For the quarterly period ended June 30, 2005
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended June 30, 2005

 

or,

 

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

 

For the transition period from              to             

 

Commission File Number: 0-24006

 


 

NEKTAR THERAPEUTICS

(Exact name of registrant as specified in its charter)

 


 

Delaware   94-3134940

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

150 Industrial Road

San Carlos, California 94070

(Address of principal executive offices)

 

650-631-3100

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 


 

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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Applicable Only to Corporate Issuers

 

The number of outstanding shares of the registrant’s Common Stock, $0.0001 par value, was 85,356,454 on July 29, 2005.

 



Table of Contents

NEKTAR THERAPEUTICS

INDEX

 

PART I:   FINANCIAL INFORMATION     
Item 1.   Condensed Consolidated Financial Statements:    3
    Condensed Consolidated Balance Sheets – June 30, 2005 and December 31, 2004    3
    Condensed Consolidated Statements of Operations for the three-month and six-month periods ended June 30, 2005 and 2004    4
    Condensed Consolidated Statements of Cash Flows for the six-month period ended June 30, 2005 and 2004    5
    Notes to Condensed Consolidated Financial Statements    6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    20
Item 3.   Quantitative and Qualitative Disclosures About Market Risk    43
Item 4.   Controls and Procedures    43
PART II:   OTHER INFORMATION     
Item 1.   Legal Proceedings    44
Item 2.   Changes in Securities and Use of Proceeds    44
Item 3.   Defaults Upon Senior Securities    44
Item 4.   Submission of Matters to a Vote of Security Holders    44
Item 5.   Other Information    45
Item 6.   Exhibits and Reports on Form 8-K    46
    Signatures    48

 

Forward-Looking Statements

 

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “1933 Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”). All statements other than statements of historical fact are “forward-looking statements” for purposes of this report, including any projections of earnings, revenues or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning proposed new products or services, any statements regarding future economic conditions or performance and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “potential,” or “continue,” or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this report are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial position and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the cautionary factors set forth in this report and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof and we do not intend to update any forward-looking statements except as required by law or applicable regulations.

 

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PART I: FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements

 

NEKTAR THERAPEUTICS

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share information)

 

     June 30, 2005

    December 31, 2004

 
     (unaudited)     *  
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 70,375     $ 32,064  

Short-term investments

     308,132       386,676  

Accounts receivable, net of allowance for doubtful accounts and sales returns of $332 and $43 at June 30, 2005 and December 31, 2004, respectively.

     10,448       12,842  

Inventory, net

     12,781       10,691  

Other current assets

     9,546       12,266  
    


 


Total current assets

     411,282       454,539  

Property and equipment, net

     146,371       151,247  

Goodwill

     129,986       130,120  

Other intangible assets, net

     4,202       6,456  

Deposits and other assets

     2,214       2,559  
    


 


Total assets

   $ 694,055     $ 744,921  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 8,461     $ 7,141  

Accrued expenses

     14,759       15,065  

Other accrued liabilities

     1,142       15  

Interest payable

     2,010       2,010  

Capital lease obligations - current

     408       1,532  

Deferred revenue

     27,764       29,890  
    


 


Total current liabilities

     54,544       55,653  

Convertible subordinated notes and debentures

     173,949       173,949  

Capital lease obligations - noncurrent

     20,536       23,568  

Other long-term liabilities

     21,615       22,292  

Accrued rent

     2,087       2,117  

Commitments and contingencies

                

Stockholders’ equity:

                

Preferred Stock, 10,000 shares authorized

                

Series A, $0.0001 par value: 3,100 shares designated; no shares issued or outstanding at June 30, 2005 and December 31, 2004.

     —         —    

Convertible Series B, $0.0001 par value: 40 shares designated; 20 shares issued and outstanding at June 30, 2005 and December 31, 2004; Liquidation preference of $19,945 at June 30, 2005 and December 31, 2004.

     —         —    

Common stock, $0.0001 par value; 300,000 authorized; 85,259 shares and 84,572 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively.

     9       8  

Capital in excess of par value

     1,196,277       1,187,575  

Deferred compensation

     (3,897 )     (2,764 )

Accumulated other comprehensive income (loss)

     (867 )     (356 )

Accumulated deficit

     (770,198 )     (717,121 )
    


 


Total stockholders’ equity

     421,324       467,342  
    


 


Total liabilities and stockholders’ equity

   $ 694,055     $ 744,921  
    


 



(*) The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date, which are included in our Form 10-K/A, as amended, for the year ended December 31, 2004 as filed with the Securities and Exchange Commission. This balance sheet does not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

See accompanying notes.

 

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NEKTAR THERAPEUTICS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share information)

(unaudited)

 

     Three-Months Ended June 30,

    Six-Months Ended June 30,

 
     2005

    2004

    2005

    2004

 

Revenue:

                                

Contract research revenue

   $ 19,552     $ 22,102     $ 39,081     $ 43,611  

Product sales and royalty revenue

     5,470       6,425       11,862       10,747  

Exubera® commercialization readiness revenue

     3,528       —         6,101       —    
    


 


 


 


Total revenue

     28,550       28,527       57,044       54,358  

Operating costs and expenses:

                                

Cost of goods sold

     5,433       6,733       10,688       9,269  

Exubera® commercialization readiness costs

     2,666       —         4,960       —    

Research and development

     35,785       33,650       70,730       64,942  

General and administrative

     10,135       8,072       19,245       14,900  

Amortization of other intangible assets

     981       981       1,963       1,962  
    


 


 


 


Total operating costs and expenses

     55,000       49,436       107,586       91,073  
    


 


 


 


Loss from operations

     (26,450 )     (20,909 )     (50,542 )     (36,715 )

Loss on extinguishment of debt

     —         —         —         (9,258 )

Other income (expense), net

     (118 )     124       (1,403 )     431  

Interest income

     2,512       1,608       4,784       2,854  

Interest expense

     (2,856 )     (2,987 )     (5,916 )     (19,344 )
    


 


 


 


Loss before provision for income taxes

     (26,912 )     (22,164 )     (53,077 )     (62,032 )

Provision for income taxes

     —         —         —         132  
    


 


 


 


Net loss

   $ (26,912 )   $ (22,164 )   $ (53,077 )   $ (62,164 )
    


 


 


 


Basic and diluted net loss per share

   $ (0.32 )   $ (0.27 )   $ (0.63 )   $ (0.85 )
    


 


 


 


Shares used in computing basic and diluted net loss per share

     85,040       83,501       84,875       72,858  
    


 


 


 


 

See accompanying notes.

 

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NEKTAR THERAPEUTICS

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

     Six-Months Ended June 30,

 
     2005

    2004

 

Cash flows used in operating activities:

                

Net loss

   $ (53,077 )   $ (62,164 )

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

                

Depreciation

     8,678       5,865  

Amortization of other intangible assets

     2,254       2,254  

Amortization of debt issuance costs

     417       530  

Amortization of deferred compensation

     906       578  

Amortization of gain related to sale of building

     (497 )     —    

Loss on termination of capital lease

     1,137       —    

Non-cash compensation for employee retirement plans

     692       676  

Non-cash compensation for employee severance

     —         60  

Stock-based compensation for services rendered

     129       339  

Loss on early extinguishment of debt

     —         9,258  

Increase in provision for doubtful accounts and sales returns reserve

     289       43  

Increase (decrease) in inventory reserve

     (1,417 )     1,441  

Changes in assets and liabilities:

                

Decrease (increase) in trade accounts receivable

     2,098       (12,834 )

Increase in inventories

     (673 )     (3,200 )

Decrease in other assets

     3,052       455  

Increase (decrease) in accounts payable

     1,334       (3,005 )

Increase (decrease) in accrued expenses

     365       (1,286 )

Decrease in interest payable

     —         (426 )

Increase (decrease) in deferred revenue

     (2,169 )     3,478  

Decrease in other liabilities

     (31 )     (296 )
    


 


Net cash used in operating activities

     (36,513 )     (58,234 )

Cash flows from investing activities:

                

Purchases of short-term investments

     (125,075 )     (368,548 )

Sales of short-term investments

     88,950       87,827  

Maturities of investments

     114,465       128,508  

Purchase of long-term investments

     —         (28 )

Sales of long-term investments

     —         12,470  

Purchases of property and equipment

     (8,053 )     (14,028 )

Disposal of property and equipment

     —         42  
    


 


Net cash provided by (used in) investing activities

     70,287       (153,757 )

Cash flows from financing activities:

                

Payments of loan and capital lease obligations

     (1,290 )     (1,327 )

Repurchase of convertible subordinated notes

     —         (461 )

Issuance of common stock, net of issuance costs

     —         196,245  

Issuance of common stock related to employee stock purchase plan

     647       615  

Issuance of common stock related to employee stock option exercises

     5,196       7,599  
    


 


Net cash provided by financing activities

     4,553       202,671  

Effect of exchange rates on cash and cash equivalents

     (16 )     —    
    


 


Net increase (decrease) in cash and cash equivalents

     38,311       (9,320 )

Cash and cash equivalents at beginning of period

     32,064       44,446  
    


 


Cash and cash equivalents at end of period

   $ 70,375     $ 35,126  
    


 


Non-cash Investing and Financing Activities

Conversion of debt into common stock

   $ —       $ 186,029  
    


 


Deferred compensation related to the issuance of restricted stock units

   $ 2,039     $ 3,902  
    


 


 

See accompanying notes.

 

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NEKTAR THERAPEUTICS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2005

(unaudited)

 

Note 1—Organization and Summary of Significant Accounting Policies

 

Organization and Basis of Presentation

 

Our Company was originally incorporated in California in 1990. We were reincorporated in Delaware in 1998. In January 2003, we changed our name from Inhale Therapeutic Systems, Inc. to Nektar Therapeutics.

 

We prepared the condensed consolidated financial statements following the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by generally accepted accounting principles in United States of America (“U.S. GAAP”) can be condensed or omitted. In the opinion of management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. Certain prior year amounts have been reclassified to conform to the current period financial statement presentation.

 

Revenues, expenses, assets, and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. The information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K/A, as amended, for the year ended December 31, 2004.

 

Restatement

 

Certain amounts reported in our Quarterly Reports on Form 10-Q for the three-month and six-month periods ended June 30, 2004 have been restated to correct for certain misapplications of our accounting policies under U.S. GAAP.

 

Specifically, we have reclassified approximately $2.8 million and $5.5 million for the three-month and six-month periods ended June 30, 2004, respectively, from research and development expenses to general and administrative expenses. This reclassification included legal expenses related to our intellectual property portfolio and a portion of finance, information systems, and human resource expenses that were not clearly related to research and development and are required to be classified outside of research and development expenses under Statement Financial Accounting Standards No. 2, Accounting for Research and Development Costs.

 

In addition, we reclassified approximately $0.2 million and $0.5 million for the three-month and six-month periods ended June 30, 2004 from general and administrative expenses to interest expense. This reclassification was made to record the amortization of debt issuance costs to interest expense as required under Accounting Principles Board No. 21, Interest on Receivables and Payables and EITF 86-15, Increasing-Rate Debt.

 

These reclassifications did not result in any change to our cash position, revenue, or net loss during the three-month or six-month periods ended June 30, 2004.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Principles of Consolidation

 

Our consolidated financial statements include the financial position and results of operations and cash flows of our wholly-owned subsidiaries: Nektar Therapeutics AL, Corporation (“Nektar AL”), formerly Shearwater Corporation; Nektar Therapeutics UK, Ltd. (“Nektar UK”), formerly Bradford Particle Design Ltd; and Inhale Therapeutic Systems Deutschland GmbH (“Inhale Germany”), and Nektar Therapeutics (India) Private Limited.

 

Our consolidated financial statements are denominated in U.S. dollars. Accordingly, changes in exchange rates between the applicable foreign currency and the U.S. dollar will affect the translation of each foreign subsidiary’s financial results into U.S. dollars for purposes of reporting our consolidated financial results. The process by which each foreign subsidiary’s financial results are translated

 

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into U.S. dollars is as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability accounts are translated at end of period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner results in an accumulated other comprehensive gain (loss) in the stockholders’ equity section. To date, such cumulative translation adjustments have not been material to our consolidated financial position.

 

Significant Concentrations

 

Cash equivalents and short-term investments are financial instruments that potentially subject us to concentration of risk. We limit our concentration of risk by diversifying our investment amount among a variety of industries and issuers and by limiting the average maturity to approximately one year. Our professional portfolio managers adhere to this investment policy as approved by our Board of Directors.

 

Our customers are primarily pharmaceutical and biotechnology companies that are located in the U.S. and Europe. Our accounts receivable balance contains trade receivables from product sales and royalties, collaborative research agreements, and commercialization readiness revenue. We provide for a general allowance for doubtful accounts by reserving for specifically identified doubtful accounts plus a percentage of past due amounts. We have not experienced significant credit losses from our accounts receivable or collaborative research agreements, and none is currently expected. We perform a regular review of our customer’s payment history and associated credit risk. We do not require collateral from our customers.

 

We are dependent on our partners, vendors, and contract manufacturers to provide raw materials, drugs, and devices of appropriate quality and reliability and to meet applicable regulatory requirements. Consequently, in the event that supplies are delayed or interrupted for any reason, our ability to develop our products could be impaired, which could have a material adverse effect on our business, financial condition and results of operation.

 

We are dependent on Pfizer as the source of a significant proportion of our revenue. The termination of our collaboration arrangement with Pfizer would have a material adverse effect on our financial position and results of operations. Should the Pfizer collaboration be discontinued prior to the launch of Exubera®, we will need to find alternative funding sources to replace the collaboration revenue and will need to reassess the realizability of assets capitalized. Additionally, we may have contingent payments to our contract manufacturers to reimburse them for their capital outlay to the extent that they cannot re-deploy their assets and may incur additional liabilities. At the present time, it is not possible to estimate the loss that will occur as a result of these obligations should the Pfizer collaboration be discontinued or Exubera® not be approved.

 

Recent Accounting Pronouncements

 

In May 2005, the Financial Accounting Standards Board (“FASB”) released Statement of Financial Accounting Standard (“SFAS”) No. 154, Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3, (“FAS 154”). FAS 154 requires retrospective application to prior periods’ financial statements for any change in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. The statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. We will be required to adopt FAS 154 for any accounting changes or corrections of errors on or after January 1, 2006. We do not expect the adoption of FAS 154 to have a material impact on our consolidated financial position, results of operations, or cash flows.

 

In December 2004, the FASB released a revision to SFAS No. 123, Accounting for Stock-Based Compensation (“FAS 123R”). FAS 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require instead that such transactions be accounted for using a fair-value-based method. We will be required to adopt FAS 123R on January 1, 2006. When we adopt the new statement, we will have to recognize substantially more compensation expense. This will have a material adverse impact on our financial position and results of operations. We are currently in the process of evaluating the effect of adopting FAS 123R.

 

In November 2004, the FASB released SFAS No. 151, Inventory Costs – An Amendment to ARB No. 43 (“FAS 151”). This Statement amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle

 

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facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as defined by ARB No. 43, Chapter 4, Inventory Pricing. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We will be required to adopt SFAS No. 151 on January 1, 2006. We are currently in the process of evaluating the effect of adopting SFAS No. 151.

