Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number: 000-51462

 


CHELSEA THERAPEUTICS INTERNATIONAL, LTD.

(Exact name of Registrant as specified in its charter)

 


 

Delaware   20-3174202
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

13950 Ballantyne Corporate Place, Suite 325, Charlotte, North Carolina 28277

(Address of principal executive offices, including zip code)

(704) 341-1516

(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  x    NO  ¨

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

Large Accelerated Filer  ¨    Accelerated Filer  ¨    Non-accelerated Filer  x

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of November 8, 2007, there were 29,917,454 shares of registrant’s Common Stock outstanding.

 



Table of Contents

Index

 

         Page
PART I FINANCIAL INFORMATION   

Item 1.

  Condensed Consolidated Financial Statements    1

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    11

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk    15

Item 4.

  Controls and Procedures    15
PART II OTHER INFORMATION   

Item 6.

  Exhibits    16
  Signatures    17


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     September 30,
2007
    December 31,
2006
 
     (unaudited)     (Note 1)  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 21,081,445     $ 15,897,329  

Prepaid contract research and manufacturing

     87,830       167,606  

Other prepaid expenses and other current assets

     166,129       49,214  
                

Total current assets

     21,335,404       16,114,149  

Property and equipment, net

     40,206       42,938  

Other assets

     13,461       13,461  
                
   $ 21,389,071     $ 16,170,548  
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 1,474,839     $ 41,255  

Accrued compensation and related expenses

     428,648       409,955  

Accrued contract research and manufacturing

     2,444,612       1,448,470  

Other accrued expenses

     218,548       134,312  
                

Total liabilities

     4,566,647       2,033,992  
                

Commitments

    

Stockholders’ equity:

    

Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares issued and outstanding

     —         —    

Common stock, $0.0001 par value, 45,000,000 shares authorized, 22,528,082 and 19,707,129 shares issued and outstanding, respectively

     2,252       1,971  

Additional paid-in capital

     46,665,952       33,738,242  

Deficit accumulated during the development stage

     (29,845,780 )     (19,603,657 )
                

Total stockholders’ equity

     16,822,424       14,136,556  
                
   $ 21,389,071     $ 16,170,548  
                

See accompanying notes to condensed consolidated financial statements.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

                            

Period from

April 3, 2002

 
     For the three months ended September 30,     For the nine months ended September 30,     (inception) to  
     2007     2006     2007     2006     September 30, 2007  

Operating expenses:

          

Research and development

   $ 2,652,206     $ 1,745,319     $ 7,975,042     $ 4,874,971     $ 22,163,645  

Sales and marketing

     235,775       150,137       1,055,195       460,668       2,390,534  

General and administrative

     662,325       458,481       2,034,431       1,551,634       7,149,673  
                                        

Total operating expenses

     3,550,306       2,353,937       11,064,668       6,887,273       31,703,852  
                                        

Operating loss

     (3,550,306 )     (2,353,937 )     (11,064,668 )     (6,887,273 )     (31,703,852 )

Interest income

     307,490       243,149       822,545       636,600       1,892,092  

Interest expense

     —         —         —         —         (34,020 )
                                        

Net loss

   $ (3,242,816 )   $ (2,110,788 )   $ (10,242,123 )   $ (6,250,673 )   $ (29,845,780 )
                                        

Net loss per basic and diluted share of common stock

   $ (0.14 )   $ (0.11 )   $ (0.47 )   $ (0.34 )  
                                  

Weighted average number of basic and diluted common shares outstanding

     22,512,364       19,707,129       21,639,903       18,468,414    
                                  

See accompanying notes to condensed consolidated financial statements.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENT OF

STOCKHOLDERS’ EQUITY

(unaudited)

 

               Additional     Deficit
accumulated
during the
   

Total

stock-

 
     Common stock    paid-in     development     holders’  
     Shares    Amount    capital     stage     equity  

Balance at January 1, 2007

   19,707,129    $ 1,971    $ 33,738,242       (19,603,657 )   $ 14,136,556  

Common stock issued in 2007, at par, pursuant to net-share (cashless) exercises of common stock warrants

   68,136      6      (6 )     —         —    

Sale and issuance of common stock with detachable warrants in March 2007 at approximately $4.33 per share, net of issuance costs

   2,648,306      265      11,476,412       —         11,476,677  

Fair value of warrants issued in May 2006 in consideration of finder’s fee at approximately $1.75 per share for which vesting was conditioned on an event that occurred in January 2007

   —        —        433,750       —         433,750  

Common stock issued in April 2007, at approximately $5.63 per share, for license fee

   26,643      3      149,997       —         150,000  

Common stock issued in June 2007, at $4.20 per share, pursuant to exercise of common stock warrants, net of fees

   60,000      6      246,994       —         247,000  

Employee stock options exercised

   17,868      1      15,704       —         15,705  

Stock-based compensation

           604,859         604,859  

Net loss

             (10,242,123 )     (10,242,123 )
                                    

