SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-K

 

 

Commission file number 0-29993

 

IntraBiotics Pharmaceuticals, Inc.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(925) 906-5331

 

Securities registered under Section 12(b) of the Exchange Act:

None.

 

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, par value $.001 per share

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in PART III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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 o     Accelerated filer o     Non-accelerated filer þ

 

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

 

The aggregate market value of the common stock, held by non-affiliates of the registrant, based on the closing price on June 30, 2005 as reported by the NASDAQ National Market was approximately $21,587,692. The determination of affiliate status for the purposes of this calculation is not necessarily a conclusive determination for other purposes. The calculation excludes approximately 6,167,912 shares held by directors, officers and stockholders whose ownership exceeds five percent of the registrant’s outstanding common stock as of June 30, 2005. Exclusion of these shares should not be construed to indicate that such person controls, is controlled by or is under common control with the Registrant. The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of January 31, 2006 was 9,287,685 shares.

 

 

TABLE OF CONTENTS

 

 

This report contains forward-looking statements. These forward-looking statements are based on our current expectations, estimates, projections and assumptions about our business and industry. In some cases, these statements may be identified by terminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue”, or the negative of such terms and other comparable terminology. These statements involve known and unknown risks and uncertainties that may cause our industry’s results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed under the captions “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. Except as required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

 

Overview

 

From inception in 1994, through May 5, 2005, we (“IntraBiotics” and the “Company”) devoted substantially all of our efforts to research and development of anti-microbial drugs, and generated no product revenues. From the fourth quarter of 2002 until June 2004 we focused our attention on developing iseganan for the prevention of ventilator-associated pneumonia (“VAP”). In June 2004, the Company discontinued its clinical trial of iseganan for the prevention of VAP following a recommendation of the independent data monitoring committee. Subsequently, the Company terminated the iseganan development program, reduced employees, and evaluated (and continues to evaluate) strategic alternatives, including mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. The Company, in any case, will continue operations until the conclusion of the securities litigation class action lawsuit described below in Part I, Item 1A, “Risk Factors” and in Part I, Item 3, “Legal Proceedings.”

 

On May 5, 2005, after considering a variety of strategic alternatives, none of which was determined by management and the Board of Directors to be in the best interests of the Company and its shareholders, the Board of Directors decided to suspend the Company’s active evaluation process and reduce operating expenses to a minimum appropriate level. In accordance with these plans, the Company terminated all of its remaining regular employees on June 15, 2005. The Company will continue to pursue strategic alternatives in the biotechnology industry with the support of consultants and the active participation of its board. In addition, the Company engaged Hickey & Hill, Inc. of Lafayette, California, a firm specializing in managing companies in transition, to assume the responsibilities of day-to-day administration of the Company, and appointed Denis Hickey of Hickey & Hill, Inc. as its Chief Executive Officer and Chief Financial Officer.

 

We plan to conduct our affairs in the most financially efficient manner practical for a public company.

 

On December 31, 2005, the Company had a total of $48.8 million in cash, cash equivalents, and short-term investments, and recorded liabilities of $0.4 million.

 

Clinical Supplies and Manufacturing

 

We have no manufacturing capabilities. We relied on third-party manufacturers to produce our products in clinical and commercial quantities to support our iseganan development programs.

 

Clinical Pipeline

 

Prior to the termination of our iseganan development program our clinical pipeline had included development of an iseganan oral solution for the prevention of ventilator-associated pneumonia and for the treatment of respiratory infections in cystic fibrosis patients. We currently have no clinical pipeline. Our research and development expenditures will depend upon the strategic alternative we elect to pursue.

 

Research and development expense for the three years ended December 31, 2005, 2004, and 2003 was $0.3 million, $11.5 million, and $7.7 million, respectively.

Marketing and Sales

 

Currently, we have no marketing and sales capability, and have no current plans to develop any. Our strategy for marketing and sales will depend upon the strategic alternative we elect to pursue.

 

Competition

 

The biotechnology and pharmaceutical industries are extremely competitive. Many companies have substantially greater financial and other resources than we do. In addition, they may have substantially more experience in effecting strategic combinations, in-licensing technology, developing drugs, obtaining regulatory approvals, and manufacturing and marketing products. We cannot give any assurances that we can effectively compete with these other pharmaceutical and biotechnology companies.

 

Intellectual Property

 

In April 1994, we entered into a license agreement (the “License Agreement”) with the Regents of the University of California, (the “Regents”) under which we obtained exclusive rights to develop and commercialize Protegrin-based products, such as iseganan. We terminated this License Agreement in December 2004 and re-assigned to the Regents its previously owned undivided ownership interest in certain joint patent rights. As owner of an interest in these patent rights, the Regents would be free to license such rights to any third party and would not be required to compensate us. A number of provisions in the License Agreement survive including confidentiality, restrictions on using either party’s names or trademarks, attorney’s fees in the event of a dispute, maintenance of books and records and certain indemnification obligations.

 

Government Regulation

 

Governmental authorities in the U.S. and other countries extensively regulate, among other things, the research, development, testing, manufacture, labeling, promotion, advertising, distribution, and marketing, of products produced by the biotechnology and pharmaceutical industry. In the United States the Food and Drug Administration (the “FDA”) regulates drugs under the Federal Food, Drug, and Cosmetic Act and its implementing regulations. Outside the U.S., the requirements governing conduct of clinical trials and marketing authorization vary widely from country to country, but involve a similar degree of oversight and rigor as in the U.S.

 

Employees

 

As of January, 31, 2006, we had no employees.

 

We face significant risks and the risks described below may not be the only risks we face. Additional risks that we do not know of, or that we currently believe are immaterial, may also adversely affect the Company. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition, or results of operations could be materially adversely affected.

