ITEM 1. BUSINESS
Corautus Genetics Inc. (referred to as “we,” “us,” “our” or “Corautus”) is a biopharmaceutical company dedicated to the development and commercialization of innovative gene therapy products for the treatment of cardiovascular and peripheral vascular disease. We are focusing our efforts and resources on the clinical development of gene therapy product candidates using a growth factor known as Vascular Endothelial Growth Factor 2, or VEGF-2.
Corautus, formerly known as GenStar Therapeutics Corporation and Urogen Corp., was formed as a Delaware corporation on June 30, 1995.
The following discussion must be read in conjunction with, and is subject to, the risks and uncertainties set forth in “Risk Factors” in Item 1A
ITEM 1A. RISK FACTORS
You should carefully consider the risks described below before making an investment decision. You should also refer to the other information in this annual report, including the information incorporated by reference into this annual report. The risks and uncertainties we describe below are those that we currently believe may materially affect us. Additional risks and uncertainties that we are unaware of or that we currently deem immaterial also may become important factors that affect us.
Risks Related to Our Business
We are a development stage company with a history of insignificant revenues and significant net losses. All of our product candidates are in the developmental stage, and we expect continued net losses for the foreseeable future and we may never become profitable.
We are a development stage company, and we have not yet generated significant revenues. From our inception in July 1991 to December 31, 2005, we have incurred net losses of approximately $109.5 million, including net losses of approximately $19.7 million in 2005, almost all of which consisted of research and development, clinical trials and general and administrative expenses. We expect to continue to spend significant additional amounts for the foreseeable future to fund our research and development activities, including the clinical trials for our lead VEGF-2 product candidate, and other product candidates. In addition, we do not expect to generate revenues from sales for a number of years, if at all. As a result, we expect our net losses from operations to continue for at least the next four years.
Our ability to generate revenues and become profitable will depend on our ability, alone or with collaborators, to timely, efficiently and successfully complete the development of our product candidates, conduct pre-clinical and clinical tests, obtain necessary regulatory approvals, and manufacture and market our product candidates. We may never generate profits and, even if we do achieve profitability, we cannot predict the level or sustainability of such profitability.
We will need substantial additional funding to develop our lead VEGF-2 product candidate and other product candidates and for our future operations.
The development of our VEGF-2 product candidates, including our lead product candidate for the treatment of severe angina, will require a commitment of substantial funds to conduct the costly and time-consuming research, pre-clinical and clinical testing necessary to obtain regulatory approvals and bring our product candidates to market. Our future capital requirements will depend on many factors, including:
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the progress of our research and development programs;
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the progress, scope and results of our pre-clinical and clinical testing;
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the time and cost involved in obtaining regulatory approvals;
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the cost of manufacturing our product candidates;
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the cost of prosecuting, defending and enforcing patent claims and other intellectual property rights;
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the cost of commercializing our product candidates;
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market acceptance of products;
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ability to secure adequate product reimbursement;
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competing technological and market developments; and
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our ability to establish and maintain collaborative and other arrangements with third parties to assist in bringing our product candidates to market and the cost of such arrangements.
We will need to raise substantial additional capital to fund our future operations. We cannot be certain that additional financing will be available on acceptable terms, or at all. To the extent we raise additional funds by issuing equity securities, our existing stockholders will be diluted. If additional funds are raised through the issuance of debt securities, these securities are likely to have rights, preferences and privileges senior to our common stock and preferred stock. Moreover, we may enter into financing transactions at prices that represent a substantial discount to market price. A negative reaction by investors and securities analysts to any discounted sale of our equity securities could result in a decline in the trading price of our common stock.
Failure to successfully address ongoing liquidity requirements will have a material adverse effect upon our business. In the event that we are unable to obtain additional capital on acceptable terms, we will be required to take actions that will harm our business and our ability to achieve cash flow in the future, including possibly the surrender of our rights to some technologies or product candidates, delaying our clinical trials or curtailing or ceasing operations.
Treatment in our lead VEGF-2 product candidate clinical trial has been suspended, is under FDA clinical hold, and it is uncertain when or if such clinical hold will be removed.
On March 14, 2006, we temporarily suspended patient treatments in the GENASIS clinical trial. Boston Scientific requested the voluntary suspension as a result of three recently reported serious adverse events of pericardial effusion. Subsequent to our advising the FDA of such voluntary suspension, we were notified by the FDA that the FDA had placed the GENASIS trial on clinical hold. Due to such clinical hold, we are required to cease further patient enrollment. At present, we are not able to determine when the FDA clinical hold will be removed, if at all. Because the GENASIS trial is testing the safety and efficacy of our lead product candidate, any delay in the trial could have serious and significant negative effects to our business.
Our lead VEGF-2 product candidate must still undergo exhaustive clinical testing and may not prove to be safe or effective. If this product candidate is delayed or fails, we may have to curtail our operations.
There are many reasons that potential drug products that appear promising at an early stage of research or development do not result in commercially successful products. Clinical trials may be suspended or
terminated if safety issues are identified, if our investigators or we fail to comply with regulations governing clinical trials or for other reasons. We cannot guarantee that our GENASIS trial will be released from clinical hold or that we or the FDA will not suspend or terminate the GENASIS trial in the future, that adequate numbers of patients can be recruited for this or subsequent clinical trials, or that the results of the GENASIS trial will warrant further development. The FDA, institutional review boards and/or institutional biosafety committees at the medical institutions and healthcare facilities where we sponsor clinical trials may suspend any trial indefinitely if they find deficiencies in the conduct of these trials. The FDA and institutional review boards may also require large numbers of patients, and the FDA may require that we repeat a clinical trial. The results of the GENASIS trial might not demonstrate the safety or efficacy of our lead product candidate. Even if clinical trials are successful, we might not obtain regulatory approval for this product candidate. Clinical data can be interpreted in many different ways, and FDA officials could interpret data that we consider promising differently, which could halt or delay our clinical trials or prevent regulatory approval. If we are not successful in commercializing our lead VEGF-2 product candidate, or are significantly delayed in doing so, our business will be materially harmed and we may need to curtail or cease operations.
In the past, our Phase I/II clinical trial was suspended, and even if our new FDA hold is released, we cannot assure that the GENASIS trial will not be suspended in the future. In February 2000, our Phase I/II clinical trial for our lead product candidate was placed on clinical hold by the FDA. Following the death of an 18-year old patient enrolled in an unrelated gene therapy study using a viral vector to deliver the genetic material, the FDA undertook extensive reviews of gene therapy clinical trials in the United States to evaluate compliance with clinical trial monitoring procedures. Based on the FDA review and issues identified by the FDA regarding the conduct of our trial, we were required to cease further patient enrollment and the administration of our lead product candidate in the clinical trial until we addressed those issues and provided data and information to allow the FDA to assess the risks to patients and remove the Phase I/IIa study from clinical hold. Patient complications or other serious adverse events that may occur in the field of gene therapy in the future may result in stricter clinical trial oversight and potential regulatory delays relating to our lead VEGF-2 product candidate for severe angina, which would harm our ability to commercialize this product candidate or generate revenues.
All of our VEGF-2 product candidates require additional research, development, testing and regulatory approvals prior to marketing. If our product candidates are delayed or fail, our financial condition will be negatively affected, and we may have to curtail or cease our operations.
We are in the early stage of product development. We currently do not sell any products and do not expect to have any product candidates commercially available for several years, if at all. Our proposed product candidates require additional research and development, clinical testing and regulatory clearances prior to marketing. There are many reasons that our proposed product candidates may fail or not advance beyond clinical testing, including the possibility that:
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our proposed product candidates may be ineffective, unsafe or associated with unacceptable side effects;
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our proposed product candidates may fail to receive necessary regulatory approvals or otherwise fail to meet applicable regulatory standards;
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our proposed product candidates may be too expensive to develop, manufacture or market;
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physicians, patients, third-party payers or the medical community in general may not accept or use our proposed product candidates;
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our collaborators may withdraw support for or otherwise impair the development and commercialization of our proposed product candidates;
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other parties may hold or acquire proprietary rights that could prevent us or our collaborators from developing or marketing our proposed product candidates; or
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others may develop equivalent or superior products candidates.
In addition, our proposed product candidates are subject to the risks of failure inherent in the development of gene therapy products based on innovative technologies. As a result, we are not able to predict whether our research, development and testing activities will result in any commercially viable products or applications. To our knowledge, the FDA has not approved any gene therapy products. If our product candidates are delayed or we fail to successfully develop and commercialize our product candidates, our financial condition may be negatively affected, and we may have to curtail or cease our operations.
No VEGF-2 gene therapy products have been developed or approved.
All of our product candidates, including our lead VEGF-2 product candidate for the treatment of severe refractory angina, utilize the Vascular Endothelial Growth Factor 2, or VEGF-2. The use of VEGF-2 to induce therapeutic angiogenesis is a relatively untested approach and has not yet been used by us or others to successfully develop any FDA-approved products. We may fail to produce an approved product based on our VEGF-2 gene therapy approach, which would materially harm our business. If our GENASIS Phase IIb clinical trial results are unsatisfactory, this may cast doubt on the viability of our VEGF-2 gene therapy approach and all of our product candidates.
Because we cannot predict whether or when we will obtain regulatory approval to commercialize our product candidates, we cannot predict the timing of any future revenue from these product candidates.
We cannot commercialize any of our product candidates to generate revenue until the appropriate regulatory authorities have reviewed and approved the applications for the product candidates. We cannot assure you that the regulatory agencies will complete their review processes in a timely manner or that we will obtain regulatory approval for any product candidate we or our collaborators develop. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources. Outside the United States, the ability to market a product is also contingent upon receiving clearances from appropriate foreign regulatory authorities. In addition, we may experience delays or rejections based upon additional government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review. If the delays are significant, they would negatively affect our financial results, ability to raise capital and our commercial prospects for future product candidates.
We may not successfully establish and maintain collaborative and licensing arrangements, which could adversely affect our ability to develop and commercialize our product candidates. We are also limited by the collaboration and marketing arrangements on which we rely.
Our strategy for the development, testing, manufacturing and commercialization of our proposed product candidates relies on establishing and maintaining collaborations with corporate partners, licensors and other third parties. At present, we have licenses from Human Genome Sciences, Inc., Caritas St. Elizabeth’s Medical Center, Inc., Boston Scientific Corporation and Vical Incorporated relating to the use and delivery of our VEGF-2 product candidates. We also have a collaboration arrangement with Boston Scientific in which they participate in the development of our VEGF-2 product candidates for the
treatment of diseases of the heart and peripheral vascular system and have exclusive rights to market and distribute such products upon any regulatory approval. We may not be able to maintain or expand these licenses and collaborations or establish additional licensing and collaboration arrangements necessary to develop and commercialize our proposed product candidates. Even if we are able to maintain or establish licensing or collaboration arrangements, these arrangements may not be on favorable terms. Any failure to maintain or establish licensing or collaboration arrangements on favorable terms could adversely affect our business prospects, financial condition or ability to develop and commercialize our product candidates.
Additionally, the terms of our collaboration agreements may restrict our ability to develop, test or market our product candidates. For example, our collaboration agreement with Boston Scientific prohibits us from entering into any development, distribution or similar agreement with respect to VEGF-2 product candidates for diseases of the heart or peripheral vascular system with third parties. The agreement also prohibits us from using any injection catheter other than Boston Scientific’s Stiletto™ catheter in clinical trails for our VEGF-2 product candidate. In addition, we currently have a distribution agreement with Boston Scientific that provides Boston Scientific with exclusive distribution rights for our proposed VEGF-2 product candidates for diseases of the heart or peripheral vascular system if and when such products have been approved and are ready for marketing.
We rely on third parties to manufacture our VEGF-2 product candidates and the catheters used to deliver the products. There can be no guarantee that we can obtain sufficient and acceptable quantities of our product candidates or the catheters on acceptable terms, which may delay or impair our ability to develop, test and market such product candidates.
We currently do not have any manufacturing capabilities. Our business strategy relies on third parties to manufacture and produce our VEGF-2 product candidates and the catheters used to deliver the products in accordance with good manufacturing practices established by the FDA. We rely on Boehringer Ingelheim for the production of VEGF-2 materials and on Boston Scientific for the supply of catheters to deliver our VEGF-2 product candidates. These third party manufacturers are subject to extensive government regulation and must receive FDA approval before they can produce clinical material or commercial product. Regulatory difficulties experienced by Boston Scientific, Boehringer Ingelheim, or others could affect our ability to obtain products and catheters when needed. Our product candidates may be subject to delays if third party manufacturers give other products greater priority than our product candidates. These third parties may also not deliver sufficient quantities of our product candidates or the catheters, manufacture our product candidates or the catheters in accordance with specifications, or comply with applicable government regulations. Additionally, if the manufactured product candidates or the catheters fail to perform as specified, our business and reputation could be severely impacted.