Balance at September 30, 2007

   22,528,082    $ 2,252    $ 46,665,952     $ (29,845,780 )   $ 16,822,424  
                                    

See accompanying notes to condensed consolidated financial statements.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

     For the nine months ended September 30,     Period from
April 3, 2002
(inception) to
 
     2007     2006     September 30, 2007  

Operating activities:

      

Net loss

   $ (10,242,123 )   $ (6,250,673 )   $ (29,845,780 )

Adjustments to reconcile net loss to net cash used in operating activities:

      

Non-cash stock-based compensation

     604,859       201,089       989,690  

Non-cash stock-based variable accounting compensation

     —         4,192       62,786  

Depreciation and amortization

     24,257       25,786       96,544  

Stock issued for license agreement

     150,000       274,621       425,023  

Non-cash interest expense

     —         —         34,020  

Fair value of warrants for finder’s agreement

     433,750       —         433,750  

Changes in operating assets and liabilities:

      

Prepaid expenses and other current assets

     (37,139 )     (132,329 )     (253,959 )

Accounts payable, accrued contract research and manufacturing expenses and other accrued expenses

     2,513,962       481,126       4,138,000  

Accrued compensation and related expenses

     18,693       59,261       428,648  
                        

Net cash used in operating activities

     (6,533,741 )     (5,336,927 )     (23,491,278 )
                        

Investing activities:

      

Acquisitions of property and equipment

     (21,525 )     (35,127 )     (136,751 )

Security deposits

     —         —         (13,461 )
                        

Net cash used in investing activities

     (21,525 )     (35,127 )     (150,212 )
                        

Financing activities:

      

Proceeds from borrowings from affiliate

     —         —         1,745,000  

Proceeds from sales of equity securities, net of issuance costs

     11,476,677       19,855,652       43,104,526  

Proceeds from exercise of employee stock options

     15,705       5,080       21,784  

Proceeds from exercise of common stock warrants

     247,000       —         247,000  

Recapitalization of the Company

     —         —         (400,000 )

Receipt of cash for stock subscription receivable

     —         —         4,625  
                        

Net cash provided by financing activities

     11,739,382       19,860,732       44,722,935  
                        

Net increase in cash and cash equivalents

     5,184,116       14,488,678       21,081,445  

Cash and cash equivalents, beginning of period

     15,897,329       3,173,434       —    
                        

Cash and cash equivalents, end of period

   $ 21,081,445     $ 17,662,112     $ 21,081,445  
                        

See accompanying notes to condensed consolidated financial statements.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

Supplemental disclosure of non-cash investing and financing activities:

During 2002, the Company issued 5,428,217 shares of its $0.0001 par value common stock for a subscription receivable of $4,625.

During 2004, the Company converted a loan with an affiliate for aggregate principal of $1,745,000 and accrued interest of $34,020 into shares of the Company’s $0.0001 par value common stock, issuing 677,919 shares, at approximately $2.62 per share in lieu of repayment of this obligation.

In December 2004, in conjunction with and as compensation for activities related to the December 2004 sale of equity securities, the Company issued warrants to purchase 483,701 shares of its $0.0001 par value common stock, with a purchase price of approximately $2.88 per share and an aggregate fair value of $14,400. In September 2007, February 2007 and March 2006, 8,667 shares, 4,928 shares and 15,461 shares, respectively, of the $0.0001 par value common stock of the Company were issued to holders upon exercise of warrants issued in December 2004 per the net share settlement provisions contained in the terms of the warrants.

In conjunction with the merger and recapitalization of the Company dated February 11, 2005, the Company issued 11,911,357 shares of its $0.0001 par value common stock in exchange for all of the issued and outstanding shares of Chelsea Therapeutics, Inc. In addition, in conjunction with and as compensation for facilitating the merger, the Company issued warrants for the purchase of 105,516 shares of its $0.0001 par value common stock at an exercise price of $2.62 per share and an aggregate fair value of $26,700. In July 2007, 33,203 shares of the $0.0001 par value common stock of the Company were issued to the holder upon exercise of warrants issued in February 2005 per the net share settlement provisions contained in the terms of the warrants.

In February 2006, in conjunction with and as compensation for activities related to the February 2006 sale of equity securities, the Company issued warrants to purchase 716,666 shares of its $0.0001 par value common stock, with a purchase price of $3.30 per share and an aggregate fair value of approximately $705,000.

In May 2006, in conjunction with and as compensation for activities related to a licensing agreement and under a Finder’s Agreement, the Company issued warrants to purchase 250,000 shares of its $0.0001 par value common stock, with an exercise price of $4.31 per share. The exercise of these warrants was conditioned on an event that occurred in January 2007 and, accordingly, the Company recorded a charge based on the warrants’ fair value determined at January 2007 of $433,750 (see Note 6).

