further, cost control initiatives could adversely affect our collaborators’ ability to commercialize our products, our ability to realize revenues from this commercialization, and our ability to fund the development of future specific combinations.
Our ability to commercialize pharmaceutical products, alone or with collaborators, may depend in part on the extent to which adequate reimbursement for the products will be available from governmental and health administration authorities, private health insurers, and other third-party payors.
Significant uncertainty exists as to the reimbursement status of newly approved health care products. Third-party payors, including Medicare, are challenging the prices charged for medical products and services. Government and other third-party payors increasingly are attempting to contain health care costs by limiting both coverage and the level of reimbursement for new drugs and by refusing, in some cases, to provide coverage for uses of approved products for disease indications for which the FDA has not granted labeling approval. Third-party insurance coverage may not be available to patients for any products we discover and develop, alone or with collaborators. If government and other third-party payors do not provide adequate coverage and reimbursement levels for our products, the market acceptance of these products may be reduced.
We do not manufacture our own specific combinations and rely on third-party manufacturers to provide the components necessary for our specific combinations.
We do not manufacture our own specific combinations and may not be able to obtain adequate supplies, which could cause delays or reduce profit margins. The manufacturing of sufficient quantities of new specific combinations is a time-consuming and complex process. We have no manufacturing capabilities. In order to continue to develop our proprietary combinations, apply for regulatory approvals and ultimately commercialize additional products, we need to contract or otherwise arrange for the necessary manufacturing.
If any of our existing or future manufacturers cease to manufacture or are otherwise unable to deliver any of the components of our specific combinations in either bulk or dosage form, or other product components, we may need to engage additional manufacturers. The cost and time to establish manufacturing facilities would be substantial. As a result, using a new manufacturer could disrupt our ability to supply our products and/or reduce our profit margins. Any delay or disruption in the manufacturing of bulk product, the dosage form of our products or other product components, including pens for delivery of our products, could harm our ability to generate product sales, harm our reputation and require us to raise additional funds.
We have not selected any third-party contract manufacturers for our proprietary combinations.
We have not yet selected manufacturers for our proprietary combinations and we cannot be certain that we will be able to obtain long-term supplies of those materials on acceptable terms. We do not currently have established quality control and quality assurance programs, including a set of standard operating procedures, analytical methods and specifications, designed to ensure that proprietary combinations are manufactured in accordance with current good manufacturing practices and other domestic and foreign regulations.
If our patents are determined to be unenforceable, or if we are unable to obtain new patents based on current patent applications or for future inventions, we may not be able to prevent others from using our intellectual property.
Our success will depend in part on our ability to obtain and expand patent protection for our specific combinations and technologies both in the United States and other countries. We cannot guarantee that any patents will issue from any pending or future
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patent applications owned by or licensed to us. Alternatively, a third party may successfully circumvent our patents. Our rights under any issued patents may not provide us with sufficient protection against competitive products or otherwise cover commercially valuable products or processes. In addition, because patent applications in the United States are maintained in secrecy for eighteen months after the filing of the applications, and publication of discoveries in the scientific or patent literature often lag behind actual discoveries, we cannot be sure that the inventors of subject matter covered by our patents and patent applications were the first to invent or the first to file patent applications for these inventions. In the event that a third party has also filed a patent on a similar invention, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention, which could result in a loss of our patent position. Furthermore, we may not have identified all U.S. and foreign patents that pose a risk of infringement.
Litigation regarding patents and other proprietary rights may be expensive, cause delays in bringing products to market and harm our ability to operate.
Our success will depend in part on our ability to operate without infringing the proprietary rights of third parties. Legal standards relating to the validity of patents covering pharmaceutical and biotechnological inventions and the scope of claims made under these patents are still developing. As a result, our ability to obtain and enforce patents is uncertain and involves complex legal and factual questions. Third parties may challenge or infringe upon existing or future patents. In the event that a third party challenges a patent, a court may invalidate the patent or determine that the patent is not enforceable. Proceedings involving our patents or patent applications or those of others could result in adverse decisions about:
| • | the patentability of our inventions and products relating to our specific combinations; and/or |
| • | the enforceability, validity or scope of protection offered by our patents relating to our specific combinations. |
The use of our technologies could potentially conflict with the rights of others.
The manufacture, use or sale of any of our proprietary combinations may infringe on the patent rights of others. If we are unable to avoid infringement of the patent rights of others, we may be required to seek a license, defend an infringement action or challenge the validity of the patents in court. Patent litigation is costly and time consuming. We may not have sufficient resources to bring these actions to a successful conclusion. In such case, we may be required to alter our products, pay licensing fees or cease activities. If our products conflict with patent rights of others, third parties could bring legal actions against us claiming damages and seeking to enjoin manufacturing and marketing of the affected products. If these legal actions are successful, in addition to any potential liability for damages, we could be required to obtain a license in order to continue to manufacture or market the affected products. We may not prevail in any legal action and a required license under the patent may not be available on acceptable terms, if at all.
We may be unable to adequately prevent disclosure of our trade secrets and other proprietary information.
In order to protect our proprietary technology and processes, we rely in part on confidentiality agreements with our corporate partners, employees, consultants, outside scientific collaborators and sponsored researchers and other advisors. These agreements may not effectively prevent disclosure of our confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of our confidential information. In addition, others may independently discover trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
Competition in the biotechnology and pharmaceutical industries may result in competing products, superior marketing of other products and lower revenues or profits for us.
There are many companies that are seeking to develop products and therapies for the treatment of diabetes and other metabolic disorders. Our competitors include multinational pharmaceutical and chemical companies, specialized biotechnology firms and universities and other research institutions. A number of our largest competitors, including Bristol-Myers Squibb Company, Sanofi-Aventis, Eli Lilly and Company, GlaxoSmithKline, Merck & Co., Novartis AG, Novo Nordisk A-S and Takeda Pharmaceuticals, are pursuing the development or marketing of pharmaceuticals that target the same diseases that we are targeting, and it is possible that the number of companies seeking to develop products and therapies for the treatment of diabetes and other metabolic disorders will increase. The government, through NCCAM, funds a variety of private, and for-profit, and academic groups to conduct trials on chromium supplementation and related alternative approaches to treat diabetes.
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Many of our competitors have substantially greater financial, technical, human and other resources than we do. In addition, many of these competitors have significantly greater experience than we do in undertaking preclinical testing and human clinical studies of new pharmaceutical products and in obtaining regulatory approvals of human therapeutic products. Accordingly, our competitors may succeed in obtaining FDA approval for products more rapidly than we do, which would provide these competitors with an advantage for the marketing of products with similar potential uses. Furthermore, if we are permitted to commence commercial sales of products, we may also be competing with respect to manufacturing and product distribution efficiency and sales and marketing capabilities, areas in which we have limited or no experience as an organization.
Our target patient population for our proprietary combinations is people with Type 2 diabetes. Other products are currently in development or exist in the market that may compete directly with the products that we are seeking to develop and market. Various products are available to treat Type 2 diabetes, including, sulfonyureas, metformin, insulin, glinides, alpha-glucosidase inhibitors, and thiazolidinediones.
In addition, several companies are developing various approaches to improve treatments for Type 1 and Type 2 diabetes. We cannot predict whether our proprietary combinations, even if successfully tested and developed, will have sufficient advantages over existing products to cause health care professionals to adopt them over other products or that our specific combinations will offer an economically feasible alternative to existing products.
We may not be able to keep up with the rapid technological change in the biotechnology and pharmaceutical industries, which could make our products obsolete and reduce our revenues.
Biotechnology and related pharmaceutical technologies have undergone and continue to be subject to rapid and significant change. Our future will depend in large part on our ability to maintain a competitive position with respect to these technologies. Any products that we develop may become obsolete before we recover expenses incurred in developing those products, which may require that we raise additional funds to continue our operations.
Our future success depends on our ability to retain our chief executive officer and other key executives.
Our success largely depends on the skills, experience and efforts of our key personnel, including our Chief Executive Officer, Jay B. Lichter, Ph.D. We have entered into a written employment agreement with Dr. Lichter that can be terminated at any time by us or by Dr. Lichter. The loss of Dr. Lichter, or our failure to retain other key personnel, would jeopardize our ability to execute our strategic plan and materially harm our business.
Our future success depends on our relationships with current and future consultants with specific areas of expertise that are critical to our business.
We currently have only two employees, and we have no immediate plans to hire additional employees. We currently are utilizing the services of eight consultants with expertise in such fields critical to our business as contract manufacturing, regulatory affairs, biostatistics, and diabetology. If we are unable to retain the services of those consultants, or obtain the services of additional consultants, our likelihood of success could decrease significantly.
Our business has a substantial risk of product liability claims, and insurance may be expensive or unavailable.
Our business exposes us to potential product liability risks that are inherent in the testing, manufacturing and marketing of human therapeutic products. Product liability claims could result in a recall of products or a change in the indications for which they may be used, either of which may have a material adverse effect on our business and results of operations.
We currently have limited product liability insurance, including clinical trial insurance, and will seek additional coverage prior to initiating clinical trials and marketing any of our specific combinations. However, we cannot assure you that our insurance will provide adequate coverage against potential liabilities. Furthermore, clinical trial and product liability insurance is becoming increasingly expensive. As a result, we may not be able to maintain current amounts of insurance coverage, obtain additional insurance or obtain insurance at a reasonable cost or in sufficient amounts to protect against losses that could have a material adverse effect on us.
The preparation of our financial statements requires the use of certain assumptions and estimates. If the facts underlying these assumptions or estimates change, or if our analyses and conclusions change, our financial position and operating results could vary significantly from period to period.
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We must make certain assumptions and estimates when preparing our consolidated financial statements. These assumptions and estimates are formed by reference to a wide range of matters including, but not limited to, facts relating to our stock-based compensation practices. For instance, we consider employee turnover, forfeiture rates, expected stock volatility and expected terms of stock options when forming critical assumptions and estimates on which we base our financial reporting . If any of the facts underlying these assumptions and estimates change, or if our analyses and conclusions change, our operating results could be materially affected. For example, in connection with the resignation of the Company’s former chief executive officer in the quarter ended December 31, 2006, we became obligated under SFAS No. 123(R) to re-evaluate and revise our estimated forfeiture rates for stock-based compensation awards. As a result of the revisions to our estimates, our non-cash stock-based compensation expense for the quarter ended December 31, 2006 was dramatically lower than in prior periods. This reduction in expense may not be sustained over time, and we may experience other similar changes in operating results due to other changes in the assumptions and estimates we use when preparing our financial statements. Ultimately, these changes could increase the volatility in our stock price and could cause our stock price to decline.