 

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“EITF 03-01”). EITF 03-01 provides guidance regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. In September 2004, the EITF delayed the effective date for the measurement and recognition guidance; however the disclosure requirements remain effective for annual periods ending after June 15, 2004 (see note 2). The FASB has since decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the staff to issue proposed FASB Staff Position (“FSP”) FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP FAS 115-1”). FAS 115-1 will replace the guidance set forth in EITF 03-01, with references to existing other-than-temporary impairment guidance, and will clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. The FASB decided that FSP FAS 115-1 would be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The finalized FSP is expected to be issued in August 2005, and we will evaluate the effects of adopting at this time.

 

Cash, Cash Equivalents and Investments

 

We consider all highly liquid investments with a remaining maturity on the date of purchase of three months or less to be cash equivalents. Cash and cash equivalents include demand deposits held in banks, interest bearing money market funds, commercial paper, federal and municipal government securities, corporate bonds, and repurchase agreements.

 

Short-term investments consist of: 1) auction rate securities with varying maturities, and 2) federal and municipal government securities, corporate bonds, and commercial paper with A1, F1, or P1 short-term ratings and A or better long-term ratings with remaining maturities at date of purchase of greater than 90 days. Investments with maturities greater than one year are classified as short-term when they represent investments of cash that are reasonably expected to be realized in cash and are available for use in current operations.

 

At June 30, 2005, all short-term investments are designated as available-for-sale and are carried at fair value, with unrealized gains and losses reported in stockholders’ equity as accumulated other comprehensive income (loss). Short-term investments are adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities, if any, are included in other income (expense). The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income.

 

At June 30, 2005 and December 31, 2004, we had outstanding letters of credit arrangements totaling $2.2 million in connection with arrangements with certain vendors, including our landlord, which are secured by investments in similar amounts.

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first-out method) or market. Cost is computed using standard cost, which approximates actual costs on a first-in, first-out basis.

 

Inventories consist of the following (in thousands):

 

     June 30,
2005


   December 31,
2004


Raw material

   $ 6,832    $ 4,848

Work-in-process

     3,304      4,552

Finished goods

     2,645      1,291
    

  

Total inventories

   $ 12,781    $ 10,691
    

  

 

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Property and Equipment

 

Property and equipment are stated at cost. Major improvements are capitalized, while maintenance and repairs are expensed when incurred. Laboratory and other equipment are depreciated using the straight-line method generally over estimated useful lives of three to seven years. Leasehold improvements and buildings are depreciated using the straight-line method over the shorter of the estimated useful life or the remaining term of the lease. Buildings are depreciated using the straight-line method over the estimated useful life of twenty years.

 

Goodwill

 

Goodwill is tested for impairment at least annually or on an interim basis if an event occurs or circumstances change that would more-likely-than-not reduce the fair value below our carrying value. During the three-month and six-month periods ended June 30, 2005 and 2004, we recorded no impairment charges under SFAS No. 142, Goodwill and Other Intangible Assets, as no indicators of impairment were identified by management.

 

Other Intangible Assets

 

Acquired technology and other intangible assets with definite useful lives are amortized on a straight-line basis over their estimated useful lives, which we currently estimate to be a period of five to seven years. Acquired technology and other intangible assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, asset values are adjusted to fair value. Acquired technology and other intangible assets include proprietary technology, intellectual property, and supplier and customer relationships acquired from third parties or in business combinations.

 

We periodically evaluate whether changes have occurred that would require revision of the remaining estimated useful lives of these assets or otherwise render the assets unrecoverable. If such an event occurred, we would determine whether the other intangibles are impaired. To date, no such impairment losses have been recorded.

 

Derivative Instruments

 

We are exposed to foreign currency exchange rate fluctuations and interest rate changes in the normal course of our business. As part of our risk management strategy, we may use derivative instruments, including forwards, swaps and options to hedge certain foreign currency and interest rate exposures. We do not use derivative contracts for speculative purposes. To date, we have not entered into any such derivative instruments other than the interest rate swap discussed below which was accounted for in accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”).

 

During the six-month period ended June 30, 2004, we had a bank loan which had been secured by one of our Nektar AL facilities in Alabama. This loan originally had a variable rate of interest tied to the LIBOR index. In November 2003, we entered into an interest rate swap agreement to limit our exposure to fluctuations in U.S. interest rates. The interest rate swap agreement effectively converts a portion of our debt to a fixed rate basis, thus reducing the impact of interest rate changes on future interest expense. The swap was designated a cash flow hedge. Under the terms of our swap arrangement, we paid an initial effective interest rate of 5.17%. This rate was variable on a monthly basis based on changes in the LIBOR index, but only to a maximum of 7.05%.

 

This swap had been accounted for as a derivative subject to SFAS No. 133. Because there was still potential variability in our effective interest rate, this specific swap arrangement was not an effective hedge. Accordingly, we recorded the fair value of this derivative at December 31, 2003 by recording a liability and corresponding interest expense of $0.2 million. The fair value was adjusted to market value on a quarterly basis, with an increase in interest rates generally resulting in a reduction in the liability and a decrease to interest expense, and a decrease in interest rates generally resulting in an increase to the liability and an increase in interest expense.

 

In September 2004, we retired the bank loan after paying the remaining principal balance of $5.6 million. We also retired the interest rate swap agreement by paying $0.3 million to the lender, representing the fair value of this instrument on that date which was equal to the swap liability recorded on our books. This amount was charged to interest expense.

 

To limit our exposure to foreign currency exchange rate fluctuations with respect to British Pounds, we have periodically purchased British Pounds on the spot market and held them in a U.S. bank account. At June 30, 2005 and at December 31, 2004, we held British Pounds valued at approximately $0.6 million and $8.4 million, respectively, using the exchange rate as of period end. Such amount is included in cash and cash equivalents on our balance sheet. During the three-month and six-month periods ended June 30, 2005, a loss of $0.1 million and $0.3 million resulting from revaluing British Pounds at the current exchange rate was included in other income (expense).

 

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Comprehensive Loss

 

Comprehensive loss is comprised of net loss and other comprehensive gain (loss). Other comprehensive gain included unrealized gains (losses) on available-for-sale securities, translation adjustments, and unrealized gains (losses) on available-for-sale securities using the specific identification method. The comprehensive loss consists of the following components net of related tax effects (in thousands):

 

     Three-Months Ended
June 30,


    Six-Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Net loss, as reported

   $ (26,912 )   $ (22,164 )   $ (53,077 )   $ (62,164 )

Change in net unrealized gains/(losses) on available-for-sale securities

     694       (2,291 )     184       (2,250 )

Net unrealized (gains)/losses reclassified into earnings

     —         1       —         (22 )

Translation adjustment

     (273 )     (81 )     (695 )     297  
    


 


 


 


Total comprehensive loss

   $ (26,491 )   $ (24,535 )   $ (53,588 )   $ (64,139 )
    


 


 


 


 

The components of accumulated other comprehensive income is as follows (in thousands):

 

     June 30,
2005


    December 31,
2004


 

Unrealized gains/(losses) on available-for-sale securities

   $ (1,672 )   $ (1,856 )

Translation adjustment

     805       1,500  
    


 


Total accumulated other comprehensive income

   $ (867 )   $ (356 )
    


 


 

Stock-Based Compensation

 

We currently apply the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for those plans. Under this opinion, no stock-based employee compensation expense is charged for options that were granted at an exercise price that was equal to the market value of the underlying common stock on the date of grant. Stock compensation costs are immediately recognized to the extent the exercise price is below the fair value on the date of grant and no future vesting criteria exist.

 

For stock awards issued below our market price on the grant date, we record deferred compensation representing the difference between the price per share of stock award issued and the fair value of the Company’s common stock at the time of issuance or grant, and we amortize this amount over the related vesting periods on a straight-line basis.

 

Pro forma information regarding net income and earnings per share required by SFAS 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation – Transition and Disclosure, regarding the fair value for employee options was estimated at the date of grant using a Black-Scholes option valuation model with the following weighted-average assumptions:

 

     Three-Months Ended
June 30,


 
     2005

    2004

 

Risk-free interest rate

   3.9 %   3.8 %

Dividend yield

   0.0 %   0.0 %

Volatility factor

   0.73     0.68  

Weighted average expected life

   4.5 years     5 years  
     Six-Months Ended
June 30,


 
     2005

    2004

 

Risk-free interest rate

   3.8 %   3.5 %

Dividend yield

   0.0 %   0.0 %

Volatility factor

   0.75     0.70  

Weighted average expected life

   4.5 years     5 years  

 

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Pro forma information regarding net income and earnings per share required by SFAS 123, as amended by SFAS 148, regarding the fair value for employee stock purchase plan shares was estimated at the date of grant using a Black-Scholes valuation model with the following weighted-average assumptions:

 

    

Six-Months Ended

June 30,


 
     2005

    2004

 

Risk-free interest rate

   1.83 %   1.04 %

Dividend yield

   0.0 %   0.0 %

Volatility factor

   0.86     0.67  

Weighted average expected life

   0.5 years     0.5 years  

 

The Black-Scholes options valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. We have presented the pro forma net loss and pro forma basic and diluted net loss per common share using the assumptions noted above.

 

The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands, except per share information):

 

     Three-Months Ended
June 30,


    Six-Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Net loss, as reported

   $ (26,912 )   $ (22,164 )   $ (53,077 )   $ (62,164 )

Add: stock-based employee compensation included in reported net loss

     542       496       1,035       917  

Deduct: total stock-based employee compensation expense determined under fair value methods for all awards

     (5,005 )     (7,238 )     (12,990 )     (14,716 )
    


 


 


 


Net loss, pro forma

   $ (31,375 )   $ (28,906 )   $ (65,032 )   $ (75,963 )
    


 


 


 


Net loss per share

                                

Basic and diluted, as reported

   $ (0.32 )   $ (0.27 )   $ (0.63 )   $ (0.85 )

Basic and diluted, pro forma

   $ (0.37 )   $ (0.35 )   $ (0.77 )   $ (1.04 )

 

Stock compensation expense for options granted to non-employees has been determined in accordance with SFAS 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in conjunction with Selling, Goods or Services, as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The fair value of options granted to non-employees is re-measured as the underlying options vest. Non-employee option awards are accounted for under FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

 

Revenue Recognition

 

We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”). Effective July 1, 2003, we adopted the provisions of Emerging Issues Task Force, Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) on a prospective basis.

 

Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectability is reasonably assured. Allowances are established for uncollectible amounts.

 

We enter into collaborative research and development arrangements with pharmaceutical and biotechnology partners that may involve multiple deliverables. For multiple-deliverable arrangements entered into after July 1, 2003 judgment is required in the areas of separability of units of accounting and the fair value of individual elements. The principles and guidance outlined in EITF No. 00-21 provide a framework to (a) determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and (b) determine how the arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. Our arrangements generally may contain the following elements: collaborative research, milestones, manufacturing and supply, royalties and license fees. For each separate unit of accounting we have objective and reliable evidence of fair value using available internal evidence for the undelivered item(s) and our arrangements generally do not contain a general right of return relative to

 

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the delivered item. In accordance with the guidance in EITF No. 00-21, the Company uses the residual method to allocate the arrangement consideration when it does not have fair value of a delivered item(s). Under the residual method, the amount of consideration allocated to the delivered item equals the total arrangement consideration less the aggregate fair value of the undelivered items.

 

Contract revenue from collaborative research and feasibility agreements is recorded when earned based on the performance requirements of the contract. Advance payments for research and development revenue received in excess of amounts earned are classified as deferred revenue until earned. Revenue from collaborative research and feasibility arrangements are recognized as the related costs are incurred. Amounts received under these arrangements are generally non-refundable if the research effort is unsuccessful.

 

Payments received for milestones achieved are deferred and recorded as revenue ratably over the next period of continued development. Management makes its best estimate of the period of time until the next milestone is reached. This estimate affects the recognition of revenue for completion of the previous milestone. The original estimate is periodically evaluated to determine if circumstances have caused the estimate to change and if so, amortization of revenue is adjusted prospectively.

 

Product sales are derived primarily from cost-plus manufacturing and supply contracts for our PEG Reagents with individual customers in our industry. Sales terms for specific PEG Reagents are negotiated in advance. Revenues related to our product sales are recorded in accordance with the terms of the contracts. We provide for a general allowance for sales returns by reserving a percentage of product sales based on our recent experience with product returns. The allowance for sales returns was $0.3 million and nil as of June 30, 2005 and December 31, 2004, respectively.

 

Research and Development

 

Research and development costs are expensed as incurred and include salaries, benefits, and other operating costs such as outside services, supplies, and allocated overhead costs. We perform research and development for our proprietary products and technology development and for others pursuant to feasibility agreements and development and license agreements. For our proprietary products and internal technology development programs, we may invest our own funds without reimbursement from a collaborative partner. Under our feasibility agreements, we are generally reimbursed for the cost of work performed. Feasibility agreements are designed to evaluate the applicability of our technologies to a particular molecule and therefore are generally completed in less than one year. Under our development and license agreements, products developed using our technologies may be commercialized by a collaborative partner. Under these development and license agreements, we may be reimbursed for development costs, may also be entitled to milestone payments when and if certain development and/or regulatory milestones are achieved, and may be compensated for the manufacture and supply of clinical and commercial product. All of our research and development agreements are generally cancelable by the partner without significant financial penalty.

 

Accounting for Income Taxes

 

We account for income taxes under SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Because of our lack of earnings history, the net deferred tax assets for our operations outside of Alabama have been fully offset by a valuation allowance.

 

We recorded a provision of $0.1 million and $0.1 million for the three-month and six-month periods ended June 30, 2004 relating entirely to state taxes on our Alabama subsidiary. We did not record a provision for income taxes for the three-month or six-month periods ended June 30, 2005 because our Alabama subsidiary had a net loss for both the three-month and six-month periods ended June 30, 2005.

 

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Table of Contents

Net Loss Per Share

 

Basic net loss per share is calculated based on the weighted-average number of common shares outstanding during the periods presented, less the weighted-average shares outstanding which are subject to the Company’s right of repurchase.

 

The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):

 

     Three-Months Ended
June 30,


    Six-Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Numerator:

                                

Net loss

   $ (26,912 )   $ (22,164 )   $ (53,077 )   $ (62,164 )

Denominator:

                                

Weighted average number of common shares outstanding

     85,040       83,501       84,875       72,858  

Net loss per share – basic and diluted

   $ (0.32 )   $ (0.27 )   $ (0.63 )   $ (0.85 )

 

Diluted earnings per share would give effect to the dilutive impact of common stock equivalents which consists of convertible preferred stock and convertible subordinated debt (using the as-if converted method), and stock options and warrants (using the treasury stock method). Potentially dilutive securities have been excluded from the diluted earnings per share computations in all years presented as such securities have an anti-dilutive effect on loss per share due to the Company’s net loss. Potentially dilutive securities included the following (in thousands):

 

     June 30,

     2005

   2004

Warrants

   36    56

Options and restricted stock units

   17,128    17,542

Convertible preferred stock

   1,023    875

Convertible debentures and notes

   3,831    3,831
    
  

Total

   22,018    22,304
    
  

 

Note 2 - Segment, Significant Customer and Geographic Information

 

We report segment information in accordance with SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The Company is managed as one operating segment. The entire business is comprehensively managed by our Executive Committee that reports to the Chief Executive Officer. The Executive Committee is our chief operating decision maker. We have multiple technologies, all of which are marketed to a common customer base (pharmaceutical and biotechnology companies which are typically located in the U.S. and Europe).