See accompanying notes to condensed consolidated financial statements.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2007

(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS

The Company

Chelsea Therapeutics International, Ltd. (the “Company”) is a specialty pharmaceutical company focused on the acquisition, development and commercialization of innovative pharmaceutical products. The Company’s currently licensed compounds target a variety of prevalent medical conditions; particularly rheumatoid arthritis, psoriasis, cancer, other immunological disorders, neurogenic orthostatic hypotension and other autonomic disorders. The Company’s operating subsidiary, Chelsea Therapeutics, Inc., was incorporated in the State of Delaware on April 3, 2002 as Aspen Therapeutics, Inc., with the name changed in July 2004. In February 2005, Chelsea Therapeutics, Inc. merged with a wholly-owned subsidiary of our predecessor company, Ivory Capital Corporation, a Colorado public company with no operations. The Company reincorporated into the State of Delaware in July 2005, changing its name to Chelsea Therapeutics International, Ltd.

Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of the Company and its operating subsidiary, which shall collectively be referred to as the “Company”. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results for the interim periods have been included. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results for the year ending December 31, 2007 or future periods. The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K filed on March 12, 2007 and available on the website of the United States Securities and Exchange Commission (www.sec.gov). The accompanying condensed consolidated balance sheet as of December 31, 2006 has been derived from the audited balance sheet as of that date included in the Form 10-K.

Since inception, the Company has focused primarily on organizing and staffing, negotiating in-licensing agreements with its partners, acquiring, developing and securing its proprietary technology, participating in regulatory discussions with the FDA, the EMEA and other regulatory agencies and undertaking pre-clinical trials and clinical trials of its product candidates. The Company is a development stage company and has generated no revenue since inception.

The Company has sustained operating losses since its inception and expects such losses to continue over the next several years. Management plans to continue financing the operations with a combination of equity issuances and debt arrangements. Should adequate funds not be available when needed, the Company may be required to delay, reduce the scope of, or eliminate one or more of its research or development programs, or cease operations.

Basis of Consolidation

All significant intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments. Management

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2007

(Unaudited)

 

bases estimates on its historical experience and on various other factors that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results might differ from these estimates under different assumptions or conditions.

 

NOTE 2 STOCK-BASED COMPENSATION

The Company has a stock incentive plan (the “Plan”) under which incentive stock options for 4,145,000 shares of the Company’s $0.0001 par value common stock may be granted. Grants under the Plan may be made to employees (including officers), directors, consultants, advisors or other independent contractors who provide services to the Company or its subsidiary.

During the three months ended September 30, 2007, the Company granted stock options to an employee for the purchase of 25,000 shares of its $0.0001 par value common stock with an exercise price of $6.88 per share, a grant date fair value of $4.10 per share and an exercise price greater than the market value at September 30, 2007 resulting in no intrinsic value as of September 30, 2007. During the three months ended September 30, 2006, the Company granted stock options to an employee for the purchase of 20,000 shares of its $0.0001 par value common stock. This grant had an exercise price of $3.10 per share, a grant date fair value of $1.27 per share and an intrinsic value of approximately $72,000 as of September 30, 2007.

During the nine months ended September 30, 2007 and 2006, the Company granted stock options to employees and non-employee directors for the purchase of 655,500 and 638,085 shares of its $0.0001 par value common stock, respectively. The grants made during the nine months ended September 30, 2007 had a weighted average exercise price of approximately $5.70 per share, a weighted average grant date fair value of approximately $3.38 per share and aggregate intrinsic value as of September 30, 2007 of approximately $0.6 million. The grants made during the nine months ended September 30, 2006 had a weighted average exercise price of $3.58 per share, a weighted average grant date fair value of approximately $1.46 per share and aggregate intrinsic value as of September 30, 2007 of approximately $2.0 million.

Each option granted to employees and non-employee directors during the three and nine months ended September 30, 2007 and 2006 vests as to 25% of the shares on the first, second, third and fourth anniversary of the vesting commencement date. Following the vesting periods, options are exercisable until the earlier of 90 days after the employee’s termination with the Company or the ten-year anniversary of the initial grant, subject to adjustment under certain conditions.

The Company utilizes the Black-Scholes-Merton valuation model for estimating the fair value of the stock options granted. The table below summarizes the assumptions utilized in estimating the fair value of the stock options granted for the three and nine months ended September 30, 2007 and 2006:

 

     For the three months ended September 30,    For the nine months ended September 30,
     2007    2006    2007    2006

Risk-free interest rate

   4.95%    4.73%    4.76% to 4.95%    4.31% to 5.12%

Expected life of options

   5 years    5 years    5 years    5 years

Expected dividend yield

   0%    0%    0%    0%

Expected volatility

   66.01%    37.66%    66.01%    37.66%

Estimated forfeitures

   0%    0%    0%    0%

The Company recorded compensation expense for the three and nine months ended September 30, 2007 of $219,154 and $604,859, respectively and compensation expense for the three and nine months ended September 30, 2006 of $79,035 and $201,089, respectively, in conjunction with option grants made to employees and non-employee directors. As of

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2007

(Unaudited)

 

September 30, 2007, the Company had total unrecognized compensation expense related to options granted to employees and non-employee directors of approximately $2.6 million, which will be recognized over a remaining average period of 2.9 years.

