UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2018

or

For the transition period from                     to

Commission File Number: 000-31161

 

ARENA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

858.453.7200

(Registrant’s telephone number, including area code)

 

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

 

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The number of shares of common stock outstanding as of the close of business on November 2, 2018:

 

 

 

 

 

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ARENA PHARMACEUTICALS, INC.

INDEX

 

 

 

TRADEMARKS AND CERTAIN TERMS

Arena Pharmaceuticals ® and Arena ® are registered service marks of Arena. Any other brand names or trademarks appearing in this Quarterly Report on Form 10-Q are the property of their respective holders.

In this Quarterly Report on Form 10-Q, “Arena Pharmaceuticals,” “Arena,” “we,” “us” and “our” refer to Arena Pharmaceuticals, Inc., and our wholly owned subsidiaries on a consolidated basis, unless the context otherwise provides. “APD” is an abbreviation for Arena Pharmaceuticals Development.

 

 

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

ARENA PHARMACEUTICALS, INC.

Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

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ARENA PHARMACEUTICALS, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except per share data)

(Unaudited)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ARENA PHARMACEUTICALS, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

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ARENA PHARMACEUTICALS, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Arena Pharmaceuticals, Inc. should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission, or SEC, from which we derived our condensed consolidated balance sheet as of December 31, 2017. The accompanying condensed consolidated financial statements have been prepared in accordance with US generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, since they are interim statements, the accompanying condensed consolidated financial statements do not include all of the information and notes required by GAAP for complete financial statements. The accompanying condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of our management, necessary to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year.

Beacon Discovery, Inc., or Beacon, is a variable interest entity in which we had a controlling financial interest until December 2017. The results of operations and comprehensive loss attributable to the noncontrolling interest in Beacon are presented as separate components from the results of operations and comprehensive loss attributable to the stockholders of Arena in the condensed consolidated statement of operations and comprehensive loss for the three and nine months ended September 30, 2017. We deconsolidated Beacon in December 2017 (see Note 13).

Liquidity.

As of September 30, 2018, we had cash, cash equivalents and available-for-sale investments of approximately $561.6 million. We believe our cash and cash equivalents and available-for-sale investments will be sufficient to fund our operations for at least the next 12 months.

We will require substantial cash to achieve our objectives of discovering, developing and commercializing drugs, as this process typically takes many years and potentially hundreds of millions of dollars for an individual drug. We may not have adequate available cash, or assets that could be readily turned into cash, to meet these objectives in the long term. We will need to obtain significant funds under our existing collaborations, under new collaboration, licensing or other commercial agreements for one or more of our drug candidates, programs or patent portfolios, or from other potential sources of liquidity, which may include the sale of equity, issuance of debt or other transactions.

Changes in Accounting Policies - Revenue Recognition.

Effective January 1, 2018, we adopted Accounting Standard Codification 606, Revenue from Contracts with Customers, or ASC 606, issued by the Financial Accounting Standards Board, or FASB. As a result, we have changed our accounting policy for revenue recognition as detailed below.

We implemented ASC 606 using the modified retrospective method by recognizing the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of our accumulated deficit at January 1, 2018. Therefore, the comparative period information has not been adjusted.

We applied ASC 606 using a practical expedient for contracts that were modified before the implementation date, which allowed us to determine an aggregate effect of all modifications that occurred before January 1, 2018, when determining the satisfied and unsatisfied performance obligations, the transaction price, and allocating that transaction price to the performance obligations instead of retrospectively restating the contracts for such contract modifications.  

The cumulative impact to our accumulated deficit balance at January 1, 2018, as a result of the adoption of ASC 606 was a decrease of $19.0 million. The decrease arose primarily from a reduction of deferred revenue balances related to upfront payments received from customers and recognition of contract assets due to a combination of (i) the effects of applying the practical expedient for contract modifications and our conclusions related to satisfied and unsatisfied performance obligations, which resulted in a relatively higher portion of the total transaction price recognized as revenue in periods prior to our adoption of ASC 606, (ii) the effect of the bill-and-hold accounting guidance for inventory in ASC 606 and (iii) the inclusion of estimated future royalty payments related to our intellectual property in the total transaction price to the extent such intellectual property was legally sold to our customer rather than licensed. The cumulative effect adjustment is net of an impairment loss of $13.1 million which was a direct effect of the adoption

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of ASC 606 on the asset group of the Manufacturing Operations, which was classified as assets of disposal group held for sale since December 2017.