 

Our research revenue is derived primarily from clients in the pharmaceutical and biotechnology industries. Revenue from Pfizer represented 67% and 58% of our total revenue for the three-month periods ended June 30, 2005 and 2004, respectively. Revenue from Pfizer represented 65% and 59% of our total revenue for the six-month periods ended June 30, 2005 and 2004, respectively. Deferred revenue from Pfizer represented 69% and 76% of total deferred revenue as of June 30, 2005 and December 31, 2004, respectively. Product sales relate to sale of our manufactured Advanced PEGylation Technology products by Nektar AL.

 

Our accounts receivable balance contains trade receivables from product sales and royalties, collaborative research agreements, and Exubera® commercialization readiness revenue. On June 30, 2005, three different customers represented 46%, 15%, and 14% of our accounts receivable, respectively. At December 31, 2004, four different customers represented 25%, 23%, 16%, and 10% of our accounts receivable, respectively.

 

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Table of Contents

We primarily receive contract research revenue from, and provide product sales to, customers located within the United States. Revenues are derived from customers in the following geographic areas (in thousands):

 

     Three-Months Ended
June 30,


   Six-Months Ended
June 30,


     2005

   2004

   2005

   2004

Contract research revenue

                           

United States

   $ 18,287    $ 21,780    $ 36,934    $ 43,174

All other countries

     1,265      322      2,147      437
    

  

  

  

Total contract research revenue

   $ 19,552    $ 22,102    $ 39,081    $ 43,611
    

  

  

  

Product sales

                           

United States

   $ 3,473    $ 3,297    $ 7,764    $ 6,465

European countries

     1,929      2,400      3,232      2,971

All other countries

     68      728      866      1,311
    

  

  

  

Total product sales

   $ 5,470    $ 6,425    $ 11,862    $ 10,747
    

  

  

  

Exubera® commercialization readiness revenue

                           

United States

   $ 3,528    $ —      $ 6,101    $ —  

All other countries

     —        —        —        —  
    

  

  

  

Total Exubera® commercialization readiness revenue

   $ 3,528    $ —      $ 6,101    $ —  
    

  

  

  

 

Note 3 – Financial Instruments

 

As of June 30, 2005 and December 31, 2004, we held a portfolio of debt securities. Certain of these securities have a fair value less than their amortized cost. In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and EITF 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, we have recorded the difference between the amortized cost and fair value as a component of accumulated other comprehensive income. Management has concluded that no impairment should be recognized related to these investments because the unrealized losses incurred to date are not considered other than temporary. Management has reached this conclusion based upon its intention to generally hold all debt investments with an unrealized loss until maturity (or reset date for auction rate securities) at which point they are redeemed at full par value, a history of actually holding the majority of our investments to maturity (or reset date for auction rate securities), and our strategy of aligning the maturity of our debt investments to meet our cash flow needs. Therefore, we will, in most cases, have the ability to hold all of our debt investments to maturity.

 

We determine the fair value amounts by using available market information. As of June 30, 2005 and December 31, 2004, the average portfolio duration was approximately one year, and the contractual maturity of any single investment did not exceed twenty-four months with the exception of auction rate securities which we held only as of December 31, 2004. Investments with maturities greater than one year are classified as short-term when they represent investments of cash that are reasonably expected to be realized in cash and are available for use in current operations. Gross unrealized gains on available for sales securities were less than $0.1 million at June 30, 2005 and December 31, 2004. The gross unrealized losses on available for sale securities at June 30, 2005 and December 31, 2004 amounted to approximately $1.7 million and approximately $1.9 million, respectively. As of June 30, 2005, there were 71 securities that had been in a loss position for twelve months or more and which had a fair value $120.2 million and an unrealized loss of $1.2 million. As of December 31, 2004, there were 21 securities that had been in a loss position for twelve months or more and which had a fair value $31.4 million and an unrealized loss of $0.1 million.

 

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Table of Contents

The following is a summary of operating cash and available-for-sale securities as of June 30, 2005 (in thousands):

 

     Amortized
Cost


   Gross
Unrealized
Gains


   Gross
Unrealized
Losses


    Estimated
Fair Value


Cash and Available-for-Sale Securities                             

Obligations of U.S. government agencies

   $ 154,906    $ 1    $ (884 )   $ 154,023

U.S. corporate commercial paper

     41,654      —        (9 )     41,645

Obligations of U.S. state and local agencies

     1,150      —        —         1,150

Obligations of U.S. corporations

     138,892      5      (769 )     138,128

Obligations of non U.S. corporations

     2,961      —        (16 )     2,945

Repurchase agreements

     29,378      —        —         29,378

Cash and other debt securities

     11,238      —        —         11,238
    

  

  


 

     $ 380,179    $ 6    $ (1,678 )   $ 378,507
    

  

  


 

Amounts included in cash and cash equivalents

   $ 70,381    $ —      $ (6 )   $ 70,375

Amounts included in short-term investments (less than one year to maturity)

     221,594      —        (1,281 )     220,313

Amounts included in short-term investments (one to two years to maturity)

     88,204      6      (391 )     87,819
    

  

  


 

     $ 380,179    $ 6    $ (1,678 )   $ 378,507
    

  

  


 

 

The following is a summary of operating cash and available-for-sale securities as of December 31, 2004 (in thousands):

 

    

Amortized

Cost


  

Gross

Unrealized

Gains


  

Gross

Unrealized

Losses


    Fair Value

Cash and Available-for-Sale Securities                             

Obligations of U.S. government agencies

   $ 164,883    $ 1    $ (923 )   $ 163,961

Obligations of U.S. state and local government agencies

     1,150      —        —         1,150

Obligations of U.S. corporations

     147,114      —        (918 )     146,196

Obligations of non U.S. corporations

     4,033      —        (16 )     4,017

Repurchase agreements

     14,200      —        —         14,200

Auction rate securities

     72,350      —        —         72,350

Cash

     16,866      —        —         16,866
    

  

  


 

Total Cash and Available-for-Sale Securities

   $ 420,596    $ 1    $ (1,857 )   $ 418,740
    

  

  


 

Amounts included in cash and cash equivalents

   $ 32,064    $ —      $ —       $ 32,064

Amounts included in short-term investments (less than one year to maturity)

     212,586      —        (916 )     211,670

Amounts included in short-term investments (one to two years to maturity)

     103,596      1      (941 )     102,656

Amounts included in short-term investments (more than 2 years to maturity)

     72,350      —        —         72,350
    

  

  


 

Total Cash and Available-for-Sale Securities

   $ 420,596    $ 1    $ (1,857 )   $ 418,740
    

  

  


 

 

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Note 4 - Other Intangible Assets

 

The components of our other intangible assets at June 30, 2005, are as follows (in thousands, except for years):

 

    

Useful

Life in

Years


  

Gross

Carrying

Amount


  

Accumulated

Amortization


   Net

Core technology

   5    $ 8,100    $ 6,480    $ 1,620

Developed product technology

   5      2,900      2,320      580

Intellectual property

   5-7      7,301      6,140      1,161

Supplier and customer relations

   5      5,140      4,299      841
         

  

  

Total

        $ 23,441    $ 19,239    $ 4,202
         

  

  

 

Amortization expense related to other intangible assets totaled $1.1 million for both of the three-month periods ended June 30, 2005 and 2004 and $2.2 million for both the six-month periods ended June 30, 2005 and 2004. The following table presents expected future amortization expense for other intangible assets until they are fully amortized (in thousands):

 

Years Ending December 31,


    

Remainder of 2005

   $ 2,253

2006

     1,949
    

Total

   $ 4,202
    

 

Note 5 - Commitments and Contingencies

 

Legal Matters

 

On September 3, 2004, a purported securities class action complaint styled Norman Rhodes, et al. v. Nektar Therapeutics, Ajit Gill, J. Milton Harris, and Robert B Chess, Case No. C 04-03735 JSW, was filed in the United States District Court for the Northern District of California against the Company and certain of its current officers and directors. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 based on statements made between March 4, 2004 and August 4, 2004 (the “Class Period”)-regarding Exubera®. On May 9, 2005, the plaintiff dismissed the complaint in its entirety without prejudice. The action is no longer pending.

 

From time to time, we are party to various other litigation matters, including several that relate to our patent and intellectual property rights. We cannot predict with certainty the eventual outcome of any pending litigation or potential future litigation, and we might have to incur substantial expense in defending these or future lawsuits or indemnifying third parties with respect to the results of such litigation. In accordance with the SFAS No. 5, Accounting for Contingencies, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impact of negotiations, settlements, ruling, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. If any unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations of that period or on our cash and/or liquidity.

 

Letters of Credit

 

At June 30, 2005 and December 31, 2004, we had outstanding letters of credit totaling $2.2 million in connection with arrangements with certain vendors, including our landlord, which are secured by investments in similar amounts.

 

Workers Compensation

 

Pursuant to the terms of our worker’s compensation insurance policy, we are required to self-fund all claims up to $250,000 per occurrence subject to a maximum of $739,250 for the term of the insurance policy, November 1, 2004 – October 31, 2005. Historically, we have not been obligated to make significant payments for these obligations, and no significant liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Royalties

 

We have certain royalty commitments associated with the shipment, licensing, or development of certain products. Royalty expense was approximately $0.9 million and $0.7 million for the three-month periods ended June 30, 2005 and 2004, respectively. Royalty expense was approximately $1.5 million and $1.2 million for the six-month periods ended June 30, 2005 and 2004, respectively. The overall maximum amount of the obligations is based upon sales of the applicable product and future royalty expenses cannot be reasonably estimated.

 

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Table of Contents

Director and Officer Indemnifications

 

As permitted under Delaware law, and as set forth in our Certificate of Incorporation and our Bylaws, we indemnify our directors, executive officers, other officers, employees, and other agents for certain events or occurrences that arose while in such capacity. The maximum potential amount of future payments we could be required to make under this indemnification is unlimited; however, we have insurance policies that may limit our exposure and may enable us to recover a portion of any future amounts paid. Assuming the applicability of coverage, the willingness of the insurer to assume coverage, and subject to certain retention, loss limits, and other policy provisions, we believe any obligations under this indemnification are not material, other than an initial $500,000 per incident retention deductible per our insurance policy. However, no assurances can be given that the covering insurers will not attempt to dispute the validity, applicability, or amount of coverage without expensive litigation against these insurers, in which case we may incur substantial liabilities as a result of these indemnification obligations. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Indemnification of Underwriters and Initial Purchasers of our Securities

 

In connection with our sale of equity and convertible debt securities from, we have agreed to defend, indemnify, and hold harmless our underwriters or initial purchasers, as applicable, as well as certain related parties from and against certain liabilities, including liabilities under the Securities Act of 1933, as amended. The term of these indemnification obligations is generally perpetual. There is no limitation on the potential amount of future payments we could be required to make under these indemnification obligations. We have never incurred costs to defend lawsuits or settle claims related to these indemnification obligations. If any of our indemnification obligations are triggered, however, we may incur substantial liabilities. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Strategic Alliance—Enzon

 

In January 2002, we announced a broad strategic alliance with Enzon Pharmaceuticals, Inc. that included a collaboration to develop up to three products using our Pulmonary Technology and/or Supercritical Fluids Technology. Under the terms of the agreement, we are responsible for the development of drug formulations for the agreed upon pharmaceutical agents. We are required to self-fund a portion of these costs. As of June 30, 2005, we are required to fund up to an incremental $1.6 million in the coming years without reimbursement for research and development expenses. To date these costs, amounting to $15.4 million, have been included in our research and development expenses. After our funding requirement has been met, Enzon will have an option to license the products and if they exercise this option, they will be required to provide research and development funding as well as milestone payments should the products progress through clinical testing.

 

Manufacturing and Supply Agreement with Contract Manufacturers

 

In August 2000, we entered into a Manufacturing and Supply Agreement with our contract manufacturers to provide for the manufacturing of our pulmonary inhaler device for Exubera®. Under the terms of the Agreement, we may be obligated to reimburse the contract manufacturers for the actual unamortized and unrecovered portion of any equipment procured or facilities established and the interest accrued for their capital overlay in the event that Exubera® does not gain FDA approval to the extent that the contract manufacturers cannot re-deploy the assets. While such payments may be significant, at the present time, it is not possible to estimate the loss that will occur should Exubera® not be approved. We have also agreed to defend, indemnify, and hold harmless the contract manufacturers from and against third party liability arising out of the agreement, including product liability and infringement of intellectual property. There is no limitation on the potential amount of future payments we could be required to make under these indemnification obligations. We have never incurred costs to defend lawsuits or settle claims related to these indemnification obligations. If any of our indemnification obligations is triggered, we may incur substantial liabilities. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

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Security Agreement with Pfizer, Inc.

 

In connection with the Collaboration, Development and License Agreement (“CDLA”) dated January 18, 1995 that we entered into with Pfizer for the development of the Exubera® product, we entered into a Security Agreement pursuant to which our obligations under the CDLA and certain Manufacturing and Supply Agreements related to the manufacture and supply of powdered insulin and pulmonary inhaler devices for the delivery of powdered insulin, are secured. Our default under any of these agreements triggers Pfizer’s rights with respect to property relating solely to, or used or which will be used solely in connection with, the development, manufacture, use and sale of Exubera® including proceeds from the sale or other disposition of the property. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Collaboration Agreements for Pulmonary Products

 

As part of our collaboration agreements with our partners for the development, manufacture, and supply of products based on our Pulmonary Technology, we generally agree to defend, indemnify, and hold harmless our partners from and against third party liabilities arising out of the agreement, including product liability and infringement of intellectual property. The term of these indemnification obligations is generally perpetual any time after execution of the agreement. There is no limitation on the potential amount of future payments we could be required to make under these indemnification obligations. We have never incurred costs to defend lawsuits or settle claims related to these indemnification obligations. If any of our indemnification obligations is triggered, we may incur substantial liabilities. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

License, Manufacturing and Supply Agreements for Products Based on our Advanced PEGylation Technology

 

As part of our license, manufacturing, and supply agreements with our partners for the development and/or manufacture and supply of PEG reagents based on our Advanced PEGylation Technology, we generally agree to defend, indemnify, and hold harmless our partners from and against third party liabilities arising out of the agreement, including product liability and infringement of intellectual property. The term of these indemnification obligations is generally perpetual any time after execution of the agreement. There is no limitation on the potential amount of future payments we could be required to make under these indemnification obligations. We have never incurred costs to defend lawsuits or settle claims related to these indemnification obligations. If any of our indemnification obligations is triggered, we may incur substantial liabilities. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Lease Restoration

 

We have several leases for our facilities in multiple locations. In the event that we do not exercise our option to extend the term of these leases, we guarantee certain costs to restore the property to certain conditions in place at the time of lease. We believe the estimated fair value of this guarantee is minimal. Because the obligated amount of this agreement is not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as of June 30, 2005 or December 31, 2004.