 

The recent delisting of our common stock could have a substantial effect on the price and liquidity of our common stock.

 

On October 14, 2005, the Company’s common stock was delisted from The NASDAQ National Market. The delisting decision was made by the NASDAQ Listings Qualifications Panel, following an appeal by the Company of a prior determination by the staff of the NASDAQ Stock Market (the “Staff”) that the Company was a “public shell,” raising public interest concerns pursuant to Marketplace Rule 4300. The Company’s quotation for its common stock currently appears in the “Pink Sheets” under the trading symbol “IBPI”. The recent delisting could result in significantly decreased liquidity for the Company’s common stock, making it more difficult for investors to purchase or sell shares of common stock or to obtain accurate quotations as to the price of the common stock. This increased difficulty in trading our common stock could also have a substantial negative effect on the price of the common stock.

As previously disclosed, the Company issued warrants to purchase shares of its common stock in connection with its Series A convertible preferred stock offering on May 1, 2003 which provide that if the Company’s common stock is delisted from NASDAQ, the purchase price for the stock upon exercise of the warrants will be reduced by 50% without any concomitant increase in the number of shares of common stock for which the warrants are then exercisable. This provision was triggered by the Company’s October 2005 delisting. As of September 30, 2005, the Company had warrants to purchase 789,171 shares of its common stock outstanding with an exercise price of $2.066 per share. As a result of the October 14, 2005 delisting, the exercise price dropped from $2.066 to $1.033 per share, and the Company recorded a non-cash charge to “other expense” and an offsetting increase in paid-in-capital in December of 2005 of $789,000 to reflect the fair market value of these warrants.

 

We are currently a party to a securities litigation class action lawsuit, which, if determined adversely, could negatively affect or limit our strategic alternatives, our financial results or business.

 

We are currently a party to securities litigation that is described in detail below in Part I, Item 3 of this annual report on Form 10-K. The cost of defense and ultimate disposition of this securities litigation could be material. The Company and the individual defendants are insured under the Company’s directors’ and officers’ insurance policies, with $15 million in total coverage, and a $500,000 deductible, which has been met. However, the Company may incur expenses in the defense or disposition of this securities litigation beyond what is covered by insurance. In addition, the securities litigation has been, and may continue to be, time-consuming and costly.

 

Directors, principal stockholders and affiliated entities beneficially own or control at least 48% of our capital stock outstanding and may be able to exert control over our activities, and the results of our operations and financial condition may suffer.

 

As of December 31, 2005, our directors, principal stockholders and affiliated entities beneficially own or control securities representing, in the aggregate, at least 48% of our outstanding common stock. These stockholders, if they determine to vote in the same manner, may be able to control the outcome of any matter requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions or terms of any liquidation. In addition certain directors, principal stockholders and affiliated entities beneficially own or control Series A Preferred stock or warrants which are convertible into or exercisable for 2,367,517 additional shares of common stock.

 

The holders of our Series A preferred stock have rights that they could exercise against the best interests. of our common stockholders.

 

The holders of our Series A preferred stock have rights to designate two members of our Board. In addition, upon our liquidation or dissolution (including a merger or acquisition), the holders of our Series A preferred stock are entitled to receive a liquidation preference in an amount equal to the greater of (i) $10,000 per share of Series A preferred stock, or approximately $3.0 million based on the 300 shares of Series A preferred stock currently outstanding, plus any declared but unpaid dividends or (ii) the amount that would have been paid had each such share of Series A preferred stock been converted to common stock. The holders of Series A preferred stock also have a right of first refusal to purchase their pro rata portion of any equity securities we propose to offer to any person. Such right of first refusal is subject to certain customary exclusions, including shares issued pursuant to any options or other stock awards granted to employees, directors or consultants of IntraBiotics, equipment leasing arrangements, debt financings, strategic financings and public offerings that have been approved by the Board. The holders of Series A preferred stock may exercise these rights to the detriment of our common stockholders.

 

The holders of our Series A preferred stock also have the right at any time to request that we register for resale the shares of our common stock that they acquire upon conversion of their Series A preferred stock or upon exercise of their warrants to purchase our common stock, subject to certain limitations. A registration statement has been filed with the Securities and Exchange Commission and is currently effective for the resale of the shares of common stock issuable upon conversion of our Series A preferred stock and upon the exercise of those warrants. In addition, the holders of our Series A preferred stock may convert their Series A preferred stock into common stock and sell those shares of the common stock, acquired upon such conversion, in the public market in reliance upon Rule 144,

subject in some cases to volume and other limitations. Future sales in the public market of such common stock, or the perception that such sales might occur, could adversely affect the market price of our common stock.

 

Anti-takeover provisions in our charter documents and under Delaware law may make it more difficult to acquire us.

 

Provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions:

 

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit large stockholders from consummating a merger with, or acquisition of us. These provisions may prevent a merger or acquisition that would be attractive to stockholders and could limit the price that investors would be willing to pay in the future for our common stock.

 

Our stock price has been, and will be volatile, and the value of your investment may continue to decline.

 

During 2005, our closing stock prices ranged from a low of $3.34, to a high of $4.07, and in 2004 ranged from a low of $3.35 to a high of $19.25. Announcements regarding strategic alternatives, including a merger or sale of the Company, or the securities litigation described in Part I, Item 3, in addition to the other risk factors described in this section, may have a significant impact on the market price of our common stock.

 

We may continue to incur net losses.

 

Our accumulated deficit as of December 31, 2005 was $235.6 million, and we may continue to incur losses through the end of 2006. We reduced operating expenses to a minimum appropriate level while conducting our affairs in the most financially efficient manner practical for a public company and litigating the our securities litigation aggressively.

 

We may not be able to complete the strategic alternative we initially elected to pursue, resulting in increased expenses and a delay in finally completing a selected alternative.