In November 2005, the Company granted a stock option to a third-party contractor to purchase 5,000 shares of its $0.0001 par value common stock at an exercise price of $3.10 per share. The option vested 25% at each calendar quarter end date from the date of issuance. For the three and nine months ended September 30, 2006, based on the fair value of these options, the Company recorded compensation expense of $118 and $4,192, respectively.

As of September 30, 2007, there were 2,270,172 options outstanding under the Plan with a weighted average remaining contractual life of 8.2 years, a weighted average exercise price of approximately $3.60 per share and an intrinsic value of approximately $7.0 million. Also, options for 741,088 shares had vested and were exercisable at September 30, 2007 with a weighted average remaining contractual life of 7.43 years, a weighted average exercise price of approximately $2.20 per share and an intrinsic value of approximately $3.3 million. During the three months ended September 30, 2007, options for 5,868 shares were exercised with an exercise price of approximately $2.62 per share and an aggregate intrinsic value as of the date of exercise of approximately $16,000. During the nine months ended September 30, 2007, options for 17,868 shares were exercised with a weighted average exercise price of approximately $0.88 per share and an aggregate intrinsic value as of the dates of exercise of approximately $79,000. During the three and nine months ended September 30, 2006, options for 78,683 shares were exercised with a weighted average exercise price of approximately $0.06 per share and an aggregate intrinsic value as of the dates of exercise of approximately $0.3 million.

 

NOTE 3 LOSS PER SHARE

Basic net loss per common share is calculated by dividing net loss by the weighted-average number of common shares outstanding for the period, without consideration for potentially dilutive securities. For the periods presented, basic and diluted net loss per common share are identical. Potentially dilutive securities from stock options and stock warrants would be antidilutive as the Company incurred a net loss. The number of shares of common stock potentially issuable at September 30, 2007 and 2006 upon exercise or conversion that were not included in the computation of net loss per share totaled 6,563,508 and 5,286,782 shares, respectively.

 

NOTE 4 PRIVATE PLACEMENT OF COMMON STOCK

On March 22, 2007, the Company raised gross proceeds of approximately $12.5 million through the sale of 2,648,306 shares of its $0.0001 par value common stock plus warrants for the purchase of 794,492 shares of its $0.0001 par value common stock (the “2007 Placement”). The aggregate fair value of these warrants was approximately $1,281,000. The warrants permit the holders to purchase the underlying common shares at $5.66 each and are exercisable in whole at any time, or in part from time to time, for cash, for five years from the date of issuance. The warrants are redeemable at par value at the Company’s option in the event that the Company’s volume weighted-average closing bid price of its common stock is greater than $12.00 per share for any twenty (20) consecutive trading days provided that the Company gives sixty (60) business days’ written notice to the holders and simultaneously calls all warrants on the same terms. Under the terms of the 2007 Placement, the Company agreed to and filed a registration statement with the SEC within 30 days of the closing for the shares of common stock sold and the shares of common stock underlying the warrants and such registration became effective on August 7, 2007.

In connection with this offering, the Company paid commissions and other offering-related expenses of approximately $1.0 million in cash.

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2007

(Unaudited)

 

NOTE 5 EXERCISE OF COMMON STOCK WARRANTS

During the three months ended September 30, 2007, various warrant holders exercised rights to purchase 107,165 shares of the $0.0001 par value common stock of the Company, with an average exercise price of approximately $2.91 per share, pursuant to cashless exercises whereby the Company, in net share settlements, issued 63,208 shares of its $0.0001 par value common stock to the warrant holders based on the excess of the market price over the exercise price on the respective dates of exercise. During the nine months ended September 30, 2007, warrant holders exercised rights to purchase 116,596 shares of the $0.0001 par value common stock of the Company, with an average exercise price of approximately $2.90 per share, pursuant to cashless exercises whereby the Company, in net share settlements, issued an aggregate of 68,136 shares of its $0.0001 par value common stock to the warrant holders based on the excess of the market price over the exercise price on the respective dates of exercise.

On June 6, 2007, a warrant holder exercised the right to purchase 60,000 shares of the $0.0001 par value common stock of the Company on a cash basis at an exercise price of $4.20 per share. The Company recorded net cash proceeds of $247,000 in conjunction with this transaction.

 

NOTE 6 LICENSING AGREEMENTS

In March 2004, the Company entered into a license agreement with Dr. M. Gopal Nair, Ph.D., of the University of South Alabama College of Medicine, for the rights to use, produce, distribute and market products derived from an invention by Dr. Nair, claimed in US Patent # 5,912,251, entitled “metabolically inert anti-inflammatory and antitumor antifolates”, designated by Chelsea as CH-1504 and related compounds. The license provides the Company exclusive, worldwide (excluding India) rights for CH-1504. The Company made an upfront payment in May 2004 of $150,000 and milestone payments as required by the agreement of $100,000 each in March 2006 and 2005. In April 2007, the Company issued 26,643 shares of its $0.0001 par value common stock, subject to trading restrictions, at a value of approximately $5.63 per share, in settlement of the $150,000 annual milestone payment liability recorded at March 31, 2007. The Company is required to make additional payments upon the achievement of specific development and regulatory approval milestones. The Company is also obligated to pay royalties under the agreement until the later of the expiration of the applicable patent or the applicable last date of market exclusivity after the first commercial sale, on a country-by-country basis. Future potential milestone and anniversary payments total approximately $1,750,000 and there are no minimum royalties required under the agreement.