 

Note 6 – Deferred Compensation

 

During the three-month period ended March 31, 2005, we issued restricted stock unit awards totaling 110,000 shares of our common stock to certain employees. The restricted stock unit awards are settled by delivery of shares of our common stock on or shortly after the date the awards vest. The restricted stock unit awards become fully vested over a period of 47 months. In connection with these restricted stock unit awards, we recorded deferred compensation of $2.0 million, which represents the intrinsic value of the restricted stock units on the date of grant. We are recognizing the stock compensation expense on a straight line basis over the vesting term of 47 months.

 

During the three-month period ended March 31, 2004, we issued restricted stock unit awards totaling 206,666 shares of our common stock to certain employees. The restricted stock unit awards are settled by delivery of shares of our common stock on or shortly after the date the awards vest. The restricted stock unit awards become fully vested over a period of 34 months. In connection with these restricted stock unit awards, we recorded deferred compensation of $3.9 million, which represents the intrinsic value of the restricted stock units on the date of grant. We are recognizing the stock compensation expense on a straight line basis over the vesting term of 34 months.

 

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For the three-month period ended June 30, 2005 and 2004, we recognized expense related to these restricted stock unit grants of approximately $0.5 million and approximately $0.3 million, respectively. For the six-month period ended June 30, 2005 and 2004, we recognized expense related to these restricted stock grants of approximately $0.9 million and approximately $0.6 million, respectively.

 

Note 7 – Exubera® Commercialization Readiness and Costs

 

Exubera® commercialization readiness represents reimbursement, by Pfizer, of certain agreed upon operating costs relating to our Exubera® drug powder manufacturing facilities in preparation for commercial production, plus a markup on such costs. Such reimbursable revenue will not necessarily equal actual costs incurred which are expensed as Exubera® commercialization readiness costs.

 

Note 8 – Loss on Termination of Capital Lease

 

Effective January 11, 2005, Nektar and BMR-201 Industrial Road LLC (landlord), entered into an agreement to terminate our obligation in the Amended and Restated Built-To-Suit Lease dated August 17, 2004 related to a portion of our office space located at our San Carlos location. In connection with the termination agreement, we have recorded other expense of approximately $1.1 million. This amount represents the write-off of the capital asset related to this space partially offset by a reduction in the present value of our liability related to this space.

 

Note 9 – Subsequent Events

 

On July 12, 2005, a complaint was filed by The Board of Trustees of the University of Alabama (“UAH”) against Nektar Therapeutics AL, Corporation, and Nektar Therapeutics, Inc., (“Defendants”) in the United States District Court for the Northern District of Alabama. Among other things, the complaint alleges patent infringement, breach of contract license, violation of the Alabama Trade Secrets Act and unjust enrichment. Generally, the complaint alleges that Defendants’ refusal to pay royalties based upon UAH patented and licensed technology represents a breach of an exclusive license agreement between UAH and Nektar Therapeutics AL, Corporation (formerly Shearwater Corporation) and that Defendants have infringed and are infringing UAH’s patent. The complaint seeks certain monetary damages and other relief. The action is in a very early stage and we have not responded to the complaint.

 

On July 26, 2005, we announced that our current Chief Financial Officer, Mr. Ajay Bansal, will be transitioning from his current duties as Chief Financial Officer and Vice President, Finance and Administration to the position of General Manager, Diabetes Group. In connection with his new position, among other matters, Mr. Bansal will be responsible for overseeing product decisions, resource allocation, and partner relationships. We are commencing a search for a new Chief Financial Officer to succeed Mr. Bansal. Mr. Bansal will continue to serve in the position of Chief Financial Officer until his successor is identified and retained.

 

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

 

The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section as well as factors under the heading “Risk Factors” at the end of this section.

 

Overview

 

Our business is to create high value products through the application of advanced drug delivery. We have three drug delivery technology platforms that are designed to improve the performance of molecules. These platforms are: Nektar Advanced PEGylation Technology, Nektar Pulmonary Technology, and Nektar Supercritical Fluid (SCF) Technology.

 

Our mission is to develop superior therapeutics to make a difference in patients’ lives. We pursue our mission in two ways. First, we partner with pharmaceutical and biotechnology companies that seek to improve and differentiate their products. In addition, we are in the early-stages of development of our own proprietary products. We are working to become one of the world’s leading drug delivery products companies.

 

To date, the revenues we have received from the sales of our products and in connection with our collaborative arrangements have been insufficient to meet our operating and other expenses. The development of a successful product is dependent upon several factors that are outside of our control. These include, among other things, the need to obtain regulatory approval to market these products and our dependence upon our collaborative partners. As a result of these or other risks, potential products for which we have invested substantial amounts in research and development may never produce revenues or income.

 

We have generally been compensated for research and development expenses during initial feasibility work performed under collaborative arrangements for all three of our technologies: Nektar Advanced PEGylation Technology, Nektar Pulmonary Technology, and Nektar Supercritical Fluid Technology. Prior to commercialization of pulmonary delivery and Advanced PEGylation products, we receive revenues from our partners for partial or full funding of research and development activities and progress payments upon achievement of certain developmental milestones. In a typical Advanced PEGylation Technology collaboration, we manufacture and supply the polyethylene glycol (“PEG”) reagents and receive manufacturing revenues and possible royalties from sales of the commercial product. In a typical Pulmonary Technology collaboration, our partner will provide the active pharmaceutical ingredient (the majority of which are already approved by the FDA in another delivery form), fund clinical and formulation development, obtain regulatory approvals, and market the resulting commercial product. We may manufacture and supply the drug delivery approach or drug formulation, and may receive revenues from drug manufacturing, as well as royalties from sales of most commercial products. In addition, for products using our Pulmonary Technology, we may receive revenues from the supply of our device for the product along with revenues for any applicable drug processing or filling. In addition to our partner-funded programs, we are applying our technologies independently through internal proprietary product development efforts. To achieve and sustain profitable operations, we, alone or with others, must successfully develop, obtain regulatory approval for, manufacture, introduce, market, and sell products using our drug delivery and other drug delivery systems. There can be no assurance that we can generate sufficient product or contract research revenue to become profitable or to sustain profitability.

 

To fund the substantial expense related to our research and development activities, we have raised significant amounts of capital through the sale of our equity and convertible debt securities. As of June 30, 2005, we had approximately $173.9 million in long-term convertible subordinated notes and debentures, $20.5 million in non-current capital lease obligations, and $11.6 million in other long-term debt. Our ability to meet the repayment obligations of this debt is dependent upon our ability to develop successful products without significant delays. Even if we are successful in this regard, we will likely require additional capital to repay our debt obligations.

 

We do not expect that sales of our currently marketed products will be sufficient for us to achieve profitability. Our ability to achieve profitability is dependent on the approval of and successful marketing of products with significant markets, and for which we realize relatively higher royalties.

 

Recent Developments

 

In July 2005, we announced that the Food and Drug Administration (“FDA”) has set the date of September 8, 2005 for the Advisory Committee meeting to discuss the New Drug Application for Exubera.

 

In July 2005, UCB Pharma announced the preliminary results of two pivotal Phase III trials for Cimzia, formerly CDP870, in the treatment of Crohn’s disease. The trials compared Cimzia to placebo in 1,330 patients over a period of 26 weeks and data demonstrated that Cimzia was well-tolerated and met primary endpoints. Nektar provides the PEG for Cimzia. UCB Pharma also announced that CDP791 successfully completed Phase I and Phase II trials for non-small cell lung cancer will start in the next few weeks. Another product, CDP484 is on hold after Phase I studies failed to meet the criteria to proceed. Nektar provides the PEG for both of these products.

 

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In June, 2005 Roche announced new data from a year-long study that show that CERA, the first Continuous Erythropoietin Receptor Activator from Roche to treat renal anemia, provided sustained and stable control of hemoglobin levels with dosing intervals up to four weeks in dialysis patients who suffer from anemia. CERA uses Nektar PEGylation Technology.

 

Results from three two-year studies presented in June 2005 at the 65th Annual Scientific Sessions of the American Diabetes Association showed that Exubera, an inhaleable, short-acting, dry powder insulin, provided effective, sustained glycemic control and was well tolerated over two years in adults with type 2 diabetes. A fourth study showed that three months of Exubera therapy was well tolerated and as effective as subcutaneous (injectable) short-acting insulin in achieving tight glycemic control in adults with type 1 diabetes.

 

On July 26, 2005, we announced that our current Chief Financial Officer, Mr. Ajay Bansal, will be transitioning from his current duties as Chief Financial Officer and Vice President, Finance and Administration to the position of General Manager, Diabetes Group. In connection with his new position, among other matters, Mr. Bansal will be responsible for overseeing product decisions, resource allocation, and partner relationships. We are commencing a search for a new Chief Financial Officer to succeed Mr. Bansal. Mr. Bansal will continue to serve in the position of Chief Financial Officer until his successor is identified and retained.

 

On July 12, 2005, a complaint was filed by The Board of Trustees of the University of Alabama (“UAH”) against Nektar Therapeutics AL, Corporation, and Nektar Therapeutics, Inc., (“Defendants”) in the United States District Court for the Northern District of Alabama. Among other things, the complaint alleges patent infringement, breach of contract license, violation of the Alabama Trade Secrets Act and unjust enrichment. Generally, the complaint alleges that Defendants’ refusal to pay royalties based upon UAH patented and licensed technology represents a breach of an exclusive license agreement between UAH and Nektar Therapeutics AL, Corporation (formerly Shearwater Corporation) and that Defendants have infringed and are infringing UAH’s patent. The complaint seeks certain monetary damages and other relief. The action is in a very early stage and we have not responded to the complaint.

 

Recent Accounting Pronouncements

 

In May 2005, the Financial Accounting Standards Board (“FASB”) released Statement of Financial Accounting Standard (“SFAS”) No. 154, Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3, (“FAS 154”). FAS 154 requires retrospective application to prior periods’ financial statements for any changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. The statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. The statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. We will be required to adopt FAS 154 for any accounting changes or corrections of errors on or after January 1, 2006. We do not expect the adoption of FAS 154 to have a material impact on our consolidated financial position, results of operations, or cash flows.

 

In December 2004, the FASB released a revision to SFAS No. 123, Accounting for Stock-Based Compensation (“FAS 123R”). FAS 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally would require instead that such transactions be accounted for using a fair-value-based method. We will be required to adopt FAS 123R on January 1, 2006. When we adopt the new statement, we will have to recognize substantially more compensation expense. This will have a material adverse impact on our financial position and results of operations. We are currently in the process of evaluating the effect of adopting FAS 123R.

 

In November 2004, the FASB released SFAS No. 151, Inventory Costs – An Amendment to ARB No. 43. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as defined by ARB No. 43, Chapter 4, Inventory Pricing. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We will be required to adopt SFAS No. 151 on January 1, 2006. We are currently in the process of evaluating the effect of adopting SFAS No. 151.

 

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In March 2004, the EITF reached a consensus on EITF 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 provides guidance regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. In September 2004, the EITF delayed the effective date for the measurement and recognition guidance; however the disclosure requirements remain effective for annual periods ending after June 15, 2004 (see note 2). The FASB has since decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the staff to issue proposed FASB Staff Position (“FSP”) FAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP FAS 115-1”). FAS 115-1 will replace the guidance set forth in EITF 03-01, with references to existing other-than-temporary impairment guidance, and will clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. The FASB decided that FSP FAS 115-1 would be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The finalized FSP is expected to be issued in August 2005, and we will evaluate the effects of adopting at this time.

 

Restatement

 

Certain amounts reported in our Quarterly Reports on Form 10-Q for the three-month and six-month periods ended June 30, 2004 have been restated to correct for certain misapplications of our accounting policies under U.S. GAAP.

 

Specifically, we have reclassified approximately $2.8 million and $5.5 million for the three-month and six-month periods ended June 30, 2004, respectively, from research and development expenses to general and administrative expenses. This reclassification included legal expenses related to our intellectual property portfolio and a portion of finance, information systems, and human resource expenses that were not clearly related to research and development and are required to be classified outside of research and development expenses under Statement Financial Accounting Standards No. 2, Accounting for Research and Development Costs.

 

In addition, we reclassified approximately $0.2 million and $0.5 million for the three-month and six-month periods ended June 30, 2004 from general and administrative expenses to interest expense. This reclassification was made to record the amortization of debt issuance costs to interest expense as required under Accounting Principles Board No. 21, Interest on Receivables and Payables and EITF 86-15, Increasing-Rate Debt.

 

These reclassifications did not result in any change to our cash position, revenue, or net loss during the three-month or six-month periods ended June 30, 2004.

 

Results of Operations

 

Three-Month and Six-Month Periods Ended June 30, 2005 and 2004

 

Revenue (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Contract revenue

   $ 19,552    $ 22,102    $ (2,550 )   (12 )%

Product and royalty revenue

     5,470      6,425      (955 )   (15 )%

Exubera® commercialization readiness revenue

     3,528      —        3,528     —    
    

  

  


     

Total revenue

   $ 28,550    $ 28,527    $ 23     <1 %
    

  

  


     
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Contract revenue

   $ 39,081    $ 43,611    $ (4,530 )   (10 )%

Product and royalty revenue

     11,862      10,747      1,115     10 %

Exubera® commercialization readiness revenue

     6,101      —        6,101     —    
    

  

  


     

Total revenue

   $ 57,044    $ 54,358    $ 2,686     5 %
    

  

  


     

 

Contract research revenue includes reimbursed research and development expenses as well as the amortization of deferred up-front signing and milestone payments received from our collaborative partners. Contract revenues are expected to fluctuate from year to year, and future contract revenue is difficult to predict accurately. The level of contract revenues depends in part upon future success in obtaining feasibility studies, the continuation of existing collaborations, and achievement of milestones under current and future agreements. Contract research revenue for the three-month period ended June 30, 2005 was approximately $19.6 million

 

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compared to $22.1 million for the three-month period ended June 30, 2004. Contract research revenue for the six-month period ended June 30, 2005, was approximately $39.1 million compared to approximately $43.6 million for the six-month period ended June 30, 2004. The decrease in contract research revenue for both the three-month and six-month periods ended June 30, 2004 was primarily due to reduced contract research revenue related to Exubera® which has been offset by revenue classified as Exubera® commercialization readiness and product revenue. In addition, during the six month period ended June 30, 2004, we recognized $2.1 million in revenue from a one-time payment related to Aventis’ termination of a collaboration with us.