We have entered into a manufacturing agreement with Boehringer Ingelheim for the production of additional VEGF-2 materials for our planned Phase III clinical trial for severe angina and any commercial use. There is a risk that the manufacturer will not be able to successfully produce our product candidates on acceptable terms, or on a timely or cost-effective basis, or that the manufacturer will be able to manufacture our product candidates in accordance with our product specifications.
In the GENASIS trial and other trials that we anticipate for coronary heart disease, our VEGF-2 product candidate is being tested together with Boston Scientific’s Stiletto™ endocardial direct injection catheter system. Our product candidate cannot be licensed or if licensed for coronary heart disease, cannot be used, unless the Stiletto™ catheter is also licensed. We have no control over the Stiletto™ catheter. Thus, we are dependent on the actions of both the FDA and Boston Scientific in connection with the licensing of the Stiletto™ catheter. On January 25, 2006 the FDA issued a Corporate Warning Letter to Boston Scientific identifying what the FDA termed serious regulatory problems involving Boston Scientific’s
medical devices. While the medical devices at issue did not include the Stiletto™ catheter and although the Stiletto™ catheter for our Phase III trial will not be produced at facilities mentioned in the Corporate Warning Letter, the letter raises the risk that regulatory issues between the FDA and Boston Scientific may adversely affect our trials and the commercialization of our product candidate. Additionally, Boston Scientific requested the voluntary suspension of our GENASIS trial as a result of three reported serious adverse events of pericardial effusion. In response to our notification to the FDA of such suspension, the FDA placed our GENASIS trial on clinical hold pending an investigation. We are uncertain when or if the clinical hold will be removed. Additionally, in the event we are unable to address any concerns that may arise out of the FDA clinical hold relating to our delivery mechanism, we may not be able to conduct future clinical trials, commercialize and market our therapeutic with the Stiletto™ catheter. Significant delays or changes in delivery methods may adversely affect our financial results and the commercial prospects for our product candidates and delay our ability to become profitable.
We depend on clinical trial arrangements with medical institutions to advance our technology, and the loss of these arrangements could impair the development of our product candidates.
We have arrangements with approximately 30 medical institutions for the conduct of the GENASIS trial for our lead VEGF-2 product candidate. The early termination of any of these clinical trial arrangements or the failure of these institutions to comply with the regulations and requirements governing clinical trials would hinder the progress of our clinical trial program. If any of these relationships are terminated, the GENASIS trial might not be completed, and the results might not be able to be evaluated.
If we are unable to maintain agreements with third parties to perform sales, marketing and distribution functions, we will be required to develop these capabilities to commercialize our proposed product candidates.
We currently have no sales, marketing or distribution capabilities. Therefore, to commercialize our product candidates, if and when such products have been approved and are ready for marketing, we must collaborate with third parties to perform these functions. We have granted exclusive sales, marketing and distribution rights for our VEGF-2 product candidates for diseases of the heart and peripheral vascular system to Boston Scientific. However, Boston Scientific might, at its discretion, limit the amount of resources and time it devotes to marketing our product candidates or terminate its agreement with us at any time and for any reason regardless of the terms of the agreement. Because our revenues will be dependent upon Boston Scientific’s sales and marketing efforts and the prices it charges for our product candidates, any failure by Boston Scientific to devote sufficient resources to our product candidates will limit our revenues and ability to become profitable.
In the event that Boston Scientific no longer acts as a distributor or if we have products that they do not choose to distribute, we cannot assure you that we would be able to enter into similar arrangements with another company to commercialize our product candidates. We have no experience in developing, training or managing a sales force, and we will incur substantial additional expenses if we are forced to market our product candidates directly. Developing a marketing and sales force is also time consuming and could delay launch of our product candidates. In addition, we will compete with many companies that currently have extensive and well-funded marketing and sales operations. Our marketing and sales efforts may be unable to compete successfully against these companies.
If we do not comply with applicable regulatory requirements in the manufacture and distribution of our product candidates, we may incur penalties that may inhibit our ability to commercialize our product candidates and adversely affect our revenue.
Our failure or the failure of our collaborators or third party manufacturers to comply with applicable FDA or other regulatory requirements including manufacturing, quality control, labeling, safety surveillance, promoting and reporting may result in criminal prosecution, civil penalties, recall or seizure of our product candidates, total or partial suspension of production or an injunction, as well as other regulatory action against our product candidates or us. Discovery of previously unknown problems with a product, supplier, manufacturer or facility may result in restrictions on the sale of our product candidates, including a withdrawal of the product candidates from the market.
If we are unable to attract and retain key employees and advisors, our ability to obtain financing, pursue collaborations or develop our product candidates may be adversely affected.
Our future success depends on our ability to attract, retain and motivate highly qualified management and scientific and regulatory personnel and advisors. To pursue our business strategy, we will need to hire or otherwise engage qualified scientific personnel and managers, including personnel with expertise in clinical trials, government regulation and manufacturing. Competition for qualified personnel is intense among companies, academic institutions and other organizations. If we are unable to attract and retain key employees and advisors, it may negatively affect our ability to successfully develop, test and commercialize our product candidates.
We depend on a few key executives, and the loss of their services could cause a material adverse effect to our company. We do not maintain “key person” life insurance policies on any of those executives. As a result, we are not insured against the losses resulting from the death of our key executives.
We use hazardous and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.
Our processes and our collaborators’ processes involve the controlled storage, use and disposal of hazardous and biological materials and waste products. We and our suppliers and other collaborators are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. Even if we and these suppliers and collaborators comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance and exceed our financial resources. We may not be able to maintain insurance that covers hazardous materials on acceptable terms, or at all. We may incur significant costs or be unable to comply with current or future environmental laws and regulations.
We have entered, and may in the future enter, into agreements allowing third parties to use VEGF-2 for their own clinical trials, which if unsuccessful or subject to adverse effects could damage our ability to successfully conclude our trial and commercialize our own product candidates.
We have entered, and may in the future enter, into agreements or arrangements with third parties allowing them to conduct trials of VEGF-2 for other indications. For example, we have recently granted rights to Caritas St. Elizabeth’s to use VEGF-2 in its Phase I clinical trials for the treatment of critical limb ischemia and diabetic neuropathy. It is possible that these additional trials that we do not sponsor or conduct could result in negative findings or adverse effects, which could cause us to be liable for damages, could adversely affect our ability to obtain commercial licenses in our own trials, and could overshadow the possible positive results of the GENASIS trial.
We are exposed to potential risks resulting from Section 404 of the Sarbanes-Oxley Act of 2002.
We are evaluating our internal controls to allow management to report on, and our independent registered certified public accounting firm to attest to, our internal controls, as required by Section 404 of the Sarbanes-Oxley Act of 2002. We may encounter unexpected delays in implementing the requirements relating to internal controls; therefore, we cannot be certain about the timing of completion of our evaluation, testing and remediation actions or the impact that these activities will have on our operations since there is no precedent available by which to measure the adequacy of our compliance. We also expect to incur additional expenses and diversion of management’s time as a result of performing the system and process evaluation, testing and remediation required in order to comply with the management certification and independent registered certified public accounting firm attestation requirements. If we are not able to timely comply with the requirements set forth in Section 404, we might be subject to sanctions or investigation by regulatory authorities. Any such action could adversely affect our business and financial results. The requirement to comply with Section 404 of the Sarbanes-Oxley Act of 2002 is expected to become effective, at the earliest, for our fiscal year ending December 31, 2006.
In addition, in our system of internal controls we may rely on the internal controls of third parties. In our evaluation of our internal controls, we will consider the implication of our reliance on the internal controls of third parties. Until we have completed our evaluation, we are unable to determine the extent of our reliance on those controls, the extent and nature of the testing of those controls, and remediation actions necessary where that reliance cannot be adequately evaluated and tested.
Risks Related to Intellectual Property
If our right to use the VEGF-2 technology or other intellectual property we license from third parties is terminated or adversely affected, our financial condition, operations or ability to develop and commercialize our proposed product candidates will be materially harmed.
We do not own any patents and have not filed any patent applications. We rely on licenses to use certain technologies that are material to our operations, both to have freedom to carry out our business and to protect our market from competitors. In particular, we license patents, patent applications and other intellectual property from Human Genome Sciences for the use of the VEGF-2 gene in our product candidates for vascular and cardiovascular disease and diabetic neuropathy. We have also obtained a license to use certain patents and patent applications from Vical relating to gene therapy delivery methods in connection with the use of VEGF-2 for gene therapy and from Caritas St. Elizabeth’s and Boston Scientific relating to stimulation of growth of new blood vessels.
The success of our operations will depend in part on our ability and that of our licensors to:
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obtain patent protection for our methods of gene therapy, therapeutic genes and/or gene-delivery methods both in the United States and in other countries with substantial markets;
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defend patents once obtained against third party infringers;
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maintain trade secrets and operate without infringing patents and proprietary rights of others; and
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obtain and maintain appropriate licenses upon reasonable terms to patents or proprietary rights held by others that are necessary or useful to us in commercializing our technology, both in the United States and in other countries with substantial markets.
In addition, the license agreements with Human Genome Sciences and Vical include certain milestones that we must meet in order to maintain these licenses. There is no assurance that we can meet such
upcoming milestones in either license or that we can obtain any necessary extensions of the milestones in the future from either Human Genome Sciences or Vical. Our licensors may terminate these licenses if we fail to meet the applicable milestones. If Human Genome Sciences or Vical elects to terminate their licenses to us, our business and financial condition may be adversely affected, and we may have to curtail or cease operations. Further, if Human Genome Sciences terminates the license to use the VEGF-2 technology for failure to meet the applicable milestones, we must grant Human Genome Sciences a license to all data and information generated by us under the license agreement. If our distribution agreement with Boston Scientific is terminated, then we will lose our license for certain intellectual property that is licensed to us thereunder only while Boston Scientific is our distributor.
If we or our licensors are not able to obtain and maintain adequate patent protection for our product candidates, we may be unable to commercialize our product candidates or to prevent others from using our technology in competitive products.
Our success will depend in part on our ability to obtain patent protection both in the United States and in other countries for our product candidates and their use. We have no patents in our own name. We have, however, licensed patents and patent applications and other proprietary rights from third parties that cover our product candidates. Our ability to protect our product candidates from unauthorized or infringing use by third parties depends at least initially on the willingness and cooperation of our licensors to assert the patent rights licensed to us. Due to evolving legal standards relating to the patentability, validity and enforceability of patents covering biotechnology inventions and the scope of claims made under these patents, the ability of our licensors to obtain and enforce patents is uncertain and involves complex legal and factual considerations. Accordingly, rights under any issued patents may not provide us with sufficient protection for our product candidates or provide sufficient protection to afford us a commercial advantage against our competitors or their competitive products or processes. In addition, we cannot guarantee that any patents will be issued from any pending or future patent applications licensed to us. Even if issued, we cannot guarantee that the claims of these patents are, or will be, valid or enforceable, or provide us with any significant protection against competitive products or otherwise be commercially valuable to us. In addition, others may challenge, seek to invalidate, infringe or circumvent any patents or patent applications we license, and rights we receive under those patents or patent applications may not provide competitive advantages to us. Further, the manufacture, use or sale of our product candidates may infringe the patent rights of others.
We may not have identified all patents, published applications or published literature that affect our business either by blocking our ability to commercialize our drugs, by negatively impacting the patentability of our product candidates to our licensees, or by disclosing the same or similar technologies on which basis our licensors’ patents may not be valid, limit the scope of our or our licensors’ future patent claims or adversely affect our ability to market our product candidates. For example, patent applications in the United States are maintained in confidence for up to 18 months after the filing of their earliest priority application. In some cases, however, patent applications, such as those filed prior to November 29, 2000, remain confidential in the United States Patent and Trademark Office, or USPTO, for the entire time prior to issuance as a U.S. patent. Similarly, patent applications filed in foreign countries are typically published 18 months after the filing date of their earliest priority application. Publication of discoveries in the scientific or patent literature often lags behind actual discoveries. Therefore, we cannot be certain that our licensors were the first to invent, or the first to file, patent applications covering our product candidates or their use. In the event that a third party has also filed a U.S. patent application covering our product candidates or a similar invention, we may have to participate in an adversarial proceeding, known as an interference, in the USPTO to determine priority of invention in the United States. The costs of these proceedings could be substantial, and our efforts could be unsuccessful, resulting in a loss of our U.S. patent position. The laws of some foreign jurisdictions do not protect intellectual property rights to the same extent as in the United States and many companies have
encountered significant difficulties in protecting and defending such rights in foreign jurisdictions. If we or our licensors encounter such difficulties in protecting or are otherwise precluded from effectively protecting our intellectual property rights in foreign jurisdictions, our business prospects could be substantially harmed.
