** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

# ***Form 10­-Q***

*** ***

**                 ****ý****  Quarterly****reportpursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934**

 

    **FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001**

 

**or**

 

                  o   **Transition****report pursuant to Section 13 or 15 (d) of the Securities Exchange Actof 1934**

 

                    **For the transition period from                    to          **

** **

** **

**COMMISSIONFILE NUMBER 0-29993**

** **

**INTRABIOTICS PHARMACEUTICALS, INC.**

(Exact name ofRegistrant as specified in its charter)

 

| **DELAWARE**                                                    |   | **94-3200380**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **1245  TERRA BELLA AVE., MT. VIEW, CA**                        |   | **94043**                                |
| (Address of principal  executive offices)                       |   | (zip code)                               |

** **

**(650)526-6800**

(Registrant’stelephone number including area code)

 

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filing  requirements for the past 90 days.

 

Yes ý                         No o

 

There were29,628,691 shares of the Company’s Common Stock, par value $.001, outstandingon October 31, 2001.

 

INTRABIOTICSPHARMACEUTICALS, INC.

 

FORM 10-Q

QUARTER ENDED SEPTEMBER30, 2001

 

TABLE OF CONTENTS

 

 
| PART I.  | FINANCIAL INFORMATION                                                                              |   |
|----------|----------------------------------------------------------------------------------------------------|--------|
|     |                                                                                               |   |
| Item 1.  | Financial Statements:                                                                              |   |
|     |                                                                                               |   |
|     | Balance Sheets as of September 30, 2001  and December 31, 2000                                     |   |
|     |                                                                                               |   |
|     | Statements of Operations for  the Three and Nine Month Periods

Ended September 30,  2001 and 2000 |   |
|     |                                                                                               |   |
|     | Statements of Cash Flows for  the Nine Month Periods Ended

September 30, 2001 and  2000           |   |
|     |                                                                                               |   |
|     | Notes to Financial  Statements                                                                     |   |
|     |                                                                                               |   |
| Item  2. | Management’s  Discussion and Analysis of Financial Condition and Results of

Operations       |   |
|     |                                                                                               |   |
| Item  3. | Quantitative  and Qualitative Disclosures About Market Risk                                        |   |
|     |                                                                                               |   |
| PART II  | OTHER  INFORMATION                                                                                 |   |
|     |                                                                                               |   |
| Item  1. | Legal Proceedings                                                                                  |   |
|     |                                                                                               |   |
| Item  2. | Changes  in Securities and Use of Proceeds                                                         |   |
|     |                                                                                               |   |
| Item 6.  | Exhibits and  Reports on Form 8-K                                                                  |   |
|     |                                                                                               |   |
|     | SIGNATURES                                                                                         |   |

 

 

INTRABIOTICSPHARMACEUTICALS, INC.

BALANCE SHEETS

(INTHOUSANDS)

 
|                                                      |   | **SEPTEMBER 30,**

**2001** |   | **DECEMBER 31,**

**2000** |   |
|-----------------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                                                      |   | **(Unaudited)**             |   | **(Note 1)**               |   |
| **Assets**                                                |   |                        |   |                       |   |
| Current assets:                                           |   |                        |   |                       |   |
| Cash and cash  equivalents                                |   | $                           | 26,208 |                       | $      | 38,983 |   |
| Restricted cash  deposits                                 |   | 7,471                       |   | 1,371                      |   |
| Short-term  investments                                   |   | 7,500                       |   | 45,711                     |   |
| Other current  assets, primarily prepayments and deposits |   | 5,830                       |   | 10,101                     |   |
|                                                      |   |                        |   |                       |   |
| Total current  assets                                     |   | 47,009                      |   | 96,166                     |   |
|                                                      |   |                        |   |                       |   |
|                                                      |   |                        |   |                       |   |
| Property and  equipment, net                              |   | 2,387                       |   | 12,056                     |   |
|                                                      |   |                        |   |                       |   |
| Other assets                                              |   | 43                          |   | 66                         |   |
|                                                      |   |                        |   |                       |   |
| Total assets                                              |   | $                           | 49,439 |                       | $      | 108,288 |   |
|                                                      |   |                        |   |                       |   |
| **Liabilities  and Stockholders' Equity**                 |   |                        |   |                       |   |
| Current  liabilities:                                     |   |                        |   |                       |   |
| Accounts payable                                          |   | $                           | 498    |                       | $      | 1,680 |   |
| Accrued clinical  costs                                   |   | 1,013                       |   | 3,236                      |   |
| Accrued employee  liabilities                             |   | 552                         |   | 625                        |   |
| Accrued  restructuring charges                            |   | 2,637                       |   | -                          |   |
| Deposits on sale  of assets                               |   | 951                         |   | -                          |   |
| Other accrued  liabilities                                |   | 1,493                       |   | 854                        |   |
| Current  financing obligations                            |   | 4,375                       |   | 3,629                      |   |
|                                                      |   |                        |   |                       |   |
| Total current  liabilities                                |   | 11,519                      |   | 10,024                     |   |
|                                                      |   |                        |   |                       |   |
| Long-term  financing obligations                          |   | 5,469                       |   | 8,309                      |   |
|                                                      |   |                        |   |                       |   |
| **Stockholders'  equity:**                                |   |                        |   |                       |   |
| Common stock                                              |   | 29                          |   | 29                         |   |
| Additional  paid-in capital                               |   | 197,050                     |   | 198,388                    |   |
| Deferred stock  compensation                              |   | (6,249                      | )      | (10,198                    | )      |
| Accumulated  other comprehensive income                   |   | (1                          | )      | 186                        |   |
| Accumulated  deficit                                      |   | (158,378                    | )      | (98,450                    | )      |
|                                                      |   |                        |   |                       |   |
| Total  stockholders' equity                               |   | 32,451                      |   | 89,955                     |   |
|                                                      |   |                        |   |                       |   |
| Total  liabilities and stockholders' equity               |   | $                           | 49,439 |                       | $      | 108,288 |   |

 

Seeaccompanying notes.

INTRABIOTICS PHARMACEUTICALS, INC 

STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

 

(UNAUDITED)

 
|                                                                  |   | ** THREE MONTHS ENDED**

**SEPTEMBER  30,** |   | ** THREE MONTHS ENDED**

**SEPTEMBER 30,** |   |
|-----------------------------------------------------------------------|--------|--------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                  |   |                                             |   |
|                                                                  |   | **2001**                                         |   | **2000**                                        |   | **2001** |   | **2000** |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Operating expenses:                                                   |   |                                             |   |                                            |   |   |   |   |   |
| Research and development                                              |   | $                                                | 6,501  |                                            | $      | 10,357 |   | $ | 32,382 |   | $ | 26,389 |   |
| General and administrative                                            |   | 580                                              |   | 3,153                                           |   | 7,164 |   | 7,937 |   |
| Restructuring and other charges                                       |   | -                                                |   | -                                               |   | 21,956 |   | - |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Total operating expenses                                              |   | 7,081                                            |   | 13,510                                          |   | 61,502 |   | 34,326 |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Operating loss                                                        |   | (7,081                                           | )      | (13,510                                         | )      | (61,502 | ) | (34,326 | ) |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Interest income                                                       |   | 531                                              |   | 1,805                                           |   | 2,528 |   | 4,139 |   |
| Interest expense                                                      |   | (351                                             | )      | (120                                            | )      | (954 | ) | (358 | ) |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Net loss                                                              |   | $                                                | (6,901 | )                                               | $      | (11,825 | ) | $ | (59,928 | ) | $ | (30,545 | ) |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Basic and diluted net loss per share                                  |   | $                                                | (0.23  | )                                               | $      | (0.41 | ) | $ | (2.04 | ) | $ | (1.50 | ) |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Shares used to compute basic and diluted net loss per share           |   | 29,431                                           |   | 29,051                                          |   | 29,345 |   | 20,301 |   |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Pro forma basic and diluted net loss per share                        |   |                                             |   |                                            |   |   |   | $ | (1.15 | ) |
|                                                                  |   |                                             |   |                                            |   |   |   |   |   |
| Shares used to compute pro forma basic and diluted net loss per share |   |                                             |   |                                            |   |   |   | 26,582 |   |

 

See accompanying notes.

 

INTRABIOTICSPHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS

(INTHOUSANDS)

 

(UNAUDITED)

 
|                                                                              |   | **NINE MONTHS ENDED SEPTEMBER 30,** |    |
|-----------------------------------------------------------------------------------|--------|-------------------------------------|---------|
|                                                                              |   | **2001**                            |    | **2000** |   |
| **Operating  activities**                                                         |   |                                |    |   |   |
| Net loss                                                                          |   | $                                   | (59,928 | ) | $ | (30,545 | ) |
|                                                                              |   |                                |    |   |   |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                                |    |   |   |
| Depreciation and  amortization                                                    |   | 1,446                               |    | 1,120 |   |
| Amortization of  deferred stock compensation                                      |   | 1,857                               |    | 2,381 |   |
| Write down of  fixed assets                                                       |   | 11,835                              |    | - |   |
| Fair value of  warrants issued                                                    |   | 560                                 |    | - |   |
|                                                                              |   |                                |    |   |   |
| Change in assets  and liabilities                                                 |   |                                |    |   |   |
| Other assets                                                                      |   | 4,294                               |    | (8,198 | ) |
| Accounts payable                                                                  |   | (1,182                              | )       | 188 |   |
| Accrued clinical  liabilities                                                     |   | (2,223                              | )       | 1,332 |   |
| Accrued employee  liabilities                                                     |   | (73                                 | )       | - |   |
| Accrued  restructuring charges                                                    |   | 2,637                               |    | - |   |
| Deposits on sale  of assets                                                       |   | 951                                 |    | - |   |
| Other accrued  liabilities                                                        |   | 639                                 |    | 1,033 |   |
| Amount payable  to contract partner                                               |   | -                                   |    | (1,677 | ) |
| Net cash (used  in) operating activities                                          |   | (39,187                             | )       | (34,366 | ) |
|                                                                              |   |                                |    |   |   |
| **Investing  activities**                                                         |   |                                |    |   |   |
| Capital  expenditures                                                             |   | (3,612                              | )       | (4,055 | ) |
| Purchase of  short-term investments                                               |   | (6,296                              | )       | (51,098 | ) |
| Maturities of  short-term investments                                             |   | 38,220                              |    | 9,065 |   |
| Net cash  provided by / (used in) investing activities                            |   | 28,312                              |    | (46,088 | ) |
|                                                                              |   |                                |    |   |   |
| **Financing  activities**                                                         |   |                                |    |   |   |
| Proceeds from  issuance of common stock                                           |   | 194                                 |    | 103,685 |   |
| Proceeds from  financing obligations                                              |   | 11,209                              |    | 6,083 |   |
| Payments on  financing obligations                                                |   | (13,303                             | )       | (754 | ) |
| Net cash (used  in) / provided by financing activities                            |   | (1,900                              | )       | 109,014 |   |
|                                                                              |   |                                |    |   |   |
| Net (decrease) /  increase in cash and cash equivalents                           |   | (12,775                             | )       | 28,560 |   |
|                                                                              |   |                                |    |   |   |
| Cash and cash  equivalents at beginning of period                                 |   | 38,983                              |    | 18,862 |   |
|                                                                              |   |                                |    |   |   |
| Cash and cash  equivalents at end of period                                       |   | $                                   | 26,208  |   | $ | 47,422 |   |
|                                                                              |   |                                |    |   |   |
| Supplemental  disclosure of cash flow information                                 |   |                                |    |   |   |
| Interest paid                                                                     |   | $                                   | 954     |   | $ | 302 |   |
|                                                                              |   |                                |    |   |   |
| Supplemental  disclosure of non-cash information                                  |   |                                |    |   |   |
| Conversion of  preferred stock to common stock                                    |   | $                                   | -       |   | $ | 79,609 |   |
| Deferred  compensation (termination)                                              |   | $                                   | (2,092  | ) | $ | 2,644 |   |

 

Seeaccompanying notes.

INTRABIOTICSPHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Basis ofPresentation

 

The accompanying condensed financial statements areunaudited and have been prepared by the Company in accordance with the rulesand regulations of the Securities and Exchange Commission for interim financialinformation, and in accordance with the instructions to Form 10-Q and Article10 of Regulation S-X.

 

Certain information and footnote disclosures normallyincluded in the Company’s annual audited financial statements (as required bygenerally accepted accounting principles) have been condensed or omitted.  The interim financial statements, in theopinion of management, reflect all adjustments (consisting of normal recurringaccruals) necessary for a fair statement of the Company’s financial position asof September 30, 2001 and December 31, 2000, and the results of its operationsand cash flows for the three and nine month periods ended September 30, 2001and 2000.

 

The results of operations of the interim periods arenot necessarily indicative of the results of operations to be expected for thefiscal year.  These interim financialstatements should be read in conjunction with the audited financial statementsfor the year ended December 31, 2000, which are contained in the Company’sAnnual Report on Form 10-K, as amended, and filed with the Securities andExchange Commission.  The accompanyingcondensed Balance Sheet as of December 31, 2000 is derived from such auditedfinancial statements.

 

Comprehensive loss is primarilycomprised of net loss and net unrealized gains or losses on available-for-salesecurities.  There is no materialdifference between the reported net loss and the comprehensive loss for allperiods presented.

 

Note 2. Lease Commitmentsand Equipment Financing Arrangements

 

The Company leases itsfacilities under operating lease agreements, which expire in July 2004 andApril 2011. At September 30, 2001 and December 31, 2000, the Company hadrestricted cash of $1,971,000 and $1,371,000, respectively, in connection withthese leases. 

 

In December 2000, the Company entered into anequipment financing agreement to finance up to $7.6 million of equipment.  The interest rate varies according to U.S.Treasury rates.  In December 2000, theCompany completed two draws against this arrangement.  The first draw was for $3.8 million with a loan term of 36 monthsand an average annual interest rate of 9.98%. The second draw was for $945,000 with a term of 48 months and an averageannual interest rate of 9.64%.  In March2001, the Company completed a third draw for $1.2 million with a loan term of48 months and an average annual interest rate of 9.64%.  The remaining balance available under thisagreement of $1.7 million expired on July 31, 2001.

 

OnAugust 20, 2001, the Company refinanced all of the existing financingobligations by entering into a new line of credit of $2.5 million and term loanagreement of $7.5 million.  At September30, 2001, the balance drawn on the line of credit was $2.5 million, fully securedby a certificate of deposit.  The termloan agreement was utilized and has a balance due of $7.3 million as ofSeptember 30, 2001, secured by the assets of the Company.  These financial obligations include variousfinancial covenants, a performance covenant and various negative covenants.

 

Note 3. Cash, Cash Equivalents and Short-term Investments

 

The Company invests its excess cash in short-termmoney market funds and commercial paper. The following is a summary of theCompany's cash, cash equivalents, restricted cash deposits and investments bymajor security type at their fair market value, which approximates carryingvalue based on quoted market values:

 
|                                                                        |   | **SEPTEMBER  30,**

**2001** |   | **DECEMBER 31,**

**2000** |   |
|-----------------------------------------------------------------------------|--------|------------------------------|--------|----------------------------|--------|
|                                                                        |   | **(IN  THOUSANDS)**          |   |
|                                                                        |   |                         |   |                       |   |
|                                                                        |   | **(UNAUDITED)**              |   |
|                                                                        |   |                         |   |                       |   |
| Operating cash                                                              |   | $                            | 3,204  |                       | $      | 723 |   |
| Money market                                                                |   | 23,004                       |   | 38,260                     |   |
| Certificates of  deposit - restricted cash                                  |   | 7,471                        |   | 1,371                      |   |
| Commercial paper                                                            |   | 7,500                        |   | 45,711                     |   |
|                                                                        |   | $                            | 41,179 |                       | $      | 86,065 |   |
|                                                                        |   |                         |   |                       |   |
|                                                                        |   |                         |   |                       |   |
|                                                                        |   |                         |   |                       |   |
| Amounts included  in cash and cash equivalents and restricted cash deposits |   | $                            | 33,679 |                  | $      | 40,354 |     |
| Amounts included  in short-term investments                                 |   | 7,500                        |   | 45,711                     |   |
|                                                                        |   | $                            | 41,179 |                       | $      | 86,065 |   |

 

The Company classifies all securities as either cash and cashequivalents or available for sale.  Therestricted cash of $7.5 million consists of $3.0 million pledged to PolyPeptideLaboratories, A/S for drug supply, $2.5 million pledged as security on the lineof credit and $2.0 million pledged as security deposits on our leasedfacilities.

 

Note 4. Net Loss PerCommon Share

 

Net loss per share has been computed according toFinancial Accounting Standards Board Statement No. 128, “Earnings Per Share”(“SFAS 128”), which requires disclosure of basic and diluted earnings pershare.  Basic and diluted earnings pershare is calculated using the weighted-average number of shares of common stockoutstanding during the period, less shares subject to repurchase.  Diluted earnings per share include theimpact of potentially dilutive securities. As the Company’s potentially dilutive securities (convertible preferredstock, stock options, and warrants) were antidilutive for all periods, theywere not included in the computation of weighted-average shares used incomputing diluted net loss per share.

 

Pro forma net loss per share has been computed asdescribed above and also gives effect to the conversion of convertiblepreferred shares not included above that automatically converted into commonstock upon completion of the Company’s initial public offering of common stockfrom the original date of issuance.

 

The following is a reconciliation of the numerator anddenominator of basic and diluted net loss per share (in thousands, except pershare amounts):

 
|                                                                                                                           |   | **THREE MONTHS ENDED**

**SEPTEMBER 30,** |   | **NINE MONTHS ENDED**

**SEPTEMBER 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                                                                                                           |   | **2001**                                  |   | **2000**                                 |   | **2001** |   | **2000** |   |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
|                                                                                                                           |   | **(UNAUDITED)**                           |   |
| Basic and  diluted:                                                                                                            |   |                                      |   |                                     |   |   |   |   |   |
| Net loss                                                                                                                       |   | $                                         | (6,901 | )                                        | $      | (11,825 | ) | $ | (59,928 | ) | $ | (30,545 | ) |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
| Weighted-average  shares used in computing basic and diluted net loss per share                                           |   | 29,431                                    |   | 29,051                                   |   | 29,345 |   | 20,301 |   |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
| Basic and  diluted net loss per share                                                                                          |   | $                                         | (0.23  | )                                        | $      | (0.41 | ) | $ | (2.04 | ) | $ | (1.50 | ) |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
| Pro forma basic  and diluted:                                                                                                  |   |                                      |   |                                     |   |   |   |   |   |
| Shares used  above                                                                                                             |   |                                      |   |                                     |   |   |   | 20,301 |   |
| Pro forma  adjustment to reflect weighted-average effect of conversion of preferred  stock from the date of issuance |   |                                      |   |                                     |   |   |   | 6,281 |   |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
| Total  weighted-average shares of common stock outstanding                                                                     |   |                                      |   |                                     |   |   |   | 26,582 |   |
|                                                                                                                           |   |                                      |   |                                     |   |   |   |   |   |
| Pro forma basic  and diluted net loss per share                                                                                |   |                                      |   |                                     |   |   |   | $ | (1.15 | ) |

 

Note 5. Agreements

 

## **OnMay 29, 2001, the Company amended its licensing and development agreement forits late stage ramoplanin program with Biosearch Italia, S.p.A.  Under the terms of the agreement,IntraBiotics was reimbursed for ongoing clinical trial expenses during athree-month transition period ending August 31, 2001.  At the end of this period, Biosearch assumed responsibility forthe clinical development of ramoplanin oral powder at its own expense andretained worldwide rights to the product. In exchange for its clinical development expenses and efforts,IntraBiotics will receive a royalty on future net sales of ramoplanin oral inNorth America, if it is successfully developed.**

 

Furthermore,the agreement specifies that IntraBiotics retains its license to topical usesof ramoplanin unless certain clinical development milestones are not met.  The agreement also allows for IntraBioticsto regain North American rights to the ramoplanin oral powder program undercertain conditions and by paying certain fees to Biosearch Italia.

 

On June 7, 2001, the Companyterminated its research collaboration agreement with Cetek Corporation(Cetek).  There were no chargesassociated with this termination agreement.

 

On June 21, 2001, the Company terminated itscollaborative research and technology agreement with New Chemical Entities,Inc. (now Albany Molecular Research, Inc.) (AMRI). Under the terms of thistermination agreement, IntraBiotics paid AMRI $300,000. 

 

On June 27, 2001, the Company entered into a bindingterm sheet related to termination of the discovery, development and licenseagreement with Diversa Corporation and on July 27, 2001, the Company enteredinto the final termination agreements. Under the terms of this termination agreement, IntraBiotics paid DiversaCorporation $1,450,000 and will pay $1,000,000 in the fourth quarter of2001.  In addition, the Company hasissued warrants to purchase 700,000 shares of its common stock at an exerciseprice of $2.00 per share, exercisable immediately for a period of four years.

 

On August 31, 2001, the Company’s researchcollaboration agreement with BioSource Pharma Inc. (BioSource) wasconcluded.  There were no charges to theCompany associated with the expiration of this agreement.

 

****Note 6. Restructuring and othercharges****

**** ****

On May 31, 2001, theCompany implemented a restructuring plan intended to conserve capital and helpdirect financial and human resources to the development of its lead product,iseganan HCl oral solution for the prevention of oral mucositis in cancerpatients. IntraBiotics incurred restructuring charges of $10.1 million andasset write down charges of $11.8 million for a total of $21.9 million incharges associated with its restructuring plan in the second quarter of 2001. As of September 30, 2001, the Company paid $6.9million of the restructuring costs, primarily in severance costs toapproximately 90 employees, facilities consolidation costs and terminatedcollaboration agreements and expensed $560,000 for warrants issued as part of acollaboration agreement termination. At September 30, 2001, approximately $2.6million remains in accrued restructuring charges.

 

Thestrategic restructuring included an immediate reduction in force ofapproximately 90 positions in research and administration, or 71% of ourworkforce on May 31, 2001, of 127 employees. All of those terminated employees left the Company by September 30,2001. Following the restructuring, the Company retained approximately 33full-time employees and several part-time employees or consultants largelyfocusing on drug development of iseganan HCl. 

 

The restructuring also includes the termination ofcertain research and development collaborations and the consolidation ofoperations into one existing facility in Mountain View, California.  The Company vacated three facilities inMountain View, California with 142,000 square feet and continues to occupy onefacility with 16,000 square feet. 

 

The 2001 restructuring charges consist of thefollowing (in thousands):

 
|                                                      |   | **Costs for**

**terminated**

**employees** |   | **Facilities**

**consolidation** |   | **Terminated**

**collaboration**

**agreements**

**and other** |          | **Total** | ** ** |
|-----------------------------------------------------------|--------|----------------------------------------------|--------|-----------------------------------|--------|------------------------------------------------------------------|---------------|-----------|------------|
|                                                      |   |                                         |   |                              |   |                                                             |          |      |       |
| Restructuring  charges                                    |   | $                                            | 2,911  |                              | $      | 3,150                                                            |          | $         | 4,060      |   | $ | 10,121 |   |
|                                                      |   |                                         |   |                              |   |                                                             |          |      |       |
| Cash payments                                             |   | (2,614                                       | )      | (1,821                            | )      | (2,489                                                           | )             | (6,924    | )          |
|                                                      |   |                                         |   |                              |   |                                                             |          |      |       |
| Non-cash  expenses                                        |   | -                                            |   | -                                 |   | (560                                                             | )             | (560      | )          |
|                                                      |   |                                         |   |                              |   |                                                             |          |      |       |
| Accrued  restructuring charges at September 30, 2001 |   | $                                            | 297    |                              | $      | 1,329                                                            |     | $         | 1,011      |     | $ | 2,637 |      |

**** ****

Additionally,the Company wrote down to fair value, leasehold improvements, laboratoryequipment, computers and other assets of $11.8 million that are no longer beingused as part of the restructuring plan. 

 

****Note 7. Legal Proceedings****

 

On April 5, 2001, we commenced arbitration proceedingsagainst Interactive Clinical Technologies, Inc. (ICTI) and Galen Holdingsregarding the previously disclosed error in the drug dispensing for two of ourPhase III clinical trials. We are seeking damages, including the full costs ofone of the previous Phase III trials and partial costs of the second.  On July 2, 2001, Galen Holdings suedIntraBiotics in the State of New Jersey Federal Court seeking an injunctionbarring the arbitration as to Galen.  Galen is not seeking damages fromIntraBiotics and the only issue raised by Galen's complaint isarbitrability.  On September 25, 2001, ICTI filed a counter claim againstIntraBiotics in the arbitration proceedings claiming unspecified damages due tobreach of a confidentiality provision in the master agreement between ICTI andIntraBiotics based on the disclosure of ICTI's name in connection with theerror.  We expect both the arbitration and the associated litigation to beresolved in or before the first quarter of 2002.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

 

                *Thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations contains forward-looking statements, which involve risksand uncertainties.  The Company’s actualresults could differ materially from those anticipated in these forward-lookingstatements as a result of certain factors, including those set forth under “RISKS RELATED TO OUR BUSINESS” below.  The following discussion should be read inconjunction with the financial statements and notes included elsewhereherein.  Except as required by law,IntraBiotics disclaims any obligation to update any of the forward-lookingstatements contained in this report to reflect any future events ordevelopments.*

 

#### **OVERVIEW**

 

IntraBiotics Pharmaceuticals,Inc. is developing new antibiotics, which address important unmet medicalneeds.  We have focused our efforts anduse of resources on our lead product, iseganan HCl oral solution for oralmucositis, which is in the third and final stage of human clinical testingprior to registration.   A contractor’serror damaged the first of two planned phase III trials, causing us to conducta third phase III trial. As a consequence, IntraBiotics restructured itsbusiness to maximize the likelihood of success in registering this potentialproduct.  During the past quarter, wecompleted the majority of the restructuring effort and focused on iseganan HClphase III trials for oral mucositis.  Wecontinue to delay our three phase II trials, iseganan HCl oral solution forprevention of ventilator-associated pneumonia, iseganan solution for inhalationfor treatment of lung infections in patients with Cystic Fibrosis, andramoplanin nasal for prevention of post-surgical staphylococcal infections,until additional capital resources become available. 

 

On January 17, 2001, we announced our discovery ofdamage to the first phase III trial of iseganan HCl for prevention of oralmucositis in patients receiving chemotherapy. Oral mucositis is a potentiallydebilitating side effect of certain anti-cancer therapies resulting in infectedulcers in the mouth.  The results wereannounced on May 14, 2001, after the trial was concluded, the final dataanalyzed, and the extent of damage assessed. The primary endpoint of ulceration did not achieve the statisticalstrength of evidence typically required for product registration (p=0.067compared to p<0.05 for statistical significance).  On May 31, 2001, IntraBiotics announced its plans to restructureits business as a result of the damage by a third party contractor’s error. 

 

Several other clinically meaningful endpoints didsucceed with statistical significance (all with p<0.05) in spite of thecontractor’s error in this trial.  Theseendpoints include mouth pain, throat pain, difficulty swallowing and pain withswallowing, and the severity of stomatitis, or reduction in inflammation of themouth.  We then completed additionalanalyses of the results that indicate that the error caused the trial tounderestimate the true benefit of iseganan HCl oral solution on each of thesemeasures of oral pain, oral function and ulceration.  Taken together, IntraBiotics believes that a repeat of theclinical trial has a high likelihood of demonstrating statistically significantresults.

 

Based on our analysis of all of the end-points and thenature of the error, we chose to restructure our business to enable us to useour current capital resources and key personnel to conduct and complete anotherphase III trial in this chemotherapy patient population.   This new trial is in addition to ourongoing and nearly fully enrolled trial in radiotherapy patients, in order toattempt to prove the efficacy and safety of the product.  The next phase III trial in chemotherapypatients is expected to start in the fourth quarter of 2001 and conclude in thefourth quarter of 2002.  The ongoing phaseIII trial in radiotherapy patients is expected to finish on schedule in thesecond quarter of 2002. 

 

We have also completedtwo earlier stage trials for other indications of the antibiotic iseganan HCl:the first to prevent pneumonia in patients using breathing assistance from amechanical ventilator, a condition called ventilator-associated pneumonia (VAP)and the second, to treat respiratory infections in patients with CysticFibrosis (CF). We obtained data from a human clinical trial that tested forpreliminary efficacy and safety, known as a phase IIa trial, for iseganan HCloral solution in patients on ventilators. The results of this trial werepresented in October 2001 at the European Society of Intensive Care Medicineand demonstrate the safety of iseganan HCl oral solution for this patientpopulation.  These data fully supportthe advancement of this program to the next stage of clinical testing.

We also obtained data from a human clinical trial thattested for preliminary safety, known as a phase I trial, for iseganan HClsolution for inhalation, (previously referred to as Protegrin IB-367 Aerosol),in patients with Cystic Fibrosis. The data from this trial was publiclypresented at the North American meeting of the Cystic Foundation Society inOctober 2001 and support the advancement to the next stage of human clinicaltesting, phase II trial, for this product. We currently plan to obtain additional capital and human resourcesbefore proceeding to these next trials for either the VAP or the CF programs.

 

We amended our licensing and development agreement forour ramoplanin oral and ramoplanin topical programs with BioSearch Italia,S.p.A., (BioSearch) on May 29, 2001. The transfer of the clinical trials oframoplanin oral powder for prevention of Vancomycin resistant enterococci (VRE)infections to BioSearch is complete. Under the terms of the new agreement,IntraBiotics will receive a royalty on future net sales on ramoplanin in NorthAmerica, if it is successfully developed. In addition, the agreement specifies that IntraBiotics retain the rightsto develop and commercialize ramoplanin for topical uses, including ramoplaninnasal, unless certain clinical development milestones are not met.

 

Since commencing operations in1994, we have not generated any revenue from product sales, and we have fundedour operations primarily from the proceeds of public and private placements ofsecurities. We have incurred a loss in each year since inception, and we expectto incur substantial losses for at least the next several years.  At September 30, 2001, our accumulateddeficit was approximately $158.4 million and our cash equivalents and shortterm investments balance was approximately $41.2 million includingrestricted cash deposits of approximately $7.5 million in connection with drugsupply agreements, line of credit and standby letters of credit for leasedfacilities.

 

#### **RESULTS OFOPERATIONS**

 

### *Three and nine month periods ended September 30, 2001and 2000*

 

IntraBiotics had noproduct sales or contract revenue for the nine-month periods ended September30, 2001 and September 30, 2000.  TheCompany does not anticipate any product revenue in the near future.

 

OnMay 31, 2001, IntraBiotics announced that it would implement a restructuringplan intended to conserve capital and help direct financial and human resourcesto the development of its lead product, iseganan HCl oral solution for theprevention of oral mucositis in cancer patients. As a result, weincurred restructuring charges of $10.1 million and asset write down charges of$11.8 million for a total of $21.9 million in the second quarter of 2001.

 

 This $10.1 million restructuring charge isfor costs to be incurred in reducing our workforce, terminating collaborationagreements and downsizing facilities. In the nine months ended September 30,2001, we paid $6.9 million of the restructuring costs, primarily in severancecosts, facilities consolidation costs and terminated collaboration agreements andexpensed $560,000 for warrants issued as part of a collaboration agreementtermination. At September 30, 2001,approximately $2.6 million remains in accrued restructuring charges. 

 

 The strategic restructuring included areduction in force of approximately 90 positions in research andadministration, or 71% of our workforce on May 31, 2001 of 127 employees.  All of the terminated employees left theCompany by September 30, 2001. Following the restructuring, we have retainedapproximately 33 full-time employees largely focusing on drug development ofiseganan HCl.

 

The restructuring also includes the termination ofcertain research and development collaborations and the consolidation ofoperations into one existing facility in Mountain View, California.  We have vacated three facilities in MountainView, California with 142,000 square feet and we continue to occupy onefacility with 16,000 square feet.

Additionally, we wrotedown to fair value, $11.8 million of leasehold improvements, laboratoryequipment, computers and other assets that are no longer being used by us aspart of the restructuring plan.  

 

As a result ofimplementing our restructuring plan, we anticipate significantly lower totaloperating expenses in the range of $6.0 million to $10.0 million for theremaining quarter of 2001 as compared to $13.5 million in the three monthsended September 30, 2000.

 

Research and development expenses decreased to $6.5million in the three-month period ended September 30, 2001 from $10.4 millionfor the same period in 2000, primarily as a result of our deliberate delay incommencing certain additional clinical trial work.   Research and development expenses increased to $32.4 million inthe nine-month period ended September 30, 2001 from $26.4 million for the sameperiod in 2000.  The increase for thenine-month period was attributable to higher personnel and payroll expenses,technology access fees, clinical trial activity, facilities and consultingexpenses prior to the implementation of the restructuring plan. 

 

General and administrative expenses decreased to $600,000and $7.2 million in the three and nine-month periods ended September 30, 2001from $3.2 million and $7.9 million for the same periods in 2000.  The decrease was primarily attributed todecreased personnel and payroll expenses, consulting, legal, travel and otherexpenses associated with decreased business development activities. 

 

In connection with the grant of certain stock optionsto employees, we recorded no deferred compensation in the three and nine-monthperiod ended September 30, 2001 compared to none in the three-month periodended September 30, 2000 and $2.6 million in the nine-month period endedSeptember 30, 2000. Deferred compensation represents the difference between thedeemed fair value of the common stock for financial reporting purposes and theexercise price of these options at the date of grant.  Deferred compensation is presented as a reduction ofstockholders’ equity and is amortized over the vesting period of the applicableoptions.  In the three and nine-monthperiods ended September 30, 2001, there was a reduction in deferredcompensation of $1.7 million and $2.1 million due to employee terminations.

 

We expensed $537,000 and $1.9 million of deferredcompensation during the three and nine-month periods ended September 30, 2001,compared to $794,000 and $2.4 million of deferred compensation for the sameperiods in 2000.  The decrease indeferred compensation expense was due to the cancellation of options forterminated employees.  These amountswere expensed to research and development and to general and administrativeexpense based on the deferred compensation liability attributed to eachdepartment.  The research anddevelopment deferred compensation amortization expense in the three and nine-monthperiods ended September 30, 2001 was $311,000 and $1.1 million, down from$460,000 and $1.4 million for the same periods in 2000.  The general and administrative deferredcompensation amortization expense in the three and nine-month periods ended September30, 2001 was $226,000 and $782,000, down from $334,000 and $1.0 million for thesame periods in 2000.   We expect thatdeferred compensation expense will decrease in the future as a result of ourreduction in workforce. 

 

Interest income decreased to $531,000 and $2.5 millionin the three and nine-month periods ended September 30, 2001 from $1.8 millionand $4.1 million for the same periods in 2000. The decrease in interest income resulted from the decrease in averagecash and investment balances.  Interestexpense increased to $351,000 and $954,000 for the three and nine-month periodsended September 30, 2001 from $120,000 and $358,000 for the same periods in2000.  The increase was primarilyattributed to additional equipment financing obligations, lines of credit andthe term loan.

 

#### **LIQUIDITY ANDCAPITAL RESOURCES**

 

At September 30, 2001, we had cash, cash equivalentsand short-term investments of $41.2 million including restricted cash depositsof approximately $7.5 million in connection with standby letters of credit forleased facilities, security deposit on the line of credit and drug supplyagreements.  The Company regularlyinvests excess funds in short-term money market funds and commercial paper.

 

Net cash used in operating activities for thenine-month periods ended September 30, 2001 and 2000 was $39.2 million and$34.4 million, respectively.  Cash used in operating activities in the nine-monthperiod ended September 30, 2001 was primarily the result of net lossesdecreases in accounts payables and decreases in accrued clinical liabilitiesoffset by the write-off of assets and accrued liabilities associated with theCompany’s restructuring plan, decreases to other assets primarily prepaidexpenses for clinical trials and decreases to interest receivable, an increaseto deposits received for the sale of assets, and increases to otherliabilities, primarily deferred rent in connection with our facilities leases. Cashused in operating activities in the nine-month period ended September 30, 2000was primarily the result of net losses after adjustments to reconcile netlosses to net cash, increased prepaid expenses primarily for clinical trials,and decreases in amounts payable to our contract partner offset by increases inaccrued liabilities, increases in accrued clinical liabilities.

 

Net cash provided by investing activities for thenine-month period ended September 30, 2001 was $28.3 million. Net cash used ininvesting activities for the nine-month period ended September 30, 2000 was$46.1 million.  Cash provided byinvesting activities in the nine-month period ended September 30, 2001 was dueto the maturities of short-term investments of $38.2 million partially offsetby the purchase of short term investments of $6.3 million and capitalexpenditures of $3.6 million. Cash used in investing activities in thenine-month period ended September 30, 2000 was due to the purchase of shortterm investments of $51.1 million and capital expenditures of $4.1 million,offset by maturities of short-term investments of $9.1 million. 

 

Net cash used in financing activities for thenine-month period ended September 30, 2001 was $1.9 million. Net cash providedby financing activities for the nine-month period ended September 30, 2000 was$109.0 million. Cash used in financing activities for the nine-month periodended September 30, 2001 was due to payments on financing obligations of $13.3million partially offset by $11.2 million in additional financing obligationsand $194,000 from the issuance of common stock. Cash provided by financingactivities for the nine-month period ended September 30, 2000, was due to netproceeds from the issuance of common stock of $103.7 million primarily from theinitial public offering, and proceeds of $6.1 million from financingobligations partially offset by payments of $754,000 on financing obligations.

 

We expect to continue to incur substantial operatinglosses.  We believe that existingcapital resources and interest income will be sufficient to fund our operationsfor at least the next 12 months. 

 

Our future capital requirements will depend on manyfactors, including:

 

-the timing, cost, extent and results of clinical trials;

 

-payments to third parties for manufacturing scale up;

 

- the costs and timing of regulatory approvals;  

 

- the costs of acquiring technologies or assets that compliment ourbusiness;  

 

-the costs of establishing sales, marketing and distribution capabilities;

 

-the progress of our research and development activities;

 

-availability of technology in-licensing opportunities; and

 

-future opportunities for raising capital.

 

Until we can generate sufficientcash from our operations, which we do not anticipate in the foreseeable future,we will need to finance future cash needs through private and publicfinancings, including equity financings. We cannot be certain that additionalfunding will be available when needed or on favorable terms. If funding is notavailable, we may need to delay or curtail our development andcommercialization activities to a significant extent.

**RISKSRELATED TO OUR BUSINESS**

 

*Ourbusiness faces significant risks and the risks described below may not be theonly risks we face.  Additional risks that we do not know of or that we currentlybelieve are immaterial may also impair our business operations.  If any of the events or circumstancesdescribed in the following risks actually occurs, our business, financialcondition, or results of operations could be materially adversely affected andthe trading price of our common stock could decline.*

 

**If we are unable to successfully complete our phase IIItrials for iseganan HCl, we may be unable to continue operations.**

** **

We are focusing our human andcapital resources on one product candidate, iseganan HCl, in late stages ofdevelopment.** **If we are unable to successfully complete our currentand planned phase III clinical trials for this product on time or at all, wemay be unable to register the product with the FDA, commercialize the product,or continue operations.  If we areunable to retain our key employees we may have to delay our clinical trials.Also, our current cash resources may not be adequate to complete all of theclinical trials necessary for product registration with the FDA.

 

**We expect to continue to incur future operating losses andmay never achieve profitability. **

 

We have never generated revenuefrom product sales and have incurred significant net losses in each year sinceinception. We incurred net losses of $23.1 million in 1999, $45.6 million in2000 and $59.9 million in the nine-months ended September 30, 2001.  Our accumulated deficit was approximately$158.4 million as of September 30, 2001. We expect to continue to incursubstantial additional losses for the foreseeable future primarily as a resultof our clinical trial expense costs, and we may never become profitable. Inaddition, we will continue to have expenses for development costs tocommercialize iseganan HCl oral solution. To date, we have financed ouroperations primarily through the private sale of equity securities, fundsreceived from a terminated collaboration agreement, the proceeds of equipmentfinancing arrangements and our initial public offering of common stock in March2000. We will receive product revenues only if we complete clinical trials withrespect to one or more products, receive regulatory approvals and successfullycommercialize such products.  

 

**We may be forced to raisecapital sooner than currently anticipated and if we fail to obtain the capitalnecessary to fund our operations, we will be unable to develop our drug candidatesand may have to cease operations.**

 

We believe that our currentcash, cash equivalents and restricted cash deposits of approximately $33.7million, short-term investments of approximately $7.5 million and interestincome are sufficient to meet our operating and capital requirements for atleast the next 12 months. However, we have based this estimate on assumptionsthat may prove to be wrong. For the nine months ended September 30, 2001 andthe years ended December 31, 2000, 1999 and 1998, net cash used for operatingactivities was $39.2 million, $50.4 million, $25.1 million and $9.3 million,respectively.  Our future liquidity andcapital requirements will depend on many factors, including the timing, cost, extentand results of clinical trials, payments associated with manufacturingscale-up, the costs and timing of regulatory approvals, costs associated withresearching drug candidates, securing in-licensing opportunities and conductingpre-clinical research.

 

Any additional equityfinancing may be dilutive to stockholders, and debt financing, if available,may involve restrictive covenants. Collaborative arrangements may require us torelinquish our rights to certain of our technologies, drug candidates ormarketing territories. We believe that additional financing may be required inthe future to fund our operations. We do not know whether additional financingwill be available when needed or on acceptable terms, if at all. If we areunable to raise additional financing when necessary, we may have to delay someor all of our product development efforts or be forced to cease operations.

**We depend on the outcomeof our clinical trials and if they are unsuccessful, we may not be able tocommercialize our products and generate product revenue.**

 

Before obtainingregulatory approvals for the commercial sale of any products, we mustdemonstrate through preclinical research and clinical trials that our drugcandidates are safe and effective for use in humans. We currently have one drugcandidate in phase III clinical trials, isegananHCl oral solution.  If this drugcandidate fails to establish safety and efficacy in phase III clinical trials,we would be unable to obtain regulatory approval from the FDA or tocommercialize the drug candidate, and we will be unable to generate productrevenue from that candidate. Clinical trials are expensive and time-consumingto conduct, and the outcome of these trials is uncertain. A number of new drugshave shown promising results in clinical trials, but subsequently failed toestablish sufficient safety and efficacy data to obtain necessary regulatoryapprovals. A number of companies have suffered significant setbacks in advancedclinical trials, even after promising results in earlier trials.

 

In addition, if we have delaysin clinical trials or the FDA approval process or if we need to perform more orlarger clinical trials, our product development costs will increase and ourability to generate product revenue will be delayed.

 

Our commencement and completionof clinical trials may be delayed by many factors, including:

 

-slower than expected rate of patient recruitment;

 

-inability to adequately obtain data about patients after their treatment;

 

- additional regulatory requests;

 

-inability to manufacture sufficient quantities of materials used for clinicaltrials; or

 

-unforeseen safety issues.

 

**If our collaborativepartners assisting in our clinical trials fail to appropriately manage ourclinical trials, the trials could be delayed or could fail.**

 

We have limited experience inconducting and managing clinical trials. We rely on several contract researchorganizations, including PharmaNet, Inc., to assist us in managing andmonitoring our clinical trials. The FDA may inspect some of our clinicalinvestigational sites, our collaborative partner’s records and our facility andfiles to determine if the clinical trials were conducted according to goodclinical practices. If the FDA determines that the trials were not incompliance, we may be required to repeat the clinical trials. If our contractresearch organizations fail to perform under our agreements with them, we mayface delays in completing our clinical trials or failure of our clinicalprogram.

 

 

**If our single-sourcethird party manufacturers fail to produce clinical or commercial quantities ofour drug candidate, we may not have sufficient quantities of our drug candidateto meet demand.**

 

We rely on PolyPeptide tomanufacture iseganan HCl on a commercial scale. While we maintain a limitedinventory of iseganan HCl, we depend on this single-source contractmanufacturer to produce our product for use in our clinical trials. Ourcontract manufacturer has limited experience in manufacturing iseganan HCl inquantities sufficient for commercialization and may have difficulty in scalingup production. If our contract manufacturer is unable or fails to produce therequired quantities of iseganan HCl for clinical use or commercial sale on atimely basis, at commercially reasonable prices and with sufficient purity, wewill not have sufficient quantities of iseganan HCl to complete current andfuture clinical trials, or to meet commercial demand. In addition, we intend tocontract with third parties for the manufacture of the final formulation. Wecannot guarantee that we will be able to contract with a reliable manufactureron commercially reasonable terms.

Our third-party manufacturer andwe are required to register manufacturing facilities with the FDA and foreignregulatory authorities. If these facilities become unavailable for any reasonor if our contract manufacturer fail to comply with the FDA’s current goodmanufacturing practices or if our contract manufacturer terminates theiragreements with us, we would have to find an alternative source formanufacturing our drug candidates. There are, on a worldwide basis, a limitednumber of contract facilities in which our drug candidates can be producedaccording to current good manufacturing practice regulations. In addition, themanufacturing processes for iseganan HCl is extremely complex and proprietary.If we are unable to continue having iseganan HCl manufactured by our currentcontract manufacturer, we do not know if we could engage another contractmanufacturer when needed or on acceptable terms, if at all.

 

**If we fail to obtain FDAapprovals for our products, we will be unable to commercialize our drugcandidates.**

 

We do not have a drug candidateapproved for sale in the United States or any foreign market. We must obtainapproval from the FDA in order to sell our drug candidates in the United Statesand from foreign regulatory authorities in order to sell our drug candidates inother countries. We must successfully complete our phase III clinical trialsand demonstrate manufacturing capability before we can file with the FDA forapproval to sell our products. The FDA could require us to repeat clinicaltrials as part of the regulatory review process. In addition, the FDA mayrequire a review of our new drug application by an advisory panel, which mayrequest additional information. Delays in obtaining or failure to obtainregulatory approvals may:

 

- delay or prevent thesuccessful commercialization of any of our drug candidate;

 

- diminish our competitiveadvantage; and

 

- defer or decrease our receiptof revenues or royalties.

 

The regulatory review andapproval process is lengthy, expensive and uncertain. Extensive preclinical andclinical data and supporting information must be submitted to the FDA for eachindication to establish safety and effectiveness in order to secure FDAapproval. We have limited experience in obtaining such approvals, and cannot becertain when, if ever, we will receive these regulatory approvals.

 

In addition to initialregulatory approval, our drug candidates will be subject to extensive andrigorous ongoing domestic and foreign government regulation.  Any approvals, once obtained, may bewithdrawn if compliance with regulatory requirements is not maintained orsafety problems are identified. Failure to comply with these requirements maysubject us to stringent penalties.

 

**Development andcommercialization of competitive products could reduce or prevent sales of ourproducts and reduce revenue.**

 

We may be unable to competesuccessfully in the marketplace if other companies develop and commercializecompetitive products that are less expensive, more effective, have fewer sideeffects or are easier to administer than our drug candidates. If we are unableto compete successfully with our drug candidates, physicians may not recommendand patients may not buy our drugs, which would cause our product revenue todecline.

 

There are several drugscommercially available or under development that might compete with isegananHCl oral solution. For oral mucositis, there is one approved device, RadiacareÒ, and several drugs in early stage clinical trials. These include growthfactors such as keratinocyte growth factors I and II, G-CSF and interleukin-11,as well as several small molecular entities including EthyolÒ, amlexanox and glutamine. The companies sponsoring these trials havesuccessfully commercialized products in the past. In addition, there may beproducts under development, which we are unaware for the treatment of oralmucositis.

Many of our competitorsand related private and public research and academic institutions havesubstantially greater experience, financial resources and larger research anddevelopment staffs than we do. In addition, many of these competitors, eitheralone or together with their collaborative partners, have significantly greaterexperience than we do in developing drugs, obtaining regulatory approvals andmanufacturing and marketing products. We also compete with these organizationsand other companies for in-licensing opportunities for future drug candidates,and for attracting scientific and management personnel.

 

**If we are unable toadequately protect our intellectual property, we may be unable to sell ourproducts or to compete effectively.**

 

We rely on a combination ofpatents, trade secrets and contractual provisions to protect our intellectualproperty. If we fail to adequately protect our intellectual property, othercompanies or individuals may prevent us from selling our products or maydevelop competing products based on our technology. Our success depends in parton our ability to:

 

- obtain patents;

 

- protect trade secrets;

 

- operate without infringingupon the proprietary rights of others; and

 

- prevent others from infringingon our proprietary rights.

 

We will be able to protect ourproprietary rights from unauthorized use by third parties only to the extentthat our proprietary rights are covered by valid and enforceable patents or areeffectively maintained as trade secrets.

 

We try to protect ourproprietary position by filing U.S. and foreign patent applications related toour proprietary technology, inventions and improvements that are important tothe development of our business. For example, we own or have rights to sevenpatents and two pending patent applications in the U.S. However, the patentposition of biopharmaceutical companies involves complex legal and factualquestions. We cannot predict the enforceability or scope of any issued patentsor those that may issue in the future. Patents, if issued, may be challenged,invalidated or circumvented. Consequently, if any patents that we own orlicense from third parties do not provide sufficient protection, ourcompetitive position would be weakened. Furthermore, others may independentlydevelop similar technologies or duplicate any technology that we havedeveloped.  In addition, we may not beissued patents for our pending patent applications, those we may file in thefuture, or those we may license from third parties.

 

In addition to patents, we relyon trade secrets and proprietary know-how. Our contract manufacturer performs the manufacturing processes coveredby these trade secrets. Accordingly, our contract manufacturer and we mustmaintain confidentiality. We have confidentiality and proprietary informationagreements with our contract manufacturer and with our employees. Theseagreements may not provide meaningful protection or adequate remedies for ourtechnology in the event of unauthorized use or disclosure of confidential andproprietary information.

 

**We may be subject tointellectual property litigation that could be costly and time-consuming.**

 

The biotechnology andpharmaceutical industries have been characterized by extensive litigationregarding patents and other intellectual property rights.  Although we are not currently a party to anyintellectual property lawsuits, third parties may assert infringement or otherintellectual property claims against us. We may have to pay substantialdamages, including treble damages, for past infringement if it is ultimatelydetermined that our products infringe a third party’s proprietary rights. Thedefense and prosecution of intellectual property suits, U.S. Patent andTrademark Office interference proceedings and related legal and administrativeproceedings in the United States and internationally are costly andtime-consuming to pursue and their outcome is uncertain. If we become involvedin any of these proceedings, we will incur substantial expense and the effortsof our technical and management personnel will be significantly diverted. Anadverse determination may result in the invalidation of our patents, subject usto significant liabilities or require us to seek licenses that may not beavailable from third parties on satisfactory terms, or at all. Our stock pricecould decline based on any public announcements related to litigation orinterference proceedings initiated or threatened against us.

**If physicians and patients do notaccept our products, we may be unable to generate significant revenue, if any.**

 

Our drug candidates may not gainmarket acceptance among physicians, patients and the medical community. If anyof our drug candidates fail to achieve market acceptance, we may be unable tosuccessfully market and sell the product, which would limit our ability togenerate revenue. The degree of market acceptance of any drug candidate dependson a number of factors, including:

 

- demonstration of clinicalefficacy and safety;

 

- cost-effectiveness;

 

- convenience and ease ofadministration;

 

- potential advantage overalternative treatment methods; and

 

- marketing and distributionsupport.

 

Currently, we have one drugcandidate in phase III clinical trials and do not have any drug candidateapproved by the FDA. Physicians will not recommend our products until such timeas clinical data or other factors demonstrate the safety and efficacy of ourdrugs as compared to other treatments. In practice, competitors may be moreeffective in marketing their drugs. Even if the clinical safety and efficacy ofour antibiotic products is established, physicians may elect not to recommendproducts. For example, physicians may be reluctant to prescribe widespread useof our products because of concern about developing bacterial strains that areresistant to our drugs.