 

Product pricing is generally determined on a cost plus basis and is dependent on the manufacturing agreement specific to each partner. Product and royalty revenue for the three-month period ended June 30, 2005 was approximately $5.5 million compared to approximately $6.4 million for the three-month period ended June 30, 2004. The 15% decrease in product revenue was primarily due to timing of orders for certain PEG products. Product and royalty revenue for the six-month period ended June 30, 2005, was approximately $11.9 million compared to approximately $10.7 million for the six-month period ended June 30, 2004. The 10% increase was primarily due to royalties from Eyetech Pharmaceuticals, Inc. based on net Macugen® sales by Eyetech in the previous three-month period. A portion of these royalties are paid to Enzon Pharmaceuticals, Inc.

 

Exubera® commercialization readiness revenue represents reimbursement, by Pfizer, of certain agreed upon operating costs relating to our Exubera® drug powder manufacturing facilities in preparation for commercial production, plus a markup on such costs. Such reimbursable revenue will not necessarily equal actual costs incurred which are expensed as Exubera® commercialization readiness costs.

 

Cost of Goods Sold (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


    Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Cost of goods sold

   $ 5,433    $ 6,733     $ (1,300 )   (19 )%

Product and royalty gross margin

   $ 37    $ (308 )   $ 345     112 %
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


    Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Cost of goods sold

   $ 10,688    $ 9,269     $ 1,419     15 %

Product and royalty gross margin

   $ 1,174    $ 1,478     $ (304 )   (21 )%

 

Cost of goods sold is associated with product sales and royalties and was approximately $5.4 million for the three-month period ended June 30, 2005 based on product and royalty revenue of approximately $5.5 million, representing a gross margin of approximately 1%. Cost of goods sold for the three-month period ended June 30, 2004 was approximately $6.7 million based on product and royalty revenue of approximately $6.4 million, representing a negative gross margin of approximately (5%) which was consistent with the three-month period ended June 20, 2005.

 

During the three-month period ended June 30, 2005, certain production resources were diverted to the completion of the construction and validation of a commercial production suite for PEG products. During the three-month period ended June 30, 2004, we experienced production problems in one of our PEG-producing manufacturing lines which caused a temporary shutdown of that line. These events caused a lower than normal absorption of overhead and had a negative impact on gross margin.

 

Cost of goods sold was approximately $10.7 million for the six-month period ended June 30, 2005 based on product and royalty revenue of approximately $11.9 million, representing a gross margin of approximately 11%. Cost of goods sold for the six-month period ended June 30, 2004 was approximately $9.3 million based on product and royalty revenue of approximately $10.7 million, representing a gross margin consistent with the three-month period ended June 20, 2005 of approximately 14%.

 

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Exubera® commercialization readiness costs (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


Exubera® commercialization readiness costs

   $ 2,666    $ —      $ 2,666    —  
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


Exubera® commercialization readiness costs

   $ 4,960    $ —      $ 4,960    —  

 

Exubera® commercialization readiness costs are start-up manufacturing costs we have incurred in our Exubera® drug powder manufacturing facility in preparation for commercial production for the three-month and six-month periods ended June 30, 2005.

 

Research and Development Expenses (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Research and development

   $ 35,785    $ 33,650    $ 2,135    6 %
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Research and development

   $ 70,730    $ 64,942    $ 5,788    9 %

 

We expense all research and development expenses as they are incurred. Research and development expenses are associated with three general categories: (i) collaborative agreements under which a portion of spending is reimbursed by our partners; (ii) spending attributed to internally funded programs; and (iii) infrastructure costs.

 

Research and development expenses were approximately $35.8 million and approximately $33.7 million for the three-month periods ended June 30, 2005 and 2004, respectively. Research and development expenses were approximately $70.7 million and approximately $64.9 million for the six-month periods ended June 30, 2005 and 2004, respectively. The increase for both the three-month and six-month periods was due to annual salary increases, a one time expense of $1.4 million associated with the buy-out of our potential future royalty and milestone obligations with a partner, and increased expenses related to validation testing of our Exubera drug delivery device and outside services related to our proprietary programs.

 

We expect research and development spending to continue to increase over the next few years as we advance our proprietary products.

 

We have reclassified approximately $2.8 million and $5.5 million for the three-month and six-month periods ended June 30, 2004, respectively, from research and development expenses to general and administrative expenses. This reclassification included legal expenses related to our intellectual property portfolio and a portion of finance, information systems, and human resource expenses that were not clearly related to research and development and are required to be classified outside of research and development expenses under Statement Financial Accounting Standards No. 2, Accounting for Research and Development Costs.

 

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General and Administrative Expenses (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

General and administrative

   $ 10,135    $ 8,072    $ 2,063    26 %
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

General and administrative

   $ 19,245    $ 14,900    $ 4,345    29 %

 

General and administrative expenses are associated with administrative staffing, business development, and marketing efforts. General and administrative expenses were approximately $10.1 million and approximately $8.1 million for the three-month periods ended June 30, 2005 and 2004, respectively. General and administrative expenses were approximately $19.2 million for the six-month period ended June 30, 2005 and approximately $14.9 million for the six-month period ended June 30, 2004. The increase for both the three-month and six-month periods was primarily due to increased outside legal and patent fees, increased compensation, and outside accounting fees.

 

We have reclassified approximately $2.8 million and $5.5 million for the three-month and six-month periods ended June 30, 2004, respectively, from research and development expenses to general and administrative expenses. This reclassification included legal expenses related to our intellectual property portfolio and a portion of finance, information systems, and human resource expenses that were not clearly related to research and development and are required to be classified outside of research and development expenses under Statement Financial Accounting Standards No. 2, Accounting for Research and Development Costs.

 

In addition, we reclassified approximately $0.2 million and $0.5 million for the three-month and six-month periods ended June 30, 2004 from general and administrative expenses to interest expense. This reclassification was made to record the amortization of debt issuance costs to interest expense as required under Accounting Principles Board No. 21, Interest on Receivables and Payables and EITF 86-15, Increasing-Rate Debt.

 

Amortization of Other Intangible Assets (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


Amortization of other intangible assets

   $ 981    $ 981    $ —      —  
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


Amortization of other intangible assets

   $ 1,963    $ 1,962    $ 1    —  

 

The components of our other intangible assets at June 30, 2005, are as follows (in thousands, except for years):

 

     Useful
Life in
Years


   Gross
Carrying
Amount


   Accumulated
Amortization


   Net

Core technology

   5    $ 8,100    $ 6,480    1,620

Developed product technology

   5      2,900      2,320    580

Intellectual property

   5-7      7,301      6,140    1,161

Supplier and customer relations

   5      5,140      4,299    841
         

  

  

Total

        $ 23,441    $ 19,239    4,202
         

  

  

 

Amortization expense related to other intangible assets totaled $1.1 million ($0.1 million included in cost of sales) for both of the three-month periods ended June 30, 2005 and 2004 and $2.2 million ($0.2 million included in cost of sales) for both the six-month

 

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periods ended June 30, 2005 and 2004. The following table presents expected future amortization expense for other intangible assets until they are fully amortized (in thousands):

 

Years Ending December 31,


    

Remainder of 2005

   $ 2,253

2006

     1,949
    

Total

   $ 4,202
    

 

Loss on Debt Extinguishment (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


    Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Loss on debt extinguishment

   $ —      $ —       $ —       —    
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


    Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Loss on debt extinguishment

   $ —      $ (9,258 )   $ (9,258 )   (100 )%

 

During the six-month period ended June 30, 2004, we recognized a loss on debt extinguishment of approximately $9.3 million in connection with two privately negotiated transactions to convert our outstanding convertible subordinated notes into shares of our common stock. In January 2004, certain holders of our outstanding 3.5% convertible subordinated notes due October 2007 completed an exchange and cancellation of $9.0 million in aggregate principal amount of the notes for the issuance of 575,605 shares of our common stock in a privately negotiated transaction. In February 2004, certain holders of our outstanding 3% convertible subordinated notes due June 2010 converted approximately $36.0 million in aggregate principal amount of such notes for approximately 3.2 million shares of our common stock and a cash payment of approximately $3.1 million in the aggregate in privately negotiated transactions. As a result of these transactions, we recognized losses on debt extinguishment of approximately $7.8 million and $1.5 million, respectively, in accordance with SFAS No. 84, Induced Conversions of Convertible Debt.

 

Other Income (Expense) (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


   

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Other income (expense)

   $ (118 )   $ 124    $ (242 )   (195 )%
    

Six Months

Ended

June 30, 2005


   

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Other income (expense)

   $ (1,403 )   $ 431    $ (1,834 )   (426 )%

 

Other expense was $1.4 million for the six-month period ended June 30, 2005 compared to other income of $0.4 million for the six-month period ended June 30, 2004. Effective January 11, 2005, Nektar and BMR-201 Industrial Road LLC (landlord), entered into an agreement to terminate our obligation in the Amended and Restated Built-To-Suit Lease dated August 17, 2004 related to 45,574 square feet of space located at our headquarters. In connection with the termination agreement, we have recorded other expense of approximately $1.1 million during the six-month period ended June 30, 2005. This amount represents the write-off the capital asset related to this space partially offset by a reduction in the present value of our liability related to this space. In addition, other income for the six-month period ended June 30, 2004 included $0.4 million of income related to our real estate partnership which was dissolved in September 2004.

 

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Table of Contents

Interest Income (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Interest income

   $ 2,512    $ 1,608    $ 904    56 %
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Interest income

   $ 4,784    $ 2,854    $ 1,930    68 %

 

Interest income was approximately $2.5 million for the three-month period ended June 30, 2005, as compared to approximately $1.6 million for the three-month period ended June 30, 2004. Interest income was approximately $4.8 million for the six-month period ended June 30, 2005, as compared to approximately $2.9 million for the six-month period ended June 30, 2004. The approximate increase in interest income for both the three-month and six-month periods ended June 30, 2005 was due to higher prevailing interest rates during 2005 compared to 2004.

 

Interest Expense (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Interest expense

   $ 2,856    $ 2,987    $ (131 )   (4 )%
    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Interest expense

   $ 5,916    $ 19,344    $ (13,428 )   (69 )%

 

Interest expense is primarily related to our outstanding convertible subordinated notes and debentures and capital lease obligations. Interest expense was approximately $2.9 million for the three-month period ended June 30, 2005 which is consistent with the $3.0 million for the three-month period ended June 30, 2004.

 

Interest expense was approximately $5.9 million and approximately $19.3 million for the six-month periods ended June 30, 2005 and 2004, respectively. For the six-month period ended June 30, 2004, interest expense included a payment of approximately $12.7 million in interest made to certain holders of our outstanding 3.0% convertible subordinated notes due June 2010 which completed an exchange of $169.3 million in aggregate principal amount of the notes held by such holders for the issuance of approximately 14.9 million shares of our common stock.

 

We have reclassified approximately $0.2 million and $0.5 million for the three-month and six-month periods ended June 30, 2004 from general and administrative expenses to interest expense. This reclassification was made to record the amortization of debt issuance costs to interest expense as required under Accounting Principles Board No. 21, Interest on Receivables and Payables and EITF 86-15, Increasing-Rate Debt.

 

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Benefit (Provision) for Income Taxes (in thousands except percentages)

 

    

Three Months

Ended

June 30, 2005


  

Three Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


  

Percentage
Increase/

(Decrease)

2005 vs 2004


Benefit (provision) for income taxes

   $ —      $ —      $ —      —  

 

    

Six Months

Ended

June 30, 2005


  

Six Months

Ended

June 30, 2004


   Increase/
(Decrease)
2005 vs 2004


   

Percentage
Increase/

(Decrease)

2005 vs 2004


 

Benefit (provision) for income taxes

   $ —      $ 132    $ (132 )   (100 )%

 

We recorded a provision of nil and $0.1 million for the six-month period ended June 30, 2005 and 2004, respectively relating entirely to state taxes on our Alabama subsidiary.

 

We account for federal income taxes under SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Because of our lack of earnings history, the net deferred tax assets for our operations outside of Alabama have been fully offset by a valuation allowance.

 

Liquidity and Capital Resources

 

We have financed our operations primarily through public and private placements of our debt and equity securities, revenue from development contracts, product sales and short-term research and feasibility agreements, financing of equipment acquisitions and tenant improvements, and interest income earned on our investments of cash. At June 30, 2005 we had cash, cash equivalents, and short-term investments of approximately $378.5 million.

 

At June 30, 2005 and December 31, 2004, we had outstanding letters of credit totaling $2.2 million in connection with arrangements with certain vendors, including our landlord, which are secured by investments in similar amounts.

 

Our operations used cash of $36.5 million for the six-month period ended June 30, 2005 as compared to cash used of $58.2 million for the six-month period ended June 30, 2004. During the six-month period ended June 30, 2005, cash used in operations was primarily due to a net loss of $53.5 million partially offset by depreciation and amortization of $12.3 million. During the six-month period ended June 30, 2004, cash used in operations was primarily due to a net loss of $62.2 million partially offset by depreciation and amortization of $9.2 million.

 

Cash provided by investing activities was $70.3 million for the six-month period ended June 30, 2005 as compared to cash used of $153.8 million for the six-month period ended June 30, 2004. Cash flows related to investing activities for the six-month periods ended June 30, 2005 and 2004 were affected primarily by the purchase, sale, and maturity of short-term investments. We purchased property and equipment of approximately $8.1 million and $14.0 million during the six-month periods ended June 30, 2005 and 2004, respectively. The decrease in purchased property and equipment of $6.0 million was primarily due to the expansion of our facility in Alabama, which was substantially completed during the year ended December 31, 2004.

 

Cash flows provided by financing activities were $4.6 million for the six-month period ended June 30, 2005 compared to cash provided of $202.7 million for the six-month period ended June 30, 2004. During the six-month period ended June 30, 2005 cash provided by financing activities was primarily due to cash received from exercises of employee stock options of $5.2 million. During the six-month period ended June 30, 2004, cash provided by financing activities was primarily due to the sale of 9.5 million shares of our common stock in March 2004 at a price of $20.71 per common share for proceeds of approximately $196.2 million, net of issuance costs. In addition, cash received from employee exercises of stock options totaled $7.6 million for the six-month period ended June 30, 2004.

 

In April 2004, we called for redemption of all of our outstanding 6¾% convertible subordinated notes due October 2006. Holders of all but $10,000 in principal amount converted their notes prior to the redemption date, resulting in the issuance of approximately 0.5 million shares of our common stock. We redeemed the $10,000 in principal amount not converted into equity for cash in the amount of $10,000. The aggregate amount of notes converted was approximately $7.8 million.

 

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In March 2004, we entered into an underwriting agreement with Lehman Brothers Inc. pursuant to which we sold 9.5 million shares of our common stock at a price of $20.71 per common share for proceeds of approximately $196.4 million, net of issuance costs. The proceeds are to be used for general corporate purposes, which may include:

 

    investing in or accelerating various product development programs, including Exubera®;

 

    undertaking potential acquisitions;

 

    developing technologies; and

 

    retiring our outstanding debt.

 

In March 2004, we called for the full redemption of our outstanding 3% convertible subordinated notes due June 2010. The aggregate principal amount outstanding of the notes at the time of the call for redemption was $133.3 million, all of which was converted into approximately 11.7 million shares of common stock prior to the redemption date. In connection with the conversion, we agreed to pay $75.00 per $1,000 of the notes to be converted, for an aggregate payment of approximately $10.0 million. This payment was recorded as interest expense.