Several biotechnology companies and research institutions have filed patent applications or received patents that cover our technologies or technologies similar to ours. These patent applications or patents may conflict with patents or patent applications that we have licensed, either by claiming the same gene or similar sequences or by claiming methods that could dominate those licensed to us. For instance, we licensed patent rights from Human Genome Sciences covering the VEGF-2 gene and its use in gene therapy. We are aware that Genentech, Inc. and the Ludwig Institute and Helsinki University Licensing Ltd. have filed a number of patent applications, and have received patents, in the United States, Europe and other countries, including countries in which Human Genome Sciences has not filed patent applications, that cover aspects of VEGF-2 technology. In particular, both Genentech and Ludwig/Helsinki are pursuing claims directed to VEGF-2 protein, gene, gene fragments, constructs and their medical uses in various countries. A number of opposition proceedings currently are ongoing in Australia and Europe. In Australia, Human Genome Sciences has opposed two of Ludwig/Helsinki’s granted patents. Both oppositions are currently in the briefing stage. Human Genome Sciences has also opposed Genentech’s Australian patent. The opposition has been briefed and scheduled for a hearing at the Australian Patent Office in March 2006. Ludwig/Helsinki have opposed Human Genome Sciences’ Australian patent. The opposition has been briefed and the parties are waiting for the Australian Patent Office to set a date for the hearing. In Europe, Human Genome Sciences and Genentech has each opposed Ludwig/Helsinki’s granted patent. Also in Europe, Human Genome Sciences and Ludwig/Helsinki have each opposed Genentech’s granted European patent. The European Patent Office has set February 24, 2006 as the final date for submission of evidence before Oral Proceedings, which will be held in April 2006. Human Genome Sciences may fail to initiate patent opposition proceedings in other countries or may be unsuccessful in any foreign proceeding attempting to prevent the issuance of, revoke or limit the scope of patents issued to Ludwig/Helsinki and Genentech. Moreover, Ludwig/Helsinki or Genentech may make additional challenges to Human Genome Sciences’ patents or patent applications in Australia, Europe, the United States or elsewhere. If Human Genome Sciences is unsuccessful in its foreign opposition proceedings or if an interference or patent litigation is commenced in the United States against Human Genome Sciences or us that affects our right to use VEGF-2, and if we do not succeed in those proceedings, then our sales, if any, of VEGF-2 may be held to infringe the patent rights of Ludwig/Helsinki or Genentech. In such event, we would not have the right to make, use or sell VEGF-2 in one or more countries in the absence of a license from Ludwig/Helsinki and/or Genentech. We may be unable to obtain such a license on commercially acceptable terms or at all.
Our license from Human Genome Sciences provides that we are required to reimburse Human Genome Sciences for 50% of its patent prosecution costs, which may include costs of international opposition proceedings. We expect the costs of the currently pending proceedings to increase significantly during the next several years and, accordingly, these reimbursement obligations are expected to be substantial. We anticipate that additional litigation or proceedings may be necessary or may be initiated to enforce any patents we license, or to determine the scope, validity and enforceability of other parties’ proprietary rights and the priority of an invention. Any of these activities could result in substantial costs or delays to us. The outcome of any of these proceedings may significantly affect our products and technology.
Our licensors, including Human Genome Sciences, are primarily responsible for patent prosecution activities, including opposition proceedings. As a result, we generally do not have the ability to institute or determine the conduct of patent proceedings unless our licensors elect not to institute or to abandon such proceedings. If our licensors elect to institute and prosecute patent proceedings, our rights will depend in part upon the manner in which these licensors conduct the proceedings. These licensors may
not vigorously pursue or defend or may decide to settle such proceedings on terms that are unfavorable to us. An adverse outcome of these proceedings could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease using such technology, any of which could adversely affect our business. Moreover, the mere uncertainty resulting from the initiation and continuation of any technology related litigation or adversarial proceeding could adversely affect our business pending resolution of the disputed matters.
We may not have adequate protection for our unpatented proprietary information, which could adversely affect our competitive position.
We also rely on unpatented trade secrets and know-how to maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with employees, consultants and others. These parties may breach or terminate these agreements, and we may not have adequate remedies for any breach. Our trade secrets may also be independently discovered by competitors. We rely on certain technologies to which we do not have exclusive rights or which may not be patentable or proprietary and thus may be available to competitors.
Risks Related to Our Industry
Negative public opinion and increased regulatory scrutiny of gene therapy and genetic research may adversely affect our ability to conduct our business or obtain regulatory approvals for our product candidates.
Ethical, social and legal concerns about gene therapy and genetic research could result in additional regulations restricting or prohibiting the products and processes we may use. Even with the requisite approvals, the commercial success of our product candidates will depend in part on public acceptance of the use of gene therapies for the treatment of human disease. Public attitudes may be influenced by claims that gene therapy is unsafe, and gene therapy may not gain the acceptance of the public or the medical community. More restrictive government regulations or negative public opinion would have a negative effect on our business or financial condition and may delay or impair the development and commercialization of our product candidates.
We are subject to significant government regulation with respect to our product candidates. Compliance with government regulation can be a costly and time-consuming process, with no assurance of ultimate regulatory approval. If these approvals are not obtained, we will not be able to sell our product candidates.
We and our collaborators are subject to extensive and rigorous government regulation in the United States and foreign countries. The FDA, the National Institutes of Health and comparable agencies in foreign countries impose many requirements on the introduction of new pharmaceutical products through lengthy and detailed clinical testing procedures and other costly and time consuming compliance procedures. These requirements vary widely from country to country and make it difficult to estimate when our product candidates will be commercially available, if at all. In addition, gene therapies such as those being developed by us are relatively new and are only beginning to be tested in humans. Regulatory authorities may require us or our collaborators to demonstrate that our product candidates are improved treatments relative to other therapies or may significantly modify the requirements governing gene therapies, which could result in regulatory delays or rejections. If we are delayed or fail to obtain required approvals for our product candidates, our operations and financial condition would be damaged. We may not sell our product candidates without applicable regulatory approvals.
Numerous regulations in the United States and abroad also govern the manufacturing, safety, labeling, storage, record keeping, reporting and marketing of our product candidates. Compliance with these regulatory requirements is time consuming and expensive. If we fail to comply with regulatory requirements, either prior to approval or in marketing our product candidates after approval, we could be subject to regulatory or judicial enforcement actions. These actions could result in withdrawal of existing approvals, product recalls, injunctions, civil penalties, criminal prosecution, and enhanced exposure to product liabilities.
Even if we achieve positive results in early clinical trials, these results do not necessarily predict final results. A number of companies in the pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after achieving positive results in earlier trials. Negative or inconclusive results or adverse medical events during a clinical trial could cause the FDA or us to terminate a clinical trial or require that we repeat a clinical trial.
We face intense competition and must cope with rapid technological change and the possibility that our competitors may develop therapies that are more advanced or effective than ours, which may adversely affect our financial condition and our ability to successfully commercialize our product candidates.
Our competitors and potential competitors include large pharmaceutical and medical device companies and more established biotechnology companies. These companies have significantly greater financial and other resources and greater expertise than us in research and development, manufacturing, pre-clinical and clinical testing, obtaining regulatory approvals and marketing. Small companies may also prove to be significant competitors, particularly through collaborative arrangements with large pharmaceutical companies. Many of these competitors have significant products approved or in development and operate large, well-funded research and development programs. Our potential competitors also include academic institutions, governmental agencies and other public and private research organizations that conduct research, seek patent protection and establish collaborative arrangements for product and clinical development and marketing.
We are engaged in gene therapy, which is a rapidly changing field. Existing products and therapies to treat vascular and cardiovascular disease, including drugs and surgical procedures, will compete directly with the products that we are seeking to develop and market. In addition, our competitors may develop more effective or more affordable products, or achieve earlier patent protection or product commercialization and market penetration than us. As these competitors develop their technologies, they may develop proprietary positions that prevent us from successfully commercializing our future products. Additionally, technologies developed by our competitors may render our potential products uneconomical or obsolete, and we may not be successful in marketing our product candidates against competitors.
Delays in recruiting clinical trial participants could adversely affect our ability to bring a product to market prior to our competitors. Our competitive position and those of our competitors can vary based on the performance of products in clinical trials. In addition, our competitors may obtain patent protection or FDA approval and commercialize products more rapidly than we do, which may impact possible future sales of our product candidates. We also may not have the access that some of our competitors have to biological materials necessary to support the research, development or manufacturing of planned therapies. If we are permitted by the FDA to commence commercial sales of products, we will also be competing with respect to marketing capabilities and manufacturing efficiency, areas in which we have limited or no experience. We expect that competition among products approved for sale will be based, among other things, on:
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product efficacy;
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price;
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safety;
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reliability;
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availability;
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ease of administration and delivery;
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patent protection; and
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sales, marketing and distribution capabilities.
Our competitive position also depends upon our ability to attract and retain qualified personnel, develop proprietary products or processes, and secure sufficient funding for the often-lengthy period between product conception and commercial sales. We cannot assure that we will be able to compete successfully in the marketplace or achieve any market acceptance of our product candidates.
We face the risk of product liability claims, which could adversely affect our business and financial condition.
Our operations will expose us to potential product liability risks that are inherent in the testing, manufacturing and marketing of gene therapy products and could prevent or delay the commercialization of our product candidates or negatively affect our financial condition. Regardless of the merit or eventual outcome, product liability claims may result in withdrawal of proposed product candidates from clinical trials, costs of litigation, and substantial monetary awards to plaintiffs and decreased demand for products.
Product liability may result from harm to patients using our product candidates as a result of mislabeling, misuse or product failure. While we require all patients enrolled in our clinical trials to sign consents, which explain the risks involved with participating in the trial, the consents provide only a limited level of protection. Additionally, we indemnify the clinical centers and related entities in connection with losses they may incur through their involvement in the clinical trials. Product liability insurance is expensive and we may not be able to maintain our product liability coverage on acceptable terms or obtain adequate coverage against potential liabilities.
We are presently engaged in litigation arising from a death in an earlier clinical trial. We are a defendant in a complaint filed in the Superior Court of Suffolk County in the Commonwealth of Massachusetts alleging wrongful death and product liability claims in connection with the death of a patient enrolled in our clinical trial at Caritas St. Elizabeth’s. The complaint alleges, in part, that the deceased patient should have been excluded from our clinical trial because his condition was treatable by conventional revascularization procedures, that the deceased patient did not receive sufficient disclosure of risks and an alleged financial conflict of interest to provide an informed consent to treatment and that we are vicariously liable for the conduct and acts of its then principal investigator. We have denied liability and the principal allegations of the complaint. The discovery stage of the litigation has concluded, and the trial has been set for April 2007. No assurances can be given as to the outcome of this action. An unfavorable settlement or decision in this action could negatively affect our operations and financial condition. Any liability resulting from this action may exceed our financial resources.
Risks Related to Our Common Stock
Our stock price has been and may continue to be volatile, and an investment in our common stock could significantly decline in value.
The market prices for securities of pharmaceutical and biotechnology companies in general, have been highly volatile and may continue to be highly volatile in the future. The market price of our common stock has been and may continue to be volatile based on the following factors, in addition to other risk factors described herein and in light of the low volume of trades in our common stock:
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developments concerning any research and development, clinical trials, manufacturing, and marketing collaborations;
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announcements of technological innovations or new commercial products by our competitors or us;
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developments concerning proprietary rights, including patents;
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publicity regarding actual or potential results relating to medicinal products under development by our competitors or us;
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regulatory developments in the United States and other countries;
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litigation;
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economic and other external factors, including disasters or crises; or
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period-to-period fluctuations in financial results.
You may have difficulty selling your shares of common stock at or above the price paid for such shares or at the time you would like to sell.
We have a low volume of daily trades in our common stock on the NASDAQ Capital Market, which could make it difficult to conduct large transactions in our common stock. In addition, any sales by stockholders of a large number of shares of our common stock, or the perception that the holders of a large number of our shares intend to sell our common stock, may cause a significant reduction in the price of our common stock. In this regard, we have a significant number of shares of common stock underlying outstanding options and warrants that are currently exercisable and eligible for immediate sale in the public market. The issuance of common stock upon the exercise of stock options and warrants would also dilute existing investors.