The following table summarizes the impacts of adopting ASC 606 on our condensed consolidated financial statements, in thousands.

 

 

Our revenues to date have been generated primarily through collaboration agreements. Our collaboration agreements frequently contain multiple elements including (i) intellectual property licenses, (ii) product research, development and regulatory services and (iii) product manufacturing. Consideration we receive under these arrangements may include upfront payments, research and development funding, cost reimbursements, milestone payments, payments for product sales and royalty payments. Our customers include Everest Medicines Limited, or Everest, Outpost Medicine, LLC, or Outpost, Eisai Inc. and Eisai Co., Ltd., or collectively, Eisai, Axovant Sciences GmbH, or Axovant, Boehringer Ingelheim International GmbH, or Boehringer Ingelheim, and Siegfried.  

Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration that we expect to be entitled to receive in exchange for these services and excludes sales incentives and amounts collected on behalf of third parties. We analyze the nature of these performance obligations in the context of individual collaboration agreements in order to assess the distinct performance obligations. We apply the following five steps to recognize revenue:

i) Identify the contract with a customer. We consider the terms and conditions of our collaboration agreements to identify contracts within the scope of ASC 606. We consider that we have a contract with a customer when the contract is approved, we can identify each party's rights regarding the goods and services to be transferred, we can identify the payment terms for the goods and services, we have determined the customer has the ability and intent to pay and the contract has commercial substance. We use

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judgment in determining the customer's ability and intent to pay, which is based upon factors including the customer's historical payment experience or, for new customers, credit and financial information pertaining to the customers.

ii) Identify the performance obligations in the contract. Performance obligations in our collaboration agreements are identified based on the goods and services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. Our performance obligations generally consist of intellectual property licenses, research, development and/or regulatory services and manufacturing and supply commitments.

 iii) Determine the transaction price. We determine the transaction price based on the consideration to which we expect to be entitled in exchange for transferring goods and services to the customer. In determining the transaction price, any variable consideration would be considered, to the extent applicable, if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. In accordance with the royalty exception under ASC 606 for licenses of intellectual property, the transaction price excludes future royalty payments to be received from our customers. None of our collaboration agreements contain consideration payable to our customer or a significant financing component.

 iv) Allocate the transaction price to performance obligations in the contract. If the contract contains a single performance obligation, the entire transaction price is allocated to that performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price.

 v) Recognize revenue when or as we satisfy a performance obligation. Revenue is recognized at the time the related performance obligation is satisfied by transferring the promised goods or services to a customer. We recognize revenue when we transfer control of the goods or services to our customers for an amount that reflects the consideration that we expect to receive in exchange for those services.

Performance Obligations.

The following is a description of principal goods and services from which we generate revenue.

 

Intellectual property licenses

We generate revenue from licensing our intellectual property including know-how and development and commercialization rights. These licenses provide customers with a term-based license to further research, develop and commercialize our internally-discovered drug candidates. The consideration we receive in the form of nonrefundable upfront consideration related to the functional intellectual property licenses is recognized when we transfer such license to the customer unless the license is combined with other goods or services into one performance obligation, in which case the revenue is recognized over a period of time based on our estimated pattern in which we satisfy the combined performance obligation. Our licensing agreements are generally cancelable. Customers have the right to terminate their contracts upon notice. We have the right to terminate the contracts generally only if the customer is in breach of the contract and fails to remedy the breach in accordance with the contractual terms.

 

Intellectual property sales

We generate royalty revenue from sales of our intellectual property. We estimate the future royalty payments and recognize revenue with a corresponding contract asset at a point in time when we transfer the intellectual property to the customer. We periodically reassess our estimate of the future royalty payments and recognize any estimate adjustments as revenue in the current period.

 

Research, development and regulatory services

We generate revenue from research, development and regulatory services we provide to our customers in connection with the licensed intellectual property. The services we provide to our customers primarily include scientific research activities, preparation for and management of clinical trials, and assistance during the regulatory approval application process. Revenue associated with these services is recognized based on our estimate of total consideration to be received for such services and the pattern in which we perform the services. The pattern of performance is generally determined to be the amount of incurred expenses reimbursed by the customer as a percentage of total expected reimbursable expenses associated with the contract.

