UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 0-28006
ESSENTIAL THERAPEUTICS, INC.
(Formerly Microcide Pharmaceuticals, Inc.)
(Exact name of registrant as specified in its charter)
Delaware 94-3186021
(State or other jurisdiction of incorporation of organization) (I.R.S. Employer Identification Number)
1365 Main Street, Waltham, Massachusetts 02451
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: 781-647-5554
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 __
--
Number of shares of Common Stock, $0.001 par value per share, outstanding as of
October 31, 2001: 16,707,339
ESSENTIAL THERAPEUTICS, INC.
INDEX FOR FORM 10-Q
SEPTEMBER 30, 2001
PAGE
NUMBER
PART I FINANCIAL INFORMATION
Item 1. Condensed Financial Statements and Notes (unaudited)
Condensed Balance Sheets as of September 30, 2001
and December 31, 2000 3
Condensed Statements of Operations for the three and nine
months ended September 30, 2001 and September 30, 2000 4
Condensed Statements of Cash Flows for the nine months
ended September 30, 2001 and September 30, 2000 5
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
PART II OTHER INFORMATION
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
2
ESSENTIAL THERAPEUTICS, INC.
CONDENSED BALANCE SHEETS
(in thousands)
September 30, December 31,
2001 2000
----------------- ------------------
(Unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 7,539 $ 3,744
Short-term investments -- 8,845
Receivables, prepaid expenses and other current assets 800 7,896
----------------- ------------------
Total current assets 8,339 20,485
Property and equipment, net 4,409 5,856
Other assets 1,717 857
----------------- ------------------
Total assets $ 14,465 $ 27,198
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,182 $ 566
Accrued compensation 1,218 879
Current portion of notes payable 662 1,597
Deferred revenue 2,442 7,323
Other accrued liabilities 1,276 906
----------------- ------------------
Total current liabilities 6,780 11,271
Long-term portion of notes payable 61 309
Accrued rent 379 294
Stockholders' equity:
Common stock 68,891 68,483
Deferred compensation (116) --
Accumulated deficit (61,530) (53,188)
Accumulated other comprehensive income -- 29
----------------- ------------------
Total stockholders' equity 7,245 15,324
----------------- ------------------
Total liabilities and stockholders' equity $ 14,465 $ 27,198
================= ==================
NOTE: The balance sheet at December 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See Notes to Condensed Financial Statements.
3
ESSENTIAL THERAPEUTICS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ----------------------------------
2001 2000 2001 2000
---------------- ------------- --------------- ---------------
Revenues:
Research revenues $ 1,030 $ 1,454 $ 3,761 $ 4,108
License fees and other revenues 1,893 50 3,677 150
---------------- ------------- --------------- ---------------
Total revenues 2,923 1,504 7,438 4,258
Operating expenses:
Research and development 4,201 3,985 12,678 12,154
General and administrative 1,045 1,242 3,508 3,167
---------------- ------------- --------------- ---------------
Total operating expenses 5,246 5,227 16,186 15,321
---------------- ------------- --------------- ---------------
Loss from operations (2,323) (3,723) (8,748) (11,063)
Interest and other income, net 69 210 406 679
---------------- ------------- --------------- ---------------
Loss before cumulative effect of change in
accounting principle (2,254) (3,513) (8,342) (10,384)
Cumulative effect of change in accounting principle --- --- --- (233)
---------------- ------------- --------------- ---------------
Net loss $ (2,254) $ (3,513) $ (8,342) $ (10,617)
================ ============= =============== ===============
Basic and diluted net loss per share:
Loss before cumulative effect of change in
accounting principle $ (0.20) $ (0.31) $ (0.73) $ (0.92)
Cumulative effect of change in accounting principle --- --- --- (0.02)
---------------- ------------- --------------- ---------------
Net loss per share $ (0.20) $ (0.31) $ (0.73) $ (0.94)
================ ============= =============== ===============
Weighted-average shares used in
basic and diluted net loss per share 11,519 11,354 11,497 11,292
See Notes to Condensed Financial Statements.
4
ESSENTIAL THERAPEUTICS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Increase (decrease) in cash and cash equivalents
Nine Months Ended
September 30,
-----------------------------------
2001 2000
-------------- --------------
Cash flows from operating activities:
Net loss $ (8,342) $ (10,617)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,624 1,926
Cumulative effect of change in accounting principle --- 233
Amortization of deferred compensation 24 ---
Loss on disposal of fixed assets 44 ---
Changes in assets and liabilities:
Receivables, prepaid expenses and other assets 6,236 (570)
Accounts payable 616 161
Accrued compensation and other accrued liabilities 709 153
Accrued rent 85 6
Deferred revenue (4,881) (537)
-------------- --------------
Net cash used in operating activities (3,885) (9,245)
-------------- --------------
Cash flows from investing activities:
Purchase of short-term investments (3,934) (7,676)
Maturities of short-term investments 12,750 14,500
Capital expenditures (221) (573)
-------------- --------------
Net cash provided by investing activities 8,595 6,251
-------------- --------------
Cash flows from financing activities:
Principal payments on notes payable (1,183) (1,065)
Net proceeds from issuance of common stock 268 1,184
-------------- --------------
Net cash provided by (used in) financing activities (915) 119
-------------- --------------
Net increase (decrease) in cash and cash equivalents 3,795 (2,875)
Cash and cash equivalents, beginning of period 3,744 5,660
-------------- --------------
Cash and cash equivalents, end of period $ 7,539 $ 2,785
============== ==============
Supplemental disclosure of cash flow information:
Interest paid $ 93 $ 202
============== ==============
See Notes to Condensed Financial Statements.
5
ESSENTIAL THERAPEUTICS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
1. Summary of Significant Accounting Policies
Organization and Basis of Presentation
Essential Therapeutics, Inc. (formerly known as Microcide
Pharmaceuticals, Inc.) (referred to herein as either the Company or Essential
Therapeutics) is a biopharmaceutical company committed to the discovery,
development and commercialization of new classes of pharmaceutical products.
Essential Therapeutics has discovery programs for inhibitors of bacterial cell
wall biosynthesis (both cephalosporins and novel agents) and for inhibitors of
efflux pumps in both bacteria and fungi. Essential Therapeutics' target
validation and drug discovery programs comprise a broad-based program, including
the Company's proprietary VALID Microbial Genomics technologies and its target
validation system, known as ACTT. The Company's structure-based drug design
(SBDD) and related technologies guide the optimization of drug candidates prior
to entry into more advanced pre-clinical testing and preparation for clinical
testing.
On October 24, 2001, Essential Therapeutics acquired The Althexis
Company, Inc. and simultaneously with that acquisition closed an equity
financing that raised an aggregate of $60.0 million dollars through a private
placement of Series B convertible redeemable preferred stock to a group of
venture capital investors. The accompanying financial statements represent the
financial position of Essential Therapeutics as of and for the period ended
September 30, 2001 without giving effect to the acquisition of The Althexis
Company or to the $60.0 million private equity financing. Please see Note 5 to
the Condensed Financial Statements.
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The results of operations for the interim periods shown herein
are not necessarily indicative of operating results for the entire year.
The Company previously recognized nonrefundable upfront license fees as
revenue when received and when all contractual obligations of the Company
relating to the fees had been fulfilled. Effective January 1, 2000, the Company
changed its method of accounting for nonrefundable upfront license fees to
recognize such fees over the term of the related research collaboration
agreement. The Company believes the change in accounting principle is preferable
based on guidance provided in SEC Staff Accounting Bulletin No. 101 - Revenue
Recognition in Financial Statements.
This unaudited financial data should be read in conjunction with the
financial statements and footnotes contained in the Company's annual report on
Form 10-K/A for the year ended December 31, 2000.
2. Net Loss per Share
Basic earnings (loss) per share is calculated using the weighted
average number of shares of common stock outstanding. Because the Company is in
a net loss position, diluted earnings per share is calculated using the weighted
average number of shares of common stock outstanding and excludes the effects of
options, which are antidilutive.
6
3. Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of net loss and other
comprehensive income (loss). Other comprehensive income (loss) includes some
changes in equity that are excluded from net loss. Specifically, unrealized
holding gains and losses on our available-for-sale securities, which were
reported separately in stockholders' equity, are included in accumulated other
comprehensive income (loss).
4. Recently Issued Accounting Standards
In June 1998, the FASB issued Statement of Financial Accounting
Standard No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities." The Company was required to adopt SFAS 133 effective January 1,
2001. SFAS 133 establishes methods of accounting for derivative financial
instruments and hedging activities related to those instruments. Essential
Therapeutics does not currently engage in hedging activities and the adoption of
SFAS 133 had no material impact on Essential Therapeutics' financial condition
and results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 summarizes certain areas of the Staff's views in applying
generally accepted accounting principles to revenue recognition. Essential
Therapeutics adopted SAB 101 in the fourth quarter of 2000, effective January 1,
2000, and recorded a cumulative effect of a change in accounting principle
related to recognition of upfront nonrefundable license payments received under
collaborative agreements. As a result of this change in accounting for
nonrefundable upfront license fees, the first quarter of 2000 reflects a charge
for the $233,000 cumulative effect of the change in accounting principle,
calculated as of January 1, 2000, and an adjustment was made to previously
reported research revenues to reflect revenue recognition of $50,000 in each of
the first, second and third quarters. The cumulative effect was initially
recorded as deferred revenue and was recognized as revenue over the remaining
contractual term of the collaborative research and development agreement.
In July 2001, the FASB issued FAS 141 "Business Combinations" and FAS
142 "Goodwill and Other Intangible Assets." FAS 141 eliminates the
pooling-of-interests method of accounting for business combinations except for
qualifying business combinations that were initiated prior to July 1, 2001. FAS
141 further clarifies the criteria to be met in order to recognize intangible
assets separately from goodwill. The requirements of FAS 141 are effective for
any business combination accounted for by the purchase method that is completed
after June 30, 2001 (i.e., the acquisition date is July 1, 2001 or after). Under
FAS 142, goodwill and indefinite-lived intangible assets are no longer amortized
but are reviewed annually for impairment (or more frequently if impairment
indicators arise). Separable intangible assets that are not deemed to have an
indefinite life will continue to be amortized over their useful lives. Essential
Therapeutics will adopt FAS 142 on January 1, 2002. Essential Therapeutics
expects that the adoption will impact its future financial position and results
of operations, related to the goodwill to be recorded associated with the
October 24, 2001 acquisition of Althexis.
5. Subsequent Events
On October 24, 2001, Essential Therapeutics:
. completed its acquisition of The Althexis Company, Inc. pursuant to terms
of the Agreement and Plan of Merger, dated as of July 27, 2001, as a result
of which Althexis became a wholly owned subsidiary of Essential
Therapeutics;
. completed an equity financing by way of a private placement of an aggregate
of 60,000 shares of its Series B convertible redeemable preferred stock for
a total purchase price of $60.0 million to a number of venture capital
investors; and
7
. changed its name from Microcide Pharmaceuticals, Inc. to Essential
Therapeutics, Inc. to better reflect the business strategy and operations
of the combined company resulting from the acquisition of Althexis.
Upon the completion of and in connection with the acquisition of
Althexis, Essential Therapeutics issued a total of 5,188,026 shares of its
common stock in exchange for all of the outstanding capital stock of Althexis.
In addition, Essential Therapeutics assumed outstanding stock options which are
presently exercisable for approximately 362,169 shares of Essential Therapeutics
common stock. In addition, Essential Therapeutics agreed to file a registration
statement with the Securities and Exchange Commission to register the resale of
Essential Therapeutics common stock acquired by the former Althexis
stockholders. All but approximately 400,000 of the total 5,188,026 shares of
common stock are subject to resale restrictions until October 2002.
Based on the fair value of Essential Therapeutics common stock on July
30, 2001, the date the transaction was announced, the purchase price was
approximately $21.0 million, including estimated transaction costs. As part of
the purchase price, Essential Therapeutics expects to incur a non-cash charge of
approximately $13.9 million relating to acquired in-process research and
development in the fourth quarter of 2001. The acquisition of Althexis was
structured as a tax-free share exchange and will be accounted for under the
purchase method of accounting.
The shares of Series B convertible redeemable preferred stock issued in
the equity financing are convertible into shares of Essential Therapeutics
common stock at a conversion price of $3.00 per share. Essential Therapeutics
has agreed to register the common stock into which the shares of preferred stock
convert by a Registration Statement on Form S-3 with the Securities and Exchange
Commission. The purchasers of Series B preferred stock have entered into a
lockup agreement and as a result certain of their shares are subject to lockup
provisions for up to 9 months after closing. In connection with the equity
financing, Essential Therapeutics expects to record a deemed dividend to the
preferred stockholders in the fourth quarter of 2001, resulting from the fact
that the shares of Series B preferred stock were priced at a discount to the
market price on July 27, 2001. The deemed dividend will be a non-cash charge of
approximately $23.8 million, and will have the effect of increasing loss per
share attributable to common stockholders.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The following discussion and analysis of financial condition and
results of operations refer to the financial position of Essential Therapeutics
as of and for the period ended September 30, 2001, without giving effect to the
acquisition of The Althexis Company or to the $60.0 million Series B convertible
redeemable preferred stock equity financing, both of which were completed on
October 24, 2001. Please see Note 5 to the Condensed Financial Statements.
As part of its strategy to enhance its research and development
capabilities and to fund, in part, its capital requirements, Essential
Therapeutics has entered into collaborative agreements with several major
pharmaceutical companies. Pursuant to Essential Therapeutics' collaborative
agreements with the R.W. Johnson Pharmaceutical Research Institute, a subsidiary
of Johnson & Johnson (RWJPRI), Daiichi Pharmaceutical Co., Ltd. (Daiichi),
Pfizer Inc. (Pfizer) and Schering-Plough Animal Health Corporation (SPAH),
Essential Therapeutics has received license fees, milestone payments and
research support payments, and may potentially receive additional research
support payments, milestone payments and royalty payments. License payments are
typically nonrefundable upfront payments for licenses to develop, manufacture
and market any products that are developed as a result of the collaboration.
Research support payments are typically contractually obligated payments to fund
research and development over the term of the collaboration. Milestone payments
are contingent payments that are made only upon the achievement of specified
milestones, such as selection of candidates for drug development, the
commencement of clinical trials or receipt of regulatory approvals. If drugs are
successfully developed and commercialized as a result of its collaborative
agreements, Essential Therapeutics will receive royalty payments based upon the
net sales of those drugs developed under the collaboration. In addition,
Essential Therapeutics has derived other revenues principally through the sale
of molecular diversity to other pharmaceutical and biotechnology companies for
use in their research programs, and through short-term contract research.
Through September 30, 2001, Essential Therapeutics had received an aggregate of
$64.1 million in license fees, milestone payments and research support payments
under the collaborative agreements previously discussed.
The initial funded research portion of the 1995 collaborative agreement
with RWJPRI concluded in late 1999. In November 1999, RWJPRI commenced Phase I
clinical trials of Essential Therapeutics' cephalosporin compound RWJ-54428
(MC-02,479) developed during the Essential Therapeutics-RWJPRI Gram-positive
research collaboration. Based upon the observation of irritation at the
injection site in some subjects in these trials, Essential Therapeutics
announced in May 2001 that RWJPRI had decided to focus current efforts on the
advancement of RWJ-442831, an Essential Therapeutics-developed prodrug form of
the cephalosporin compound RWJ-54428, into pre-clinical toxicology studies
which, if successful, would allow the compound to advance into Phase I clinical
trials. A prodrug is a modified form of a drug that is readily converted to the
active drug in the body. Preliminary studies of RWJ-442831 in animals, conducted
by Essential Therapeutics, demonstrated reduced venous irritation at the
injection site compared to RWJ-54428. We cannot assure you that any compounds
developed to address the incidence of irritation at the injection site will
successfully proceed through pre-clinical development and clinical trials. In
addition, work continues on a second parenteral (administered by injection)
Essential Therapeutics cephalosporin compound, RWJ-333441 (MC-04,546), in
pre-clinical development with RWJPRI.
In December 2000, Essential Therapeutics and RWJPRI extended their
collaboration for one year to develop a new class of cephalosporins, having
similar spectrum and potency to the collaboration's parenteral compounds, but
that would be bioavailable following oral administration. During the third
quarter of 2001, Essential Therapeutics announced that it had received a
milestone payment for achievement of specified development goals related to
Essential Therapeutics' pre-clinical research under this collaboration. In
December 2000, a new and unrelated collaboration with RWJPRI was established, to
focus on the discovery of products from Essential Therapeutics' Natural Product
extracts. The agreement covers collaborative research to discover novel drugs
from natural
9
products. Essential Therapeutics has provided RWJPRI with access to its Natural
Products Library for the purpose of screening for activity in various biological
and therapeutic applications. RWJPRI will undertake a program for the
development, manufacture and sale of products developed from the collaborative
research.
The initial funded research portion of the 1995 collaborative agreement
with Daiichi concluded in 1999. In May 2000, Essential Therapeutics and Daiichi
signed a subsequent one-year funded research agreement to discover and develop
inhibitors to overcome the effect of efflux pumps in Pseudomonas aeruginosa. In
May 2001, Essential Therapeutics announced the successful completion of this
funded pre-clinical research phase. Daiichi will continue pre-clinical and
clinical work on candidates resulting from the collaboration. Essential
Therapeutics will receive milestone payments and royalties on worldwide sales of
any marketed products resulting from the research.
The five-year funded research portion of the 1996 collaborative
agreement with Pfizer concluded at the end of February 2001. Each of Essential
Therapeutics and Pfizer now has the right without further obligation to the
other to independently use the technology developed during the collaboration.
Consequently, Essential Therapeutics began using the validated essential gene
targets from this collaboration in its Essential Therapeutics-owned Microbial
Genomics program beginning in March 2001. In January 1999, Essential
Therapeutics and Pfizer Animal Health entered into a collaborative research
agreement to discover novel approaches to the control of bacterial infections
important in animal health. In October 2000, Pfizer Animal Health notified
Essential Therapeutics of its decision to extend the collaborative research
agreement for an additional year, beginning January 2001.
In October 2000, Essential Therapeutics entered into a research
collaboration and license agreement with SPAH to discover and develop compounds
to be used in the treatment of veterinary bacterial infections, based upon
application of Essential Therapeutics' efflux pump technology to existing SPAH
antibacterials. In July 2001, Essential Therapeutics announced an amendment to
this agreement that increases the level of research at Essential Therapeutics
funded by SPAH.
Essential Therapeutics continues to enhance its discovery and
development programs by entering into research and/or license agreements. In May
2001, Essential Therapeutics announced that it had entered into a collaborative
research and development agreement with NeoGenesis, Inc. to discover and develop
new classes of antibiotics. The collaboration will identify and optimize
chemical compounds with antibacterial activity, utilizing a specified number of
Essential Therapeutics' proprietary essential gene targets from Essential
Therapeutics' VALID (Validated Antimicrobial Lead Identification and
Development) System and from NeoGenesis' ALIS (Automated Ligand Identification
System) screening system and its small molecule libraries. Essential
Therapeutics will have worldwide product development and commercialization
rights. In June 2001, Essential Therapeutics announced that it had entered into
a collaborative research and development agreement with Cetek Corporation to
discover and develop new classes of anti-infective agents. The collaboration
will utilize a specified number of Essential Therapeutics' proprietary
bacterial, fungal and viral targets from its Microbial Genomics program,
together with Cetek's proprietary capillary electrophoresis technology, to
identify novel compounds and natural products with antimicrobial activity.
Essential Therapeutics will have worldwide development and commercialization
rights on products that result from the collaboration. In July 2001, Essential
Therapeutics entered into a collaborative research and license agreement with
NAEJA Pharmaceutical Inc. to discover, develop and commercialize drugs based
upon NAEJA's proprietary azole antifungals and Essential Therapeutics'
proprietary fungal efflux pump inhibitor leads. Essential Therapeutics will have
worldwide development and commercialization rights on azole antifungals, fungal
efflux pump inhibitors and combinations thereof that result from the
collaboration. Some of these collaborative agreements provide for potential
milestone payments and/or royalties to be paid by Essential Therapeutics to its
collaborators. The milestone payments, of up to approximately $7.4 million, are
contingent upon achieving specified research and product development milestones
through product approval.
In the event that Essential Therapeutics and its collaborators achieve
the specified research and product development milestones, Essential
Therapeutics will be entitled to receive milestone payments as follows: up to
$16.5 million for the first parenteral product, up to $15.5 million for each
additional
10
parenteral product and up to $18.5 million for an orally-absorbed product
developed pursuant to the RWJPRI agreements, and up to $6.5 million for each
product developed pursuant to the Daiichi agreements. The Pfizer Animal Health
and SPAH collaborations provide for a lower level of milestone payments than
those applicable to human health applications. Receipt of the above milestone
payments is contingent upon achieving specified research and product development
milestones, a number of which may not be achieved for several years, if ever.
While the collaborative agreements provide for royalty payments on future
products that may result, Essential Therapeutics does not expect to receive
royalties based upon net sales of drugs for a significant number of years, if at
all.
Essential Therapeutics has incurred substantial losses in the past and
expects to continue to incur operating losses over the next several years.
Quarterly results of operations are subject to significant fluctuations based on
the timing and amount of certain revenues earned under the collaborative
agreements. Fluctuations in Essential Therapeutics' operating results and market
conditions for biotechnology stocks in general could have a significant impact
on the volatility of the market price for the common stock and on the future
price of the common stock. The stock market has experienced significant price
and volume fluctuations that are often unrelated to the operating performance of
particular companies. The market price of the common stock, like that of the
securities of many other biopharmaceutical companies, has been and is likely to
continue to be highly volatile.
The biotechnology industry is highly competitive, and new developments are
occurring at an increasing pace. Competition from biotechnology and
pharmaceutical companies, joint ventures, academic and other research
institutions and others is intense and is expected to increase. Many competitors
have substantially greater financial, technical and personnel resources than
Essential Therapeutics. Although Essential Therapeutics believes that it has
identified new and distinct approaches to drug discovery, there are other
companies with drug discovery programs, at least some of the objectives of which
are the same as or similar to Essential Therapeutics'. Competing technologies
may be developed which would render Essential Therapeutics' technologies
obsolete or non-competitive.