 

In February 2004, certain holders of our outstanding 3% convertible subordinated notes due June 2010 converted approximately $36.0 million in aggregate principal amount of such notes into approximately 3.2 million shares of our common stock and a cash payment of approximately $3.1 million in the aggregate in privately negotiated transactions.

 

In January 2004, certain holders of our outstanding 3.5% convertible subordinated notes due October 2007 completed an exchange and cancellation of $9.0 million in aggregate principal amount of the notes for the issuance of approximately 0.6 million shares of our common stock in a privately negotiated transaction.

 

As a result of the transactions related to convertible subordinated debt during the year ended December 31, 2005, our total contractual obligation with regard to convertible subordinated debt has decreased from $360.0 million at December 31, 2003 to $173.9 million at June 30, 2005. All of our outstanding convertible subordinated debt as of June 30, 2005 will mature in 2007.

 

Given our current cash requirements, we forecast that we will have sufficient cash to meet our net operating expense requirements through at least the end of 2006. We plan to continue to invest in our growth and the need for cash will be dependent upon the timing of these investments. Our capital needs will depend on many factors, including continued progress in our research and development arrangements, progress with preclinical and clinical trials of our proprietary and partnered products, the time and costs involved in obtaining regulatory approvals, the costs of developing and scaling up manufacturing operations of our technologies, the timing and cost of our clinical and commercial production facilities, the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims, the need to acquire licenses to new technologies, and the status of competitive products. The entire outstanding balance of convertible subordinated debt as of June 30, 2005 of $173.9 million will mature in 2007. We are not likely to be able to satisfy this entire obligation through cash flow generated by our operations. To satisfy our long-term needs, we intend to seek additional funding, as necessary, from corporate partners and from the sale of securities. Because we are an early stage biotechnology company, we do not qualify to issue investment grade debt or have access to certain credit facilities. As a result, any financing we undertake will likely involve the issuance of equity, convertible debt instruments, or high-yield debt to fund our working capital. To date we have been primarily dependent upon equity and convertible debt financings for capital and have incurred substantial debt as a result of our issuances of subordinated notes and debentures that are convertible into our common stock. Our substantial debt, the market price of our securities, and the general economic climate, among other factors, could have material consequences for our financial position and could affect our sources of short-term and long-term funding. There can be no assurance that additional funds, if and when required, will be available to us on favorable terms, if at all.

 

Issuer Purchases of Equity Securities

 

There were no purchases of any class of our equity securities by us or any affiliate pursuant to any publicly announced repurchase plan in the three-month or six-month periods ended June 30, 2005.

 

Approval of Non-Audit Services

 

During the three-month and six-month periods ended June 30, 2005, the Audit Committee of the Board of Directors approved $70,000 and $101,000, respectively, in tax-related consultation and preparation services to be provided by Ernst & Young LLP, our independent registered public accounting firm.

 

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Table of Contents

RISK FACTORS

 

The following section should be read carefully in connection with evaluating our business. Any of the following factors could materially and adversely affect our business, financial position, or results of operations.

 

If the collaborative partners we depend on to obtain regulatory approvals for and commercialize our products are not successful, or if such collaborations fail, then the product development or commercialization of our products may be delayed or unsuccessful.

 

When we sign a collaborative development agreement or license agreement to develop a product with a drug or biotechnology company, the drug or biotechnology company is generally expected to:

 

    synthesize active pharmaceutical ingredients to be used as medicines;

 

    design and conduct large scale clinical studies;

 

    prepare and file documents necessary to obtain government approval to sell a given drug product; and/or

 

    market and sell our products when and if they are approved.

 

Reliance on collaborative relationships poses a number of risks, including:

 

    the potential inability to control whether and the extent to which our collaborative partners will devote sufficient resources to our programs or products;

 

    disputes which may arise in the future with respect to the ownership of rights to technology and/or intellectual property developed with collaborative partners;

 

    disagreements with collaborative partners which could lead to delays in or termination of the research, development or commercialization of product candidates, or result in litigation or arbitration;

 

    the potential for contracts with our collaborative partners to fail to provide significant protection or to be effectively enforced if one of these partners fails to perform. Collaborative partners have considerable discretion in electing whether to pursue the development of any additional products and may pursue alternative technologies or products either on their own or in collaboration with our competitors;

 

    the potential for collaborative partners with marketing rights to choose to devote fewer resources to the marketing of our products than they do to products of their own development;

 

    risks related to the ability of our collaborative partners to pay us; and

 

    the potential for collaborative partners to terminate their agreements with us unilaterally for any or no reason.

 

Given these risks, there is a great deal of uncertainty regarding the success of our current and future collaborative efforts.

 

We have entered into collaborations in the past that have been subsequently terminated. If other collaborations are suspended or terminated, our ability to commercialize certain other proposed products could also be negatively impacted. If our collaborations fail, our product development or commercialization of products could be delayed and our financial position and results of operations would be significantly harmed.

 

If the FDA does not timely approve the NDA filed for Exubera®, if the EMEA does not timely approve a marketing authorization application for Exubera®, or if our collaboration with Pfizer is discontinued prior to the commercial launch of Exubera®, then our financial position and results of operations will be significantly harmed.

 

We are developing with Pfizer an inhaleable version of insulin, Exubera®, for the treatment of Type 1 and Type 2 diabetes that will be administered using our Pulmonary Technology. Exubera® is currently in extended Phase III clinical trials. We currently depend on Pfizer as the source of a significant portion of our revenues. For the three-month periods ended June 30, 2005 and 2004,

 

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Table of Contents

revenue from Pfizer accounted for approximately 67% and approximately 58% of our total revenue, respectively. For the six-month periods ended June 30, 2005 and 2004, revenue from Pfizer accounted for approximately 65% and approximately 59% of our total revenue, respectively. On March 2, 2005, Pfizer and Sanofi-Aventis jointly announced that the FDA had accepted the filing of an NDA for Exubera®. In March 2004, Pfizer and Sanofi-Aventis announced that the EMEA has accepted the filing of a marketing authorization application for Exubera®. There can be no assurance that Exubera® will be approved for marketing and/or commercial use in the U.S. or E.U. Among the factors that may delay the approval of the NDA, to market Exubera® in the U.S., the approval by the EMEA to market Exubera® in the E.U., or the commercial launch of Exubera® in the U.S. or the E.U., or that may impact a decision to proceed at all with respect to any of the foregoing, are the following:

 

    Pfizer is currently conducting studies to generate controlled long-term safety data with respect to Exubera®, in particular its effect on lung function, and the results of the studies may impact regulatory approvals.

 

    We and/or Pfizer may experience difficulties with respect to the processing of the dry powder formulation of inhaleable insulin and the filling and packaging of the inhaleable insulin powder for the large-scale commercial production of Exubera®.

 

    We, with our contract manufacturers, may experience difficulties with respect to the production of the pulmonary inhaler device for Exubera®, including the design, scale-up and automation of the commercial manufacture of the pulmonary inhaler device for Exubera®, and any such difficulties may delay the filing and approval of the NDA or the approval to market in the E.U. Our contract manufacturers may also experience difficulties with respect to manufacturing the device in high volumes for commercial use.

 

    Pfizer may elect for marketing or other reasons, to delay or not proceed with the commercial launch of Exubera®, once approved.

 

If the approval by the FDA of the NDA is substantially delayed beyond the internal estimates we have made for purposes of budgeting and resource allocation, we may not have the financial ability to continue supporting the Exubera® program or be able to meet our contractual obligations relating to the commercial launch of Exubera®. In the event of any such delay, we may also elect to divert resources away from Exubera® related activities or otherwise reduce our activities relating to the Exubera® program. Any material delay in receiving regulatory approval (which in some countries includes pricing approval), or failure to receive regulatory approval for Exubera® at all, would affect our contract research revenue from Pfizer, may result in the payment by us of substantial reimbursements to the contract manufacturers of our proprietary inhaler device with respect to the capital they have deployed in support of such activity, and would significantly harm our financial position and results of operations. Furthermore, should the collaboration with Pfizer be discontinued, our financial position and results of operations will be significantly harmed.

 

In December 2004, Aventis, Pfizer’s partner with respect to the manufacture, co-development, and co-marketing of Exubera®, announced that its stockholders had approved all resolutions relating to the proposed merger with and into Sanofi As a consequence of the merger, the agreement by and between Pfizer and Sanofi-Aventis is being challenged and is the subject of litigation. Although we are not a party to this litigation, any disruption or delays to the Exubera® program could adversely affect the ability to market this product if and when it is approved for use, which would materially and adversely impact our business.

 

If we fail to establish future successful collaborative relationships, then our financial results may suffer and our product development efforts may be delayed or unsuccessful.

 

We intend to seek future collaborative relationships with pharmaceutical and biotechnology partners to fund some of our research and development expenses and to develop and commercialize potential products. Further, we anticipate that the timing of drug development programs under existing collaborative agreements with our partners will continue to affect our revenues from such agreements. We may not be able to negotiate acceptable collaborative arrangements in the future, and any arrangements we do negotiate may not be successful. If we fail to establish additional collaborative relationships, we will be required to undertake research, development, marketing, and manufacturing of our proposed products at our own expense or discontinue or reduce these activities.

 

Our increasing investment in the development and commercialization of new products prior to seeking collaborative arrangements may be unsuccessful and adversely impact our operating results, financial condition, and liquidity.

 

We intend to fund significant development expenses associated with the development and commercialization of new products, including clinical trials, developed through our Proprietary Products Group prior to seeking collaborative relationships with pharmaceutical and biotechnology partners. While we believe this strategy may result in improved economics for any products ultimately developed and approved, it will require us to invest significant funds in developing these products without reimbursement from a collaborative partner. If we are ultimately not able to negotiate acceptable collaborative arrangements with respect to these products, or any arrangements we do negotiate are not successful, we will not receive an adequate return on these investments and our

 

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operating results and financial condition would suffer. Even if our development efforts are ultimately acceptable, our increased investment in the development of these products could adversely impact our results of operations and liquidity prior to their commercialization.

 

We may not be successful in conducting human clinical trials for products developed by our Proprietary Products Group.

 

Historically, we have engaged in drug development in partnership with larger pharmaceutical and biotechnology companies. Those companies typically have been responsible for designing and conducting human clinical trials and obtaining regulatory approvals. We have begun, and intend in the future, to develop certain drugs, including designing and conducting human clinical trials for such drugs, without the assistance of such pharmaceutical and biotechnology partners. We have limited experience in designing and conducting human clinical trials and obtaining regulatory approvals, and may not be successful in those endeavors.

 

If our drug delivery technologies are not commercially feasible, then our revenues and results of operations will be impacted negatively.

 

We are in an early stage of development with respect to most of our products. There is a risk that our technologies will not be commercially feasible. Even if our technologies are commercially feasible, they may not be commercially accepted across a range of large and small molecule drugs. None of the products using our Pulmonary Technology has been approved for use. Although our Advanced PEGylation Technology has been incorporated in seven products most of the products incorporating this technology are still in clinical trials. Our Supercritical Fluid Technology is primarily in an early stage of feasibility testing. Our potential products require extensive research, development, and preclinical and clinical testing. Our potential products also may involve lengthy regulatory reviews and require regulatory approval before they can be sold. We do not know if, and cannot provide assurance that, any of our potential products will prove to be safe and effective, accomplish the objectives that we or our collaborative partners are seeking through the use of our technologies, meet regulatory standards or continue to meet such standards if already approved. There is a risk that we, or our collaborative partners, may not be able to produce any of our potential products in commercial quantities at acceptable costs, or market them successfully. Failure to achieve commercial feasibility, demonstrate safety, achieve clinical efficacy, obtain regulatory approval for, or successfully market products will negatively impact our revenues and results of operations.

 

If our research and development efforts are delayed or unsuccessful, then we will experience delay or be unsuccessful in having our products commercialized, and our business will suffer.

 

Except for products using our Advanced PEGylation Technology that have already been approved by the FDA or other regulatory agencies, our product candidates are still in research and development, including preclinical testing and clinical trials. Preclinical testing and clinical trials are long, expensive, and uncertain processes. It may take us, or our collaborative partners, several years to complete this testing, and failure can occur at any stage in the process. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in later stage clinical trials, even after promising results in earlier trials.

 

Any clinical trial may fail to produce results satisfactory to us, our collaborative partners, the FDA, or other regulatory authorities. Preclinical and clinical data can be interpreted in different ways, which could delay, limit, or prevent regulatory approval or commercialization. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be repeated or a program to be terminated. We typically rely on collaborative partners and third-party clinical investigators to conduct clinical trials of our products and, as a result, we may face additional delaying factors outside our control.

 

We do not know if any of our research and development efforts, including preclinical testing or clinical trials, will adhere to our planned schedules or be completed on a timely basis or at all. Typically, there is a high rate of attrition for product candidates in preclinical and clinical trials.

 

If our drug delivery technologies do not satisfy certain basic feasibility requirements such as total system efficiency, then our products may not be competitive.

 

We may not be able to achieve the total system efficiency for products based on our Pulmonary Technology that is needed to be competitive with alternative routes of delivery or formulation technologies. We determine total system efficiency by the amount of drug loss during manufacture, in the delivery system, and in reaching the ultimate site at which the drug exhibits its activity. We would not consider a drug to be a good candidate for development and commercialization using our Pulmonary Technology if drug loss is excessive at any one stage or cumulatively in the manufacturing and delivery process.

 

Our ability to efficiently attach PEG polymer chains to a drug molecule is the initial screen for determining whether drug formulations using our Advanced PEGylation Technology are commercially feasible. We would not consider a drug formulation to be a good candidate for development and commercialization using our Advanced PEGylation Technology if we could not efficiently attach a PEG polymer chain to such drug to result in an efficacious drug.

 

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For our Supercritical Fluid Technology, solubility characteristics of a drug and the solvents, which may be incorporated in the manufacturing process, provide the initial screen for whether drug formulations using this technology are commercially feasible. We would not consider a drug to be a good candidate for this technology if its solubility characteristics were such that the application of our technology results in very low efficiency in manufacturing of drug powders.

 

If our drug formulations are not stable, then we will not be able to develop or commercialize products.

 

We may not be able to identify and produce powdered or other formulations of drugs that retain the physical and chemical properties needed to work effectively with our inhaler devices for deep lung delivery using our Pulmonary Technology, or through other methods of drug delivery using our Advanced PEGylation or Supercritical Fluid Technologies. Formulation stability is the physical and chemical stability of the drug over time and under various storage, shipping, and usage conditions. Formulation stability will vary with each drug formulation and the type and amount of ingredients that are used in the formulation. Since our drug formulation technology is new and largely unproven, we do not know if our drug formulations will retain the needed physical and chemical properties and performance of the drugs. Problems with formulated drug powder stability in particular would negatively impact our ability to develop products based on our Pulmonary Technology or Supercritical Fluid Technology, or obtain regulatory approval for or market such products.

 

If our drug delivery technologies are not safe, then regulatory approval of our (or our partners) products may not be obtained, or our (or our partners) products may not be developed or marketed of our (or our partners) products may be suspended following commercialization.