 

Product manufacturing

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We generate revenue from manufacturing and clinical supply promises to our customers in connection with securing a supply of drug products for development and clinical trial purposes. The drug products are generally manufactured by our contract manufacturing organizations. We used our product manufacturing facility in Zofingen, Switzerland for a portion of the product manufacturing requirements until we sold the Manufacturing Operations on March 31, 2018 (see Note 2). Revenue associated with product manufacturing obligations is recognized at a point in time as control of the related product is transferred to the customer.

Contracts with Multiple Performance Obligations.

Most of our collaboration agreements with customers contain multiple promised goods or services. Based on the characteristics of the promised goods and services we analyze whether they are separate or combined performance obligations. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. We determine standalone selling price based on our overall pricing and discounting objectives, taking into consideration the type of services, estimates of hourly market rates, and stage of the development and clinical trials.

Variable Consideration.

Our contracts with customers primarily include two types of variable consideration: (i) development and regulatory milestone payments, which are due to us upon achievement of specific development and regulatory milestones and (ii) one-time sales-based payments and sales-based royalties associated with sold or licensed intellectual property.

Due to uncertainty associated with achievement of the development and regulatory milestones, the related milestone payments are excluded from the contract consideration and the corresponding revenue is not recognized until we conclude it is probable that reversal of such milestone revenue will not occur.

Product sales-based royalties under licensed intellectual property and one-time payments are accounted for under the royalty exception. We recognize revenue for sales-based royalties under licensed intellectual property and one-time payments at the later of when the sales occur or the performance obligation is satisfied or partially satisfied.

Disaggregation of Revenue.

We operate in one reportable business segment. We provide goods and services to our customers in collaboration agreements pursuant to various geographical markets. In the following table, revenue is disaggregated by major customers, timing of revenue recognition and revenue classification, in thousands.

 

 

Contract Assets and Contract Liabilities.

We receive payments from customers based on contractual terms. Accounts receivable are recorded when the right to consideration becomes unconditional. For research and development services, we generally bill our customers monthly or quarterly as

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the services are performed. Product sales are generally billed as completed. Payment terms on invoiced amounts are typically 30 days. Contract assets include amounts related to our contractual right to consideration for both completed and partially completed performance obligations that have not been invoiced and for which we do not yet have the right to payment. The current portion of contract asset is included in prepaid expenses and other current assets in the condensed consolidated balance sheet. The non-current portion of contract assets is included in other non-current assets in the condensed consolidated balance sheet. As of January 1, 2018, we recorded a contract asset of $4.1 million, of which $1.4 million is classified as current and $2.7 million is classified as non-current, related to future royalties associated with intellectual property patents previously sold to a customer which do not qualify for the royalty exception in ASC 606. We estimated the amount of the contract asset by applying the expected value method to our estimate of future royalty payments we will receive from this customer. Any future changes to this estimate will be recorded as an adjustment to revenue in the period in which the change in estimate is made.  

Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract.

The following table provides detail of changes in our contract assets and deferred revenues, in thousands. The deferred revenue balances as of December 31, 2017, presented in the following table include balances classified as liabilities of disposal group held for sale:

 

Cost to Obtain and Fulfill a Contract.

We generally do not incur costs to obtain new contracts. Costs to fulfill contracts are expensed as incurred.

Remaining Performance Obligations.

The following table provides detail of estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied) pursuant to our existing collaboration agreements as of September 30, 2018, in thousands:

 

Under the royalty exception in ASC 606 for licensed intellectual property we do not recognize any revenue for the variable amounts related to sales-based royalties until the later of when the sales occur or the performance obligation is satisfied or partially satisfied. Accordingly, the revenue related to future royalties and sales-based milestones is not included in the table above.

Recent Accounting Pronouncements.

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU No. 2016-02 amends the accounting guidance for leases. The amendments contain principles that will require lessees to recognize most leases on the balance sheet by recording a right-of-use asset and a lease liability, unless the lease is a short-term lease that has an accounting lease term of 12 months or less. The amendments also contain other changes to the current lease guidance that may result in changes to how entities determine which contractual arrangements qualify as a lease, the accounting for executory costs (such as property taxes and insurance), as well as which lease origination costs will be capitalizable. The new standard also requires expanded quantitative and qualitative disclosures.