This Form 10-Q contains forward-looking statements based upon current
expectations and such forward-looking statements involve risks and
uncertainties, including, without limitation, those set forth in the section
entitled "Risk Factors" elsewhere in this report.
Results of Operations
Three Months Ended September 30, 2001 and September 30, 2000
Revenues. Total revenues for the third quarter of 2001 were $2.9 million, as
compared to $1.5 million in the third quarter of 2000, derived from the major
collaborative agreements. The increase in comparative revenues during the period
was due primarily to research revenues and license fees recognized under both
the amended agreement and the Natural Product agreement signed with RWJPRI in
December 2000, as well as research support revenues from the joint research
agreement signed in October 2000 with SPAH. Revenues from RWJPRI included a
milestone payment received during the quarter for achievement of certain
development goals relating to Essential Therapeutics' pre-clinical research to
develop an orally-active, novel cephalosporin. The increase in comparative
revenues was partially offset by the conclusion of funded research with Pfizer
and Daiichi at the end of the first quarter of 2001.
Research and Development Expenses. Research and development expenses for the
third quarter increased from $4.0 million in 2000 to $4.2 million in 2001. The
increase was due primarily to higher expenses for planned contract research
services to accelerate Essential Therapeutics' lead optimization programs
related to Essential Therapeutics-owned antifungal compounds and
personnel-related costs.
General and Administrative Expenses. General and administrative expenses for the
third quarter decreased from $1.2 million in 2000 to $1.0 million in 2001,
primarily due to reductions in personnel-related costs.
11
Interest Income, net. Interest income for the third quarter decreased from
$268,000 in 2000 to $89,000 in 2001, primarily due to a decrease in average cash
balances and to lower interest rates. Interest expense for the third quarter
decreased from $59,000 in 2000 to $22,000 in 2001, primarily due to the
declining balance on an equipment financing loan.
Nine Months Ended September 30, 2001 and September 30, 2000
Revenues. Total revenues for the first nine months of 2001 were $7.4 million, an
increase from $4.3 million in revenues recognized in the first nine months of
2000. Increased revenues were derived from the RWJPRI and SPAH research and
license agreements, and were partially offset by lower revenues resulting from
the conclusion of funded research with Pfizer and Daiichi at the end of the
first quarter of 2001.
Research and Development Expenses. Research and development expenses for the
first nine months of 2001 increased from $12.2 million in 2000 to $12.7 million
in 2001, primarily a result of higher expenses for planned contract research
services to accelerate Essential Therapeutics' lead optimization programs
related to Essential Therapeutics-owned antifungal compounds and
personnel-related costs.
General and Administrative Expenses. General and administrative expenses for the
first nine months of 2001 increased from $3.2 million in 2000 to $3.5 million in
2001. The increase was due primarily to higher expenses for outside services.
In the fourth quarter of 2001, Essential Therapeutics expects to incur a
non-cash charge of approximately $23.8 million, reflecting the discount
associated with the preferred stock sale in the October 2001 private equity
financing. Additionally, Essential Therapeutics expects to incur a non-cash
charge of approximately $13.9 million relating to acquired in-process research
and development in the fourth quarter of 2001.
Interest Income, net. Interest income for the first nine months of 2001
decreased from $878,000 in 2000 to $541,000 in 2001, primarily due to a decrease
in average cash balances and to lower interest rates. Interest expense for the
first nine months of 2001 decreased from $202,000 in 2000 to $93,000 in 2001,
primarily due to the declining balance on an equipment financing loan.
Liquidity and Capital Resources
Essential Therapeutics has financed its operations since inception
primarily through the sale of equity securities, through funds provided under
its collaborative agreements, through other revenues principally consisting of
sales of molecular diversity and contract research and through equipment
financing. As of September 30, 2001, Essential Therapeutics had received $66.4
million from the sale of equity and $64.1 million in cash from license and
milestone fees and research support payments under its collaborative agreements.
Cash, cash equivalents and short-term investments at September 30, 2001
were $7.5 million compared to $12.6 million at December 31, 2000. The decrease
during the first nine months of 2001 was due to cash used by operations of $3.9
million, $1.2 million utilized in making principal payments on Essential
Therapeutics' equipment financing arrangement and $221,000 in capital
expenditures. This decrease was partially offset by $268,000 in net proceeds
from the issuance of common stock from the exercise of employee stock options.
On October 24, 2001, Essential Therapeutics announced that it had completed
its acquisition of Althexis and completed a $60.0 million private placement of
convertible redeemable preferred stock. Preferred shares
12
converted into common stock will be registered by a Form S-3 filing, and are
subject to certain lockup provisions for up to 9 months after closing. Please
see Note 5 to the Condensed Financial Statements included elsewhere in this
report.
Essential Therapeutics expects that its existing capital resources,
including the funds from the October 2001 private equity financing, interest
income and future payments due under its collaborative agreements will enable
Essential Therapeutics to maintain current and planned operations at least
through 2003. Essential Therapeutics expects that it will need to seek
additional funds to continue its business activities beyond that time, and will
seek to raise such additional funding from other collaborative arrangements, or
public or private financings, including sales of equity or debt securities. Any
such collaborative or licensing arrangements could result in limitations on
Essential Therapeutics' ability to control the commercialization of resulting
drugs, if any, and could limit profits, if any, therefrom. Any such equity
financing could result in dilution to Essential Therapeutics' then-existing
stockholders.
On February 9, 2001 Essential Therapeutics filed a registration statement
on Form S-3 for a "shelf" registration, which was amended on March 21, 2001.
Pursuant to the registration statement, Essential Therapeutics may offer up to
$35 million of newly issued common stock. The registration statement became
effective in March 2001. While Essential Therapeutics has no current plans to
do so, we may in the future offer additional shares of common stock under our
"shelf" registration statement in order to finance our operations. If we do, we
cannot assure you that additional funds will be available on favorable terms or
at all, or that any funds, if raised, would be sufficient to permit Essential
Therapeutics to continue to conduct its operations. If adequate funds are not
available, Essential Therapeutics may be required to curtail significantly or
eliminate one or more of its research programs.
Risk Factors
IF OUR RESEARCH AND DEVELOPMENT EFFORTS DO NOT RESULT IN POTENTIAL DRUG
CANDIDATES AND/OR WE CANNOT ADVANCE POTENTIAL PRODUCTS THROUGH CLINICAL TRIALS,
WE MAY FAIL TO DEVELOP PHARMACEUTICAL PRODUCTS.