 

We, or our collaborative partners, may not be able to prove that potential products using our drug delivery technologies are safe. Our products require lengthy laboratory, animal and human testing. We cannot be certain that these products, and our technology that developed these products, are safe or will not produce unacceptable adverse side effects. The safety of our formulations will vary with each drug and the ingredients used in our formulation. If any product is found not to be safe, the product will not be approved for marketing or commercialization. In addition, even if a product is approved and commercialized, regulatory authorities could still later suspend or terminate the license to market the product if it is determined that the product does not meet safety or other standards.

 

If product liability lawsuits are brought against us, we may incur substantial liabilities.

 

The manufacture, testing, marketing, and sale of medical products entail an inherent risk of product liability. If product liability costs exceed our liability insurance coverage, we may incur substantial liabilities. Whether or not we were ultimately successful in product liability litigation, such litigation would consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business. We may not be able to maintain our clinical trial insurance or product liability insurance at an acceptable cost, if at all, and this insurance may not provide adequate coverage against potential claims or losses.

 

If the products using our Pulmonary Technology do not provide consistent doses of medicine, then we will not be able to develop, and we or our partners will not be able to obtain regulatory approval for and commercialize products.

 

We may not be able to provide reproducible dosing of stable formulations of drug compounds. Reproducible dosing is the ability to deliver a consistent and predictable amount of drug into the bloodstream over time both for a single patient and across patient groups. Reproducible dosing of drugs based on our Pulmonary Technology requires the development of:

 

    an inhalation or other device that consistently delivers predictable amounts of dry powder to the deep lung;

 

    accurate unit dose packaging of dry powder; and

 

    moisture resistant packaging.

 

Since our Pulmonary Technology is still in development and is yet to be used in commercialized products, we cannot be certain that we will be able to develop reproducible dosing of any potential product.

 

If we or our partners do not obtain regulatory approval for our products on a timely basis, then our revenues and results of operations may be affected negatively.

 

There is a risk that we, or our partners, will not obtain regulatory approval (which in some countries includes pricing approval) for unapproved products on a timely basis, or at all. Unapproved products must undergo rigorous animal and human testing and an extensive FDA mandated or equivalent foreign authorities’ review process. This process generally takes a number of years and requires the expenditure of substantial resources. The time required for completing such testing and obtaining such approvals is uncertain. The FDA and other U.S. and foreign regulatory agencies also have substantial discretion to terminate clinical trials, require

 

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additional testing, delay or withhold registration and marketing approval, and mandate product withdrawals including recalls. Even though our partners have obtained regulatory approval for some of our products, these products and our manufacturing processes are subject to continued review by the FDA and other regulatory authorities. Even if we or our partners receive regulatory approval of a product, the approval may limit the indicated uses for which the product may be marketed. In addition, any marketed products and manufacturing facilities used in the manufacture of such products will be subject to continual review and periodic inspections. Later discovery from such review and inspection of previously unknown problems may result in restrictions on marketed products or on us, including withdrawal of such products from the market. The failure to obtain timely regulatory approval of products, any product marketing limitations, or a product withdrawal would negatively impact our revenues and results of operations.

 

In addition, we may encounter delays or rejections based upon changes in FDA regulations or policies, including policies relating to cGMP, during the period of product development. We or our partners may encounter similar delays in other countries.

 

If our technologies cannot be integrated successfully to bring products to market, then our or our partners’ ability to develop, obtain approval for, or market products, may be delayed or unsuccessful.

 

We may not be able to integrate all of the relevant technologies to provide complete drug delivery and formulation systems. In particular, our development of drugs based on our Pulmonary Technology relies upon the following several different but related technologies:

 

    dry powder formulations;

 

    dry powder processing technology;

 

    dry powder packaging technology; and

 

    deep lung delivery devices.

 

Our other technologies may face similar challenges relating to the integration of drug formulation, processing, packaging and delivery device technologies. At the same time we or our partners must:

 

    perform laboratory, pre-clinical, and clinical testing of potential products; and

 

    scale-up manufacturing processes.

 

All of these steps must be accomplished without delaying any aspect of product development. Any delay in one component of product or business development could delay our or our partners’ ability to develop, obtain approval for, or market products using our delivery and formulation technologies.

 

If we are not able to manufacture our products in commercially feasible quantities or at commercially feasible costs, then our products will not be successfully commercialized.

 

Nektar Advanced PEGylation Technology and Supercritical Fluid Technology

 

We are currently expanding our Advanced PEGylation Technology manufacturing capacity and anticipate having to add additional Supercritical Fluid Technology manufacturing capacity. If we are not able to scale-up to large clinical trials or commercial manufacturing for products incorporating either of these technologies in a timely manner or at a commercially reasonable cost, we risk not meeting our customers’ supply requirements or our contractual obligations. Our failure to solve any of these problems could delay or prevent late stage clinical testing, regulatory approval for, and commercialization of our products and could negatively impact our revenues and results of operations.

 

Production problems encountered during the second and third quarters of 2004 resulted in the temporary shutdown of our manufacturing facility with respect to our Advanced PEGylation products. This resulted in a decrease in product revenues and gross margin compared to 2003. Although we believe we have addressed these manufacturing problems, our failure to satisfactorily address these issues or additional production problems may negatively impact our product revenues and results of operations in future periods.

 

Nektar Pulmonary Technology

 

The manufacture of products using Nektar Pulmonary Technology involves multiple processes, all of which involve substantial risk.

 

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Powder Processing. We have no experience manufacturing powder products for commercial purposes. With respect to drugs based on our Pulmonary Technology, we have only performed powder processing on the scale needed for testing formulations, and for early stage and larger clinical trials. We may encounter manufacturing and control problems as we attempt to scale-up powder processing facilities. We may not be able to achieve such scale-up in a timely manner or at a commercially reasonable cost, if at all, and the powder processing system we implement may not be applicable for other drugs. Our failure to solve any of these problems could delay or prevent some late stage clinical testing and commercialization of our products and could negatively impact our revenues and results of operations.

 

To date, we rely primarily on two particular methods of powder processing. There is a risk that these technologies will not work with all drugs or that the cost of drug production with this processing will preclude the commercial viability of certain drugs. Additionally, there is a risk that any alternative powder processing methods we may pursue will not be commercially practical for aerosol drugs or that we will not have, or be able to acquire the rights to use, such alternative methods.

 

Powder Packaging. Our fine particle powders and small quantity packaging utilized for drugs based on our Pulmonary Technology require special handling. We have designed and qualified automated filling equipment for small and moderate quantity packaging of fine powders. We face significant technical challenges in scaling-up an automated filling system that can handle the small dose and particle sizes of our powders in commercial quantities. There is a risk that we will not be able to scale-up our automated filling equipment in a timely manner or at commercially reasonable costs. Any failure or delay in such scale-up would delay product development or bar commercialization of products based on our Pulmonary Technology and would negatively impact our revenues and results of operations.

 

There can be no assurance we will be able to manufacture products on our autofiller system in a timely manner or at a commercially reasonable cost; any delay or failure in further developing such technology would delay product development or inhibit commercialization of our products and would have a materially adverse effect on us.

 

Nektar Pulmonary Inhaler Device. We face many technical challenges in developing our pulmonary inhaler device to work with a broad range of drugs, to produce such devices in sufficient quantities, and to adapt the devices to different powder formulations. Our pulmonary inhaler device being used with Exubera® is still in clinical testing. Additional design and development work may be required to optimize the device for regulatory approval, field reliability, or other issues that may be important to its commercial success.

 

Additional design and development work may lead to a delay in regulatory approval for any product that incorporates the device. In addition, we are attempting to develop a smaller inhaler device, which presents particular technical challenges. There is a risk that we will not successfully achieve any of these challenges. Our failure to overcome any of these challenges would negatively impact our revenues and results of operations.

 

For late stage clinical trials and initial commercial production, we intend to use one or more contract manufacturers to produce our pulmonary inhaler devices. There is a risk that we will not be able to maintain arrangements with our contract manufacturers on commercially acceptable terms or at all, or effectively scale-up production of our pulmonary inhaler devices through contract manufacturers. Our failure to do so would negatively impact our revenues and results of operations. Dependence on third parties for the manufacture of our pulmonary inhaler devices and their supply chain may adversely affect our cost of goods and ability to develop and commercialize products on a timely or competitive basis. Because our manufacturing processes and those of our contract manufacturers are very complex and subject to lengthy governmental approval processes, alternative qualified production sources or capacity may not be available on a timely basis or at all. Disruptions or delays in our manufacturing processes or those of our contract manufacturers for existing or new products could result in increased costs, loss of revenues or market share, or damage to our reputation.

 

In August 2000, we entered into a Manufacturing and Supply Agreement with our contract manufacturers to provide for the manufacturing of our pulmonary inhaler device for Exubera®. Under the terms of the Agreement, we may be obligated to reimburse the contract manufacturers for the actual unamortized and unrecovered portion of any equipment procured or facilities established and the interest accrued for their capital overlay in the event that Exubera® does not gain FDA approval to the extent that the contract manufacturers cannot re-deploy the assets. While such payments may be significant, at the present time, it is not possible to estimate the loss that will occur should Exubera® not be approved. We have also agreed to defend, indemnify, and hold harmless the contract manufacturers from and against third party liability arising out of the agreement, including product liability and infringement of intellectual property. There is no limitation on the potential amount of future payments we could be required to make under these indemnification obligations. If any of our indemnification obligations is triggered, we may incur substantial liabilities.

 

There is no assurance that devices designed by us and built by contract manufacturers will be approved or will meet approval requirements on a timely basis or at all, or that any of our device development will be successful or commercially viable.

 

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If Pfizer is not able to fill the bulk drug powders for Exubera® in commercially feasible quantities, then Exubera® will not be successfully commercialized and would negatively impact our revenues and results of operations.

 

We have developed a high capacity automated filling technology, which when validated, we believe will be capable of filling blisters on a production scale for moderate and large volume products using our Pulmonary Technology. The high capacity automated filling technology has been transferred to Pfizer who will have the responsibility of packaging and filling the bulk drug powders for Exubera®. There are significant technical challenges in scaling-up an automated filling system that can handle the small dose and particle sizes of our powders in commercial quantities. In addition, there is the additional risk that Pfizer has no backup manufacturing facility for this process. Any failure or delay in the manufacturing facility or process would delay product development or bar commercialization of Exubera® and would negatively impact our revenues and results of operations.

 

If we are not able to manufacture our dry powder inhaler device in commercially feasible quantities or at commercially feasible costs, then our Pulmonary Technology products may not be successfully commercialized.

 

In addition to our inhaler device being used with Exubera®, we are developing a breath actuated compact dry powder inhaler device (“DPI”). We are developing the DPI device to be appropriate for the delivery of either large or small molecules for short-term use. We face many unique technical challenges in developing the DPI device to work with a broad range of drugs, producing the DPI device in sufficient quantities, and adapting the DPI device to different powder formulations. Our DPI device is still in clinical testing and production scale-up work is ongoing. Further design and development will be required to obtain regulatory approval for the DPI device, enable commercial manufacturing, insure field reliability, or manage other issues that may be important to its commercial success. Such additional design and development work may lead to a delay in efforts to obtain regulatory approval for any product that incorporates the DPI device, or could delay the timeframe within which the device could be ready for commercial launch. There is a risk that we will not successfully achieve any of these challenges. Our failure to overcome any of these challenges would negatively impact our revenues and results of operations.

 

We depend on sole or exclusive suppliers for our pulmonary inhaler devices, bulk active pharmaceutical ingredients and PEG polymer chains and if such suppliers fail to supply when required, then our product development efforts may be delayed or unsuccessful and our commercial supply obligations may be compromised.

 

We agreed to subcontract the manufacture of our pulmonary inhaler devices used with Exubera® before commercial production. We have identified contract manufacturers that we believe have the technical capabilities and production capacity to manufacture such device and which can meet the requirements of cGMP. We are not certain that we will be able to maintain satisfactory contract manufacturing on commercially acceptable terms, if at all. Our failure to maintain ongoing commercial relationships with our existing contract manufacturers may subject us to significant reimbursement obligations upon termination of such relationships. Our dependence on third parties for the manufacture of our pulmonary inhaler devices may negatively impact our cost of goods and our ability to develop and commercialize products based on our Pulmonary Technology on a timely and competitive basis.

 

For the most part, we obtain the bulk active pharmaceutical ingredients we use to manufacture products using our technologies from sole or exclusive sources of supply. For example, with respect to our source of bulk insulin, we have entered into a collaborative agreement with Pfizer that has, in turn, entered into an agreement with Sanofi-Aventis to manufacture regular human insulin. Under the terms of their agreement, Pfizer and Sanofi-Aventis agreed to construct a jointly owned manufacturing plant in Frankfurt, Germany. Until needed, Pfizer will provide us with insulin from Sanofi-Aventis’s existing plant. We obtain our supply of PEG polymer chains that we use in our products that incorporate our Advanced PEGylation Technology from a single supplier. If our sole or exclusive source suppliers fail to provide either active pharmaceutical ingredients or PEGylation materials in sufficient quantities when required, our revenues and results of operations may be negatively impacted.

 

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If the market does not accept products using our drug delivery technologies, then our revenues and results of operations will be adversely affected.

 

The commercial success of our potential products depends upon market acceptance by health care providers, third-party payors like health insurance companies and Medicare and patients. Our products under development use new drug delivery technologies and there is a risk that the market will not accept our potential products. Market acceptance will depend on many factors, including:

 

    the safety and efficacy of products demonstrated in clinical trials;

 

    favorable regulatory approval and product labeling;

 

    the frequency of product use;

 

    the ease of product use;

 

    the availability of third-party reimbursement;

 

    the availability of alternative technologies; and

 

    the price of our products relative to alternative technologies.

 

There is a risk that health care providers, patients, or third-party payors will not accept products using our drug delivery and formulation technologies. If the market does not accept our potential products, our revenues and results of operations would be significantly and negatively impacted.

 

If our products are not cost effective, then government and private insurance plans may not pay for them and our products may not be widely accepted, which will adversely affect our revenues and results of operations.

 

In both domestic and foreign markets, sales of our products under development will depend in part upon pricing approvals by government authorities and the availability of reimbursement from third-party payors, such as government health administration authorities, managed care providers, private health insurers and other organizations. In addition, such third-party payors are increasingly challenging the price and cost effectiveness of medical products and services. Significant uncertainty exists as to the pricing approvals for, and the reimbursement status of, newly approved health care products. Moreover, legislation and regulations affecting the pricing of pharmaceuticals may change before regulatory agencies approve our proposed products for marketing. Adoption of such legislation and regulations could further limit pricing approvals for, and reimbursement of, medical products. A government or third-party payor decision not to approve pricing for, or provide adequate coverage and reimbursements of, our products would limit market acceptance of such products.

 

If our competitors develop and sell better drug delivery and formulation technologies, then our products or technologies may be uncompetitive or obsolete and our revenues and results of operations will be adversely affected.