Our quarterly operating results may fluctuate, causing volatility in our stock price.
We do not receive any revenues from sales of our product candidates. Our results of operations historically have fluctuated on a quarterly basis, which we expect to continue. Our results of operations at any given time will be based primarily on the following factors:
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the status of development of our product candidates;
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whether we enter into additional collaboration agreements and the timing and accounting treatment of payments, if any, to us under those agreements;
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whether and when we achieve specified development or commercialization milestones; and
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the addition or termination of research programs or funding support
We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. These fluctuating results may cause the price of our stock to fluctuate, perhaps substantially.
ITEM 2.
ITEM 2. PROPERTIES
We currently lease approximately 4,800 square feet of administrative offices in the Advanced Technology Development Center in Atlanta, Georgia. The lease for this office expires in April 2006 and has consecutive 90 day renewals at our option.
We also currently lease approximately 2,200 square feet of laboratory and office space in San Jose, California. The lease for this space expires in July 2006.
We believe that our current leased facilities are adequate for our current needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Susan Darke, individually and as Executrix of the Estate of Roger J. Darke v. Estate of Dr. Jeffrey Isner, et al., Suffolk Superior Court, Suffolk County Massachusetts (Case No. SUCV2002-02194). Vascular Genetics has been named as a defendant in the above titled action, alleging that Vascular Genetics is liable for intentional battery, wrongful death, gross negligence, intentional infliction of emotional distress, product liability, deceit/intentional misrepresentation/fraud in the inducement, and loss of consortium. The complaint does not state a specific dollar amount for the damages sought by the plaintiff. However, pursuant to a letter required by Massachusetts law to be delivered to the defendants, the plaintiff demanded $5,000,000. Subsequent to such letter, the plaintiff has offered to settle this matter for $947,000. Our Motion for Summary Judgment was decided by the Court in November 2005, with the motion being granted in part and denied in part. Vascular Genetics believes it has insurance coverage for any amounts that may be awarded in this action. The case is expected to be tried in April 2007.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2005.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below, in accordance with General Instruction G(3) of Form 10-K and Instruction 3 of Item 401(b) of Regulation S-K, are the names, ages and positions of our executive officers along with their business experience during the past five years. Unless otherwise indicated, the information set forth is as of December 31, 2005. The age of each officer listed is as of the date of the filing of this report. Unless otherwise indicated, all of our executive officers have served continuously since the dates indicated. There are no family relationships among the officers.
(1) Richard E. Otto is our Chief Executive Officer, President and director and has served as Chief Executive Officer and director since the merger between GenStar and Vascular Genetics in February 2003. Mr. Otto became President of Corautus in April 2003. Prior to the merger, he served as Chief Executive Officer, President and a director of Vascular Genetics since January 2002. From March 1998 through January 2002, Mr. Otto served as a consultant to various charitable and commercial organizations. Mr. Otto has spent the past 35 years in the cardiac therapy industry. From September 1995 to March 1998 he served as Chief Executive Officer and a director of CardioDynamics International Corporation, a publicly traded company listed on NASDAQ that develops, manufactures and markets noninvasive heart-monitoring devices. Mr. Otto has served as a consultant to the founder of WebMD and as a consultant to the Cardiac Rhythm Management division of St. Jude Medical. His career includes key management positions with Cardiac Pacemakers Inc. (now a Guidant company). Mr. Otto also held positions at Intermedics, Inc., Medtronic Inc., and Eli Lilly and Company. Mr. Otto has served on the Georgia board of directors of the Juvenile Diabetes Foundation, and Leukemia Society. Mr. Otto was a semifinalist in the 1997 Entrepreneur of the Year Award for the Southern California Region. He received a B.S. in chemistry from the University of Georgia.
(2) Robert T. Atwood is our Chief Financial Officer, Executive Vice President, Secretary and Director and has served as Chief Financial Officer and Secretary since the merger between GenStar and Vascular Genetics in February 2003. Mr. Atwood became Executive Vice President in October 2003 and director in November 2003. Prior to the merger, he served as Chief Financial Officer of Vascular Genetics since January 2002. Prior to joining Vascular Genetics, Mr. Atwood served for 10 years as Executive Vice President and Chief Financial Officer of First Union Corporation. Prior to working with First Union, Mr. Atwood was a partner in the international accounting firm of Deloitte & Touche, having spent 28 years serving clients and in administrative positions in Atlanta, the District of Columbia, and New York. Throughout his career, Mr. Atwood has served on numerous professional association and industry committees. He was appointed to the President’s Price Advisory Committee to the Council on Wage and Price Stability from 1978 to 1980 and to the Investment Policy Advisory Committee to the United States Trade Representative from 1984 to 1987. In addition, Mr. Atwood has served on the board of trustees of many educational, cultural, and charitable activities. In 2001, Mr. Atwood received the Spirit of Giving Award from the Mint Museum of Art and the Royal and Sun Alliance Company in Charlotte, North Carolina. Mr. Atwood graduated from the University of San Diego in 1962 and in May 2001 was awarded the Author E. Hughes Career Achievement Award by the University of San Diego School of Business Administration.
(3) Yawen L. Chiang, Ph.D., joined Corautus as Senior Vice President - Research & Development in August 2001. In February 2003, Dr. Chiang became Chief Scientific Officer of Corautus. Dr. Chiang has twenty-two years of research and development experience in the biotechnology and pharmaceutical industries. Dr. Chiang has had experience with numerous gene therapy clinical trials and has published many articles in the field of gene therapy. She is named as inventor on several issued or pending patent applications including the 1999 issued patent on “Vectors for Tissue Specific Replication.” From February 1998 to August 2001, Dr. Chiang was Site Director for the Aventis/Gencell Research Center in Hayward, California where she was responsible for research and project management, alliance and collaboration management, and technology transfer. Prior to Aventis/Gencell, she was Vice President, Preclinical Studies at Novartis/Genetic Therapy Inc. for ten years. She was the principal investigator on numerous collaborative research and development agreement programs and received SBIR Phase I and II grants. She also has considerable experience with gene therapy clinical production. Dr. Chiang received a B.S. in Medical Technology, Allied Health, from the University of Maryland, an M.A. in Health Care Administration from Central Michigan University and both an M.S. in Biochemistry and a PhD. in Genetics from George Washington University.
(4) Jack W. Callicutt has served as Vice President - Finance and Administration, Chief Accounting Officer and Assistant Secretary since September 2003. Prior to joining Corautus, Mr. Callicutt spent 14 years with Deloitte & Touche, the last six years as an audit senior manager. Mr. Callicutt is a Certified Public Accountant and graduated, with honors, from Delta State University in 1989 with degrees in Accounting and Computer Information Systems.
(5) Michael K. Steele has served as Vice President - Business Development since May 1, 2005. Prior to joining Corautus, Mr. Steele was the Corporate Vice President of Business Development for Life Therapeutics Ltd., a principal at Business Development Solutions, a life sciences consultancy, and held a number of managerial positions at Serologicals Corporation. Mr. Steele earned his B.S. and M.B.A. at James Madison University.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is currently traded on the NASDAQ Capital Market under the symbol “VEGF.” Prior to October 13, 2004, our common stock was traded on the American Stock Exchange under the symbol “CAQ.” As of March 14, 2006, there were approximately 505 registered holders of record of common stock.
As of December 31, 2005, there were outstanding options to purchase 3,858,094 shares of our common stock and warrants to purchase 1,204,419 shares of our common stock. There are 2,000 shares of our Series C preferred stock outstanding.
We have never paid any cash dividends on our common stock to date. We currently anticipate that we will retain all future earnings, if any, to fund the development and growth of our business and do not anticipate paying any cash dividends for at least the next five years, if ever.
The following table shows for the periods indicated the high and low closing prices for our common stock on the NASDAQ Capital Market from October 13, 2004 forward and on the American Stock exchange for periods prior to October 13, 2004.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from our consolidated financial statements, which have been audited by Ernst & Young LLP, our independent registered public accounting firm. Ernst & Young LLP’s report on our consolidated financial statements as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005, and for the period from July 1, 1991 (Inception) to December 31, 2005, appears elsewhere herein. The financial data for all other periods and dates have been derived from consolidated audited financial statements of Corautus that are not included in this annual report. The data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and other financial information included in this annual report. The historical results are not necessarily indicative of results to be expected for any future period.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are subject to a variety of risks and uncertainties including those set forth under “Risk Factors” in Item 1A of this report. The statements that are not purely historical are 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, including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements. See the section at the beginning of this report titled “Cautionary Factors That May Affect Future Results.”
Introduction
Corautus is a biopharmaceutical company dedicated to the development and commercialization of innovative gene therapy products for the treatment of cardiovascular and peripheral vascular disease. Corautus, formerly known as GenStar Therapeutics Corporation and Urogen Corp., was formed as a Delaware corporation on June 30, 1995. Under the name UroGen Corp., UroGen operated as a division of Medstone International, Inc. between July 1, 1991 (Inception) and June 30, 1995. UroGen changed its name to GenStar Therapeutics Corporation in March 2000. Gene therapy is technology that uses genetic materials as therapeutic agents to treat disease. Gene therapy seeks to restore, augment or correct gene functions either by the addition of normal genes or by neutralizing the activity of defective genes.
On February 5, 2003, GenStar Therapeutics Corporation completed a merger with Vascular Genetics Inc. and concurrently changed its name to Corautus Genetics Inc. The focus of the combined entity is the clinical development of gene therapy products using a vascular growth factor gene, Vascular Endothelial Growth Factor 2 (VEGF-2), for the treatment of cardiovascular and peripheral vascular disease.
Looking ahead, the most critical component to our current business plan is successfully completing the Phase IIb clinical trial for our product candidate for the treatment of severe angina related to coronary heart disease. Prior to the completion of our merger with Vascular Genetics, Vascular Genetics had already completed Phase I/IIa clinical trials for this product candidate utilizing a surgical procedure and a randomized, placebo-controlled Phase I/IIa clinical trial employing a percutaneous catheter-based method to deliver the VEGF-2 plasmid DNA directly to the heart muscle. The Phase I/IIa clinical trials provided preliminary data that we believe supports the safety of the product candidate and its delivery method. In the clinical trial process, the next step is a later Phase II, or Phase IIb, clinical trial to further evaluate the safety and efficacy of this product candidate. We initiated the GENASIS Phase IIb clinical trial in the Fall of 2004.
From December 2003 through December 2005, we raised gross proceeds of approximately $31,000,000 through private sales of our common stock and warrants. From July 2003 through December 2005, we also have received $33,000,000 in equity, license revenues and convertible debt from our alliance with Boston Scientific. Since we have no significant revenues at this time, we must raise funds either from equity or loans. We expect that the remaining costs of our GENASIS Phase IIb clinical trial for severe angina subsequent to 2005, including research and development and general and administration costs but not including the costs of manufacturing the VEGF-2 for Phase III and commercialization, will be substantial. Subsequent trials needed prior to the receipt of commercial revenues, if ever achieved, will cost additional substantial sums of money. Additionally, the implementation of plans to file a protocol and conduct of Phase II clinical trial for Buerger’s disease would increase our expenditures.
We believe that our existing capital resources will be sufficient to support our current operating plan through the first quarter of 2007. We will need to raise substantial additional capital to fund our planned operations, and we are continuing our efforts to raise additional funds at the present time.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, accrued liabilities and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our consolidated financial statements (see Note 1 to our consolidated financial statements).
Revenue Recognition
Grant revenue is recognized as the research expenses related to the grants are incurred. Contract revenue arising from collaborative research agreements is recognized either (i) ratably over the term of the agreement, which approximates the performance of services, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement, for contracts specifying payment on a per full-time employee basis. All amounts received under collaborative research agreements or research grants are not refundable, regardless of the success of the underlying research.
Accrued Liabilities
As part of the process of preparing our financial statements, we are required to estimate expenses that we believe we have incurred, but have not yet been billed for. This process involves identifying services and activities that have been performed by third-party vendors on our behalf and estimating the level to which they have been performed and the associated cost incurred for such service as of each balance sheet date in our financial statements. Examples of expenses for which we accrue based on estimates we make include fees for professional services, such as those provided by certain clinical research organizations and investigators in conjunction with clinical trials, and fees owed to contract manufacturers in conjunction with the manufacture of material for planned clinical trials and commercial use. We must sometimes estimate the date on which certain services commence and/or the level of services performed on or before a given date and the cost of such services. We make these estimates based upon the facts and circumstances known to us at the time and in accordance with U.S. generally accepted accounting principles.