In May 2006, the Company entered into an agreement with Dainippon Sumitomo Pharma Co., Ltd. (“DSP”) for a worldwide, exclusive, sub-licensable license and rights to certain intellectual property and proprietary information (the “DSP Agreement”) relating to L-threo-3,4-dihydroxyphenylserine (“L-DOPS” or “droxidopa”) including, but not limited to all information, formulations, materials, data, drawings, sketches, designs, testing and test results, records and Regulatory Documentation. As consideration for these rights, the Company paid DSP $100,000 and issued 63,131 shares of its $0.0001 par value common stock, with a value of approximately $4.35 per share, or $274,621. As additional consideration, the Company agreed to pay DSP and or its designees (1) royalties on the sales should any compound be approved for commercial sale; and (2) milestone payments, payable upon achievement of milestones as defined in the DSP Agreement. During the nine months ended September 30, 2007, the Company made a milestone payment under the agreement of $250,000 and has remaining future milestone payments, subject to the Company’s right to terminate the license agreement, totaling $3.75 million. The Company and DSP have also initiated, and the Company has agreed to fund, activities focused on modifying the manufacturing capabilities of DSP in order to expand capacity and comply with regulations and requirements of the United States Food and Drug Administration. Such activities are currently ongoing and shall continue over a two-year period. Based on work performed by DSP as of September 30, 2007, the Company had recorded $1.6 million in liabilities.

In conjunction with and as consideration for activities related to the execution of the DSP Agreement, the Company entered into a Finder’s Agreement with Paramount BioCapital, Inc. (“Paramount”). In May 2006, pursuant to the Finder’s Agreement, the Company issued warrants for the purchase of 250,000 shares of its $0.0001 par value common stock at an exercise price of $4.31 per share. The exercise of these warrants is conditioned on an event that occurred in January 2007 and, accordingly, the Company recorded a charge for the fair value of the warrants at January 2007 of $433,750. The

 

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CHELSEA THERAPEUTICS INTERNATIONAL, LTD. AND SUBSIDIARY

(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2007

(Unaudited)

 

Company utilized the Black-Scholes-Merton valuation model for estimating the fair value of the warrants at the date the condition lapsed, based on a risk-free interest rate of 4.79%, an expected life of three (3) years, an expected dividend yield of 0%, an expected volatility of 66.01% and no estimated forfeitures. As additional consideration, the Company agreed to (1) make future milestone payments, upon achievement of milestones as defined in the Finder’s Agreement, to Paramount; (2) pay royalties on sales should any licensed compound become available for commercial sale; and (3) compensate a stated third-party consultant for services rendered in the evaluation of the transaction with DSP. During the nine months ended September 30, 2007, the Company made a milestone payment to Paramount under the Finder’s Agreement of $35,000 and has remaining future milestone payments under the Finder’s Agreement of $150,000.

 

NOTE 7 DEVELOPMENT AND COMMERCIALIZATION AGREEMENT

Effective May 2006, the Company entered into a development and commercialization agreement (the “Development Agreement”) with Active Biotech AB to co-develop and commercialize the I-3D portfolio of orally active, Dihydroorotate dehydrogenase (DHODH) inhibiting compounds for the treatment of autoimmune diseases and transplant rejection. Under the terms of the license and co-development agreement, an initial payment of $1.0 million was made to AB during the quarter ended June 30, 2006 with such funds to be utilized to cover the initial costs of research and development efforts jointly approved by both parties. During the three and nine months ended September 30, 2007, the Company expensed approximately $60,000 and $0.5 million, respectively, pursuant to its agreement with Active Biotech. The Company had also recorded a net accrued liability of approximately $81,000 million at September 30, 2007. In addition to sharing development costs, both the Company and Active Biotech will pay the other partner royalty payments on sales in their respective markets. Active Biotech will also receive certain defined milestone payments related to clinical development and receipt of revenue from commercialization of the compounds. Unless terminated by either party with six months written notice, the agreement shall remain in effect until the earlier of (1) the expiration of the last to expire patent rights indicated under the Development Agreement or (2) fifteen (15) years from the date of the first commercial sale of the product. As of September 30, 2007, remaining future milestone payments, subject to the Company’s right to terminate the Development Agreement, totaled $15.5 million.

 

NOTE 8 SUBSEQUENT EVENTS

On October 1, 2007, the Company granted options for the purchase of 10,000 shares of its $0.0001 par value common stock to an employee. The grant has an exercise price of $6.75 per share, a grant date fair value of $3.97 per share and was granted at an exercise price equal to the closing market value of the Company’s stock on the date of grant.