 

We may select a strategic alternative that we may not be able to complete for various reasons, including a decision of our principal stockholders not to approve such alternative, our inability to obtain regulatory approval, actions of other companies or litigation involving the selected alternative or other matters. In addition, the pendency and or resolution of our securities litigation may adversely affect or limit our strategic alternatives, including adversely affecting our financial results or our ability to liquidate, or deterring other companies from entering into a merger or acquisition with us.

We face risks associated with clinical trial liability claims in the event that the prior use, or misuse, of our product candidates in clinical trials, that have since been terminated, results in personal injury or death.

 

From the fourth quarter of 2002 until June 2004, we conducted clinical trials focusing on developing iseganan for the prevention of ventilator-associated pneumonia (“VAP”). In June 2004, we discontinued our clinical trial of iseganan for the prevention of VAP following a recommendation of the independent data monitoring committee. We face a risk of clinical trial liability claims in the event that the prior use, or misuse, of our product candidates during such clinical trials results in personal injury or death. Our clinical liability insurance coverage may not be sufficient to cover claims that may be made against us. Any claims against us, regardless of their merit, could severely harm our financial condition and strain our management and other resources.

 

None.

 

We currently have no properties. Administration of the Company is performed by Hickey & Hill at its offices at 1009 Oak Hill Road in Lafayette, California.

 

Beginning on July 2, 2004, three purported class action shareholder complaints were filed in the United States District Court for the Northern of California against IntraBiotics and several of its officers. The actions were consolidated and a consolidated amended complaint has been filed, purportedly brought on behalf of purchasers of IntraBiotics common stock between September 5, 2003 and June 22, 2004. The amended complaint generally alleges that IntraBiotics and several of its officers and directors made false or misleading statements concerning the clinical trial of iseganan. The plaintiffs seek unspecified monetary damages. On February 28, 2005, the Company and the individual defendants filed a motion to dismiss the amended complaint. On January 23, 2006, the court issued its decision on the motion, granting the motion to dismiss the claim under the Securities Exchange Act of 1934, with leave to amend, and denying the motion to dismiss the claims under the Securities Act of 1933. The court has given the plaintiffs 30 days to file an amended complaint.

 

The Company believes the suit to be without merit and intends to defend itself vigorously. However, the Company believes it is likely that the litigation will continue through at least the end of 2006. Due to the uncertainties surrounding the final outcome of this matter, no amounts have been accrued at December 31, 2005. The Company and the individual defendants are insured under the Company’s directors’ and officers’ insurance policies, with $15 million in total coverage, and a $500,000 deductible, which has been met. However, the Company may incur expenses in the defense or disposition of the litigation beyond what is covered by insurance.

 

No matters were submitted to a vote of stockholders through the solicitation of proxies or otherwise during the three-month period ended December 31, 2005.

 

Market for Common Equity

 

Our common stock began trading on the NASDAQ National Market on March 28, 2000, under the symbol “IBPI.” On October 14, 2005 the Company’s stock was delisted from the NASDAQ National Market and currently sells on Pink Sheets. The table below sets forth the high and low bid prices for our common stock for the periods indicated:

 

 

As of January 31, 2006, there were 111 holders of record of common stock. We estimate that, included within the holders of record, there are approximately 1,800 beneficial owners of common stock. As of January 31, 2006, the closing price for our common stock was $3.65.

 

Dividend Policy

 

We have never paid dividends on our common stock. We currently intend to retain any future earnings to support the development of our business. The holders of our Series A preferred stock are entitled to receive cumulative dividends at the rate of 8% per annum of the original purchase price of $10,000 per share of Series A preferred stock, prior to and in preference to any declaration or payment of a dividend to the holders of common stock. The dividends are payable quarterly in shares of common stock. The number of shares payable is determined based on the average closing sale price of the common stock on the Pink Sheets, on which our common stock is traded, for each of the five trading days immediately preceding the applicable dividend payment date. Until accrued and unpaid dividends on the Series A preferred stock are paid and set apart, no dividends or other distributions in respect of any other shares of our capital stock shall be declared. We do not currently anticipate paying any cash dividends in the foreseeable future.

 

The following selected financial data should be read in conjunction with our financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Items 7 and 8 of this report. The financial data for periods prior to the financial statements presented in Item 8 of this Form 10-K are derived from audited financial statements not included in this Form 10-K.

 

 

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under “Risk Factors”. All forward-looking statements included in this document are based on information available to us on the date of this document and we assume no obligation to update any forward-looking statements contained in this Form 10-K.

 

Overview

 

From inception in 1994, through May 2005, we devoted substantially all of our efforts to research and development of anti-microbial drugs, and generated no product revenues. From the fourth quarter of 2002 until June 2004 we focused our attention on developing iseganan for the prevention of ventilator-associated pneumonia (“VAP”). In June 2004, the Company discontinued its clinical trial of iseganan for the prevention of VAP following a recommendation of the independent data monitoring committee. Subsequently, the Company terminated the iseganan development program, reduced employees, and evaluated (and continues to evaluate) strategic alternatives, including mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. The Company, in any case, will continue operations until the conclusion of the securities litigation class action lawsuit described above in Part I, Item 1A, “Risk Factors,” and below in Part I, Item 3, “Legal Proceedings”.

 

On May 5, 2005, after considering a variety of strategic alternatives, none of which was determined by management and the Board of Directors to be in the best interests of the Company and its shareholders, the Board of Directors decided to suspend the Company’s active evaluation process and reduce operating expenses to a minimum appropriate level. In accordance with these plans, the Company terminated all of its remaining regular employees on June 15, 2005. The Company will continue to pursue strategic alternatives in the biotechnology industry with the support of consultants and the active participation of its board. In addition, the Company engaged Hickey & Hill, Inc. of Lafayette, California, a firm specializing in managing companies in transition, to assume the responsibilities of day-to-day administration of the Company, and appointed Denis Hickey of Hickey & Hill, Inc. as its Chief Executive Officer and Chief Financial Officer.