If we fail to maintain an effective disclosure controls and procedures or if we have material weaknesses in our internal control over financial reporting, we may not be able to accurately report our financial results, and current and potential stockholders may lose confidence in our financial reporting.
We are responsible for establishing and maintaining effective disclosure controls and procedures and adequate internal control over financial reporting, in each case as prescribed by applicable SEC rules and regulations. Together, these elements are intended to provide reasonable (but not absolute) assurance regarding the reliability of our financial reporting. As a result of the restatement described in this Amendment, management has determined that our disclosure controls and procedures were not effective as of December 31, 2006 and that we have a material weakness in our internal control over financial reporting. As described in greater detail in Item 9A in this Amendment, this material weakness relates to our failure to implement a policy for routinely evaluating the assumptions and estimates that we use when calculating our non-cash stock-based compensation expenses in accordance with SFAS No. 123(R).
Since the time we determined that our disclosure controls and procedures were not effective and identified the material weakness in our internal control over financial reporting, we have devoted significant time to developing remedial measures to address these deficiencies. Although we believe that these measures have strengthened our disclosure controls and procedures and our internal control over financial reporting, we cannot be certain that they will ensure that we maintain effective disclosure controls and procedures or adequate internal control over our financial reporting in future periods. Any failure to maintain such effective disclosure controls and procedures or adequate internal control over financing reporting could adversely impact our ability to report our financial results on a timely and accurate basis. If we are no longer able to report our financial results on a timely and accurate basis, we may erode our investors’ understanding of and confidence in our financial reporting, as well as face severe consequences from regulatory authorities, either of which may have a material adverse affect on our business and a negative effect on the trading price of our stock.
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| Item 6. | Selected Financial Data |
The following table shows selected financial data for the last five years ended December 31, 2006. The selected financial data has been derived from our audited consolidated financial statements for years 2002 through 2006 and is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements, and Notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in Item 7 of Part II of this Amendment. The selected financial data has been adjusted to reflect the restatement of the Company’s consolidated financial statements for the year ended December 31, 2006 as set forth in this report. The consolidated balance sheet data as of December 31, 2006, and the consolidated statement of operations data for the year ended December 31, 2006, have been restated to reflect the impact of the item discussed in Note 1 to the consolidated financial statements included in this Form 10-K/A. Please see the Explanatory Note to this Amendment and Note 1 to our consolidated financial statements for more detailed information regarding the restatement of our consolidated financial statements for the year ended December 31, 2006.
| Years Ended December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
| (as restated) | ||||||||||||||||||||
Consolidated Statement of Operations Data: | ||||||||||||||||||||
Revenues | $ | — | $ | — | $ | — | $ | 4,785 | $ | 26,621 | ||||||||||
Operating expenses | $ | 1,367,544 | $ | 3,110,246 | $ | 1,517,691 | $ | 28,480 | $ | 152,283 | ||||||||||
Loss from operations | $ | (1,367,544 | ) | $ | (3,110,246 | ) | $ | (1,517,691 | ) | $ | (25,397 | ) | $ | (130,726 | ) | |||||
Net loss | $ | (1,357,992 | ) | $ | (3,105,826 | ) | $ | (1,525,539 | ) | $ | (31,291 | ) | $ | (132,687 | ) | |||||
Net loss per common share—basic and diluted | $ | (0.08 | ) | $ | (0.21 | ) | $ | (0.24 | ) | $ | (0.01 | ) | $ | (0.02 | ) | |||||
Weighted average common shares outstanding—basic and diluted | 16,020,232 | 14,993,031 | 6,341,604 | 5,377,466 | 5,377,466 | |||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||
Cash and cash equivalents | $ | 4,111,070 | $ | 388,551 | $ | 1,234,250 | $ | — | $ | 1,747 | ||||||||||
Working capital | $ | 3,973,153 | $ | 320,278 | $ | 1,267,814 | $ | (29,621 | ) | $ | (20,814 | ) | ||||||||
Total assets | $ | 4,199,083 | $ | 415,107 | $ | 1,350,250 | $ | — | $ | 5,697 | ||||||||||
Stockholder loan | $ | — | $ | — | $ | — | $ | 92,930 | $ | 70,716 | ||||||||||
Stockholders’ equity (deficit) | $ | 4,058,615 | $ | 337,670 | $ | 1,267,814 | $ | (122,551 | ) | $ | (91,530 | ) | ||||||||
8
| Quarters Ended (Unaudited) | ||||||||||||||||
| Quarterly Statement of Operations Data For 2006: | March 31, | June 30, | September 30, | December 31, | ||||||||||||
| (as restated) | ||||||||||||||||
Total revenues | $ | — | $ | — | $ | — | $ | — | ||||||||
Net income (loss) | $ | (552,251 | ) | $ | (446,313 | ) | $ | (378,005 | ) | $ | 18,577 | |||||
Basic and diluted net income (loss) per share | $ | (0.04 | ) | $ | (0.03 | ) | $ | (0.02 | ) | $ | 0.00 | |||||
Basic and diluted weighted average number of shares of common stock | 15,228,552 | 15,347,552 | 15,347,552 | 18,131,609 | ||||||||||||
| Quarters Ended (Unaudited) | ||||||||||||||||
| Quarterly Statement of Operations Data For 2005: | March 31, | June 30, | September 30, | December 31, | ||||||||||||
Total revenues | $ | — | $ | — | $ | — | $ | — | ||||||||
Net loss | $ | (892,500 | ) | $ | (862,088 | ) | $ | (777,725 | ) | $ | (573,513 | ) | ||||
Basic and diluted net loss per share | $ | (0.06 | ) | $ | (0.06 | ) | $ | (0.05 | ) | $ | (0.04 | ) | ||||
Basic and diluted weighted average number of shares of common stock | 14,992,552 | 14,992,552 | 14,992,552 | 14,994,454 | ||||||||||||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
This discussion and analysis should be read in conjunction with our audited financial statements and accompanying notes included elsewhere in this Amendment. Operating results are not necessarily indicative of results that may occur in future periods.
Introduction
One of our predecessors, Akesis Delaware, was incorporated on April 27, 1998, for the purpose of direct marketing to consumers an established over-the-counter product for lowering blood glucose levels in the treatment of diabetes.
Effective December 9, 2004, pursuant to the Merger Agreement among Akesis Delaware, Liberty and MergerSub, MergerSub merged with and into Akesis Delaware, with Akesis Delaware as the surviving corporation and wholly owned subsidiary of Liberty.
Although we acquired Akesis Delaware as a result of the transaction, Akesis Delaware stockholders held a majority of our common stock following the transaction. Accordingly, for accounting purposes, the acquisition was a “reverse acquisition” and Akesis Delaware was the “accounting acquiror.” Therefore, the transaction was accounted for as a recapitalization of Akesis Delaware and recorded based on the fair value of Liberty’s net tangible assets acquired by Akesis Delaware. No goodwill or other intangible assets were recorded. Effective January 11, 2005, we changed our name to Akesis Pharmaceuticals, Inc. and the trading symbol was changed to AKES.OB.
Since Akesis Delaware was the surviving entity, the “Selected Financial Data” in Item 6 above and the “Financial Statements and Supplementary Data,” elsewhere in this Form 10-K/A reflect Akesis Delaware’s historical results of operations prior to its acquisition by us. The Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows is a discussion and analysis of that financial data. The accounts of Liberty and Akesis Delaware have been consolidated as of December 9, 2004, the effective date of the acquisition.
The following discussion of results of operations, liquidity and capital resources contains forward-looking statements that involve risks and uncertainties. As described in Part I, our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause or contribute to such differences include those discussed below and in the section entitled “Risk Factors” of this Amendment.
9
Major Research and Development Projects
We are an early stage biopharmaceutical company engaged in the discovery, development and commercialization of complementary and alternative therapies for the treatment of three principal forms of carbohydrate intolerance – Type 2 diabetes, Syndrome X, and impaired glucose tolerance – and their associated complications. We have been granted patents and filed patent applications for a number of proprietary combination therapies, including combinations with existing diabetes medications, for use in the treatment of Type 2 diabetes. We intend to use our proprietary combinations to develop prescription treatments for diabetes and related metabolic disorders. These products are in an early stage of development and no regulatory filings to commercialize our products have yet been made with the FDA or any similar state or foreign authorities.
We have completed an initial clinical study of a specific combination product and demonstrated a consistent improvement in HbA1clevels, as compared to base line, after three months of treatment in a diabetic population. The observed overall reduction in HbA1c (which is an established long-term measure of blood glucose), in this open-label study was approximately 1.7% for all treatment groups. This reduction implies an average improvement of almost 20% in blood glucose parameters in this patient population, including patients taking the initial product candidate as monotherapy, as well as with concomitant medications. We believe that these clinical studies may suggest that our combinations show the potential for enhancing currently available oral antidiabetic therapeutic agents. We intend to conduct follow-on feasibility clinical trials with one or more of our combination products with a goal of confirming and extending the results of our initial clinical studies. We believe that the successful completion of these feasibility trials could lead to partnering opportunities in the pharmaceutical industry. We are not currently in discussions with the FDA regarding the specific requirements for approval of our products.
The risks and uncertainties associated with completing the development of our products on schedule, or at all, include the following, as well as the other risk factors described in this report:
| • | Our products may not be shown to be safe and efficacious in the clinical trials; |
| • | We may be unable to obtain regulatory approval of our products or be unable to obtain such approval on a timely basis; |
| • | We may be unable to recruit enough patients to complete the clinical trials in a timely manner; and |
| • | We may not have adequate funds to complete the development of our products even if we secure the additional amount of capital we have targeted if we have underestimated the cost of the clinical trials. |
If our products fail to achieve statistically significant results in the clinical trials, or we do not complete the clinical trials on a timely basis, our operations, financial position and liquidity could be severely impaired, including as follows:
| • | It could make it more difficult for us to consummate partnering opportunities in the pharmaceutical industry, or at all. |
| • | Our reputation among investors might be harmed, which could make it more difficult for us to obtain equity capital on attractive terms, or at all. |
Because of the many risks and uncertainties relating to the completion of clinical trials, consummation of partnering opportunities in the pharmaceutical industry, receipt of marketing approvals and acceptance in the marketplace, we cannot predict the period in which material cash inflows from our products will commence, if ever.