On November 8, 2007, the Company raised gross proceeds of approximately $48.9 million through the sale of 7,388,172 shares of its $0.0001 par value common stock. These shares were offered pursuant to the Company’s shelf registration statement as filed with the Securities and Exchange Commission under which the Company may offer shares of its common stock and preferred stock, various series of debt securities and/or warrants to purchase any of such securities, either individually or in units, in one or more offerings, up to a total dollar amount of $60,000,000. Such registration statement became effective as of October 11, 2007. In connection with this offering, the Company paid commissions and recorded or accrued other offering-related expenses of approximately $3.2 million.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The statements contained in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding the expectations, beliefs, intentions or strategies regarding the future. We intend that all forward-looking statements be subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In particular, this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements that reflect our current views with respect to future events and financial performance. We use words such as we “expect,” “anticipate,” “believe,” and “intend” and similar expressions to identify forward-looking statements. A number of important factors could, individually or in the aggregate, cause actual results to differ materially from those expressed or implied in any forward-looking statement.

Overview

Since inception we have focused primarily on organizing and staffing our company, negotiating in-licensing agreements with our partners, acquiring, developing and securing our proprietary technology, participating in regulatory discussions with the FDA, the EMEA and other regulatory agencies and undertaking pre-clinical trials and clinical trials of our product candidates. We are a development stage company and have generated no revenue since inception. We do not anticipate generating any revenue until and unless we successfully obtain approval from the FDA or equivalent foreign regulatory bodies to begin selling our pharmaceutical candidates. However, developing pharmaceutical products is a lengthy and expensive process. Even if we do not encounter unforeseen safety issues or timing or other delays during the course of developing our currently licensed product candidates, we would not anticipate receiving regulatory approval to market such products until at least 2009. Development expenses have and are being funded with proceeds from private equity financings completed in December 2004, February 2006 and March 2007. In addition, we completed an equity financing in November 2007 subsequent to the end of the quarter. To the extent we are successful in acquiring additional product candidates for our development pipeline and as we move our products into more extensive clinical trials, our need to finance research and development costs will continue to increase. Accordingly, our success depends not only on the safety and efficacy of our product candidates, but also on our ability to finance the development of the products.

Critical Accounting Policies

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are more fully described in Note 1 to the financial statements. The following accounting policies are critical in fully understanding and evaluating our reported financial results.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements as well as the reported revenue and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments. Management bases estimates on historical experience and on various other factors that it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results might differ from these estimates under different assumptions or conditions.

Research and Development Expense. Research and development expenditures are expensed as incurred. We often contract with third parties to facilitate, coordinate and perform agreed upon research and development activities. To ensure that research and development costs are expensed as incurred, we measure expense based on work performed for the underlying contract, typically utilizing a percentage-of-completion approach, and record prepaid assets or accrue expenses on a monthly basis for such activities based on the measurement of liability from expense recognition and the receipt of invoices.

These contracts typically call for the payment of fees for services at the initiation of the contract and/or upon the achievement of certain milestones. In the event that we prepay fees for future milestones, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted research

 

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and development services are performed. Most fees are incurred throughout the contract period and are expensed based on their percentage of completion at a particular date.

These contracts generally include pass through fees. Pass through fees include, but are not limited to, regulatory expenses, investigator fees, travel costs, and other miscellaneous costs including shipping and printing fees. Because these fees are incurred at various times during the contract term and they are used throughout the contract term, we record a monthly expense allocation to recognize the fees during the contract period. Fees incurred to set up the clinical trial are expensed during the setup period.

Costs related to the acquisition of technology rights and patents for which development work is still in process are expensed as incurred and considered a component of research and development costs.

Accounting for Stock-Based Compensation. We account for our employee stock options and warrants using the fair value method as prescribed in Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), Share-based Payment. SFAS 123R defines a fair value based method of accounting for employee stock options or similar equity instruments. In determining the fair value of the equity instrument, we considered, among other factors, (i) the risk-free interest rate, (ii) the expected life of the options granted, (iii) the anticipated dividend yield, (iv) the estimated future volatility of the underlying shares and (v) anticipated future forfeitures. To determine the risk-free interest rate, we utilized the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected term of our awards. We estimated the expected life of the options granted based on anticipated exercises in future periods assuming the success of our business model as currently forecasted. The expected dividends reflect our current and expected future policy for dividends on our common stock. To determine the expected stock price volatility for our stock options, we examined historical volatilities for industry peers closely related to the current status of our business, but with sufficient trading history to be able to determine volatility. Utilizing a weighted average calculation to account for the limited price history of our stock, we utilized the historical volatility of our stock price in combination with the historical volatility of the industry peers selected to determine an appropriate volatility factor. We will continue to analyze the expected stock price volatility and expected term assumption at each grant date as more historical data for our common stock becomes available. Given the limited service period for our current employees and the senior nature of the roles for those employees, we currently estimate that we will experience no forfeitures for those options currently outstanding. Our results include non-cash compensation expense as a result of the issuance of stock option grants utilizing this method. We expect to record additional non-cash compensation expense in the future, which might be significant. Due to the limited amount of historical data available to us, particularly with respect to stock-price volatility, employee exercise patterns and forfeitures, actual results could differ from our assumptions.