 

The registrant plans to conduct its affairs in the most financially efficient manner practical for a public company. During the period that Hickey  & Hill, Inc. will handle the administration of the Company’s affairs, the Board of Directors and selected consultants will evaluate any strategic alternatives that come to the Company’s attention.

 

On December 31, 2005, the Company had a total of $48.8 million in cash, cash equivalents, and short-term investments, and recorded liabilities of $0.4 million. Based on current projections, the Company expects cash outflows of between $0.5 million and $1.0 million during 2006. This estimate does not include any costs that may be associated with completing a merger, acquisition, in-license opportunity, liquidation of the Company or the disposition of the securities litigation referred to in Part 1, Item 3 of this Form 10-K. There can be no assurance that such a range will be achieved, as actual expenditures and interest income may differ significantly from projected levels.

 

In February 2003, the Board of Directors approved a cancellation and re-grant of 308,835 unexercised stock options held by existing employees and directors of the Company in a one-for-one exchange and 12,500 options that were re-granted in connection with the cancellation of 54,166 unexercised stock options held by a director of the Company. The re-granted options have an exercise price equal to the closing price of the Company’s common stock on the NASDAQ National Market on February 5, 2003, or $2.76 per share. The options generally vest over a four-year period and will expire in February 2008 if not previously exercised. Variable accounting is being applied to the re-granted options throughout their term. As of December 31, 2005, 203,334 of these options remain outstanding. The related compensation expense depends on both the cumulative vesting of outstanding options and the price of the Company’s common stock at each quarter end, and therefore may have a significant impact on the Company’s future results of operations. In 2005, we recorded a non-cash stock compensation recovery $38,000, as compared with a recovery of $638,000 in connection with variable accounting for re-granted stock options. In addition, we

recorded non-cash stock compensation expense related to the amortization of deferred stock compensation of $51,000, $61,000, and $126,000 during the years ended December 31, 2005, 2004, and 2003, respectively, primarily in connection with the grant of certain stock options to employees and officers on, or prior to, the Company’s initial public offering on March 20, 2000. In addition, we have granted stock options to consultants, which resulted in non-cash stock compensation expense of $148,000, $472,000, and $254,000 during the years ended December 31, 2005, 2004, and 2003, respectively. For additional details and a tabular summary of stock compensation expense see Note 10 of the notes to the financial statements included in Item 8 of this Form 10-K.

 

We intend that the following discussion of our results of operations and financial condition will provide information to assist in the understanding of our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our financial statements.

 

Critical Accounting Policies and Estimates

 

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the financial statements. We review the accounting policies used in our financial statements on a regular basis. In addition, management has reviewed these critical accounting policies and related disclosures with our Audit Committee.

 

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses, and related disclosures. On an ongoing basis, we evaluate these estimates, including those related to clinical trial accruals, income taxes, restructuring costs and stock-based compensation. Estimates are based on historical experience, information received from third parties 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 could therefore differ materially from those estimates under different assumptions or conditions.

 

Stock-Based Compensation

 

In February 2003, the Board of Directors approved a cancellation and re-grant of 308,835 unexercised stock options held by existing employees and directors of the Company in a one-for-one exchange and 12,500 options that were re-granted in connection with the cancellation of 54,166 unexercised stock options held by a director of the Company. The re-granted options have an exercise price equal to the closing price of the Company’s common stock on the NASDAQ National Market on February 5, 2003, or $2.76 per share. The options generally vest over a four-year period and will expire in February 2008 if not previously exercised. Variable accounting is being applied to the re-granted options throughout their term. The related compensation expense depends on both the cumulative vesting of outstanding options and the price of the Company’s common stock at each quarter end, and therefore may have a significant impact on the Company’s future results of operations. No adjustments for material changes in estimates have been recognized in any period presented.

 

As permitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation”, as amended by Statement of Financial Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company has elected to follow APB 25 and related interpretations in accounting for stock-based employee compensation. Under APB 25, if the exercise price of an employee or director stock option is set equal or in excess of the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. In February 2003, certain employee and director stock options for which the exercise prices had originally been set at less than the fair market value of the underlying stock on the grant date, were cancelled and re-granted in a one-for-one exchange. The Company had recorded deferred compensation for

the difference between the original exercise price and the fair market value of the underlying stock on the grant date as a component of stockholders’ equity, and the total was being amortized on a straight-line basis over the vesting period of the original awards, ranging from four to six years. The related re-granted options all vest over a four-year period, and the remaining unamortized deferred compensation as of the re-grant date is now being amortized over the new four-year vesting schedule, commencing at the date of re-grant. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options, for which accrued but unvested compensation has been recognized, are forfeited prior to vesting. No adjustments for material changes in estimates have been recognized in any period presented.

 

Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123 and the FASB’s 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 or Services”, and are recognized over the related service period and are periodically re-measured as the underlying options vest. The fair values are estimated using the Black-Scholes option pricing model, and are periodically re-measured as the underlying options vest. The option pricing model is dependent on a number of inputs, which may change over time. Other option pricing models may produce fair values that are substantially different from the Black-Scholes model. No adjustments for material changes in estimates have been recognized in any period presented.

 

Clinical Trial Accruals

 

The Company’s accrued costs for clinical trial activities are based upon estimates of the services received and related expenses incurred that have yet to be invoiced by the contract research organizations (CROs) or other clinical trial service providers that perform the activities. Related contracts vary significantly in length, and may be for a fixed amount, a variable amount based on actual costs incurred, capped at a certain limit, or for a combination of these elements. All estimates may differ significantly from the actual amount subsequently invoiced. No adjustments for material changes in estimates have been recognized in any period presented. As of December 31, 2005 amounts accrued related to clinical trials are approximately $99,000, due to the cessation of clinical trial activity.