Stock Based Compensation
We grant stock options for a fixed number of shares to employees in accordance with Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, and accordingly, recognize no compensation expense for the stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of the grant. The
value of options, warrants, or stock awards issued to non-employees have been determined in accordance with SFAS No. 123, Accounting for Stock Based Compensation, and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and are periodically remeasured as the options vest, if required. Warrants for common stock are valued at the date of issuance and are recorded to the expense category related to the services provided.
Results of Operations
Revenues
We have generated revenues to date of $2,744,000 from contract research agreements and grants. Total revenues for the years ended December 31, 2005, 2004 and 2003 were approximately $83,000, $83,000, and $35,000, respectively. These revenues were from the sublicense of certain patents to Boston Scientific Corporation as part of Boston Scientific’s investment in Corautus. We do not anticipate revenues from product sales for at least three to four years. Product revenues are contingent on the success of our clinical trials.
Research and Development and Acquired In-Process Technology
Research and development expenses increased $9,356,000 to $15,949,000 for the year ended December 31, 2005 compared to approximately $6,593,000 for the year ended December 31, 2004. Research and development expenses increased $3,376,000 to $6,593,000 for the year ended December 31, 2004 compared to approximately $3,217,000 for the year ended December 31, 2003.
The increase in research and development expense was primarily caused by our ongoing GENASIS Phase IIb clinical trial that began in Fall of 2004, including patient treatment costs and clinical research organization costs and by costs incurred under the manufacturing agreement in developing processes and procedures for the intended production of our clinical material for planned Phase III clinical trial and commercial use.
We estimate that it will take at least three to four years to complete clinical testing of any of our products and obtain regulatory approvals, if we are able to obtain approvals. We anticipate increasing research and development expenditures in the future as we conduct clinical testing necessary to bring our products to market.
The charge of approximately $17,295,000 for the write-off of acquired in-process technology in 2003 related to the merger with Vascular Genetics as it did not otherwise qualify for capitalization because there were significant required regulatory approvals remaining.
General and Administrative Expenses
General and administrative expenses increased $216,000 for the year ended December 31, 2005 to approximately $3,897,000 compared to approximately $3,681,000 for the year ended December 31, 2004. General and administrative expenses decreased $4,258,000 for the year ended December 31, 2004 to approximately $3,681,000 compared to approximately $7,939,000 for the year ended December 31, 2003.
General and administrative expenses include the costs of our administrative personnel and consultants, office lease expenses and other overhead costs, including legal and accounting costs. The increase in general and administrative expense in 2005 over 2004 relates primarily to increases in personnel costs. In 2003, we settled a lease obligation for approximately $3,400,000 in cash and stock, which was incurred
when we terminated a lease on a manufacturing facility which would have run eight more years and had minimum payments of approximately $16,500,000. The majority of the remaining change in 2003 over 2004 in general and administrative expenses related to legal fees, severance and other costs associated with relocating Corautus’ principal offices to Atlanta, Georgia from San Diego, California.
Write-off of Property and Equipment
There were no write-offs of property and equipment in 2005 or 2004. The write-off of property and equipment of approximately $1,946,000 in 2003 related to the decision to abandon our manufacturing facility and outsource future manufacturing operations. The charge relates to tenant improvement costs and certain equipment related to the manufacturing operations.
Interest Income and Expense
Interest income increased $564,000 for the year ended December 31, 2005 to approximately $815,000 compared to approximately $251,000 for the year ended December 31, 2004. Interest income increased $193,000 for the year ended December 31, 2004 to approximately $251,000 compared to approximately $58,000 for the year ended December 31, 2003. Interest income is a result of investment of excess cash in auction rate securities, money market accounts, and certificates of deposit. The increase in interest income is due to increases in the balances in those investments and in the investment yield.
Interest expense increased $380,000 for the year ended December 31, 2005 to approximately $832,000 compared to approximately $452,000 for the year ended December 31, 2004. Interest expense increased $329,000 for the year ended December 31, 2004 to approximately $452,000 compared to approximately $123,000 for the year ended December 31, 2003. The increase in interest expense is due to the timing of issuance of the notes payable partially offset by lower interest on capital lease obligations.
Liquidity and Capital Resources
From inception through December 31, 2005, we have primarily financed our operations through private placements of equity and convertible debt securities, our strategic alliance with Boston Scientific Corporation and through our partnership with Baxter Healthcare. We have raised approximately $16,400,000 in convertible debt offerings (including $15,000,000 from Boston Scientific Corporation), $55,500,000 in private equity financings, $16,000,000 in net proceeds from the Boston Scientific Corporation investment in our common and preferred stock and received equity funding of $14,900,000 related to our relationship with Baxter Healthcare.
Net cash used by operating activities in 2005 was approximately $18,133,000 and primarily consists of expenditures for research and development and general and administrative expenses. Net cash used in investing activities of $4,525,000 during 2005 consists of sales of short-term investments, purchases of short-term investments and the purchase and sales of property and equipment. Net cash provided by financing activities of $23,923,000 during 2005 consists primarily of proceeds from the private sales of common stock, the exercise of stock options, and proceeds from convertible debt, offset by repayments of capital leases.
As of December 31, 2005, we had cash, cash equivalents and short-term investments totaling approximately $30,962,000. Our operations to date have consumed substantial amounts of cash and have generated insignificant revenues. The negative cash flow from operations is expected to continue and to accelerate for at least the next three years. The development of our products will require a commitment of substantial funds to conduct the costly and time-consuming research, preclinical and clinical testing necessary to bring our products to market and to establish manufacturing and marketing capabilities. Our
future capital requirements will depend on many factors including the progress of our research and development programs; the progress, scope and results of our preclinical and clinical testing; the time and cost involved in obtaining regulatory approvals; the cost of manufacturing for our proposed products; the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; competing technological and market developments; and our ability to establish and maintain collaborative and other arrangements with third parties, such as licensing and manufacturing agreements, and the cost of such arrangements.
We expect that our existing capital resources will enable us to maintain our current and planned operations through the first quarter of 2007. We will need to raise substantial additional capital to fund our planned operations. We will be seeking this additional funding either through collaborative arrangements or through public or private equity or debt financings. We cannot be certain that additional financing will be available on acceptable terms, or at all. We do not have any commitments or arrangements assuring us of any additional funds in the future, and there is no assurance that we will be able to obtain additional capital on acceptable terms, or at all. Failure to successfully address ongoing liquidity requirements will have a material adverse effect upon our business. In the event that we are unable to obtain additional capital, we will be required to take actions that will harm our business and our ability to achieve cash flow in the future. To the extent we raise additional cash by issuing equity securities, our existing stockholders will be diluted. If additional funds are raised through the issuance of debt securities, these securities are likely to have rights, preferences and privileges senior to our common stock and preferred stock.
Contractual Obligations
The following is a summary of our contractual obligations as of December 31, 2005:
The long-term debt payments above include interest to be accrued during the remaining term of the related agreements. The purchase obligations payments reflect estimated payments to be made under our manufacturing agreement for certain development, optimization, and manufacturing services for our VEGF-2 material for our planned Phase III clinical trial and future commercialization. The payments under the manufacturing agreement are denominated in Euros and the US dollar amounts in the table above were converted at the exchange rate at December 31, 2005.
New Accounting Pronouncements
In December 2004 the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment issued to employees. SFAS No. 123R applies to all transactions involving issuance of equity by
a company in exchange for goods and services, including employees. SFAS No. 123R is effective for fiscal periods beginning after June 15, 2005. We adopted SFAS No. 123R in the first quarter of 2006. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net loss and loss per share in the pro forma information in Note 1 - Stock Based Compensation in the Notes to our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the market value of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including auction-rate securities, commercial paper, money market funds, government and non-government debt securities and certificates of deposit. The average duration of the majority of our investments in 2005 and 2004 was less than two months. Due to the short-term nature of these investments, we believe that we have no material exposure to interest rates arising from our investments. Therefore, no quantitative tabular disclosure is included in this report.
We are subject to a certain amount of short-term foreign exchange risk related to a manufacturing contract we entered into on May 13, 2005 with Boehringer Ingelheim Austria GmbH. The contract is for the manufacture of the VEGF-2 plasmid material for our planned Phase III clinical trial and commercial use. The payments made under the contract are denominated in euros, and the majority of the payments are expected to be made over the next two to three years. Because payments under the contract are denominated in euros and we currently do not have a formal hedging arrangement in place for currency risk for amounts to be paid after 2006, our operating expenses could be negatively impacted by currency exchange fluctuations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SEE ITEM 15. “Exhibits and Financial Statement Schedules.”
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
NONE
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our chief executive officer and chief financial officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in the Securities and Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) for the company. Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures as of the end of the period covered by this annual report, have concluded that our disclosure controls and procedures were effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Changes in internal controls over financial reporting. There were no changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to directors is set forth under the captions “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” “Proposal 1 - Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2006 Proxy Statement and is incorporated herein by reference. The information required by this item with respect to the executive officers is, pursuant to Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G (3) of Form 10-K, set forth at Part I, Item 4(A) of this report under the caption “Executive Officers of the Registrant.”
We have adopted a code of business conduct and ethics, which applies to our chief executive officer and our senior financial officers. Our code of business conduct and ethics is posted on our website at www.corautus.com under the headings “Investor Relations- Corporate Governance- Code of Business Conduct and Ethics.” We will also provide a copy of the code of business conduct and ethics to stockholders upon request. Any amendments to or waivers from any provision of our code of business conduct and ethics will be disclosed by posting such information on our website.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption “Compensation of Directors and Executive Officers,” “Compensation Committee Report on Executive Compensation” and “Stock Performance Graph” in the 2006 Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.
Information required by this item is set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in the 2006 Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the caption “Certain Relationships and Related Transactions” in the 2006 Proxy Statement and is incorporated by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth under the caption “Proposal 3 - Ratification of Re-Appointment of Independent Registered Public Accounting Firm” in the 2006 Proxy Statement and is incorporated by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this report:
(a)
1. Historical Financial Statements
2. Schedules to Financial Statements
All schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.
(b) Exhibits
* Form S-4/A file no. 333-101606
** Form S-3 file no. 333-112239
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on March 20, 2006.
CORAUTUS GENETICS INC.
A Delaware Corporation
By:
/s/ Robert T. Atwood
Robert T. Atwood
Executive Vice President, Chief Financial Officer,
Secretary and Director
Power of Attorney
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard E. Otto, Robert T. Atwood and Jack W. Callicutt, and each of them his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K for the calendar year ended December 31, 2005, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or ay of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated as of March 20, 2006.
Signatures
Title
/s/ Richard E. Otto
Richard E. Otto
Chief Executive Officer (Principal Executive
Officer), President and Director
/s/ Robert T. Atwood
Robert T. Atwood
Executive Vice President, Chief Financial Officer
(Principal Financial Officer), Secretary, and Director
/s/ Jack W. Callicutt
Jack W. Callicutt
Vice President of Finance and Administration
(Principal Accounting Officer), Chief Accounting
Officer & Assistant Secretary
/s/ James C. Gilstrap
James C. Gilstrap
Chairman of the Board of Directors
/s/ Eric N. Falkenberg
Eric N. Falkenberg
Director
/s/ John R. Larson
John R. Larson
Director
/s/ B. Lynne Parshall
B. Lynne Parshall
Director
/s/ F. Richard Nichol
F. Richard Nichol
Director
/s/ Ivor Royston, M.D.
Ivor Royston, M.D.
Director
/s/ Victor W. Schmitt
Victor W. Schmitt
Director
REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Corautus Genetics Inc.
We have audited the accompanying consolidated balance sheets of Corautus Genetics Inc. (a development stage enterprise) (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2005 and for the period from July 1, 1991 (inception) to December 31, 2005. 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principals used and significant estimates made by management, and 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 Corautus Genetics Inc. (a development stage enterprise) at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 and for the period from July 1, 1991 (inception) to December 31, 2005, in conformity with U. S. generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Atlanta, Georgia
February 24, 2006
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Period July 1, 1991 (Inception) To December 31, 2005
Continued on next page
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Period July 1, 1991 (Inception) To December 31, 2005 (Continued)
Continued on next page
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Period July 1, 1991 (Inception) To December 31, 2005 (Continued)
Continued on next page.
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Period July 1, 1991 (Inception) To December 31, 2005 (Continued)
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes 3, 6 and 11 for supplemental cash flow information.
See accompanying notes.
CORAUTUS GENETICS INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Organization
Corautus Genetics Inc. (the “Company”) is a biopharmaceutical company dedicated to the development of innovative gene transfer therapy products for the treatment of severe cardiovascular and peripheral vascular disease.