Results of Operations

Three Months Ended September 30, 2007 and 2006

The table below sets forth, for the periods indicated, certain items in our consolidated statements of income and other pertinent financial and operating data (in thousands).

 

     For the three months ended            
     September 30,
2007
   September 30,
2006
   $
Increase
   %
Change
 

Research and development expense

   $ 2,652    $ 1,745    $ 907    52 %

Sales and marketing expense

     236      150      86    57 %

General and administrative expense

     662      458      204    45 %

Interest income

     307      243      64    26 %

Research and development expenses for each period consisted primarily of expenses incurred for compensation and related expenses and amounts paid to outside contract manufacturing and contract research organizations relating to our product candidates. Although, as a percentage of operating expenses, research and development costs increased only slightly to 75% from 74% for the three months ended September 30, 2007 and 2006, actual research and development spending increased by approximately $0.9 million. During the three months ended September 30, 2007, we recorded expenses related to our manufacturing, Phase I and Phase II activities for CH-1504 as well as costs for our manufacturing and pre-clinical

 

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activities for additional antifolates and a portfolio of therapeutics in partnership with Active Biotech. We also recorded expenses for manufacturing, non-clinical and Phase III activities related to droxidopa during the three months ended September 30, 2007. During the period, such expenses totaled approximately $2.0 million, an increase of approximately $0.7 million when compared to expenses of a similar nature for the three months ended September 30, 2006. There were also increases in compensation and related expenses and relocation costs during the three months ended September 30, 2007 when compared to the three months ended September 30, 2006 that contributed to the increase in research and development costs.

Sales and marketing expenses. We had no formalized selling activities during the three month periods ended September 30, 2007 and 2006. Sales and marketing expenses are primarily the costs of business development activity and, during the three months ended September 30, 2007, expenses incurred in the initiation and development of marketing and branding programs for droxidopa. Such costs include compensation and related costs, promotional activities, contractor expenses and certain legal expenses. The increase in sales and marketing expenses for the three months ended September 30, 2007 compared to September 30, 2006 is primarily related to an increase in compensation, and related costs, reflecting the addition of a marketing executive during 2007. Also contributing to the increase are increases in promotional expenditures related to droxidopa and legal expenditures, principally for intellectual property and patent activities, incurred during the three months ended September 30, 2007.

General and administrative expenses. General and administrative expenses focus on support of administrative activities and consisted primarily of compensation and related expenses, consulting and professional fees, travel costs, insurance and facility expenses. Contributing to the increase in general and administrative expenses for the three months ended September 30, 2007 compared to September 30, 2006 were increases in compensation and related expenses, office expenses, professional fees, stock exchange fees and governmental fees and taxes, offset by a decrease in depreciation expense.

Interest income. During the three months ended September 30, 2007, our cash available for investment had increased reflecting the gross proceeds of approximately $12.5 million received from our March 2007 financing. In addition, cash available for investment includes the remaining proceeds from our February 2006 financing after funding operations during 2006. Accordingly, interest earned on short-term, cash equivalent, liquid investments from cash on deposit increased for the three months ended September 30, 2007.

Nine Months Ended September 30, 2007 and 2006

The table below sets forth, for the periods indicated, certain items in our consolidated statements of income and other pertinent financial and operating data (in thousands).

 

     For the nine months ended            
     September 30,
2007
   September 30,
2006
   $
Increase
   %
Change
 

Research and development expense

   $ 7,975    $ 4,875    $ 3,100    64 %

Sales and marketing expense

     1,055      461      594    129 %

General and administrative expense

     2,034      1,552      482    31 %

Interest income

     823      637      186    29 %

Research and development expenses for each period consisted primarily of expenses incurred for compensation and related expenses, licensing fees and amounts paid to outside contract manufacturing and contract research organizations relating to our product candidates. As a percentage of operating expenses, research and development costs increased slightly to 72% from 71% for the nine months ended September 30, 2007 and 2006, respectively. During the nine months ended September 30, 2007, we continued our manufacturing, non-clinical, Phase I and Phase II activities for CH-1504 as well as our manufacturing and pre-clinical activities for additional antifolates and a portfolio of therapeutics in partnership with Active Biotech. We also incurred costs related to our manufacturing, non-clinical and Phase III activities for droxidopa. Additionally, we incurred licensing costs for CH-1504, licensing costs for droxidopa and an expense of approximately $0.4 million related to warrants for 250,000 shares of our common stock, dated May 2006, the vesting of which was conditioned on an event that occurred in January 2007. During the nine months ended September 30, 2007, such expenses were approximately $6.2 million, an increase of approximately $2.6 million when compared to similar expenses for the nine months ended September 30, 2006. Also contributing to the increase in research and development costs were increases in compensation and related expenses and clinical trials insurance expenses.