 

Results of Operations

 

Comparison of Years Ended December 31, 2005, 2004, and 2003

 

Revenues

 

IntraBiotics had no product sales or contract revenue for the years ended December 31, 2005, 2004, and 2003.

 

Expenses

 

Research and Development

 

 

Research and development expenses primarily include clinical trial expenses, research and development payroll expense, drug substance expense, allocated facilities costs and non-cash stock compensation charges. Research and development expenses decreased 98% in 2005 from 2004 because of the cessation of activities due to the termination of our Iseganan development project in June 2004. Except for the adjustment of certain payables, current research and development costs have ceased as a result of our decision to discontinue the Iseganan program and reduce operating expenses to a minimum appropriate level.

 

Research and development expenses increased in 2004 by $3.8 million from 2003. These expenses increased by $0.4 million as a result of additional headcount and by $3.4 million from clinical trial expenses associated with the commencement of phase III trials of iseganan for the prevention of VAP. Although these expenses increased during 2004, as compared to 2003, $8.9 million of the total expense was incurred in the first half of 2004, with only $2.1 million and $0.6 million of research and development expense in the third and fourth quarters of 2004,

respectively. This significant reduction in the fourth quarter is as a result of the termination of our iseganan development project in June 2004.

 

In 2003, research and development expenses include a write-off of $2.4 million for prepaid iseganan drug substance, relating to an order of seven kilograms of iseganan bulk drug substance that was expected to be delivered in 2003. Due to significant uncertainty over the timing and outcome of discussions with the contract manufacturer about whether the drug substance was manufactured in accordance with a validation plan and the adequacy of manufacturing documentation, the entire $2.4 million prepaid amount was written off in September 2003.

 

Non-cash stock compensation reflected charges of $8,000 in 2005 compared to charges of $26,000, and $59,000 for the years ended December 31, 2004, and 2003, respectively. The decrease from 2004 to 2005 was due to the decrease in stock options outstanding. The decrease from 2003 to 2004 was due to lower amortization of deferred stock compensation expense during 2004 and a recovery related to stock compensation for variable options awards during 2004, as compared to an expense during 2003. These decreases were offset, in part, by an increase in the stock compensation expense for consultant services.

 

General and Administrative

 

 

General and administrative costs primarily include administrative payroll expense, outside contractors, legal and accounting fees, insurance, non-cash stock compensation charges, facilities, travel and other general administrative expenses. General and administrative expenses decreased by $1.8 million from 2004 to 2005 as a result of expenses associated with decreased headcount and facilities of $0.9 million, and outside contractors and services of $0.8 million. This decrease was offset by an increase in stock compensation expense of $0.3 million related to deferred compensation and variable accounting for stock options for employees and stock compensation for consultants. Stock compensation expense was $153,000 during the year ended 2005 as compared to a stock compensation recovery of $131,000 during the year ended 2004.

 

General and administrative expenses decreased by $1.0 million from 2003 to 2004. Expenses associated with increased headcount and facilities increased by $0.4 million, which was offset by a reduction in stock compensation expense of $1.4 million primarily related to variable accounting for stock options. During 2003 stock compensation charges were $1.3 million as compared with a recovery of $0.1 million during 2004.

 

Non-cash stock compensation charges were $0.2 million in 2005, as compared to a recovery in the year ended December 31, 2004 of $0.1 million and an expense of $1.3 million for the year ended December 31, 2003.

 

Restructuring and Other Charges

 

 

On May 5, 2005, after considering a variety of strategic alternatives, none of which was determined by management and the Board of Directors to be in the best interests of the Company and its shareholders, the Board of Directors decided to suspend the Company’s active strategic evaluation process and reduce operating expenses to a minimum appropriate level (the “2005 Restructuring”). In accordance with these plans, the Company terminated all of its remaining employees on June 15, 2005. All restructuring charges are accounted for in accordance with Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities.”

 

The Company recorded a restructuring charge of $675,000 during the three months ended June 30, 2005, all of which related to employee termination benefits. As of September 30, 2005, $648,000 of the restructuring charge had been settled in cash. The remaining $27,000 was health benefits to terminated employees that did not have to be paid and restructuring charges were adjusted accordingly.

In June 2004, the Company discontinued its clinical trial of iseganan for the prevention of VAP, following a recommendation of the independent data monitoring committee. The Company terminated its iseganan development program, and focused efforts on evaluating various strategic options, including mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. As a result, in August 2004, the Company implemented a restructuring plan, which included the termination of nine employees and various operating lease commitments. The Company recorded a restructuring charge of $858,000 during the year ended December 31, 2004, of which $748,000 related to involuntary employee termination benefits and $110,000 related to the termination of facility operating leases and the write-off of certain property and equipment. The $748,000 of involuntary employee benefits were comprised primarily of $700,000 of lump sum severance payments and related employer taxes and health and other benefits payable.

 

There were no restructurings during 2003.

 

Interest Income and Expense

 

 

Interest income in 2005 increased from 2004 because of the substantially higher average interest earning investment balances. 2004 increased from 2003 because of substantially higher average interest earning investment balances due to a public stock offering in May 2004, which raised net proceeds of $41.5 million. For additional information on the public stock offering in May 2004 please see Liquidity and Capital Resources, below.

 

Other Income/(Expense), net

 

 

In September 2004 the Company recorded an expense of $175,000 included in other income/(expense) related to the write-down of the carrying value of 350,000 shares of Series A redeemable preferred stock of Micrologix Biotechnology Inc., (“Micrologix”).