Our first potential pharmaceutical product, a compound in the cephalosporin
class of antibacterials, commenced Phase I clinical trials under the direction
of our partner, The R.W. Johnson Pharmaceutical Research Institute (RWJPRI), an
affiliate of Johnson & Johnson, in November 1999. The cephalosporin class of
antibacterial drugs is the largest class of antibiotics in terms of global
sales. The purpose of these Phase I studies is to assess the compound's safety,
tolerability and pharmacokinetics. Safety and tolerability are measures of the
body's ability to assimilate a compound at various dose levels without adverse
reactions or side effects. Pharmacokinetics is an analysis of the absorption,
distribution, metabolism and excretion of the compound in the body. Based upon
the observation of irritation at the injection site in some subjects in these
trials, we announced in May 2001 that RWJPRI had decided to focus current
efforts on the advancement of RWJ-442831, an Essential Therapeutics-developed
prodrug form of the collaboration's lead parenteral cephalosporin product
(RWJ-54428), into pre-clinical toxicology studies which, if successful, would
allow the compound to advance into Phase I clinical trials. A prodrug is a
modified form of a drug that is readily converted to the active drug in the
body. Preliminary studies of RWJ-442831 in animals, conducted by Essential
Therapeutics, demonstrated reduced venous irritation at the injection site
compared to RWJ-54428. The Phase I clinical trials for this cephalosporin
compound may not be completed. There are two other Essential Therapeutics
cephalosporin compounds in the Johnson & Johnson collaboration: another
parenteral compound that is in pre-clinical development and a cephalosporin
intended for oral administration, in the research stage. Our other potential
products are in the pre-clinical or research stage. Our potential products will
require significant additional research and development efforts before we can
sell them. These efforts include extensive pre-clinical and clinical testing
prior to submission to the Food and Drug Administration (FDA) or other
regulatory authority. Pre-clinical and clinical testing will likely take several
years. After submission, these potential products will be subject to lengthy
13
regulatory review. We cannot predict with accuracy the time required to
commercialize new pharmaceutical products.
The development of new pharmaceutical products is highly uncertain and
subject to a number of significant risks. We do not expect any of our potential
products to be commercially available for a number of years, if at all.
Pharmaceuticals that appear to be promising at early stages of development may
not reach the market for a number of reasons including the following:
. we or our collaborators may not successfully complete our research and
development efforts;
. any pharmaceuticals we or our collaborators develop may be found to be
ineffective or to cause harmful side effects during pre-clinical testing
or clinical trials;
. we may fail to obtain required regulatory approvals for any products
that we develop;
. we may be unable to manufacture enough of any potential products at an
acceptable cost and with appropriate quality;
. our products may not be competitive with other existing or future
products; and
. proprietary rights of third parties may prevent us from commercializing
our products.
IF WE ARE UNABLE TO MAINTAIN OUR CURRENT CORPORATE COLLABORATIONS OR ENTER INTO
NEW COLLABORATIONS, DEVELOPMENT OF OUR POTENTIAL PRODUCTS COULD BE DELAYED.
Our strategy for enhancing our research and development capability and
funding, in part, our capital requirements involves entering into collaboration
agreements with major pharmaceutical companies. We have entered into
collaboration agreements with Johnson & Johnson, Daiichi Pharmaceutical Co.,
Ltd., Pfizer Inc.'s animal health group and Schering-Plough Animal Health
Corporation. Under these agreements, our collaborative partners are responsible
for:
. selecting which compounds discovered in the collaboration will proceed
into subsequent development, if any;
. conducting pre-clinical testing, clinical trials and obtaining required
approvals for potential products; and
. manufacturing and commercializing any approved products.
We cannot control the timing of these actions or the amount of
resources devoted to these activities by our partners. In addition, these
agreements are subject to cancellation or the election not to extend by our
partners. As a result, our receipt of revenue, whether in the form of continued
research funding, product development milestones, or royalties on sales, depends
upon the decisions made and the actions taken by our partners. Our collaborative
partners may view compounds that we may discover as competitive with their own
products or potential products, and therefore any partner may elect not to
proceed with the development of our potential product. Our partners are free to
pursue their own existing or alternative technologies to develop products in
preference to our potential products. We cannot be certain that our interests
will continue to coincide with those of our partners, or that disagreements
concerning our rights, technology, or other proprietary interests will not arise
with our partners.
Substantially all of our revenues to date have resulted from our
collaborations. We intend to continue to rely on our collaborations to fund a
substantial portion of our research and development activities over the next
several years. If our existing partners do not extend our collaborations or if
we are unable to enter into new
14
collaborations, the development and commercialization of our potential products
may be delayed. In addition, we may be forced to seek alternative sources of
financing for such product development and commercialization activities.
WE HAVE INCURRED SUBSTANTIAL LOSSES IN THE PAST, EXPECT TO CONTINUE TO INCUR
LOSSES FOR THE NEXT SEVERAL YEARS AND MAY NEVER ACHIEVE PROFITABILITY.
We have incurred substantial net losses in every year since our
inception in December 1992. We had net losses of $4.6 million in 1997, $9.8
million in 1998, $10.7 million in 1999, and $13.9 million in 2000. We had an
accumulated deficit of $61.5 million through September 30, 2001. We expect to
continue to incur operating losses over the next several years.
Substantially all of our revenues to date have resulted from license
fees, research support and milestone payments under our collaborative
agreements. We will not receive revenues or royalties from drug sales until we
or our collaborative partners successfully complete clinical trials with regard
to a drug candidate, obtain regulatory approval for this drug candidate, and
successfully commercialize the drug. We do not expect to receive revenues or
royalties from sales of drugs for a number of years, if at all. If we fail to
achieve sufficient revenues to become profitable or sustain profitability, we
may be unable to continue operations.
OUR APPROACH TO DRUG DISCOVERY IS UNPROVEN AND WE MAY NOT SUCCEED IN IDENTIFYING
ANY DRUG CANDIDATES WITH CLINICAL BENEFITS.
We are developing a gene-function-based technology platform and other
proprietary technology to attempt to identify and commercialize novel
antibiotics, antifungals and antiviral agents. To date these technologies have
identified a small number of compounds that have demonstrated potential clinical
benefits. We cannot be certain that these or any other technology we may develop
will allow us to identify drug candidates that may have clinical benefits. The
failure to identify and develop new drug candidates will have a material adverse
effect on our business.
IF WE FAIL TO SATISFY SAFETY AND EFFICACY REQUIREMENTS OR MEET REGULATORY
REQUIREMENTS IN OUR CLINICAL TRIALS, WE WILL NOT BE ABLE TO COMMERCIALIZE OUR
DRUG CANDIDATES.
Either we or our collaborators must show through pre-clinical studies
and clinical trials that each of our pharmaceutical products is safe and
effective in humans for each indication before obtaining regulatory clearance
from the FDA for the commercial sale of that pharmaceutical. If we fail to
adequately show the safety and effectiveness of a pharmaceutical, regulatory
approval could be delayed or denied. The results from pre-clinical studies and
early clinical trials are often different than the results that are obtained in
large-scale testing. We cannot be certain that we will show sufficient safety
and effectiveness in our clinical trials that would allow us to
15
obtain the needed regulatory approval. A number of companies in the
pharmaceutical industry, including biotechnology companies, have suffered
significant setbacks in advanced clinical trials, even after promising results
in earlier trials.
Any drug is likely to produce some level of toxicity or undesirable
side effects in animals and in humans when administered at sufficiently high
doses and/or for a long period of time. Unacceptable toxicities or side effects
may occur in the course of toxicity studies or clinical trials. We have observed
local irritation at the injection site in some subjects receiving RWJ-54428, one
of our potential cephalosporin products, in Phase I clinical trials conducted by
our collaborator, RWJPRI. In addressing this problem, we announced in May 2001
that RWJPRI had decided to focus current efforts on the advancement of
RWJ-442831, an Essential Therapeutics-developed prodrug form of the
cephalosporin compound RWJ-54428, into pre-clinical toxicology studies which, if
successful, would allow the compound to advance into Phase I clinical trials.
Preliminary studies of RWJ-442831 in animals, conducted by Essential
Therapeutics, demonstrated reduced venous irritation at the injection site as
compared to RWJ-54428. If we observe further unacceptable toxicities or other
side effects, we, our collaborators or regulatory authorities may interrupt,
limit, delay or halt the development of the drug. In addition, unacceptable
toxicities or side effects could prevent approval by the FDA or foreign
regulatory authorities for any or all indications.
We must obtain regulatory approval before marketing or selling our
future drug products. In the United States, we must obtain FDA approval for each
drug that we intend to commercialize. The FDA approval process is lengthy and
expensive, and approval is never certain. Products distributed abroad are also
subject to foreign government regulation. The process of obtaining FDA and other
required regulatory approvals can vary a great deal based upon the type,
complexity and novelty of the products involved. Delays or rejections may be
encountered based upon additional government regulation from future legislation
or administrative action or changes in FDA policy during the period of clinical
trials and FDA regulatory review. Similar delays also may be encountered in
foreign countries.
None of our drug candidates have received regulatory approval. If we
fail to obtain this approval, we will be unable to manufacture and sell our drug
products commercially. Even if we obtain regulatory approval, we may be required
to continue clinical studies even after we have started selling a
pharmaceutical. In addition, identification of some side effects after a drug is
on the market or the occurrence of manufacturing problems could cause subsequent
withdrawal of approval, reformulation of the drug, additional pre-clinical
testing or clinical trials and changes in labeling of the product. This could
delay or prevent us from generating revenues from the sale of that drug or cause
our revenues to decline.
If we obtain regulatory approval, we will also be subject to ongoing
existing and future FDA regulations and guidelines and continued regulatory
review. In particular, we, our collaborators, or any third party that we use to
manufacture the drug will be required to adhere to regulations setting forth
current good manufacturing practices. The regulations require that we
manufacture our products and maintain our records in a particular way with
respect to manufacturing, testing and quality control activities. Furthermore,
we, our collaborators, or our third-party manufacturers must pass a pre-approval
inspection of manufacturing facilities by the FDA before obtaining marketing
approval.
Failure to comply with the FDA or other relevant regulatory
requirements may subject us to administrative or legally imposed restrictions.
These include: warning letters, civil penalties, injunctions, product seizure or
detention, product recalls, total or partial suspension of production and FDA
refusal to approve pending New Drug Applications, or NDAs, or supplements to
approved NDAs.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY LOSE THE
COMPETITIVE ADVANTAGE INHERENT IN OUR PROPRIETARY TECHNOLOGIES.
Our success depends in part on our ability to establish, protect and
enforce our proprietary rights relating to our lead compounds, gene discoveries,
screening technology and other proprietary technology. We have filed
16
more than 80 patent applications in the United States, in addition to
applications filed in other countries, in order to protect lead compounds, gene
discoveries and screening technology, and more than 20 United States patents
have been issued to date on these applications. We cannot be certain that
patents will be granted with respect to any of our patent applications currently
pending in the United States or in other countries, or with respect to
applications filed in the future. For example, although in 2000 a patent was
granted in the U.S. covering our cephalosporin compounds now in development,
prosecution has not yet begun on more recently filed patent applications related
to prodrugs of our earlier inventions, as well as on our new compounds having
potential for oral administration. Our failure to obtain patents pursuant to our
current or future applications could have a material adverse effect on our
business. Furthermore, we cannot be certain that any patents issued to us will
not be infringed, challenged, invalidated or circumvented by others, or that the
rights granted thereunder will provide competitive advantages to us. In
particular, it is difficult to enforce patents covering methods of use of
screening and other similar technologies. Litigation to establish the validity
of patents, to defend against copatent infringement claims and to assert
infringement claims against others can be expensive and time-consuming, even if
the outcome is favorable to us. If the outcome of patent prosecution or
litigation is not favorable to us, our business could be materially adversely
affected.
Our commercial success also depends on our ability to operate without
infringing patents and proprietary rights of third parties. We cannot assure you
that our products will not infringe on the patents or proprietary rights of
others. For example, many companies are active in the field of genomics, and
some have filed patents on essential genes in bacteria. While we are not
currently aware of any patents encumbering our ability to practice the
technologies we have discovered, it is possible that a patent of this nature may
issue in the future. We may be required to obtain licenses to patents or other
proprietary rights of others. Any licenses may not be available on terms
acceptable to us, if at all. The failure to obtain these licenses could delay or
prevent our collaborative partners' activities, including the development,
manufacture or sale of drugs requiring such licenses.
In addition to patent protection, we rely on trade secrets, proprietary
know-how and technological advances that we seek to protect, in part, by
confidentiality agreements with our collaborative partners, employees and
consultants. We cannot assure you that these agreements will not be breached,
that we would have adequate remedies for any such breach, or that our trade
secrets, proprietary know-how and technological advances will not otherwise
become known or be independently discovered by others.
IF OTHER COMPANIES DEVELOP BETTER PRODUCTS THAN OURS OR MARKET SIMILAR PRODUCTS
SOONER, OUR PRODUCTS MAY BE RENDERED OBSOLETE OR NONCOMPETITIVE.
We operate in a field in which new developments are occurring at an
increasing pace. Competition from biotechnology and pharmaceutical companies,
joint ventures, academic and other research institutions and others is intense
and is expected to increase. Many of our competitors have substantially greater
financial, technical and personnel resources than we have. Although we believe
that we have identified new and distinct approaches to drug discovery, there are
other companies with drug discovery programs, at least some of the objectives of
which are the same as or similar to ours. For example, there are other companies
that have recently described cephalosporins in early stages of development that
are designed for treatment of resistant gram-positive infections in hospitals,
the same objective as our lead cephalosporin compound. Similarly, several other
companies are seeking to capitalize on the expanding body of knowledge of efflux
pumps in microorganisms.
Competing technologies may be developed that would render our
technologies obsolete or non-competitive. We are aware of many pharmaceutical
and biotechnology companies that are engaged in efforts to treat each of the
infectious diseases for which we are seeking to develop therapeutic products. We
cannot assure you that our competitors will not develop competing drugs that are
more effective than those developed by us and our collaborative partners or
obtain regulatory approvals of their drugs more rapidly than we and our
collaborative partners, thereby rendering our and our collaborative partners'
drugs obsolete or noncompetitive. Moreover, we
17
cannot assure you that our competitors will not obtain patent protection or
other intellectual property rights that would limit our and our collaborative
partners' ability to use our technology or commercialize our or their drugs.
OUR POTENTIAL PRODUCTS MAY NOT BE ACCEPTABLE IN THE MARKET OR ELIGIBLE FOR THIRD
PARTY REIMBURSEMENT, RESULTING IN A NEGATIVE IMPACT ON OUR FUTURE FINANCIAL
RESULTS.
Any products successfully developed by us or our collaborative partners may
not achieve market acceptance. The antibiotic products that we are attempting to
develop will compete with a number of well-established traditional antibiotic
drugs manufactured and marketed by major pharmaceutical companies. The degree of
market acceptance of any of our products will depend on a number of factors,
including:
. the establishment and demonstration in the medical community of the
clinical efficacy and safety of our products;
. the potential advantage of our products over existing treatment methods;
and
. reimbursement policies of government and third-party payors.
Physicians, patients or the medical community in general may not accept or
use any products that may be developed by us or our collaborative partners. Our
ability to receive revenues and income with respect to drugs, if any, developed
through the use of our technology will depend, in part, upon the extent to which
reimbursement for the cost of these drugs will be available from third-party
payors, such as government health administration authorities, private health
care insurers, health maintenance organizations, pharmacy benefits management
companies and other organizations. Third-party payors are increasingly
challenging the prices charged for pharmaceutical products. If third-party
reimbursement was not available or sufficient to allow profitable price levels
to be maintained for drugs developed by us or our collaborative partners, it
could adversely affect our business.