 

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Sales and marketing expenses. We had no formalized selling activities during the nine month periods ended September 30, 2007 and 2006. Sales and marketing expenses are primarily the costs of business development activity and, during the nine months ended September 30, 2007, expenses incurred in the initiation and development of marketing and branding programs for droxidopa. Such costs include compensation and related costs, promotional activities, contractor expenses and certain legal expenses. The significant increase in sales and marketing expenses for the nine months ended September 30, 2007 compared to September 30, 2006 is primarily related to approximately $0.4 million of costs for branding activities, investor symposium costs and non-advertising publication activities for droxidopa. Also contributing to the increase are increases in compensation and related expenses, offset by a decrease in legal expenditures.

General and administrative expenses. General and administrative expenses focus on support of administrative activities and consisted primarily of compensation and related expenses, consulting and professional fees, travel costs, insurance and facility expenses. Contributing to the increase in general and administrative expenses for the nine months ended September 30, 2007 compared to September 30, 2006 were increases in compensation and related expenses, computer and office expenses, professional fees and governmental fees and taxes, offset by decreases in legal fees, recruiting costs and stock exchange fees.

Interest income. During the nine months ended September 30, 2007, our cash available for investment had increased reflecting the gross proceeds of approximately $12.5 million received from our March 2007 financing. In addition, cash available for investment includes the remaining proceeds from our February 2006 financing after funding operations during 2006. Accordingly, interest earned on short-term, cash equivalent, liquid investments from cash on deposit increased for the nine months ended September 30, 2007.

Liquidity and Capital Resources

From inception to September 30, 2007, we have incurred an aggregate net loss of approximately $29.8 million, as a result of expenses similar in nature to those described above.

We have financed our operations since inception primarily through equity and debt financing. As of September 30, 2007, we had working capital of approximately $16.8 million and cash and cash equivalents of approximately $21.1 million. The cash on hand at September 30, 2007 results from the net proceeds of financing activities in March 2007, February 2006 and December 2004, offset by cash utilized for operating activities. Subsequent to September 30, 2007, we received approximately $45.7 million as proceeds from an additional sale of our common stock, net of the expenses of the transaction.

We have incurred negative cash flows from operations since inception. We have spent, and expect to continue to spend, substantial amounts in connection with implementing our business strategy, including our planned product development efforts, our clinical trials and our continuing efforts to secure in-licensing opportunities. We believe that our cash on hand at September 30, 2007, combined with the net proceeds of $45.7 million from our stock offering subsequent to quarter-end, should provide sufficient capital resources to meet our operating needs into early 2009. Beyond that, continued operations will depend on whether we are able to generate additional funds through various potential sources, such as equity and debt financing or strategic relationships. Such additional funds might not become available on acceptable terms, or at all, and there can be no assurance that any additional funds that we do obtain will be sufficient to meet our needs in the long term. From inception through September 30, 2007 we had losses of $29.8 million, and we anticipate losses in the range of $35 million to $58 million during the 12 to 18 months commencing October 2007.

Actual losses will depend on a number of considerations, including:

 

   

the pace and success of pre-clinical development and clinical trials for our droxidopa, CH-1504 and other product candidates;

 

   

the rates charged by contract research organizations and clinical investigators;

 

   

obtaining European Orphan Drug approval for droxidopa from the EMEA;

 

   

discussions with regulatory agencies concerning the design of our clinical trials;

 

   

possible out-licensing of certain of our product candidates;

 

   

in-licensing and development of additional product candidates;

 

   

the number and scope of our research programs;

 

   

the costs involved in prosecuting and enforcing patent claims and other intellectual property rights;

 

   

implementing additional internal systems and infrastructure; and

 

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hiring additional personnel.

We have based our estimate on assumptions that might prove to be incorrect. Potential sources of future financing include strategic relationships, public or private sales of equity or debt and other sources. Additional financing might be needed for future activities and we might again seek to access the public or private equity markets when and if conditions are again favorable to meet additional long term capital requirements. Should we raise additional funds by selling shares of common stock or other securities convertible into common stock, the ownership interest of our existing stockholders will be diluted. If we are not able to obtain financing when needed, we might be unable to carry out our long term business plan. As a result, we might have to significantly delay certain activities or limit our operations and our business, financial condition and results of operations would be materially harmed.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Due to the nature of our short-term investments and our lack of material debt, we have concluded that we face no material market risk exposure. Therefore, no quantitative tabular disclosures are required.

 

Item 4. Controls and Procedures

(a) Disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) are designed only to provide reasonable assurance that they will meet their objectives. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

(b) No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We will be subject to the internal control requirements of Section 404 of the Sarbanes-Oxley Act of 2002 beginning with our Annual Report on Form 10-K for fiscal year 2007.

 

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PART II – OTHER INFORMATION

 

Item 6. Exhibits

 

Exhibit
Number
 

Description of Document

  

Registrant’s

Form

   Dated    Exhibit
Number
   Filed
Herewith
31.1   Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.             X
31.2   Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.             X
32.1   Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.             X
32.2   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.             X

 

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    Chelsea Therapeutics International, Ltd.
Date: November 13, 2007   By:  

/s/ J. Nick Riehle

    J. Nick Riehle
    Vice President, Administration and Chief Financial Officer

 

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