Results of Operations for the Years Ended December 31, 2006 and 2005
Year Ended December 31, 2006 Compared with December 31, 2005
Total operating expenses decreased to $1.4 million for the year ended December 31, 2006 (as restated), from $3.1 million for the same time period in 2005. During the fourth quarter of 2005, we terminated one employee, and reduced the salaries of the three remaining employees to $14,400 annually. Effective March 15, 2006, we terminated a third employee. Salaries for the two remaining employees remained at $14,400 annually through November 15, 2006. At that time we increased the annual salary of our Chief Executive Officer and Chief Financial Officer to $150,000 and $100,000, respectively, and in addition paid performance bonuses to the Chief Executive Officer and Chief Financial Officer of $100,000 and $106,300, respectively. As a result, our cash-based payroll costs for 2006 decreased to approximately $268,000 from approximately $448,000 during 2005. Our non cash-based compensation costs for 2006 consisted of $103,386 (as restated) of stock-based compensation charges determined in accordance with SFAS No. 123(R) and warrants issued to two terminated employees with a value of $230,105 determined in accordance with a Black-Scholes
10
model. Non cash-based compensation expense for 2005 consisted of stock-based compensation of approximately $1.8 million determined in accordance with SFAS No. 123(R). The primary reason for the decline in non-cash stock-based compensation charges is that, in the fiscal quarter ended December 31, 2006 (as restated), we recognized a credit of approximately $1.0 million related to a cumulative change in the estimated forfeiture rate of stock options as more fully explained in Note 1 to the consolidated financial statements. Also, we did not pay cash fees to our outside directors from October 1, 2005 through November 16, 2006. Director fees for the years ended December 31, 2006 and 2005 were $9,000 and $81,000, respectively. In addition, in May 2006, we began the development of a clinical research protocol and began conducting other activities to support the initiation of new clinical trials related to our proposed pharmaceutical products. The cost of the clinical trial work during the year ended December 31, 2006 was approximately $98,000 compared to zero for 2005. Finally, our legal fees decreased to approximately $154,000 during the year ended December 31, 2006 from approximately $277,000 for 2005. The primary reason for the decrease in legal fees during 2006 was that 2005 was the first full year we were a publicly traded company.
Year Ended December 31, 2005 Compared with December 31, 2004
Total operating expenses increased to $3.1 million for the year ended December 31, 2005, from $1.5 million for the same time period in 2004. Total operating expenses for the year ended December 31, 2005 included a non-cash stock-based compensation charge of approximately $1.8 million compared to $1.1 million for the year ended December 31, 2004. The stock-based compensation charges for the years ended December 31, 2005 and 2004 were determined in accordance with the provisions of SFAS No. 123(R), and recognized the expense for options to acquire our common stock that were issued to Edward B. Wilson, our former Chief Executive Officer, and John T. Hendrick, our current Chief Financial Officer, in December 2004 and to Kelly Joy, our former Vice President of Business Development, and Kevin Sayer, a member of our Board of Directors in December 2005. Additionally, we incurred approximately $448,000 in payroll related expenses during 2005 compared to approximately $32,000 during 2004 since we did not have any employees during 2004 prior to the completion of the acquisition of Akesis Delaware in December 2004. During the fourth quarter of 2005, in order to conserve cash, we terminated one employee and reduced the salaries of the remaining three employees to an amount approximating the minimum wage in the State of California. We also incurred approximately $456,000 in legal, audit and outside accounting fees, as well as printing and other charges, primarily related to being a publicly traded company during 2005 compared to $159,000 during 2004. Finally, our liability insurance premiums and outside director fees totaled approximately $198,000 during 2005 and we incurred no costs for those items during 2004. We did not pay fees to our outside directors during the fourth quarter of 2005.
Liquidity and Capital Resources
We have financed our operations primarily through the sale of equity securities and stockholder loans. We invest excess cash in investment securities that will be used to fund future operating costs. Cash, cash equivalents and investment securities totaled $4,111,070 at December 31, 2006, compared to $388,551 at December 31, 2005. We primarily fund current operations with our existing cash and investments. Cash used in operating activities for 2006 totaled $877,807. We have no long-term financial commitments.
We had no revenues or other income sources in 2006 to cover operating expenses, and we do not expect any revenues in the foreseeable future. During the fourth quarter of 2006, the salaries of our employees and other operating expenses increased significantly from the levels we incurred during the first nine months of 2006 and the fourth quarter of 2005. As explained in the following paragraphs, we sold common stock resulting in net proceeds of approximately $4.247 million in the fourth quarter of 2006. In addition, we have entered into a three year term loan credit facility that enables us to borrow up to $1 million as more fully explained below. We believe our current financial resources should enable us to fund one clinical feasibility study as well as satisfy all of our general and administrative expenses for approximately the next fifteen to eighteen months based on our current level of commitments.
During the first quarter of 2006, we sold an aggregate of 180,000 shares of our common stock at a purchase price of $2.00 per share to certain accredited investors. In addition, we issued to those investors warrants to purchase an aggregate of up to 90,000 shares of our common stock in connection with the financing. The warrants are exercisable for shares of our common stock for three years from the date of issuance at an exercise price per share of $3.00. Our net proceeds in connection with those sales of common stock after deducting expenses related to the financing were approximately $350,000. All the shares and warrants issued in connection with the financing were exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In connection with the financing described in the preceding paragraph, the Company (a) paid its placement agent a cash fee equal to one percent (1%) of all funds invested by investors introduced by such placement agent (excluding amounts paid by investors upon exercise of warrants), and (b) issued to its placement agent a warrant to purchase up to 11,550 shares of common stock.
11
During the fourth quarter of 2006, we sold an aggregate of 7,233,332 shares of our common stock at a purchase price of $0.60 per share to certain accredited investors. In addition, we issued to those investors warrants to purchase an aggregate of up to 1,085,000 shares of our common stock in connection with the financing. The warrants are exercisable for shares of our common stock for three years from the date of issuance at an exercise price per share of $0.60. Our net proceeds in connection with those sales of common stock after deducting expenses related to the financing were approximately $4.247 million. All the shares and warrants issued in connection with the financing were exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In connection with the financing described in the preceding paragraph, the Company (a) paid its placement agent a cash fee equal to eight percent (8%) of all funds invested by investors introduced by such placement agent (excluding amounts paid by investors upon exercise of warrants), and (b) issued to its placement agent a warrant to purchase up to 83,000 shares of common stock.
In December 2006, we entered into a loan and security agreement with Square 1 Bank that provides for a loan of up to $1.0 million to finance general corporate purposes. The loan bears an interest rate equal to the lender’s prime rate plus 0.75% and matures in December 2009. We have granted a security interest in substantially all of our tangible assets as collateral for the loans under the loan and security agreement. The agreement imposes certain limitations on our ability to engage in certain transactions. At December 31, 2006, we had no borrowings under the loan and security agreement.
In order to finance additional feasibility trials beyond the trial scheduled for 2007-2008 to further validate our products, we will need to raise a significant amount of capital. We will also need to raise additional capital to finance our future operating cash needs. We may seek to raise capital through the sale of equity or debt securities or the development of other funding mechanisms. In addition, we may seek to form a strategic partnership for the development and commercialization of our products.
The first clinical feasibility study that we intend to initiate with the proceeds from the fourth quarter 2006 private placements of our common stock is related to our metformin combination product. If we realize sufficient proceeds from future sources of capital, then we also plan to conduct clinical studies related to additional combination products including our thalidazione combination product.
Our actual capital requirements will depend upon numerous factors, including:
| • | the rate of progress and costs of our clinical trial and research and development activities; |
| • | actions taken by the FDA and other regulatory authorities; |
| • | the timing and amount of milestone or other payments we might receive from potential strategic partners; |
| • | our degree of success in commercializing our product candidates; |
| • | the emergence of competing technologies and products, and other adverse market developments; and |
| • | the costs of preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property rights. |
There can be no assurance that we will be able to obtain needed additional capital or enter into relationships with corporate partners on a timely basis, on favorable terms, or at all. Conditions in the capital markets in general, and the life science capital market specifically, may affect our potential financing sources and opportunities for strategic partnering.
Critical Accounting Policies
Basis of Revenue Recognition: To date, we have not had any significant ongoing revenue sources.
Stock-based compensation: We adopted SFAS No. 123(R) in 2004. Stock-based compensation for 2006 (as restated), 2005 and 2004 was $103,386, $1,804,000 and $1,087,500, respectively. See the Explanatory Note to this Amendment and Note 1 to our consolidated financial statements for more detailed information regarding the restatement of our consolidated financial statements for the year ended December 31, 2006.
Effect of New Accounting Standards
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of SFAS No. 140” (“SFAS No. 156”), which clarifies when servicing rights should be separately accounted for, requires companies to account
12
for separately recognized servicing rights initially at fair value, and gives companies the option of subsequently accounting for those servicing rights at either fair value or under the amortization method. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. We do not expect the adoption of SFAS No. 156 to affect future reporting or disclosures.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. This Interpretation prescribes 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. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are in the process of evaluating the adoption of FIN 48.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities and requires expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are in the process of evaluating the adoption of SFAS No. 157.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”), an amendment of SFAS No. 87, 88, 106, and 132(R). SFAS No. 158 requires, among other things, that a company (1) recognize a net liability or asset to report the funded status of their defined benefit pensions and other postretirement plans on its balance sheet and (2) measure benefit plan assets and benefit obligations as of the company’s balance sheet date. SFAS No. 158 is effective for calendar year-end companies with publicly traded equity securities as of December 31, 2006. We do not expect the adoption of SFAS No. 158 to affect future reporting or disclosures.
13
| Item 8. | Financial Statements and Supplementary Data |
INDEX TO FINANCIAL STATEMENTS
| Page | ||
| 15 | ||
| 16 | ||
| 17 | ||
| 18 | ||
| 19 | ||
| 20 | ||
14
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Akesis Pharmaceuticals, Inc.