WE HAVE NO MANUFACTURING, MARKETING OR SALES EXPERIENCE, AND IF WE ARE UNABLE TO
ENTER INTO MANUFACTURING AGREEMENTS OR MAINTAIN COLLABORATIONS WITH MARKETING
PARTNERS OR IF WE ARE UNABLE TO DEVELOP OUR OWN MANUFACTURING, SALES AND
MARKETING CAPABILITY, WE MAY NOT BE SUCCESSFUL IN COMMERCIALIZING OUR PRODUCTS.
We do not have any experience in the manufacture of commercial quantities
of drugs, and our current facilities and staff are inadequate for the commercial
production or distribution of drugs. We intend to rely on our collaborative
partners for the manufacturing, marketing and sales of any products that result
from these collaborations. The current third-party manufacturer of our potential
cephalosporin product has in the past encountered difficulties with the
manufacture of related compounds in sufficient quantities for clinical trial
purposes. Manufacturers often encounter difficulties in scaling up to
manufacture commercial quantities of pharmaceutical products. We cannot be
certain that our current or any other manufacturer will not encounter similar
delays in the scale-up to manufacture this or any other compound in commercial
quantities in the future.
We will be required to contract with third parties for the manufacture of
our products or to acquire or build production facilities before we can
manufacture any of our products. We cannot assure you that we will be able to
enter into contractual manufacturing arrangements with third parties on
acceptable terms, if at all, or acquire or build production facilities
ourselves.
To date we have no experience with sales, marketing or distribution. In
order to market any of our products, we will be required to develop marketing
and sales capabilities, either on our own or in conjunction with others. We
cannot be certain that we will be able to develop any of these capabilities.
18
HEALTH CARE REFORM MEASURES OR COST CONTROL INITIATIVES MAY NEGATIVELY IMPACT
PHARMACEUTICAL PRICING.
The levels of revenue and profitability of pharmaceutical companies may be
affected by continuing governmental efforts to contain or reduce the costs of
health care through various means. For example, in some foreign markets pricing
or profitability of prescription pharmaceuticals is already subject to
governmental control. In the United States, there have been, and we expect that
there will continue to be, a number of federal and state proposals to implement
similar governmental control. Cost control initiatives could decrease the price
that we or our collaborative partners receive for any products which we or they
may develop in the future which would adversely affect our business. Further, to
the extent that these types of proposals or initiatives have a material adverse
effect on our collaborative partners or potential collaborative partners, our
ability to commercialize our potential products may be materially adversely
affected.
IF OUR PRODUCTS HARM PEOPLE, WE MAY EXPERIENCE PRODUCT LIABILITY CLAIMS THAT MAY
NOT BE COVERED BY INSURANCE.
We face an inherent business risk of exposure to potential product
liability claims in the event that drugs, if any, developed through the use of
our technology are alleged to have caused adverse effects on patients. This risk
exists for products being tested in human clinical trials, as well as products
that receive regulatory approval for commercial sale. We will, if appropriate,
seek to obtain product liability insurance with respect to drugs developed by us
and our collaborative partners. We may not, however, be able to obtain
insurance. Even if insurance is obtainable, it may not be available at a
reasonable cost or in a sufficient amount to protect us against liability.
IF WE CANNOT ATTRACT AND RETAIN MANAGEMENT AND SCIENTIFIC STAFF, WE MAY NOT BE
ABLE TO PROCEED WITH OUR DRUG DISCOVERY AND DEVELOPMENT PROGRAMS.
We are highly dependent on management and scientific staff, including Mark
Skaletsky, our Chairman and Chief Executive Officer, George H. Miller, Ph.D.,
our Senior Vice President - Research and Development, Paul Mellett, our Senior
Vice President and Chief Financial Officer and on our other officers.
Considering the time necessary to recruit replacements, if we lose the services
of any of the named individuals or other senior management and key scientific
staff, we may incur delays in our product development and commercialization
efforts or experience difficulties in raising additional funds. We may also lose
a significant amount of revenues without the senior staff necessary to
adequately maintain existing corporate collaborations or to enter into new
collaborations. We do not carry key-man life insurance on any of our executives.
We believe that our future success will depend, in part, on our ability to
attract and retain highly talented managerial and scientific personnel and
consultants. We face intense competition for talented personnel from, among
others, biotechnology and pharmaceutical companies, as well as academic and
other research institutions. We cannot be certain that we will be able to
attract and retain the personnel we require on acceptable terms.
OUR OPERATIONS INVOLVE HAZARDOUS MATERIALS, WHICH COULD SUBJECT US TO
SIGNIFICANT LIABILITY.
As with many biotechnology and pharmaceutical companies, our activities
involve the use of radioactive compounds and hazardous materials. As a
consequence, we are subject to numerous environmental and safety laws and
regulations. Any violation of, and the cost of compliance with, these
regulations could materially adversely affect our operations. We are subject to
periodic inspections for possible violations of any environmental or safety law
or regulation.
ANTI-TAKEOVER PROVISIONS IN OUR CHARTER AND BYLAWS AND DELAWARE LAW, TOGETHER
WITH OUR STOCKHOLDER RIGHTS PLAN, COULD MAKE THE ACQUISITION OF OUR COMPANY BY
ANOTHER COMPANY MORE DIFFICULT.
19
Some provisions of our Restated Certificate of Incorporation and Bylaws may
have the effect of making it more difficult for a third party to acquire, or
discouraging a third party from attempting to acquire, control of our company.
These provisions could limit the price that investors might be willing to pay in
the future for shares of our common stock. These provisions allow us to issue
preferred stock without a vote or further action by our stockholders, provide
for staggered elections of our Board of Directors and specify procedures for
director nominations by stockholders and submission of other proposals for
consideration at stockholder meetings. None of these provisions provides for
cumulative voting in the election of directors. Some provisions of Delaware law
applicable to us could also delay or make more difficult a merger, tender offer
or proxy contest involving us, including Section 203 of the Delaware General
Corporation Law, or DGCL, which prohibits a Delaware corporation from engaging
in any business combination with any stockholder owning fifteen percent or more
of our outstanding voting stock for a period of three years from the date such
person became a 15% stockholder unless specified conditions are met.
We adopted a stockholder rights plan, dated as of February 2, 1999,
pursuant to which our Board of Directors declared a dividend of one right for
each share of the common stock outstanding, which right entitles the holder to
purchase for $30.00 a fraction of a share of our Series A preferred stock with
economic terms similar to that of one share of the common stock. In the event
that an acquiror obtains 20% or more of our outstanding common stock, each
right, other than rights owned by the acquiror or its affiliates, will
thereafter entitle the holder thereof to purchase, for the exercise price, a
number of shares of the common stock having a then current market value equal to
twice the exercise price. If, after an acquiring person obtains 20% or more of
our outstanding common stock, we merge into another entity, an acquiring entity
merges into our company, or we sell more than 50% of our assets or earning
power, then each right, other than rights owned by the acquiring person or its
affiliates, will entitle the holder thereof to purchase for the exercise price,
a number of shares of common stock of the person engaging in the transaction
having a then current market value equal to twice the exercise price.
The possible issuance of Series A preferred stock, the procedures required
for director nominations and stockholder proposals and Delaware law could have
the effect of delaying, deferring or preventing a change in control of Essential
Therapeutics, including without limitation, discouraging a proxy contest or
making more difficult the acquisition of a substantial block of our common
stock. These provisions could also limit the price that investors might be
willing to pay in the future for shares of our common stock.