The Company was incorporated as UroGen Corp. in the State of Delaware on June 30, 1995, as a wholly-owned subsidiary of Medstone International, Inc. Between July 1, 1991 (Inception) and June 30, 1995, the Company operated as a division of Medstone. On December 29, 1995, Medstone declared a dividend of all of the stock of UroGen Corp. to be distributed to all Medstone stockholders. In March 2000, the Company’s name was changed to GenStar Therapeutics Corporation.
On February 5, 2003, the Company completed a merger with Vascular Genetics Inc. and concurrently changed the Company’s name from GenStar Therapeutics Corporation to Corautus Genetics Inc. The Company’s focus for the foreseeable future is the clinical development of gene therapy products using a vascular growth factor gene known as Vascular Endothelial Growth Factor 2, or VEGF-2, for the treatment of severe cardiovascular and vascular disease.
Basis of Presentation
The consolidated financial statements include the accounts of Corautus Genetics Inc. and its wholly-owned subsidiary, Vascular Genetics Inc. All significant intercompany transactions and balances have been eliminated in consolidation. As the Company is devoting its efforts to research and the development of its products and there has been no revenue generated from product sales, the Company’s financial statements are presented as statements of a development stage enterprise.
Certain amounts from previous periods have been reclassified to conform to the 2005 presentation. These reclassifications had no impact on our results of operations or stockholders’ equity.
Revenue Recognition
Grant revenue is recognized as the research expenses related to the grants are incurred. Contract and license revenue arising from collaborative research agreements is recognized either (i) ratably over the term of the agreement, which approximates the performance of services, for contracts specifying payment for services over a given period, or (ii) as services are performed under the agreement, for contracts specifying payment on a per full-time employee basis. All amounts received under research grants or from collaborative research agreements are not refundable, regardless of the success of the underlying research. For the years ended December 31, 2005, 2004, and 2003, all revenue was from the license fee related to certain intellectual property licensed to Boston Scientific Corporation, which is being recognized as revenue over the licenses’ expected life of 12 years.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. The carrying amount of cash and cash equivalents approximates fair value at December 31, 2005 and 2004.
Short-Term Investments
In accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, management determines the appropriate classification of short-term investment securities at the time of purchase and reevaluates such designation as of each balance sheet date. Securities classified as available-for-sale are carried at fair value based upon quoted market prices, with gains and losses, if any, reported as a separate component of stockholders’ equity and included in comprehensive loss. Realized gains and losses are calculated on the specific identification method and are recorded as interest income. For the year ended December 31, 2003, realized gains on available-for-sale securities were $47,759 and realized losses were $63,694. The Company had no short-term investments at December 31, 2003. As of December 31, 2004 and 2005, the Company had short-term investments in Auction Rate Securities, or ARS. ARS generally have long-term stated maturities of 20 to 30 years. However, these securities have certain economic characteristics of short-term investments due to a rate-setting mechanism and
the ability to liquidate them through a Dutch auction process that occurs on pre-determined intervals of less than 90 days. As such, these investments are classified as short-term investments. These investments are classified as available-for-sale securities due to management’s intent regarding these securities. As of December 31, 2005 and 2004, there were no unrealized gains or losses associated with these investments and the adjusted fair market value equaled the adjusted cost.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the useful lives of the assets, estimated at three to five years, or the term of the lease if shorter. Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $61,939, $78,278, and $420,820, respectively.
Patents
Costs related to filing and pursuing patent applications are expensed as incurred as recoverability of such expenditures is uncertain.
Stock Based Compensation
The Company grants stock options for a fixed number of shares to employees in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, recognizes no compensation expense for the stock option grants to employees provided that the option exercise price is not less than the fair market value of the underlying stock on the date of the grant. The value of options or stock awards issued to non-employees have been determined in accordance with SFAS No. 123, Accounting for Stock Based Compensation, and Emerging Issues Task Force (“EITF”) Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and are periodically remeasured as the options vest.
As required under SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure, the pro forma effects of stock-based compensation on net income (loss) and net earnings (loss) per common share are estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for 2005, 2004, and 2003: a risk-free interest rate of 3.8%, 2.7%, and 2.6%, respectively, a dividend yield of 0% for all periods, a volatility factor of the expected market price of the Company’s common stock of 54%, 93%, and 95%, respectively, and an expected life of the option ranging from two to five years.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information follows:
Segment Reporting
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, requires the use of a management approach in identifying segments of an enterprise. Management has determined that the Company operates in one business segment, which is scientific research and development activities.
Net Loss Per Share
Net loss per share is computed on the basis of the weighted average number of common shares outstanding during the periods presented. Loss per share assuming dilution is computed on the basis of the weighted-average number of common shares outstanding and the dilutive effect of all common stock equivalents and convertible securities. Net loss per share assuming dilution for the years ended December 31, 2005, 2004 and 2003 is equal to net loss per share since the effect of common stock equivalents outstanding during the periods, including stock options, warrants and convertible, are antidilutive.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes, which requires that provision be made for taxes currently due and for the expected future tax effects of temporary differences between book and tax bases of assets and liabilities.
Research and Development
Research and development costs are expensed as incurred.
Comprehensive Income (Loss)
SFAS No. 130, Reporting Comprehensive Income, requires that all components of comprehensive income or loss, including net income or loss, be reported in the financial statements in the period in which they are recognized. Comprehensive income or loss is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net loss and other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments, shall be reported, net of their related tax effect, to arrive at comprehensive loss. Comprehensive loss for the years ended December 31 consisted of the following:
Use of Estimates
The preparation of financial statements in accordance with U. S. 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 amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R requires companies to recognize compensation expense in an amount equal to the fair value of the share-based payment (stock options and restricted stock) issued to employees. SFAS No. 123R applies to all transactions involving issuance of equity by a Company in exchange for goods and services, including employees. SFAS No. 123R is effective for fiscal periods beginning after June 15, 2005. The Company will adopt the provisions of the statement for its first quarter 2006 financial statements. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net loss and loss per share discussed above.
2. Property and Equipment
Property and equipment are comprised of the following:
During 2003, the Company abandoned its manufacturing facility and moved operations into a smaller facility. As a result of this, all tenant improvements related to the manufacturing facility and certain manufacturing equipment, including equipment under capital leases, and excess furniture and fixtures were identified as having no future use to the Company. A charge of approximately $1,946,000 was recorded in 2003 to write-off the property and equipment, net of estimated salvage value of approximately $200,000, which was recovered from proceeds of sale of the equipment through a third party in 2004.
3. Capital Lease Obligation
During 2005, the Company financed $6,526 of computer equipment under a capital lease arrangement that will expire in April 2007.
As discussed above in Note 2, in April 2003, the Company decided to outsource future manufacturing and wrote-off the value of all manufacturing equipment, less an estimated salvage value. Therefore, at December 31, 2004, there was no equipment under capital leases recorded.
4. Notes and Interest Payable
On June 30, 2005, Corautus executed a senior convertible promissory note and received proceeds of $5,000,000 from Boston Scientific Corporation. The note is convertible into 933,911 shares of common stock and is only convertible in the event of a change of control, as defined in the note. The note bears interest at 6% and if it remains unconverted, shall be repaid in three equal, annual payments of principal and interest beginning on the fifth anniversary of issuance, June 30, 2010.
On September 22, 2004, Corautus executed a senior convertible promissory note and received proceeds of $2,500,000 from Boston Scientific Corporation. The note is convertible into 376,288 shares of common stock and is only convertible in the event of a change of control, as defined in the note. The note bears interest at 6% and if it remains unconverted, shall be repaid in three equal, annual payments of principal and interest beginning on the fifth anniversary of issuance, September 22, 2009.
On July 22, 2004, Corautus executed a senior convertible promissory note and received proceeds of $5,000,000 from Boston Scientific Corporation. The note is convertible into 675,740 shares of common stock and is only convertible in the event of a change of control, as defined in the note. The note bears interest at 6% and if it remains unconverted, shall be repaid in three equal, annual payments of principal and interest beginning on the fifth anniversary of issuance, July 22, 2009.
On December 31, 2003, the Company executed a senior convertible promissory note and received proceeds of $2,500,000 from Boston Scientific Corporation. The note is convertible into 250,011 shares of common stock and is only convertible in the event of a change of control, as defined in the note. The note bears interest at 6% and if it remains unconverted, shall be repaid in three equal, annual payments of principal and interest beginning on the fifth anniversary of issuance, December 31, 2008.
Maturities of notes and interest payable at December 31, 2005 are as follows:
5. Acquisition of Technology and Related Agreements
On February 5, 2003, in connection with the merger with Vascular Genetics, a total of 5,320,166 shares of the Company’s common stock were issued to Vascular Genetics stockholders. Additionally, the Company assumed options to purchase 229,648 shares of common stock and warrants to purchase 19,164 shares of common stock. In connection with the acquisition, the Company also reserved 556,904 shares of common stock for potential indemnity obligations to former Vascular Genetics stockholders. In September 2004, the indemnity period for the merger ended and Corautus issued an additional 13,576 shares of common stock to the former Vascular Genetics stockholders resulting from claims asserted against Corautus under the indemnity provisions. Corautus recorded an expense in the third quarter of 2004 of $77,655 representing the fair value of the 13,576 shares computed in accordance with the merger agreement. The acquisition was accounted for as a purchase of assets by the Company for financial reporting purposes, in accordance with U. S. generally accepted accounting principles. Pursuant to the Emerging Issues Task Force’s Issue No. 98-3, Determining Whether a Nonmonetary Transaction Involves the Receipt of Productive Assets or of a Business, Vascular Genetics did not meet the criteria necessary to qualify as a business. Therefore, the Company’s acquisition of Vascular Genetics did not qualify as a business combination under SFAS No. 141, Business Combinations, and no goodwill resulted from the recording of the transaction. The value of the in-process research and development was charged to operations upon the close of the merger. The value allocated to acquired workforce of $80,000 was being amortized over two years. Amortization expense in 2005, 2004 and 2003 was $3,334, $40,000 and $36,667, respectively, and is included in general and administrative expenses.
In May 2000, the Company acquired all of the outstanding shares of Allegro Cell Systems, Inc. in exchange for 41,143 shares of common stock and an obligation to issue an additional 1,714 shares of common stock. The additional 1,714 shares of common stock were issued during 2002. Allegro’s sole asset was a license to certain technologies for the treatment and prevention of AIDS and for lentiviral gene therapy. Allegro had no products, revenues, employees, facilities or other assets. The shares issued to acquire the technologies were valued at $1,458,720 based on the fair value of the common stock on the date of the agreement which was charged to acquired in-process technology due to the early stage of development of the technology and the lack of alternative future uses for it.
In July 1998, the Company executed various agreements with Baxter Healthcare pursuant to which the Company acquired certain rights and assets from Baxter Healthcare. Under the terms of the agreements, the Company obtained the rights to Baxter Healthcare’s adenoviral-based gene transfer technologies and certain equipment in exchange for 5,830 shares of non-voting convertible Series A preferred stock and 263,031 shares of common stock. The shares issued to acquire the gene transfer technologies were valued at $5,455,505 based upon a discounted cash flow analysis, estimated research and development costs for six years and product revenues commencing in year seven, after the assumed completion of clinical trials and product approval by the U.S. Food and Drug Administration, or FDA. The value of the technology was charged to acquired in-process technology because technological feasibility had not been achieved nor had alternative future uses of the technology been identified. The value of the stock issued for property and equipment was $343,937 based upon the fair value of those assets.
Under the terms of the Company’s Developmental Collaboration Agreement and Credit Agreement with Baxter Healthcare, Baxter Healthcare was required to provide funding for pre-clinical development of the hemophilia product. When the Company treated the first patient in a Phase I clinical trial for the hemophilia product, a milestone payment of $2,000,000 was due from Baxter Healthcare. On June 13, 2001, the first patient was treated using the hemophilia product, and Baxter Healthcare paid the $2,000,000 milestone payment in exchange for 2,000 shares of Series C preferred stock. Additionally, the remaining balance under the Credit Agreement of approximately $5,848,000 was converted to Series B preferred stock in August 2001. The Series B preferred stock was convertible at Baxter Healthcare’s option into 287,274 shares of common stock and was converted to common stock in February 2003 in connection with the closing of the merger with Vascular Genetics. (See Note 6).