We have audited the accompanying consolidated balance sheets of Akesis Pharmaceuticals, Inc., a Nevada corporation, as of December 31, 2006 and 2005 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with United States generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the consolidated financial statements for the year ended December 31, 2006 have been restated.
| SWENSON ADVISORS, LLP |
| Independent Registered Public Accounting Firm |
| San Diego, California |
| February 7, 2007, except for Note 1 which is as of May 15, 2007 |
15
Consolidated Balance Sheets
As of December 31, 2006 and 2005
| 2006 | 2005 | |||||||
| (as restated— see Note 1) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 4,111,070 | $ | 388,551 | ||||
Prepaid insurance and other current assets | 2,551 | 9,164 | ||||||
Total current assets | 4,113,621 | 397,715 | ||||||
Property and equipment, net | — | 17,392 | ||||||
Debt issuance costs, net | 85,462 | — | ||||||
Total assets | $ | 4,199,083 | $ | 415,107 | ||||
Liabilities and Stockholders’ Equity (Deficit) | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 140,468 | $ | 77,437 | ||||
Total current liabilities | 140,468 | 77,437 | ||||||
Total liabilities | 140,468 | 77,437 | ||||||
Commitments and contingencies (Note 6) | — | — | ||||||
Stockholders’ equity: | ||||||||
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, and zero shares issued and outstanding as of December 31, 2006 and December 31, 2005 | — | — | ||||||
Common stock, $0.001 par value, 50,000,000 shares authorized: 22,580,884 and 15,167,552 shares issued and outstanding at December 31, 2006 and December 31, 2005, respectively | 22,581 | 15,168 | ||||||
Additional paid-in capital | 11,245,080 | 6,173,556 | ||||||
Accumulated deficit | (7,209,046 | ) | (5,851,054 | ) | ||||
Total stockholders’ equity | 4,058,615 | 337,670 | ||||||
Total liabilities and stockholders’ equity | $ | 4,199,083 | $ | 415,107 | ||||
See accompanying notes.
16
Consolidated Statements of Operations
For the Years Ended December 31, 2006, 2005, and 2004
| 2006 | 2005 | 2004 | ||||||||||
| (as restated— see Note 1) | ||||||||||||
Revenue | $ | — | $ | — | $ | — | ||||||
Operating costs and expenses: | ||||||||||||
Selling, general and administrative | 1,269,360 | 3,110,246 | 1,517,691 | |||||||||
Research and development | 98,184 | — | — | |||||||||
Total expenses | 1,367,544 | 3,110,246 | 1,517,691 | |||||||||
Loss from operations | (1,367,544 | ) | (3,110,246 | ) | (1,517,691 | ) | ||||||
Interest income/(expense), net | 25,157 | 7,620 | (6,248 | ) | ||||||||
Loss on disposal of assets | (13,805 | ) | — | — | ||||||||
Loss before income taxes | (1,356,192 | ) | (3,102,626 | ) | (1,523,939 | ) | ||||||
Provision for income taxes | 1,800 | 3,200 | 1,600 | |||||||||
Net loss | $ | (1,357,992 | ) | $ | (3,105,826 | ) | $ | (1,525,539 | ) | |||
Net loss per common share – basic and diluted | $ | (0.08 | ) | $ | (0.21 | ) | $ | (0.24 | ) | |||
Weighted-average common shares outstanding – basic and diluted | 16,020,232 | 14,993,031 | 6,341,604 | |||||||||
See accompanying notes.
17
Consolidated Statements of Stockholders’ Equity
For the Years Ended December 31, 2006, 2005, and 2004
| Convertible Preferred Stock | |||||||||||||||||||||||||||||||||
| Series A | Series B | Series C | Common Stock | Additional Paid-In Capital | Accumulated Deficit | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||
Balance at December 31, 2003 | 404,444 | $ | 404 | 166,022 | $ | 166 | — | $ | — | 5,377,466 | $ | 1,633 | $ | 1,094,935 | $ | (1,219,689 | ) | ||||||||||||||||
Issuance of preferred stock – series C | — | — | — | — | 288,653 | 289 | — | — | 129,326 | — | |||||||||||||||||||||||
Issuance of common stock | — | — | — | — | — | — | 1,366,316 | 415 | 165,585 | — | |||||||||||||||||||||||
Conversion of preferred stock – series A | (404,444 | ) | (404 | ) | — | — | — | — | 1,331,562 | 404 | — | — | |||||||||||||||||||||
Conversion of preferred stock – series B | — | — | (166,022 | ) | (166 | ) | — | — | 546,599 | 166 | — | — | |||||||||||||||||||||
Conversion of preferred stock – series C | — | — | — | — | (288,653 | ) | (289 | ) | 950,340 | 289 | — | — | |||||||||||||||||||||
Exercise of stock options | — | — | — | — | — | — | 927,702 | 282 | 134,072 | — | |||||||||||||||||||||||
Merger with Liberty Mint, Ltd. | — | — | — | — | — | — | 4,492,567 | 11,804 | 1,386,631 | — | |||||||||||||||||||||||
Stock-based compensation | — | — | — | — | — | — | — | — | 1,087,500 | — | |||||||||||||||||||||||
Net loss | — | — | — | — | — | — | — | — | — | (1,525,539 | ) | ||||||||||||||||||||||
Balance at December 31, 2004 | — | — | — | — | — | — | 14,992,552 | 14,993 | 3,998,049 | (2,745,228 | ) | ||||||||||||||||||||||
Issuance of common stock | — | — | — | — | — | — | 175,000 | 175 | 339,900 | — | |||||||||||||||||||||||
Issuance of warrants for private | — | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||
placement fees | — | — | — | — | — | — | — | — | 31,607 | — | |||||||||||||||||||||||
Stock-based compensation | — | — | — | — | — | — | — | — | 1,804,000 | — | |||||||||||||||||||||||
Net loss | — | — | — | — | — | — | — | — | — | (3,105,826 | ) | ||||||||||||||||||||||
Balance at December 31, 2005 | — | — | — | — | — | — | 15,167,552 | 15,168 | 6,173,556 | (5,851,054 | ) | ||||||||||||||||||||||
Issuance of common stock | — | — | — | — | — | — | 7,413,332 | 7,413 | 4,589,813 | — | |||||||||||||||||||||||
Sale of warrants to former employees | — | — | — | — | — | — | — | — | 3,000 | — | |||||||||||||||||||||||
Issuance of warrants for employee termination costs | — | — | — | — | — | — | — | — | 230,105 | — | |||||||||||||||||||||||
Issuance of warrants for private placement fees | — | — | — | — | — | — | — | — | 89,715 | — | |||||||||||||||||||||||
Issuance of warrants for debt issuance costs | — | — | — | — | — | — | — | — | 55,505 | — | |||||||||||||||||||||||
Stock-based compensation (as restated) | — | — | — | — | — | — | — | — | 103,386 | — | |||||||||||||||||||||||
Net loss (as restated) | — | — | — | — | — | — | — | — | — | (1,357,992 | ) | ||||||||||||||||||||||
Balance at December 31, 2006 (as restated) | — | $ | — | — | $ | — | — | $ | — | 22,580,884 | $ | 22,581 | $ | 11,245,080 | $ | (7,209,046 | ) | ||||||||||||||||
See accompanying notes.
18
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2006, 2005, and 2004
| Year Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| (as restated— see Note 1) | ||||||||||||
Cash flows from operating activities: | ||||||||||||
Net loss | $ | (1,357,992 | ) | $ | (3,105,826 | ) | $ | (1,525,539 | ) | |||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Depreciation and amortization | 5,929 | 4,192 | — | |||||||||
Loss on disposal of assets | 13,805 | — | — | |||||||||
Stock-based compensation | 103,386 | 1,804,000 | 1,087,500 | |||||||||
Warrants issued for private placement fees | 89,715 | 31,607 | — | |||||||||
Warrants issued for employee terminations | 230,105 | — | — | |||||||||
Changes in assets and liabilities: | ||||||||||||
Other current assets | 6,613 | 106,836 | (116,000 | ) | ||||||||
Debt issuance costs, net of warrants issued to lender | (32,399 | ) | — | — | ||||||||
Accounts payable | 63,031 | (4,999 | ) | 52,815 | ||||||||
Net cash used in operating activities | (877,807 | ) | (1,164,190 | ) | (501,224 | ) | ||||||
Cash flows from investing activities: | ||||||||||||
Sale/(Purchase) of property and equipment | 100 | (21,584 | ) | — | ||||||||
Net cash provided (used) in investing activities | 100 | (21,584 | ) | — | ||||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from Series C preferred stock issuances | — | — | 129,615 | |||||||||
Proceeds from common stock issuances | 4,597,226 | 340,075 | 1,698,789 | |||||||||
Proceeds from sale of warrants to former employees | 3,000 | — | — | |||||||||
Payment of shareholders’ loans | — | — | (92,930 | ) | ||||||||
Net cash provided by financing activities | 4,600,226 | 340,075 | 1,735,474 | |||||||||
Net increase (decrease) in cash and cash equivalents | 3,722,519 | (845,699 | ) | 1,234,250 | ||||||||
Cash and cash equivalents at beginning of period | 388,551 | 1,234,250 | — | |||||||||
Cash and cash equivalents at end of year | $ | 4,111,070 | $ | 388,551 | $ | 1,234,250 | ||||||
Supplemental Disclosures of Cash Flow Information: | ||||||||||||
Interest Expense | $ | 2,442 | $ | — | $ | 6,248 | ||||||
Income Taxes Paid | $ | 1,800 | $ | 3,200 | $ | 1,600 | ||||||
Supplemental Disclosures of Non-Cash Investing and Financing Activities: | ||||||||||||
Conversion of shareholders’ loans to Series C convertible preferred stock | $ | — | $ | — | $ | 129,615 | ||||||
Conversion of Series A, B and C convertible preferred stock to common stock | $ | — | $ | — | $ | 1,120,404 | ||||||
See accompanying notes.
19
Notes to Consolidated Financial Statements
As of December 31, 2006 (as restated) and 2005 and For the Years Ended December 31, 2006 (as restated), 2005 and 2004
| 1. | Restatement of Consolidated Financial Statements |
Background Information (Unaudited)
In December 2004, the FASB issued SFAS No. 123(R). SFAS No. 123(R) requires all share-based payments to employees, including stock awards, to be recognized as expenses in the issuer’s financial statements based on the fair values of those payments, reduced as appropriate based on any estimated forfeitures. In the case of stock-based compensation, the estimation of the number of stock awards that will ultimately be forfeited requires significant judgment and is based on the issuer’s determination of an appropriate rate of estimated forfeitures calculated by reference to a variety of data and assumptions. SFAS No. 123(R) also requires issuers to periodically review their estimated forfeiture rates and, to the extent necessary based on differences between estimated and actual results, to revise such estimated forfeiture rates. In the event of such a revision, any differences between estimated and actual results are required by SFAS No. 123(R) to be recorded as a cumulative adjustment in the period in which the estimated forfeiture rate is revised.
In May 2007, the Company conducted a review of its estimated forfeiture rate, taking into account, among other things, the types of awards typically granted by the Company, the types of employees who typically receive such awards and the Company’s historical forfeiture rate. As a result of this review, the Company determined that, due to the resignation of the Company’s former chief executive officer in October 2006 and the corresponding forfeiture by such former chief executive officer of a large number of stock awards, the Company’s estimated rate of forfeitures should have been materially revised during the fiscal quarter ended December 31, 2006. Accordingly, as required by SFAS No. 123(R), the Company revised its estimated forfeiture rate based on the differences between its estimated and actual results. However, because the Company determined that it should have revised its estimated forfeiture rate concurrently with the resignation of the Company’s former chief executive officer in the fiscal quarter ended December 31, 2006, the Company likewise concluded that the cumulative adjustment required by SFAS No. 123(R) should have been recorded in that period as opposed to the period during which the Company conducted the review.