IF WE CANNOT OBTAIN ADDITIONAL FUNDING FOR FUTURE OPERATIONS, WE MAY NOT BE ABLE
TO PROCEED WITH OUR DRUG DISCOVERY AND DEVELOPMENT PROGRAMS.
The development of our potential pharmaceutical products will require
substantially more money than we currently have. We intend to seek to raise such
additional funding from sources including other collaborative partners and
through public or private financings involving the sale of equity or debt
securities. We cannot be certain that any financings will be available when
needed, or if available will be on acceptable terms. Funding from collaborative
partners could limit our ability to control the research, development and
commercialization of potential products, and could limit our revenues and
profits from such products, if any. Collaborative agreements may also require us
to give up rights to products or technologies that we would otherwise seek to
develop or commercialize ourselves. Any additional equity financing will result
in dilution to our current stockholders. If we fail to secure sufficient
additional funding we will have to delay or terminate some or all of our drug
discovery and development programs.
MARKET CONDITIONS AND CHANGES IN OPERATING RESULTS MAY CONTINUE TO CAUSE
VOLATILITY IN THE MARKET PRICE OF OUR STOCK, MAKING FUTURE EQUITY FINANCINGS
MORE DIFFICULT.
The market price of the common stock, like that of the securities of many
other biopharmaceutical companies, has been and is likely to continue to be
highly volatile. The stock market has experienced significant price and volume
fluctuations that are often unrelated to the operating performance of particular
companies. Factors contributing to volatility in the market price of our common
stock include:
. results of pre-clinical studies and clinical trials by us or our
competitors;
. announcements of new collaborations;
. announcements of our technological innovations or new therapeutic products
or that of our competitors;
. developments in our patent or other proprietary rights or that of our
competitors, including litigation;
. governmental regulation; and
. healthcare legislation.
20
Fluctuations in our operating results and market conditions for
biotechnology stocks in general could have a significant impact on the
volatility of the market price for our common stock and on the future price of
our common stock.
WE EXPECT TO RETAIN ALL FUTURE EARNINGS AND HAVE NO INTENTION TO PAY DIVIDENDS.
We have never paid any cash dividends on Essential Therapeutics common
stock. We currently intend to retain all future earnings, if any, for use in our
business and do not expect to pay any dividends in the foreseeable future.
WE MAY NOT REALIZE ANY OF THE ANTICIPATED BENEFITS FROM OUR ACQUISITION OF
ALTHEXIS.
On October 24, 2001, we concluded our acquisition of Althexis. We
consummated the transaction with the expectation that it will result in mutual
benefits including benefits relating to expanded and complementary product
offerings, increased market opportunity, new technology and the addition of
research and development personnel. Achieving the benefits of the acquisition
will depend in part on the integration of our technology, operations and
personnel in a timely and efficient manner so as to minimize the risk that the
acquisition will result in the loss of market opportunity or key employees or
the diversion of the attention of management. We cannot assure you that,
following the transaction, our businesses will achieve revenues, specific net
income or loss levels, efficiencies or synergies that justify the acquisition or
that the acquisition will result in increased earnings, or reduced losses, for
the combined company in any future period.
WE MAY NOT BE ABLE TO EFFECTIVELY AND EFFICIENTLY INTEGRATE THE OPERATIONS OF
ESSENTIAL THERAPEUTICS AND ALTHEXIS.
Integrating the operations and management of Essential Therapeutics and
Althexis will be a complex process, and we cannot assure you that this
integration will be completed rapidly or will achieve all of the anticipated
synergies and other benefits expected from the merger. The integration of the
two companies will require significant management attention, which may
temporarily distract management from its usual focus on the daily operations of
the combined company. Moreover, as a result of the change of Essential
Therapeutics' corporate headquarters from California to Massachusetts and the
operation of offices on both coasts, management will face new challenges not
previously encountered. Management's inability to integrate successfully the
operations of Essential Therapeutics and Althexis, or any significant delay in
achieving this integration, could cause our business to suffer.
FORWARD-LOOKING STATEMENTS
This document contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. In some cases, these statements can be identified by the
use of forward-looking terminology such as "may," "will," "could," "should,"
"would," "expect," "anticipate," "continue" or other similar words. These
statements discuss future expectations, contain projections of results of
operations or of financial condition or state trends and known uncertainties or
other forward-looking information. Furthermore, these statements are based on
current expectations that involve a number of uncertainties including those set
forth in the risk factors above. When considering forward-looking
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statements, you should keep in mind that the risk factors noted above and other
factors noted throughout this document or incorporated by reference could cause
our actual results to differ significantly from those contained in any
forward-looking statement.
Forward-looking statements include the information concerning possible
or assumed future results of operations of Essential Therapeutics, including any
forecasts, projections and descriptions of anticipated synergies related to the
acquisition of Althexis by Essential Therapeutics. Many factors could affect our
actual financial results, and could cause these actual results to differ
materially from those in the forward-looking statements. These factors include
the following:
. costs or difficulties related to the integration of the businesses of
the companies being greater than expected;
. demands placed on management by the increase in the combined company's
size;
. unanticipated increases occurring in financing and other costs;
. general economic or business conditions being less favorable than
expected;
. legislative or regulatory changes adversely affecting the businesses in
which the companies are engaged; and
. other opportunities being presented to and pursued by us.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about Essential Therapeutics' market risk
disclosure involves forward-looking statements. Essential Therapeutics is
exposed to market risk related mainly to changes in interest rates. Essential
Therapeutics does not invest in derivative financial instruments.
Interest Rate Sensitivity
Essential Therapeutics' investment policy is to manage its marketable
securities portfolio to preserve principal and liquidity while maximizing the
return on the investment portfolio. Essential Therapeutics' marketable
securities portfolio is primarily invested in corporate debt securities with an
average maturity of under one year and a minimum investment grade rating of A or
A-1 or better to minimize credit risk. Although changes in interest rates may
affect the fair value of the marketable securities portfolio and cause
unrealized gains or losses, such gains or losses would not be realized unless
the investments are sold prior to maturity. At September 30, 2001, Essential
Therapeutics did not hold marketable securities.
Foreign Currency Exchange Risk
At this time, Essential Therapeutics does not participate in any
foreign currency exchange activities, and therefore is not subject to risk of
gains or losses for changes in foreign exchange rates.
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PART II OTHER INFORMATION
Item 5. Other Information
Events Subsequent to September 30, 2001:
On November 8, 2001, Essential Therapeutics, Inc. filed a current
report on Form 8-K with the Securities and Exchange Commission. The
purpose of the filing was to disclose that on October 24, 2001, the
Company completed its acquisition of The Althexis Company, Inc.,
completed an equity financing and changed its name to Essential
Therapeutics, Inc.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits have been filed with this report:
None.
(b) Reports on Form 8-K.
On August 6, 2001, Essential Therapeutics, Inc. filed a current
report on Form 8-K with the Securities Exchange Commission. The
purpose of the filing was to disclose the proposed merger between
Essential Therapeutics, Inc. and The Althexis Company, Inc. and the
related financing.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 14, 2001
ESSENTIAL THERAPEUTICS, INC.
---------------------------
(Registrant)
/s/ Mark Skaletsky
-------------------------------------------
Mark Skaletsky
President and Chief Executive Officer
(principal executive officer)
/s/ Paul Mellett
-------------------------------------------
Paul Mellett
Senior Vice President and Chief Financial Officer
(principal financial officer)
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