 

The Company issued warrants to purchase shares of its common stock in connection with its Series A convertible preferred stock offering on May 1, 2003 which provide that if the Company’s common stock is delisted from NASDAQ, the purchase price for the stock upon exercise of the warrants will be reduced by 50% without any associated increase in the number of shares of common stock for which the warrants are then exercisable. This provision was triggered by the Company’s October 2005 delisting from the Nasdaq National Market. As of September 30, 2005, the Company had warrants to purchase 789,171 shares of its common stock outstanding with an exercise price of $2.066 per share. As a result of the October 14, 2005 delisting, the exercise price dropped from $2.066 to $1.033 per share, and the Company recorded a non-cash charge of $789,000 to “other expense” and an offsetting increase in “paid-in-capital” in December of 2005 to reflect the fair market value of these warrants.

 

Income Taxes

 

Since inception, we have incurred operating losses and accordingly have not recorded a provision for income taxes for any of the periods presented. As of December 31, 2005, we had net operating loss carry forwards for federal and state income tax purposes of approximately $214.0 million and $37.0 million, respectively. We also had federal and state research and development tax credits each of approximately $3.2 million. If not utilized, the net operating losses and credits will expire in the years 2005 through 2025. Utilization of net operating losses and credits are subject to a substantial annual limitation due to ownership change limitations provided by the Internal Revenue Code of 1986, as amended. The annual limitation could result in the expiration of our net operating losses and credit carryforwards before they can be used. Please read Note 11 of the notes to the financial statements included in Item 8 of this Form 10-K for further information.

Liquidity and Capital Resources

 

 

At December 31, 2005, we had cash and cash equivalents of $2.8 million, representing a decrease of $1 million from December 31, 2004. Short-term investments were $46 million at December 31, 2005 as compared to $49 million at December 31, 2004. We had no debt outstanding as of December 31, 2005. We invest excess funds in short-term money market funds and securities pursuant to our investment policy guidelines as more fully described in Part I, Item 7A — “Quantitative and Qualitative Disclosures About Market Risk.” The following is an analysis of changes in our cash and cash equivalents in each respective year.

 

 

The net cash used in operating activities decreased in 2005 from 2004. The operating cash outflow during 2005 was primarily due to the net loss of $3.2 million. The net cash used in operating activities increased in 2004 from 2003. The operating cash outflow during 2004 was primarily due to the net loss of $16.7 million. During 2003 operating cash outflow was comprised of the net loss of $13.3 million, offset by non-cash stock compensation expense of $1.4 million, decreases in prepaid expenses of $2.1 million and an increase in accrued clinical liabilities of $1.0 million. We expect cash outflows from operating activities for the foreseeable future.

 

The net cash provided by investing activities in 2005 relates to the purchase of $193 million of short-term investments, offset by the maturity of short-term investments of $196 million. The net cash used in investing activities in 2004 relates to the purchase of $65.2 million of short-term investments, partially offset by the maturity of short-term investments of $28.2 million. The net cash used in investing activities in 2003 relates to the purchase of $12.1 million of short-term investments, partially offset by the maturity of short-term investments of $2.9 million.

 

Historically we have relied upon cash flows from financing activities to fund our operations. Details of our financing activities during the last three years are as follows:

 

 

Contractual Obligations

 

At December 31, 2005, the Company had no operating lease commitments.

 

The holders of our Series A preferred stock are entitled to receive cumulative dividends at the rate of 8% per annum of the original purchase price of $10,000 per share of Series A preferred stock. Based on the number of shares of preferred stock outstanding as of December 31, 2005, this equates to $245,000. The dividends are payable quarterly in shares of common stock, and the number of shares payable are determined based on the average closing sale price of the common stock on the Pink Sheets market, on which our common stock is traded, for each of the five trading days immediately preceding the applicable dividend payment date. We do not currently anticipate paying any cash dividends in the foreseeable future.

 

There were no purchase obligations as of December 31, 2005 that included material penalties for cancellation and were enforceable and legally binding.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements (as that term is defined in Rule 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

 

Indemnifications

 

In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of IntraBiotics or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial. In addition, we have entered into indemnity agreements with each of our directors and executive officers. Such indemnity agreements contain provisions, which are in some respects broader than the specific indemnification provisions contained in Delaware law. We also maintain an insurance policy for our directors and executive officers insuring against certain liabilities arising in their capacities as such.

 

Future Capital Requirements

 

We expect to continue to incur operating losses, partially offset by interest income, and will not receive any product revenues. Our efforts are focused on reducing operating expenses to a minimum appropriate level, conducting our affairs in the most financially efficient manner practical for a public company, litigating our securities litigation aggressively, and pursuing strategic alternatives in the biotechnology industry, or liquidation. Based on current projections, the Company expects cash, cash equivalents and short-term investments at December 31, 2006 to be in the range of $47.8 to $48.3 million. This estimate does not include any costs that may be associated with completing any strategic alternative, liquidation of the Company or the disposition of our securities litigation. We currently anticipate our cash, cash equivalents and short-term investments to be sufficient to fund the foregoing efforts for at least the next 12 months. This forecast is a forward-looking statement that involves risks and uncertainties, and actual results could vary.

 

Recent Accounting Pronouncements

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after January 1, 2006, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123, no longer will be an alternative to financial statement recognition. We are required to adopt SFAS 123R beginning January 1, 2006. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method

for compensation cost and the transition method to be used at date of adoption. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R. We are evaluating the requirements of SFAS 123R and we expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share.