As a result of the foregoing, on May 11, 2007, following consultation with, and upon the recommendation of, the Company’s management, the board of directors of the Company determined that it was necessary to restate the Company’s previously issued consolidated financial statements for the fiscal quarter and year ended December 31, 2006 in order to correct the amount of stock-based compensation expense recorded by the Company for those periods.
Restatement (audited)
The restatement has been accounted for in accordance with SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3”, as a revision of previously issued financial statements to reflect the correction of an error.
The Company has calculated the amount of the necessary cumulative adjustment resulting from the restatement to be equal to $1,047,575, which amount should have been recorded as a reduction of non-cash stock-based compensation expense within the Company’s operating expenses in the fiscal quarter ended December 31, 2006. Previously, in the Form 10-K, the Company reported a non-cash stock-based compensation expense of $1,150,961 for the fiscal year ended December 31, 2006. As a result, after applying the necessary cumulative adjustment referenced above, the Company’s non-cash stock-based compensation expense for the fiscal year ended December 31, 2006 is equal to $103,386.
The restatement does not result in a change in the Company’s previously reported revenues, cash flow from operations or total cash and cash equivalents shown in its financial statements for the fiscal quarter and year ended December 31, 2006. Instead, the resulting reduction in non-cash stock-based compensation expense effects a decrease of $1,047,575 in the Company’s net loss for the fiscal quarter and year ended December 31, 2006. In addition, because the amount of the reduction in non-cash stock-based compensation expense decreased both the Company’s accumulated deficit and paid-in capital, there was no net effect on the Company’s balance sheet at December 31, 2006. Likewise, the restatement has no impact on the Company’s operating results for any periods prior to the fiscal quarter ended December 31, 2006.
There is no difference between the gross adjustment to non-cash stock-based compensation described herein and the net effect after taxes as the Company has a history of net losses and a valuation allowance has been recorded to offset the net deferred tax assets for the year ended December 31, 2006.
20
Consolidated Balance Sheet Adjustments
The following is a summary of the adjustments to our previously issued consolidated balance sheet as of December 31, 2006.
| December 31, 2006 | ||||||||||||
| (adjustments) | ||||||||||||
| (as reported) | (1) | (as restated) | ||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 4,111,070 | $ | 4,111,070 | ||||||||
Prepaid insurance and other current assets | 2,551 | 2,551 | ||||||||||
Total current assets | 4,113,621 | — | 4,113,621 | |||||||||
Property and equipment, net | — | — | ||||||||||
Debt issuance costs, net | 85,462 | 85,462 | ||||||||||
Total assets | $ | 4,199,083 | $ | — | $ | 4,199,083 | ||||||
Liabilities and Stockholders' Equity (Deficit) | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 140,468 | $ | 140,468 | ||||||||
Total current liabilities | 140,468 | — | 140,468 | |||||||||
Total liabilities | 140,468 | — | 140,468 | |||||||||
Commitments and contingencies (Note 5) | — | — | ||||||||||
Stockholders' equity: | ||||||||||||
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, and zero shares issued and outstanding as of December 31, 2006 and December 31, 2005 | — | — | ||||||||||
Common stock, $0.001 par value, 50,000,000 shares authorized: 22,580,884 and 15,167,552 shares issued and outstanding at December 31, 2006 and December 31, 2005, respectively | 22,581 | 22,581 | ||||||||||
Additional paid-in capital | 12,292,655 | (1,047,575 | ) | 11,245,080 | ||||||||
Accumulated deficit | (8,256,621 | ) | 1,047,575 | (7,209,046 | ) | |||||||
Total stockholders' equity | 4,058,615 | — | 4,058,615 | |||||||||
Total liabilities and stockholders' equity | $ | 4,199,083 | $ | — | $ | 4,199,083 | ||||||
21
Consolidated Statements of Operations Adjustments
The following is a summary of the adjustments to our previously issued consolidated statements of operations for the year ended December 31, 2006.
| December 31, 2006 | ||||||||||||
| (adjustments) | ||||||||||||
| (as reported) | (1) | (as restated) | ||||||||||
Revenue | $ | — | $ | — | $ | — | ||||||
Operating costs and expenses: | ||||||||||||
Selling, general and administrative | 2,316,935 | (1,047,575 | ) | 1,269,360 | ||||||||
Research and development | 98,184 | 98,184 | ||||||||||
Total expenses | 2,415,119 | (1,047,575 | ) | 1,367,544 | ||||||||
Loss from operations | (2,415,119 | ) | 1,047,575 | (1,367,544 | ) | |||||||
Interest income/(expense), net | 25,157 | 25,157 | ||||||||||
Loss on disposal of assets | (13,805 | ) | (13,805 | ) | ||||||||
Loss before income taxes | (2,403,767 | ) | 1,047,575 | (1,356,192 | ) | |||||||
Provision for income taxes | 1,800 | 1,800 | ||||||||||
Net loss | $ | (2,405,567 | ) | $ | 1,047,575 | $ | (1,357,992 | ) | ||||
Net loss per common share - basic and diluted | $ | (0.15 | ) | $ | 0.07 | $ | (0.08 | ) | ||||
Weighted-average common shares outstanding - basic and diluted | 16,020,232 | 16,020,232 | 16,020,232 | |||||||||
22
Consolidated Statements of Cash Flows Adjustments
The following is a summary of the adjustments to our previously issued consolidated statements of cash flows for the fiscal years ended December 31, 2006.
| December 31, 2006 | ||||||||||||
| (adjustments) | ||||||||||||
| (as reported) | (1) | (as restated) | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net loss | $ | (2,405,567 | ) | $ | 1,047,575 | $ | (1,357,992 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Depreciation and amortization | 5,929 | 5,929 | ||||||||||
Loss on disposal of assets | 13,805 | 13,805 | ||||||||||
Stock-based compensation | 1,150,961 | (1,047,575 | ) | 103,386 | ||||||||
Warrants issued for private placement fees | 89,715 | 89,715 | ||||||||||
Warrants issued for employee termination costs | 230,105 | 230,105 | ||||||||||
Changes in assets and liabilities: | ||||||||||||
Other current assets | 6,613 | 6,613 | ||||||||||
Debt issuance costs, net of warrants issued | ||||||||||||
to lender | (32,399 | ) | (32,399 | ) | ||||||||
Accounts payable | 63,031 | 63,031 | ||||||||||
Net cash used in operating activities | (877,807 | ) | — | (877,807 | ) | |||||||
Cash flows from investing activities: | ||||||||||||
Sale/(Purchase) of property and equipment | 100 | 100 | ||||||||||
Net cash used in investing activities | 100 | — | 100 | |||||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from Series C preferred stock issuances | — | — | ||||||||||
Proceeds from common stock issuances | 4,597,226 | 4,597,226 | ||||||||||
Proceeds from sale of warrants to former employees | 3,000 | 3,000 | ||||||||||
Net cash provided by financing activities | 4,600,226 | — | 4,600,226 | |||||||||
Net increase (decrease) in cash and cash equivalents | 3,722,519 | 3,722,519 | ||||||||||
Cash and cash equivalents at beginning of period | 388,551 | 388,551 | ||||||||||
Cash and cash equivalents at end of year | $ | 4,111,070 | $ | — | $ | 4,111,070 | ||||||
Supplemental Disclosures of Cash Flow Information: | ||||||||||||
Interest Expense | $ | 2,442 | $ | 2,442 | ||||||||
Income Taxes Paid | $ | 1,800 | $ | 1,800 | ||||||||
| (1) | All of the above restatement adjustments are related to the cumulative non-cash stock-based compensation expense adjustment described above. |
| 2. | The Company and Recapitalization |
One of our predecessors, Akesis Delaware, was incorporated on April 27, 1998, for the purpose of direct marketing to consumers an established over-the-counter product for lowering blood glucose levels in the treatment of diabetes.
23
Effective December 9, 2004, pursuant to the Merger Agreement among Akesis Delaware, Liberty and MergerSub, MergerSub merged with and into Akesis Delaware, with Akesis Delaware as the surviving corporation and wholly owned subsidiary of Liberty.
Although Liberty acquired Akesis Delaware as a result of the transaction, Akesis Delaware stockholders held a majority of the Company’s common stock following the transaction. Accordingly, for accounting purposes, the acquisition was a “reverse acquisition” and Akesis Delaware was the “accounting acquiror.” Therefore, the transaction was accounted for as a recapitalization of Akesis Delaware and recorded based on the fair value of Liberty’s net tangible assets acquired by Akesis Delaware. No goodwill or other intangible assets were recorded. Effective January 11, 2005, Liberty changed its name to Akesis Pharmaceuticals, Inc. and the trading symbol was changed to AKES.OB.
| 3. | Summary of Significant Accounting Policies |
Principles of consolidation
The acquisition of Akesis Delaware by Liberty has been accounted for as a recapitalization of Akesis Delaware as described in Note 2. Since Akesis Delaware is the surviving entity, the accompanying consolidated financial statements reflect its historical results of operations prior to the acquisition. The accounts of Liberty and Akesis Delaware have been consolidated as of December 9, 2004, the effective date of the acquisition described in Note 2 above.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles 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 amount of expenses during the reporting period. Actual results could differ from those estimates.
Business risk and concentrations of credit risk
Akesis Delaware’s business is in the health care industry and sells products that may not be successful in the marketplace. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, including money market accounts. Substantially all of our cash and cash equivalents are maintained with one financial institution in the United States. Deposits held with that financial institution exceed the amount of insurance provided on such deposits. Those deposits may be redeemed upon demand and, therefore, bear minimal risk.
Fair value of financial instruments
The carrying amounts of cash and cash equivalents, prepaid assets and accounts payable approximate fair market value because of the short maturity of those instruments.
Cash and cash equivalents
Cash equivalents consist of highly liquid investment with original maturities of three months or less when purchased.
Property and equipment
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the related assets ranging from 3 to 5 years. Maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in operations in the period realized.
Income taxes
Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Revenue recognition
Product sales are recognized upon shipment to the customer and when payment is probable or collected immediately.
Research and development
Research and development costs are expensed as incurred. Such costs include consultants, supplies, and clinical trials.