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The FASB has subsequently issued additional ASUs to clarify certain elements of the new lease accounting guidance. ASU No. 2016-02 is effective for annual reporting periods, and interim periods within those periods, beginning after December 15, 2018, with early adoption permitted.

The new guidance requires a modified retrospective transition, with the cumulative effect of transition, including initial recognition by lessees of lease assets and liabilities for existing operating leases, as of either: (a) the effective date meaning the cumulative effect of applying the new guidance is recognized as an adjustment to the opening retained earnings balance for the year of implementation, or (b) the beginning of the earliest comparative period presented. We plan to adopt the new lease standard effective January 1, 2019, using the effective date method with the cumulative effect of the change reflected in retained earnings as of January 1, 2019, if any. We plan to elect the package of practical expedients available in the new lease standard, allowing us not to reassess: (a) whether expired or existing contracts contain leases under the new definition of a lease; (b) lease classification for expired or existing leases; and (c) whether previously capitalized initial direct costs would qualify for capitalization under the new lease standard.

We have continued to monitor FASB activity to assess certain interpretative issues and the associated implementation of the new standard. We are in the process of reviewing our lease arrangements, including our property leases and subleases, and are not yet able to estimate the anticipated impact to our consolidated financial statements from the implementation of the new standard as we continue to interpret the principles of the new standard.

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash. ASU No. 2016-18 requires that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. In accordance with ASU No. 2016-18, we adopted this standard in the first quarter of 2018 and retrospectively adjusted the condensed consolidated statement of cash flows for the nine months ended September 30, 2017, to conform to the current period’s presentation. The adoption of this ASU did not have a material impact on our consolidated financial statements.  

The following table provides a reconciliation of the components of cash, cash equivalents, and restricted cash reported in our condensed consolidated balance sheets to the total of the amount presented in the condensed consolidated statements of cash flows, in thousands:

 

The restricted cash relates to our property leases. The restriction will lapse when the related leases expire.

Use of Estimates.

The preparation of financial statements in accordance with GAAP requires our management to make estimates and assumptions that affect the reported amounts (including assets, liabilities, revenues and expenses) and related disclosures. The amounts reported could differ under different estimates and assumptions.

Contingencies.

We disclose information regarding each material claim where the likelihood of a loss contingency is probable or reasonably possible. If a loss contingency is probable and the amount of the loss can be reasonably estimated, we record an accrual for the loss. In such cases, there may be an exposure to potential loss in excess of the amount accrued. The insurance recoveries are recorded in the period when the insurance reimbursement is deemed probable. The ability to predict the ultimate outcome of such matters involves judgments, estimates and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates. 

 

 

2. Sale of Manufacturing Operations

In order to further focus our efforts and resources on our strategic objectives of developing our pipeline drug candidates, on March 9, 2018, we entered into an Asset Purchase Agreement, or Sale Agreement, with Siegfried Pharma AG and Siegfried AG,

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(collectively and individually, Siegfried). Under the Sale Agreement, we agreed to sell and assign to Siegfried, and Siegfried agreed to purchase and assume from Arena GmbH, certain drug product finishing facility assets and know-how, including fixtures, equipment, other personal property and real estate assets located in Zofingen, Switzerland and related contracts and certain related liabilities, or collectively, the Manufacturing Operations. We refer to this transaction as the Siegfried Transaction. The Siegfried Transaction was completed on March 31, 2018. In connection with the Siegfried Transaction, all of Arena GmbH’s approximately 50 employees transferred to Siegfried. We have excluded from our continuing operations for all periods presented in this report revenues and expenses associated with the disposed Manufacturing Operations, which are reported as discontinued operations. The total sales price for the Manufacturing Operations was approximately CHF 4 million of which approximately CHF 3 million was received in cash in March 2018 with the remaining portion to be received in March 2019, net of any qualifying claims by Siegfried. In the event Siegfried agrees to sell or transfer some or all of the transferred assets to certain third parties on or prior to December 31, 2018, for a consideration in excess of a specified amount, Arena GmbH will be entitled to percentage of such excess amount.

We have retrospectively revised the condensed consolidated statements of operations for the three and nine months ended September 30, 2017, and cash flows for the nine months ended September 30, 2017, to reflect the operations and cash flows of the disposed Manufacturing Operations as discontinued operations. The following table summarizes the results of discontinued operations for the periods presented in the condensed consolidated statements of operations, in thousands: