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SEC Filings

S-1/A
OREXIGEN THERAPEUTICS, INC. filed this Form S-1/A on 02/16/2007
Entire Document
 
Orexigen Therapeutics, Inc.
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As filed with the Securities and Exchange Commission on February 16, 2007
Registration No. 333-139496
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Amendment No. 2
to
 
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
 
 
 
OREXIGEN THERAPEUTICS, INC.
(Exact name of Registrant as specified in its charter)
 
 
 
 
         
Delaware
  2834   65-1178822
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)
12481 High Bluff Drive, Suite 160
San Diego, CA 92130
(858) 436-8600
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
 
 
 
 
Gary D. Tollefson, M.D., Ph.D.
President and Chief Executive Officer
Orexigen Therapeutics, Inc.
12481 High Bluff Drive, Suite 160
San Diego, CA 92130
(858) 436-8600
(Name, address, including zip code, and telephone number, including area code, of agent for service)
 
 
 
 
Copies to:
 
     
Charles K. Ruck, Esq.
Cheston J. Larson, Esq.
Latham & Watkins LLP
12636 High Bluff Drive
Suite 400
San Diego, CA 92130
(858) 523-5400
  Kenneth L. Bressler, Esq.
Elise M. Adams, Esq.
Blank Rome LLP
The Chrysler Building
405 Lexington Avenue
New York, NY 10174
(212) 885-5000
 
 
 
 
Approximate date of commencement of proposed sale to the public:  As soon as practicable after the effective date of this Registration Statement.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
 
 
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 


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The information contained in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.
 
Subject to Completion
Preliminary Prospectus dated February 16, 2007
 
P R O S P E C T U S
 
          Shares
 
(LOGO)
 
Common Stock
 
 
 
 
This is the initial public offering of our common stock. We are offering      shares of common stock.
 
We expect the initial public offering price to be between $      and $      per share. Currently, no public market exists for the shares of our common stock. After pricing of the offering, we expect that our common stock will be listed on the Nasdaq Global Market under the symbol “OREX.”
 
Investing in our common stock involves risks that are described in the “Risk Factors” section beginning on page 9 of this prospectus.
 
 
 
 
         
    Per Share   Total
 
Public offering price
  $   $
Underwriting discount
  $   $
Proceeds, before expenses, to us
  $   $
 
The underwriters may also purchase up to an additional      shares of common stock from us at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover overallotments.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
The shares of common stock will be ready for delivery on or about           , 2007.
 
 
 
 
     
Merrill Lynch & Co.
  JPMorgan
     
JMP Securities
  Leerink Swann & Company
 
 
 
 
The date of this prospectus is          , 2007.


 

 
TABLE OF CONTENTS
 
         
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  F-1
 EXHIBIT 3.2
 EXHIBIT 3.4
 EXHIBIT 10.1
 EXHIBIT 10.2
 EXHIBIT 10.4
 EXHIBIT 10.5
 EXHIBIT 23.1
 
 
You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with information different from or in addition to that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where such offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.
 
For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus.


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PROSPECTUS SUMMARY
 
This summary does not contain all of the information you should consider before buying shares of our common stock. You should read the entire prospectus carefully, especially the “Risk Factors” section and our financial statements and the related notes appearing at the end of this prospectus, before deciding to invest in shares of our common stock. Unless the context requires otherwise, references in this prospectus to “Orexigen,” “we,” “us” and “our” refer to Orexigen Therapeutics, Inc.
 
Orexigen Therapeutics, Inc.
 
Our Company
 
We are a biopharmaceutical company focused on the development of pharmaceutical product candidates for the treatment of central nervous system, or CNS, disorders, with an initial focus on obesity. Our strategy involves combining individual generic drugs that have previously received regulatory approval for other indications and, thus, have established post-marketing safety records. We systematically screen these drugs for synergistic CNS activity and combine them into new product candidates that we believe address unmet medical needs and are patentable. We are testing combinations of individual generic drugs in our product candidates in an effort to demonstrate adequate efficacy and safety for potential regulatory approval and have not yet received regulatory approval of any product candidate. Our lead combination product candidates targeted for obesity are Contravetm, which we plan to advance into Phase III clinical trials in the first half of 2007, and Excaliatm, which is in late Phase II clinical trials. In addition, we plan to continue to screen drugs for synergistic CNS activity and, based on the results, we may advance other potential combination product candidates into clinical trials.
 
The Obesity Epidemic
 
Obesity is a serious condition that is growing in prevalence and afflicts populations worldwide. In 1980, approximately 15% of the adult population in the United States was obese, according to the National Health and Nutrition Examination Survey. By 2002, the obesity rate had doubled to approximately 30% of the U.S. adult population, according to a later installment of the same survey. In addition, the survey estimated that another 34% of the U.S. adult population was overweight in 2002. We expect that given current trends, many members of this group will become obese in coming years.
 
In 2004, the Centers for Disease Control and Prevention identified obesity as the number one health threat in the United States. Approximately 300,000 deaths per year in the United States are associated with obesity according to the Department of Health and Human Services, or HHS. Obesity is also a significant health problem outside of the United States. According to the World Health Organization, there are as many as 1.6 billion people worldwide considered to be overweight, of which at least 400 million are estimated to be obese. Research has established a new disease category called metabolic syndrome, which comprises the various co-morbidities, or related conditions, that often accompany obesity, such as diabetes, cancer, hypertension and high cholesterol. We believe there is a growing recognition within the medical community that obesity significantly exacerbates these conditions. In addition, obesity and its co-morbidities are believed to cause significant added cost to the health care system. In 2000, HHS estimated the overall economic costs of obesity in the United States to be $117 billion. Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for more effective pharmacological interventions.
 
Our Product Candidates
 
We have selected our product candidates based on our research regarding CNS regulation of appetite and energy expenditure, as well as the reward-based mechanisms in the brain that reinforce unhealthy eating behaviors. The components of each of our product candidates exhibited strong synergy within our screening model, which enabled us to prioritize these product candidates over others considered. In particular, we have focused our clinical development programs on drug combinations that we expect will generate weight loss and


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attenuate, or limit the effect of, the pathways in the brain that prevent extended weight loss. Our combination approach contrasts with most currently approved weight loss drug therapies, which utilize a single active ingredient and have typically shown early weight loss followed by a plateau after several months of treatment. We believe that our approach to obesity drug development will permit a more sustained, clinically relevant pattern of weight reduction. Results from our clinical trials to date for both Contrave and Excalia have supported this hypothesis. We believe that our strategy will increase our probability of technical success while reducing both the time and cost associated with development.
 
In addition, we are seeking to improve the profiles of our product candidates by developing proprietary sustained release, or SR, drug delivery formulations for their constituent drugs. To date, compositions of Contrave and Excalia using these proprietary SR formulations for the constituents naltrexone and zonisamide, respectively, have demonstrated improved patient tolerability compared to those using previously approved immediate release, or IR, formulations of naltrexone and zonisamide. Because of differences in pharmacokinetics between the generically available formulations and our proprietary SR formulations, we believe we can enhance patient outcomes and our competitive position.
 
We will need to conduct additional clinical trials, however, in order to provide enough evidence regarding efficacy and safety to submit an NDA to the FDA for potential regulatory approval. These trials may not corroborate our earlier results. In addition, undesirable side effects of our product candidates may delay or prevent their regulatory approval.
 
In April 2006, we met with the U.S. Food and Drug Administration, or FDA, to discuss the remaining clinical trial requirements for submission of new drug application, or NDA, filings for both Contrave and Excalia. Based on feedback from the FDA, we intend to conduct clinical development programs to provide active drug exposure among 1,500 patients for one year, under double-blind, placebo-controlled conditions for each product candidate. We expect to file an NDA with the FDA in the second half of 2009 for Contrave and in 2011 for Excalia, assuming that our clinical trials proceed as scheduled and are successful.
 
Contrave
 
Contrave is a fixed dose combination of naltrexone SR and bupropion SR. We chose these constituents based on the results of our screening model as well as our understanding of the circuitries in the brain that regulate appetite and energy balance. In particular, naltrexone was chosen as a complement to bupropion in order to block compensating mechanisms that attempt to prevent long term, sustained weight loss. We hold the exclusive license to two issued U.S. patents covering the Contrave composition, and we have filed additional patents covering various compositions, methods of use and formulations.
 
Naltrexone was approved in the United States in 1984 for the treatment of opioid addiction and in 1995 for the treatment of alcoholism. Naltrexone works by blocking opioid receptors in the brain and inhibits the reinforcing aspects of addictive substances, reducing their perceived reward. It has been shown in numerous studies to negatively alter the palatability, or taste, of many foods, particularly sweets, including, for example, a study published in the October 2002 issue of Neuroscience and Biobehavioral Reviews. However, nausea is a well-known side effect associated with naltrexone that affects its tolerability. In our Contrave clinical trials to date, we have used the generic IR formulation of naltrexone. Commencing with our planned Phase III trials, naltrexone will be delivered in our proprietary SR formulation in order to improve its tolerability.
 
Bupropion was approved for marketing in the United States in 1985 for depression and in 1997 for smoking cessation. Functionally, bupropion is thought to increase the level of dopamine activity at specific receptors of the brain, which appears to lead to a reduction in appetite and increase in energy expenditure. It is currently among the most commonly prescribed anti-depressants in the United States, according to IMS Health. Bupropion has become popular in the treatment of depression not only for its clinical efficacy, but also its attractive side effect profile, including modest weight loss.


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We initiated clinical testing of Contrave with a Phase II clinical trial in 2004. This trial enrolled 238 patients at eight U.S. clinical trial sites to evaluate the safety and efficacy of the Contrave combination. The primary endpoint for this trial was percent change in body weight 16 weeks after the start of treatment, with secondary endpoints that included the percent change in body weight 24 weeks after the start of treatment. Results from this trial are summarized as follows:
 
  •      On an intent-to-treat basis, which includes all randomized patients who recorded at least one post-baseline body weight measurement, Contrave demonstrated mean weight loss of 4.0% of baseline body weight at 16 weeks and 5.2% at 24 weeks.
 
  •      On a completer basis, which includes patients who completed treatment through particular milestones, Contrave demonstrated mean weight loss of 4.8% of baseline body weight at 16 weeks and 6.8% at 24 weeks.
 
  •      Patients who received placebo in this trial showed mean weight loss of 1.0% at 16 weeks on both an intent-to-treat and completer basis. The placebo arm of the trial was discontinued at that point, as specified in the clinical trial protocol.
 
In July 2005, we proceeded to study Contrave in a larger Phase IIb trial exploring a higher dose of bupropion SR paired with three different doses of naltrexone IR. This trial enrolled 419 patients at eight U.S. clinical trial sites under placebo-controlled, double-blind conditions. The primary endpoint for this trial was percent change in body weight 24 weeks after the start of treatment. Results from this trial are summarized as follows:
 
  •      On an intent-to-treat basis, the three Contrave dosage groups demonstrated mean weight loss of 4.3% to 5.4% of baseline body weight at 24 weeks, compared to mean weight loss of 0.8% among the placebo group.
 
  •      On a completer basis, the three Contrave dosage groups demonstrated mean weight loss of 7.0% to 7.6% of baseline body weight at 24 weeks, compared to mean weight loss of 1.1% among the placebo group.
 
The protocol for this study permitted participants to continue on Contrave for an additional 24 weeks of open-label treatment. The study is ongoing and 48 week data are not yet available. Through 36 weeks:
 
  •      On an intent-to-treat basis, the three Contrave dosage groups demonstrated mean weight loss of 4.6% to 6.1% of baseline body weight.
 
  •      On a completer basis, the three Contrave dosage groups demonstrated mean weight loss of 8.0% to 9.3% of baseline body weight.
 
The most common side effects observed in our clinical trials of Contrave to date include nausea, dizziness, insomnia and headaches.
 
Excalia
 
Excalia is a fixed dose combination of zonisamide SR and bupropion SR. The combination of zonisamide and bupropion, in our screening model, produced an eight-fold increase in relevant neuronal activity, suggesting that this drug combination would enhance satiety and energy expenditure. Based on the strength of these results and Excalia’s unique mechanism of action, we selected this product combination to complement our Contrave clinical development program. We hold an exclusive license to an issued U.S. patent covering the Excalia composition, and we have filed additional patents covering various compositions, methods of use and formulations.
 
Zonisamide IR was approved in the United States in 2000 for the adjunctive treatment of partial seizures, which is a form of epilepsy. The precise mechanism of zonisamide is unknown; however, it is believed that zonisamide has a number of pharmacologic mechanisms including sodium-channel modulation and enhancement of dopamine and serotonin neurotransmission. Zonisamide, given alone, has also shown weight loss in prior clinical trials conducted at Duke University.


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We initiated clinical testing of Excalia, using fixed dosages of zonisamide IR and bupropion SR, with a Phase II clinical trial in 2004. This trial enrolled 127 patients across five clinical sites in a similar protocol to our Phase II clinical trial of Contrave. The primary endpoint for this trial was percent change in body weight 16 weeks after the start of treatment, with secondary endpoints that included percent change in body weight 24 weeks after the start of treatment. The placebo group from the Phase II trial of Contrave also served as the placebo arm in this trial. Results from this trial are summarized as follows:
 
  •      On an intent-to-treat basis, Excalia demonstrated mean weight loss of 5.2% of baseline body weight at 16 weeks and 5.8% at 24 weeks.
 
  •      On a completer basis, Excalia demonstrated mean weight loss of 8.3% at baseline body weight at 16 weeks and 9.2% at 24 weeks.
 
The trial design also included a re-randomization option after week 28 where Excalia subjects could continue either at their same dose or a reduced dose for up to an additional 20 weeks of open-label treatment. For those study participants who continued treatment on Excalia for an additional 20 week extension and remained on the full Excalia dose, mean weight loss at 36 weeks and 48 weeks was approximately 12% of baseline body weight.
 
The most common side effects observed in our clinical trials of Excalia to date include gastrointestinal upset, insomnia and mild rash.
 
We recently initiated a Phase IIb clinical trial of Excalia utilizing our proprietary SR formulation of zonisamide. This trial has a matrix design intended to determine the optimal dose ratio of zonisamide SR and bupropion SR to evaluate in further clinical development. The primary outcome measure for this trial will be percent change in body weight 24 weeks after the start of treatment, with a 24 week extension period. We have enrolled over 600 patients across 14 sites in this trial.
 
Commercialization
 
We currently retain worldwide marketing rights for both Contrave and Excalia. If approved, we may consider marketing these product candidates to select specialists; however, we expect that Contrave and Excalia have the potential to be prescribed to a significant extent by primary care physicians. In order to target this large group of potential prescribers, we may consider entering into a collaboration with a pharmaceutical company with the sales force and marketing resources to adequately address this physician audience. However, for the foreseeable future, we expect to maintain commercial rights to our product candidates and to continue to develop them independently. We expect to position Contrave for mild to moderate weight loss, particularly in women who report food craving. We believe that Excalia may be especially well-suited for men and post-menopausal women who are heavier and require greater weight reduction. However, the FDA does not distinguish between these types of obesity and, if approved, any potential label for Contrave or Excalia would be expected to refer to obesity generally.
 
Risk Factors
 
We are a development stage company with no product revenues and only limited revenues from licensing and collaborative agreements, and our operations to date have generated substantial and increasing needs for cash. Our business and our ability to execute on our business strategy are subject to a number of risks that you should be aware of before you decide to buy our common stock. In particular, you should consider the following risks, which are discussed more fully in “Risk Factors” beginning on page 9:
 
  •      We are largely dependent on the success of our only two product candidates, Contrave and Excalia, and we cannot be certain that our planned clinical development programs will be sufficient to support NDA submissions or that either product candidate will receive regulatory approval or be successfully commercialized.


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  •      Delays in the commencement, enrollment or completion of clinical testing for either of our product candidates could result in increased costs to us and delay or limit our ability to obtain regulatory approval.
 
  •      Contrave and Excalia may cause undesirable side effects or have other properties that could delay or prevent their regulatory approval or commercialization.
 
  •      We rely on third parties to conduct our clinical trials and manufacture our product candidates, and we cannot be sure that they will successfully carry out their contractual duties or meet expected deadlines.
 
  •      Our product candidates have not been, and may not be, approved for sale by regulatory authorities.
 
  •      Even if our product candidates are approved by regulatory authorities, we expect intense competition in the obesity marketplace.
 
  •      Although we have exclusive licenses to composition of matter patents covering the combinations of drug products in Contrave and Excalia, physicians may nevertheless seek to prescribe the individual components of our product candidates in different, generically-available forms, and pharmacies and benefit managers may seek to substitute generic products, in either case diminishing our market opportunity.
 
  •      We have had a history of losses since our inception and we expect that losses will continue and increase in future periods. Our net losses were $1.9 million in 2003, $7.7 million in 2004, $12.1 million in 2005 and $27.5 million in 2006. As of December 31, 2006, we had an accumulated deficit of $49.2 million.
 
Corporate Information
 
We were incorporated in Delaware in September 2002. Our principal executive offices are located at 12481 High Bluff Drive, Suite 160, San Diego, California 92130, and our telephone number is (858) 436-8600. Our website address is http://www.orexigen.com. The information on or accessible through our website is not part of this prospectus.
 
We have received a Notice of Allowance from the U.S. Patent and Trademark Office, or PTO, for the intent-to-use trademark application for our corporate logo for use in connection with pharmaceutical preparations and substances, including for the treatment of obesity, inducement of weight loss and prevention of weight gain. We have foreign trademark applications pending in Europe, Canada and Japan for the same mark. We have obtained foreign trademark registrations for the corporate name Orexigen Therapeutics, Inc. and the mark OREXIGEN in Japan and have pending trademark applications for the same mark in the United States, Canada and Europe. We have received a Notice of Allowance from the PTO for the intent-to-use trademark application for the mark CONTRAVE for use in connection with pharmaceutical preparations, including for the treatment of obesity and inducing weight loss. We have also applied for U.S. trademark registrations for the mark EXCALIA and have filed applications to register these marks in Europe, Canada and Japan. This prospectus also includes trademarks of other persons, including Acomplia®, Alli®, Depade®, Extavia®, Meridia®, Revia®, Trexan®, Vivitrol®, Wellbutrin®, Xenical®, Zimulti®, Zyban® and Zonegran®.


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THE OFFERING
 
Common stock offered            shares
 
Common stock to be outstanding after this offering            shares
 
Use of proceeds We expect to use the net proceeds from this offering to fund clinical development of our product candidates and for working capital and other general corporate purposes. We may also use a portion of the net proceeds to in-license, acquire or invest in complementary businesses or products.
 
Proposed Nasdaq Global Market symbol OREX
 
The number of shares of common stock to be outstanding after this offering is based on 37,720,558 shares outstanding as of December 31, 2006, after giving effect to the conversion of all of our shares of preferred stock outstanding as of December 31, 2006 into shares of common stock, and excludes:
 
  •      4,594,125 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2006 at a weighted average exercise price of $0.62 per share; and
 
  •                 shares of our common stock reserved for future issuance under our 2007 equity incentive award plan, which will become effective on the day prior to the day on which we become subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act (including 1,516,479 shares of common stock reserved for future grant or issuance under our 2004 stock plan, which shares will be added to the shares to be reserved under our 2007 equity incentive award plan upon the effectiveness of the 2007 equity incentive award plan).
 
Except as otherwise indicated, all information in this prospectus assumes:
 
  •      no exercise by the underwriters of their option to purchase up to an additional           shares of common stock to cover overallotments;
 
  •      the filing of our amended and restated certificate of incorporation and amended and restated bylaws upon completion of this offering;
 
  •      the conversion of all outstanding shares of our preferred stock into 32,924,474 shares of common stock upon completion of this offering; and
 
  •      a one-for-    reverse stock split of our common stock to be effected before the completion of this offering.


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SUMMARY FINANCIAL DATA
 
The following table summarizes certain of our financial data. The summary financial data as of December 31, 2006 and for the years ended December 31, 2004, 2005 and 2006 and for the period from September 12, 2002 (inception) to December 31, 2006 have been derived from our audited financial statements included elsewhere in this prospectus. The summary financial data for the period from September 12, 2002 (inception) to December 31, 2002 and for the year ended December 31, 2003 have been derived from our audited financial statements not included in this prospectus. The data should be read together with our financial statements and related notes, “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The pro forma as adjusted balance sheet data gives effect to the conversion of all outstanding shares of our preferred stock into 32,924,474 shares of our common stock and our sale of           shares of our common stock in this offering at the assumed initial public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus), after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.
 
                                                 
                                  Period from
 
    September 12,
                            September 12,
 
    2002
                            2002
 
    (Inception)
                            (Inception)
 
    Through
                            Through
 
    December 31,
    Years Ended December 31,     December 31,
 
    2002     2003     2004     2005     2006     2006  
 
Statement of Operations Data:
                                               
Revenues:
                                               
Collaborative agreement
  $     $     $     $ 174,137     $     $ 174,137  
License revenue
                      88,230       88,239       176,469  
                                                 
Total revenues
                      262,367       88,239       350,606  
Operating expenses:
                                               
Research and development
          1,163,953       6,144,510       9,708,935       22,586,151       39,603,549  
General and administrative
    1,300       667,088       1,590,500       3,386,167       5,869,438       11,514,493  
                                                 
Total operating expenses
    1,300       1,831,041       7,735,010       13,095,102       28,455,589       51,118,042  
                                                 
Loss from operations
    (1,300 )     (1,831,041 )     (7,735,010 )     (12,832,735 )     (28,367,350 )     (50,767,436 )
Other income (expense):
                                               
Interest income
                47,376       744,165       871,904       1,663,445  
Interest expense
          (50,045 )     (5,702 )           (8,266 )     (64,013 )
                                                 
Total other income (expense)
          (50,045 )     41,674       744,165       863,638       1,599,432  
                                                 
Net loss
    (1,300 )     (1,881,086 )     (7,693,336 )     (12,088,570 )     (27,503,712 )     (49,168,004 )
Accretion to redemption value of redeemable convertible preferred stock
                (12,920 )     (24,142 )     (30,538 )     (67,600 )
Accretion of beneficial conversion for Series C convertible preferred stock
                            (13,859,649 )     (13,859,649 )
                                                 
Net loss attributable to common stockholders
  $ (1,300 )   $ (1,881,086 )   $ (7,706,256 )   $ (12,112,712 )   $ (41,393,899 )   $ (63,095,253 )
                                                 
Basic and diluted net loss per share(1)
  $ (0.00 )   $ (1.16 )   $ (2.50 )   $ (3.06 )   $ (9.44 )        
                                                 
Shares used to calculate net loss per share(1)
    1,288,182       1,627,105       3,077,256       3,960,509       4,386,141          
                                                 
Pro forma basic and diluted net loss per share (unaudited)(1)
                                  $ (0.93 )        
                                                 
Shares used to calculate pro forma net loss per share (unaudited)(1)
                                    29,475,960          
                                                 
 
(1) See Note 2 of Notes to Financial Statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of the per share amounts.


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    As of December 31, 2006  
          Pro Forma
 
    Actual     as Adjusted(1)(2)  
 
Balance Sheet Data:
               
Cash and cash equivalents and investment securities, available-for-sale
  $ 34,413,603     $             
Working capital
    29,645,294          
Total assets
    36,809,984          
Redeemable convertible preferred stock
    45,896,934          
Deficit accumulated during the development stage
    (49,168,004 )        
Total stockholders’ equity (deficit)
    (15,846,922 )        
 
(1) Does not include $17.0 million available for borrowings under the terms of, and subject to the conditions in, our credit and security agreement entered into with Merrill Lynch Capital in December 2006. See Note 3 of Notes to Financial Statements.
 
(2) Each $1.00 increase or decrease in the assumed initial public offering price of $     (the mid-point of the price range set forth on the cover page of this prospectus) would increase or decrease, respectively, the amount of cash and cash equivalents and securities available-for-sale, working capital, total assets and total stockholders’ equity by $     , assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.

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RISK FACTORS
 
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in shares of our common stock. The occurrence of any of the following risks could harm our business, financial condition, results of operations and/or growth prospects. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
 
Risks Related to Our Business and Industry
 
We are largely dependent on the success of our two product candidates in clinical development: Contrave (naltrexone/bupropion, each in a sustained release, or SR, formulation) and Excalia (zonisamide SR/bupropion SR). We cannot be certain that either product candidate will receive regulatory approval or be successfully commercialized.
 
We currently have only two product candidates in clinical development, and our business currently depends entirely on their successful development and commercialization. We currently have no drug products for sale and we may never be able to develop marketable drug products. The research, testing, manufacturing, labeling, approval, sale, marketing and distribution of drug products are subject to extensive regulation by the U.S. Food and Drug Administration, or FDA, and other regulatory authorities in the United States and other countries, which regulations differ from country to country. We are not permitted to market our product candidates in the United States until we receive approval of a new drug application, or NDA, from the FDA, or in any foreign countries until we receive the requisite approval from such countries. We have not submitted an NDA or received marketing approval for either of our product candidates. Obtaining approval of an NDA is a lengthy, expensive and uncertain process. The FDA also has substantial discretion in the drug approval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. For example:
 
  •      the FDA may not deem a product candidate safe and effective;
 
  •      the FDA may not find the data from preclinical studies and clinical trials sufficient to support approval;
 
  •      the FDA may not approve of our third-party manufacturers’ processes and facilities; or
 
  •      the FDA may change its approval policies or adopt new regulations.
 
Contrave is currently being evaluated in clinical trials for the treatment of obesity and will require the successful completion of at least two pivotal clinical trials before we are able to submit an NDA with respect to Contrave to the FDA for potential approval. Excalia is in a Phase IIb clinical trial and, following its Phase II trials, also will need to complete two or more pivotal trials prior to our submission of an NDA to the FDA for potential approval. Our product candidates may not be approved even if they achieve their specified endpoints in these and future clinical trials. The FDA may disagree with our trial design and our interpretation of data from clinical trials, or may change the requirements for approval even after it has reviewed and commented on the design for our clinical trials. The FDA may also approve a product candidate for fewer or more limited indications than we request, or may grant approval contingent on the performance of costly post-approval clinical trials. In addition, the FDA may not approve the labeling claims that we believe are necessary or desirable for the successful commercialization of our product candidates. Any failure to obtain regulatory approval of Contrave or Excalia would limit our ability to ever generate revenues (and any failure to obtain such approval for all of the indications and labeling claims we deem desirable could reduce our potential revenue) and would have a material and adverse impact on our business.
 
Our clinical trials may fail to demonstrate acceptable levels of safety and efficacy of our product candidates, which could prevent or significantly delay their regulatory approval.
 
Our product candidates are prone to the risks of failure inherent in drug development. Before obtaining regulatory approvals for the commercial sale of Contrave, Excalia or any other product candidate for


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a target indication, we must demonstrate with substantial evidence gathered in well-controlled clinical trials, and, with respect to approval in the United States, to the satisfaction of the FDA and, with respect to approval in other countries, similar regulatory authorities in those countries, that the product candidate is safe and effective for use for that target indication.
 
With respect to Contrave, we submitted to the FDA in October 2006 the results of our Phase II clinical trial, which we characterize as a Phase IIb trial because we believe the results from this clinical trial provide sufficient evidence of the superiority of the combination drug therapy to the individual monotherapies in the treatment of obesity. We received correspondence from the FDA in December 2006 in which the FDA agreed that our future pivotal studies for Contrave may be performed against placebo only. While the FDA has provided us with guidance on the general efficacy benchmarks required in pivotal trials for comparison against placebo, we may not be able to achieve these requirements or replicate the results observed in our earlier Phase II and IIb clinical trials. Furthermore, the FDA’s guidelines were set forth in correspondence and not in the form of a binding special protocol assessment and, therefore, may change in the future.
 
With respect to Excalia, we are currently conducting a second Phase II clinical trial to evaluate optimal dose ratios for its active ingredients, and we intend to conduct an additional Phase II trial for Excalia to establish that the combination is more effective than the individual components. It is not clear what magnitude of superiority the FDA will require Excalia to demonstrate versus the most active individual component in order to agree that Phase III trials may be conducted against placebo only. We have not yet commenced any Phase III clinical trials for this product candidate. We also may need to complete additional preclinical testing of our product candidates to evaluate safety and toxicity before we can submit an NDA to the FDA for potential regulatory approval. We will also need to demonstrate comparable bioavailability and bioequivalence of any components of our product candidates used in our Phase II and Phase IIb clinical trials to the components used in our Phase III clinical trials if the formulations of the components to be used in the Phase III clinical trials are different.
 
The results from the preclinical and clinical trials that we have completed for Contrave and Excalia may not be predictive of results obtained in pending or future trials, and we may be unable to demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals for either product candidate. A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. If our drug candidates are not shown to be safe and effective in clinical trials, our clinical development programs could be delayed or terminated. Any delays could also result in the need for additional financing, and our failure to adequately demonstrate the efficacy and safety of Contrave, Excalia or any other product candidates that we may develop, in-license or acquire would prevent receipt of regulatory approval and, ultimately, the commercialization of that product candidate.
 
Our product candidates may cause undesirable side effects or have other properties that could delay or prevent their regulatory approval or limit the commercial profile of any approved label.
 
Undesirable side effects caused by our product candidates could cause us or regulatory authorities to interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities. For example, in each trial evaluating Contrave, some patients experienced nausea. We have developed new formulations and techniques in an effort to reduce the frequency and magnitude of this side effect; however, we have not yet tested these methods in any Phase II or III trials. Other less common side effects reported in our Contrave trials were dizziness, insomnia and headaches. The most common side effects reported in our trials to date of Excalia were gastrointestinal upset, insomnia and mild rash. In addition, while the constituent drugs that make up Contrave and Excalia have post-marketing safety records and while we have tested these constituent drugs in combination in our clinical trials of Contrave and Excalia to date, the combination of these constituent drugs is still being tested and has not received regulatory approval. Accordingly, the safety of their combined use is not yet fully known.
 
A key constituent of Contrave and Excalia is bupropion, which is used in the treatment of depression and to assist smoking cessation. The FDA has directed manufacturers of all antidepressant drugs to include in


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their product labels a “black box” warning and expanded warning statements regarding an increased risk of suicidal thinking and behavior in children and adolescents being treated with these drugs. The package insert for bupropion includes such a “black box” warning statement. Although neither Contrave nor Excalia is intended to be indicated for or used in the treatment of primary depression, many obese patients are depressed and it is possible that depressed obese patients will use our product candidates, if approved. We expect that a similar warning statement will be required on labeling for both Contrave and Excalia. In December 2006, the FDA held an advisory committee meeting regarding suicidal thinking and behavior in adults being treated with antidepressant drugs. The advisory committee recommended that the “black box” warning be extended to cover adults up to their mid-20’s. We expect that any additional warnings or other labeling changes related to suicidal thinking and behavior in adults will be required on labeling for both Contrave and Excalia. The FDA has also directed manufacturers of antidepressant drugs to create Medication Guides to be distributed to patients regarding the risk of suicidal thinking and behavior in children and adolescents. Although we have not designed either the Contrave or Excalia programs for the treatment of children or adolescents, it is possible that the FDA will require a Medication Guide for both Contrave and Excalia. These warnings and other requirements may have the effect of limiting the market acceptance by our targeted physicians and patients of Contrave and Excalia, if these product candidates are approved.
 
In addition, the package insert for zonisamide, one of the two components of Excalia, has a “Category C” pregnancy precaution in its current approved labeling for an epilepsy indication. This means that animal studies have shown zonisamide to be teratogenic, potentially causing birth defects, and that there are no adequate and well-controlled studies of zonisamide in pregnant women, but the benefits from the use of the drug in pregnant woman may be acceptable despite the potential risks. Zonisamide also has a warning that women of childbearing age should be advised to use contraception due to the teratogenicity seen in animal studies. Because of published concerns in academic journals regarding the possible developmental effects of zonisamide in animals as well as reports from Japan in which women receiving zonisamide combined with other anticonvulsants had children with birth defects, it is likely that Excalia, if approved, will receive a “Category X” pregnancy precaution and would be contraindicated for use by pregnant or nursing women with warnings about use of Excalia in women of childbearing age. This means that there would be a limitation on the use of Excalia without adequate contraception or perhaps a prohibition on the use of Excalia by all women of childbearing age.
 
If any of our product candidates receives marketing approval and we or others later identify undesirable side effects caused by the product, a number of potentially significant negative consequences could result, including:
 
  •      regulatory authorities may withdraw their approval of the product;
 
  •      regulatory authorities may require the addition of labeling statements, such as a “black box” warning with Contrave or Excalia or a contraindication;
 
  •      we may be required to create a Medication Guide outlining the risks of such side effects for distribution to patients;
 
  •      we may be required to change the way the product is administered, conduct additional clinical trials or change the labeling of the product;
 
  •      we could be sued and held liable for harm caused to patients; and
 
  •      our reputation may suffer.
 
Any of these events could prevent us from achieving or maintaining market acceptance of the affected product candidate and could substantially increase the costs of commercializing our product candidates.
 
Delays in the commencement or completion of clinical testing could result in increased costs to us and delay or limit our ability to generate revenues.
 
Delays in the commencement or completion of clinical testing could significantly affect our product development costs. We do not know whether planned clinical trials will begin on time or be completed on


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schedule, if at all. The commencement and completion of clinical trials can be delayed for a number of reasons, including delays related to:
 
  •      obtaining regulatory approval to commence a clinical trial;
 
  •      reaching agreement on acceptable terms with prospective clinical research organizations, or CROs, and trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;
 
  •      manufacturing sufficient quantities of a product candidate for use in clinical trials;
 
  •      obtaining institutional review board, or IRB, approval to conduct a clinical trial at a prospective site;
 
  •      recruiting and enrolling patients to participate in clinical trials for a variety of reasons, including competition from other clinical trial programs for the treatment of obesity or similar indications; and
 
  •      retaining patients who have initiated a clinical trial but may be prone to withdraw due to side effects from the therapy, lack of efficacy or personal issues, or who are lost to further follow-up.
 
Clinical trials may also be delayed as a result of ambiguous or negative interim results. In addition, a clinical trial may be suspended or terminated by us, the FDA, the IRB overseeing the clinical trial at issue, any of our clinical trial sites with respect to that site, or other regulatory authorities due to a number of factors, including:
 
  •      failure to conduct the clinical trial in accordance with regulatory requirements or our clinical protocols;
 
  •      inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;
 
  •      unforeseen safety issues; and
 
  •      lack of adequate funding to continue the clinical trial.
 
Additionally, changes in regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect these changes. Amendments may require us to resubmit our clinical trial protocols to IRBs for reexamination, which may impact the costs, timing or successful completion of a clinical trial. If we experience delays in completion of, or if we terminate, any of our clinical trials, the commercial prospects for our product candidates may be harmed and our ability to generate product revenues will be delayed. In addition, many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also ultimately lead to the denial of regulatory approval of a product candidate.
 
Our product candidates are combinations of generically-available pharmaceutical products, and our success is dependent on our ability to prevent off-label generic substitution of our combination products through our patent estate and laws that may prevent substituting drug products that are not therapeutically equivalent to our own.
 
The patents we have in-licensed and our pending patent applications may not prevent physicians from prescribing the generic constituents of our product candidates. We believe that a practitioner seeking safe and effective therapy is not likely to prescribe off-label generics in place of Contrave or Excalia because the dosage strengths, pharmacokinetic profiles and titration regimens recommended for our Contrave and Excalia product candidates are not available using existing generic preparations of naltrexone IR, zonisamide IR and bupropion SR. However, a physician could seek to prescribe off-label generics in place of Contrave or Excalia. Off-label use occurs when a drug that is approved by the FDA for one indication is prescribed by physicians for a different, unapproved indication.
 
With regard to off-label substitution at the pharmacy level, we expect to rely on the novel dose ratios and novel pharmacokinetic properties of our product candidates, as well as the differences in their approved


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indications, to provide sufficient distinction such that generic preparations are not considered therapeutic equivalents by the FDA. State pharmacy laws in many instances preclude pharmacists from substituting with generic preparations if the products are not therapeutic equivalents. Therefore, the lack of therapeutic equivalency restricts generic substitution by pharmacies and/or pharmacy benefit managers. However, we cannot be certain that pharmacists and/or pharmacy benefit managers will not substitute generics in place of Contrave and Excalia, which could significantly diminish their market potential.
 
In addition, although we believe the current market prices for the generic forms of naltrexone and zonisamide make generic substitution by physicians, pharmacists or pharmacy benefit managers unlikely, should the prices of the generic forms decline, the motivation for generic substitution may become stronger. Generic substitution by physicians and at the pharmacy level could have substantial negative consequences to our business.
 
We rely on third parties to conduct our clinical trials. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may not be able to obtain regulatory approval for or commercialize our product candidates within our expected timeframes or at all.
 
We currently rely primarily on Metropolitan Research Associates, or MRA, a CRO, to conduct our clinical trials for Contrave and Excalia, and we may depend on other CROs and independent clinical investigators to conduct our clinical trials in the future. We utilize the services of HHI Clinical & Statistical Services to conduct our data management and an independent statistical consultant to conduct our statistical analysis. The CROs with which we contract for execution of our clinical trials play a significant role in the conduct of these trials and the subsequent collection and analysis of data. CROs and investigators are not our employees, and we have limited ability to control the amount or timing of resources that they devote to our programs. If MRA, other CROs, consultants or independent investigators fail to devote sufficient time and resources to our drug development programs, or if their performance is substandard, it will delay the potential approval of our regulatory applications and the commercialization of our product candidates. In addition, the execution of clinical trials, and the subsequent compilation and analysis of the data produced, requires coordination among various parties. In order for these functions to be carried out effectively and efficiently, it is imperative that these parties communicate and coordinate with one another. Moreover, these independent investigators and CROs may also have relationships with other commercial entities, some of which may compete with us. If independent investigators and CROs assist our competitors, it could harm our competitive position.
 
We expect intense competition in the obesity marketplace for Contrave and Excalia, and new products may emerge that provide different or better therapeutic alternatives for obesity and weight loss.
 
If approved and commercialized, both Contrave and Excalia will compete with well established prescription drugs for the treatment of obesity, including Xenical, marketed by Roche Laboratories Inc., and Meridia, marketed by Abbott Laboratories. Xenical has been launched by GlaxoSmithKline in over-the-counter form, which will represent additional competition and potential negative pricing pressure. Both of these drugs are marketed by pharmaceutical companies with substantially greater resources than us. In addition, a number of generic pharmaceutical products are prescribed for obesity, including phentermine, phendimetrazine, mazindol, benzphetamine and diethylpropion. Some of these generic drugs, and others, are prescribed in combinations that have shown anecdotal evidence of efficacy. These products are sold at much lower prices than we intend to charge for our product candidates, if approved. The availability of a large number of branded prescription products, generic products and over-the-counter products could limit the demand for, and the price we are able to charge for, our product candidates.
 
Other products are also in development which could become successful competitors against our product candidates. These include products being developed by Arena Pharmaceuticals, Inc., Amylin Pharmaceuticals, Inc., Alizyme plc, Merck & Co., Inc., Peptimmune, Inc. and Vivus, Inc., among others. With the exception of Vivus, Inc., most of these efforts are directed toward a monotherapeutic approach which we would expect to be subject to the same early weight loss plateau typically seen. Vivus, Inc. has shown strong efficacy with a combination approach of phentermine and topiramate in a single center study. Rimonabant,


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which is being developed by Sanofi-Aventis, has been approved in certain countries outside of the United States and has received an approvable letter from the FDA relating to potential marketing in the United States. An approvable letter indicates that the FDA is prepared to approve the application upon the satisfaction of conditions specified in the approvable letter.
 
New developments, including the development of other drug technologies and methods of preventing the incidence of disease, occur in the pharmaceutical and medical technology industries at a rapid pace. These developments may render our product candidates obsolete or noncompetitive. Compared to us, many of our potential competitors have substantially greater:
 
  •      research and development resources, including personnel and technology;
 
  •      regulatory experience;
 
  •      drug development and clinical trial experience;
 
  •      experience and expertise in exploitation of intellectual property rights; and
 
  •      capital resources.
 
As a result of these factors, our competitors may obtain regulatory approval of their products more rapidly than we or may obtain patent protection or other intellectual property rights that limit our ability to develop or commercialize our product candidates. Our competitors may also develop drugs that are more effective, useful and less costly than ours and may also be more successful in manufacturing and marketing their products. In addition, if we receive regulatory approvals for our products, manufacturing efficiency is likely to be a significant competitive factor. We currently have no commercial manufacturing infrastructure. There can be no assurance that we can develop or contract for these capabilities on acceptable economic terms, or at all.
 
In addition, should both Contrave and Excalia be approved to treat obesity, these product candidates may compete with one another. We are developing Contrave to treat mild to moderate obesity, especially in women with food craving. We are developing Excalia to treat more severe obesity, especially in men and in women beyond the childbearing years. While we intend to direct each product candidate to specific segments of the obesity marketplace, the FDA does not distinguish between these types of obesity and, if approved, any potential label for our product candidates would be expected to refer to obesity generally. There is no guarantee that we will be successful in marketing Contrave and Excalia to their target markets or avoiding competition between them.
 
We have limited sales and marketing experience or resources, and we may not be able to effectively market and sell our products.
 
We are developing product candidates for large markets traditionally served by general and family practitioners and internists. Generalist physicians number in the several hundred thousand in the United States. Traditional pharmaceutical companies employ groups of sales representatives numbering in the thousands to call on these large generalist physician populations. In order to adequately address these physician groups, we must either establish sales and marketing collaborations or co-promotion arrangements or expend significant resources to develop our own sales and marketing presence. We currently possess limited resources and may not be successful in establishing collaborations or co-promotion arrangements on acceptable terms, if at all. We also face competition in our search for collaborators, co-promoters and sales force personnel. By entering into strategic collaborations or similar arrangements, we may rely on third parties for financial resources and for development, commercialization, sales and marketing and regulatory expertise. Our collaborators may fail to develop or effectively commercialize our product candidates because they cannot obtain the necessary regulatory approvals or decide to pursue a competitive potential product that may be developed outside of the collaboration. Even if we are able to identify suitable collaborators to assist in the commercialization of our product candidates, they may fail to devote the resources necessary to realize the full commercial potential of our product candidates.


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Our development and commercialization strategy depends upon access to findings of safety and effectiveness based on data not developed by us but which the FDA may reference in reviewing our U.S. marketing applications. In territories outside the United States, we must either negotiate access to these safety and effectiveness findings or develop them ourselves.
 
The Drug Price Competition and Patent Term Restoration Act of 1984, also known as the Hatch-Waxman Act, added Section 505(b)(2) to the Federal Food, Drug, and Cosmetic Act. Section 505(b)(2) permits the filing of an NDA where at least some of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. This statutory provision expressly allows the FDA to rely, for purposes of approving an NDA, on findings of safety and effectiveness based on data not developed by the filer of the NDA. Under these guidelines, we were able to move directly into Phase II clinical trials for each of our drug combinations, because our planned NDAs will rely, in part, upon the FDA’s findings of safety and effectiveness for the previously-approved products that are incorporated into Contrave and Excalia. Analogous legislation does not exist in other countries. In territories where data is not freely available, we may not have the ability to commercialize our products without negotiating rights from third parties to refer to their clinical data in our regulatory applications, which could require the expenditure of significant additional funds. We may be unable to obtain rights to the necessary clinical data and may be required to develop our own proprietary safety and manufacturing dossiers. In addition, even though we can take advantage of Section 505(b)(2) to support potential U.S. approval for our Contrave and Excalia product candidates, the FDA may also require us to perform additional studies or measurements to support changes from the previously-approved products incorporated into our product candidates.
 
To the extent that a Section 505(b)(2) application relies on the FDA’s finding of safety and effectiveness of a previously-approved drug, the applicant is required to certify to the FDA concerning any patents listed for the approved product in the FDA’s publication called “Approved Drug Products with Therapeutic Equivalence Evaluations,” otherwise known as the “Orange Book.” Specifically, the applicant must certify when the application is submitted that: (1) there is no patent information listed; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patent is invalid or will not be infringed by the manufacture, use, or sale of the new product. A certification that the new product will not infringe the already approved product’s Orange Book listed patents or that such patents are invalid is called a paragraph IV certification. If the applicant has provided a paragraph IV certification to the FDA, the applicant must also send notice of the paragraph IV certification to the NDA holder and patent owner. When we file our NDAs for Contrave and Excalia, we intend to make paragraph IV certifications that our products do not infringe the bupropion patents listed in the Orange Book, and send the appropriate notice to the patent holder and NDA holder. In the event that the patent holder or NDA holder files a patent infringement lawsuit against us within 45 days of its receipt of our paragraph IV certification, such lawsuit would automatically prevent the FDA from approving our Section 505(b)(2) NDA until the earliest of 30 months, expiration of the patent (2013), settlement of the lawsuit or a decision in the infringement case that is favorable to us. Any such patent infringement lawsuit could be costly, take a substantial amount of time to resolve and divert management resources. If we obtain FDA approval for either Contrave or Excalia, we could obtain three years of Hatch-Waxman marketing exclusivity for such product, assuming we obtain the first approval for either product candidate for the indication supported by the clinical studies we conducted. Under this form of exclusivity, the FDA would be precluded from approving a marketing application for a duplicate drug product (for example, a product that incorporates the change or innovation represented by our product) for a period of three years, although the FDA may accept and commence review of such applications. However, this form of exclusivity might not prevent the FDA from approving an NDA that relies on its own clinical data to support the change or innovation. Further, if another company obtains approval for either product candidate for the same indication we are studying before we do, our approval could be blocked until the other company’s three-year Hatch-Waxman marketing exclusivity expires.


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Even if our product candidates receive regulatory approval, they may still face future development and regulatory difficulties.
 
Even if U.S. regulatory approval is obtained, the FDA may still impose significant restrictions on a product’s indicated uses or marketing or impose ongoing requirements for potentially costly post-approval studies. For example, the label ultimately approved for Contrave or Excalia, if any, may include restrictions on use, including restrictions based on pregnancy status, level of obesity and duration of treatment or a “black box” warning related to general concerns regarding antidepressants or otherwise. The FDA may also require the distribution of a Medication Guide to patients outlining the increased risk of suicidal thinking or behavior in children and adolescents or other populations. Our product candidates will also be subject to ongoing FDA requirements governing the labeling, packaging, storage, advertising, promotion, recordkeeping and submission of safety and other post-market information. In addition, manufacturers of drug products and their facilities are subject to continual review and periodic inspections by the FDA and other regulatory authorities for compliance with current good manufacturing practices, or cGMP, regulations. If we or a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product, the manufacturer or us, including requiring withdrawal of the product from the market or suspension of manufacturing. If we, our product candidates or the manufacturing facilities for our product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:
 
  •      issue warning letters or untitled letters;
 
  •      impose civil or criminal penalties;
 
  •      suspend regulatory approval;
 
  •      suspend any ongoing clinical trials;
 
  •      refuse to approve pending applications or supplements to applications filed by us;
 
  •      impose restrictions on operations, including costly new manufacturing requirements; or
 
  •      seize or detain products or require us to initiate a product recall.
 
Even if our product candidates receive regulatory approval in the United States, we may never receive approval or commercialize our products outside of the United States.
 
In order to market any products outside of the United States, we must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks detailed above regarding FDA approval in the United States as well as other risks. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA approval in the United States. As described above, such effects include the risks that our product candidates may not be approved for all indications requested, which could limit the uses of our product candidates and have an adverse effect on their commercial potential or require costly, post-marketing follow-up studies.
 
If the suppliers upon whom we rely for active pharmaceutical ingredients, or API, fail to produce such ingredients in the volumes that we require on a timely basis, or to comply with stringent regulations applicable to pharmaceutical drug manufacturers, we may face delays in the conduct of our clinical trials.
 
We do not manufacture any of our API nor do we plan to develop any capacity to do so. Instead, we rely on suppliers of API to provide component materials to our other contract manufacturers, who produce


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finished pharmaceutical products incorporating the API for use in our clinical trials. Currently, we have only one supply arrangement for zonisamide API, a component in our Excalia product candidate, one supplier of naltrexone API, a component in our Contrave product candidate, and one supplier of bupropion API, a component in each of our Excalia and our Contrave product candidates.
 
While a number of manufacturers are FDA qualified to produce zonisamide and bupropion, and we have already entered into negotiations with other suppliers to act as secondary or supplemental suppliers of these ingredients, we may not be successful in securing these additional supply arrangements on a commercially reasonable basis or at all. The failure or inability of our API suppliers to satisfy our API requirements on a timely basis could cause a disruption of our trials and delay our development program.
 
Synthesis of naltrexone is a multi-step process with a natural opiate starting material, which is a scheduled substance under Drug Enforcement Administration, or DEA, standards due to the addictive nature of the material. As such, manufacturers must be qualified by the DEA. Because of the DEA-related requirements and modest current demand for naltrexone API, there exist few current manufacturers of this API. Therefore, API costs for naltrexone are greater than for the other constituents of our product candidates. Demand for Contrave may require amounts of naltrexone greater than the currently available supply. Any lack of sufficient quantities of naltrexone would limit our ability to complete our planned clinical trials and the commercial launch of Contrave. Although we are evaluating additional possible manufacturers to supplement our current naltrexone manufacturing capacity, including those in South and East Asia, we may not be successful in accessing additional manufacturing supply of naltrexone API or other necessary components of our product candidates at the appropriate quantities, quality or price.
 
To date, all of our purchases of API have been completed by purchase orders. We have no long-term commitments or supply agreements with any of our API suppliers. Although we may seek to establish long-term supply commitments in the future, we may be required to agree to minimum volume requirements, exclusivity arrangements or other restrictions. We may not be able to enter into long-term agreements on commercially reasonable terms, or at all.
 
If the contract manufacturers upon whom we rely fail to produce our product candidates in the volumes that we require on a timely basis, or fail to comply with stringent regulations applicable to pharmaceutical drug manufacturers, we may face delays in the development and commercialization of our product candidates.
 
We do not currently possess nor do we plan to implement manufacturing processes internally. We currently utilize the services of contract manufacturers to manufacture our clinical supplies. These clinical supplies include the formulations of our product candidates’ components using the API from our API suppliers, the tablets combining those components and the Contrave Titration Packs, Excalia Titration Packs and bottles used to package these tablets for use in clinical trials. To date, all of these contract manufacturers have performed services under short-term purchase orders or similar arrangements. We have no long-term commitments or supply agreements with these contract manufacturers. Recently, the University of Iowa, the manufacturer of our bupropion SR formulation, advised us that it will no longer be able to meet our supply requirements due to its limited capacity. The University of Iowa advised us that it will supply up to six additional batches of bupropion SR, which we believe will be sufficient to meet our requirements for our Contrave and Excalia clinical trials through mid 2007. While we do not have alternate manufacturing plans in place at this time and cannot guarantee that we will have such arrangements in place as and when we need them, we believe that there are other manufacturers capable of meeting our bupropion SR needs within the time frames we will require. We have entered into negotiations with an alternative manufacturer for future supplies of bupropion SR. We will need to demonstrate comparable bioavailability and bioequivalence of the bupropion SR formulation used in clinical trials to date to the bupropion SR formulation we will use going forward.
 
We intend to eventually transfer the manufacturing of our clinical supplies to larger manufacturers to provide Phase III clinical supplies and commercial scale product. There can be no assurance we will be able to transfer any manufacturing processes to a larger manufacturer. Furthermore, we may be required to agree to


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minimum volume requirements, exclusivity arrangements or other restrictions. We may not be able to enter into long-term agreements on commercially reasonable terms, or at all. If we change to other manufacturers, the FDA and comparable foreign regulators must approve these manufacturers’ facilities and processes prior to use, which would require new testing and compliance inspections, and the new manufacturers would have to be educated in or independently develop the processes necessary for the production of our product candidates.
 
The manufacture of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up initial production. These problems include difficulties with production costs and yields, quality control, including stability of the product candidate and quality assurance testing, shortages of qualified personnel, as well as compliance with strictly enforced federal, state and foreign regulations. If our manufacturers were to encounter any of these difficulties or otherwise fail to comply with their obligations to us, our ability to provide product candidates to patients in our clinical trials would be jeopardized. Any delay or interruption in the supply of clinical trial supplies could delay the completion of our clinical trials, increase the costs associated with maintaining our clinical trial program and, depending upon the period of delay, require us to commence new trials at significant additional expense or terminate the trials completely.
 
In addition, all manufacturers of our products must comply with cGMP requirements enforced by the FDA through its facilities inspection program. These requirements include, among other things, quality control, quality assurance and the maintenance of records and documentation. Manufacturers of our products may be unable to comply with these cGMP requirements and with other FDA, state and foreign regulatory requirements. We have little control over our manufacturers’ compliance with these regulations and standards. A failure to comply with these requirements may result in fines and civil penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. If the safety of any product supplied is compromised due to our manufacturers’ failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for or successfully commercialize our products, and we may be held liable for any injuries sustained as a result. Any of these factors could cause a delay of clinical trials, regulatory submissions, approvals or commercialization of our product candidates, entail higher costs or result in our being unable to effectively commercialize our products. Furthermore, if our manufacturers fail to deliver the required commercial quantities on a timely basis and at commercially reasonable prices, we may be unable to meet demand for our products and would lose potential revenues.
 
We are combining drugs in novel combinations and cannot be sure that the combined drugs can co-exist for extended periods in close proximity.
 
Bupropion, which is an API in both Contrave and Excalia, is known to have issues with stability that require manufacturing processes which minimize exposure to moisture. In addition, bupropion is formulated with ingredients that are designed to limit oxidation. Naltrexone, which is an API in our Contrave product candidate, contains water within its crystal structure. We are performing stability testing to ensure that our combination tablet of Contrave has sufficient stability to provide the customary two-year stability characteristics and shelf life expected of a conventional pharmaceutical product. Although we are currently conducting stability studies, we cannot be sure that either Contrave or Excalia will be stable, and we may not be able to demonstrate sufficient long term stability to provide at least two years of shelf life for these product candidates, which could jeopardize our ability to bring such product candidates to market.
 
We face potential product liability exposure, and, if successful claims are brought against us, we may incur substantial liability.
 
The use of our product candidates in clinical trials and the sale of any products for which we obtain marketing approval expose us to the risk of product liability claims. Product liability claims might be brought against us by consumers, health care providers, pharmaceutical companies or others selling or otherwise coming into contact with our products. If we cannot successfully defend ourselves against product liability


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claims, we could incur substantial liabilities. In addition, regardless of merit or eventual outcome, product liability claims may result in:
 
  •      decreased demand for our product candidates;
 
  •      impairment of our business reputation;
 
  •      withdrawal of clinical trial participants;
 
  •      costs of related litigation;
 
  •      distraction of management’s attention from our primary business;
 
  •      substantial monetary awards to patients or other claimants;
 
  •      loss of revenues; and
 
  •      the inability to commercialize our product candidates.
 
We have obtained product liability insurance coverage for our clinical trials with a $5 million annual aggregate coverage limit. Our insurance coverage may not be sufficient to reimburse us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. If and when we obtain marketing approval for any of our product candidates, we intend to expand our insurance coverage to include the sale of commercial products; however, we may be unable to obtain this product liability insurance on commercially reasonable terms. On occasion, large judgments have been awarded in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us could cause our stock price to decline and, if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.
 
If any of our product candidates for which we receive regulatory approval does not achieve broad market acceptance, the revenues that we generate from their sales will be limited.
 
The commercial success of our product candidates for which we obtain marketing approval from the FDA or other regulatory authorities will depend upon the acceptance of these products by the medical community. Coverage and reimbursement of our product candidates by third-party payors, including government payors, generally is also necessary for optimal commercial success. The degree of market acceptance of any of our approved products will depend on a number of factors, including:
 
  •      our ability to provide acceptable evidence of safety and efficacy;
 
  •      the relative convenience and ease of administration;
 
  •      the prevalence and severity of any adverse side effects;
 
  •      limitations or warnings contained in a product’s FDA-approved labeling, including, for example, potential “black box” warnings or pregnancy precautions associated with the active ingredients of Contrave and/or Excalia;
 
  •      availability of alternative treatments, including, in the case of Contrave and/or Excalia, a number of competitive products already approved for the treatment of weight loss or expected to be commercially launched in the near future;
 
  •      pricing and cost effectiveness;
 
  •      the effectiveness of our or any future collaborators’ sales and marketing strategies;
 
  •      our ability to obtain sufficient third-party coverage or reimbursement; and
 
  •      the willingness of patients to pay out of pocket in the absence of third-party coverage.
 
If our product candidates are approved but do not achieve an adequate level of acceptance by physicians, health care payors and patients, we may not generate sufficient revenue from these products, and


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we may not become or remain profitable. In addition, our efforts to educate the medical community and third-party payors on the benefits of our product candidates may require significant resources and may never be successful.
 
We are subject to uncertainty relating to reimbursement policies which, if not favorable to our product candidates, could hinder or prevent our product candidates’ commercial success.
 
Our ability to commercialize our product candidates successfully will depend in part on the extent to which governmental authorities, private health insurers and other third-party payors establish appropriate coverage and reimbursement levels for our product candidates and related treatments. As a threshold for coverage and reimbursement, third-party payors generally require that drug products have been approved for marketing by the FDA. Third-party payors also are increasingly challenging the effectiveness of and prices charged for medical products and services. We cannot provide any assurances that we will be able to obtain third-party coverage or reimbursement for our product candidates in whole or in part.
 
The obesity market, in particular, continues to be marked by poor coverage and reimbursement from health insurers and other payors, who have historically viewed obesity as a lifestyle issue. For example, state Medicaid programs, administered by individual states for qualifying low income individuals, are permitted to exclude coverage for weight loss drugs. In addition, weight loss drugs are excluded from coverage under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 designed for eligible seniors and disabled individuals and which went into effect on January 1, 2006.
 
Currently, our competitors’ drug products have limited third-party payor coverage. This means that individuals prescribed such drug products often either have significant out-of-pocket costs or self-pay. If our product candidates do not receive adequate coverage or reimbursement, the market acceptance and commercial success of our products may be limited.
 
Recently, the Medicare program, a federal governmental third-party payor whose policies often are emulated or adopted by other payors, has removed longstanding policy language that obesity itself cannot be considered an illness. This deletion did not alter the statutory prohibition on drug reimbursement by Medicare or result in a change to coverage for particular obesity-related procedures, and treatment for obesity alone remains uncovered. However, the Medicare program has since issued a national policy recognizing coverage for bariatric surgery for co-morbid conditions associated with obesity. Although third-party payor attitudes regarding obesity-related products and services appear to be changing, as exemplified by Medicare changes, we may be faced with a continued poor coverage and reimbursement environment.
 
Our failure to successfully acquire, develop and market additional product candidates or approved products would impair our ability to grow.
 
As part of our growth strategy, we intend to acquire, develop and/or market additional products and product candidates. Because our internal research capabilities are limited, we may be dependent upon pharmaceutical and biotechnology companies, academic scientists and other researchers to sell or license products or technology to us. The success of this strategy depends partly upon our ability to identify, select and acquire promising pharmaceutical product candidates and products.
 
The process of proposing, negotiating and implementing a license or acquisition of a product candidate or approved product is lengthy and complex. Other companies, including some with substantially greater financial, marketing and sales resources, may compete with us for the license or acquisition of product candidates and approved products. We have limited resources to identify and execute the acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. Moreover, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts. We may not be able to acquire the rights to additional product candidates on terms that we find acceptable, or at all.


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In addition, future acquisitions may entail numerous operational and financial risks, including:
 
  •      exposure to unknown liabilities;
 
  •      disruption of our business and diversion of our management’s time and attention to develop acquired products or technologies;
 
  •      incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;
 
  •      higher than expected acquisition and integration costs;
 
  •      increased amortization expenses;
 
  •      difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel;
 
  •      impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and
 
  •      inability to retain key employees of any acquired businesses.
 
Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot provide assurance that any products that we develop or approved products that we acquire will be manufactured profitably or achieve market acceptance.
 
Healthcare reform measures could hinder or prevent our product candidates’ commercial success.
 
In the United States, there have been a number of legislative and regulatory changes to the healthcare system in ways that could affect our future revenues and profitability and the future revenues and profitability of our potential customers. For example, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 established a new Part D prescription drug benefit, which became effective January 1, 2006. It remains difficult to predict the impact that the prescription drug program will have on us and our industry. Under the prescription drug benefit, Medicare beneficiaries can obtain prescription drug coverage from private sector plans that are permitted to limit the number of prescription drugs that are covered in each therapeutic category and class on their formularies. However, at this time, weight loss drugs are not covered under Part D. As a result, our products will not be placed on the formularies of the private sector providers participating in the Part D program unless the law is changed in the future to allow for coverage of obesity products or unless the drugs are offered as a separate supplemental benefit not funded by Medicare, and if our products are not placed on such formularies, this could negatively impact our ability to sell our products.
 
There also have been, and likely will continue to be, legislative and regulatory proposals at the federal and state levels directed at containing or lowering the cost of health care. We cannot predict the initiatives that may be adopted in the future. The continuing efforts of the government, insurance companies, managed care organizations and other payors of health care services to contain or reduce costs of health care may adversely affect:
 
  •      our ability to set a price we believe is fair for our products;
 
  •      our ability to generate revenues and achieve or maintain profitability; and
 
  •      the availability of capital.


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We will need to increase the size of our organization, and we may experience difficulties in managing growth.
 
As of February 15, 2007, we had 13 full-time employees and three part-time employees. In addition, we have engaged part-time individual consultants and the consulting firm PharmaDirections, Inc. to assist us with certain initiatives relating to pharmacology and product development, among others. We will need to continue to expand our managerial, operational, financial and other resources in order to manage our operations and clinical trials, continue our development activities and commercialize our product candidates. Our management and personnel, systems and facilities currently in place may not be adequate to support this future growth. Our need to effectively execute our growth strategy requires that we:
 
  •      manage our clinical trials effectively, including our upcoming Phase III clinical trials for Contrave and our ongoing Phase II clinical trials for Excalia, which are being conducted at numerous clinical trial sites;
 
  •      manage our internal development efforts effectively while carrying out our contractual obligations to licensors, contractors, collaborators and other third parties;
 
  •      continue to improve our operational, financial and management controls, reporting systems and procedures; and
 
  •      attract and retain sufficient numbers of talented employees.
 
We have traditionally utilized the services of outside vendors to perform tasks including clinical trial management, statistics, regulatory affairs, formulation development, pharmacokinetics and other drug development functions. Our growth strategy may also entail expanding our group of contractors to implement these tasks going forward. Because we rely on a substantial number of consultants, effectively outsourcing many key functions of our business, we will need to be able to effectively manage these consultants to ensure that they successfully carry out their contractual obligations and meet expected deadlines. However, if we are unable to effectively manage our outsourced activities or if the quality or accuracy of the services provided by consultants is compromised for any reason, our clinical trials may be extended, delayed or terminated, and we may not be able to obtain regulatory approval for our product candidates or otherwise advance our business. There can be no assurance that we will be able to manage our existing consultants or find other competent outside contractors and consultants on economically reasonable terms, or at all.
 
We may not be able to manage our business effectively if we are unable to attract and retain key personnel.
 
We may not be able to attract or retain qualified management and scientific and clinical personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the San Diego, California area. Our industry has experienced a high rate of turnover of management personnel in recent years. If we are not able to attract, retain and motivate necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our development objectives, our ability to raise additional capital and our ability to implement our business strategy.
 
We are highly dependent on the development, regulatory, commercial and financial expertise of our senior management, particularly Gary D. Tollefson, M.D., Ph.D., our President and Chief Executive Officer, Anthony A. McKinney, our Chief Operating Officer, Graham K. Cooper, our Chief Financial Officer, Treasurer and Secretary, Michael A. Cowley, Ph.D., our Chief Scientific Officer, Eduardo Dunayevich, M.D., our Chief Medical Officer, and Ronald P. Landbloom, M.D., our Vice President of Medical and Regulatory Affairs. If we lose any members of our senior management team, we may not be able to find suitable replacements, and our business may be harmed as a result. However, we are not aware of any key personnel who have plans to retire or leave our company in the near future. In addition to the competition for personnel, the San Diego area in particular is characterized by a high cost of living. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment and retention efforts.


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Although we have employment agreements with each of our executive officers, these agreements are terminable at will at any time with or without notice and, therefore, we may not be able to retain their services as expected. In addition, certain of our executive officers are only required to devote a portion of their full business time to our business, and therefore may not contribute as much to our growth and development as a full-time member of management could.
 
In addition, we have scientific and clinical advisors who assist us in formulating our product development and clinical strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us, or may have arrangements with other companies to assist in the development of products that may compete with ours.
 
We will need to obtain FDA approval of our proposed product names, Contrave and Excalia, and any failure or delay associated with such approval may adversely impact our business.
 
Any name we intend to use for our product candidates will require approval from the FDA regardless of whether we have secured a formal trademark registration from the U.S. Patent and Trademark Office, or PTO. The FDA typically conducts a rigorous review of proposed product names, including an evaluation of potential for confusion with other product names. The FDA may also object to a product name if it believes the name inappropriately implies medical claims. If the FDA objects to the product names Contrave or Excalia, we may be required to adopt an alternative name for our initial product candidates. If we adopt an alternative name, we would lose the benefit of our existing trademark applications for Contrave and/or Excalia and may be required to expend significant additional resources in an effort to identify a suitable product name that would qualify under applicable trademark laws, not infringe the existing rights of third parties and be acceptable to the FDA. We may be unable to build a successful brand identity for a new trademark in a timely manner or at all, which would limit our ability to commercialize our product candidates.
 
Recent federal legislation and actions by state and local governments may permit re-importation of drugs from foreign countries into the United States, including foreign countries where the drugs are sold at lower prices than in the United States, which could materially adversely affect our operating results and our overall financial condition.
 
We may face competition for our products from lower priced products from foreign countries that have placed price controls on pharmaceutical products. The Medicare Prescription Drug Improvement and Modernization Act of 2003 contains provisions that may change U.S. importation laws and expand consumers’ ability to import lower priced versions of our product candidates and competing products from Canada, where there are government price controls. These changes to U.S. importation laws will not take effect unless and until the Secretary of Health and Human Services certifies that the changes will lead to substantial savings for consumers and will not create a public health safety issue. The Secretary of Health and Human Services has not yet announced any plans to make this required certification. As directed by Congress, a task force on drug importation conducted a comprehensive study regarding the circumstances under which drug importation could be safely conducted and the consequences of importation on the health, medical costs and development of new medicines for U.S. consumers. The task force report issued its report in December 2004, finding that there are significant safety and economic issues that must be addressed before importation of prescription drugs is permitted. In addition, a number of federal legislative proposals have been made to implement the changes to the U.S. importation laws without any certification, and to broaden permissible imports in other ways. Even if the changes do not take effect, and other changes are not enacted, imports from Canada and elsewhere may continue to increase due to market and political forces, and the limited enforcement resources of the FDA, the U.S. Customs Service and other government agencies. For example, Pub. L. No. 109-295, which was signed into law in October 2006 and provides appropriations for the Department of Homeland Security for the 2007 fiscal year, expressly prohibits the U.S. Customs Service from using funds to prevent individuals from importing from Canada less than a 90-day supply of a prescription drug for personal use, when the drug otherwise complies with the Federal Food, Drug, and Cosmetic Act. Further, several states and local governments have implemented importation schemes for their citizens, and, in the absence of federal action to curtail such activities, we expect other states and local governments to launch importation efforts. The importation of foreign products that compete with our own products could negatively impact our profitability.


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If we fail to comply with healthcare regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.
 
As a manufacturer of pharmaceuticals, even though we do not and will not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, certain federal and state healthcare laws and regulations pertaining to fraud and abuse and patients’ rights are and will be applicable to our business. We could be subject to healthcare fraud and abuse and patient privacy regulation by both the federal government and the states in which we conduct our business, without limitation. The regulations that may affect our ability to operate include:
 
  •      the federal healthcare program Anti-Kickback Law, which prohibits, among other things, persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;
 
  •      federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers;
 
  •      the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information;
 
  •      the Federal Food, Drug, and Cosmetic Act, which among other things, strictly regulates drug product marketing, prohibits manufacturers from marketing drug products for off-label use and regulates the distribution of drug samples; and
 
  •      state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.
 
If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, achieving and sustaining compliance with applicable federal and state privacy, security and fraud laws may prove costly.
 
Our business involves the use of hazardous materials and we and our third-party manufacturers must comply with environmental laws and regulations, which can be expensive and restrict how we do business.
 
Our third-party manufacturers’ activities involve the controlled storage, use and disposal of hazardous materials owned by us, including the components of our product candidates and other hazardous compounds. We and our manufacturers are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials. Although we believe that the safety procedures utilized by our third-party manufacturers for handling and disposing of these materials comply with the standards prescribed by these laws and regulations, we cannot eliminate the risk of accidental contamination or injury from these materials. In the event of an accident, state or federal authorities may


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curtail the use of these materials and interrupt our business operations. We do not currently maintain hazardous materials insurance coverage. If we are subject to any liability as a result of our third-party manufacturers’ activities involving hazardous materials, our business and financial condition may be adversely affected. In the future we may seek to establish longer term third-party manufacturing arrangements, pursuant to which we would seek to obtain contractual indemnification protection from such third-party manufacturers potentially limiting this liability exposure.
 
Our business and operations would suffer in the event of system failures.
 
Despite the implementation of security measures, our internal computer systems and those of our CROs and other contractors and consultants are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. While we have not experienced any such system failure, accident or security breach to date, if such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our drug development programs. For example, the loss of clinical trial data from completed or ongoing clinical trials for Contrave or Excalia could result in delays in our regulatory approval efforts and significantly increase our costs to recover or reproduce the data. To the extent that any disruption or security breach were to result in a loss of or damage to our data or applications, or inappropriate disclosure of confidential or proprietary information, we could incur liability and the further development of our product candidates could be delayed.
 
Risks Related to Intellectual Property
 
The issued patent rights that we have in-licensed covering Contrave and Excalia are limited to the United States, and our market opportunity for these product candidates may be limited by the lack of patent protection in other territories.
 
Contrave is currently protected by U.S. patent number 5,512,593 issued in April 1996 and U.S. patent number 5,817,665 issued in October 1998, which we have licensed on an exclusive basis from Dr. Lee Dante. Provided maintenance fees are paid, U.S. patent number 5,512,593 is expected to expire in April 2013 and U.S. patent 5,817,665 is expected to expire in March 2013. These patents do not protect our Contrave product candidate outside of the United States. The Dante patents cover compositions of certain specified opioid antagonists (including naltrexone) combined with certain specified antidepressants (including bupropion).
 
In addition to the Dante patents that are licensed to us, we own a U.S. patent application and a related continuation patent application, referred to by us as the Weber/Cowley patent applications, which are the subject of an agreement with Oregon Health & Science University, or OHSU. The claims currently pending in the Weber/Cowley patent applications are directed to the current composition of our Contrave product candidate and methods for using that composition to effect weight loss. The Weber/Cowley patent applications have not yet issued and we cannot provide assurance that they will issue on a timely basis or at all. We have filed a number of international counterparts to the Weber/Cowley patent applications in foreign countries and also cannot provide assurance that they will issue on a timely basis or at all.
 
Both pending Weber/Cowley patent applications have been initially rejected by the U.S. Patent and Trademark Office, or PTO, one on the basis that a prior Dante patent anticipated the composition claims and the other primarily on the basis that the claimed methods of treatment were obvious. Although we believe that we have sufficient arguments, and can amend our applications in such a way as to overcome these initial rejections of claims, there can be no assurance that these rejections and any future rejections will ultimately be overcome or that any claims that may issue will be sufficiently broad to protect our Contrave product in the United States. If these U.S. patent applications and their international counterparts ultimately issue, we expect to have protection extended through 2024. However, we cannot be certain that the scope of any issued U.S. or foreign patent will be consistent with the currently pending claims, as there is a significant likelihood that the scope of the currently pending claims will be modified. A European counterpart application to the Weber/Cowley patents applications is currently pending in the European Patent Office, or EPO. However, there is no assurance that the claims in this application, or any other claims, will issue in their currently pending form or at all.


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We have filed patent applications in the United States with the goal of protecting the formulations and use of SR oral naltrexone, but we cannot provide assurance that these patent applications will issue. Accordingly, unless the Weber/Cowley patent applications or our other pending patent applications ultimately issue with a scope of protection that protects our Contrave product candidate, a competitor could file an NDA for the development of naltrexone in combination with bupropion, seeking approval as early as 2013, when the Dante patents expire. Alternatively, if a competitor is willing to challenge the scope or validity of the Dante patents, the competitor could file an NDA seeking approval any time before we obtain approval from the FDA of an NDA for Contrave and three years after we obtain such approval. If issued, the Weber/Cowley patent applications and other patent filings have the potential to protect Contrave for an additional 11 years following the expiration of the Dante patents.
 
Our intellectual property protection for Excalia derives from U.S. patent number 7,109,198, which was issued in September 2006 and which we call the Gadde patent. We in-license this patent on an exclusive basis from Duke University, or Duke, together with several related patent applications. This patent provides composition coverage for the Excalia zonisamide/bupropion combination and also covers methods for using Excalia to treat obesity and to reduce the risk of hypertension, diabetes or dyslipidemia. Provided maintenance fees are paid, this patent is expected to expire in May 2023. Although Duke has filed international counterparts to the Gadde patent that are currently pending, there is no assurance that the claims in these applications will issue in their currently pending form or at all.
 
Although we have international patent applications pending, we do not currently have patent protection for our Contrave and Excalia product candidates outside the United States.
 
While we have filed patent applications in many countries outside the United States, we do not currently have patent protection for Contrave or Excalia in any of these foreign jurisdictions. Even if international patents ultimately issue or receive approval, it is likely that the scope of protection provided by such patents will be different from, and possibly less than, the scope provided by our corresponding U.S. patents. The success of our international market opportunity is dependent upon the enforcement of patent rights in various other countries. A number of countries in which we have filed or intend to file patent applications have a history of weak enforcement of intellectual property rights. Even if we have patents issued in these jurisdictions, there can be no assurance that our patent rights will be sufficient to prevent generic competition or unauthorized use.
 
We may face competition from the off-label use of other dosage forms of the generic components in our product candidates. In addition, others may attempt to commercialize our product candidate combinations in the countries of the European Union, Canada, Mexico, Japan or other markets where we do not have patent protection for Contrave or Excalia. Due to the lack of patent protection for these combinations in territories outside the United States and the potential for correspondingly lower prices for the drugs in those markets, it is possible that patients will seek to acquire the generic IR components of Contrave and Excalia, naltrexone IR and zonisamide IR, respectively, in those other territories. The off-label use of the generic IR components in the United States or the importation of the generic IR components from foreign markets could adversely affect the commercial potential for Contrave and Excalia and adversely affect our overall business and financial results.
 
We have in-licensed the rights to our product candidates from third parties. If we default on any of our material obligations under those licenses, we could lose rights to Contrave and Excalia.
 
We have in-licensed and otherwise contracted for rights to our product candidates, and we expect to enter into similar licenses in the future to supplement our product candidate pipeline. Under the relevant agreements, we are subject to commercialization and development, sublicensing, royalty, insurance and other obligations. If we fail to comply with any of these requirements, or otherwise breach these license agreements, the licensor may have the right to terminate the license in whole or to terminate the exclusive nature of the license. Loss of any of these licenses or the exclusive rights provided therein could harm our financial condition and operating results. For example, our license agreement with Dr. Dante requires us to use commercially reasonable efforts to develop, obtain regulatory approval of and commercialize our Contrave


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product candidate. To the extent we are unable to comply with these obligations, the license may be terminated.
 
Restrictions on our patent rights relating to our product candidates may limit our ability to prevent third parties from competing against us.
 
Our success will depend on our ability to obtain and maintain patent protection for our product candidates, preserve our trade secrets, prevent third parties from infringing upon our proprietary rights and operate without infringing upon the proprietary rights of others. Composition of matter patents on active pharmaceutical ingredients are generally considered to be the strongest form of intellectual property protection for pharmaceutical products as they apply without regard to any method of use. Entirely new individual chemical compounds, often referred to as new chemical entities, or NCEs, are typically entitled to composition of matter coverage. Current law also allows novel and unobvious combinations of old compounds to receive composition of matter coverage for the combination. However, we cannot be certain that the current law will remain the same, or that our product candidates will be considered novel and unobvious by the PTO and courts.
 
In addition to composition of matter patents and patent applications, we also have filed method of use patent applications. This type of patent protects the use of the product only for the specified method. However, this type of patent does not prevent a competitor from making and marketing a product that is identical to our product for an indication that is outside the scope of the patented method. Moreover, even if these competitors do not actively promote their product for our targeted indication, physicians may prescribe these products “off-label.” Although off-label prescriptions may infringe or contribute to the infringement of method of use patents, the practice is common and such infringement is difficult to prevent or prosecute.
 
Although we believe we and our licensors have conducted appropriate prior art searches relating to our method of use patents and patent applications, there is no assurance that all of the potentially relevant prior art has been found. Moreover, because the constituents of our combination product candidates have been on the market as separate monotherapeutic products for many years, it is possible that these monotherapies have previously been used off-label in such a manner that such prior usage would affect the validity of our method of use patents.
 
Patent applications in the United States and most other countries are confidential for a period of time until they are published, and publication of discoveries in scientific or patent literature typically lags actual discoveries by several months or more. As a result, we cannot be certain that we and the inventors of the issued patents and applications that we in-licensed were the first to conceive inventions covered by the patents and pending patent applications or that we and those inventors were the first to file patent applications for such inventions.
 
We also rely upon unpatented trade secrets, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our employees and our collaborators and consultants, some of whom assist with the development of other obesity drugs. We also have agreements with our employees and selected consultants that obligate them to assign their inventions to us. It is possible that technology relevant to our business will be independently developed by a person that is not a party to such an agreement. Furthermore, if the employees and consultants that are parties to these agreements breach or violate the terms of these agreements, we may not have adequate remedies for any such breach or violation, and we could lose our trade secrets through such breaches or violations. Further, our trade secrets could otherwise become known or be independently discovered by our competitors.
 
If we are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.
 
Our commercial success depends upon our ability and the ability of our collaborators to develop, manufacture, market and sell our product candidates and use our proprietary technologies without infringing


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the proprietary rights of third parties. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we and our collaborators are developing products. As the biotechnology and pharmaceutical industry expands and more patents are issued, the risk increases that our potential products may give rise to claims that our products infringe the patent rights of others. There may be issued patents of third parties of which we are currently unaware, that may be infringed by our product candidates or proprietary technologies. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our product candidates or proprietary technologies may infringe.
 
We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our product candidates and/or proprietary technologies infringe their intellectual property rights. If one of these patents was found to cover our product candidates, proprietary technologies or their uses, we or our collaborators could be enjoined by a court and required to pay damages and could be unable to commercialize our product candidates or use our proprietary technologies unless we or they obtained a license to the patent. A license may not be available to us or our collaborators on acceptable terms, if at all. In addition, during litigation, the patent holder could obtain a preliminary injunction or other equitable relief which could prohibit us from making, using or selling our products, technologies or methods pending a trial on the merits, which could be years away.
 
There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and pharmaceutical industries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including, but not limited to:
 
  •      infringement and other intellectual property claims which, regardless of merit, may be expensive and time-consuming to litigate and may divert our management’s attention from our core business;
 
  •      substantial damages for infringement, which we may have to pay if a court decides that the product at issue infringes on or violates the third party’s rights, and if the court finds that the infringement was willful, we could be ordered to pay treble damages and the patent owner’s attorneys’ fees;
 
  •      a court prohibiting us from selling or licensing the product unless the third party licenses its product rights to us, which it is not required to do;
 
  •      if a license is available from a third party, we may have to pay substantial royalties, fees and/or grant cross-licenses to intellectual property rights for our products; and
 
  •      redesigning our products or processes so they do not infringe, which may not be possible or may require substantial monetary expenditures and time.
 
We will be obtaining our bupropion SR, zonisamide SR, naltrexone SR, our finished Contrave and Excalia tablets combining these components, and our Contrave Titration Packs, Excalia Titration Packs and bottles used to package these tablets from third-party manufacturers. Each aspect of product design, formulation, manufacturing, packaging, and use has the potential to implicate third-party patent rights. We have conducted a search of weight loss and drug combination patents issued to third parties, however no assurance can be given that patents do not exist, have not been filed, or could not be filed or issued, which contain claims covering these or other aspects of our products, technology or methods, as implemented by us or by third-party manufacturers with whom we contract. Because of the large number of patents issued and patent applications filed in our field, we believe there is a risk that third parties may allege they have patent rights encompassing our products, technology or methods. Such third-party patent rights, if relevant, could prevent us from adopting or marketing a particular formulation or product, or could expose us to patent infringement liability.


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Although we have entered into a settlement agreement designed to prevent the parties to the agreement from asserting infringement and other specified claims against our Excalia product candidate in the United States, if an acceptable settlement of foreign patent rights cannot be reached, or our efforts to assert patent rights outside of the Unites States prove unsuccessful, we could be prevented from marketing and selling our Excalia product in foreign countries.
 
On June 12, 2004, we jointly filed a lawsuit with Duke, against Elan Corporation, plc, Elan Pharma International Ltd. and Elan Pharmaceuticals, Inc., which we refer to collectively as Elan, Eisai, Inc. and Eisai Co., Ltd., which we refer to together as Eisai, and Julianne E. Jennings, a former employee of Elan, in the U.S. District Court for the Middle District of North Carolina, Durham Division, to resolve a dispute over rights in an invention relating to the use of zonisamide to treat obesity. We alleged in this lawsuit that scientists at Duke made the invention, and that Elan improperly used information supplied by the Duke scientists to file a U.S. patent application on the invention, in which Ms. Jennings (then an Elan product manager) is named as the sole inventor. This patent application was later assigned by Elan to Eisai. Duke also filed a U.S. patent application on the invention at issue, which patent application is exclusively licensed to us. On December 14, 2006, we, Elan, Eisai, Duke and Ms. Jennings entered into a settlement agreement to settle the lawsuit. Upon execution of the settlement agreement, the lawsuit was dismissed with prejudice.
 
Under the terms of the settlement agreement, the parties have, subject to limitations set forth in the agreement, released each other from all claims and demands arising under the laws of the United States or any state within the United States existing as of the date of the settlement agreement that arise out of or relate to the lawsuit or the specified Duke and Eisai patent applications. The releases do not apply to the parties’ rights with respect to claims and demands outside the United States. In addition, each of Elan and Ms. Jennings have represented that they are not currently seeking and do not currently possess any patent rights in the United States relating to the use of zonisamide for the treatment of obesity or other weight-related disorders or conditions. In addition, Elan, Eisai and Ms. Jennings have agreed not to assert any such U.S. patent against our Excalia product, which contains zonisamide and bupropion to treat obesity, even if Eisai later obtains a U.S. patent containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions that issues from or is based upon the Eisai patent application. Likewise, if Duke obtains a U.S. patent containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions that issues from or is based upon the Duke patent application, we and Duke have agreed that we will not assert any such patent against Elan, Eisai or Ms. Jennings for any conduct relating to Zonegran, which is a zonisamide product currently marketed by Eisai.
 
Although we have resolved the U.S. lawsuit and entered into a settlement agreement containing terms that would prevent Eisai, Elan and Ms. Jennings from asserting specified U.S. patents against our Excalia product, there is no assurance that Eisai, Elan and/or Ms. Jennings will abide by the settlement agreement. There also is no assurance that Eisai, Elan and/or Ms. Jennings do not have, or will not in the future obtain, other patent rights not covered by the settlement agreement that could be asserted against our Excalia product candidate or our other product candidates.
 
We believe that Eisai also owns and is prosecuting foreign patent applications in at least Europe and Japan that are based upon and claim priority to the Eisai patent application that was filed in the United States. We have entered into negotiations with Eisai with respect to any and all foreign patent rights based on the Eisai and Duke patent applications. These settlement negotiations are ongoing and settlement terms similar to the U.S. settlement are being sought in the foreign settlement process. If an acceptable settlement of the foreign patent rights is reached, we anticipate that it will contain a covenant by at least Eisai that, if Eisai obtains a foreign patent containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions that claims priority to or is based upon the disclosure of Eisai patent application, Eisai will not assert any such foreign patent against any of our products, such as Excalia, containing zonisamide in combination with any other active pharmaceutical agent intended for use in the treatment of humans. However, we may not be able to enter into a settlement agreement relating to any countries outside the United States on acceptable terms, or at all.


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If an acceptable settlement of the foreign patent rights cannot be reached, then it may be necessary for us to formally challenge Eisai’s entitlement to the patent rights at issue through legal proceedings in Europe, Japan, and perhaps other countries. If it is necessary to commence foreign legal proceedings, it likely will take several years to reach a decision in those proceedings. If the decision in those proceedings is unfavorable to us, and if a foreign patent issues to Eisai containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions, then we could be prevented from marketing and selling our Excalia product in those countries where such patents exist.
 
Obtaining and maintaining our patent protection depends on compliance with various procedural, document submission, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with these requirements.
 
Periodic maintenance fees on the Gadde patent covering Excalia are due to be paid to the PTO in several stages over the lifetime of the patent. Future maintenance fees will also need to be paid on the Dante patents. We have systems in place to remind us to pay these fees, and we employ an outside firm, Computer Patent Annuities, to remind us to pay annuity fees due to foreign patent agencies on our pending foreign patent applications. The U.S. PTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. We employ reputable law firms and other professionals to help us comply, and in many cases, an inadvertent lapse can be cured by payment of a late fee or by other means in accordance with the applicable rules. However, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. In such an event, our competitors might be able to enter the market and this circumstance would have a material adverse effect on our business.
 
We have not yet registered our trademarks in all of our potential markets, and failure to secure those registrations could adversely affect our business.
 
We have received a Notice of Allowance from the PTO for the intent-to-use trademark application for our corporate logo for use in connection with pharmaceutical preparations and substances, including for the treatment of obesity, inducement of weight loss and prevention of weight gain. We have foreign trademark applications pending in Europe, Canada and Japan for the same mark. We have obtained foreign trademark registrations for the corporate name Orexigen Therapeutics, Inc. and the mark OREXIGEN in Japan and have pending trademark applications for the same mark in the United States, Canada and Europe. We have received a Notice of Allowance from the PTO for the intent-to-use trademark application for the mark CONTRAVE for use in connection with pharmaceutical preparations, including for the treatment of obesity and inducing weight loss. We have also applied for U.S. trademark registrations for the mark EXCALIA and have filed applications to register these marks in Europe, Canada and Japan. However, no assurance can be given that our allowed trademark applications will actually become registered, or that our registered trademarks can be maintained or enforced. During trademark registration proceedings in the various countries, we have received and expect to receive rejections. Although we are given an opportunity to respond to those rejections, there can be no assurance that the rejections can be successfully overcome. In addition, in the PTO and in many foreign jurisdictions, third parties are given an opportunity to oppose pending trademark applications and to cancel registered trademarks. No assurance can be given that opposition or cancellation proceedings will not be filed against our trademarks, nor can there be any assurance that our trademarks would survive such proceedings. On February 6, 2007, Novartis AG, or Novartis, filed an opposition to our U.S. trademark application for EXCALIA, claiming that it is confusingly similar to its registered trademark EXTAVIA. We have also been informed that Novartis has opposed the registration of the EXCALIA mark in Europe, though we have not received a formal notice of opposition. Novartis has expressed interest in resolving this dispute, but no assurance can be given that such a resolution will be achieved, or that we would be successful in defending the pending oppositions, or that Novartis or another party will not oppose our application or seek to cancel any registrations in foreign jurisdictions.


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We may be subject to claims that our employees have wrongfully used or disclosed alleged trade secrets of their former employers.
 
As is common in the biotechnology and pharmaceutical industry, we employ individuals who were previously employed at other biotechnology or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.
 
Risks Related to Our Finances and Capital Requirements
 
We have incurred significant operating losses since our inception and anticipate that we will incur continued losses for the foreseeable future.
 
We are a development stage company with a limited operating history. We have focused primarily on developing our two product candidates, Contrave and Excalia, with the goal of supporting regulatory approval for these product candidates. We have financed our operations almost exclusively through private placements of preferred stock and debt and have incurred losses in each year since our inception in September 2002. Net losses were $1.9 million in 2003, $7.7 million in 2004, $12.1 million in 2005 and $27.5 million in 2006. As of December 31, 2006, we had an accumulated deficit of $49.2 million. These losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity and working capital. We expect our development expenses, as well as clinical product manufacturing expenses, to increase in connection with our ongoing Phase II and planned Phase III clinical trials for our product candidates. In addition, if we obtain regulatory approval for any of our product candidates, we may incur significant sales, marketing and outsourced manufacturing expenses as well as continued development expenses. As a result, we expect to continue to incur significant and increasing operating losses for the foreseeable future. Because of the numerous risks and uncertainties associated with developing pharmaceutical products, we are unable to predict the extent of any future losses or when we will become profitable, if at all.
 
We have not generated any revenue from our product candidates and may never be profitable.
 
Our ability to become profitable depends upon our ability to generate revenue. To date, we have not generated any revenue from our development-stage product candidates, and we do not know when, or if, we will generate any revenue. Our ability to generate revenue depends on a number of factors, including, but not limited to, our ability to:
 
  •      successfully complete our ongoing and planned clinical trials for Contrave and Excalia;
 
  •      obtain regulatory approval for Contrave and Excalia;
 
  •      manufacture commercial quantities of our product candidates at acceptable cost levels if regulatory approvals are received; and
 
  •      identify and enter into one or more strategic collaborations to effectively market and sell our product candidates.
 
Even if one or more of our product candidates is approved for commercial sale, which we do not expect to occur for several years (we do not expect to file our first NDA until the second half of 2009 at the earliest), we anticipate incurring significant costs associated with commercializing any approved product. We may not achieve profitability soon after generating product sales, if ever. If we are unable to generate product revenues, we will not become profitable and may be unable to continue operations without continued funding.
 
Our short operating history makes it difficult to evaluate our business and prospects.
 
We were incorporated in September 2002. Our operations to date have been limited to organizing and staffing our company and conducting product development activities for our two product candidates. We have


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not yet demonstrated an ability to obtain regulatory approval for or commercialize a product candidate. Consequently, any predictions about our future performance may not be as accurate as they could be if we had a history of successfully developing and commercializing pharmaceutical products.
 
We will need additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or commercialization efforts.
 
Developing products for the obesity market, conducting clinical trials, establishing outsourced manufacturing relationships and successfully manufacturing and marketing drugs that we may develop is expensive. We believe that our existing cash and cash equivalents, together with the borrowing capacity under our $17.0 million credit and security agreement with Merrill Lynch Capital, will be sufficient to meet our projected operating requirements through at least March 31, 2008 and that the addition of the net proceeds from this offering will allow us to complete our planned Phase III clinical trials for Contrave and complete our ongoing Phase IIb clinical trial for Excalia. However, we have based these estimates on assumptions that may prove to be wrong, and we could spend our available financial resources much faster than we currently expect. Further, we will need to raise additional capital following this offering to:
 
  •      fund our operations and continue to conduct clinical trials to support potential regulatory approval of marketing applications;
 
  •      qualify and outsource the commercial-scale manufacturing of our products under cGMPs; and
 
  •      commercialize Contrave, Excalia or any other product candidates that we may develop, in-license or acquire, if any of these product candidates receive regulatory approval.
 
The amount and timing of our future funding requirements will depend on many factors, including, but not limited to:
 
  •      the rate of progress and cost of our clinical trials and other product development programs for Contrave, Excalia and any other product candidates that we may develop, in-license or acquire;
 
  •      the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights associated with our product candidates;
 
  •      the costs and timing of completion of outsourced commercial manufacturing supply arrangements for each product candidate;
 
  •      the timing of regulatory approval of our product candidates, if at all;
 
  •      the costs of establishing sales, marketing and distribution capabilities, should we elect to do so;
 
  •      the effect of competing technological and market developments; and
 
  •      the terms and timing of any collaborative, licensing, co-promotion or other arrangements that we may establish.
 
Future capital requirements will also depend on the extent to which we acquire or invest in additional complementary businesses, products and technologies. We currently have no commitments or agreements relating to any of these types of transactions.
 
Until we can generate a sufficient amount of product revenue and achieve profitability, we expect to finance future cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements, as well as through interest income earned on cash balances. We cannot be certain that additional funding will be available on acceptable terms, or at all. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate one or more of our development programs or our commercialization efforts.


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Our quarterly operating results may fluctuate significantly.
 
We expect our operating results to be subject to quarterly fluctuations. Our net loss and other operating results will be affected by numerous factors, including:
 
  •      variations in the level of expenses related to our two existing product candidates or future development programs;
 
  •      addition or termination of clinical trials or funding support;
 
  •      any intellectual property infringement lawsuit in which we may become involved;
 
  •      regulatory developments affecting our product candidates or those of our competitors;
 
  •      our execution of any collaborative, licensing or similar arrangements, and the timing of payments we may make or receive under these arrangements; and
 
  •      if either of our product candidates receives regulatory approval, the level of underlying demand for our product candidates and wholesalers’ buying patterns.
 
If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.
 
Raising additional funds by issuing securities may cause dilution to existing stockholders and raising funds through lending and licensing arrangements may restrict our operations or require us to relinquish proprietary rights.
 
To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership will be diluted. Debt financing typically contains covenants that restrict operating activities. Our credit and security agreement with Merrill Lynch Capital is secured by a pledge of all of our assets other than, subject to certain limited exceptions, intellectual property, and contains a variety of operational covenants, including limitations on our ability to incur liens or additional debt, pay dividends, redeem our stock, make certain investments and engage in certain merger, consolidation or asset sale transactions, among other restrictions. Any future debt financing we enter into may involve similar or more onerous covenants that restrict our operations. Any borrowings under the credit agreement with Merrill Lynch Capital or any future debt financing will need to be repaid, which creates additional financial risk for our company, particularly if our business or prevailing financial market conditions are not conducive to paying-off or refinancing our outstanding debt obligations.
 
If we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rights to our current product candidates, potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. If adequate funds are not available, our ability to achieve profitability or to respond to competitive pressures would be significantly limited and we may be required to delay, significantly curtail or eliminate the development of one or more of our product candidates.
 
We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
 
As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC and the Nasdaq Global Market, have imposed various new requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase our legal and


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financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors, our board committees or as executive officers.
 
The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure. In particular, commencing in fiscal 2008, we must perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. We expect to incur significant expense and devote substantial management effort toward ensuring compliance with Section 404. We currently do not have an internal audit function, and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal controls that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by Nasdaq, the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.
 
Risks Relating to Securities Markets and Investment in Our Stock
 
There may not be a viable public market for our common stock.
 
Prior to this offering, there has been no public market for our common stock, and there can be no assurance that a regular trading market will develop and continue after this offering or that the market price of our common stock will not decline below the initial public offering price. The initial public offering price will be determined through negotiations between us and the representatives of the underwriters and may not be indicative of the market price of our common stock following this offering. Among the factors considered in such negotiations are prevailing market conditions, certain of our financial information, market valuations of other companies that we and the representatives of the underwriters believe to be comparable to us, estimates of our business potential, the present state of our development and other factors deemed relevant. See “Underwriting” for additional information.
 
As a new investor, you will experience immediate and substantial dilution in the net tangible book value of your shares.
 
The initial public offering price of our common stock in this offering is considerably more than the net tangible book value per share of our outstanding common stock. Investors purchasing shares of common stock in this offering will pay a price that substantially exceeds the value of our tangible assets after subtracting liabilities. As a result, investors will:
 
  •      incur immediate dilution of $      per share, based on an assumed initial public offering price of $      per share, the mid-point of the price range set forth on the cover page of this prospectus; and
 
  •      contribute     % of the total amount invested to date to fund our company based on an assumed initial offering price to the public of $      per share, the mid-point of the price range set forth on the cover page of this prospectus, but will own only     % of the shares of common stock outstanding after the offering.
 
To the extent outstanding stock options are exercised, there will be further dilution to new investors.
 
We believe that our existing cash, cash equivalents and short-term investments, together with the borrowing capacity under our $17.0 million credit and security agreement with Merrill Lynch Capital, will be


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sufficient to meet our projected operating requirements through at least March 31, 2008. However, because we will need to raise additional capital to fund our clinical development programs, among other things, we may conduct substantial additional equity offerings. These future equity issuances, together with the exercise of outstanding options and any additional shares issued in connection with acquisitions, will result in further dilution to investors.
 
We expect that the price of our common stock will fluctuate substantially.
 
The initial public offering price for the shares of our common stock sold in this offering has been determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. The price of our common stock may decline. In addition, the market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors, including:
 
  •      the results from our clinical trials, including our planned Phase III clinical program for Contrave and our ongoing Phase II clinical trial for Excalia;
 
  •      FDA or international regulatory actions, including failure to receive regulatory approval for any of our product candidates;
 
  •      failure of any of our product candidates, if approved, to achieve commercial success;
 
  •      announcements of the introduction of new products by us or our competitors;
 
  •      market conditions in the pharmaceutical and biotechnology sectors;
 
  •      announcements concerning product development results or intellectual property rights of others;
 
  •      litigation or public concern about the safety of our potential products;
 
  •      actual and anticipated fluctuations in our quarterly operating results;
 
  •      deviations in our operating results from the estimates of securities analysts or other analyst comments;
 
  •      additions or departures of key personnel;
 
  •      third-party coverage and reimbursement policies;
 
  •      developments concerning current or future strategic collaborations; and
 
  •      discussion of us or our stock price by the financial and scientific press and in online investor communities.
 
The realization of any of the risks described in these “Risk Factors” could have a dramatic and material adverse impact on the market price of our common stock. In addition, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could hurt our business, operating results and financial condition.
 
Our management team may invest or spend the proceeds of this offering in ways with which you may not agree or in ways which may not yield a significant return.
 
Our management will have broad discretion over the use of proceeds from this offering. The net proceeds from this offering will be used to fund clinical trials and other research and development activities, and to fund working capital and other general corporate purposes. We may also use a portion of the net proceeds to in-license, acquire or invest in complementary businesses or products. We have no present understandings, commitments or agreements with respect to any such in-licenses, acquisitions or investments and no portion of the net proceeds from this offering has been allocated for any specific transaction. Our management will have considerable discretion in the application of the net proceeds, and you will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used appropriately.


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The net proceeds may be used for corporate purposes that do not increase our operating results or market value. Until the net proceeds are used, they may be placed in investments that do not produce significant income or that may lose value.
 
Future sales of our common stock may depress our stock price.
 
Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. After this offering, we will have          outstanding shares of common stock based on the number of shares outstanding as of December 31, 2006 and after giving effect to the conversion of all of the shares of our preferred stock outstanding as of December 31, 2006 into shares of common stock in connection with this offering. This also includes the shares that we are selling in this offering, which may be resold in the public market immediately. Of the remaining shares,           shares are currently restricted as a result of securities laws or lock-up agreements but will be available for resale in the public market as described in the “Shares Eligible for Future Sale” section of this prospectus. As a result of the lock-up agreements between our underwriters and our security holders and the provisions of Rule 144, Rule 144(k) and Rule 701 under the Securities Act, the shares of our common stock (excluding the shares sold in this offering) that will be available for sale in the public market are as follows:
 
  •                shares will be eligible for sale under Rule 144(k) or Rule 701 upon the expiration of the lock-up agreements, beginning 180 days after the date of this prospectus;
 
  •                shares will be eligible for sale under Rule 144 upon the expiration of the lock-up agreements, subject to volume limitations, manner of sale requirements and other restrictions, beginning 180 days after the date of this prospectus; and
 
  •                shares will be eligible for sale, upon exercise of vested options, upon the expiration of the lock-up agreements, beginning 180 days after the date of this prospectus.
 
Moreover, after this offering, holders of approximately 33,444,474 shares of common stock will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. These rights will continue following this offering and will terminate six years following the completion of this offering, or for any particular holder with registration rights who holds less than 1% of our outstanding capital stock, at such time following this offering when all securities held by that stockholder subject to registration rights may be sold pursuant to Rule 144 under the Securities Act within a single 90 day period. We also intend to register all shares of common stock that we may issue under our equity compensation plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to the lock-up agreements described in the “Underwriting” section of this prospectus.
 
Our executive officers and directors and their affiliates will exercise control over stockholder voting matters in a manner that may not be in the best interests of all of our stockholders.
 
Immediately following this offering, our executive officers and directors and their affiliates will together control approximately     % of our outstanding common stock. As a result, these stockholders will collectively be able to significantly influence all matters requiring approval of our stockholders, including the election of directors and approval of significant corporate transactions. The concentration of ownership may delay, prevent or deter a change in control of our company even when such a change may be in the best interests of some stockholders, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company or our assets and might affect the prevailing market price of our common stock.


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Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control which could limit the market price of our common stock and may prevent or frustrate attempts by our stockholders to replace or remove our current management.
 
Our amended and restated certificate of incorporation and amended and restated bylaws, which are to become effective at the closing of this offering, contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions include:
 
  •      a board of directors divided into three classes serving staggered three-year terms, such that not all members of the board will be elected at one time;
 
  •      a prohibition on stockholder action through written consent;
 
  •      a requirement that special meetings of stockholders be called only by the chairman of the board of directors, the chief executive officer, the president or by a majority of the total number of authorized directors;
 
  •      advance notice requirements for stockholder proposals and nominations;
 
  •      a requirement of approval of not less than 662/3% of all outstanding shares of our capital stock entitled to vote to amend any bylaws by stockholder action, or to amend specific provisions of our certificate of incorporation; and
 
  •      the authority of the board of directors to issue preferred stock on terms determined by the board of directors without stockholder approval.
 
In addition, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including to delay or impede a merger, tender offer or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.
 
We have never paid dividends on our capital stock, and because we do not anticipate paying any cash dividends in the foreseeable future, capital appreciation, if any, of our common stock will be your sole source of gain on an investment in our stock.
 
We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future earnings, if any, to fund the development and growth of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Furthermore, our credit and security agreement with Merrill Lynch Capital restricts our ability to pay dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.
 
We may become involved in securities class action litigation that could divert management’s attention and harm our business.
 
The stock markets have from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of pharmaceutical companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because biotechnology and biopharmaceutical companies have experienced significant stock price volatility in recent years. We may become involved in this type of litigation in the future. Litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This prospectus contains forward-looking statements, including statements regarding the progress and timing of clinical trials, the safety and efficacy of our product candidates, the goals of our development activities, estimates of the potential markets for our product candidates, estimates of the capacity of manufacturing and other facilities to support our products, projected cash needs and our expected future revenues, operations and expenditures. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that could cause our actual results, levels of activity, performance or achievement to differ materially from those expressed or implied by these forward-looking statements. These risks and uncertainties include, among others:
 
  •      our ability to successfully complete clinical development of our product candidates, Contrave and Excalia, on expected timetables, or at all, which includes enrolling sufficient patients in our clinical trials and demonstrating the safety and efficacy of these product candidates in such trials;
 
  •      the content and timing of submissions to and decisions made by the FDA and other regulatory agencies, including foreign regulatory agencies, demonstrating to the satisfaction of the FDA and such other agencies the safety and efficacy of our product candidates;
 
  •      intense competition in the obesity market and the ability of our competitors, many of whom have greater resources than we do, to offer different or better therapeutic alternatives than our product candidates;
 
  •      market acceptance of and future development and regulatory difficulties relating to any product candidates for which we do receive regulatory approval;
 
  •      our ability to develop sales, distribution and marketing capabilities or enter into agreements with third parties to sell, distribute and market any of our product candidates that may be approved for sale;
 
  •      our ability to obtain coverage and reimbursement for any of our product candidates that may be approved for sale from the government or third-party payors, and the extent of such coverage and reimbursement, and the willingness of third-party payors to pay for our product candidates versus less expensive therapies;
 
  •      our compliance with the agreements under which we license certain patents and other rights related to our product candidates;
 
  •      our reliance on third parties to conduct our clinical trials and manufacture our product candidates;
 
  •      our ability to grow our business by identifying and acquiring or in-licensing new product candidates, increasing the size of our organization and attracting and retaining key personnel;
 
  •      our and our licensors’ ability to obtain, maintain and successfully enforce adequate patent and other intellectual property protection of our product candidates and the rights relating thereto; and
 
  •      our short operating history, our lack of significant revenue and profitability, our significant historical operating losses and our ability to obtain additional funding to continue to operate our business, which funding may not be available on commercially reasonable terms, or at all.


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Forward-looking statements include all statements that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential,” or the negative of those terms, and similar expressions and comparable terminology intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this prospectus and, except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this prospectus. The forward-looking statements contained in this prospectus are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended.


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USE OF PROCEEDS
 
We estimate that we will receive net proceeds of approximately $      million from the sale of the shares of common stock offered in this offering, based on an assumed initial public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us. Each $1.00 increase or decrease in the assumed public offering price of $      per share would increase or decrease, respectively, the net proceeds to us from this offering by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.
 
The principal purposes for this offering are to fund clinical development of our product candidates, Contrave and Excalia, to fund working capital and other general corporate purposes, to create a public market for our common stock and to increase our ability to access the capital markets in the future.
 
We currently expect to use our net proceeds from this offering as follows:
 
  •      approximately $60.0 million to fund clinical trials for Contrave and Excalia and other research and development activities; and
 
  •      the remainder to fund working capital and other general corporate purposes, including rent, salaries and benefits, insurance and professional fees.
 
We anticipate that the net proceeds from this offering, together with our existing cash, cash equivalents and short-term investments and the borrowing capacity under our $17.0 million credit and security agreement with Merrill Lynch Capital, will allow us to complete our planned Phase III clinical trials for Contrave and our ongoing Phase IIb clinical trial for Excalia.
 
We may also use a portion of the net proceeds set aside for our general corporate purposes to in-license, acquire or invest in complementary businesses or products. However, we have no current understandings, commitments or agreements to do so.
 
The amounts and timing of our actual expenditures will depend on numerous factors, including the progress in, and costs of, our clinical trials and other product development programs. We therefore cannot estimate the amount of net proceeds to be used for all of the purposes described above. We may find it necessary or advisable to use the net proceeds for other purposes, and we will have broad discretion in the application of the net proceeds. Pending the uses described above, we intend to invest the net proceeds in short-term, interest-bearing, investment-grade securities.
 
DIVIDEND POLICY
 
We have never declared or paid any cash dividends on our capital stock and we do not currently intend to pay any cash dividends on our common stock. We expect to retain future earnings, if any, to fund the development and growth of our business. The payment of dividends by us on our common stock is limited by our credit and security agreement with Merrill Lynch Capital. Any future determination to pay dividends on our common stock will be at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions.


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CAPITALIZATION
 
The following table sets forth our cash and cash equivalents and investment securities, available for sale, and capitalization as of December 31, 2006:
 
  •      on an actual basis; and
 
  •      on a pro forma as adjusted basis to reflect (a) the conversion upon the consummation of this offering of all outstanding shares of our preferred stock into 32,924,474 shares of common stock and (b) our sale of           shares of common stock in this offering and our receipt of the estimated net proceeds therefrom, based on an assumed initial public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.
 
The pro forma information below is illustrative only and our capitalization following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering to be determined at pricing. You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes appearing elsewhere in this prospectus.
 
                 
    As of December 31, 2006  
          Pro Forma as
 
    Actual     Adjusted(1)  
 
Cash and cash equivalents and investment securities, available-for-sale
    $34,413,603     $               
                 
Series A redeemable convertible preferred stock, $0.001 par value: actual — 9,322,035 shares authorized, issued and outstanding; pro forma as adjusted — no shares authorized, issued or outstanding
    $10,954,497          
Series B redeemable convertible preferred stock, $0.001 par value: actual — 14,830,509 shares authorized, issued and outstanding; pro forma as adjusted — no shares authorized, issued or outstanding
    34,942,437          
Stockholders’ equity (deficit):
               
Preferred stock, $0.001 par value: actual — no shares authorized, issued or outstanding; pro forma as adjusted — 10,000,000 shares authorized, no shares issued or outstanding
             
Series C convertible preferred stock, $0.001 par value: actual — 8,771,930 shares authorized, issued and outstanding; pro forma as adjusted — no shares authorized, issued or outstanding
    8,772          
Common stock, $0.001 par value; actual — 50,000,000 shares authorized, 4,796,084 shares issued and outstanding; pro forma as adjusted — 100,000,000 shares authorized,          shares issued and outstanding
    4,796          
Additional paid-in capital
    33,296,081          
Accumulated other comprehensive gain
    11,433          
Deficit accumulated during the development stage
    (49,168,004 )        
                 
Total stockholders’ equity
    (15,846,922 )        
                 
Total capitalization
    $30,050,012     $  
                 
 
(1) Each $1.00 increase or decrease in the assumed public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) would increase or decrease, respectively, the amount of cash and cash equivalents and securities available-for-sale, additional paid-in capital and total capitalization by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.


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The number of shares of common stock shown as issued and outstanding in the table excludes:
 
  •      4,594,125 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2006 at a weighted average exercise price of $0.62 per share; and
 
  •                shares of our common stock reserved for future issuance under our 2007 equity incentive award plan, which will become effective on the day prior to the day on which we become subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act (including 1,516,479 shares of common stock reserved for future grant or issuance under our 2004 stock plan, which shares will be added to the shares to be reserved under our 2007 equity incentive award plan upon the effectiveness of the 2007 equity incentive award plan).


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DILUTION
 
If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. As of December 31, 2006, our historical negative net tangible book value was $(15.8) million, or $(1.17) per share of common stock, based on 13,568,014 shares of our common stock outstanding at December 31, 2006, including the equivalent common shares related to our Series C convertible preferred stock. Our historical negative net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities and redeemable convertible preferred stock, divided by the total number of shares of our common stock outstanding as of December 31, 2006, including the equivalent common shares related to our Series C convertible preferred stock. After giving effect to the conversion upon consummation of this offering of all of our outstanding shares of redeemable preferred stock into 24,152,544 shares of our common stock, our pro forma net tangible book value as of December 31, 2006 would have been $30.1 million, or $0.80 per share. After giving effect to our sale in this offering of           shares of our common stock at an assumed initial public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting estimated underwriting discounts and commissions and estimated offering costs payable by us, our pro forma as adjusted net tangible book value as of December 31, 2006 would have been $        million, or $      per share of our common stock. This represents an immediate increase of net tangible book value of $      per share to our existing stockholders and an immediate dilution of $      per share to investors purchasing shares in this offering. The following table illustrates this per share dilution:
 
                 
Assumed initial public offering price per share
          $         
Historical net tangible book value per share at December 31, 2006
  $ (1.17 )        
Pro forma increase per share attributable to conversion of all outstanding shares of preferred stock
    1.97          
                 
Pro forma net tangible book value per share at December 31, 2006 before giving effect to this offering
    0.80          
Increase per share attributable to investors purchasing shares in this offering
               
                 
Pro forma net tangible book value per share, as adjusted to give effect to this offering
               
                 
Dilution to investors in this offering
          $        
                 
 
Each $1.00 increase or decrease in the assumed public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) would increase or decrease, our pro forma net tangible book value by approximately $      million, the pro forma net tangible book value per share after this offering by approximately $      per share and the dilution in pro forma net tangible book value per share to investors in this offering by approximately $      per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.
 
If the underwriters exercise their overallotment option in full, the pro forma net tangible book value per share after giving effect to this offering would be $      per share, and the dilution in pro forma net tangible book value per share to investors in this offering would be $      per share.


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The following table summarizes, as of December 31, 2006, the differences between the number of shares of common stock purchased from us, after giving effect to the conversion of all of our outstanding shares of preferred stock into common stock, the total effective cash consideration paid, and the average price per share paid by our existing stockholders and by our new investors purchasing stock in this offering at an assumed initial public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) before deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us:
 
                                         
    Shares Purchased     Total Consideration     Average Price
 
    Number     Percent     Amount     Percent     per Share  
 
Existing stockholders before this offering
    37,720,558       %   $ 76,060,866       %   $ 2.02  
Investors participating in this offering
                                       
                                         
Total
            100.0 %   $         100.0 %        
                                         
 
Each $1.00 increase or decrease in the assumed public offering price of $      per share (the mid-point of the price range set forth on the cover page of this prospectus) would increase or decrease total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $      million, $      million and $     , respectively, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering costs payable by us.
 
If the underwriters exercise their overallotment option in full, our existing stockholders would own     % and our new investors would own     % of the total number of shares of our common stock outstanding after this offering.
 
The above information assumes no exercise of stock options outstanding as of December 31, 2006, and excludes:
 
  •      4,594,125 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2006 at a weighted average exercise price of $0.62 per share; and
 
  •                shares of our common stock reserved for future issuance under our 2007 equity incentive award plan, which will become effective on the day prior to the day on which we become subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act (including 1,516,479 shares of common stock reserved for future grant or issuance under our 2004 stock plan, which shares will be added to the shares to be reserved under our 2007 equity incentive award plan upon the effectiveness of the 2007 equity incentive award plan).


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SELECTED FINANCIAL DATA
 
The following selected statement of operations data for the years ended December 31, 2004, 2005 and 2006 and the period from September 12, 2002 (inception) to December 31, 2006 and the balance sheet data as of December 31, 2005 and 2006 have been derived from our audited financial statements included elsewhere in this prospectus. The selected statement of operations data for the period from September 12, 2002 (inception) through December 31, 2002 and the year ended December 31, 2003 and the balance sheet data as of December 31, 2002, 2003 and 2004 have been derived from our audited financial statements not included in this prospectus. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes included elsewhere in this prospectus.
 
                                                 
                                  Period from
 
    September 12,
                            September 12,
 
    2002
                            2002
 
    (Inception)
                            (Inception)
 
    Through
                            Through
 
    December 31,
    Years Ended December 31,     December 31,
 
    2002     2003     2004     2005     2006     2006  
 
Statement of Operations Data:
                                               
Revenues:
                                               
Collaborative agreement
  $     $     $     $ 174,137     $     $ 174,137  
License revenue
                      88,230       88,239       176,469  
                                                 
Total revenues
                      262,367       88,239       350,606  
Operating expenses:
                                               
Research and development
          1,163,953       6,144,510       9,708,935       22,586,151       39,603,549  
General and administrative
    1,300       667,088       1,590,500       3,386,167       5,869,438       11,514,493  
                                                 
Total operating expenses
    1,300       1,831,041       7,735,010       13,095,102       28,455,589       51,118,042  
                                                 
Loss from operations
    (1,300 )     (1,831,041 )     (7,735,010 )     (12,832,735 )     (28,367,350 )     (50,767,436 )
Other income (expense):
                                               
Interest income
                47,376       744,165       871,904       1,663,445  
Interest expense
          (50,045 )     (5,702 )           (8,266 )     (64,013 )
                                                 
Total other income (expense)
          (50,045 )     41,674       744,165       863,638       1,599,432  
                                                 
Net loss
    (1,300 )     (1,881,086 )     (7,693,336 )     (12,088,570 )     (27,503,712 )     (49,168,004 )
Accretion to redemption value of redeemable convertible preferred stock
                (12,920 )     (24,142 )     (30,538 )     (67,600 )
Deemed dividend related to beneficial conversion for Series C convertible preferred stock
                            (13,859,649 )     (13,859,649 )
                                                 
Net loss attributable to common stockholders
  $ (1,300 )   $ (1,881,086 )   $ (7,706,256 )   $ (12,112,712 )   $ (41,393,899 )   $ (63,095,253 )
                                                 
Basic and diluted net loss per share(1)
  $ (0.00 )   $ (1.16 )   $ (2.50 )   $ ( 3.06 )   $ (9.44 )        
                                                 
Shares used to calculate net loss per share(1)
    1,288,182       1,627,105       3,077,256       3,960,509       4,386,141          
                                                 
Pro forma basic and diluted net loss per share (unaudited)(1)
                                  $ (0.93 )        
                                                 
Shares used to calculate pro forma net loss per share (unaudited)(1)
                                    29,475,960          
                                                 
 
(1) See Note 2 of Notes to Financial Statements for an explanation of the method used to calculate the historical and pro forma net loss per share and the number of shares used in the computation of the per share amounts.
 


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    As of December 31,  
    2002     2003     2004     2005     2006  
 
Balance Sheet Data:
                                       
Cash and cash equivalents and investment securities, available-for-sale
  $          —     $ 19,089     $ 1,674,337     $ 27,647,112     $ 34,413,603  
Working capital (deficit)
          (188,393 )     1,318,246       26,411,688       29,645,294  
Total assets
          45,709       1,749,672       28,113,629       36,809,984  
Redeemable convertible preferred stock
                10,927,533       45,866,396       45,896,934  
Deficit accumulated during the development stage
    (1,300 )     (1,882,386 )     (9,575,722 )     (21,664,292 )     (49,168,004 )
Total stockholders’ equity (deficit)
          (1,877,112 )     (9,536,669 )     (20,576,544 )     (15,846,922 )

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and our financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
Background
 
We are a biopharmaceutical company focused on the development of pharmaceutical product candidates for the treatment of central nervous system, or CNS, disorders, with an initial focus on obesity. Our strategy involves combining individual generic drugs that have previously received regulatory approval for other indications and, thus, have established post-marketing safety records. We systematically screen these drugs for synergistic CNS activity and combine them into new product candidates that we believe address unmet medical needs and are patentable. We are testing combinations of individual generic drugs in our product candidates in an effort to demonstrate adequate efficacy and safety for potential regulatory approval and have not yet received regulatory approval of any product candidate. Our lead combination product candidates targeted for obesity are Contrave, which we plan to advance into Phase III clinical trials in the first half of 2007, and Excalia, which is in late Phase II clinical trials. In addition, we plan to continue to screen drugs for synergistic CNS activity and, based on the results, we may advance other potential combination product candidates into clinical trials.
 
We are a development stage company. We have incurred significant net losses since our inception. As of December 31, 2006, we had an accumulated deficit of $49.2 million. These losses have resulted principally from costs incurred in connection with research and development activities, primarily costs of clinical trial activities associated with our current product candidates, and general and administrative expenses. We expect to continue to incur operating losses for the next several years as we pursue the clinical development and market launch of our product candidates and acquire or in-license additional products and technologies, and add the necessary infrastructure to support our growth.
 
Revenues
 
We have generated approximately $351,000 in revenue from inception through December 31, 2006, resulting from the sublicensing of technology and amounts earned under a collaborative agreement. During 2005, we sublicensed technology to Cypress Bioscience, Inc., or Cypress, for an upfront payment of $1.5 million, and this amount is being recognized ratably over the estimated life of the sublicensed patent. In addition, we recognized revenue of approximately $174,000 during the year ended December 31, 2005 related to a collaborative agreement with Eli Lilly and Company, or Eli Lilly, the term of which has since expired. We do not expect to generate any significant revenues from licensing, achievement of milestones or product sales unless and until we are able to obtain regulatory approval of, and commercialize, our product candidates either ourselves or with a collaborator. However, we may never generate revenues from our product candidates as we may never succeed in obtaining regulatory approval or commercializing products.
 
Research and Development Expenses
 
The majority of our operating expenses to date have been incurred in research and development activities. Our research and development expenses consist primarily of costs associated with clinical trials managed by our contract research organizations, or CROs, product development efforts and manufacturing costs. License fees, salaries and related employee benefits for certain personnel, and costs associated with


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certain non-clinical activities such as regulatory expenses, are also included in this amount. Our most significant costs are expenses incurred in connection with the clinical trials for Contrave and Excalia. The clinical trial expenses include payments to vendors such as CROs, investigators, suppliers of clinical drug materials and related consultants. We charge all research and development expenses to operations as incurred because the underlying technology associated with these expenditures relates to our research and development efforts and has no alternative future uses.
 
At any time, we have several ongoing research projects. Our internal research and development resources are not directly tied to any individual research project and are primarily deployed across our Contrave and Excalia programs, both of which target the obesity market. We are developing our product candidates in parallel and, due to the fact that we use shared resources across projects, we do not maintain information regarding the costs incurred for our research and development programs on a program-specific basis. Our external service providers similarly have not generally billed us on a program-specific basis.
 
At this time, due to the risks inherent in the clinical trial process and given the early stage of our product development programs, we are unable to estimate with any certainty the costs we will incur in the continued development of our product candidates for potential commercialization. Clinical development timelines, the probability of success and development costs can differ materially from expectations. While we are currently focused on advancing each of our product development programs, our future research and development expenses will depend on the clinical success of each product candidate, as well as ongoing assessments as to each product candidate’s commercial potential. In addition, we cannot forecast with any degree of certainty which product candidates will be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.
 
We expect our development expenses to grow over the next few years as we continue the advancement of our product development programs. We initiated our Phase IIb clinical trial program for Contrave in July 2005 and our Phase IIb trial for Excalia in July 2006. In the first half of 2007, we expect to initiate two Phase III clinical trials for Contrave. The lengthy process of completing clinical trials and seeking regulatory approval for our product candidates requires the expenditure of substantial resources. Any failure by us or delay in completing clinical trials, or in obtaining regulatory approvals, could cause a delay in the commencement of product revenues and cause our research and development expense to increase and, in turn, have a material adverse effect on our results of operations. We do not expect any of our current product candidates to be commercially available in major markets before 2010, if at all.
 
General and Administrative
 
Our general and administrative expenses consist primarily of salaries and related costs for personnel in executive, finance, accounting and internal support functions. In addition, administrative expenses include professional fees for legal, consulting and accounting services. We anticipate increases in general and administrative expenses as we add personnel, comply with the reporting obligations applicable to publicly-held companies, and continue to build our corporate infrastructure in support of our continued development and preparation for the potential commercialization of our product candidates.
 
Interest and Other Income
 
Interest and other income consists of interest earned on our cash, cash equivalents and investment securities.
 
Income Taxes
 
As of December 31, 2006, we had federal and state net operating loss carryforwards of approximately $42.1 million and $42.6 million, respectively. If not utilized, the net operating loss carryforwards will begin expiring in 2022 for federal purposes and 2012 for state purposes. As of December 31, 2006, we had federal


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and state research and development tax credit carryforwards of approximately $2.2 million and $1.7 million, respectively. The federal tax credits will begin expiring in 2023 unless previously utilized and the state tax credits carry forward indefinitely. Under Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, substantial changes in our ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset taxable income. Any such annual limitation may significantly reduce the utilization of the net operating losses before they expire. In each period since our inception, we have recorded a valuation allowance for the full amount of our deferred tax asset, as the realization of the deferred tax asset is uncertain. As a result, we have not recorded any federal or state income tax benefit in our statement of operations.
 
Beneficial Conversion Feature
 
During November 2006, we completed the sale of 8,771,930 shares of Series C convertible preferred stock for net proceeds of approximately $29.9 million. The Series C convertible preferred stock was sold at a price per share below the anticipated initial public offering price. Accordingly, pursuant to EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features, we recorded a deemed dividend on the Series C convertible preferred stock of $13,859,649, which is equal to the number of shares of Series C convertible preferred stock sold multiplied by the difference between the estimated fair value of the underlying common stock and the Series C conversion price per share.
 
Critical Accounting Policies and Estimates
 
Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates.
 
We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.
 
Research and Development Expenses
 
A substantial portion of our ongoing research and development activities are performed under agreements we enter into with external service providers, including CROs, who conduct many of our research and development activities. We accrue for costs incurred under these contracts based on factors such as estimates of work performed, patient enrollment, progress of patient studies and other events. However, the level of estimates can be significant. To date, we have not made any material adjustments to our estimates of clinical trial expenses. We make good faith estimates that we believe to be accurate, but the actual costs and timing of clinical trials are highly uncertain, subject to risks and may change depending upon a number of factors, including our clinical development plan. When any of our product candidates enters Phase III clinical trials, the process of estimating clinical trial costs may become more complex because the trials will involve larger numbers of patients and clinical sites.
 
Stock-Based Compensation
 
On January 1, 2006, we adopted Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment, which revises SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires that share-based payment transactions with employees be recognized in the financial statements based on their fair value and recognized as compensation expense over the vesting period. Prior to SFAS No. 123(R), we disclosed the pro forma effects of applying SFAS No. 123 under the minimum


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value method. We adopted SFAS No. 123(R) effective January 1, 2006, prospectively for new equity awards issued subsequent to January 1, 2006.
 
The adoption of SFAS 123(R) for the year ended December 31, 2006 resulted in the recognition of additional stock-based compensation expense of $834,500. Of this amount, $372,000 is included in research and development expense and $462,500 is included in general and administrative expense for the year ended December 31, 2006.
 
Under SFAS No. 123(R), we calculate the fair value of stock option grants using the Black-Scholes option-pricing model. The weighted average assumptions used in the Black-Scholes model were 6.2 years for the expected term, 70% for the expected volatility, 4.7% for the risk free rate and 0% for dividend yield for the year ended December 31, 2006. Future expense amounts for any particular quarterly or annual period could be affected by changes in our assumptions.
 
The weighted average expected option term for 2006 reflects the application of the simplified method set out in SEC Staff Accounting Bulletin, or SAB, No. 107 which was issued in March 2005. The simplified method defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.
 
Estimated volatility for fiscal 2006 also reflects the application of SAB No. 107 interpretive guidance and, accordingly, incorporates historical volatility of similar public entities.
 
At December 31, 2006, total unrecognized share-based compensation costs related to non-vested option awards was $11.0 million, of which $8.4 million arose from the adoption of SFAS No. 123(R). This $8.4 million is expected to be recognized over a weighted average period of approximately 3.6 years. The remaining $2.6 million relates to stock awards granted prior to the adoption of SFAS No. 123(R) and is expected to be recognized over a weighted average period of 2.2 years.
 
As of December 31, 2006, there were outstanding options to purchase 4,594,125 shares of common stock. Of these, options to purchase 1,007,785 shares were vested with a weighted-average exercise price of $0.30 per share and options to purchase 3,586,340 shares were unvested with a weighted-average exercise price of $0.71 per share. The intrinsic value of outstanding vested and unvested options based on an estimated initial public offering price of $      per share was $      million.
 
Prior to January 1, 2006, we applied the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25 and related interpretations. Under this method, if the exercise price of the award equaled or exceeded the fair value of the underlying stock on the measurement date, no compensation expense was recognized. The measurement date was the date on which the final number of shares and exercise price were known and was generally the grant date for awards to employees and directors. If the exercise price of the award was below the fair value of the underlying stock on the measurement date, then compensation cost was recorded, using the intrinsic-value method, and was generally recognized in the statements of operations over the vesting period of the award.
 
However, in connection with the preparation of our financial statements necessary for this offering and based on the preliminary valuation information presented by the underwriters of this offering, we retrospectively reassessed the estimated fair value of our common stock in light of the potential completion of this offering. The valuation methodology that most significantly impacted our reassessment of fair value at September 30, 2006 was our market-based assessment of the valuation of existing comparable small capitalization, recently public biopharmaceutical companies along with the valuation information presented by the underwriters. In determining the reassessed fair value of our common stock during 2006, we established $5.00 as the reassessed fair value at December 31, 2006. We also then reassessed our estimate of fair value for the period from April 1, 2005 to December 31, 2005 and the year ended 2006 based on the nature of our operations and our achievements in executing against our operating plan during 2006 and market trends. Because of the impact that achievement of unique milestones had on our valuation during the various points in


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time before the reassessment, certain additional adjustments for factors unique to us were considered in the reassessed values determined for the 21 months ended December 31, 2006, including:
 
  •      during April and May 2005, we completed our Series B redeemable convertible preferred stock financing;
 
  •      during April 2005, we hired our current President and Chief Executive Officer, formerly the President of the Neuroscience Product Group at Eli Lilly;
 
  •      during March of 2006, we received data to support the tolerability of the sustained release formulation of zonisamide;
 
  •      during June 2006, we completed and compiled data from a significant subset of our Phase IIb clinical trial for Contrave;
 
  •      during June 2006, we began enrolling patients in our Phase IIb clinical trial for Excalia;
 
  •      during September 2006, we expanded our management team by hiring additional senior officers; and
 
  •      during November 2006, we completed the sale of our Series C preferred stock financing.
 
Stock-based compensation expense for the period from April 1, 2005 to December 31, 2005 includes the difference between the reassessed fair value per share of our common stock on the date of grant and the exercise price per share and is amortized over the vesting period of the underlying option, generally four years, using the straight-line method. There are significant judgments and estimates inherent in the determination of the reassessed fair values. For this and other reasons, the reassessed fair value used to compute the stock-based compensation expense may not be reflective of the fair market value that would result from the application of other valuation methods, including accepted valuation methods for tax purposes.
 
During the period from April 1, 2005 to December 31, 2005, we granted options to employees to purchase a total of 2,226,793 shares of common stock at an exercise price of $0.30 per share. During the year ended December 31, 2006, we granted options to employees to purchase a total of 2,470,888 shares of common stock at exercise prices ranging from $0.35 to $3.00 per share. These fair market values of our common stock were established by our board of directors. We did not use a contemporaneous valuation from an unrelated valuation specialist because, at the time these stock options were issued, we believed our estimates of the fair value of the common stock to be reasonable and consistent with our understanding of how similarly situated companies in our industry were valued. Given the absence of the an active market for our common stock, our board of directors determined the estimated fair value of our common stock on the date of grant based on several factors, including the price of $2.36 per share at which Series B redeemable convertible preferred stock was issued to investors in April and May 2005, and the rights, preferences and privileges of the preferred stock relative to the common stock, important developments relating to the results of the clinical trials, our stage of development and business strategy, and the likelihood of achieving a liquidity event for our outstanding shares of stock. Of the $35.0 million in gross proceeds received from the sale of Series B redeemable convertible preferred stock, approximately $15.0 million was received from related parties, including 5% stockholders and certain investors affiliated with members of our board of directors. The rights, preferences and privileges of each series of preferred stock include a liquidation preference, dividend provisions, antidilution protective provisions and voting preferences, among other rights, while the common stock has none of these features. On the date of issuance, these preferences were considered significant and our board of directors concluded at that time that the common stock had a nominal fair value compared to the preferred stock, primarily because the likelihood of achieving a liquidity event could not be determined at that time. In reassessing the fair values of our common stock in connection with this offering, including the milestones leading up to the initiation of this public offering, we concluded that the value of the preferences of our Series B preferred stock should not be given as much weight and the reassessed fair value of our common stock starting April 2005 was equal to 90% of $2.36 per share, the price at which we sold our Series B redeemable convertible preferred stock, or $2.12 per share. The reassessed fair value of our common stock was increased from $2.12 per share in April 2005 to


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$5.00 per share in September 2006 based on the estimated increase in valuation resulting from achieving the specific milestones outlined above.
 
The Company granted options in May 2005 at $0.30 per share, in May 2006 at $0.35 per share, in September 2006 at $1.00 per share and in November 2006 at $3.00 per share. Based upon the reassessment discussed above, we determined that the reassessed fair value of the options to purchase 2,226,793 shares of common stock granted to employees during May 2005 was $3.00 per share and the 525,888 options granted in May 2006 and 1,945,000 options granted to employees in September and November 2006 were at $3.50 and $5.00 per share, respectively.
 
Equity instruments issued to non-employees are recorded at their fair value as determined in accordance with SFAS No. 123(R) and Emerging Issues Task Force 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods and Services, and are periodically revalued as the equity instruments vest and are recognized as expense over the related service period.
 
Results of Operations
 
Comparison of year ended December 31, 2006 to year ended December 31, 2005
 
Revenues.  Revenues for the year ended December 31, 2006 were $88,000 and were related to our sublicensed technology to Cypress. Revenues decreased $174,000 as a result of the completion of the collaborative agreement with Eli Lilly as of December 31, 2005. Cypress accounted for 34% and 100% of our revenue for the year ended December 31, 2005 and the year ended December 31, 2006, respectively. Eli Lilly accounted for 66% of our revenue for the year ended December 31, 2005.
 
Research and Development Expenses.  Research and development expenses increased to $22.6 million for the year ended December 31, 2006 from $9.7 million for the comparable period during 2005. This increase of $12.9 million was due primarily to increased expenses in connection with clinical trials and consulting expenses totaling approximately $12.5 million. The remaining increase is the result of increases in salaries and personnel related costs and stock-based compensation costs totaling approximately $1.1 million, offset by a decrease in licensing fees of approximately $560,000.
 
General and Administrative Expenses.  General and administrative expenses increased to $5.9 million for the year ended December 31, 2006 from $3.4 million for the comparable period during 2005. This increase of $2.5 million was primarily due to an increase in stock-based compensation costs of $751,000, and an increase in legal fees, salaries and personnel related costs, other professional fees, travel, and consulting fees totaling $1.3 million.
 
Interest and Other Income.  Interest income increased to $872,000 for the year ended December 2006 from $744,000 for the year ended December 31, 2005. This increase of $128,000 was due to the increase in average cash and investment balances as a result of investing the proceeds received from the sale of Series B preferred stock in May 2005 and higher interest rates in 2006.
 
Interest Expense.  Interest expense increased to $8,300 for the year ended December 31, 2006 primarily due to the amortization of debt issuance costs incurred in connection with the $17.0 million credit and security agreement with Merrill Lynch Capital.
 
Comparison of year ended December 31, 2005 to year ended December 31, 2004
 
Revenues.  Revenues for the year ended December 31, 2005 consisted of $88,000 resulting from a sublicensing of technology and $174,000 from amounts earned under a collaborative agreement. We received no revenues in prior years. During 2005, we sublicensed technology to Cypress for an upfront payment of $1.5 million and this amount is being recognized ratably over the estimated life of the patent. In addition, we recognized revenue of approximately $174,000 during the year ended December 31, 2005 related to a


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collaborative agreement with Eli Lilly. Cypress accounted for 34% and Eli Lilly accounted for 66% of our revenue for the year ended December 31, 2005.
 
Research and Development Expenses.  Research and development expenses increased to $9.7 million for the year ended December 31, 2005 from $6.1 million for the year ended December 31, 2004. This increase of $3.6 million was due primarily to increased expenses in connection with clinical trials and consulting expenses totaling approximately $2.9 million. In addition, salaries and related personnel costs increased by approximately $229,000 and stock-based compensation costs increased by approximately $214,000.
 
General and Administrative Expenses.  General and administrative expenses increased to $3.4 million for the year ended December 31, 2005 from $1.6 million for year ended December 31, 2004. This increase of $1.8 million was primarily due to an increase of approximately $900,000 related to stock-based compensation charges and $600,000 for salaries and related personnel costs as we expanded our general and administrative functions to support our operations.
 
Interest and Other Income.  Interest income increased to $744,000 for the year ended December 31, 2005 from $47,000 for the year ended December 31, 2004. This increase of $697,000 was due to the increase in average cash and investment balances as a result investing the proceeds received from the sale of Series B Preferred stock in May 2005.
 
Comparison of year ended December 31, 2004 to year ended December 31, 2003
 
Research and Development Expenses.  Research and development expenses increased to $6.1 million for the year ended December 31, 2004 from $1.2 million for year ended December 31, 2003. This increase of $4.9 million was due primarily to increased expenses in connection with clinical trials and consulting expenses totaling approximately $4.8 million.
 
General and Administrative Expenses.  General and administrative expenses increased to $1.6 million for the year ended December 31, 2004 from $700,000 for the year ended December 31, 2003. This increase of $900,000 was due primarily to an increase in salaries and related personnel costs totaling approximately $261,000 and an increase in legal expenses of approximately $518,000.
 
Interest and Other Income.  Interest income increased to $47,000 for the year ended December 31, 2004 as a result from an increase in average cash balances.
 
Interest Expense.  Interest expense decreased by $44,000 for the year ended December 31, 2004 due to the principal amount outstanding under promissory notes being converted into equity during January 2004.
 
Liquidity and Capital Resources
 
Since inception, our operations have been financed primarily through the private placement of equity securities. Through December 31, 2006, we received net proceeds of approximately $75.8 million from the sale of shares of our preferred and common stock as follows:
 
  •      from September 12, 2002 to December 31, 2006, we issued and sold a total of 2,107,146 shares of common stock for aggregate net proceeds of $14,801;
 
  •      in March 2004, we issued and sold a total of 9,322,035 shares of Series A redeemable convertible preferred stock for aggregate net proceeds of $9.2 million and the conversion of promissory notes and interest thereon totaling $1.7 million;
 
  •      from April 2005 to May 2005, we issued and sold 14,830,509 shares of Series B redeemable convertible preferred stock for aggregate net proceeds of $34.9 million; and
 
  •      in November 2006, we issued and sold a total of 8,771,930 shares of Series C convertible preferred stock for aggregate net proceeds of $29.9 million.


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As of December 31, 2006, we had $19.4 million in cash and cash equivalents and an additional $15 million in investment securities, available-for-sale. We have invested a substantial portion of our available cash in money market funds placed with reputable financial institutions for which credit loss is not anticipated and in corporate debt obligations. In addition, we have established guidelines relating to diversification and maturities of our investments to preserve principal and maintain liquidity.
 
Net cash used in operating activities was $7.5 million, $8.7 million and $21.8 million for fiscal years ended December 31, 2004, 2005 and 2006, respectively. Net cash used in each of these periods was primarily a result of external research and development expenses, clinical trial costs, personnel-related costs, third-party supplier expenses and professional fees.
 
Net cash used in investing activities was $30,000 and $19.1 million for fiscal years ending December 31, 2004 and 2005, respectively. Net cash used in the 2005 period resulted from net purchases of investment securities totaling $19.0 million and the purchase of equipment of $151,000. Net cash provided by investing activities for the year ended December 31, 2006 was $3.4 million, resulting from net sales of investment securities. Investing activities consist primarily of purchases and sales of marketable securities and capital purchases. Purchases of property and equipment were $0, $151,000 and $427,000 in 2004, 2005 and 2006, respectively.
 
Net cash provided by financing activities was $9.2 million, $34.9 million and $29.1 million for fiscal years ending December 31 2004, 2005 and 2006, respectively. Financing activities consist primarily of the net proceeds from the sale of our preferred stock. In 2004, 2005, and 2006 we received net proceeds from the issuance of preferred stock of $9.2 million, $34.9 million, and $29.9 million respectively.
 
We cannot be certain if, when or to what extent we will receive cash inflows from the commercialization of our product candidates. We expect our development expenses to be substantial and to increase over the next few years as we continue the advancement of our product development programs.
 
As a biopharmaceutical company focused on in-licensing, developing and commercializing proprietary pharmaceutical product candidates, we have entered into license agreements to acquire the rights to develop and commercialize our two product candidates, Contrave and Excalia. Pursuant to these agreements, we obtained exclusive licenses to the patent rights and know-how for selected indications and territories. Under our license agreement with Duke University, we issued 885,249 shares of our common stock in March 2004 and may be required to make future milestone payments totaling up to $1.7 million upon the achievement of various milestones related to regulatory or commercial events. Under our license agreement with Lee Dante, M.D., we issued an option to purchase 146,897 shares of our common stock in April 2004 at an exercise price of $0.05 per share, which expires in April 2014. In April 2006, Dr. Dante exercised options with respect to 70,000 of these shares. We also paid Dr. Dante an upfront fee of $100,000 and may be required to make future milestone payments totaling up to $1.0 million upon the achievement of a milestone related to a regulatory event. Under our license agreement with Oregon Health & Science University, we issued 152,630 shares of our common stock in December 2003 and paid an upfront fee of $65,000. Under these three agreements, we are also obligated to pay royalties on any net sales of the licensed products.
 
Our future capital uses and requirements depend on numerous factors. These factors include but are not limited to the following:
 
  •      the progress of our clinical trials, including expenses to support the trials and milestone payments that may become payable;
 
  •      our ability to establish and maintain strategic collaborations, including licensing and other arrangements;
 
  •      the costs involved in enforcing or defending patent claims or other intellectual property rights;
 
  •      the costs and timing of regulatory approvals;
 
  •      the costs of establishing sales or distribution capabilities;


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  •      the successful commercialization of our products; and
 
  •      the extent to which we in-license, acquire or invest in other indications, products, technologies and businesses.
 
In December 2006, we entered into a credit and security agreement with Merrill Lynch Capital providing for potential borrowing until June 30, 2007 of up to $17.0 million. We have not yet drawn down any amounts under the credit and security agreement, although we have paid a non-refundable fee totaling $85,000. If we borrow amounts under the credit and security agreement, we will be required to make monthly payments of principal and interest and all amounts then outstanding will become due and payable upon the earlier to occur of June 30, 2010 or three years from the last funding of any amounts under the agreement. Interest accrues on amounts outstanding under the agreement at a base rate set forth in the agreement plus an applicable margin, which ranges from 3.75% to 4.25% based on the date of borrowing. The loan is collateralized by substantially all of our assets other than, subject to certain limited exceptions, intellectual property. Subject to certain limited exceptions, amounts prepaid under the credit and security agreement are subject to a prepayment fee equal to 3% of the amount prepaid. In addition, upon repayment of the amounts borrowed for any reason, we will be required to pay an exit fee equal to the greater of $500,000 or 5% of the total amounts borrowed under the credit facility. Under the terms of the agreement, we are subject to operational covenants, including limitations on our ability to incur liens or additional debt, pay dividends, redeem our stock, make specified investments and engage in merger, consolidation or asset sale transactions, among other restrictions.
 
We believe that our existing cash and cash equivalents, together with the borrowing capacity under our $17.0 million credit and security agreement with Merrill Lynch Capital, will be sufficient to meet our projected operating requirements through at least March 31, 2008.
 
Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources generated from the proceeds of offerings of our equity securities, potential borrowings and potential corporate collaborations. In addition, we may finance future cash needs through the sale of additional equity securities, strategic collaboration agreements and other debt financing. In addition, we cannot be sure that our existing cash and investment resources will be adequate, that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, scale back or eliminate some or all of our development programs, relinquish some or even all rights to product candidates or renegotiate less favorable terms than we would otherwise choose. Failure to obtain adequate financing also may adversely affect our ability to operate as a going concern. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial requirements that may restrict our ability to operate our business.
 
Contractual Obligations and Commitments
 
The following table describes our long-term contractual obligations and commitments as of December 31, 2006:
 
                                         
    Payments Due by Period  
          Less than 1
                   
    Total     Year     1-3 Years     4-5 Years     After 5 Years  
 
Long-term debt obligations(1)
  $      —     $      —     $      —     $      —     $      —  
Long-term liabilities(2)
    534,052            —       1,433       532,619            —  
Operating lease obligations
    1,037,900       202,200       425,300       410,400        
License obligations(3)
                             
                                         
Total
  $ 1,571,952     $ 202,200     $ 426,733     $ 943,019     $  
                                         


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(1) In December 2006, we entered into a credit and security agreement with Merrill Lynch Capital providing for the potential borrowing of up to $17.0 million. We have not yet drawn down any amounts under the credit and security agreement, although we have paid a non-refundable fee totaling $85,000.
 
(2) Primarily represents costs incurred in connection with our credit and security agreement with Merrill Lynch Capital.
 
(3) License obligations do not include additional payments of up to $2.7 million due upon the occurrence of certain milestones related to regulatory or commercial events or potential payments of up to $5.7 million to Duke should we receive milestone payments from Cypress under our agreement with Cypress (up to $3.7 million excluding milestone payments unrelated to sleep apnea). We may also be required to pay royalties on any net sales of the licensed products. License payments may be increased based on the timing of various milestones and the extent to which the licensed technologies are pursued for other indications. These milestone payments and royalty payments under our license agreements are not included in the table above because we cannot, at this time, determine when or if the related milestones will be achieved or the events triggering the commencement of payment obligations will occur.
 
We also enter into agreements with third parties to manufacture our product candidates, conduct our clinical trials and perform data collection and analysis. Our payment obligations under these agreements depend upon the progress of our development programs. Therefore, we are unable at this time to estimate with certainty the future costs we will incur under these agreements.
 
Related Party Transactions
 
For a description of our related party transactions, see the “Certain Relationships and Related Party Transactions” section of this prospectus.
 
Off-Balance Sheet Arrangements
 
We have not engaged in any off-balance sheet activities.
 
Quantitative and Qualitative Disclosures About Market Risk
 
Our cash and cash equivalents as of December 31, 2006 consisted primarily of money market funds and corporate debt obligations. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example, if we purchase a security that was issued with a fixed interest rate and the prevailing interest rate later rises, the value of our investment will probably decline. To minimize this risk, we intend to continue to maintain our portfolio of cash equivalents and short-term investments in a variety of securities including commercial paper, money market funds and government and non-government debt securities, all with various maturities. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.


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BUSINESS
 
Overview
 
We are a biopharmaceutical company focused on the development of pharmaceutical product candidates for the treatment of central nervous system, or CNS, disorders, with an initial focus on obesity. Our lead product candidates targeted for obesity are Contrave, which we plan to advance into Phase III clinical trials in the first half of 2007, and Excalia, which is in late Phase II clinical trials. Each of our product candidates is a combination of generic drugs, which we have systematically screened for synergistic CNS activity. We seek to combine chemical entities that, individually, have already received regulatory approval and have been commercialized previously, into new product candidates that we believe address unmet medical needs and are patentable. We are testing these combinations in an effort to demonstrate adequate efficacy and safety for potential regulatory approval. We have not yet received regulatory approval of any product candidate. In addition, we plan to continue to screen drugs for synergistic CNS activity and, based on the results, we may advance other potential combination product candidates into clinical trials.
 
We have selected our product candidates based on our research regarding CNS regulation of appetite and energy expenditure, as well as the reward-based mechanisms in the brain that reinforce unhealthy eating behaviors. These product candidates exhibited strong synergy within our screening model, which enabled us to prioritize them over others considered. In particular, we have focused our clinical development programs on drug combinations that we expect will generate weight loss and attenuate, or limit the effect of, the pathways in the brain that prevent extended weight loss. Our combination approach contrasts with most currently-approved weight loss drug therapies, which utilize a single active ingredient and have typically shown early weight loss followed by a plateau after several months of treatment. We believe that our approach to obesity drug development will permit a more sustained, clinically-relevant pattern of weight reduction. Results from our clinical trials to date for both Contrave and Excalia have supported this hypothesis. We believe that our strategy will increase our probability of technical success while reducing both the time and cost associated with development.
 
In addition, we are seeking to improve the profiles of our product candidates by developing proprietary sustained release, or SR, drug delivery formulations for their constituent drugs. To date, compositions of Contrave and Excalia using these proprietary SR formulations for the constituents naltrexone and zonisamide, respectively, have demonstrated improved patient tolerability compared to those using previously approved immediate release, or IR, formulations of naltrexone and zonisamide. Because of differences in pharmacokinetics between the generically available formulations and our proprietary SR formulations, we believe we can enhance patient outcomes and our competitive position.
 
We maintain an aggressive intellectual property strategy, which includes patent and trademark filings in multiple jurisdictions including the United States and other commercially significant markets. We hold exclusive licenses to two issued U.S. patents covering the Contrave composition and an exclusive license to an issued U.S. patent covering the Excalia composition. In addition, we own or have exclusive rights to 14 patent applications currently pending in the United States with respect to various compositions, methods of use and formulations relating to Contrave and/or Excalia.
 
In April 2006, we met with the U.S. Food and Drug Administration, or FDA, to discuss the clinical trial requirements for submission of new drug application, or NDA, filings for both Contrave and Excalia. Based on feedback from the FDA, we intend to conduct clinical development programs to provide active drug exposure among 1,500 patients for one year, under double-blind, placebo-controlled conditions for each product candidate. We expect to file an NDA with the FDA in the second half of 2009 for Contrave and in 2011 for Excalia, assuming that our clinical trials proceed as planned and are successful.
 
We currently retain worldwide marketing rights for both Contrave and Excalia. If approved, we may consider marketing these product candidates to select specialists; however, we expect that Contrave and Excalia have the potential to be prescribed to a significant extent by primary care physicians. In order to target this large group of potential prescribers, we may consider entering into a collaboration with a pharmaceutical company with the sales force and marketing resources to adequately address this physician audience. We


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expect to position Contrave for mild to moderate weight loss, particularly in women who report food craving. Excalia, in contrast, may be better suited for moderate to severe obesity in men and post-menopausal women.
 
The Obesity Epidemic
 
Obesity is a serious condition that is growing in prevalence and afflicts populations worldwide. In 1980, approximately 15% of the adult population in the United States was obese, according to the National Health and Nutrition Examination Survey. By 2002, the obesity rate had doubled to approximately 30% of the U.S. adult population, according to a later installment of the same survey. In addition, the survey estimated that another 34% of the U.S. adult population was overweight in 2002. We expect that given current trends, many members of this group will become obese in coming years. These estimates are based on thresholds of Body Mass Index, or BMI, which measures weight on a height-adjusted basis. A BMI level exceeding 30, or a BMI over 27 with other risk factors, is typically classified as obese, while a BMI between 25 and 30 is typically categorized as overweight. As an example, an individual who is six feet tall weighing 220 pounds would have a BMI of approximately 30. BMI is generally accepted within the medical community as a reliable indicator of body fat and is the standard for measurement used to determine if a person is overweight or obese, according to the National Institutes of Health, or NIH. Moreover, it is a relative risk predictor of the morbidity and mortality associated with being obese.
 
The growing prevalence of obesity has increasingly been recognized as a significant public health problem. In 2004, the Centers for Disease Control and Prevention identified obesity as the number one health threat in the United States. Approximately 300,000 deaths per year in the United States are associated with obesity according to the Department of Health and Human Services, or HHS. Obesity is also a significant health problem outside of the United States. According to the World Health Organization, there are as many as 1.6 billion people worldwide considered to be overweight, of which at least 400 million are estimated to be obese. Despite recognition of obesity as a public health crisis, we believe that the obesity epidemic will continue to grow in the United States given the trend towards larger meals, fattier foods and a sedentary lifestyle.
 
Excessive body weight is also associated with various physical complications that are often present and exacerbated by the obese condition. Diabetes, cancer, hypertension, high cholesterol, coronary artery disease, sleep apnea, liver and pulmonary disease, among others, are seen in greater prevalence among the obese than the general population, according to HHS and the North American Association for the Study of Obesity. In addition, research has established a new disease category called metabolic syndrome, which comprises the various co-morbidities, or related conditions, that often accompany obesity. Beyond these consequences, a number of co-morbidities involving the CNS may be complicated by obesity. These co-morbidities include anxiety, depression, substance abuse, chronic pain and insomnia. We believe there is a growing recognition within the medical community that obesity significantly exacerbates these conditions. Obesity and its co-morbidities are believed to cause significant added cost to the health care system. In 2000, HHS estimated the overall economic costs of obesity in the United States to be $117 billion. We expect that more effective treatment of obesity may also be a cornerstone in managing its co-morbidities.
 
Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for more effective pharmacological interventions.
 
Limitations of Current Therapies
 
Treatments for obesity consist of behavioral modification, pharmaceutical therapies, surgery and device implantation. Modifications to diet and exercise are the preferred initial treatment in obesity, according to the NIH. However, the rigors of behavioral modification often cause significant attrition over time and thus, suboptimal weight loss outcomes. Additionally, such an approach is not optimal for every individual. When pharmaceutical therapies are recommended, it is generally after behavioral modification alone has failed. Bariatric surgery, including gastric bypass and gastric banding procedures, is employed in more extreme cases, typically for obese individuals with a BMI over 40. Surgery can be effective in helping patients to lose 50% or


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more of their total body weight. However, surgery can be associated with significant side effects, potential complications including mortality, and substantial costs and recovery time. In addition, while surgery may be effective in achieving weight loss, recent publications have cited “addiction transfer,” where patients begin heavy alcohol consumption, drug use or other addictive habits in response to the reduced ability to consume food, including the October 2006 issue of Bariatric Times. Device implantation, such as neurostimulation, is a newer therapy which has yet to be widely adopted within the medical community.
 
Several pharmaceutical products have been approved for obesity marketing in the United States. Approved obesity drugs are generally prescribed for short-term use; only a select few have been approved for longer-term maintenance therapy. Several older drugs, indicated for short-term administration, have an amphetamine-like profile, including phentermine, phendimetrazine, benzphetamine and diethylpropion, according to the FDA approved product information. However, according to that same product information, these drugs have an increased risk for abuse potential and may be associated with adverse cardiovascular or CNS effects. Of these drugs, phentermine, a Class IV controlled substance indicated for short-term use, is the most widely used. Like diet alone, these older treatments, according to a December 1996 issue of The Journal of the American Medical Association, are generally associated with the classic weight loss plateau typically seen after several months of use.
 
Two drugs approved in the United States for long term use in the treatment of obesity are sibutramine and orlistat. Sibutramine is marketed in the United States by Abbott Laboratories under the brand name Meridia. An extensive meta-analysis of various clinical trials published in The Annals of Internal Medicine in April 2005 indicates that sibutramine produces average weight loss in patients of approximately 4.5 kg; however, patients typically experience a weight loss plateau after approximately 12 weeks. Sibutramine has been associated with increased risk of hypertension and tachycardia as evidenced in the FDA approved product information. This can represent a significant medical risk for obese patients already susceptible to heart disease.
 
Orlistat is marketed in the United States by Roche Laboratories, Inc. under the brand name Xenical. The above meta-analysis reported that orlistat produces average weight loss of approximately 2.75 kg. Orlistat is associated with frequent and, occasionally, severe gastrointestinal side effects, the nature of which can be socially constraining, as evidenced in the FDA approved product information. These include flatulence, fecal incontinence and urgency.
 
Due to the side effects and limited efficacy of these approved drugs, less than 2% of the obese population in the United States was treated with a pharmaceutical intervention in 2005, according to a September 2006 report by Frost & Sullivan. This represented approximately five million total U.S. prescriptions, which we believe substantially understates the potential demand for effective treatments. In the mid-1990s, fenfluramine or dexfenfluramine were used off-label in combination with phentermine, together known as “fen-phen,” and demonstrated significant weight loss. At its peak in 1996 before fenfluramine and dexfenfluramine were withdrawn for safety issues, fen-phen, along with other prescribed pharmaceuticals, represented over 20 million total U.S. prescriptions, according to IMS Health. We believe this history, combined with the substantial economic cost associated with obesity, underscores the unmet need and the potential for novel therapeutics to dramatically grow the market for obesity therapies.
 
The Orexigen Solution
 
Obesity is increasingly recognized as a disorder of CNS regulation of appetite and energy expenditure. The brain, including the hypothalamus, plays a critical role in governing many fundamental processes throughout the body. The hypothalamus receives chemical and hormonal stimuli from various sources, including glucose, insulin, leptins and the peptides secreted by the gut as it processes food. These inputs govern a person’s appetite, satiety and energy expenditure. The brain governs body weight by establishing a setpoint, much like a thermostat in an air conditioning system. The body then tries to maintain this value even when the food supply varies a great deal. However, malfunctioning of this system may allow the setpoint to slide up or down, causing overeating and obesity on the one hand or progressive weight loss and cachexia, a physical wasting disorder, on the other.


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The brain contains numerous redundant circuits and compensatory mechanisms to preserve body weight, which should not be surprising given that maintenance of body weight is essential to survival. Such mechanisms are invoked in the presence of weight loss whether intentional (in the case of diet) or not (in the case of starvation). This explains the cause of a weight loss plateau. Moreover, in order to appropriately motivate humans to seek food, reward circuitries in the brain stimulate the urge to consume higher calorie food and in turn reward that behavior. The craving cycle is particularly intense with highly palatable foods, such as sweets.
 
Existing products cause some weight loss for most patients. We believe their modest effect stems from their failure to address these natural compensatory mechanisms in the body. As a result, most of these products have been vulnerable to a classic early weight loss plateau typically seen after several months of therapy. In addition, they generally do not address the psycho-behavioral elements that contribute to unhealthy eating behaviors and, ultimately, obesity. We have designed our product candidates to circumvent the body’s natural compensating mechanisms and drive weight loss further, beyond this commonly seen plateau. In addition, with Contrave in particular, we are attempting to go beyond the traditional approach to weight reduction by also targeting the underlying behavioral mechanisms of craving and reward that drive excess consumption.
 
The combinations we have chosen are based on the output of a low-throughput screening model developed by our co-founder and Chief Scientific Officer, Michael Cowley, Ph.D. We have obtained a co-exclusive license to this technology from Oregon Health & Science University, or OHSU. This screening technology uses a mouse model that allows us to quantify firing rates for specific neuronal populations using green fluorescent protein tagging. In particular, research has shown that there is one group of hypothalamic neurons called proopiomelanocortin, or POMC, neurons that play a critical role in managing weight. By exposing POMC neurons in our mouse model to varying concentrations of one or more drug products, we are able to measure the difference in firing activity of these neurons at baseline and over time. This permits us to predict whether a drug will produce weight loss and, more importantly, whether the addition of a second drug has a previously undiscovered synergistic effect on POMC firing rates. We have screened several known compounds as part of the model’s validation. Our lead compounds, Contrave and Excalia, both demonstrated a strong synergistic profile with respect to POMC firing rates in the model. Additionally, we have verified this predicted synergy in more traditional animal feeding studies. Both combinations have subsequently demonstrated this synergy in human clinical trials.
 
Our Lead Product Candidates
 
We are developing Contrave and Excalia for the treatment of obesity. Both product candidates have been prepared with combinations of chemical entities that, individually, have already received regulatory approval and have been commercialized previously. If we receive approval to market these product candidates in the United States or elsewhere, we anticipate that they will be produced and sold as single tablets to be taken orally twice a day.
 
                 
Product Candidate
 
Drug Components
 
Trials Completed
 
Stage of Development
 
Commercial Rights
 
Contrave
  Bupropion SR/ Naltrexone SR   Phase II, Phase IIb   Entering Phase III   Orexigen (worldwide)
Excalia
  Bupropion SR/ Zonisamide SR   Phase II   Ongoing Phase IIb   Orexigen (worldwide)
 
Contrave
 
Contrave is a fixed dose combination of naltrexone SR and bupropion SR. We chose these constituents based on the results of our screening model as well as our understanding of the circuitries in the brain that regulate appetite and energy balance. In particular, naltrexone was chosen as a complement to bupropion in order to block compensating mechanisms that attempt to prevent long-term, sustained weight loss. We hold the exclusive license to two issued U.S. patents covering the Contrave composition, and we have filed additional patents covering various compositions, methods of use and formulations.


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Naltrexone was approved in the United States in 1984 for the treatment of opioid addiction and in 1995 for the treatment of alcoholism. It is marketed under the brand names Trexan, Depade, Revia, and in an injectable extended release formulation, Vivitrol. Naltrexone IR became available in generic form in the United States in 1998. Naltrexone works by blocking opioid receptors in the brain and inhibits the reinforcing aspects of addictive substances, reducing their perceived reward. Naltrexone was evaluated in the 1980s for weight loss and was shown to have negligible effects in clinical trials. However, it has been shown in numerous studies to negatively alter the palatability, or taste, of many foods, particularly sweets, including, for example, a study published in the October 2002 issue of Neuroscience and Biobehavioral Reviews. In addition, nausea is a well-known side effect associated with naltrexone that affects its tolerability. In our Contrave clinical trials to date, we have used the generic IR formulation of naltrexone. Commencing with our planned Phase III trials, naltrexone will be delivered in our proprietary SR formulation in order to improve its tolerability.
 
Bupropion was approved for marketing in the United States in 1985 for depression, marketed under the brand name Wellbutrin, and in 1997 for smoking cessation, marketed under the brand name Zyban. The IR version became available in generic form in the United States in 1999. Bupropion SR became available in generic form in the United States in 2004 and bupropion XL became available in generic form in the United States in December 2006. Bupropion is active at the neuronal uptake site for the neurotransmitters dopamine and norepinephrine. Functionally, bupropion is thought to increase the level of dopamine activity at specific receptors in the brain, which appears to lead to a reduction in appetite and increase in energy expenditure. Bupropion is currently among the most commonly prescribed anti-depressants in the United States; in 2005, its sales totaled approximately $2.1 billion and approximately 9% of the total prescriptions written for depression, according to IMS Health. Bupropion has become popular in the treatment of depression not only for its clinical efficacy, but also its attractive side effect profile relative to other anti-depressants on the market. One of the reported side effects of bupropion clinical trials was modest weight loss. Subsequently, bupropion has been studied for weight loss; results have shown approximately 3% weight loss before reaching plateau, according to a study published in the October 2002 issue of Obesity Research.
 
Scientific Rationale
 
Contrave’s two drug constituents were chosen in order to leverage the brain’s normal circuitry and biochemistry to reduce appetite, expend more calories, diminish food craving and food-based reward, and block compensating mechanisms that attempt to prevent long term, sustained weight loss. Bupropion has been shown in studies to activate the POMC neurons within an area in the hypothalamus known as the arcuate nucleus. As bupropion increases firing of POMC neurons, two important chemical products are released. One is alpha-Melanocyte Stimulating Hormone, or α-MSH, which activates a receptor in the hypothalamus known as the melanocortin-4, or MC-4, receptor which appears to lead to a reduction of appetite and an increase in energy expenditure. This is a major pathway by which naturally occurring peptides such as leptin regulate body weight. However, in obese patients, a resistance to circulating leptin prevents the body from acting in its normal way to regulate weight. Bupropion-induced stimulation of POMC circumvents leptin resistance and activates this weight loss pathway.
 
In addition to α-MSH, stimulation of POMC also produces beta-endorphin, an opioid occurring naturally in the body. Our Chief Scientific Officer, Michael Cowley, Ph.D., identified an auto-receptor on the POMC neuron that recognizes beta-endorphin. Dr. Cowley discovered that by binding to this receptor, beta-endorphin serves as a brake on the POMC system. Left unchecked, this braking system acts to reduce POMC firing rates, thus moderating potential weight loss and likely explaining the characteristic plateau in weight loss. Based on this discovery, we chose naltrexone as the second component in Contrave. Naltrexone is a potent opioid receptor antagonist which competes with beta-endorphin, thus limiting its access at the auto-receptor on the POMC neuron. When bupropion and naltrexone are co-administered, they both induce an increase in POMC firing that is maintained for an extended duration. This is expected to translate into a greater weight loss that should be sustained over an extended time period.
 
As a second benefit, both bupropion and naltrexone are known to act on the reward pathways in the brain that have been implicated in addiction to a number of substances, including food. These reward


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pathways are primarily regulated by dopamine and endogenous opioids, which are the targets of bupropion and naltrexone, respectively. Given that both drugs are approved for addiction-related disorders, we expect that together they may attenuate food craving and reward. As a result, we expect that Contrave may have an additional therapeutic benefit in patients who report food craving or obsession, which drives them to eat even when not hungry.
 
Contrave Clinical Results
 
Phase II Clinical Trial.  We initiated clinical testing of Contrave with a Phase II clinical trial in 2004. This trial enrolled 238 patients at eight U.S. clinical trial sites to evaluate the safety and efficacy of the Contrave combination. Patients accepted for the trial had a BMI in the range of 30 to 40, were non-smokers and did not have diabetes or other significant medical complications. On average, patients enrolled in this trial weighed approximately 95 kilograms, or 209 pounds, at the beginning of the trial, or baseline. Patients were randomly placed into one of four treatment groups:
 
  •      combination therapy, which consisted of 50mg naltrexone IR plus 300mg bupropion SR;
 
  •      bupropion monotherapy, which consisted of 300mg bupropion SR plus placebo;
 
  •      naltrexone monotherapy, which consisted of 50mg naltrexone IR plus placebo; and
 
  •      placebo, which consisted of two placebo pills.
 
The primary endpoint for this trial was percent change in body weight measured 16 weeks after the start of treatment, with secondary endpoints that included the percent change in body weight 24 weeks after the start of treatment, and response rates based on the percentage of patients who lost at least 5% and 10% of their baseline weight 16 and 24 weeks after the start of treatment. The outcomes for patients receiving the combination regimen were compared to each individual monotherapy and placebo. We also monitored the safety and tolerability of Contrave in this trial. The statistical analysis plans for the first Phase II clinical trials for Contrave and Excalia specified the use of an adjusted least-squares mean methodology for analysis of the primary endpoints. Accordingly, we have reported our results for these trials using this methodology. Least-square means methodology is based on a linear regression technique applied by statisticians to clinical trial data. We note that graphs that show weight loss over time for each treatment group in our trials utilize arithmetic mean data, because we believe this is the typical methodology used to present this type of chronological data.
 
On an intent-to-treat basis, which includes all randomized patients who recorded at least one post-baseline body weight measurement, Contrave demonstrated in this trial mean weight loss of 4.0% of baseline body weight at 16 weeks, compared to 3.6% for bupropion alone, 2.0% for naltrexone alone and 1.0% for placebo. One important observation in this trial was that the benefit of adding naltrexone became more apparent over time, as weight loss curves for the combination therapy group gradually diverged from the bupropion monotherapy group. Accordingly, by 24 weeks, Contrave showed 5.2% weight loss on an intent-to-treat basis, compared to 4.0% for bupropion alone. When this analysis is restricted to those patients who completed 16 weeks of treatment, Contrave demonstrated mean weight loss of 4.8% of baseline body weight, compared to 3.9 % for bupropion alone, 2.3% for naltrexone alone and 1.0% for placebo. By 24 weeks, Contrave showed 6.8% weight loss among completers, compared to 4.5% for bupropion alone.


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Weight loss, plotted over time on both an intent-to-treat basis as well as for completers, is as follows:
 
Contrave Phase II Mean Weight Loss through 24 Weeks
Intent-to-Treat Population
 
(GRAPH)
 
Contrave Phase II Mean Weight Loss through 24 Weeks
Completer Population
 
(GRAPH)
 
There were three serious adverse events identified in this trial, all reported by the investigators as unrelated to the study drugs. At 16 weeks, approximately 17.6% of the patients receiving Contrave had discontinued its use due to a treatment-related adverse event, compared to 16.4% for the bupropion monotherapy group, 24.1% for the naltrexone monotherapy group and 9.4% for the placebo group. The most common side effect reported for Contrave was nausea, which was experienced early in treatment and generally resolved over time. Most cases of nausea were reported to be mild; a few were rated as moderate. Nausea is a well-known side effect associated with naltrexone.
 
Phase IIb Clinical Trial.  Based on the results of our initial Phase II trial for Contrave, we concluded that Contrave showed sufficient efficacy and an acceptable safety and tolerability profile to warrant continued development. In July 2005, we proceeded to study Contrave in a larger Phase IIb trial exploring a higher dose of bupropion and lower doses of naltrexone at eight clinical sites in the United States. This trial was submitted


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to the FDA as a Phase II trial. However, because we believed that the results from this clinical trial provide sufficient evidence of the superiority of the combination drug therapy to the individual monotherapies and placebo in the treatment of obesity, we have characterized this study as a Phase IIb trial. In recent correspondence with the FDA, the agency has indicated that the results from this trial enable future pivotal studies to be conducted based on a comparison of the combination therapy to placebo only. This determination will limit the amount of additional data we need to collect to support our future NDA filing. Furthermore, the use of placebo as a comparitor for evaluating the efficacy of Contrave should increase the likelihood that Contrave will demonstrate efficacy in our Phase III program.
 
Prior to the commencement of the Phase IIb trial, in an effort to determine the optimal dose of naltrexone, we evaluated in a Positron Emission Tomography, or PET, study three doses less than the 50mg employed in the previous Phase II clinical trial. PET permits quantification of the extent to which a given drug dosage occupies its target receptors. In general, an antagonist such as naltrexone should occupy 70% to 80% of the relevant receptor population in order to be functionally effective. We tested naltrexone dosages of 16mg, 32mg and 48mg in this PET trial. Results indicated that each of these three doses would be predicted to be effective and we therefore believed that there was little rationale to go either above or below this dose range. Accordingly, these three doses were taken into our Phase IIb clinical trial for Contrave.
 
The Phase IIb trial was designed to evaluate patients for 24 weeks under double-blind conditions. Patients accepted for the trial had a BMI in the range of 30 to 40, were non-smokers and did not have diabetes or other significant medical complications. On average, patients enrolled in this trial weighed approximately 95 kilograms, or 209 pounds, at baseline. Patients were initially placed randomly into one of five treatment groups:
 
  •      48mg naltrexone IR plus 400mg bupropion SR;
 
  •      16mg naltrexone IR plus 400mg bupropion SR;
 
  •      bupropion monotherapy, which consisted of 400mg bupropion SR plus placebo;
 
  •      naltrexone monotherapy, which consisted of 48mg naltrexone IR plus placebo; and
 
  •      placebo, which consisted of two placebo pills.
 
The primary endpoint for this trial was percent change in body weight measured 24 weeks after the start of treatment, with secondary endpoints that included the percentage of patients who lost at least 5% and 10% of their baseline weight 24 weeks after the start of treatment. The outcomes for patients receiving the combination regimen were compared to each individual monotherapy and placebo. We also monitored the safety and tolerability of Contrave in this trial. For the Contrave Phase IIb clinical trial, the statistical analysis plan specified the use of an unadjusted least-squares mean methodology for analysis of the primary endpoint. Accordingly, we have reported our results for this trial using this methodology.
 
In addition, on the basis of the PET results, we added a second set of patients randomized either to 32mg naltrexone plus 400mg bupropion or a double placebo. While these patients were enrolled subsequent to the initial group of patients, the clinical sites, investigators and study protocols remained constant. The statistical analysis plan submitted to the FDA included specifications for a pooled analysis of both groups of patients. In total, 361 patients between the two sets were randomized and had at least one post-baseline body measurement. These patients represent the intent-to-treat population.
 
After 24 weeks, patients were permitted to continue in the study for an additional 24 weeks of open-label treatment. Patients that were initially randomized to placebo or naltrexone monotherapy were crossed over to naltrexone 32mg plus bupropion 400mg therapy; all other patients that remained with the study continued to receive their originally assigned treatment. This extended study is ongoing. Data for the crossover group have been segregated and are not considered in the 36 week efficacy analyses presented below.


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We believe the 24 week data show significant advantages of Contrave therapy for the treatment of obesity compared to the efficacy demonstrated by the respective monotherapies and placebo. The 24 week results are depicted graphically for the intent-to-treat and completer populations as follows:
 
Contrave Phase IIb Mean Weight Loss at 24 Weeks
Intent-to-Treat Population
 
(GRAPH)
 
* Calculated on the basis of unadjusted least-squares mean methodology.
 
“N” indicates the number of patients in the treatment group. “P”-values indicate the likelihood that clinical trial results were due to random statistical fluctuations rather than true cause and effect. The lower the p-value, the more likely there is a true cause-and-effect relationship. Typically, the FDA requires a p-value of less than 0.05 to establish the statistical significance of a clinical trial.
 
Contrave Phase IIb Mean Weight Loss at 24 Weeks
Completer Population
 
(GRAPH)
 
* Calculated on the basis of unadjusted least-squares mean methodology.


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As noted, the p-values were statistically significant among all comparisons (intent-to-treat and completers) with the exception of a single comparison for the intent-to-treat population between 48mg naltrexone IR plus 400mg bupropion SR compared to 400mg bupropion SR alone where the p-value was 0.068.
 
With regard to the 5% and 10% categorical response rates, patients in the three Contrave combination therapy groups performed substantially better than monotherapy as well as placebo patients. For the intent-to-treat population at 24 weeks, between 39% and 52% of patients on the three dosages of Contrave lost at least 5% of their body weight, compared to 26% for bupropion alone, 10% for naltrexone alone and 15% for placebo. Between 15% and 19% of patients on the three dosages of Contrave in the intent-to-treat group lost at least 10% of their body weight, compared to 7% for bupropion alone, 2% for naltrexone alone and 2% for placebo. For the completer population, between 64% and 70% of patients on the three dosages of Contrave lost at least 5% of their body weight, compared to 32% for bupropion alone, 15% for naltrexone alone and 20% for placebo. Between 24% and 32% of patients on the three dosages of Contrave in the completer group lost at least 10% of their body weight, compared to 9% for bupropion alone, 3% for naltrexone alone and 3% for placebo.
 
There were three serious adverse events in this trial through the 24 week primary endpoint, all reported by investigators as unrelated to the study drugs. Overall, approximately 68% of subjects completed treatment through 24 weeks. The rates of discontinuation of study drug at 24 weeks ranged from 19.0% to 29.5% for the three Contrave dosages, compared to 8.3% for bupropion monotherapy, 10.7% for naltrexone monotherapy and 8.2% for placebo. As in the previous Phase II clinical trial with naltrexone IR, nausea was the most common adverse event leading to discontinuation of therapy. The rate of discontinuation of study drug due to nausea appeared to be dose-dependent, with the lower doses of naltrexone demonstrating a substantially lower rate of discontinuation than the highest Contrave dose (48mg naltrexone IR/400mg bupropion SR). All other adverse event-related causes of study drug discontinuation were below a 5% frequency except non-postural dizziness, which was seen in the highest Contrave dose (48mg naltrexone IR/400mg bupropion SR) at a rate of 6.6%.
 
Discontinuation of study drug due to an adverse event generally occurred early in treatment. As a result, in the intent-to-treat analysis, the 48mg naltrexone IR plus 400mg bupropion SR treatment appears somewhat less effective than other Contrave dosages. Use of the last-observation-carried-forward, or LOCF, method implies that data for patients who drop out of the study prior to completion are carried forward in the analysis. Thus, limited weight loss observed early in the course of treatment in patients who discontinue treatment early averages down the efficacy observed in patients who remained on therapy for longer periods of time. This effect is illustrated when comparing the intent-to-treat results to the completer analysis.


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As noted, weight loss at 24 weeks was the primary endpoint for this trial. However, the protocol permitted study participants to continue on Contrave or bupropion for an additional 24 week period. The study is ongoing and 48 week data is not yet available. Data through 36 weeks of treatment indicates that subjects, on average, continued to lose weight in the interval from weeks 24 to 36. For the intent-to-treat and completer populations, the results were as follows:
 
Contrave Phase IIb Mean Weight Loss at 36 Weeks
Intent-to-Treat Population
 
(GRAPH)
 
* Calculated on the basis of unadjusted least-squares mean methodology.
 
Contrave Phase IIb Mean Weight Loss at 36 Weeks
Completer Population
 
(GRAPH)
 
* Calculated on the basis of unadjusted least-squares mean methodology.


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As noted, the p-values were statistically significant among all comparisons (intent-to-treat and completers) with the exception of a single comparison for the intent-to-treat population between 48mg naltrexone IR plus 400mg bupropion SR compared to 400 mg bupropion SR alone where the p-value was 0.083. Weight loss through 36 weeks, plotted for the intent-to-treat and completer populations, is as follows:
 
Contrave Phase IIb Mean Weight Loss Over 36 Weeks
Intent-to-Treat Population
 
(GRAPH)
 
 
Contrave Phase IIb Mean Weight Loss Over 36 Weeks
Completer Population
 
(GRAPH)
 
As these results imply, most patients continued to lose weight between 24 weeks and 36 weeks. No additional serious adverse events have been observed thus far during the extension portion of the trial.
 
We will need to conduct additional clinical trials, the results of which may not corroborate our earlier results, in order to provide enough evidence regarding efficacy and safety to submit an NDA to the FDA for potential regulatory approval. In addition, undesirable side effects of Contrave may delay or prevent regulatory approval. The most common side effects observed in our clinical trials of Contrave to date include nausea, dizziness, insomnia and headaches.


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A subset of subjects participating in our Phase IIb study for Contrave also participated in a study assessing the effects of Contrave therapy on visceral fat. Visceral fat is the fat that surrounds the organs in the abdomen, and is particularly worrisome as it is associated with increased risk for cardiovascular disease, insulin resistance and other metabolic syndromes. In this substudy, patients from all study arms (Contrave at three different naltrexone dosages, bupropion monotherapy, naltrexone monotherapy and placebo) received body scans to measure body composition at the start of treatment and six months after the start of treatment. These measurements enabled determination of patients’ total and visceral fat and lean tissue composition at the beginning of treatment and at the six month point. Of the patients analyzed, the three Contrave-treated groups experienced a mean decrease in total body fat at six months of between 12.2% and 16.0%, compared to a 3.2% to 4.1% mean decrease for patients receiving either of the monotherapies or placebo. Patients in the three Contrave therapy groups experienced a mean decrease in visceral body fat at six months of between 13.7% and 16.7%, compared to a 0.1% to 4.6% mean decrease for patients receiving either of the monotherapies or placebo. These results suggest that weight loss associated with Contrave therapy results primarily from fat tissue loss, including loss of visceral fat that is associated with significant health risks.
 
Future Contrave Clinical Development Plans
 
In April 2006, we met with the FDA to discuss the remaining clinical trial requirements for submission of NDA filings for both Contrave and Excalia. Based on feedback from the FDA, we intend to conduct clinical development programs to provide active drug exposure among 1,500 patients for one year, under double-blind, placebo-controlled conditions for each product candidate. We believe that this clinical development program will provide the basis of an NDA submission for Contrave in the second half of 2009.
 
For Contrave, we intend to conduct at least four Phase III clinical trials. We believe these studies will provide required efficacy, safety and exposure data required by the FDA. In recent correspondence with the FDA, the agency agreed that based on the results of our Phase IIb clinical trial for Contrave, future clinical trials will need to evaluate the safety and efficacy of Contrave relative to placebo only, and will not need to compare Contrave to the individual constituent drugs. We also submitted the protocol for the first of our planned Phase III clinical trials. We expect that we will initiate our Phase III clinical trials in the first half of 2007. The dosages to be used in these trials will be determined based on our review of the 48 week data from the extension portion of our ongoing Phase IIb study. The primary endpoint for these studies will be percent change in body weight one year after the start of treatment. One of these trials will examine the benefit of Contrave plus an intensive program of behavior modification therapy versus behavior modification therapy alone. We also intend to evaluate Contrave in obese patients with related health conditions, such as diabetes. We expect to receive the results from these Phase III trials beginning in the second half of 2008.
 
We believe that our clinical trial experience with Contrave has demonstrated and replicated the validity of our naltrexone hypothesis, specifically, that the addition of naltrexone to bupropion permits greater weight loss than bupropion alone and sustains weight loss beyond 24 weeks. Moreover, in our clinical trials, Contrave has demonstrated significantly greater weight loss than naltrexone alone as well as placebo. The rate of response (greater than 5% and 10% reduction in body weight from baseline) has also favored Contrave and provides additional support for our belief that Contrave will provide a clinically relevant alternative for clinicians and obese patients.
 
While Contrave has generally been well tolerated, the principal adverse event across our trials to date has been nausea. Nausea is typically seen early upon initiating treatment and appears to be transient in most cases. Subjects have generally rated their nausea as mild and, on occasion, moderate in severity. Clinical results from our studies suggest that the incidence of nausea has generally been related to the dose of IR naltrexone, particularly at dosages of 48mg or higher. The pharmacology of naltrexone suggests that nausea is related to both gastrointestinal motility and a dose-related CNS effect. There are a number of ways in which we can attempt to address this issue, including lowering the dose, titrating the drug more slowly and adjusting the formulation to release the drug more gradually. Concerning the latter, we hypothesized that, if the drug could be released beyond the stomach, such as in the small bowel, and the Cmax lowered, the incidence and/or intensity of nausea and other adverse events may be reduced.


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Accordingly, we have successfully developed and tested a sustained release formulation of naltrexone which achieves similar exposure, or AUC, to that obtained with IR naltrexone but with a lowered Cmax. This SR preparation is primarily absorbed in the small bowel where the density of opioid receptors is lower, thus reducing the local effects of naltrexone in the gut. In a recent Phase I pharmacokinetic study that we conducted, this SR preparation demonstrated an improvement in tolerability across various measures. These included overall adverse events and gastrointestinal-related events. Not only were the rates of reported adverse events lower in the SR group, the severity of reported adverse events was also lower. We intend to incorporate this proprietary SR formulation into the Contrave tablet for our planned Phase III pivotal trials.
 
As part of the exploration of the putative effect of Contrave on food craving, we plan to initiate a study utilizing functional magnetic resonance imaging, or fMRI, in self-identified obese food cravers. This technique is a brain imaging technology that permits the regional localization and quantification of changes in neuronal activation. Based on emerging literature demonstrating that the brain’s basic reward mechanisms are activated when exposed to individualized food cues (picture, image, smell, etc.), we believe the potential exists to demonstrate such a regional activation in select brain centers with select food cues, and in turn, the ability of Contrave to reduce this activation relative to placebo. The constituents of Contrave have been shown individually to be effective in attenuating craving-associated behaviors (bupropion in smoking under the brand name Zyban, and naltrexone in alcoholism and drug addiction under the brand names Vivitrol, Trexan and Revia). Our proposed study would be conducted in a randomized, double-blind fashion by one or two select academic centers. Under current plans, patients will receive an fMRI at baseline and at study termination at week eight. We intend to conduct and report results from this study in 2007. It is anticipated that this study, to the extent that it substantiates our hypothesis, may be useful in positioning Contrave as a treatment that reduces the craving-based consumption of select high calorie foods among obese individuals.
 
Excalia
 
Excalia is a fixed dose combination of zonisamide SR and bupropion SR. The combination of zonisamide and bupropion, in our screening model, produced a synergistic increase in POMC neuronal firing, suggesting that this drug combination would enhance satiety and energy expenditure. We have also validated this synergy in mice. Based on the strength of these results and Excalia’s unique mechanism of action, we selected this product combination to complement our Contrave clinical development program. We hold an exclusive license to an issued U.S. patent covering the Excalia composition, and we have filed additional patents covering various compositions, methods of use and formulations.
 
Zonisamide IR was approved in the United States in 2000 for the adjunctive treatment of partial seizures, which is a form of epilepsy. It is marketed under the brand name Zonegran by Eisai Inc., which acquired the rights to the product from Elan Pharmaceuticals in 2004. Zonegran became available in generic form in the United States in 2005, and at its peak produced approximately $177 million in annual sales, according to IMS Health. The precise mechanism of zonisamide is unknown; however, it is believed that zonisamide has a number of pharmacologic mechanisms including sodium-channel modulation and enhancement of dopamine and serotonin neurotransmission. Zonisamide, given alone, has also shown weight loss in prior clinical trials conducted at Duke University.
 
We have developed a proprietary SR formulation of zonisamide in order to improve its tolerability. Controlling the release of zonisamide via our novel SR formulation reduces the Cmax while retaining a similar area under the curve to zonisamide IR. We have shown in a single-dose, double-blind, crossover Phase I clinical trial that zonisamide SR exhibits a considerably improved side effect profile compared to the IR product. Specifically, we have shown a reduction in frequency of adverse events from 44% to 8% in this trial. We are currently utilizing our proprietary zonisamide SR formulation in a large ongoing Phase IIb clinical trial of Excalia. Our Phase II clinical trial used an IR formulation of zonisamide. In commercial form, if approved, zonisamide SR and bupropion SR would be paired in a single tablet given orally twice a day.


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Scientific Rationale
 
Like Contrave, Excalia employs bupropion to increase α-MSH secretion via POMC stimulation. The second component in Excalia, zonisamide, has been shown in our research to synergistically increase the firing rate of POMC neurons by up to eight-fold in the presence of bupropion. However, we also believe that zonisamide may have one or more additional effects. Within the hypothalamus, a set of neurons acts in a reciprocal way to POMC. These are referred to as the Neuropeptide Y/Agouti-related peptide, or NPY/AgRP, neurons. Stimulation of NPY/AgRP neurons results in the release of AgRP, which competes with α-MSH for access to the MC-4 receptor. Binding of AgRP at the MC-4 receptor results in an increase in appetite and energy conservation, which tends to counteract the weight loss promoting activity of α-MSH. The pharmacology of zonisamide has been hypothesized to also inhibit the firing of NPY/AgRP neurons. Strategies that minimize AgRP competition for the MC-4 receptor and maximize α-MSH activation of the MC-4 receptor thus may have the potential to lead to substantive weight loss. We plan to continue to explore the combination of increased POMC firing and reduced NPY/AgRP activity in our clinical development of Excalia.
 
Excalia Clinical Results
 
Phase II Clinical Trial.  We initiated clinical testing of Excalia with a Phase II clinical trial in 2004. This trial enrolled 127 patients across five clinical sites in a similar protocol to our Phase II clinical trial of Contrave. Patients accepted for the Excalia Phase II clinical trial had a BMI between 30 to 40, were non-smokers and did not have diabetes or other significant medical complications. On average, patients enrolled in this trial weighed approximately 94 kilograms, or 207 pounds, at baseline. Patients were randomly placed into one of two treatment groups:
 
  •      combination therapy, which consisted of 300mg bupropion SR plus 400mg zonisamide IR; or
 
  •      zonisamide monotherapy, which consisted of 400mg zonisamide IR plus placebo.
 
Since the design was nearly identical to our Phase II clinical trial of Contrave, and because it was performed immediately following that trial and conducted at a subset of the same investigative sites, the analysis plan anticipated utilizing the placebo and bupropion monotherapy data from the Contrave Phase II clinical trial for comparative purposes. The primary endpoint for the Excalia Phase II clinical trial was percent change in body weight measured 16 weeks after the start of treatment, with secondary endpoints that included the percent change in body weight 24 weeks after the start of treatment and the percent of subjects who lost at least 5% and 10% of their baseline weight 16 and 24 weeks after the start of treatment. The trial design also included a re-randomization option at week 28 where Excalia subjects could continue either at their same dose or a reduced dose for up to an additional 20 weeks of open-label treatment.


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On an intent-to-treat basis, Excalia demonstrated in this trial mean weight loss of 5.2% from baseline at 16 weeks, compared to 4.3% for zonisamide alone. On a completers analysis, Excalia patients demonstrated mean weight loss of 8.3% from baseline 16 weeks after the start of treatment, compared to 5.7% for zonisamide alone. At 24 weeks, the advantage of Excalia treatment in weight loss became more apparent. For the intent-to-treat and completer populations, the results at 24 weeks were as follows:
 
Excalia Phase II Mean Weight Loss at 24 Weeks
Intent-to-Treat Population
 
(GRAPH)
 
 *  Calculated on the basis of adjusted least-squares mean methodology.
 
  (1)  Placebo and bupropion monotherapy groups represent patients from our Contrave Phase II clinical trial, which we consider comparative due to the similarity of clinical trial protocols and overlapping clinical trial sites. Placebo data represents results at 16 weeks, as the placebo arm was discontinued at that point.
 
Excalia Phase II Mean Weight Loss at 24 Weeks
Completer Population
 
(GRAPH)

(footnotes on following page)


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* Calculated on the basis of adjusted least-squares mean methodology.
 
  (1)  Placebo and bupropion monotherapy groups represent patients from our Contrave Phase II clinical trial, which we consider comparative due to the similarity of clinical trial protocols and overlapping clinical trial sites. Placebo data represents results at 16 weeks, as the placebo arm was discontinued at that point.
 
 
The p-values for the 24 week intent-to-treat data were 0.005 and 0.10 for the Excalia combination against bupropion and zonisamide monotherapies, respectively. For the 24 week completer data, the p-values were 0.00006 and 0.024 for the Excalia combination against bupropion and zonisamide monotherapies, respectively. We have ascribed no p-value for the Excalia combination against placebo for either the intent-to-treat or the completer populations since, as described in footnote 1 above, the placebo data used in the Excalia trial came from our Contrave Phase II trial and represented 16 week results.
 
Weight loss, plotted over time for the intent-to-treat and completer populations, was as follows:
 
Excalia Phase II Mean Weight Loss Over 24 Weeks
Intent-to-Treat Analysis
 
(GRAPH)
 
Excalia Mean Weight Loss Over 24 Weeks
Phase II Completer Analysis
 
(GRAPH)


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There were two serious adverse events reported in this trial, both of which were designated by the investigators as unrelated to the study drugs. In addition, two patients (one patient in the combination group and one patient in the zonisamide plus placebo group) experienced suicidal ideation, which is a labeled adverse event for both bupropion and zonisamide. The symptoms resolved after discontinuation of study drugs. Among patients receiving Excalia, the rate of discontinuation of the trial at 24 weeks due to an adverse event was 37%, compared to 20% for the zonisamide IR monotherapy group. Adverse events were typically reported shortly after initiation of therapy and tended to resolve over time.
 
For those study participants who continued treatment on Excalia for an additional 20-week extension and remained on the 400mg zonisamide plus 300mg bupropion SR dose, mean weight loss at 36 weeks and 48 weeks was approximately 12% of baseline body weight.
 
We will need to conduct additional clinical trials, the results of which may not corroborate our earlier results, in order to provide enough evidence regarding efficacy and safety to submit an NDA to the FDA for potential regulatory approval. In addition, undesirable side effects of Excalia may delay or prevent regulatory approval. The most common side effects observed in our clinical trials of Excalia to date include gastrointestinal upset, insomnia and mild rash.
 
Future Excalia Clinical Development Plans
 
We recently initiated a Phase IIb clinical trial of Excalia. This Phase IIb clinical trial is a matrix design intended to determine the optimal dose ratio(s) of our proprietary zonisamide SR formulation and bupropion SR to evaluate in further clinical development. We have enrolled over 600 patients across 14 sites in seven groups, including six groups of varying active drug dosages as well as a seventh placebo group. The active groups utilize dosages ranging from 180mg to 360mg of zonisamide SR combined with dosages ranging from 280mg to 360mg of bupropion SR. The enrollment criteria for this trial are consistent with previous trials, although we are allowing patients with a BMI of up to 42 in accordance with FDA suggestion. The primary outcome measure for this trial will be percent change in body weight 24 weeks after the start of treatment. There will be an extension period providing an additional 24 weeks of exposure.
 
Based on the results of the ongoing Phase IIb clinical trial, we expect to take the optimal one or two Excalia dose ratios into pivotal Phase III clinical trials. Based on our April 2006 meeting with the FDA, our Phase III clinical development program for Excalia will be designed to provide exposure for approximately 1,500 patients for one year under double-blind, placebo-controlled conditions. Given the clinically significant magnitude of weight loss experienced in our first Excalia Phase II clinical trial among patients receiving the zonisamide/bupropion combination, we anticipate including patients in future pivotal trials with higher BMI levels, including for example patients who might be candidates for surgical intervention. We may also conduct studies that include patients with dyslipidemia, hypertension and/or diabetes. Zonisamide carries a Category C pregnancy rating, which means that women of childbearing age will be excluded from trial participation unless meeting pre-stated pregnancy prevention criteria. Assuming favorable results from the ongoing Phase IIb trial, we plan to initiate a clinical trial evaluating the optimal dose(s) of Excalia against individual monotherapies and placebo in late 2007. We would expect that subsequent pivotal studies would compare Excalia to placebo and that the results of all these trials will begin to become available in 2010 and provide the basis of an NDA submission for Excalia in 2011.
 
Sales and Marketing
 
We maintain worldwide commercial rights to our product candidates, and have the opportunity to build a specialty sales force to market and sell these products independently. However, we expect that Contrave and Excalia, if approved, will be prescribed predominantly by primary care physicians, including general practitioners, family practitioners and internists. In order to target this large group of potential prescribers, we may consider entering into a collaboration, either in the United States, outside the United States or both, with a pharmaceutical company that has the sales force and marketing resources to adequately address this physician audience. However, for the foreseeable future, we expect to maintain commercial rights to our product candidates and to continue to develop them independently.


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While both product candidates are designed to produce weight loss, we expect to position Contrave and Excalia to target different segments of the obese population. The two components of Contrave, bupropion and naltrexone, are both approved to treat addictive disorders: smoking in the case of bupropion, and alcoholism and opioid addiction in the case of naltrexone. Recent research suggests that for many obese patients, overconsumption of food is an addiction, much like smoking and alcoholism. Notably, women report substantially greater food craving than men, according to a 1991 study. In addition, women were responsible for 90% of all weight loss prescriptions written in the United States from 1998 to 2003, according to IMS Health. Given its profile, we believe that Contrave may be particularly well-suited for mild-to-moderately obese women who report food cravings.
 
We believe that Excalia, given its profile, may be more effective than Contrave in reducing weight, at least in the early stages of treatment. The overall tolerability of Excalia has yet to be determined. However, it is likely to have labeling which would recommend appropriate birth control for women of childbearing age and to be contraindicated in women who are pregnant or breast feeding. As a result, we believe that Excalia may be especially well-suited for men and post-menopausal women who are heavier and require greater weight reduction. We expect that the experience gained from future clinical trials will enable us to further refine the positioning and brand characteristics of both products.
 
To date, we have focused our clinical development efforts exclusively in the United States. This appears to be the largest commercial market for obesity therapeutics and the market which we believe we best understand. However, we have also sought to establish intellectual property covering our product candidates, primarily in the form of patent application filings, in various foreign markets. We recognize that there is a significant emerging obesity market in Europe, Asia and Latin America. We believe that conducting the necessary supplemental trials, engaging in local regulatory dialogue and conducting local market research is likely best done through strategic collaborators in territories outside the United States or possibly in partnership with a global pharmaceutical company. We will continue to consider international opportunities, and appropriately prioritize these opportunities in the context of the opportunity in the United States.
 
Intellectual Property
 
We rely on a combination of in-licensed patent rights, our own patent rights, trademarks, trade secrets and know-how to protect Contrave and Excalia. We own or have exclusive rights to 14 patent applications currently pending in the United States with respect to various compositions, methods of use and formulations relating to Contrave and/or Excalia. We also have a number of patent applications currently pending in various foreign countries that correspond to some of the pending U.S. applications. We also seek to protect our trade secrets and our know-how relating to our products and our business. These intellectual property rights are in addition to any regulatory exclusivity that we may be able to obtain.
 
Contrave is currently protected in the United States by U.S. Patent Nos. 5,817,665 and 5,512,593, which we have in-licensed on an exclusive basis from Dr. Lee Dante pursuant to a patent license agreement described in further detail below. These patents, which we refer to as the Dante patents, provide basic composition of matter coverage for the Contrave naltrexone/bupropion combination. In addition to the Dante patents, we own a U.S. patent application and a related continuation patent application, each of which stem from a provisional patent application that we own but that is the subject of agreements with OHSU and Duke University, or Duke, requiring us to pay them specified royalties on sales of products covered by the patent applications. These agreements are described in further detail below. These patent applications, which we refer to as the Weber/Cowley patent applications, are directed to the current composition of our Contrave product candidate, including our SR formulation of naltrexone, and methods for using that composition to effect weight loss. We and/or our licensors have also filed a number of international counterparts to these patent applications in foreign countries. If patents ultimately issue from these U.S. patent applications and their international counterparts, we expect to have coverage through at least 2024. The “CONTRAVE” mark is the subject of trademark applications that we have filed in the United States and in certain countries overseas.
 
Excalia is currently protected in the United States by U.S. Patent Number 7,109,198, which is based on the work of Dr. Kishore Gadde, and which we refer to as the Gadde patent and have licensed on an


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exclusive basis from Duke University pursuant to a patent license described in further detail below. The Gadde patent, which is expected to expire in 2023, provides basic composition of matter coverage for the Excalia zonisamide/bupropion combination and also covers methods of using Excalia to treat obesity and to reduce the risk of hypertension, diabetes or dyslipidemia. We have also exclusively licensed from Duke an international patent application that was filed as a counterpart to the Gadde patent in foreign countries, and this international application has now matured into national applications pending in several foreign countries. The “EXCALIA” mark is the subject of trademark applications that we have filed in the United States and in certain countries overseas.
 
Licensing Agreements
 
Oregon Health & Science University License Agreement
 
In June 2003, we entered into a license agreement with OHSU whereby we acquired an assignment of any rights OHSU may have to a U.S. provisional patent application that we filed, which formed the basis for our subsequently filed and currently pending Weber/Cowley patent applications. These applications cover the current composition of our Contrave product candidate, including our SR formulation of naltrexone and methods for using that composition to effect weight loss. OHSU and the inventors have assigned all rights in the underlying invention to us. This license agreement was amended in November 2003 and December 2006.
 
As consideration for this license agreement, we paid an upfront fee of $65,000 and issued 152,630 shares of our common stock to OHSU. We are also obligated to pay a royalty to OHSU on net sales for Contrave and any other products covered by the assigned patent rights.
 
The term of the agreement generally extends until the last of the subject patent rights expire, which is expected to occur in 2024 assuming patents issue with respect to our pending Weber/Cowley patent applications. We may unilaterally terminate the agreement and/or any licenses in any country upon specified written notice to OHSU. OHSU may terminate the agreement upon delivery of written notice if we commit a material breach of our obligations and fail to remedy the breach within a specified period or may immediately terminate the agreement upon the delivery of written notice concerning the occurrence of specified bankruptcy proceedings. In addition, upon written notice and our failure to remedy any of the following breaches within a specified period, OHSU may terminate or modify the agreement: if we cannot demonstrate to OHSU’s satisfaction that we have taken, or can be expected to take within a reasonable time, effective steps to achieve practical application of the licensed products and/or licensed processes; or if we have willfully made a false statement of, or willfully omitted, a material fact in any report required by the agreement; or if we commit a substantial breach of a covenant or agreement contained in the license. Under the terms of the agreement, we are responsible for all prosecution and maintenance (including all costs associated therewith) of any patent applications, including the Weber/Cowley patent applications, that stem from the assigned rights, and for any patents that may issue with respect thereto. If and when issued, we will also be responsible for enforcing any such patents.
 
In addition to assigning us any rights it had in our provisional patent application directed to the Contrave combination of naltrexone and bupropion, OHSU has licensed to us, on a co-exclusive basis, the issued patent underlying the in vitro model that we have used for screening combination therapies for impact on neuronal activity. Our rights to this model extend through the expiration of the patent, which is expected to occur in 2024. We have the right to grant sublicenses to third parties for this patented technology, subject to our obligation to pay OHSU a royalty on revenue received by us from the sale of any products covered under such sublicensing arrangements. Under the terms of the agreement, OHSU is solely responsible for the prosecution, maintenance and enforcement (including all costs associated therewith) of this patent; however, we are required to pay 50% of the prosecution and maintenance expenses incurred by OHSU in connection with this patent. As of December 31, 2006, we have paid a total of $33,604 in connection with the maintenance and prosecution of this patent, of which $3,298 was paid during 2006 and at this time, we are not aware of any significant future costs which may arise. The license is characterized as co-exclusive because OHSU has also licensed the rights to the model to a university.


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Lee Dante License Agreement
 
In June 2004, we entered into a patent license agreement with Lee G. Dante, M.D., whereby we acquired an exclusive worldwide license to two U.S. patents covering compositions of specified opioid antagonists (including naltrexone) combined with specified antidepressants (including bupropion) and, as such, provide basic composition of matter coverage for the Contrave naltrexone/bupropion combination.
 
As consideration for this license, we paid upfront fees totaling $100,000 and granted Dr. Dante an option to purchase 146,897 shares of our common stock at an exercise price of $0.05 per share which expires in April 2014. In April 2006, Dr. Dante exercised options with respect to 70,000 of these shares. We are also obligated to pay a royalty on net sales of products covered by the license. We will be required to make a one-time milestone payment to Dr. Dante in the amount of $1.0 million upon the occurrence of a specified regulatory event. We have the right to grant sublicenses of the patented technology to third parties, subject to our obligation to pay Dr. Dante a royalty on any revenue we receive from such arrangements.
 
The term of the agreement generally extends until the last licensed patent right expires, which is expected to occur in 2013. Either party may terminate the agreement upon delivery of written notice if the other party commits fraud, willful misconduct, or illegal conduct of the other party with respect to the subject matter of the agreement. In addition, either party may terminate the agreement upon delivery of written notice if the other party commits a material breach of its obligations and fails to remedy the breach within a specified period. We may also voluntarily terminate the agreement upon delivery of written notice within a specified time period. In addition, Dr. Dante may terminate the agreement upon specified bankruptcy, liquidation or receivership proceedings.
 
Under this agreement, we have the responsibility to defend and/or settle any third party patent infringement claims, assume all costs associated therewith and, to the extent these claims result from our activities or those of our sublicensees and not from Dr. Dante’s activities, indemnify him for any damages resulting therefrom. In the case of third party infringement of the licensed patents, we have the right, but not the obligation, to either settle or prosecute at our own expense any such infringement. Dr. Dante has the right, but not the obligation, to join any suit we commence at our expense and, if we do not undertake action within three months of being made aware of infringing activity, the right to commence his own suit at his expense.
 
Duke University License Agreement
 
In March 2004, we entered into a patent license agreement with Duke whereby we acquired an exclusive worldwide license to the Gadde patent. The Gadde patent is a U.S. patent covering the composition of our Excalia product candidate and methods for using Excalia to treat obesity and reduce the risk of hypertension, diabetes or dyslipidemia. Under the agreement, we also acquired a license to several related patent applications, including an international patent application, and any patents or patent applications that ultimately issue therefrom. The license agreement was amended in December 2004 and July 2006.
 
As consideration for this license, we issued 885,249 shares of our common stock to Duke and may be required to make future milestone payments totaling $1.7 million upon the achievement of various milestones related to regulatory or commercial events. We are also obligated to pay a royalty on net sales of products covered by the license. We have the right to grant sublicenses to third parties, subject to our obligation to pay Duke a royalty on any revenue we receive from such sublicensing arrangements. In addition, under this agreement we are obligated to pay Duke a specified royalty on sales of products covered by the Weber/Cowley patent applications.
 
The term of the agreement generally extends until the last licensed patent right expires, which is expected to occur in 2023. Either party may terminate the agreement upon delivery of written notice if the other party commits fraud, willful misconduct, or illegal conduct of the other party with respect to the subject matter of the agreement. In addition, either party may terminate the agreement upon delivery of written notice if the other party commits a material breach of its obligations and fails to remedy the breach within a specified period. We may also voluntarily terminate the agreement upon delivery of written notice within a specified time period. Duke may terminate the agreement upon delivery of written notice if we fail to meet certain specified milestones


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of the agreement and fail to remedy such a breach within the specified period. In addition, Duke may terminate the agreement upon specified bankruptcy, liquidation or receivership proceedings.
 
Under this agreement, we have the responsibility to defend and/or settle any third party patent infringement claims, assume all costs associated therewith and, to the extent these claims result from our activities or those of our sublicensees and not from Duke’s activities, indemnify Duke for any damages resulting therefrom. In the case of third party infringement of the licensed patents, we have the right, but not the obligation, to either settle or prosecute at our own expense any such infringement. Duke has the right, but not the obligation, to join in any suit we commence at our expense and, if we do not undertake action within three months of being made aware of infringing activity, the right to commence its own suit at Duke’s expense.
 
Cypress Bioscience, Inc. License Agreement
 
In January 2005, we entered into a license agreement with Cypress Bioscience, Inc., or Cypress, whereby we sublicensed certain of our rights under the Duke agreement to Cypress for specified uses. The technology sublicensed relates to the use of zonisamide with either of two specified therapeutics: mirtazapine and setipiline. As consideration for this license, Cypress paid us non-refundable upfront fees of $1.5 million. In addition, Cypress is obligated to pay us a royalty on net sales of any products covered by the sublicensed technology. Cypress may also be required to make future milestone payments to us of up to $57.0 million upon its achievement of various regulatory milestones. In June 2006, Cypress announced that the results of a completed Phase IIa trial did not support continuing its development program for obstructive sleep apnea, one of the specified uses under the agreement. Therefore, our receipt of the $20.0 million portion of the milestones related to sleep apnea is unlikely at this time.
 
The term of the Cypress agreement generally extends until the last licensed patent right expires, which is expected to occur in 2023. Either party may terminate the agreement upon delivery of written notice if the other party commits fraud, willful misconduct, or illegal conduct of the other party with respect to the subject matter of the agreement. In addition, either party may terminate the agreement upon delivery of written notice if the other party commits a material breach of its obligations and fails to remedy the breach within a specified period. Cypress may terminate the agreement for any reason upon delivery of written notice within the specified period. Cypress may also terminate with no notice if an unfavorable judgment is entered against us or any other party relating to the patents we have sublicensed to Cypress. In addition, Cypress may terminate the agreement upon specified bankruptcy, liquidation or receivership proceedings.
 
Under this agreement, each party has the sole right to control the defense, at its own expense, of any third party patent infringement claim asserted against it. In the case of third party infringement of the licensed patents, Cypress has the right, but not the obligation, to settle or prosecute at its own expense any such infringement. We have the right, but not the obligation, to join any suit commenced by Cypress, at its expense, and if Cypress does not undertake action within three months of having been made aware of infringing activity, the right to commence suit ourselves at our expense.
 
As a result of our sublicensing of the Duke technology to Cypress for specified uses, we may be required to make future payments to Duke of up to $5.7 million upon Cypress’s achievement of various regulatory milestones.
 
Manufacturing
 
To date, our products used in clinical trials have been produced by outside contractors under our supervision. PharmaDirections is our primary drug development consultant and manages subcontractors on our behalf.
 
In December 2005, we entered into a consulting agreement with PharmaDirections under which PharmaDirections agreed to serve as our primary drug development consultant managing subcontractors on our behalf and assisting us with certain initiatives, including new formulation development, management of our chemistry, manufacturing and control function, coordination of our regulatory function and pre-clinical/Phase I research, among others. Under this agreement, we pay fees to PharmaDirections on a per-project basis as approved on corresponding work orders. This agreement was amended in January 2006. The term of this


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agreement generally extends until December 31, 2007. However, we may terminate the agreement upon 30 days written notice.
 
The University of Iowa produces our bupropion SR formulation using bupropion active pharmaceutical ingredient, or API, from Solmag S.p.A. Recently, the University of Iowa advised us that it will no longer be able to meet our supply requirements for bupropion SR due to its limited manufacturing capacity. The University of Iowa advised us that it will supply up to six additional batches of bupropion SR, which we believe will be sufficient to meet our requirements for our Contrave and Excalia clinical trials through mid 2007. While we do not have alternate manufacturing plans in place at this time, we believe that there are other manufacturers capable of producing our bupropion SR needs within the time frames we will require. We have entered into negotiations with an alternative manufacturer for future supplies of bupropion SR. We will need to demonstrate comparable bioavailability and bioequivalence of the bupropion SR formulation used in clinical trials to date to the bupropion SR formulation we will use going forward.
 
Pharm Ops, Inc. and QS Pharma, LLC produce our SR and IR naltrexone requirements using API supplied by Diosynth. Pharm Ops, Inc. also produces our zonisamide SR using API from ChemAgis. Our tablets are produced for us by Pharm Ops, Inc. and we utilize the services of Almac Clinical Services to package our clinical supplies into Contrave Titration Packs, Excalia Titration Packs and bottles for use in our clinical trials. To date, all of our contract manufacturers have performed services under short-term purchase order or similar arrangements. We have no long-term commitments or supply agreements with these contract manufacturers.
 
In the future, if we are able to achieve approval in the United States or other countries to market and sell our products, we intend to continue to rely on outside contractors for the production of necessary supplies. We do not currently intend to establish our own manufacturing capabilities.
 
Competition
 
Treatments for obesity consist of behavioral modification (diet and exercise), pharmaceutical therapies, surgery and device implantation. Modifications to diet and exercise are the preferred initial treatment in obesity. However, the demands of behavioral modification tend to cause significant attrition over time and, frequently, suboptimal weight loss outcomes. When pharmaceutical therapies are recommended it is generally after behavioral modification alone has failed. Bariatric surgery, including gastric bypass and gastric banding procedures, is employed in more extreme cases, typically for patients with a BMI exceeding 40 or who are experiencing obesity-related complications such as diabetes. Surgery can be effective in helping patients to lose 50% or more of their body weight. However, surgery is associated with significant side effects, potential complications and high costs. In addition, while surgery may be effective in achieving weight loss, recent reports have cited “addiction transfer,” where patients begin heavy alcohol consumption, drug use or other addictive habits in response to the reduced ability to consume food, including the October 2006 issue of Bariatric Times. Device implantation is a newer therapy which has yet to be widely adopted within the medical community.
 
Several pharmaceutical products are approved for marketing in the United States with an obesity indication. These pharmaceutical products generally are prescribed for short-term use; fewer agents have been approved for longer-term maintenance therapy. Several older agents, indicated for short term administration, are amphetamine-like compounds including phentermine, phendimetrazine, benzphetamine and diethylpropion. Of these, phentermine is the most widely used, accounting for approximately 3,059,000 prescriptions in the United States in 2005, or approximately $44 million in sales, according to IMS Health.
 
Sibutramine is marketed in the United States by Abbott Laboratories under the brand name Meridia. Sibutramine appears to suppress appetite by inhibiting the reuptake of serotonin, norepinephrine and dopamine in the brain. In 2005, Meridia accounted for approximately 535,000 prescriptions in the United States, or approximately $56 million in sales, according to IMS Health.
 
Orlistat is marketed in the United States by Roche Laboratories, Inc. under the brand name Xenical. Orlistat works by inhibiting lipase, an enzyme that blocks the absorption of fat in the gastrointestinal tract. In


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2005, Xenical accounted for approximately 679,000 prescriptions in the United States, or approximately $87 million in sales, according to IMS Health. Orlistat was recently launched over-the-counter in the United States by GlaxoSmithKline under the brand name Alli.
 
Despite the large market opportunity for anti-obesity agents, there are relatively few competitive products in late stage clinical development. Rimonabant, which has been developed by Sanofi-Aventis under the U.S. brand name Acomplia and in Europe as Zimulti, is the most advanced. It has been approved in certain countries outside of the United States and has received an approvable letter from the FDA relating to potential marketing in the United States. Rimonabant is the first in a new class of anti-obesity drugs that work as antagonists at the cannabinoid type 1, or CB-1, receptor. This is the same receptor that is stimulated by cannabis. While rimonabant has shown efficacy (average 4.7kg or 4.85%) across several large Phase III clinical trials at the highest dose tested, it has also been associated with significant CNS side effects, including depression and related symptoms, according to a 2006 report published in Drugs. The overall risk-to-benefit profile of rimonabant is yet to be defined.
 
A number of other biotechnology and pharmaceutical companies have drugs in development for obesity. These include Arena Pharmaceuticals, Inc., Amylin Pharmaceuticals, Inc., Alizyme plc, Merck & Co., Inc., Peptimmune, Inc. and Vivus, Inc., among others. With the exception of Vivus, Inc., most of these efforts are directed toward a monotherapeutic approach which we would expect to be subject to the same early plateau typically seen. Vivus, Inc. has shown strong efficacy with a combination approach of phentermine and topiramate in a single center study, according to that company’s May 2006 press release.
 
In addition, we may face competition from generic products. Each of bupropion, naltrexone and zonisamide is available in generic form. However, we have undertaken strategies which we believe may impede potential competition from generic products. Supplementing our existing composition patents and patent applications, we have developed formulations and dosages of Contrave and Excalia that we believe may improve patient outcomes and provide further barriers to entry for potential competitors. We believe there cannot be an AB-equivalence designation for the generic versions of the constituents comprising Contrave and Excalia because of differences in pharmacokinetics between the existing generically available formulations and doses and the formulations and doses we plan to use. For naltrexone and zonisamide, we have selected dosages and are using formulations that are not currently available in generic form and create a different pharmacokinetic profile from the generic forms of these drugs. For bupropion, we are utilizing dosages that are not currently generically available. As a result, pharmacists are legally prohibited from substituting generics to match the dosages of Contrave and Excalia. We believe that our existing in-licensed composition patents and, if issued, our pending composition patents, will prevent generic firms from manufacturing comparable formulations and from marketing the constituent compounds together. In addition, we believe that practitioners who are seeking to prescribe safe and effective therapy are not likely to prescribe off-label generics in place of Contrave or Excalia because the dosages, pharmacokinetic profile and titration regimens for our Contrave and Excalia product candidates would not be available using existing generic preparations. Moreover, while general practitioners are the primary prescribers of anti-obesity therapies and are generally familiar with bupropion, they are not the primary prescribers of the other constituents of our product candidates, naltrexone and zonisamide. Accordingly, we believe that general practitioners will be unlikely to prescribe generic compounds with which they are unfamiliar. As a result, we believe that we have established a position with both Contrave and Excalia that will limit generic competition.
 
Third-Party Reimbursement
 
Despite the recognition of obesity as a chronic disease and its enormous cost to our health care system, universal coverage of and reimbursement for drugs to treat obesity by both public and private payors is lacking. However, third-party reimbursement in obesity care appears to be evolving. Recent changes in government-sponsored programs, in addition to growing recognition by private commercial plans of the economic benefits of treating obesity, has led to increasing coverage of pharmaceutical treatments.


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Medicaid
 
Coverage for obesity drugs by Medicaid, the nation’s public health insurance program for individuals who are poor and meet certain other eligibility criteria, is expanding but is not universal. Each individual state administers its own program within broad federal requirements, and states and the federal government finance the program jointly.
 
With respect to prescription drug coverage under the Medicaid Rebate Program, states that elect to cover outpatient prescription drugs are required to cover all FDA-approved drugs of every manufacturer that has entered into a rebate agreement with HHS, although states are allowed to exclude certain types of drugs including anorexia, weight loss or weight gain drugs. In 2000, 32 out of 44 Medicaid programs surveyed by the Kaiser Commission excluded these drugs. More recent data suggests that state Medicaid programs may have increased coverage for certain anti-obesity drugs. For example, Meridia (sibutramine) and Xenical (orlistat) are listed on the formularies of 52% and 58% of state Medicaid programs, respectively.
 
Medicare
 
The Medicare program provides health insurance for individuals aged 65 and over and those with serious disability or end-stage renal disease, regardless of income. Until 2004, the Medicare coverage manual stated that obesity itself cannot be considered an illness. In 2004, this language was removed in favor of a policy that opens the door for future requests for coverage of interventions to treat obesity but only for services that are an integral and necessary part of a course of treatment for a medical condition. In February 2006, Medicare began covering certain designated bariatric surgical services for Medicare patients with a BMI equal to or greater than 35, who have at least one co-morbidity and have been previously unsuccessful with the medical treatment of obesity. However, the policy reiterates that treatments for obesity alone are not covered because such treatments are not considered reasonable and necessary. In addition, Medicare’s new prescription drug benefit, which went into effect in January 2006, cannot by statute cover weight loss drugs. Specifically, the Medicare Prescription Drug Improvement and Modernization Act of 2003, prohibits the Medicare program from paying for any drug that was excludable under the Medicaid rebate program, including those for weight loss.
 
Private Commercial Plans
 
There is a wide range of coverage by private commercial plans for Meridia and Xenical. Based on data obtained from Fingertip Formulary databases, almost half of commercial plans reviewed (excluding Blue Cross Blue Shield) listed Meridia and Xenical on their formularies. Over 85% of the Blue Cross Blue Shield plans reviewed listed Meridia and over 90% listed Xenical. In addition, over 90% of the pharmacy benefit management companies, or PBMs, reviewed listed both Meridia and Xenical on their formularies. The amount of coverage provided by these commercial plans varies, however, and significant out-of-pocket payments are often still required.
 
Although third-party payor attitudes regarding obesity-related products and services appear to be changing, as exemplified by Medicare changes and the coverage of Meridia and Xenical by PBMs and Blue Cross Blue Shield plans, our product candidates, if approved, may not achieve broad coverage. Moreover, the amount of any coverage provided under the various plans may be minimal. We do not, however, expect the success of our product candidates to be contingent upon third-party payor coverage and reimbursement, but rather on their acceptance by physicians and by people who want to lose weight and are willing to pay for the drugs out of pocket.
 
Government Regulation
 
Prescription drug products are subject to extensive pre- and post-market regulation by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling, storage, record keeping, advertising and promotion of such products under the Federal Food Drug and Cosmetic Act, or FFDCA, and its implementing regulations, and by comparable agencies and laws in foreign countries. Failure to comply


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with applicable FDA or other requirements may result in civil or criminal penalties, recall or seizure of products, partial or total suspension of production or withdrawal of the product from the market.
 
FDA approval is required before any new unapproved drug or dosage form, including a new use of a previously approved drug, can be marketed in the United States. All applications for FDA approval must contain, among other things, information relating to pharmaceutical formulation, stability, manufacturing, processing, packaging, labeling, and quality control.
 
New Drug Approval (NDA)
 
A new drug approval by the FDA is generally required before a drug may be marketed in the United States. This process generally involves:
 
  •      completion of preclinical laboratory and animal testing in compliance with the FDA’s good laboratory practice, or GLP, regulations;
 
  •      submission to the FDA of an investigational new drug, or IND, application for human clinical testing which must become effective before human clinical trials may begin;
 
  •      performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug product for each intended use;
 
  •      satisfactory completion of an FDA pre-approval inspection of the facility or facilities at which the product is produced to assess compliance with the FDA’s current Good Manufacturing Practice, or cGMP, regulations; and
 
  •      submission to and approval by the FDA of an NDA application.
 
The preclinical and clinical testing and approval process requires substantial time, effort and financial resources, and we cannot be certain that any approvals for our product candidates will be granted on a timely basis, if at all.
 
Preclinical tests include laboratory evaluation of product chemistry, formulation and stability, as well as studies to evaluate toxicity in animals. The results of preclinical tests, together with manufacturing information and analytical data, are submitted as part of an IND application to the FDA. The IND automatically becomes effective 30 days after receipt by the FDA, unless the FDA, within the 30 day time period, raises concerns or questions about the conduct of the clinical trial, including concerns that human research subjects will be exposed to unreasonable health risks. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before the clinical trial can begin. Our submission of an IND may not result in FDA authorization to commence a clinical trial. A separate submission to an existing IND must also be made for each successive clinical trial conducted during product development. Further, an independent institutional review board, or IRB, for each medical center proposing to conduct the clinical trial must review and approve the plan for any clinical trial before it commences at that center and it must monitor the study until completed. The FDA, the IRB, or the sponsor may suspend a clinical trial at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. Clinical testing also must satisfy extensive Good Clinical Practice, or GCP, regulations, including regulations for informed consent.
 
For purposes of an NDA submission and approval, human clinical trials are typically conducted in the following three sequential phases, which may overlap:
 
  •      Phase I:  Studies are initially conducted in a limited population to test the product candidate for safety, dose tolerance, absorption, metabolism, distribution and excretion in healthy humans or, on occasion, in patients, such as cancer patients.
 
  •      Phase II:  Studies are generally conducted in a limited patient population to identify possible adverse effects and safety risks, to determine the efficacy of the product for specific targeted indications and to determine dose tolerance and optimal dosage. Multiple Phase II clinical trials may be conducted by the sponsor to obtain information prior to beginning larger and more


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  expensive Phase III clinical trials. In some cases, a sponsor may decide to run what is referred to as a “Phase IIb” evaluation, which is a second, confirmatory Phase II trial that could, if positive and accepted by the FDA, serve as a pivotal trial in the approval of a product candidate.
 
  •      Phase III:  These are commonly referred to as pivotal studies. When Phase II evaluations demonstrate that a dose range of the product is effective and has an acceptable safety profile, Phase III trials are undertaken in large patient populations to further evaluate dosage, to provide substantial evidence of clinical efficacy and to further test for safety in an expanded and diverse patient population at multiple, geographically-dispersed clinical trial sites.
 
  •      Phase IV:  In some cases, FDA may condition approval of an NDA for a product candidate on the sponsor’s agreement to conduct additional clinical trials to further assess the drug’s safety and effectiveness after NDA approval. Such post approval trials are typically referred to as Phase IV studies.
 
Because both product candidates are fixed-combination prescription drugs, we will need to comply with the FDA’s policy that requires each component of each product to make a contribution to the claimed effects. This means that our clinical trials for both product candidates will need to evaluate the combination as compared to each component separately and to placebo. The results of product development, preclinical studies and clinical trials are submitted to the FDA as part of an NDA. NDAs must also contain extensive manufacturing information. Once the submission has been accepted for filing, by law the FDA has 180 days to review the application and respond to the applicant. In 1992, under the Prescription Drug User Fee Act, or PDUFA, the FDA agreed to specific goals for improving the drug review time and created a two-tiered system of review times — Standard Review and Priority Review. Standard Review is applied to a drug that offers at most, only minor improvement over existing marketed therapies. The 2002 amendments to PDUFA set a goal that a Standard Review of an NDA be accomplished within a ten-month timeframe. A Priority Review designation is given to drugs that offer major advances in treatment, or provide a treatment where no adequate therapy exists. A Priority Review means that the time it takes the FDA to review an NDA is reduced such that the goal for completing a Priority Review initial review cycle is six months. It is likely that the product candidates will be on a ten-month initial review cycle. The review process is often significantly extended by FDA requests for additional information or clarification. The FDA may refer the application to an advisory committee for review, evaluation and recommendation as to whether the application should be approved. The FDA is not bound by the recommendation of an advisory committee, but it generally follows such recommendations. The FDA may deny approval of an NDA if the applicable regulatory criteria are not satisfied, or it may require additional clinical data and/or an additional pivotal Phase III clinical trial. Even if such data are submitted, the FDA may ultimately decide that the NDA does not satisfy the criteria for approval. Data from clinical trials are not always conclusive and FDA may interpret data differently than us. Once issued, the FDA may withdraw product approval if ongoing regulatory requirements are not met or if safety problems occur after the product reaches the market. In addition, the FDA may require testing, including Phase IV studies, and surveillance programs to monitor the effect of approved products which have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these postmarketing programs. Drugs may be marketed only for the approved indications and in accordance with the provisions of the approved label. Further, if there are any modifications to the drug, including changes in indications, labeling, or manufacturing processes or facilities, we may be required to submit and obtain FDA approval of a new or supplemental NDA, which may require us to develop additional data or conduct additional preclinical studies and clinical trials.
 
Section 505(b)(2) New Drug Applications
 
As an alternate path to FDA approval for modifications to formulations of products previously approved by the FDA, an applicant may file an NDA under Section 505(b)(2) of the FFDCA. Section 505(b)(2) was enacted as part of the Drug Price Competition and Patent Term Restoration Act of 1984, also known as the Hatch-Waxman Act. This statutory provision permits the filing of an NDA where at least some of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. The Hatch-Waxman Act permits the applicant to rely upon the


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FDA’s findings of safety and effectiveness based on certain preclinical or clinical studies. The FDA may then approve the new product candidate for all or some of the label indications for which the referenced product has been approved, as well as for any new indication sought by the Section 505(b)(2) applicant. We intend to submit our initial NDAs for Contrave and Excalia under Section 505(b)(2), based on the extensive safety information that has been collected for the approved drug products that are incorporated in these product candidates. To the extent that a Section 505(b)(2) application relies on the FDA’s finding of safety and effectiveness of a previously-approved drug, the applicant is required to certify to the FDA concerning any patents listed for the approved product in the FDA’s publication called “Approved Drug Products with Therapeutic Equivalence Evaluations,” otherwise known as the “Orange Book.” Specifically, the applicant must certify when the application is submitted that: (1) there is no patent information listed; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patent is invalid or will not be infringed by the manufacture, use or sale of the studies conducted for an approved product. The FDA may also require companies to perform additional studies or measurements to support the change from the approved product. A certification that the new product will not infringe the already approved product’s Orange Book listed patents or that such patents are invalid is called a paragraph IV certification. If the applicant has provided a paragraph IV certification to the FDA, the applicant must also send notice of the paragraph IV certification to the patent holder and the NDA holder. When we file our NDAs for Contrave and Excalia, we intend to make paragraph IV certifications that our products do not infringe the bupropion patents listed in the Orange Book and send the appropriate notice to the patent holder and NDA holder. In the event that the patent holder or NDA holder files a patent infringement lawsuit against us within 45 days of its receipt of our paragraph IV certification, such lawsuit would automatically prevent the FDA from approving our Section 505(b)(2) NDA until the earliest of 30 months, expiration of the patent (2013), settlement of the lawsuit or a decision in the infringement case that is favorable to us. Any such patent infringement lawsuit could be costly, take a substantial amount of time to resolve and divert management resources.
 
PDUFA, which has been reauthorized twice and is likely to be reauthorized again before the submission of the NDA for either Contrave or Excalia, requires the payment of user fees with the submission of NDAs, including 505(b)(2) NDAs. These application fees are substantial ($896,200 in the FDA’s Fiscal Year 2007) and will likely increase in future years. The statute provides for waiver of the application fee for the first NDA for a small business under certain circumstance, and we may meet the requirements for this waiver for our first NDA. If we obtain FDA approval for either Contrave or Excalia, we could obtain three years of Hatch-Waxman marketing exclusivity for such product, assuming we obtain the first approval for either product candidate for the indication supported by the clinical studies we conducted. Under this form of exclusivity, the FDA would be precluded from approving a marketing application for a duplicate drug product (for example, a product that incorporates the change or innovation represented by our product) for a period of three years, although the FDA may accept and commence review of such applications. However, this form of exclusivity might not prevent the FDA from approving an NDA that relies on its own clinical data to support the change or innovation. Further, if another company obtains approval for either product candidate for the same indication we are studying before we do, our approval could be blocked until the other company’s three-year Hatch-Waxman marketing exclusivity expires.
 
Manufacturing cGMP Requirements
 
We and our contract manufacturers are required to comply with applicable FDA manufacturing requirements contained in the FDA’s current Good Manufacturing Practice, or cGMP, regulations. cGMP regulations require among other things, quality control, and quality assurance as well as the corresponding maintenance of records and documentation. The manufacturing facilities for our products must meet cGMP requirements to the satisfaction of the FDA pursuant to a pre-approval inspection before we can use them to manufacture our products. We and our third-party manufacturers are also subject to periodic inspections of facilities by the FDA and other authorities, including procedures and operations used in the testing and manufacture of our products to assess our compliance with applicable regulations.


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Failure to comply with statutory and regulatory requirements subjects a manufacturer to possible legal or regulatory action, including Warning Letters, the seizure or recall of products, injunctions, consent decrees placing significant restrictions on or suspending manufacturing operations, and civil and criminal penalties. Adverse experiences with the product must be reported to the FDA and could result in the imposition of market restriction through labeling changes or in product removal. Product approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the product occur following approval.
 
Other Regulatory Requirements
 
With respect to post-market product advertising and promotion, the FDA imposes a number of complex regulations on entities that advertise and promote pharmaceuticals, which include, among others, standards for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific and educational activities, and promotional activities involving the internet. The FDA has very broad enforcement authority under the FFDCA, and failure to abide by these regulations can result in penalties, including the issuance of a warning letter directing entities to correct deviations from FDA standards, a requirement that future advertising and promotional materials be pre-cleared by the FDA, and state and federal civil and criminal investigations and prosecutions.
 
We are also subject to various laws and regulations regarding laboratory practices, the experimental use of animals, and the use and disposal of hazardous or potentially hazardous substances in connection with our research. In each of these areas, as above, the FDA has broad regulatory and enforcement powers, including the ability to levy fines and civil penalties, suspend or delay issuance of approvals, seize or recall products, and withdraw approvals, any one or more of which could have a material adverse effect on us.
 
Outside the United States, our ability to market a product is contingent upon receiving marketing authorization from the appropriate regulatory authorities. The requirements governing marketing authorization, pricing and reimbursement vary widely from country to country. At present, foreign marketing authorizations are applied for at a national level, although within the European Union registration procedures are available to companies wishing to market a product in more than one European Union member state. The regulatory authority generally will grant marketing authorization if it is satisfied that we have presented it with adequate evidence of safety, quality and efficacy.
 
DEA Regulation
 
Naltrexone, one of the components of our Contrave product candidate, is manufactured from semi-synthetic opiates. Although naltrexone is not a narcotic or a controlled-substance, manufacturing of naltrexone active pharmaceutical ingredient, or API, is subject to regulation by the U.S. Drug Enforcement Administration, or DEA. Controlled substances are those drugs that appear on one of five schedules promulgated and administered by the DEA under the Controlled Substances Act, or CSA. The CSA governs, among other things, the distribution, recordkeeping, handling, security, and disposal of controlled substances. Our third-party suppliers of naltrexone must be registered by DEA in order to engage in these activities, and are subject to periodic and ongoing inspections by the DEA and similar state drug enforcement authorities to assess ongoing compliance with DEA’s regulations. Any failure to comply with these regulations could lead to a variety of sanctions, including the revocation, or a denial of renewal, of DEA registration, injunctions, or civil or criminal penalties.
 
Employees
 
As of February 15, 2007, we had 13 full-time employees and three part-time employees, consisting of clinical and preclinical development, regulatory affairs, marketing and administration. We consider our relations with our employees to be good.
 
Facilities
 
We lease approximately 4,369 square feet of space in our headquarters in San Diego, California under a lease that expires in October 2011. We have no laboratory, research or manufacturing facilities. We believe that our


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current facilities are adequate for our needs for the immediate future and that, should it be needed, suitable additional space will be available to accommodate expansion of our operations on commercially reasonable terms.
 
Legal Proceedings
 
On June 14, 2004, we jointly filed a lawsuit with Duke against Elan Corporation, plc, Elan Pharma International Ltd. and Elan Pharmaceuticals, Inc., which we refer to collectively as Elan, Eisai, Inc. and Eisai Co., Ltd., which we refer to together as Eisai, and Julianne E. Jennings, a former employee of Elan, in the U.S. District Court for the Middle District of North Carolina, Durham Division, to resolve a dispute over rights in an invention relating to the use of zonisamide to treat obesity. We alleged in this lawsuit that scientists at Duke made the invention, and that Elan improperly used information supplied by the Duke scientists to file a U.S. patent application on the invention, in which Ms. Jennings (then an Elan product manager) is named as the sole inventor. This patent application was later assigned by Elan to Eisai. Duke also filed a U.S. patent application on the invention at issue, which patent application has been exclusively licensed to us. On December 14, 2006, we, Elan, Eisai, Duke and Ms. Jennings entered into a settlement agreement to settle the lawsuit. Upon execution of the settlement agreement, the lawsuit was dismissed with prejudice.
 
Under the terms of the settlement agreement, the parties have, subject to limitations set forth in the agreement, released each other from all claims and demands arising under the laws of the United States or any state within the United States existing as of the date of the settlement agreement that arise out of or relate to the lawsuit or the specified Duke and Eisai patent applications. The releases do not apply to the parties’ rights with respect to claims and demands outside the United States. In addition, each of Elan and Ms. Jennings have represented that they are not currently seeking and do not currently possess any patent rights in the United States relating to the use of zonisamide for the treatment of obesity or other weight-related disorders or conditions. In addition, Elan, Eisai and Ms. Jennings have agreed not to assert any such U.S. patent against our Excalia product, which contains zonisamide and bupropion to treat obesity, even if Eisai later obtains a U.S. patent containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions that issues from or is based upon the Eisai patent application. Likewise, if Duke obtains a U.S. patent containing a claim that encompasses the use of zonisamide as the sole active ingredient to treat obesity or other weight-related disorders or conditions that issues from or is based upon the Duke patent application, we and Duke have agreed that we will not assert any such patent against Elan, Eisai or Ms. Jennings for any conduct relating to Zonegran, which is a zonisamide product currently marketed by Eisai.
 
Although we have resolved the U.S. lawsuit and entered into a settlement agreement containing terms that would prevent Eisai, Elan and Ms. Jennings from asserting specified U.S. patents against our Excalia product, there is no assurance that Eisai, Elan and/or Ms. Jennings will abide by the settlement agreement. There also is no assurance that Eisai, Elan and/or Ms. Jennings do not have, or will not in the future obtain, other patent rights not covered by the settlement agreement that could be asserted against our Excalia product candidate or our other product candidates.
 
We believe that Eisai also owns and is prosecuting foreign patent applications in at least Europe and Japan that are based upon and claim priority to the Eisai patent application that was filed in the United States. We have entered into negotiations to settle the dispute with respect to any and all foreign patent rights based on the Eisai and Duke patent applications. These settlement negotiations are ongoing and settlement terms similar to the U.S. settlement are being sought in the foreign settlement process.
 
On February 6, 2007, Novartis AG, or Novartis, filed an opposition to our U.S. trademark application for EXCALIA, claiming that it is confusingly similar to its registered trademark EXTAVIA. We have also been informed that Novartis has opposed the registration of the EXCALIA mark in Europe, though we have not received a formal notice of opposition.
 
We believe that there are currently no other claims that would have a material adverse impact on our financial position, operations or potential performance.


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MANAGEMENT
 
Executive Officers and Directors
 
The following table sets forth certain information about our executive officers and directors:
 
             
Name
 
Age
 
Position
 
Gary D. Tollefson, M.D., Ph.D. 
  56   President, Chief Executive Officer and Director
Anthony A. McKinney
  45   Chief Operating Officer
Graham K. Cooper
  37   Chief Financial Officer, Treasurer and Secretary
Michael A. Cowley, Ph.D. 
  38   Chief Scientific Officer
Eduardo Dunayevich, M.D. 
  40   Chief Medical Officer
Ronald P. Landbloom, M.D. 
  60   Vice President of Medical and Regulatory Affairs
Franklin P. Bymaster
  61   Vice President of Neuroscience
James C. Lancaster, Jr. 
  60   Vice President of Commercial Operations
Eckard Weber, M.D. 
  57   Chairman of the Board of Directors
Louis C. Bock(1)(2)
  41   Director
Brian H. Dovey(2)(3)
  65   Director
Joseph S. Lacob(3)
  51   Director
Michael F. Powell, Ph.D.(1)(2)
  52   Director
Daniel K. Turner III(1)(3)
  45   Director
 
(1) Member of the Audit Committee.
 
(2) Member of the Nominating/Corporate Governance Committee.
 
(3) Member of the Compensation Committee.
 
Executive Officers
 
Gary D. Tollefson, M.D., Ph.D. has served as our President and Chief Executive Officer and as a member of our board of directors since May 2005. Previously, he spent 13 years at Eli Lilly where he was President of the Neuroscience Product Group from January 1999 to December 2000 and Vice President of Lilly Research Laboratories from January 1997 to March 2004. His product responsibilities have included Prozac, Strattera, Cymbalta, Symbyax, Serafem, Permax and Zyprexa. Dr. Tollefson has also served as a volunteer Clinical Professor of Psychiatry at Indiana University School of Medicine from April 2004 to the present and has established Consilium, Inc., a consulting company dedicated to psychopharmacological product development. He currently holds the senior guest scientific position at Eli Lilly as the Distinguished Visiting Lilly Research Scholar. Dr. Tollefson has previously worked with over 20 small to mid-size companies on product strategy, clinical development, business development, regulatory affairs and commercial opportunity analyses. He serves on the Boards of Directors for Cypress Bioscience, Inc., Xenoport, Inc. and Cortex Pharmaceuticals, Inc., each publicly traded companies. Dr. Tollefson obtained his M.D. from the University of Minnesota where he went on to complete a residency in psychiatry and a Ph.D. in psychopharmacology.
 
Anthony A. McKinney has served as our Chief Operating Officer since January 2005. He served as our consultant from July 2004 to December 2004. From June 2003 to January 2005, he was President of LysoPlex LLC, an affiliate of a patient advocacy group focusing on newborn screening for lysosomal storage disorders. From April 2000 to August 2001, Mr. McKinney was Vice President, Drug Development and then Senior Vice President Pharmaceutical Operations of Novazyme Pharmaceuticals, Inc., a biotechnology company involved with protein therapies for orphan diseases. After the Novazyme acquisition by Genzyme in


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2001, Mr. McKinney held the role of Senior Vice President and General Manager of Genzyme Therapeutics until May 2003. Mr. McKinney also previously held several roles at Texas Biotechnology in Houston from March 1994 to April 2000, where he most recently served as Head of Strategic Planning. Mr. McKinney earned his B.S. degree in Microbiology from the University of Oklahoma and his M.B.A. from Thunderbird, the Garvin School of International Management.
 
Graham K. Cooper has served as our Chief Financial Officer, Treasurer and Secretary since May 2006. Previously, Mr. Cooper held the position of Director, Health Care Investment Banking at Deutsche Bank Securities. During his tenure from August 1997 to February 2006 at Deutsche Bank and its predecessor firm Alex. Brown & Sons, he was responsible for executing and managing a wide variety of financing and merger and acquisition transactions in the life sciences field. From August 1992 to January 1995, he worked as an accountant at Deloitte & Touche, where he earned his C.P.A. Mr. Cooper received a B.A. in Economics with highest distinction from the University of California at Berkeley and an M.B.A. from the Stanford Graduate School of Business.
 
Michael A. Cowley, Ph.D. is one of our co-founders and has served as our Chief Scientific Officer since November 2006. Dr. Cowley is a scientist in the Division of Neuroscience at the Oregon National Primate Research Center of the Oregon Health & Science University where he is also director of the Electrophysiology Core, which positions he has held since December 2001. Research in Dr. Cowley’s lab has focused on the discovery of signals within the body that regulate energy balance, as well as describing how other known signals exert their effects on the brain. Research in the lab now focuses on how these signals from the body change with obesity and how the reward based pathways overrule homeostatic signals of satiety. Dr. Cowley received a B.Sc. in biochemistry from The University of Melbourne and a Ph.D. in reproductive neuroendocrinology from Monash University.
 
Eduardo Dunayevich, M.D. has served as our Chief Medical Officer since August 2006. Previously, Dr. Dunayevich spent five years with Lilly Research Laboratories where most recently he was a Medical Advisor in the Clinical Neuroscience Program Phase, a position he held from January 2005 to August 2006. At Lilly Research Laboratories, he was responsible for the development of several early phase compounds, overseeing protocol development, clinical trial implementation, data analysis and reporting and adherence to good clinical practice standards. Prior to joining Lilly Research Laboratories, Dr. Dunayevich served as Director of the Clinical Psychobiology Program, Psychobiology Inpatient Unit and Division of Clinical Trials of the Psychotic Disorders Research Program at the University of Cincinnati, a position he held from July 1998 to June 2001. Dr. Dunayevich obtained his M.D. from the Buenos Aires Medical School where he graduated with honors and received residency training in psychiatry at both the Hospital of the Italian Community, Buenos Aires, Argentina and the University of Cincinnati Medical Center.
 
Ronald P. Landbloom, M.D. has served as our Vice President of Medical and Regulatory Affairs since September 2006. Previously, Dr. Landbloom spent over four years with Eli Lilly, where he was the Associate Medical Director for Neuroscience in their U.S. affiliate organization from April 2005 to October 2006. Prior to joining Eli Lilly, Dr. Landbloom had over 20 years of clinical, research and teaching experience within the University of Minnesota affiliated teaching programs, where he served from 1981 to March 2002. He has also held administrative positions while in the U.S. Army Medical Corp. and at several major healthcare institutions including HealthPartners Medical Group and Clinics, and Regions Hospital in Saint Paul, Minnesota. Dr. Landbloom has been the principal investigator on over 80 different research projects in the fields of depression, schizophrenia, dementia, Alzheimer’s disease and obsessive compulsive disorder. Dr. Landbloom earned his B.S. degree from the University of New Mexico and his M.D. from the University of Minnesota, where he also completed his residency in psychiatry.
 
Franklin P. Bymaster has served as our Vice President of Neuroscience since September 2006. Previously, Mr. Bymaster spent more than 30 years as a leading biochemist for Eli Lilly, culminating in his position as the Biochemistry Scientific Leader of the Neuroscience Division and Senior Research Scientist, a position he held from December 1999 to December 2003. At Eli Lilly, Mr. Bymaster made significant contributions in several marketed compounds such as Prozac, Permax, Zyprexa, Strattera, Cymbalta and Symbyax. He has been involved with more than 40 patents, over 45 IND reports, and has published over


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160 papers in the field of pharmacology. Since retiring from Eli Lilly in 2003, he became a research consultant working with Eli Lilly, Compellis Pharmaceuticals and Hypnion. He is a member of the Society for Neuroscience, CINP, and has academic appointments in the Department of Psychiatry at Indiana University’s School of Medicine and in Pharmacology at the Butler University’s College of Pharmacy and Health Sciences. Mr. Bymaster has a B.S. degree in Pharmacy from Butler University and an M.S. degree in Pharmacology from Indiana University.
 
James C. Lancaster, Jr. has served as our Vice President of Commercial Operations since August 2006. Previously, Mr. Lancaster was most recently a marketing consultant from March 2004 to August 2006 for Alkermes, Inc., G and S Research, Corcept Therapeutics, Neuronetics and Eli Lilly, among others. He continues in his role as a marketing consultant with Neuronetics, Devonport and Pamlab. Mr. Lancaster has broad commercial experience in the pharmaceutical industry, having started off in June 1971 at the individual retail level as the owner and store manager of his own pharmacy. From September 1977 to December 1999, he served as Sales Representative, Brand Manager of Prozac and Global Marketing Director of Zyprexa, and finally, from January 2000 to February 2003, the Director of Commercial Affairs for Eli Lilly’s Global Neuroscience division. In these roles, Mr. Lancaster was responsible for working with advocacy, clinical, regulatory and sales groups. Mr. Lancaster has a B.S. degree in Pharmacy from the University of Tennessee.
 
Board of Directors
 
Eckard Weber, M.D. is one of our co-founders and has served as a member of our board of directors since our inception in September 2002, and as the chairman of our board of directors since March 2004. Dr. Weber is also a partner at Domain Associates, L.L.C., a private venture capital management firm focused on life sciences, a position he has held since 2001. Dr. Weber has been a founder, founding chief executive officer and board member of multiple biopharmaceutical companies in the Domain portfolio including Cytovia, Inc., Acea Pharmaceuticals, Inc., NovaCardia, Inc., Novalar Pharmaceuticals, Inc., Novacea, Inc., Domain AntiBacterial Acquisition Corporation, Ascenta Therapeutics, Inc., Konova, Inc., Renovia, Inc., Tragara Pharmaceuticals, Syndax Pharmaceuticals and Tobira Therapeutics, Inc. Dr. Weber is currently a member of the board of directors of Novacea, Inc., a publicly held biopharmaceutical company, and he currently serves as interim Chief Executive Officer of Tramoxia Therapeutics, Inc., an early-stage biopharmaceutical company. He is also a current board member of Cerexa, Inc., Biovascular, Inc., Ocera, Inc., and Diobex, Inc. Dr. Weber holds a B.S. from Kolping College in Germany and an M.D. from the University of Ulm Medical School in Germany.
 
Louis C. Bock has served as a member of our board of directors since April 2005. Mr. Bock is a Managing Director of Scale Venture Partners, a venture capital firm. Mr. Bock joined Scale Venture Partners in September 1997 from Gilead Sciences, Inc., a biopharmaceutical company, where he held positions in research, project management, business development and sales from September 1989 to September 1997. Prior to Gilead, he was a research associate at Genentech, Inc. from November 1987 to September 1989. He currently serves as a director of Ascenta Therapeutics, diaDexus Inc., SGX Pharmaceuticals, Inc., Horizon Therapeutics and Zogenix, Inc. and is responsible for Scale Venture Partners’ investments in Prestwick Pharmaceuticals. Mr. Bock received his B.S. in Biology from California State University, Chico and an M.B.A. from California State University, San Francisco.
 
Brian H. Dovey has served as a member of our board of directors since January 2004. Mr. Dovey is a managing member of Domain Associates, L.L.C., a private venture capital management firm focused on life sciences, and has served in this capacity with the firm since 1988. He has served as chairman of three companies and on the board of directors of approximately 30 additional companies, including Align Technology, Inc. and Cardiac Science, Inc. Mr. Dovey currently serves on the board of Neose Technologies, Inc., a publicly traded company. Prior to joining Domain, Mr. Dovey spent six years at Rorer Group, Inc. (now Aventis), including as president from 1986 to 1988. Previously, he was president of Survival Technology, Inc., a start-up medical products company. He also held management positions with Howmedica, Inc., Howmet Corporation, and New York Telephone. Mr. Dovey has served as both president and chairman of the National Venture Capital Association. He is Chair of the Wistar Institute, a non-profit preclinical biomedical research company. Mr. Dovey is also Co-Dean of the Kauffman Fellows Program at the Center for Venture Education.


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Mr. Dovey received his B.A. from Colgate University and an M.B.A. degree from the Harvard Business School.
 
Joseph S. Lacob has served as a member of our board of directors since January 2004. Since 1987, Mr. Lacob has been a partner at Kleiner Perkins Caufield & Byers, a venture capital firm. Mr. Lacob serves on the board of directors of Align Technology, Inc. and eHealth, Inc., as well as several privately held companies, including Opthonix, Inc., AutoTrader.com L.L.C., Codon Devices, Inc. and TherOx, Inc. Mr. Lacob holds a B.S. in biological sciences from the University of California, Irvine, a Master’s in Public Health from the University of California, Los Angeles and an M.B.A. from the Stanford Graduate School of Business.
 
Michael F. Powell, Ph.D. has served as a member of our board of directors since January 2004. Dr. Powell has been a Managing Director of Sofinnova Ventures, Inc., a venture capital firm, since 1997. Dr. Powell was Group Leader of Drug Delivery at Genentech, Inc. from 1990 to 1997. From 1987 to 1990, he was the Director of Product Development for Cytel Corporation, a biotechnology firm. He has been an Adjunct Professor at the University of Kansas and an editorial board member of several pharmaceutical journals. Dr. Powell also serves on the board of directors of Threshold Pharmaceuticals, Inc. and Anesiva Pharmaceuticals, Inc., as well as several private companies, including Ocera Therapeutics, Inc., Ascenta Therapeutics, Inc., DioBex, Inc. and Saegis Pharmaceuticals, Inc. He received his B.S. and Ph.D. from the University of Toronto and completed his post-doctorate work at the University of California.
 
Daniel K. Turner III has served as a member of our board of directors since April 2005. Mr. Turner is a General Partner of Montreux Equity Partners, a position he has held since February 1993. Mr. Turner has 20 years of experience as an entrepreneur, operating manager and venture capitalist. Prior to Montreux, Mr. Turner managed the Turnaround Group for Berkeley International. Previously, Mr. Turner was the founding Chief Financial Officer of Oclassen Pharmaceuticals Inc., a specialty pharmaceutical company focused in dermatology, which merged with Watson Pharmaceuticals. Mr. Turner started his career with Price Waterhouse. Mr. Turner currently serves as a director of Somaxon Pharmaceuticals, Inc, as well as several private companies. Mr. Turner holds a B.S. degree from Sacramento State University (magna cum laude) and attended the MBA program at the Haas School of Business at the University of California, Berkeley, where he has established the Turner Fellowship. Mr. Turner is a Certified Public Accountant.
 
Board Composition
 
Our board of directors is currently authorized to have eight members, and is currently composed of six non-employee members and our current President and Chief Executive Officer, Gary D. Tollefson, M.D., Ph.D. Upon completion of this offering, our amended and restated certificate of incorporation will provide for a classified board of directors consisting of three classes of directors, each serving staggered three-year terms. As a result, a portion of our board of directors will be elected each year. To implement the classified structure, prior to the consummation of this offering, two of the nominees to the board will be appointed to one-year terms, two will be appointed to two-year terms and three will be appointed to three-year terms. Thereafter, directors will be elected for three-year terms. Our Class I directors, whose terms will expire at the 2007 annual meeting of stockholders, will be Drs. Tollefson and Weber. Our Class II directors, whose terms will expire at the 2008 annual meeting of stockholders, will be Messrs. Bock and Lacob. Our Class III directors, whose terms will expire at the 2009 annual meeting of stockholders, will be Messrs. Dovey and Turner and Dr. Powell.
 
Pursuant to a voting agreement originally entered into in January 2004 and most recently amended in November 2006 by and among us and certain of our stockholders, Drs. Weber, Tollefson and Powell and Messrs. Dovey, Lacob, Bock and Turner were each elected to serve as members of our board of directors and, as of the date of this prospectus, continue to so serve. The voting agreement will terminate upon completion of this offering, and members previously elected to our board of directors pursuant to this agreement will continue to serve as directors until their successors are duly elected by holders of our common stock. For a more complete description of the voting agreement, see “Certain Relationships and Related Party Transactions — Voting Agreement.”


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Board Committees
 
Our board of directors has established three committees: the audit committee, the compensation committee and the nominating/corporate governance committee. Our board of directors may establish other committees to facilitate the management of our business.
 
Audit Committee.  Our audit committee consists of Messrs. Turner (chair and audit committee financial expert) and Bock and Dr. Powell, each of whom our board of directors has determined is independent within the meaning of the independent director standards of the Securities and Exchange Commission and the Nasdaq Stock Market, Inc.
 
This committee’s main function is to oversee our accounting and financial reporting processes, internal systems of control, independent registered public accounting firm relationships and the audits of our financial statements. This committee’s responsibilities include:
 
  •      selecting and hiring our independent registered public accounting firm;
 
  •      evaluating the qualifications, independence and performance of our independent registered public accounting firm;
 
  •      approving the audit and non-audit services to be performed by our independent registered public accounting firm;
 
  •      reviewing the design, implementation, adequacy and effectiveness of our internal controls and our critical accounting policies;
 
  •      overseeing and monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters;
 
  •      reviewing with management and our auditors any earnings announcements and other public announcements regarding our results of operations;
 
  •      preparing the report that the SEC requires in our annual proxy statement; and
 
  •      reviewing and approving any related party transactions and reviewing and monitoring compliance with our code of conduct and ethics.
 
Compensation Committee.  Our compensation committee consists of Messrs. Dovey (chair), Lacob and Turner, each of whom our board of directors has determined is independent within the meaning of the independent director standards of the Nasdaq Stock Market, Inc. This committee’s purpose is to determine, approve and review the compensation plans, policies and programs for our senior management. This committee’s responsibilities include:
 
  •      reviewing and approving compensation and benefit plans for our executive officers and recommending compensation policies for members of our board of directors and board committees;
 
  •      reviewing the terms of offer letters and employment agreements and arrangements with our officers;
 
  •      setting performance goals for our officers and reviewing their performance against these goals;
 
  •      evaluating the competitiveness of our executive compensation plans and periodically reviewing executive succession plans; and
 
  •      preparing the report that the SEC requires in our annual proxy statement.
 
Nominating/Corporate Governance Committee.  Our nominating/corporate governance committee consists of Messrs. Bock (chair) and Dovey and Dr. Powell, each of whom our board of directors has determined is independent within the meaning of the independent director standards of the Nasdaq Stock Market, Inc. This committee’s purpose is to assist our board by identifying individuals qualified to become


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members of our board of directors, consistent with criteria set by our board, and to develop our corporate governance principles. This committee’s responsibilities include:
 
  •      evaluating the composition, size and governance of our board of directors and its committees and making recommendations regarding future planning and the appointment of directors to our committees;
 
  •      administering a policy for considering stockholder nominees for election to our board of directors;
 
  •      evaluating and recommending candidates for election to our board of directors;
 
  •      overseeing our board of directors’ performance and self-evaluation process; and
 
  •      reviewing our corporate governance principles and providing recommendations to the board regarding possible changes.
 
Compensation Committee Interlocks and Insider Participation
 
Prior to establishing the compensation committee, our board of directors as a whole performed the functions delegated to the compensation committee. None of the members of our compensation committee has ever been one of our officers or employees. None of our executive officers currently serves, or has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee.


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COMPENSATION DISCUSSION AND ANALYSIS
 
Objectives and Philosophy of Executive Compensation
 
The compensation committee of our board of directors, composed entirely of independent directors, administers the Company’s executive compensation program. The role of the compensation committee is to oversee the Company’s compensation and benefit plans and policies, administer its stock plans and review and approve annually all compensation decisions relating to all executive officers. Our company’s compensation programs are designed to:
 
  •      Attract and retain individuals of superior ability and managerial talent;
 
  •      Ensure senior officer compensation is aligned with our corporate strategies, business objectives and the long-term interests of our stockholders;
 
  •      Increase the incentive to achieve key strategic and financial performance measures by linking incentive award opportunities to the achievement of performance goals in these areas; and
 
  •      Enhance the officers’ incentive to increase our stock price and maximize stockholder value, as well as promote retention of key people, by providing a portion of total compensation opportunities for senior management in the form of direct ownership in our company through stock options and/or restricted stock.
 
To achieve these objectives, the compensation committee expects to implement and maintain compensation plans that tie a substantial portion of the executives’ overall compensation to key strategic financial and operational goals such as clinical trial progress, formulations development, continued establishment of intellectual property and implementation of appropriate financing strategies. The compensation committee evaluates individual executive performance with the goal of setting compensation at levels the committee believes are comparable with executives in other companies of similar size and stage of development operating in the biotechnology industry, taking into account our relative performance and our own strategic goals. In order to ensure that we continue to remunerate our executives appropriately, we plan to retain a compensation consultant to review our policies and procedures with respect to executive compensation.
 
Elements of Executive Compensation
 
Executive compensation consists of the following elements:
 
Base Salary.  Base salaries for our executives are generally established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies for similar positions and recognizing cost of living considerations. Base salaries for Dr. Tollefson, our President and Chief Executive Officer, and Mr. McKinney, our Chief Operating Officer, were set judgmentally, based on negotiations with Eckard Weber, our Chairman of the Board. Base salaries for Mr. Cooper, our Chief Financial Officer, Treasurer and Secretary, Dr. Dunayevich, our Chief Medical Officer, and Dr. Landbloom, our Vice President of Medical and Regulatory Affairs, were set through negotiations with Dr. Tollefson, preliminarily using the Thelander Survey as a reference point. The Thelander Survey is an analysis of compensation which uses private biotechnology companies for benchmarking purposes.
 
Generally, we believe that our executive base salaries should be targeted in the upper half of the range of salaries for executives in similar positions in private biotechnology companies. We use the Thelander Survey for such benchmarking purposes. We have adopted this practice partly to enable us to recruit executives from areas of the United States that have a lower cost of living than San Diego, California. Base salaries are reviewed at least annually, and adjusted from time to time to realign salaries with market levels and adjust for inflation.
 
Annual Performance Bonus.  The compensation committee has the authority to award annual performance bonuses to our executives. Each of our executives is eligible to receive an annual performance bonus equal to up to 25% of his base salary, based solely upon the achievement of performance goals and


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objectives to be determined by our board of directors or compensation committee. In 2006, the compensation committee awarded annual performance bonuses to Dr. Tollefson, Mr. McKinney, Mr. Cooper, Dr. Dunayevich and Dr. Landbloom in the amounts of $91,875, $71,500, $43,134, $21,896, and $15,781, respectively, in recognition of such executives’ outstanding performance and, for those executives who commenced employment with Orexigen in 2006, pro-rated for start date. The compensation committee expects to adopt a more formal process for annual performance bonuses in 2007. The compensation committee intends to utilize annual incentive bonuses to compensate the executives for achieving financial and operational goals and for achieving individual annual performance objectives. These objectives will vary depending on the individual executive, but will relate generally to strategic factors such as clinical trial progress, formulations development, continued establishment of intellectual property and implementation of appropriate financing strategies. The compensation committee believes that the annual performance bonus provides incentives necessary to retain executive officers and reward them for short-term company performance.
 
Long-Term Incentive Program.  We believe that long-term performance will be enhanced through stock and equity awards that reward our executives for maximizing shareholder value over time and that align the interests of our employees and management with those of stockholders. The compensation committee believes that the use of stock and equity awards offers the best approach to achieving our compensation goals because equity ownership ties a significant portion of an executive’s compensation to the performance of our company’s stock. We have historically elected to use stock options as the primary long-term equity incentive vehicle.
 
Stock Options.  Our 2007 equity incentive award plan, or the 2007 plan, and our 2004 Stock Plan, or the 2004 plan, authorize us to grant options to purchase shares of common stock to our employees, directors and consultants. Our compensation committee oversees the administration of our stock option plans. Stock option grants are made at the commencement of employment and, occasionally, following a significant change in job responsibilities or to meet other special retention objectives. The compensation committee reviews and approves stock option awards to executive officers based upon a review of competitive compensation data, its assessment of individual performance, a review of each executive’s existing long-term incentives, and retention considerations. Periodic stock option grants are made at the discretion of the compensation committee to eligible employees and, in appropriate circumstances, the compensation committee considers the recommendations of members of management, such as Dr. Tollefson. In 2006, certain named executive officers were awarded stock options in the amounts indicated in the section entitled “Grants of Plan-Based Awards.” This includes stock options granted to Mr. Cooper, Dr. Dunayevich and Dr. Landbloom in May 2006 and September 2006 in connection with the commencement of their employment and options granted to Dr. Tollefson and Mr. McKinney in September 2006, based on their performance, to encourage continued service with us and to recalibrate their ownership on a percentage basis, taking into account equity dilution resulting from stock issuance and grants made to recently hired executives. Stock options granted by us have an exercise price equal to the fair market value of our common stock on the day of grant, typically vest over a four-year period (with 25% vesting 12 months after the vesting commencement date and the remainder vesting ratably each month thereafter based upon continued employment) and generally expire ten years after the date of grant. Incentive stock options also include certain other terms necessary to assure compliance with the Internal Revenue Code.
 
We expect to continue to use stock options as a long-term incentive vehicle because:
 
  •      Stock options and the vesting period of stock options attract and retain executives.
 
  •      Stock options are performance based. Because all the value received by the recipient of a stock option is based on the growth of the stock price, stock options enhance the executives’ incentive to increase our stock price and maximize stockholder value.
 
  •      Stock options help to provide a balance to the overall executive compensation program as base salary and our annual performance bonus program focus on short-term compensation, while stock options reward executives for increases in shareholder value over the longer term.


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In determining the number of stock options to be granted to executives, we generally take into account the range of ownership, on a percentage basis, granted to executives in similar positions in the biotechnology industry, the individual’s ownership relative to other executives within the company, the individual’s position, scope of responsibility, ability to positively affect shareholder value, and the individual’s historic and recent performance. More specifically, initial stock option grants to Dr. Tollefson and Mr. McKinney were set judgmentally, based on negotiations with Mr. Weber. Subsequent awards for Dr. Tollefson and Mr. McKinney were made in recognition of their outstanding performance, in order to offset equity dilution and to recalibrate based on option grants made to newly hired executives. Option grants for Mr. Cooper, Dr. Dunayevich and Dr. Landbloom were based on negotiations with Dr. Tollefson, preliminarily using the Thelander Survey as a reference point.
 
Restricted Stock and Restricted Stock Units.  Our 2007 plan authorizes us to grant restricted stock and restricted stock units and our 2004 plan authorizes us to grant restricted stock. To date, we have not granted any restricted stock or restricted stock units. While we have no current plans to grant restricted stock and/or restricted stock units under our 2007 plan, we may choose to do so in order to implement the long-term incentive goals of the compensation committee.
 
Other Compensation.  Consistent with our compensation philosophy, we intend to continue to maintain our current benefits for our executive officers, including medical, dental, vision and life insurance coverage; however, the compensation committee in its discretion may revise, amend or add to the officer’s executive benefits if it deems it advisable. We have no current plans to change the levels of benefits currently provided to our executives.
 
Change in Control and Severance Arrangements.  As of the date of this prospectus, we will have in place amended employment agreements with each member of our senior executive management team, including Dr. Tollefson, Mr. McKinney, Mr. Cooper, Dr. Dunyavich and Dr. Landbloom, which provide change in control and severance arrangements. We believe that granting these arrangements to our key executive officers is an important element in the retention of such executive officers.
 
Pursuant to each of such employment agreements, if the executive is terminated by us other than for “cause,” as defined in the agreements and described below, or if the executive’s employment is terminated by us other than for cause, or is terminated by the executive due to “constructive termination,” as defined in the employment agreements and described below, within the one-month period before the effective date of a change in control and the six-month period immediately following the effective date of a change in control, the executive shall receive any accrued but unpaid base salary as of the date of termination, and, provided that he first executes and does not revoke a general release, he shall also be entitled to continue to be compensated by us, at his annual base salary as then in effect, for a period of nine months. Further, the employment agreements also provide that, in connection with a change in control, 50% of the unvested underlying shares of common stock subject to the options held by the executive will become vested and exercisable, or our right of repurchase will expire and lapse with respect to 50% of the shares of common stock then subject to such right of repurchase, as applicable. (Such rights of repurchase provide that our company has the right to repurchase an executive’s shares of our common stock subject to an early exercised stock option upon the executive’s termination of service with us.) Thereafter, remaining shares of common stock subject to such options will vest and become exercisable, or our right of repurchase will expire with respect to any shares of common stock remaining subject to the right of repurchase, as applicable, in equal monthly installments over the 12 months following the effective date of the change in control; provided, however, that in the event that fewer than 12 months remain until an option is fully vested and exercisable, or the right of repurchase has lapsed in full, the vesting period of such option or the lapsing period of the right of repurchase, as applicable, will remain unchanged by the change in control. In addition, if the executive’s employment is terminated by us or a successor company of us other than for cause or is terminated by the executive due to a constructive termination within the period beginning on the first day of the calendar month immediately preceding the calendar month in which the effective date of a change in control occurs and ending on the last day of the twelfth calendar month following the calendar month in which the effective date of a change in control occurs, then the option will vest and become exercisable, or the right of repurchase will expire, as applicable, in full with respect to all shares of our common stock, as of the date of such termination of employment.


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Under the employment agreements, “cause” means, generally, (i) the executive’s conviction of or plea of guilty or nolo contendere to any felony or a crime of moral turpitude; (ii) the executive’s willful and continued failure or refusal to follow reasonable instructions of our chief executive officer or our board of directors or our reasonable policies, standards and regulations; (iii) the executive’s willful and continued failure or refusal to faithfully and diligently perform the usual, customary duties of his employment with us or our affiliates; (iv) unprofessional, unethical, immoral or fraudulent conduct by the executive; (v) conduct by the executive that materially discredits us or any of our affiliates or is materially detrimental to the reputation, character and standing of us or any of our affiliates; or (vi) the executive’s material breach of the proprietary information and inventions agreement to which each executive is a party. An event described under (ii) through (vi) of the preceding sentence will not be treated as “cause” until after the executive has been given written notice of such event, failure or conduct and he fails to cure such event, failure, conduct or breach within 30 days from the written notice.
 
Under the employment agreements, “constructive termination” means, generally, (i) a material reduction in the level of responsibility associated with the executive’s employment with us or any surviving entity (other than a change in job title or officer title); (ii) any reduction in the executive’s level of base salary; or (iii) a relocation of the executive’s principal place of employment by more than 50 miles (other than reasonable business travel required as part of the job duties associated with the executive’s position); provided, and only in the event that, such change, reduction or relocation is effected by us without cause and without the executive’s consent.
 
Under the employment agreements, “change in control” means the occurrence of any of the following events:
 
  •      the direct or indirect acquisition by any person or related group of persons (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) of beneficial ownership (within the meaning of Rule 13d-3 of the Exchange Act) of securities possessing more than 50% of our total combined voting power of outstanding securities pursuant to a tender or exchange offer made directly to our shareholders which our board of directors does not recommend such shareholders to accept;
 
  •      a change in the composition of our board of directors over a period of 36 months or less such that a majority of our board members ceases, by reason of one or more contested elections for board membership, to be comprised of individuals who either (A) have been board members continuously since the beginning of such period, or (B) have been elected or nominated for election as board members during such period by at least a majority of the board members described in clause (A) who were still in office at the time such election or nomination was approved by our board of directors;
 
  •      the consummation of any consolidation, share exchange or merger of us (A) in which our stockholders immediately prior to such transaction do not own at least a majority of the voting power of the entity which survives/results from that transaction, or (B) in which a stockholder of us who does not own a majority of our voting stock immediately prior to such transaction, owns a majority of our voting stock immediately after such transaction; or
 
  •      the liquidation or dissolution of us or any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all our assets, including stock held in subsidiary corporations or interests held in subsidiary ventures.
 
Executive Compensation
 
Summary Compensation Table
 
The following table provides information regarding the compensation that we paid to each person serving as our chief executive officer or chief financial officer, and each of our other three most highly paid


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executive officers, sometimes referred to herein as our “named executive officers,” during the fiscal year ended December 31, 2006.
 
                                                                         
                                        Change in
             
                                        Pension Value
             
                                        and
             
                                        Nonqualified
             
                                  Non-Equity
    Deferred
             
                      Stock
    Option
    Incentive Plan
    Compensation
    All Other
       
Name and
        Salary
    Bonus(1)
    Awards
    Awards(2)
    Compensation(3)
    Earnings
    Compensation
    Total
 
Principal Position
  Year     ($)     ($)     ($)     ($)     ($)     ($)     ($)     ($)  
 
Gary D. Tollefson, M.D., Ph.D. 
    2006       367,500                   1,290,037       91,875             29,722 (4)     1,779,134  
President, Chief Executive Officer and Member of the Board of Directors
                                                                       
Anthony A. McKinney
Chief Operating Officer
    2006       286,000       160,000             71,466       71,500             200,355 (5)     789,321  
Graham K. Cooper
Chief Financial Officer, Treasurer and Secretary(6)
    2006       154,688                   275,277       43,134             22,951 (7)     496,050  
Eduardo Dunayevich, M.D. 
Chief Medical Officer
    2006       94,667       100,000             220,479       21,896             88,248 (8)     525,290  
Ronald P. Landbloom, M.D.
Vice President of Medical and Regulatory Affairs
    2006       80,000       100,000             162,699       15,781             95,268 (9)     453,748  
Lynne Rollins
Chief Financial Officer(10)
    2006                                           36,530 (11)     36,530  
 
 
(1) Each bonus listed represents a one-time bonus paid in connection with signing and relocation.
 
(2) The value of each of the option awards was computed in accordance with FAS 123(R) for 2006. Valuation assumptions are described in Note 2 of Notes to Financial Statements.
 
(3) Represents bonuses earned under the Executive Bonus Plan in 2006 and paid in 2007.
 
(4) Includes $25,848 for commuting expenses and $3,874 of relocation expenses.
 
(5) Includes $165,968 of relocation expenses, $11,117 for commuting expenses, $20,841 for reimbursement of taxes, and $2,429 as reimbursement for other expenses.
 
(6) Mr. Cooper joined us in May 2006.
 
(7) Represents $22,951 for commuting expenses.
 
(8) Includes $74,424 of relocation expenses, $6,205 for commuting expenses and $7,619 for reimbursement of taxes.
 
(9) Includes $82,796 of relocation expenses, $4,976 for commuting expenses and $7,496 for reimbursement of taxes.
 
(10) During 2006, Ms. Rollins served in a consulting capacity as our chief financial officer until her resignation in July 2006.
 
(11) Represents consulting fees.
 
Grants of Plan-Based Awards
 
All plan based awards granted to our named executive officers are incentive stock options, to the extent permissible under the Internal Revenue Code. The exercise price per share of each option granted to our named executive officers was determined in good faith by our board of directors to be equal to the fair market value of our common stock as determined by our board of directors on the date of the grant. All options were granted under our 2004 plan, as described below in the section entitled “Employee Benefit and Stock Plans — 2004 Stock Plan.”


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The following table presents information concerning grants of plan-based awards to each of the named executive officers during 2006.
 
                                 
          All Other Option
             
          Awards: Number of
    Exercise or Base
    Grant Date Fair
 
          Securities
    Price of Option
    Value of Stock and
 
          Underlying Options
    Awards
    Option Awards(1)
 
Name
  Grant Date     (#)     ($/Sh)     ($)  
 
Gary D. Tollefson, M.D., Ph.D. 
    9/28/2006       400,000 (2)     1.00       1,776,000  
Anthony A. McKinney
    9/28/2006       250,000 (3)     1.00       1,110,000  
Graham K. Cooper
    5/12/2006       525,888 (4)     0.35       1,724,913  
Eduardo Dunayevich, M.D. 
    9/28/2006       500,000 (5)     1.00       2,220,000  
Ronald P. Landbloom. M.D. 
    9/28/2006       500,000 (6)     1.00       2,220,000  
Lynne Rollins
                       
 
 
(1) The value of option awards granted to our named executive officers was computed in accordance with FAS 123(R). Valuation assumptions are described in Note 2 of Notes to Financial Statements.
 
(2) The option to purchase 400,000 shares of common stock granted to Dr. Tollefson under the 2004 plan has a term of ten years and vests in accordance with the following schedule: 1/48th of the total number of shares vest on the first day of each of the immediately following calendar months following September 28, 2006.
 
(3) The option to purchase 250,000 shares of common stock granted to Mr. McKinney under the 2004 plan has a term of ten years and vests in accordance with the following schedule: 1/48th of the total number of shares vest on the first day of each of the immediately following calendar months following September 28, 2006.
 
(4) The option to purchase 525,888 shares of common stock granted to Mr. Cooper under the 2004 plan has a term of ten years and vests in accordance with the following schedule: 1/48th of the total number of shares vest on the fifteenth day of each of the immediately following calendar months following May 12, 2006.
 
(5) The option to purchase 500,000 shares of common stock granted to Dr. Dunyavich under the 2004 plan has a term of ten years and vests in accordance with the following schedule: 1/4th of the total number of shares vest on August 8, 2007 and 1/36th of the total remaining number of shares vest on the same day of each month thereafter.
 
(6) The option to purchase 500,000 shares of common stock granted to Dr. Landbloom under the 2004 plan has a term of ten years and vests in accordance with the following schedule: 1/4th of the total number of shares vest on September 15, 2007 and 1/36th of the total remaining number of shares vest on the same day of each month thereafter.
 
Employee Benefit and Stock Plans
 
2007 Equity Incentive Award Plan
 
In          , our board of directors approved our 2007 equity incentive award plan, or 2007 plan, which was approved by our stockholders in           . The 2007 plan will become effective on the day prior to the date of this prospectus.
 
We have initially reserved           shares of our common stock for issuance under the 2007 plan, plus (i) the number of shares of our common stock remaining available for issuance and not subject to awards granted under the 2004 plan as of the effective date of the 2007 plan and (ii) the number of shares of our common stock subject to each award granted under the 2004 plan on or before the effective date of the 2007 plan as to which such award was not exercised prior to its expiration or cancellation or which are forfeited or repurchased by us. In addition, the 2007 plan contains an “evergreen provision” that allows for an annual increase in the number of shares available for issuance under the 2007 plan on January 1 of each year during


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the ten-year term of the 2007 plan, beginning on January 1, 2008. The annual increase in the number of shares shall be equal to the least of:
 
  •           % of our outstanding common stock on the applicable January 1;
 
  •           shares of common stock; and
 
  •      a lesser number of shares of our common stock determined by our board of directors.
 
In any event, the maximum aggregate number of shares that may be issued or transferred under the 2007 plan during the term of the 2007 plan may in no event exceed           shares. In addition, no participant in our 2007 plan may be issued or transferred more than           shares of common stock per fiscal year pursuant to awards under the 2007 plan; provided, however, that such limitation shall not apply until required by Section 162(m) of the Internal Revenue Code.
 
The material terms of the 2007 plan are summarized below. The 2007 plan is filed as an exhibit to the registration statement of which this prospectus is a part.
 
Administration.  The compensation committee of our board of directors will administer the 2007 plan (except with respect to any award granted to “independent directors” (as defined in the 2007 plan), which must be administered by our full board of directors). To administer the 2007 plan, our compensation committee must consist of at least two members of our board of directors, each of whom is a “non-employee director” for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, and, with respect to awards that are intended to constitute performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended, an “outside director” for purposes of Section 162(m). Subject to the terms and conditions of the 2007 plan, our compensation committee has the authority to select the persons to whom awards are to be made, to determine the type or types of awards to be granted to each person, the number of awards to grant, the number of shares to be subject to such awards, and the terms and conditions of such awards, and to make all other determinations and decisions and to take all other actions necessary or advisable for the administration of the 2007 plan. Our compensation committee is also authorized to adopt, amend or revise rules relating to the administration of the 2007 plan. Our board of directors may at any time abolish the compensation committee and revest in itself the authority to administer the 2007 plan. The full board of directors will administer the 2007 plan with respect to awards to non-employee directors.
 
Eligibility.  Options, stock appreciation rights, or SARs, restricted stock and other awards under the 2007 plan may be granted to individuals who are then our officers, consultants or employees or are the officers or employees of any of our subsidiaries. Such awards may also be granted to our directors but only employees may be granted incentive stock options, or ISOs. The maximum number of shares of our common stock that may be subject to awards granted under the 2007 plan to any individual in any fiscal year cannot exceed ; provided, however, that such limitation shall not apply until required by Section 162(m) of the Internal Revenue Code.
 
Awards.  The 2007 plan provides that our compensation committee (or the board of directors, in the case of awards to non-employee directors) may grant or issue stock options, SARs, restricted stock, restricted stock units, dividend equivalents, performance share awards, performance stock units, stock payments, deferred stock, performance bonus awards, performance-based awards, and other stock-based awards, or any combination thereof. The compensation committee (or the board of directors, in the case of awards to non-employee directors) will consider each award grant subjectively, considering factors such as the individual performance of the recipient and the anticipated contribution of the recipient to the attainment of the company’s long-term goals. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type, terms and conditions of the award.
 
  •      Nonqualified stock options, or NQSOs, will provide for the right to purchase shares of our common stock at a specified price which may not be less than the fair market value of a share of common stock on the date of grant, and usually will become exercisable (at the discretion of our compensation committee or the board of directors, in the case of awards to non-employee directors) in one or more installments after the grant date, subject to the participant’s continued


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  employment or service with us and/or subject to the satisfaction of performance targets established by our compensation committee (or the board of directors, in the case of awards to non-employee directors). NQSOs may be granted for any term specified by our compensation committee (or the board of directors, in the case of awards to non-employee directors), but the term may not exceed ten years.
 
  •      ISOs will be designed to comply with the provisions of the Internal Revenue Code and will be subject to specified restrictions contained in the Internal Revenue Code. Among such restrictions, ISOs must have an exercise price of not less than the fair market value of a share of common stock on the date of grant, may only be granted to employees, must expire within a specified period of time following the optionee’s termination of employment, and must be exercised within the ten years after the date of grant. In the case of an ISO granted to an individual who owns (or is deemed to own) more than 10% of the total combined voting power of all classes of our capital stock, the 2007 plan provides that the exercise price must be at least 110% of the fair market value of a share of common stock on the date of grant and the ISO is exercisable for no more than five years from the date of grant.
 
  •      Restricted stock may be granted to participants and made subject to such restrictions as may be determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors). Typically, restricted stock may be forfeited for no consideration if the conditions or restrictions are not met, and they may not be sold or otherwise transferred to third parties until restrictions are removed or expire. Recipients of restricted stock, unlike recipients of options, may have voting rights and may receive dividends, if any, prior to the time when the restrictions lapse.
 
  •      Restricted stock units may be awarded to participants, typically without payment of consideration or for a nominal purchase price, but subject to vesting conditions including continued employment or on performance criteria established by our compensation committee (or the board of directors, in the case of awards to non-employee directors). Like restricted stock, restricted stock units may not be sold or otherwise transferred or hypothecated until vesting conditions are removed or expire. Unlike restricted stock, stock underlying restricted stock units will not be issued until the restricted stock units have vested, and recipients of restricted stock units generally will have no voting or dividend rights prior to the time when vesting conditions are satisfied.
 
  •      SARs may be granted in connection with a stock option, or independently. SAR rights typically will provide for payments to the holder based upon increases in the price of our common stock over the exercise price of the related option. Our compensation committee (or the board of directors, in the case of awards to non-employee directors) may elect to pay SARs in cash or in common stock or in a combination of cash and common stock.
 
  •      Dividend equivalents are rights to receive the equivalent value of dividends paid on our common stock. They represent the value of the dividends per share paid by us, calculated with reference to the number of shares covered by stock options, stock appreciation rights, or other awards held by the participant.
 
  •      Performance share awards are denominated in a number of shares of our common stock and which may be linked to one or more performance criteria determined appropriate by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
  •      Performance stock units are denominated in units of value including dollar value of shares of our common stock. They may provide for payment based on specific performance criteria determined by our compensation committee (or the board of directors, in the case of awards to


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  non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
  •      Stock payments include payments in the form of common stock, options or other rights to purchase shares of our common stock and may be based upon specific performance criteria determined appropriate by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
  •      Deferred stock awards may provide for payment based on specified performance criteria determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors). Shares subject to deferred stock awards will not be issued until the awards have vested, and recipients of the deferred stock awards generally will have no voting or dividend rights prior to the time the vesting conditions are satisfied.
 
  •      Performance-based awards include awards other than options or stock appreciation rights which comply with Internal Revenue Service, or IRS, requirements under Section 162(m) of the Internal Revenue Code for performance-based compensation. They may provide for payments based upon specific performance criteria determined appropriate by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
  •      Performance bonus awards may be granted in the form of a cash bonus payable upon the attainment of performance goals established by our compensation committee (or the board of directors, in the case of awards to non-employee directors) and relate to specific performance criteria determined appropriate by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
  •      Other stock-based awards provide participants with shares of our common stock or the right to purchase shares of our common stock or that have a value derived from the value of, or an exercise or conversion privilege at a price related to, or that are otherwise payable in shares of our common stock and which may be linked to specific performance criteria determined appropriate by our compensation committee (or the board of directors, in the case of awards to non-employee directors), in each case over a period or periods determined by our compensation committee (or the board of directors, in the case of awards to non-employee directors).
 
Change in Control.  The 2007 plan contains a change in control provision, which provides that in the event of a change in control of our company (for example, if we are acquired by merger or asset sale) where the acquiror does not assume awards granted under the 2007 plan, awards issued under the 2007 plan will be subject to accelerated vesting such that 100% of the awards will become vested and exercisable or payable, as applicable.
 
Section 162(m) Limitation.  In general, under Section 162(m) of the Internal Revenue Code, income tax deductions of publicly-held corporations may be limited to the extent total compensation (including base salary, annual bonus, stock option exercises and non-qualified benefits paid) for certain executive officers exceeds $1,000,000 (less the amount of any “excess parachute payments” as defined in Section 280G of the Internal Revenue Code) in any one year. However, under Section 162(m), the deduction limit does not apply to certain “performance-based compensation” if an independent compensation committee determines performance goals, and if the material terms of the performance-based compensation are disclosed to and approved by our stockholders. In particular, stock options and SARs will satisfy the “performance-based


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compensation” exception if the awards are made by a qualifying compensation committee. The 2007 plan sets the maximum number of shares that can be granted to any person within a specified period and the compensation is based solely on an increase in the stock price after the grant date. Specifically, the option exercise price must be equal to or greater than the fair market value of the stock subject to the award on the grant date. Under a Section 162(m) transition rule for compensation plans of corporations which are privately held and which become publicly held in an initial public offering, the 2007 plan will not be subject to Section 162(m) until a specified transition date, which is the earlier of (i) the first material modification of the 2007 plan, (ii) the issuance of all employer stock that has been allocated under the 2007 plan, (iii) the expiration of the 2007 plan, (iv) the first annual meeting of stockholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the initial public offering occurs, or (v) such other date required by Section 162(m) of the Internal Revenue Code. After the transition date, rights or awards granted under the 2007 plan, other than options and SARs, will not qualify as “performance-based compensation” for purposes of Section 162(m) unless such rights or awards are granted or vest upon pre-established objective performance goals, the material terms of which are disclosed to and approved by our stockholders.
 
We have attempted to structure the 2007 plan in such a manner that, after the transition date, the compensation attributable to stock options and SARs which meet the other requirements of Section 162(m) will not be subject to the $1,000,000 limitation. We have not, however, requested a ruling from the Internal Revenue Service, or IRS, or an opinion of counsel regarding this issue.
 
Amendment and Termination of the 2007 Plan.  Our compensation committee, with the approval of our board of directors, may terminate, amend or modify the 2007 plan. However, stockholder approval of any amendment to the 2007 plan will be obtained to the extent necessary and desirable to comply with any applicable law, regulation or stock exchange rule, or for any amendment to the 2007 plan that increases the number of shares available under the 2007 plan, permits our compensation committee (or our board of directors, in the case of awards to non-employee directors) to grant options with an exercise price that is below the fair market value on the date of grant, or permits our compensation committee (or our board of directors, in the case of awards to non-employee directors) to extend the exercise period for an option beyond ten years from the date of grant. If not terminated earlier by the compensation committee or the board of directors, the 2007 plan will terminate on the tenth anniversary of the date of its initial approval by our board of directors.
 
Non-Employee Director Awards.  The 2007 plan permits our board to grant awards to our non-employee directors pursuant to a written non-discretionary formula established by the plan administrator. Pursuant to this authority, our board has adopted the Independent Director Compensation Policy. For a further description of non-employee director awards see “Director Compensation.”
 
2004 Stock Plan
 
Our 2004 stock plan, or 2004 plan, was initially adopted by our board of directors and approved by our stockholders in January 2004. As amended to date, we have reserved a total of 6,318,550 shares of common stock for issuance under the 2004 plan. As of December 31, 2006, options to purchase 207,946 shares of common stock had been exercised, options to purchase 4,594,125 shares of common stock were outstanding and 1,516,479 shares of common stock remained available for grant. As of December 31, 2006, the outstanding options were exercisable at a weighted average exercise price of approximately $0.62 per share. The material terms of the 2004 plan are summarized below. The 2004 plan is filed as an exhibit to the registration statement of which this prospectus is a part.
 
No Further Grants.  After the effective date of the 2007 plan, no additional awards will be granted under the 2004 plan.
 
Administration.  Our board of directors administers the 2004 plan, and it may in turn delegate authority to administer the plan to a committee. Subject to the terms and conditions of the 2004 plan, the administrator has the authority to determine the terms and conditions of the awards granted under the 2004 plan, and to make all other determinations and to take all other actions necessary or advisable for the


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administration of the 2004 plan. Our board of directors may at any time abolish the compensation committee and revest in itself the authority to administer the 2004 plan, to the extent permitted by the applicable laws.
 
Eligibility.  Options and restricted stock under the 2004 plan may be granted to individuals who are then our officers or employees or are the officers or employees of any of our subsidiaries. Such awards may also be granted to our non-employee directors or consultants, but only employees may be granted incentive stock options.
 
Awards.  The 2004 plan provides that our board of directors or a committee appointed by our board of directors to administer the 2004 plan may grant or issue stock options and restricted stock. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type, terms and conditions of the award.
 
  •      NQSOs provide for the right to purchase shares of our common stock at a specified price, which for purposes of the 2004 plan prior to the date of this offering may be no less than 85% of the fair market value on the date of grant if required by applicable laws and, if not so required, shall be such price as determined by our board of directors (or, following the completion of this offering, our compensation committee), and usually will become exercisable (at the discretion of our board of directors (or, following completion of this offering, our compensation committee)) in one or more installments after the grant date, subject to the participant’s continued employment or service with us and/or subject to the satisfaction of performance targets established by our board of directors (or, following the completion of this offering, our compensation committee). Under the 2004 plan, in the case of a nonstatutory stock option granted to an individual who owns (or is deemed to own) more than 10% of the total combined voting power of all classes of our capital stock, the 2004 plan provides that the exercise price must be at least 110% of the fair market value on the date of grant if required by applicable laws and, if not so required, shall be such price as determined by our board of directors (or, following the completion of this offering, our compensation committee). Under the 2004 plan, in the case of a nonstatutory stock option granted on any date on which our common stock is a security listed on a national securities exchange or national market system to any eligible person, the exercise price shall be such price as determined by our board of directors (or, following the completion of this offering, our compensation committee) provided that if such eligible person is, at the time of the grant of such option, a named executive, the exercise price shall be no less than 100% of the fair market value on the date of grant if such option is intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code. Notwithstanding the foregoing, nonstatutory stock options may be granted with an exercise price other than as required above pursuant to a merger or other corporate transaction described below. Nonstatutory stock options may be granted for a maximum 10-year term.
 
  •      ISOs are designed to comply with the provisions of the Internal Revenue Code and will be subject to specified restrictions contained in the Internal Revenue Code and as further described above in connection with the 2007 plan. Under the 2004 plan, in the case of an ISO granted to an individual who owns (or is deemed to own) more than 10% of the total combined voting power of all classes of our capital stock, the 2004 plan provides that the exercise price must be at least 110% of the fair market value of a share of common stock on the date of grant and the ISO is exercisable for no more than five years from the date of grant; or granted to any other employee, the exercise price must be at least 100% of the fair market value of a share of common stock on the date of grant and the ISO may be granted for a maximum 10-year term. Any ISO granted under the 2004 plan is exercisable at such times and under such conditions as determined by our board of directors (or, following the completion of this offering, our compensation committee), consistent with the terms of the 2004 plan and reflected in the applicable option agreement, including vesting requirements and/or performance criteria.
 
To date, we have only granted stock options under the 2004 plan.


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Change in Control.  In the event of a change in control where the acquiror does not assume awards granted under the 2004 plan and does not substitute substantially similar awards for those outstanding under the 2004 plan, awards issued under the 2004 plan will terminate upon the consummation of the transaction. Under the 2004 plan, a change in control is generally defined as:
 
  •      a merger, consolidation or other business combination transaction with or into another corporation, entity or person, or the direct or indirect acquisition (including by way of a tender or exchange offer) by any person, or persons acting as a group, of beneficial ownership or a right to acquire beneficial ownership of shares representing a majority of the voting power of the then outstanding shares of our capital stock; or
 
  •      a sale of all or substantially all of our assets.
 
Amendment and Termination of the 2004 plan.  Our board of directors may terminate, amend or modify the 2004 plan. However, stockholder approval of any amendment to the 2004 plan will be obtained to the extent necessary and desirable to comply with any applicable law, regulation, or stock exchange rule. If not terminated earlier by our board of directors the 2004 plan will terminate on the tenth anniversary of the date of its initial adoption by our board of directors.
 
Outstanding Equity Awards at Fiscal Year-End
 
The following table presents the outstanding equity awards held by each of the named executive officers as of December 31, 2006.
 
                                         
    Option Awards  
                Equity Incentive
             
                Plan Awards: Number
             
    Number of
    Number of
    of Securities
             
    Securities
    Securities
    Underlying
             
    Underlying
    Underlying
    Unexercised
             
    Unexercised Options
    Unexercised Options
    Unearned
    Option Exercise
    Option
 
    (#)     (#)     Options
    Price
    Expiration
 
Name
  Exercisable     Unexercisable     (#)     ($)     Date  
 
Gary D. Tollefson, M.D., Ph.D. 
    408,434       (1)           0.30       5/26/2015  
      666,666       666,666 (1)             0.30       5/26/2015  
      25,000       375,000 (1)             1.00       9/28/2016  
Anthony A McKinney
    294,574       (2)           0.05       3/10/2015  
      15,625       234,375 (1)             1.00       9/28/2016  
Graham K. Cooper
    525,888       (1)           0.35       7/12/2016  
Eduardo Dunayevich, M.D. 
          500,000 (2)           1.00       9/28/2016  
Ronald P. Landbloom, M.D. 
          500,000 (2)           1.00       9/28/2016  
Lynne Rollins
                             
 
(1) 1/48th of the total number of shares subject to the option vest monthly.
 
(2) 25% of the total number of shares subject to the option vest at the end of the first year, the remainder vest 1/36th per month thereafter.


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Option Exercises and Stock Vested at Fiscal Year End
 
The following table presents certain information concerning the exercise of options by each of the named executive officers during the fiscal year ended December 31, 2006.