24
Stock-based compensation
In December 2004, the FASB issued SFAS No. 123(R). SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and does not allow the previously permitted pro forma disclosure as an alternative to financial statement recognition. SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations and amends SFAS No. 95, “Statement of Cash Flows”. SFAS No. 123(R) is required to be effective beginning in the first quarter of fiscal 2006. However, the Company decided to adopt SFAS No. 123(R) effective with the acquisition of Akesis Delaware by Liberty on December 9, 2004. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS No. 123(R), which among other things, expanded the coverage of SFAS No. 123(R) to include share-based payments to outside directors. The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123(R).
Compensation costs for all share-based awards to employees and outside directors are measured based on the grant date fair value of those awards and is recognized over the period during which the employee or outside director is required to perform service in exchange for the award (generally over the vesting period of the award). The cost of share-based compensation awards is recognized during the period based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period, and is amortized under the multiple option methodology prescribed by SFAS No. 123(R).
As share-based compensation expense recognized in the consolidated statement of operations for the years ended December 31, 2006, 2005 and 2004 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimation of the number of stock awards that will ultimately be forfeited requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts are required by SFAS No. 123(R) to be recorded as a cumulative adjustment in the period in which estimates are revised.
We have no awards with market or performance conditions. Excess tax benefits, as defined by SFAS No. 123(R), will be recognized as an addition to additional paid-in capital. The adoption of the SFAS No. 123(R) fair value method resulted in a non-cash stock-based compensation charge on the Company’s reported results of operations of $103,386, $1,804,000 and $1,077,000 for the years ended December 31, 2006 (as restated), 2005 and 2004, respectively.
Prior to the adoption of SFAS No. 123(R), no stock options had been issued by Akesis Delaware to employees. However, stock options were issued prior to the recapitalization to non-employees and were recorded at their fair value in accordance with SFAS No. 123 and EITF 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”. Such stock options to non-employees were periodically re-measured as the stock options vested, and no re-measurement issues having a material impact on the financial statements were identified.
Stock offering costs
Expenses incurred in connection with common stock issuances are recorded as an offset to additional paid-in capital on the consolidated balance sheets. Such expenses consist of third-party related offering expenses.
Debt issuance costs
Debt issuance costs incurred to obtain debt financing are deferred and included on the consolidated balance sheets. The costs are amortized over the term of the debt. The amortization expense is included in interest expense on the consolidated statements of operations.
Net loss per share
Basic and diluted net loss per share is computed in accordance with Statement of Financial Accounting Standards No. 128, “Earnings per Share”. Basic loss per share includes no dilution and is computed by dividing net loss by the weighted-average number of shares of common stock outstanding for the period. Diluted loss per share reflects the potential dilution of securities that could share in the Company’s earnings, such as common stock equivalents which may be issued upon exercise of outstanding common stock options. Diluted loss per share is identical to basic loss per share for all periods reported because inclusion of common stock equivalents would be anti-dilutive.
25
For the years ended December 31, 2006, 2005, and 2004, the following options and warrants to purchase shares of common stock were excluded from the computation of diluted net loss per share, as the inclusion of such shares would be antidilutive:
| Years Ended December 31, | ||||||
| 2006 | 2005 | 2004 | ||||
Stock options | 1,000,000 | 1,462,499 | 1,062,499 | |||
Stock warrants | 1,726,300 | 106,750 | — | |||
Effect of new accounting standards
In March 2006, the FASB issued SFAS No. 156, which clarifies when servicing rights should be separately accounted for, requires companies to account for separately recognized servicing rights initially at fair value, and gives companies the option of subsequently accounting for those servicing rights at either fair value or under the amortization method. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. The Company does not expect the adoption of SFAS No. 156 to affect future reporting or disclosures.
In June 2006, the FASB issued FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes 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, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the adoption of FIN 48.
In September 2006, the FASB issued SFAS No. 157. SFAS No. 157 provides guidance for using fair value to measure assets and liabilities and requires expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the adoption of SFAS No. 157.
In September 2006, the FASB issued SFAS No. 158. SFAS No. 158 requires, among other things, that a company (1) recognize a net liability or asset to report the funded status of their defined benefit pensions and other postretirement plans on its balance sheet and (2) measure benefit plan assets and benefit obligations as of the company’s balance sheet date. SFAS No. 158 is effective for calendar year-end companies with publicly traded equity securities as of December 31, 2006. The Company does not expect the adoption of SFAS No. 158 to affect future reporting or disclosures.
| 4. | Property and Equipment |
As of December 31, 2004, Akesis Delaware had no property and equipment, and depreciation expense for the year ended December 31, 2004 was zero. Property and equipment as of December 31, 2005 consisted of the following:
| Cost | Accumulated Depreciation | Net | ||||||||
Furniture and fixtures | $ | 14,919 | $ | (2,753 | ) | $ | 12,166 | |||
Office equipment | 6,665 | (1,439 | ) | 5,226 | ||||||
Total property and equipment | $ | 21,584 | $ | (4,192 | ) | $ | 17,392 | |||
On October 2, 2006, the Company sold its furniture, fixtures and office equipment to its former chief executive officer for $100 as part of a Separation Agreement and Release. Depreciation expense recognized in 2006 prior to the sale of the assets was $3,487 and the Company recorded a loss in the consolidated statement of operations of $13,805 on the disposal of the assets. As of December 31, 2006, the Company had no property and equipment.
26
| 5. | Stockholder Loans |
Akesis Delaware received working capital contributions from two related-party lenders prior to its acquisition by Liberty in December 2004. Included in these balances was a convertible promissory note effective April 4, 2002 with the related-party lenders. The notes were due and payable to the related-party lenders at the earlier of 18 months from the effective date, Akesis Delaware closing a minimum financing by qualified investors in excess of $1,000,000, execution of a licensing agreement that would provide sufficient cash flow to repay the note, or a sale of all or substantially all of the Company’s assets. Interest accrues at 8% per annum based on a 360 day period. The note, including principal and accrued interest, could have been converted to stock of Akesis Delaware at any time, including Series B Preferred Stock with a conversion price of $5.00 or the same security from the closing of a minimum financing transaction by qualified investors in excess of $1,000,000. Akesis Delaware had the right to prepay the note with a 20 day written notice to the lender in either cash or stock. If no election was made by the lender within 10 days of notice, the prepayment would have been made in cash.
In September 2004, the holders of the loans and the Akesis Delaware Board of Directors agreed to convert stockholder loan principal balances of $115,461 into Series C Preferred Stock at $0.40 per share for a total of 288,653 shares. The principal balances converted into Series C Preferred Stock as of September 30, 2004. Additionally, Akesis Delaware recorded imputed interest of $14,154 as of September 30, 2004. However, interest was forgiven by the lenders, not paid upon conversion of the loans, and accordingly was recorded as additional paid-in capital.
| 6. | Commitments, Contingencies and Related Party Transactions |
Leases
The Company leases an aggregate of approximately 300 square feet of office space located in La Jolla, California, and San Diego, California, pursuant to two leases each on a month-to-month basis. The La Jolla office space is sublet from Avalon Ventures. One of the Company’s directors, Kevin Kinsella, is a managing member of Avalon Ventures. The San Diego office space is sublet from Sirion. Jay Lichter, the Company’s Chief Executive Officer and a member of the Board of Directors, is a former officer and current consultant to Sirion, and Kevin Kinsella is a current member of the Board of Directors of Sirion. In addition, from December 9, 2004 through July 31, 2006, the Company sublet approximately 900 square feet of office space in Carefree, Arizona from its former chief executive officer at his cost. The Board of Directors has determined that the rent charged to the Company for all three leases is fair and reasonable. The Company recorded rent expense during the years ended December 31, 2006, 2005 and 2004 of $25,200, $24,840 and $5,500, respectively.
Loan
In December 2006, the Company entered into a loan and security agreement with Square 1 Bank (the “Bank”) that provides for a loan of up to $1.0 million to finance general corporate purposes. The loan bears an interest rate equal to the Bank’s prime rate plus 0.75% and matures in December 2009. The agreement requires monthly interest payments on any outstanding principal balance, and any outstanding principal balance is amortized and payable over the term of the agreement beginning in June 2007. The Company has granted a security interest in substantially all of its tangible assets as collateral for the loans under the loan and security agreement, and the agreement imposes certain limitations on the Company’s ability to engage in certain transactions. At December 31, 2006, the Company had no borrowings under the loan and security agreement.
| 7. | Stock-based Compensation |
Stock-based compensation expense for the years ended December 31, 2006 (as restated), 2005 and 2004, was $103,386, $1,804,000 and $1,087,500, respectively. Since we have a net operating loss carryforward as of December 31, 2006, no excess tax benefits for the tax deductions related to share-based awards were recognized in the consolidated statement of operations. At the present time, we intend to issue new common shares upon the exercise of stock options. None of the share-based awards are classified as a liability as of December 31, 2006.
Immediately following the acquisition of Akesis Delaware by Liberty in December 2004, two executive officers became entitled, through their respective employment offer letters, to nonstatutory stock options with a term of 10 years to acquire a total of 1,062,499 shares of common stock at an exercise price of $1.50 per share. Twenty percent of the shares of common stock subject to the options vested as of the effective date of the officers’ employment immediately following the acquisition of Akesis Delaware by Liberty and one forty-eighth ( 1/48th) of the remaining shares subject to the options were scheduled to vest each month following the effective date of the officers’ employment, subject to the officers’ continued employment with the Company on any such date. In addition, in the event of a change of control of the Company, then the officers would fully vest in and have the right to exercise the options as to all of the shares of common stock subject to the options. Effective October 2, 2006, one of the officers resigned and did not exercise the option to acquire the shares that had vested under the option agreement.
27
On October 2, 2006, the Company issued nonstatutory stock options with a term of 10 years to acquire a total of 600,000 shares of common stock at an exercise price of $0.94 per share to two executive officers and an outside director. The shares subject to the options vest one thirty-sixth ( 1/36th) each month for three years from the date of grant subject to the officers’ continued employment with the Company and the outside director’s continued service on the Company’s Board of Directors. In addition, in the event of a change of control of the Company, then the officers and outside director shall fully vest in and have the right to exercise the options as to all of the shares of common stock subject to the options.