 

The adoption of the following recent accounting pronouncements did not have a material impact on IntraBiotics results of operations and financial condition:

 

 

Effective February 3, 2006, the FASB decided to move forward with the issuance of a final FSP FAS 123R-4 Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. The guidance in this FSP FAS 123R-4 amends paragraphs 32 and A229 of FASB Statement No. 123R to incorporate the concept articulated in footnote 16 of FAS 123R. That is, a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employee’s control does not meet the condition in paragraphs 32 and A229 until it becomes probable that the event will occur. Originally under FAS 123R, a provision in a share-based payment plan that required an entity to settle outstanding options in cash upon the occurrence of any contingent event required classification and accounting for the share based payment as a liability. This caused an issue under certain awards that require or permit, at the holder’s election, cash settlement of the option or similar instrument upon (a) a change in control or other liquidity event of the entity or (b) death or disability of the holder. With this new FSP, these types of cash settlement features will not require liability accounting so long as the feature can be exercised only upon the occurrence of a contingent event that is outside the employee’s control (such as an initial public offering) until it becomes probable that event will occur. The guidance in this FSP shall be applied upon initial adoption of Statement 123(R). An entity that adopted Statement 123(R) prior to the issuance of the FSP shall apply the guidance in the FSP in the first reporting period beginning after February 2006. Early application of FSP FAS 123R-4 is permitted in periods for which financial statements have not yet been issued. The Company does not anticipate that this new FSP will have any material impact upon its financial condition or results of operations.

 

The primary objective of our investment activities is to preserve our capital until it is required to fund operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. As of December 31, 2005, we own financial instruments that are sensitive to market risk as part of our investment portfolio. To minimize this risk, in accordance with our investment policy guidelines, we place investments with high credit quality issuers (rated A1/P1 for short-term investments and Aa3/AA- for long-term investments) and limit the amount of credit exposure to any one issuer to the greater of 5% of the investment portfolio or $1 million, whichever is greater. There are no concentration limits set for obligations of the government of the United States of America and its federal agencies. The average duration of our investment portfolio in 2005 and 2004 was less than one year and the maximum term allowed for any investment was 15 months. Due to the short-term nature of these investments, a 50 basis point movement in market interest rates would not have a material impact on the fair value of our portfolio as of December 31, 2005 and 2004. We have no investments denominated in foreign currencies and therefore our investments are not subject to foreign currency exchange risk.

 

The following table summarizes the average interest rate and estimated fair value of the short-term investments held by us as of December 31, 2005, and 2004 (in thousands).

 

 

The following is a summary of the Company’s available-for-sale investments as of December 31, 2005 and 2004 (in thousands):

 

 

 

None of the investments held as of December 31, 2005 or 2004 had been in a continuous unrealized loss position for more than 12 months. The aggregate fair value of US government agency investments held at December 31, 2005 and December 31, 2004 which had unrealized losses was $29.3 million and $30.5 million, respectively. During 2005 interest rates generally rose and as a result all US government agency investments held at

December 31, 2005 are in an unrealized loss position. The unrealized loss position will continue until either the investment matures, or, until interest rates drop below the rate in effect on the date the various securities were purchased. As a result, the Company has concluded that the impairment is temporary.

 

The following is a summary of amortized cost and estimated fair value of available-for-sale investments by contract maturity (in thousands):

 

 

INTRABIOTICS PHARMACEUTICALS, INC.

 

INDEX TO FINANCIAL STATEMENTS

 

TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF
INTRABIOTICS PHARMACEUTICALS INC.

 

We have audited the accompanying balance sheets of IntraBiotics Pharmaceuticals Inc. as of December 31, 2005 and December 31, 2004 and the related statements of operations, stockholders’ equity and cash flows for each of the years ended December 31, 2005 and December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of IntraBiotics Pharmaceuticals, Inc. as of December 31, 2005 and December 31, 2004 and the results of its operations and its cash flows for each of the years ended December 31, 2005 and December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

 

STONEFIELD JOSEPHSON, INC.

 

San Francisco, California

January 27, 2006

 

The Board of Directors and Stockholders of

IntraBiotics Pharmaceuticals, Inc.

 

We have audited the statements of operations, stockholders’ equity, and cash flows of IntraBiotics Pharmaceuticals, Inc. for the year ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the results of IntraBiotics Pharmaceuticals, Inc.’s operations and its cash flows for the year ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.

 

 

Palo Alto, California

February 6, 2004

INTRABIOTICS PHARMACEUTICALS, INC.

 

BALANCE SHEETS

 

 

The accompanying notes are an integral part of these financial statements.

INTRABIOTICS PHARMACEUTICALS, INC.

 

STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of these financial statements.

 

INTRABIOTICS PHARMACEUTICALS, INC.

 

STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

The accompanying notes are an integral part of these financial statements.

INTRABIOTICS PHARMACEUTICALS, INC.

 

STATEMENTS OF CASH FLOWS

 

 

The accompanying notes are an integral part of these financial statements.

INTRABIOTICS PHARMACEUTICALS, INC.

 

NOTES TO FINANCIAL STATEMENTS

 

 

IntraBiotics Pharmaceuticals, Inc. (“IntraBiotics” or the “Company”), was incorporated in the state of Delaware in 1994. From the fourth quarter of 2002 until June 2004, we focused our efforts on developing iseganan for the prevention of ventilator-associated pneumonia (“VAP”). In June 2004, we discontinued our clinical trial of iseganan for the prevention of VAP following a recommendation of the independent data monitoring committee. Subsequently, the Company terminated the iseganan development program, reduced employees, and evaluated (and continues to evaluate) strategic alternatives, including mergers, acquisitions, in-licensing opportunities, and liquidation of the Company. The Company, in any case, will continue operations until the conclusion of the securities litigation class action lawsuit described below in Part I, Item 1A, “Risk Factors,” and in Part I, Item 3, “Legal Proceedings.”