The Company entered into a Distribution Agreement with Baxter Healthcare whereby Baxter Healthcare has an exclusive, worldwide right to market, sell and distribute all products that may be developed under the Developmental Collaboration Agreement. The term of the Distribution Agreement is the longer of ten years from the date of regulatory approval of the first product or the expiration of the last to expire of any related patents issued on or before ten years from the date of regulatory approval.
The Company, Baxter Healthcare and certain founding shareholders of the Company entered into an Investor Rights Agreement under which the shares held by these entities were subject to certain restrictions on transfer until July 8, 2003 and these entities have certain registration rights. Additionally, under this agreement, Baxter Healthcare has the obligation to purchase Series C preferred stock at a price of $1,000 per share upon the Company’s achievement of the following milestones: (i) $2,000,000 upon treatment of the first patient in a Phase I clinical trial for a product developed under the Developmental Collaboration Agreement; (ii) $5,000,000 upon commencement of Phase III clinical trials of a product developed under the Developmental Collaboration Agreement; and (iii) $10,000,000 upon approval by the FDA of a product developed under the Developmental Collaboration Agreement. (See related discussion in Note 6).
6. Stockholders’ Equity
Convertible Preferred Stock
The Company is authorized to issue 5,000,000 shares of preferred stock, $0.001 par value. As of December 31, 2005, 40,000, 13,000, 17,000 and 1,400,000 shares were designated Series A, Series B, Series C and Series D preferred stock, respectively.
As of December 31, 2005, there were no shares of Series A preferred stock issued and outstanding. Former holders of the Series A preferred stock were not entitled to receive dividends, had a liquidation preference amount of ten dollars ($10.00) per share and had no voting rights. The Series A preferred stock was convertible into common stock on a 143 to 1 basis; provided, however, that no shares were convertible prior to July 8, 2001. In February 2003, the stockholders approved an amendment to the certificate of designation for the Series A preferred stock in which the Series A preferred stock would be convertible at the Company’s option following consummation of the merger with Vascular Genetics. The outstanding shares of Series A preferred stock were converted into shares of common stock on March 7, 2003.
As of December 31, 2005, there were no shares of Series B preferred stock issued and outstanding. The Series B preferred stock was previously issued to Baxter Healthcare in payment for amounts funded by Baxter Healthcare under the Credit Agreement. Total funding under the Development Collaboration Agreement and Credit Agreement was $12,890,000. Previous holders of the Series B preferred stock were not entitled to receive dividends, had a liquidation preference amount of one thousand dollars ($1,000.00) per share prior to any distribution to holders of Series A preferred stock and holders of common stock and had no voting rights, except for a vote as to whether the Company may issue additional Series B preferred stock. The Series B preferred stock was convertible into common stock upon certain triggering events. A triggering event occurred on June 13, 2001, thus the Series B preferred stock was convertible at Baxter Healthcare’s option. In February 2003, the stockholders approved an amendment to the certificate of designation for the Series B preferred stock in which the Series B preferred stock would convert to common stock immediately prior to the consummation of the merger with Vascular Genetics. The outstanding shares of Series B preferred stock were converted into shares of common stock on February 5, 2003.
As of December 31, 2005, there were 2,000 shares of Series C preferred stock issued and outstanding. The Company anticipates that Series C preferred stock will be sold only to Baxter Healthcare upon the Company meeting certain specified milestones, referred to as the “Series C Milestones.” Holders of the Series C preferred stock are not entitled to receive dividends, have a liquidation preference amount of one thousand dollars ($1,000.00) per share prior to any distribution to holders of Series A preferred stock and to holders of common stock and have no voting rights, except as to the issuance of additional Series C preferred stock. Each share of Series C preferred stock becomes convertible into common stock upon the earlier of (i) the first business day following the approval by the FDA of the right to market, sell or distribute any product using the MAXIMUM-AD Vector Technology for treatment of blood clotting disorders in humans relating to Hemophilia A, which product has been developed pursuant to the Company’s Developmental Collaboration Agreement with Baxter Healthcare and (ii) the date seven years after the achievement of the most recently achieved Series C Milestone. The Series C preferred stock is convertible into common stock in an amount equal to (a) the quotient of (i) the Liquidation Value (adjusted for Recapitalizations), divided by (ii) one hundred and ten percent (110%) of the per share Fair Market Value of the Company’s common stock (as defined), multiplied by (b) the number of shares of Series C Preferred converted. In February 2003, the stockholders approved an amendment to the certificate of designation for the Series C preferred stock in which the Series C preferred stock would be convertible upon the earlier of (i) the first business day following the approval by the FDA of the right to market, sell or distribute any product using the MAXIMUM-AD Vector Technology for treatment of blood clotting disorders in humans relating to Hemophilia A, which product has been developed pursuant to the Developmental Collaboration Agreement with Baxter Healthcare and (ii) June 13, 2010.
On July 31, 2003, Boston Scientific Corporation made a $9,000,000 investment in exchange for 1,385,377 shares of Series D Preferred Stock, which was initially convertible into the same number of shares of common stock, subject to adjustment. As of December 31, 2005, the 1,385,377 shares of Series D Preferred Stock were convertible into 1,420,339 shares of common stock. The Series D Preferred Stock is convertible into common shares at any time at the option of the holder and votes with the common stock on an “as adjusted basis.” The Series D Preferred Stock has a liquidation preference of $9,004,951 that is payable prior to any distribution to holders of Series A Preferred Stock and common stock.
Warrants
In conjunction with the lease settlement discussed in Note 10, in November 2003 the Company issued a warrant, exercisable for 5 years, to acquire 100,000 shares of Corautus common stock at an exercise price of $4.50 per share. The value of the warrant totaled approximately $490,000 in 2003, which was recorded in general and administrative expense.
In October 2003, the Company issued a warrant to purchase 1,000 shares of common stock in partial consideration for past public relations services. The warrant is fully vested and exercisable for seven years at an exercise price of $5.87. The warrant was valued at $4,660 and recorded in general and administrative expense.
In March 2003, a warrant to purchase 100,000 shares of common stock at $1.53 was issued as part of the consideration paid for investor relations and public relations services. One-fourth of the common stock under the warrant vested upon issuance, with the remaining portion vesting over the next nine months. The warrant was exercisable for ten years from the issuance date and was exercised by the holder in 2004. The value of the vested portion of the warrant totaled approximately $104,000 and $230,000 in 2004 and 2003, respectively, and was recorded in general and administrative expense.
In October 2001, the Company issued a warrant to purchase 12,785 shares of common stock to a service provider. The warrant is fully vested and is exercisable for five years at an exercise price of $16.45 per share. The warrant was valued at $134,250 and was recorded to general and administrative expense in 2001.
Holders of the convertible notes payable issued in 1998 and 1999 also were granted warrants to purchase 73,571 and 194,881 shares of common stock at an exercise price of $5.18 and $2.10 per share, respectively. The remaining 48,208 warrants issued in 1998 with an exercise price of $5.18 per share expired unexercised during 2005. As of December 31, 2005, warrants to purchase 97,611 shares of common stock at $2.10 per share remain outstanding and will expire on April 28, 2006 if not exercised.
Private Sale of Common Stock and Warrants
On June 27, 2005, Corautus entered into an investment agreement whereby Boston Scientific Corporation (“Boston Scientific”) agreed to purchase 2,105,264 shares of restricted common stock for a per share purchase price of $3.80. The $8,000,000 in proceeds resulting from the sale of shares of common stock to Boston Scientific were held in escrow at June 30, 2005, subject to stockholder approval at a special meeting that occurred on August 11, 2005.
Also, on June 27, 2005, Corautus and a group of investors closed a private placement offering. Pursuant to the agreement with the investors, Corautus sold 2,640,055 shares of restricted common stock for a purchase price of $3.80 per share. The proceeds of the offering, which closed on August 11, 2005 (totaling approximately $10,032,000 less direct expenses of $17,000), will be used to fund projected operations, including expenditures related to the GENASIS trial, the manufacturing costs for VEGF-2 for a Phase III trial, and the initial costs related to conducting a planned Phase III clinical trial. The net proceeds from the transactions entered into on June 27, 2005, will be used for funding projected operations, including expenditures related to Corautus’ clinical trial and manufacturing agreement.
On July 7, 2004, Corautus and thirteen investors entered into the Common Stock and Warrant Purchase Agreement, whereunder the investors agreed to purchase an aggregate of 1,886,952 shares of Corautus common stock and warrants exercisable for an aggregate of 471,732 shares of Corautus common stock for net cash proceeds to Corautus of $9,320,540. The transaction closed in two tranches. The first tranche in the amount of $4,666,572 closed on July 7, 2004. The commitment for the second tranche in the amount of $4,653,968 was initially placed into escrow and then closed on September 14, 2004 after the treatment of the first patient in Corautus’ Phase IIb clinical trial. The common stock in both tranches was issued at a price of $5.22 per share, which equals 90% of the average closing price during the thirteen trading days prior to execution of the definitive agreement. The warrants for each tranche are exercisable for five years at a price equal to 120% of the closing price on the day prior to the closing of that tranche (e.g. $8.064 and $6.30 for the warrants issued in the first and second tranches, respectively). The proceeds of the offering were used for working capital and other general corporate purposes.
On May 10, 2004, thirteen current or former directors, advisors and officers of Corautus or its subsidiaries purchased an aggregate of 97,909 shares of unregistered common stock from the company at $5.50 per share for aggregate net cash proceeds to Corautus of $538,500. The subscription agreements were entered into effective May 7, 2004 and the price per share was the closing price of the publicly traded stock of the Company on that date. The proceeds of the offering were used for working capital and other general corporate purposes.
In March 2004, Corautus and two separate investors entered into Common Stock and Warrant Purchase Agreements, whereunder the investors agreed to purchase an aggregate of 376,000 shares of Corautus common stock and warrants exercisable for 18,800 shares of Corautus common stock. The common stock was issued at a price equal to 88% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $5.9835 per share). The warrants are exercisable at a price equal to 125% of the closing market price of Corautus common stock on the day immediately preceding the date the transaction closed (i.e., $8.375 per share). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on March 18, 2004. The proceeds of the offering (totaling $2,249,984) were used in funding Corautus’ Phase IIb clinical trial.
On January 8, 2004, Corautus and a group of investors entered into the Common Stock and Warrant Purchase Agreement, whereunder the investors agreed to purchase an aggregate of 1,200,000 shares of Corautus common stock and warrants exercisable for 240,000 shares of Corautus common stock. The common stock was issued at a price equal to 90% of the closing market price of Corautus
common stock on the day immediately preceding the agreement execution date (i.e., $4.3819 per share). The warrants are exercisable at a price equal to 120% of the closing market price of Corautus common stock on the day immediately preceding the date the transaction closed (i.e., $6.72 per share). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on January 16, 2004. The proceeds of the offering (totaling $5,260,680 less $289,337 in finder’s fees) were used for working capital and other general corporate purposes.
On December 19, 2003, Corautus and three investors entered into the Common Stock and Warrant Purchase Agreement, whereunder the investors agreed to purchase in two tranches an aggregate of 793,640 shares of Corautus common stock and warrants exercisable for 160,639 shares of Corautus common stock. The common stock was issued at a price equal to 90% of the closing market price of Corautus common stock on the day immediately preceding the agreement execution date (i.e., $3.967 per share). The warrants are exercisable at a price equal to 125% of the closing market price of Corautus common stock on the day immediately preceding the date each transaction closed (i.e., $5.4375 per share for tranche one (108,338 shares) and $6.7625 per share for tranche two (50,390 shares)). Additionally, the warrants are exercisable by the holder for up to five years immediately following issuance. The transaction closed on December 31, 2003 with respect to 541,690 shares and January 27, 2004 with respect to the remaining shares. In connection with this offering, the Company issued warrants to purchase an aggregate of 30,420 shares of its common stock at an exercise price of $1.00 per share as a finder’s fee for the offering. The proceeds of the offering (totaling $3,149,957 with no underwriting discounts or commissions) were used for working capital and other general corporate purposes.
Employee Stock Purchase Plan
In May 2001, the Company adopted an Employee Stock Purchase Plan (the “Purchase Plan”), which was approved by the stockholders in July 2001. A total of 142,857 shares of common stock have been authorized and reserved for issuance under this Purchase Plan. The Purchase Plan permits all eligible employees to purchase common stock through payroll deductions (which cannot exceed 15% of each employee’s compensation) at the lower of 85% of fair market value at the beginning or the end of a 24 month offering period. No shares have been issued under this plan. As of December 31, 2005, twelve employees participate in the plan.