 

**If we are unable toestablish sales, marketing and distribution capabilities or enter intoagreements with third parties to perform these services, we will be unable tocommercialize our drug product.**

 

We do not currently havemarketing, sales or distribution capabilities. Initially we intend to establisha direct marketing and sales force in the United States and Canada. If we failto establish successful marketing and sales capabilities or fail to entersuccessful marketing arrangements with third parties, we would be unable tocommercialize our drug product. We must develop a marketing and sales forcewith technical expertise and distribution capabilities to market our productdirectly.  We intend to enter intoarrangements with third parties to market and sell most of our products outsideof the United States and Canada. To the extent that we enter into marketing andsales arrangements with other companies, our revenues will be lower than if wemarketed the products directly.

 

**The failure to recruitand retain key personnel may delay our ability to complete, develop andcommercialize iseganan HCl oral solution.**

 

We are highly dependenton our management and technical staff. Competition for personnel is intense. Ifwe lose the services of any of our senior management, , we may be delayed inour product development and commercialization efforts. We do not maintain keyperson life insurance and do not have employment agreements with our managementand technical staff. In order to pursue product development, marketing andcommercialization plans, we may need to hire additional qualified scientificpersonnel.  We will also need to hirepersonnel with expertise in clinical testing, government regulation,manufacturing, marketing and finance. We may not be able to attract and retainpersonnel on acceptable terms given the competition for such personnel amongbiotechnology, pharmaceutical and other companies.

 

In addition, we rely onconsultants to assist us in formulating our research and clinical developmentstrategy. All of our consultants are employed by other entities. They may havecommitments to, or relationships with, other entities that may limit theiravailability to us. The loss of the services of these personnel may delay ourresearch and development efforts.

**Directors, executive officers,principal stockholders and affiliated entities own a significant portion of ourcapital stock and will have substantial control over our activities.**

 

Our directors, executiveofficers, principal stockholders and affiliated entities beneficially own, inthe aggregate, approximately 51% of our outstanding common stock. Thesestockholders, if acting together, will be able to significantly influence allmatters requiring approval by our stockholders, including the election ofdirectors and the approval of mergers or other business combinationtransactions.

 

**Antitakeover provisionsin our charter documents and under Delaware law may make an acquisition of usmore difficult.**

 

Provisions of our certificate ofincorporation and bylaws could make it more difficult for a third party toacquire us, even if doing so would be beneficial to our stockholders.

 

These provisions:

 

- provide for a classified boardof directors of which approximately one third of the directors will be electedeach year;

 

- allow the authorized number ofdirectors to be changed only by resolution of the board of  directors;

 

- require that stockholderactions must be effected at a duly called stockholder meeting and prohibitstockholder action by written consent; 

 

- establish advance noticerequirements for nominations to the board of directors or for proposals thatcan be acted on at stockholder meetings; and

 

- limit who may call stockholdermeetings.

 

In addition, because we areincorporated in Delaware, we are governed by the provisions of Section 203 ofthe Delaware General Corporation Law, which may prohibit large stockholdersfrom consummating a merger with, or acquisition of us. These provisions mayprevent a merger or acquisition that would be attractive to stockholders andcould limit the price that investors would be willing to pay in the future forour common stock.

 

**Our stock price may bevolatile, and the value of your investment may decline. **

 

The market prices for securitiesof biotechnology companies in general have been highly volatile and our stockmay be subject to volatility. The following factors, in addition to the otherrisk factors described in this section, may have a significant impact on themarket price of our common stock:

 

-announcements of technological innovations or new commercial products by ourcompetitors or us;

 

- developments concerningproprietary rights;

 

-publicity regarding actual or perceived changes in program timelines or resultsobtained in our clinical trials;

 

- publicity regarding actual orperceived adverse events in our clinical trials or relating to products underdevelopment by our competitors;

 

- regulatory developments in theUnited States or foreign countries;

 

- litigation;

 

- significant short selling inour common stock;

 

- economic and other externalfactors; and

 

- period-to-period fluctuationsin our financial results and changes in analysts’ recommendations.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE REGARDING MARKET RISK

 

The primary objective of our investment activities isto preserve our capital until it is required to fund operations at the sametime maximizing the income we receive from our investments withoutsignificantly increasing risk.  We ownfinancial instruments that are sensitive to market risks as part of ourinvestment portfolio.  To minimize thisrisk, we maintain a portfolio of cash equivalents and short-term investments ina variety of securities, including money market funds and commercialpaper.  The average maturity of all ourinvestments in the nine months ended September 30, 2001 was less than oneyear.  Due to the short-term nature ofthese investments, a 50 basis point movement in market interest rates would nothave a material impact on the fair value of our portfolio as of September 30,2001 and the fiscal years December 31, 2000 and 1999. We have no investmentsdenominated in foreign country currencies and therefore our investments are notsubject to foreign currency exchange risk.

PART II OTHER INFORMATION

 

ITEM 1. LEGALPROCEEDINGS

 

On April 5, 2001, wecommenced arbitration proceedings against Interactive Clinical Technologies,Inc. (ICTI) and Galen Holdings regarding the previously disclosed error in thedrug dispensing for two of our Phase III clinical trials. We are seekingdamages, including the full costs of one of the previous Phase III trials andpartial costs of the second.  On July 2,2001, Galen Holdings sued IntraBiotics in the State of New Jersey Federal Courtseeking an injunction barring the arbitration as to Galen.  Galen is notseeking damages from IntraBiotics and the only issue raised by Galen'scomplaint is arbitrability.  On September 25, 2001, ICTI filed a counterclaim against IntraBiotics in the arbitration proceedings claiming unspecifieddamages due to breach of a confidentiality provision in the master agreementbetween ICTI and IntraBiotics based on the disclosure of ICTI's name inconnection with the error.  We expect both the arbitration and theassociated litigation to be resolved in or before the first quarter of 2002.

 

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

 

Our Registration Statement on Form S-1 filed pursuantto the Securities Act of 1933 (No. 333-95461) was declared effective on March27, 2000.  The net offering proceeds tous after all expenses was approximately $103.3 million.  From the effective date of the registrationstatement through September 30, 2001, $33.1 million of the net proceeds havebeen used for our clinical trials, $6.3 million for the development and scaleup of manufacturing processes by our contract manufacturers, $26.3 million forresearch and development, $22.0 million for restructuring charges and $16.5million for working capital and other general purposes.

 

On July 27, 2001, we issued to Diversa Corporation awarrant to purchase up to 700,000 shares of our common stock at an exerciseprice of $2.00 per share in connection with the termination of the Discovery,Development and License Agreement with Diversa.  The sale and issuance of the warrant was made in reliance onSection 4(2) of the Securities Act of 1933 as a transaction not involving apublic offering.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a)   List of Exhibits

 

None

 

(b)           Reportson Form 8-K

 

The Company did not filea report on Form 8-K during the quarter ended September 30, 2001.

                                

                Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   |             |   | IntraBiotics Pharmaceuticals, Inc.    |
|--------|------------------|--------|---------------------------------------|
|   |             |   |                                  |
|   |             |   |                                  |
|   |             |   | /S/ Kenneth J. Kelley                 |
|   | November 8, 2001 |   | Kenneth J. Kelley                     |
|   |             |   | Chairman of the Board,                |
|   |             |   | President and Chief Executive Officer |
|   |             |   |                                  |
|   |             |   |                                  |
|   |             |   | /S/ Gary S. Titus                     |
|   | November 8, 2001 |   | Gary S. Titus                         |
|   |             |   | Senior Director, Finance              |
|   |             |   | (Chief Accounting Officer)            |