The Company’s Board of Directors also authorized and reserved 1,500,000 shares of the Company’s common stock pursuant to a 2005 Stock Plan in January 2005 for option grants to the Company’s employees, directors and consultants. Options were granted pursuant to such 2005 Stock Plan to an officer and an outside director during the year ended December 31, 2005 for each of them to acquire 200,000 shares of our common stock. The stock options are nonqualified stock options with a term of 10 years and an exercise price of $1.94 per share. Twenty-five percent of the shares of common stock subject to the options were scheduled to vest as of the first anniversary of the officer’s and outside director’s service to the Company, and one forty-eighth ( 1/48th) of the shares subject to the options were scheduled to vest each month following the first anniversary of the commencement of the officer’s and outside director’s service to the Company, subject to the officer’s and outside director’s continued service to the Company on any such date. In addition, in the event of a change of control of the Company, then the officer and outside director would fully vest in and have the right to exercise the options as to all of the shares of common stock subject to the options as to which the officer and outside director would not otherwise be vested or exercisable. Both the officer and outside director joined the Company in January 2005. Effective March 15, 2006, the officer resigned and did not exercise the option to acquire the shares that had vested under the option agreement.
The fair value of each option award is estimated on the date of grant using the Black-Scholes method for option pricing that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of our common stock and other factors. The expected term of options granted is based on our management’s estimate since our operating history is too brief to have established historical rates for employee termination and option exercises. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. Assumptions used in the Black-Scholes model for the years ended December 31, 2006, 2005 and 2004, respectively, were as follows:
| Years Ended December 31, | |||||||||
| 2006 | 2005 | 2004 | |||||||
| (as restated) | |||||||||
Expected volatility | 125 | % | 125 | % | 85 | % | |||
Annual expected termination rate | 35 | % | 25 | % | 5 | % | |||
Risk-free interest rate (zero coupon U.S. Treasury Note) | 4.68 | % | 3.7% to 4.0 | % | 1.9% to 3.4 | % | |||
Expected dividend yield | 0 | % | 0 | % | 0 | % | |||
The fair value of options granted during the years ended December 31, 2006, 2005 and 2004 was $292,153, $428,584 and $4,505,500, respectively, and the fair value is amortized over the vesting period of the option using the multiple option methodology in accordance with the provisions of SFAS No. 123(R).
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The following is a summary of the status of the 2006 and 2004 nonstatutory options and the options under the 2005 Stock Plan for the years ended December 31, 2006, 2005 and 2004:
| Number of Shares | Weighted Average Exercise Price Per Share | Weighted Average Remaining Contractual Term (in years) | Aggregate Intrinsic Value (in millions) | ||||||||
Balance at December 31, 2003 | — | $ | — | ||||||||
Granted | 1,062,499 | $ | 1.50 | ||||||||
Exercised | — | — | |||||||||
Cancelled | — | — | |||||||||
Balance at December 31, 2004 | 1,062,499 | $ | 1.50 | 9.92 | $ | 4.5 | |||||
Granted | 400,000 | $ | 1.94 | ||||||||
Exercised | — | — | |||||||||
Cancelled | — | — | |||||||||
Balance at December 31, 2005 | 1,462,499 | $ | 1.62 | 9.21 | $ | 4.9 | |||||
Granted | 600,000 | $ | 0.94 | ||||||||
Exercised | — | — | |||||||||
Expired | (532,707 | ) | $ | 1.55 | |||||||
Cancelled | (529,792 | ) | $ | 1.62 | |||||||
Balance at December 31, 2006 | 1,000,000 | $ | 1.25 | 9.06 | $ | 1.4 | |||||
Exercisable at December 31, 2006 | 265,333 | $ | 1.55 | 8.33 | $ | 0.6 | |||||
The grant-date fair values of options granted during the years ended December 31, 2006, 2005 and 2004 were $0.49 per share, $1.07 per share and $4.24 per share, respectively.
A summary of the status of our non-vested stock options as of December 31, 2006, 2005 and 2004 and changes during the years then ended are presented below.
Number of Shares | Average Fair Value | |||||
Nonvested at December 31, 2003 | — | $ | — | |||
Granted | 1,062,499 | $ | 4.24 | |||
Vested | (212,500 | ) | $ | 4.24 | ||
Cancelled | — | $ | — | |||
Nonvested at December 31, 2004 | 849,999 | $ | 4.24 | |||
Granted | 400,000 | $ | 1.07 | |||
Vested | (212,500 | ) | $ | 4.24 | ||
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Number of Shares | Average Fair Value | |||||
Cancelled | — | $ | — | |||
Nonvested at December 31, 2005 | 1,037,499 | $ | 3.02 | |||
Granted | 600,000 | $ | 0.49 | |||
Vested | (373,040 | ) | $ | 2.43 | ||
Cancelled | (529,792 | ) | $ | 3.39 | ||
Nonvested at December 31, 2006 | 734,667 | $ | 0.98 | |||
As of December 31, 2006 (as restated), there was $0.8 million of total unrecognized compensation cost, related to non-vested stock options, which is expected to be recognized over a weighted-average period of approximately 2.57 years. The total fair values of shares vested during the years ended December 31, 2006, 2005 and 2004 were $905,617, $901,000 and $901,000 respectively.
1998 Stock Option Plan
Akesis Delaware adopted the 1998 Incentive Stock Plan and terminated such immediately prior to the acquisition by Liberty of Akesis Delaware. All then outstanding options and rights were terminated immediately prior to the acquisition by Liberty of Akesis Delaware. Under the plan, nonstatutory stock options and stock purchase rights were granted to service providers, and incentive stock options were granted to employees. The fair market value of the shares was determined on the date of the option grant.
The term of each option was 10 years unless sooner terminated or amended by the Board. In the case of an incentive stock option granted to an optionee who, at the time of the grant, owned more than 10% of the voting power of all classes of stock, the term of the option was five years from the date of grant or as provided on the option agreement.
The exercise price of an option was determined by the Company’s administrator with the following exceptions: For an incentive stock option granted to an employee who owned more than 10% percent of the voting power of all classes of stock, the exercise price was no less than 110% of the fair market value per share on the date of grant. The exercise price for employees was no less than 100% of the fair market value on the date of grant. For nonstatutory stock options, the service provider who owned more than 10% percent of the voting power of all classes of stock, the exercise price was no less than 110% of the fair market value per share on the date of grant. The exercise price for other service providers was no less than 85% of the fair market value on the date of grant.
Options vested at a rate of no less than 20% per year over five years from the date of grant, except for options granted to officers, directors, and consultants.
The following is a summary of the status of options under the 1998 Incentive Stock Plan as of certain dates:
| Options Outstanding | Weighted- Average Exercise Price | |||||
Balance at December 31, 2003 | 878,592 | $ | 0.15 | |||
Granted | 115,233 | $ | 0.12 | |||
Exercised | (927,714 | ) | $ | 0.14 | ||
Cancelled | (66,111 | ) | $ | 0.11 | ||
Balance at December 31, 2004 | — | $ | — | |||
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| 8. | Common Stock |
During the first quarter of 2006, the Company conducted a financing with certain accredited investors, including two members of its Board of Directors, where it sold an aggregate of 180,000 shares of its common stock at a purchase price of $2.00 per share. In addition, the Company issued warrants to the investors to purchase an aggregate of up to 90,000 shares of its common stock in connection with the financings. The warrants are exercisable for shares of the Company’s common stock for three years from the date of issuance at an exercise price per share of $3.00. The net proceeds from the financings after deducting expenses related to the financing were approximately $350,000. All the shares and warrants issued in connection with the financing were exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In connection with the financing described in the preceding paragraph, the Company (a) paid its placement agent a cash fee equal to one percent (1%) of all funds invested by investors introduced by such placement agent (excluding amounts paid by investors upon exercise of warrants), and (b) issued to its placement agent a warrant to purchase up to 11,550 shares of its common stock. The warrant is exercisable for five years from the date of issuance at an exercise price per share of $2.00. The one percent cash commission totalling $2,100 paid to the placement agent was recorded as a reduction of paid in capital. The fair value of the warrant issued to the placement agent in connection with the financing was determined to be $18,965 using a Black-Scholes model, and that amount was recorded as a consulting fee. The warrant issued to the placement agents was exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
During the fourth quarter of 2006, the Company conducted an additional financing with certain accredited investors where it sold an aggregate of 7,233,332 shares of its common stock at a purchase price of $0.60 per share. In addition, the Company issued warrants to the investors to purchase an aggregate of up to 1,085,000 shares of its common stock in connection with the financing. The warrants are exercisable for shares of the Company’s common stock for three years from the date of closing at an exercise price per share of $0.60. The net proceeds from the financing after deducting expenses related to the financing were approximately $4.247 million. All the shares and warrants issued in connection with the financing were exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In connection with the financing described in the preceding paragraph, an affiliate of Avalon Ventures purchased 5,000,000 shares of common stock for $3,000,000 and received a warrant to purchase up to 750,000 shares of common stock. Kevin Kinsella, a beneficial owner of the Company’s common stock, a holder of warrants to purchase common stock and member of the Company’s board of directors, is a managing member of Avalon Ventures. Jay Lichter, the Company’s President and Chief Executive Officer and an optionholder and member of the Company’s board of directors, is a venture partner of Avalon Ventures.
Also in connection with the fourth quarter 2006 financing described above, the Company (a) paid its placement agent a cash fee equal to eight percent (8%) of all funds invested by investors introduced by such placement agent (excluding amounts paid by investors upon exercise of warrants), and (b) issued to its placement agent a warrant to purchase up to 83,000 shares of its common stock. The warrant is exercisable for five years from the date of issuance at an exercise price per share of $0.60. The eight percent cash commission totalling $66,400 paid to the placement agent was recorded as a reduction of paid in capital. The fair value of the warrant issued to the placement agent in connection with the financing was determined to be $70,750 using a Black-Scholes model, and that amount was recorded as a consulting fee. The warrant issued to the placement agent was exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In December 2006, the Company entered into a loan and security agreement with the Bank that provides for a loan of up to $1.0 million to finance general corporate purposes as described in Note 5 above. In connection with the loan agreement, the Company issued to the Bank a warrant to purchase up to 50,000 shares of its common stock. The warrant is exercisable for seven years from the date of issuance at an exercise price per share of $0.60. The fair value of the warrants issued to the Bank in connection with the loan was determined to be $55,505 using a Black-Scholes model, and that amount was recorded as debt issuance costs. The warrant issued to the Bank was exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
In connection with separation agreements entered into with two former officers during 2006, the Company issued the former officers warrants to purchase up to 50,000 and 250,000 shares, respectively, of its common stock. The warrants are exercisable for shares of the Company’s common stock for three years from the effective date of the applicable separation agreement at an exercise price per share of $1.42 and $0.94, respectively. The officers purchased the warrants from the Company for $500 and $2,500, respectively. The fair value of these warrants was determined to be a total of $230,105 using a Black-Scholes model, and that amount was recorded as employee termination expense. The warrants were exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended.