Stock Options
In November 2002, the Board of Directors adopted the 2002 Stock Plan, which was approved by the stockholders in February 2003 and was amended by stockholder approval in May 2004. Under the 2002 Stock Plan, the Board or a committee has the authority to grant options and rights to purchase common stock to officers, key employees, consultants and certain advisors to the Company. Options granted under the 2002 Stock Plan may be either incentive stock options or nonstatutory stock options, as determined by the Board or a committee. The 2002 Stock Plan, as amended in May 2004, reserves 3,500,000 shares for issuance under the Plan plus (a) any shares of common stock which have been reserved but not issued under the 1999 Stock Plan, the 1995 Stock Plan and the 1995 Directors’ Option Plan as of the date of stockholder approval of the 2002 Stock Plan, (b) any shares of common stock returned to the 1999 Stock Plan, the 1995 Stock Plan and the 1995 Directors’ Option Plan as a result of the termination of options or repurchase of shares of common stock issued under those plans and (c) an annual increase on the first day of each year by the lesser of (i) 300,000 shares, (ii) the number of shares equal to two percent of the total outstanding common shares or (iii) a lesser amount determined by the Board of Directors. Generally, options are granted with vesting periods from two to four years and expire ten years from date of grant or 90 days after termination of employment, if sooner.
The following table summarizes the activity of the Company’s stock options:
Options outstanding as of December 31, 2005:
The weighted-average grant date fair value of options granted at fair value on the grant date in 2005, 2004 and 2003 was $1.70, $3.06, and $1.20, respectively. The weighted-average grant date fair value of options granted at less than fair value on the grant date in 2004 and 2003 was $4.64 and $1.99, respectively. There were no options granted at less than fair value in 2005.
During 2004 and 2003, the Company accelerated the vesting of certain employee stock options upon the employees’ termination. Also, the Company extended the period during which certain vested employee stock options could be exercised upon employee termination. Because these changes qualified as stock option modifications under Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, the Company recorded compensation expense of approximately $44,000 and $68,000 in general and administrative expense in 2004 and 2003, respectively, representing the excess of the intrinsic value of the options on the modification date over the options’ original intrinsic value.
During 2004 and 2003, the Company granted stock options to certain individuals, which had exercise prices below the market price of the Company’s common stock on the date of grant. In accordance with APB No. 25, the Company recorded compensation expense over the vesting period of approximately $6,700 and $164,500 in general and administrative expense in 2004 and 2003, respectively, based on the intrinsic value of the options on the date of grant.
The following common stock is reserved for future issuance at December 31, 2005:
The number of shares of common stock into which Series C preferred stock will be converted will not be known until the date of conversion because the conversion factor is based on fair value of the Company’s common stock on the date the Series C preferred stock becomes convertible, June 13, 2010.
7. Income Taxes
There is no income tax provision (benefit) for federal or state income taxes as the Company has incurred operating losses since inception.
A reconciliation of the statutory income tax rate to the effective income tax rate as recognized in the statements of operations for the years ended December 31, 2005, 2004 and 2003, is as follows:
As of December 31, 2005, the Company has federal and state net operating loss carryforwards of approximately $123,000,000 and $85,000,000, respectively, which will begin to expire in 2011 and 2006, respectively, unless previously utilized. The Company has federal and state research and development credit carryforwards of approximately $1,666,000 and $1,434,000, respectively. The federal research and development credit carryforwards will begin to expire in 2011 unless previously utilized. The Company has a California manufacturer’s investment credit of approximately $60,000 that will begin to expire in 2008 unless previously utilized.
Under Internal Revenue Code Sections 382 and 383, the Company’s use of net operating loss and tax credit carryforwards could be limited in the event of certain cumulative changes in the Company’s stock ownership.
Deferred tax assets are comprised of the following:
8. Related Party Balances and Transactions
In connection with the merger with Vascular Genetics, Inc. in February 2003, the Company assumed $380,000 of promissory notes and $8,266 of related accrued interest, which were payable to stockholders. During 2003, these notes were repaid.
In 2000, the Company entered into a facility lease and a note payable with a research organization in the amount of $200,000 to finance leasehold improvements on the facility. The research organization is a related party due to a common director. During 2003 and 2002, the Company paid the research organization $560,621 and $1,166,051, respectively, for rent, common area charges, license fees and services (Note 10). There were no payments to this research organization in 2005 or 2004.
During 2001, the Company entered into a note receivable with an officer and stockholder in the amount of $37,000. The note was originally to be repaid over a four year period, however in April, 2002, the Company agreed to forgive the loan. Under the terms of the forgiveness arrangement, the loan will be forgiven over a four-year period beginning April, 2002. The amount of the loan that was forgiven in 2005, 2004 and 2003 was $9,633, $9,633 and $9,633, respectively. The balance of this loan was $3,198 and $12,664 as of December 31, 2005 and 2004, respectively.
9. Commitments
Facilities
The Company leases approximately 4,800 square feet of office space under an operating lease that may be terminated by the Company at any time with ninety days notice. Also, the Company leases approximately 2,200 square feet of office and laboratory space under an operating lease that expires on July 31, 2006.
In December 2002, the Company vacated the Altman Row facility and consolidated all operations into the Barnes Canyon facility. In accordance with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a Restructuring), the Company recorded a charge of $510,000, which was the equivalent of six months rent and common area maintenance charges for the Altman Row facility. The Company entered into a termination agreement with respect to this facility in 2003. Additionally, the Company recorded a charge of $254,000 related to the unamortized portion of capitalized leasehold improvements at the Altman Row facility from which the Company will receive no further benefit.
In May 2003, the Company entered into an agreement to terminate the lease for its manufacturing facility (Barnes Canyon) and to surrender possession of such facility without prejudice to any remedies of the landlord for the recovery of rent. As of the date of such termination, future payments due under this operating lease for the remaining eight year term were approximately $16.5 million. The Company entered into a settlement and release agreement with the landlord, dated as of November 7, 2003, for the settlement of the remaining payments that would have been due for the original term of such lease. Pursuant to the settlement and release agreement, the Company was obligated to pay or deliver to the landlord the following:
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immediately upon execution of the agreement, a warrant to acquire 100,000 shares of Corautus common stock at an exercise price of $4.50 per share;
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$650,000 in cash on or before April 15, 2004, in one or more installments;
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an aggregate of $550,000 in cash in twenty-two equal consecutive monthly installments beginning February 2004;
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for twenty-four months beginning November 2003, that number of shares of Corautus common stock which on the first day of each such month shall have a trading value of $50,000; and
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$681,000 in cash on or before January 5, 2006, subject to reduction for certain amounts received by the landlord prior to December 1, 2004 from re-leasing the property.
The Company had delivered to the landlord a standby letter of credit, secured by a restricted certificate of deposit, for $680,901, securing a portion of its obligations under the agreement. The Company agreed to file a registration statement to register the shares delivered to the landlord, including the shares underlying the warrants, pursuant to the Securities Act of 1933, on or before June 1, 2004. Such registration statement was filed on January 27, 2004 and was amended on February 3, 2004. Effective with the $650,000 cash payment due on or before April 15, 2004, the Company was released from its obligations under the lease. The net present value of this settlement amount of $3.4 million was charged to expense in 2003. The estimated fair value of the warrants of $490,000 was recorded to additional paid in capital. In 2005 and 2004, the Company made payments of $955,901 and $925,000, respectively, and issued 186,007 and 53,180 shares of common stock valued at $900,000 and $300,000, respectively, to the landlord pursuant to the settlement agreement. As of December 31, 2005, all obligations under this settlement agreement had been met, eliminating the liability.
For the years ended December 31, 2005, 2004 and 2003, rent expense was approximately $151,000, $305,000, and $875,000, respectively.
Future minimum lease payments under all of these leases are as follows:
Purchase Commitments
On May 13, 2005, the Company entered into a Manufacturing Agreement with Boehringer Ingelheim Austria GmbH (“BI”) regarding BI’s provision of certain development, optimization, and manufacturing services for our VEGF-2 material. The Manufacturing Agreement with BI is a long-term agreement for manufacturing VEGF-2 for commercial use, our planned Phase III cardio-vascular clinical trial and any potential clinical trials related to peripheral artery disease. The Manufacturing Agreement has a term extending from its execution until seven years after the first licensing of VEGF-2, renewable thereafter on successive four-year terms unless either party terminates with 24 months notice. We estimate that our total payments under the agreement will be approximately 11.1 million euros (equating to approximately $13.2 million in U.S. dollars as of December 31, 2005), of which approximately 4.7 million euros (equating to approximately $6 million in U.S. dollars) have been paid through December 31, 2005. Based on the exchange rate at December 31, 2005, we expect to pay approximately $1.5 million in 2006, $5.2 million in 2007, and $0.8 million beyond 2007.
10. Profit Sharing Plan and Deferred Compensation Plan
In 1998, the Company established a savings plan which covers all employees working more than 1,000 hours per year which has been established pursuant to the provisions of Section 401(k) of the Internal Revenue Code. Contributions to the plan are discretionary and contributions made prior to September 2005 vest over a four-year period. Beginning September 1, 2005, contributions made to eligible employees under the Safe Harbor Matching Contribution are 100% vested. Employer contributions during the years ended December 31, 2005, 2004 and 2003 were $58,946, $49,774, and $48,904, respectively.
In 1998, the Company established a deferred compensation plan. Prior to 2003, certain employees were allowed to defer up to 100% of their salaries and bonuses under this plan. Additionally, the Company allowed certain employees approximately 18% of their salaries for employee benefits and employer payroll taxes. A portion of the employer allocation for employee benefits was allocated to the deferred compensation plan. During the years ended December 31, 2002 and 2001, the Company’s contributions to the deferred compensation plan were $47,150 and $66,613, respectively. Employer contributions vested over a rolling four-year period based upon the date each employer contribution was made. This plan was terminated as of January 1, 2003 and vested balances were paid to the respective participants.
11. Supplemental Cash Flow Information
Cash paid for income taxes was $1,600 for each of the years ended December 31, 2005, 2004 and 2003. Cash paid for interest was $1,904, $23,948 and $78,366 for the years ended December 31, 2005, 2004 and 2003, respectively.
In October 2003, the Company issued common stock with a market value of $50,000 (8,696 common shares) to a vendor in settlement for outstanding obligations. The expense was recorded in general and administrative expense.
During the years ended December 31, 2001 and 2000, amounts due Baxter Healthcare under the Credit Agreement of $5,848,361 and $4,043,079 were converted into 5,849 and 4,043 shares of Series B preferred stock, respectively. Additionally, during 2001, 2,000 shares of Series C preferred stock were issued to Baxter Healthcare in exchange for a $2,000,000 milestone payment (Note 5).
During 2000, the Company issued 41,143 shares of common stock valued at $1,519,500 to acquire the license for technologies for the treatment and prevention of AIDS and for lentiviral gene therapy (Note 5). During 2002, an additional 1,714 shares of common stock were issued in connection with this transaction.
During 2000, a warrant for 14,286 shares of common stock was issued to Baxter Healthcare in conjunction with Baxter Healthcare’s guarantee of a note payable. The warrant was valued at $687,000 and classified as deferred loan fees and was amortized to interest expense over the term of the note payable, which matured in 2003. Additionally, the Company acquired $200,000 of leasehold improvements under a note payable to a related party.
As more fully described in Note 5, in 1998 the Company acquired certain technology and equipment in exchange for 5,830 shares of Series A preferred stock and 263,031 shares of common stock valued at $5,799,442. The equipment acquired was valued at $343,937 based on an appraisal.
12. Selected Quarterly Data (Unaudited)
The following tables set forth certain unaudited quarterly information for each of the eight fiscal quarters in the two-year period ended December 31, 2005. This quarterly information has been prepared on a consistent basis with the audited financial statements and, in the opinion of management, includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information for the periods presented. The Company’s quarterly operating results may fluctuate significantly as a result of a variety of factors and operating results for any quarter are not necessarily indicative of results for a full fiscal year or future quarters.
13. Litigation
The Company is involved in various litigation and administrative proceedings arising in the normal course of business. In the opinion of management, any liabilities that may result from these claims will not, individually or in the aggregate, have a material adverse effect on the Company’s financial position, results of operations, or cash flows.
In 2002, Vascular Genetics received notification of a claim alleging wrongful death and product liability claims in connection with the death of a patient enrolled in Vascular Genetics clinical trials. Vascular Genetics has liability insurance with limits of $5,000,000 in the aggregate. Vascular Genetics denies liability and will vigorously contest the claim. Based on proposals made by the plaintiffs, the Company believes that the claim can be settled within the policy limits. The Company has determined, without considering any possible insurance recovery, that a loss in connection with this matter is possible, but not probable. Accordingly, the Company has not recorded any liability relating to this matter.