 

On May 5, 2005, after considering a variety of strategic alternatives, none of which was determined by management and the Board of Directors to be in the best interests of the Company and its shareholders, the Board of Directors decided to suspend the Company’s active evaluation process and reduce operating expenses to a minimum appropriate level. In accordance with these plans, the Company terminated all of its remaining regular employees on June 15, 2005. The Company will continue to pursue strategic alternatives in the biotechnology industry with the support of consultants and the active participation of its board. In addition, the Company engaged Hickey & Hill, Inc. of Lafayette, California, a firm specializing in managing companies in transition, to assume the responsibilities of day-to-day administration of the Company, and appointed Denis Hickey of Hickey & Hill, Inc. as its Chief Executive Officer and Chief Financial Officer.

 

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including amounts accrued for clinical trial costs and stock-based compensation.

 

The Company’s estimate of accrued costs is based on historical experience, information received from third parties 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 could therefore differ materially from those estimates under different assumptions or conditions.

 

Concentrations of Credit Risk and Fair Value of Financial Instruments

 

Financial instruments, which subject the Company to concentrations of credit risk, consist primarily of investments in certain debt securities and accounts receivable. The Company invests its cash equivalents and short-term investments in high credit quality investments, in accordance with its investment policy, and limits its exposure to certain issuers, which minimizes the possibility of a loss. The Company does not require collateral on cash equivalents and short-term investments. The Company is exposed to credit risks in the event of default by the financial institutions or issuers of investments to the extent recorded on the balance sheet.

 

The fair value of financial instruments, including cash, cash equivalents, short-term investments, accounts payable and accrued liabilities approximate their carrying value.

 

Cash Equivalents and Short-Term Investments

 

Cash equivalents are comprised of money market funds and debt securities with original maturities of less than 90 days. Short-term investments include securities with maturities of less than one year from the balance sheet date, or securities with maturities of greater than one year that are specifically identified to fund current operations. All

 

INTRABIOTICS PHARMACEUTICALS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

cash equivalents and short-term investments are classified as available-for-sale. The Company’s investment securities are recorded at their fair market value, based on quoted market prices. The cost of securities when sold is based upon the specific identification method. Any unrealized gains and losses are recorded as “other comprehensive income” and included as a separate component of stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale investments are included in “other income” in the statements of operations. Gains and losses on sales of available-for-sale investments have been immaterial.

 

Property and Equipment

 

Property and equipment are stated at cost less accumulated depreciation, which is calculated using the straight-line method over the estimated useful lives of the respective assets, generally being three to five years. Leasehold improvements are depreciated over the terms of the facilities leases.

 

Research and Development

 

Research and development expenditures are charged to operations as incurred, and include fees paid to contract research organizations and other clinical service providers, payroll expense, drug substance expense, allocated facilities costs and non-cash stock compensation charges.

 

Restructuring Charges

 

The Company has undertaken a number of restructuring efforts. Up until the restructuring efforts undertaken in 2004 the Company accounted for restructuring charges in accordance with the provisions of Emerging Issues Task Force 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” and related interpretations. During 2004 and 2005, the Company accounted for restructuring charges in accordance with Statement of Accounting Standards No. 146, “Accounting for Costs Associated with Exit of Disposal of Activities.” See Note 7 — Restructuring and Other Charges for additional disclosures.

 

Clinical Trial Accruals

 

The Company’s accrued costs for clinical trial activities are based upon estimates of the services received and related expenses incurred that have yet to be invoiced by the contract research organizations (CROs), investigators, drug processors, laboratories, consultants, or other clinical trial service providers that perform the activities. Related contracts vary significantly in length, and may be for a fixed amount, a variable amount based on actual costs incurred, capped at a certain limit, or for a combination of these elements. In June 2004, we discontinued our clinical trial of iseganan for the prevention of VAP. As of December 31, 2005 and 2004, clinical trial accruals of $99,000 and $161,000, respectively, consisted of amounts due to hospitals and doctors who participated in this trial.

 

Stock-Based Compensation

 

As permitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation”, as amended by Statement of Financial Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the Company has elected to follow APB 25 and related interpretations in accounting for stock-based employee compensation. Under APB 25, if the exercise price of an employee or director stock option is set equal or in excess of the fair market value of the underlying stock on the date of grant, no compensation expense is recognized. In February 2003, certain stock options issued to employees for whom the exercise prices had originally been set at less than the fair market value of the underlying stock on the grant date were cancelled and re-granted in a one-for-one exchange. The Company had recorded deferred compensation for the difference between the original exercise price and the fair market value of the underlying stock on the grant date as a component of stockholders’ equity, and the total was being amortized on a straight-line basis over the vesting

 

INTRABIOTICS PHARMACEUTICALS, INC.

 

NOTES TO FINANCIAL STATEMENTS — (Continued)

period of the original awards, ranging from four to six years. The related re-granted options all vest over a four-year period, and the remaining unamortized deferred compensation as of the re-grant date is now being amortized over the new four-year vesting schedule, commencing at the date of re-grant.

 

In February 2003, the Board of Directors approved a cancellation and re-grant of 308,835 unexercised stock options held by existing employees and directors of the Company in a one-for-one exchange and 12,500 options that were re-granted in connection with the cancellation of 54,166 unexercised stock options held by a director of the Company. The re-granted options have an exercise price equal to the closing price of the Company’s common stock on the NASDAQ National Market on February 5, 2003, or $2.76 per share. The options generally vest over a four-year period and will expire in February 2008 if not previously exercised. Variable accounting is being applied to the re-granted options throughout their term.

 

Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS 123 and the FASB’s 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 or Services”, and are recognized over the related service period and are periodically re-measured as the underlying options vest.

 

See Note 10 — Employee Benefit Plans — Stock Compensation for details of stock compensation expense.

 

The following table illustrates the effect on net loss and net loss per share applicable to common stockholders if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation. For purposes of this pro-forma disclosure, the value of the options is estimated using a Black-Scholes option pricing model and amortized ratably to expense over the options’ vesting periods.