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| 9. | Income Taxes |
Income taxes consisted of the following:
| 2006 | 2005 | |||||||
Deferred (benefit) | ||||||||
Federal | $ | (277,000 | ) | $ | (377,000 | ) | ||
State | (49,000 | ) | (67,000 | ) | ||||
| (326,000 | ) | (444,000 | ) | |||||
Change in valuation allowance | 326,000 | 444,000 | ||||||
| $ | — | $ | — | |||||
At December 31, 2006, Akesis Delaware has federal tax net operating loss carryforwards of approximately $4.6 million. The federal net operating loss carryforwards will begin to expire in 2018, unless previously utilized. Pursuant to Internal Revenue Code Section 382 and 383, use of Akesis Delaware’s net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within a three-year period. No assessment has been made as to whether such a change in ownership has occurred.
Significant components of Akesis Delaware’s net deferred tax assets at December 31, 2006 and 2005 are shown below. A valuation allowance of $1,605,000 and $1,279,000 has been established to offset the net deferred tax assets at December 31, 2006 and 2005, respectively, as realization of such assets is uncertain.
| December 31, 2006 | ||||||||
| 2006 | 2005 | |||||||
Noncurrent Net Operating Loss Carryforwards | $ | 1,565,000 | $ | 1,241,000 | ||||
Other noncurrent | 27,000 | 25,000 | ||||||
Total noncurrent | 1,592,000 | 1,266,000 | ||||||
Other current | 13,000 | 13,000 | ||||||
Total deferred tax assets | 1,605,000 | 1,279,000 | ||||||
Deferred tax asset valuation allowance | (1,605,000 | ) | (1,279,000 | ) | ||||
Net deferred taxes | $ | — | $ | — | ||||
A reconciliation of income taxes at the federal statutory rate to the effective tax rate is as follows:
| Years Ended December 31, | ||||||||
| 2006 | 2005 | |||||||
| (as restated) | ||||||||
Income taxes (benefit) computed at the federal statutory rate | $ | (475,000 | ) | $ | (1,087,080 | ) | ||
Tax effect of change in valuation analysis | 326,000 | 444,000 | ||||||
Nondeductible compensation | 36,000 | 632,000 | ||||||
Deduction arising from exercise of stock options | — | — | ||||||
Nondeductible expenses arising from issuance of warrants | 113,000 | 11,000 | ||||||
| $ | — | $ | — | |||||
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| Item 9A. | Controls and Procedures |
For the reasons discussed in the Explanatory Note to this Amendment and Note 1 to our consolidated financial statements, we have restated herein our: (i) consolidated balance sheet as of December 31, 2006; and (ii) the consolidated statements of operations, the consolidated statements of stockholder’s equity and consolidated statements of cash flows for the fiscal year ended December 31, 2006. The certifications of our Chief Executive Officer and Chief Financial Officer, filed as Exhibits 31.1, 31.2 and 32.1, should be read in conjunction with this Item 9A.
Evaluation of disclosure controls and procedures. Our Chief Executive Officer and our Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-K/A. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have determined that our disclosure controls and procedures were not effective as of December 31, 2006 and that we have a material weakness in our internal control over financial reporting. This material weakness relates to our failure to implement a policy for routinely evaluating the assumptions and estimates that we use when calculating our non-cash stock-based compensation expenses in accordance with SFAS No. 123(R).
Remediation of Material Weaknesses. Since the time we determined that our disclosure controls and procedures were not effective and identified the material weakness in our internal control over financial reporting, we have devoted significant time to developing remedial measures to address these deficiencies. In particular, with oversight from our Audit Committee, we have formulated a remediation plan intended to address and eliminate the material weakness in our internal control over financial reporting, and we are committed to effectively implementing the plan as expeditiously as possible. Specifically, this plan includes the adoption and implementation of a new Company policy that requires management, with appropriate assistance from qualified experts, to evaluate the Company’s estimated forfeiture rate for purposes of SFAS No. 123(R) and to record any necessary adjustments resulting from any changes in such estimated forfeiture rate for each quarterly and annual reporting period.Notwithstanding the adoption and implementation of this policy, the material weakness in our internal control over financial reporting will not be deemed to have been eliminated until our remediation plan has been fully implemented, in operation for a sufficient period of time, tested by our management and concluded to be operating effectively. Despite the existence of the material weakness in our internal control over financial reporting, as a result of the restatement of our previously issued financial statements contained in this Amendment, management believes that the consolidated financial statements included in this Amendment fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented.
Changes in internal control over financial reporting. Based on an evaluation performed by our Chief Executive Officer and Chief Financial Officer, we have concluded that there was no change in our internal control over financial reporting that occurred during the period covered by this Amendment that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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| Item 15. | Exhibits and Financial Statement Schedules |
| (a) | The following documents are filed as part of this Form 10-K/A: |
| (1) | Consolidated Financial Statements (included in Part II of this report): |
| • | Report of Swenson Advisors, LLP, Independent Registered Public Accounting Firm. |
| • | Consolidated Balance Sheets |
| • | Consolidated Statements of Operations |
| • | Consolidated Statement of Stockholders’ Equity |
| • | Consolidated Statements of Cash Flows |
| • | Notes to Consolidated Financial Statements |
| (2) | Consolidated Financial Statement Schedules: |
All consolidated financial statement schedules are omitted because the information is inapplicable or presented in the notes to the financial statements.
| (3) | Exhibits: |
Exhibit Number | Description | ||
| 2.1 | (1) | Agreement and Plan of Merger and Reorganization dated September 27, 2004 by and among the Registrant, Ann Arbor Acquisition Corporation, and Liberty Mint, Ltd. | |
| 3.1 | (2) | Articles of Incorporation, as amended, of the Registrant | |
| 3.2 | (2) | Bylaws of the Registrant | |
| 4.1 | (3) | Form of Warrant to Purchase Common Stock issued pursuant to that certain Common Stock and Warrant Purchase Agreement dated December 30, 2005 between the Company and the purchasers therein | |
| 4.2 | (3) | Form of Warrant to Purchase Common Stock issued pursuant to the Form of Finder Agreement | |
| 4.3 | (7) | Form of Warrant to Purchase Common Stock issued pursuant to that certain Securities Purchase Agreement dated November 21, 2006 between the Company and the purchasers therein | |
| 4.4 | (7) | Warrant to Purchase Common Stock dated November 21, 2006 between the Company and Globalvest Partners, LLC | |
| 4.5 | (8) | Form of Warrant issued to Investors in the Financing dated December 15, 2006 | |
| 4.6 | (8) | Warrant, dated as of December 15, 2006, issued to Globalvest Partners, LLC | |
| 4.7 | (8) | Warrant, dated as of December 15, 2006, issued to Square 1 Bank | |
| 4.8 | (6) | Warrant to Purchase Common Stock dated October 2, 2006 between the Company and Edward Wilson | |
| 10.1 | (2) | Employment Offer Letter dated December 13, 2004 for Edward B. Wilson, President and CEO of the Registrant | |
| 10.2 | (2) | Employment Offer Letter dated December 13, 2004 for John T. Hendrick, CFO of the Registrant | |
| 10.3 | (2) | Stand-Alone Stock Option Agreement dated January 24, 2005 for Edward B. Wilson, President and CEO of the Registrant | |
| 10.4 | (2) | Stand-Alone Stock Option Agreement dated January 24, 2005 dated for John T. Hendrick, CFO of the Registrant | |
| 10.5 | (2) | 2005 Stock Plan of the Registrant | |
| 10.6 | (3) | Form of Finder Agreement | |
| 10.7 | (5) | Common Stock and Warrant Purchase Agreement dated March 31, 2006 | |
| 10.8 | (6) | Separation Agreement and Release dated October 2, 2006 between the Company and the Edward Wilson | |
| 10.9 | (6) | Form of Stand-Alone Stock Option Agreement | |
| 10.10 | (6) | Offer Letter dated October 2, 2006 between the Company and Jay Lichter | |
| 10.11 | (7) | Securities Purchase Agreement dated November 21, 2006 between the Company and the purchasers therein | |
| 10.12 | (7) | Finders Agreement dated November 8, 2006 between the Company and Globalvest Partners, LLC | |
| 10.13 | (8) | Securities Purchase Agreement, dated as of December 15, 2006, by and among the Company and the Investors | |
34
| 10.14 | (8) | Loan and Security Agreement, dated as of December 15, 2006, by and between the Company and Square 1 Bank | |
| 14.1 | (4) | Code of Ethics of the Registrant | |
| 21.1 | (9) | Subsidiaries of the Registrant | |
| 23.1 | Consent of Swenson Advisors, LLP, Independent Registered Public Accounting Firm | ||
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| 32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| (1) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on September 28, 2004 |
| (2) | Incorporated by reference to the Registrant’s Form 10-K as filed with the SEC on March 25, 2005 |
| (3) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on January 6, 2006 |
| (4) | Incorporated by reference to the Registrant’s Amendment to Form 10-K as filed with the SEC on April 28, 2005 |
| (5) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on April 4, 2006 |
| (6) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on October 3, 2006 |
| (7) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on November 27, 2006 |
| (8) | Incorporated by reference to the Registrant’s Form 8-K as filed with the SEC on December 20, 2006 |
| (9) | Incorporated by reference to the Registrant’s Form 10-K as filed with the SEC on February 9, 2007 |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| AKESIS PHARMACEUTICALS, INC. | ||||
| By: | /s/ Jay B. Lichter | |||
| Jay B. Lichter | ||||
| President, Chief Executive Officer and Director | ||||
| Dated: May21, 2007 | ||||
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Jay B. Lichter and John T. Hendrick and each of them acting individually, as his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Form 10-K/A, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorney to any and all amendments said Form 10-K/A.
Pursuant to the requirements of the Securities Act, this Form 10-K/A has been signed by the following persons in the capacities and on the dates indicated:
Signature | Title | Date | ||
/s/ Jay B. Lichter | President, Chief Executive Officer and Director | |||
| Jay B. Lichter | (Principal Executive Officer) | May21, 2007 | ||
/s/ John T. Hendrick | Chief Financial Officer | |||
| John T. Hendrick | (Principal Financial and Accounting Officer) | May21, 2007 | ||
/s/ Kevin J. Kinsella | Director | |||
| Kevin J. Kinsella | May21, 2007 | |||
/s/ Kevin R. Sayer | Director | |||
| Kevin R. Sayer | May18, 2007 | |||
/s/ John F. Steel, IV | Director | |||
| John F. Steel, IV | May21, 2007 | |||
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