 

We are aware of other companies engaged in developing and commercializing drug delivery and formulation technologies similar to our technologies. Some of our competitors with regard to our Pulmonary Technology include Alexza MDC, Alkermes, Inc., Aradigm Corporation, AeroGen, Inc., 3M, MannKind Corporation, Microdose Technologies Inc., Quadrant Technologies Limited, Skyepharma, and Vectura. In the non-invasive delivery of insulin, we have direct competition from companies such as Aradigm Corporation, Alkermes, Inc., Microdose Technologies Inc., Quadrant Technologies Limited, and MannKind Corporation, all of which are working on pulmonary products and most with announced pharmaceutical partners. Our competitors with regard to our Advanced PEGylation Technology include Dow Chemical Company, SunBio Corporation, Mountain View Pharmaceuticals, Inc., Neose, NOF Corporation, and Valentis, Inc., and there may be several chemical, biotechnology, and pharmaceutical companies also developing PEGylation technologies. Some of our competitors with regard to our Supercritical Fluid Technology include Alkermes, Battelle Memorial Institute, Ethypharm SA, Ferro Corp., Lavipharm SA, and RxKinetics. Some of these companies license or provide the technology to other companies, while others are developing the technology for internal use. Many of these companies have greater research and development capabilities, experience, manufacturing, marketing, financial and managerial resources than we do and represent significant competition for us. Acquisitions of or collaborations with competing drug delivery companies by large pharmaceutical or biotechnology companies could enhance our competitors’ financial, marketing and other resources. Accordingly, our competitors may succeed in developing competing technologies, obtaining regulatory approval for products or gaining market acceptance before us. Developments by others could make our products or technologies uncompetitive or obsolete. Our competitors may introduce products or processes competitive with or superior to our products or processes.

 

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If any of our pending patent applications do not issue or following issuance are deemed invalid or if any of our patents are deemed invalid, we may lose valuable intellectual property protection. If any of our products infringe third-party intellectual property rights, we may suffer adverse effects to our ability to develop and commercialize products and to our revenues and results from operations.

 

We have filed patents applications (and we plan to file additional patent applications) covering, among other things, aspects of: (i) our Pulmonary Technology (in general and as it relates to specific molecules) including, without limitation, our powder processing technology, our powder formulation technology, and our inhalation device technology; (ii) our Advanced PEGylation Technology; and (iii) our Supercritical Fluid Technology. As of June 30, 2005, we owned 923 issued U.S. and foreign patents that cover various aspects of our technologies, and we have a number of patent applications pending.

 

The patent positions of pharmaceutical, biotechnology and drug delivery companies, including ours, are uncertain and involve complex legal and factual issues. There can be no assurance that patents we apply for will be issued, or that patents that are issued will be valid and enforceable. Even if such patents are enforceable, we anticipate that any attempt to enforce our patents could be time consuming and costly. Additionally, the coverage claimed in a patent application can be significantly reduced before the patent is issued. As a consequence, we do not know whether any of our pending patent applications will be granted with broad coverage or whether the claims that eventually issue or that have issued will be circumvented. Since publication of discoveries in scientific or patent literature often lag behind actual discoveries, we cannot be certain that we were the first inventor of inventions covered by our issued patents or pending patent applications or that we were the first to file patent applications for such inventions. Moreover, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office, which could result in substantial cost to us, even if the eventual outcome is favorable. An adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from or to third parties or require us to cease using the technology in dispute.

 

Numerous pending and issued U.S. and foreign patent rights and other proprietary rights owned by third parties relate to pharmaceutical compositions and reagents, medical devices, and equipment and methods for preparation, packaging, and delivery of pharmaceutical compositions. We cannot predict with any certainty which, if any, patent references will be considered relevant to our technology by authorities in the various jurisdictions where such rights exist, nor can we predict with certainty which, if any, of these rights will or may be asserted against us by third parties. There can be no assurance that we can obtain a license to any technology that we determine we need on reasonable terms, if at all, or that we could develop or otherwise obtain alternate technology. The failure to obtain licenses if needed would have a material adverse effect on us.

 

We also rely upon trade secret protection for our confidential and proprietary information. No assurance can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology, or that we can meaningfully protect our trade secrets.

 

Third parties from time to time have asserted or may assert that we are infringing their proprietary rights based upon issued patents, trade secrets or know-how that they believe cover our technology. In addition, future patents may be issued to third parties that our technology may infringe. We could incur substantial costs in defending ourselves and our partners against any such claims. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief, which could effectively block our ability to develop or commercialize some or all of our products in the United States and abroad, and could result in the award of substantial damages. In the event of a claim of infringement, we and our partners may be required to obtain one or more licenses from third parties. There can be no assurance that our partners and we will be able to obtain such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain any such required license could have a material adverse effect on us.

 

Access, or our partners’ access, to drugs to be formulated using our various delivery technologies affects our ability to develop and commercialize our technologies. For our collaborative arrangements, we intend generally to rely on the ability of our partners to provide access to drugs that we formulate for pulmonary and other forms of delivery. There is a risk that our partners will not be able to provide access to such drugs. This situation is complex, and as such, the ability of any one company, including us, to commercialize a particular drug is unpredictable.

 

In addition, formulations of drugs that are presently under development by us, as well as our drug formulation and delivery technologies, may be subject to issued U.S. and foreign patents (and may be subject in the future to patents that issue from pending patent applications) owned by competitors. Therefore, even if our partners provide access to drugs for the formulation of pulmonary and other forms of delivery, there is a risk that third parties will accuse, and possibly a court or a governmental agency will determine, that we and/or our partners infringe third party patent rights covering such drugs and/or the formulation or delivery technologies utilizing such drugs, and we will be prohibited from working with the drug or formulation or delivery technology, or we will be found liable for damages that may not be subject to indemnification, or we may elect to pay such third party royalties under a license to such patent rights if one is available. Any such restrictions on access to drugs, liability for damages, prohibition, or payment of royalties would negatively impact our revenues and results of operations.

 

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We may incur material litigation costs, which may adversely affect our business and results of operations.

 

On Tuesday, July 12, 2005, a complaint was filed by The Board of Trustees of the University of Alabama (“UAH”) against Nektar Therapeutics AL, Corporation, and Nektar Therapeutics, Inc., (“Defendants”) in the United States District Court for the Northern District of Alabama. Among other things, the complaint alleges patent infringement, breach of contract license, violation of the Alabama Trade Secrets Act and unjust enrichment. Generally, the complaint alleges that Defendants’ refusal to pay royalties based upon UAH patented and licensed technology represents a breach of an exclusive license agreement between UAH and Nektar Therapeutics AL, Corporation (formerly Shearwater Corporation) and that Defendants have infringed and are infringing UAH’s patent. The complaint seeks certain monetary damages and other relief. The action is in a very early stage and we have not responded to the complaint.

 

From time to time, we are party to various other litigation matters, including several that relate to our patent and intellectual property rights. We cannot predict with certainty the eventual outcome of any pending litigation or potential future litigation, and we might have to incur substantial expense in defending these or future lawsuits or indemnifying third parties with respect to the results of such litigation.

 

If earthquakes, tornadoes, hurricanes and other catastrophic events strike, our business may be negatively affected.

 

Our corporate headquarters, including a substantial portion of our research and development operations, are located in the San Francisco Peninsula, a region known for seismic activity. A significant natural disaster such as an earthquake could have a material adverse impact on our business, operating results, and financial condition. There are no backup facilities for some of our manufacturing operations located in the San Francisco Peninsula. Certain of our other facilities, such as our facility in Huntsville, Alabama and certain of our collaborative partners located elsewhere may also be subject to catastrophic events such as hurricanes and tornadoes, any of which could have a material adverse effect on our business, operating results, and financial condition.

 

Investors should be aware of industry-wide risks, which are applicable to us and may affect our revenues and results of operations.

 

In addition to the risks associated specifically with us described above, investors should also be aware of general risks associated with drug development and the pharmaceutical and biotechnology industries. These include, but are not limited to:

 

    changes in and compliance with government regulations;

 

    handling and disposal of hazardous materials;

 

    workplace health and safety requirements;

 

    hiring and retaining qualified people; and

 

    insuring against product liability claims.

 

If we do not generate sufficient cash flow through increased revenues or raising additional capital, then we may not be able to meet our substantial debt obligations.

 

As of June 30, 2005, we had approximately $173.9 million in long-term convertible subordinated notes and debentures, $20.5 million in non-current capital lease obligations, and $11.6 million in other long-term debt. Our substantial long-term indebtedness, which totaled $206.0 million as of June 30, 2005, has and will continue to impact us by:

 

    making it more difficult to obtain additional financing; and

 

    constraining our ability to react quickly in an unfavorable economic climate.

 

Currently we are not generating positive cash flow. Delay in the approval of Exubera®, or other adverse occurrences related to our product development efforts will adversely impact our ability to meet our obligations to repay the principal amounts on our convertible subordinated notes and debentures when due. In addition, if the market price of our common stock is below the related conversion price, the holders of the related outstanding convertible subordinated notes and debentures will not likely convert such securities to equity in accordance with their existing terms. If we are unable to satisfy our debt service requirements, substantial liquidity problems could result. As of June 30, 2005 we had cash, cash equivalents, and short-term investments valued at approximately $378.5 million. We expect to use a substantial portion of these assets to fund our on-going operations over the next few years. As of June 30, 2005, we had approximately $173.9 million outstanding convertible subordinated notes and debentures, all

 

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of which will mature in 2007. We do not expect to generate sufficient cash from operations to repay our convertible subordinated notes and debentures or satisfy any other of these obligations when they become due and anticipate that we will need to raise additional funds from the sale of equity or debt securities or otherwise restructure our obligations in order to do so. There can be no assurance that any such financing or restructuring will be available to us on commercially acceptable terms, if at all.

 

If we cannot raise additional capital our financial condition may suffer.

 

Our capital needs may change as a result of numerous factors, and may result in additional funding requirements. In addition, we may choose to raise additional capital due to market conditions or strategic considerations. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to our stockholders.

 

We have no material credit facility or other material committed sources of capital. To the extent operating and capital resources are insufficient to meet future requirements, we will have to raise additional funds to continue the development and commercialization of our technologies and products. Such funds may not be available on favorable terms, or at all. In particular, our substantial leverage may limit our ability to obtain additional financing. In addition, as an early stage biotechnology company, we do not qualify to issue investment grade debt and therefore any financing we do undertake will likely involve the issuance of equity, convertible debt instruments, and/or high-yield debt. These sources of capital may not be available to us in the event we require additional financing. If adequate funds are not available on reasonable terms, we may be required to curtail operations significantly or obtain funds by entering into financing, supply or collaboration agreements on unattractive terms. Our inability to raise capital could negatively impact our business.

 

If we fail to manage our growth effectively, our business may suffer.

 

Our ability to offer commercially viable products, achieve our expansion objectives, manage our growth effectively and satisfy our commitments under our collaboration agreements depends on a variety of factors, all of which must be successfully managed. Key factors include our ability to develop products internally, enter into strategic partnerships with collaborators, attract and retain skilled employees and effectively expand our internal organization to accommodate anticipated growth including integration of any potential businesses that we may acquire. If we are unable to manage some or all of these factors effectively, our business could grow too slowly or too quickly to be successfully sustained, thereby resulting in material adverse effects on our business, financial condition and results of operations.

 

If we acquire additional companies, products, or technologies, we may not be able to effectively integrate personnel and operations and such failure may disrupt our business and results of operations.

 

We have acquired companies, products, and/or technologies in the past, and may continue to acquire or make investments in complementary companies, products, or technologies in the future. We may not receive the anticipated benefits of these acquisitions or investments. We may face risks relating to difficult integrations of personnel, technology and operations, uncertainty whether any integration will be successful and whether earnings will be negatively affected, and potential distractions to our management with respect to these acquisitions. In addition, our earnings may suffer because of acquisition-related costs.

 

We expect to continue to lose money for the next few years and may not reach profitability if our products do not generate sufficient revenue.

 

We have never had a profitable year and, through June 30, 2005, we have an accumulated deficit of approximately $770.2 million. We expect to continue to incur substantial and potentially increasing losses over at least the next few years as we expand our research and development efforts, testing activities and manufacturing operations, and as we further expand our late stage clinical and early commercial production facilities. Most of our potential products are in the early stages of development. Except for the approved products incorporating our Advanced PEGylation Technology, we have generated no revenues from product sales. Our revenues to date have consisted primarily of payments under short-term research and feasibility agreements and development contracts.

 

To achieve and sustain profitable operations, we must, alone or with others, successfully develop, obtain regulatory approval for, manufacture, introduce, market and sell products using our drug delivery technologies. There is risk that we will not generate sufficient product or contract research revenue to become profitable or to sustain profitability.

 

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

 

Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us. These anti-takeover provisions include:

 

    establishment of a classified board of directors such that not all members of the board may be elected at one time;

 

    lack of a provision for cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;

 

    the ability of our board to authorize the issuance of “blank check” preferred stock to increase the number of outstanding shares and thwart a takeover attempt;

 

    prohibition on stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of stockholders;

 

    establishment of advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and

 

    limitations on who may call a special meeting of stockholders.

 

Further, we have in place a preferred share purchase rights plan, commonly known as a “poison pill.” The provisions described above, our “poison pill” and provisions of Delaware law relating to business combinations with interested stockholders may discourage, delay, or prevent a third party from acquiring us. These provisions may also discourage, delay or prevent a third party from acquiring a large portion of our securities, or initiating a tender offer or proxy contest, even if our stockholders might receive a premium for their shares in the acquisition over the then current market prices.

 

We expect our stock price to remain volatile.

 

Our stock price is volatile. In the twelve-month period ending June 30, 2005, based on closing bid prices on The NASDAQ National Market, our stock price ranged from $9.69 to $20.46. We expect our stock price to remain volatile. A variety of factors may have a significant effect on the market price of our common stock, including:

 

    clinical trial results or product development delays or delays in product approval or launch;

 

    announcements by collaboration partners as to their plan or expectations related to products using our technologies;

 

    announcement or termination of collaborative relationships by us or our competitors;

 

    fluctuations in our operating results;

 

    developments in patent or other proprietary rights;

 

    announcements of technological innovations or new therapeutic products;

 

    governmental regulation;

 

    public concern as to the safety of drug formulations developed by us or others; and

 

    general market conditions.

 

Any litigation brought against us as a result of this volatility could result in substantial costs and a diversion of our management’s attention and resources, which could negatively impact our financial condition, revenues, results of operations, and the price of our common stock.

 

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New and potential new accounting pronouncements may impact our future financial position and results of operations.

 

There may be potential new accounting pronouncements or regulatory rulings, which may have an impact on our future financial position and results of operations. For example, in December 2004, the FASB issued an amendment to SFAS No. 123, Accounting For Stock-Based Compensation (“FAS 123R”). We will be required to implement FAS 123R beginning January 1, 2006. The cumulative effect of adoption, if any, applied on a modified prospective basis, would be measured and recognized on January 1, 2006. SFAS No. 123R would eliminate the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 (“APB 25”), and would instead require companies to recognize compensation expense using a fair-value based method for costs related to share-based payments including stock options and employee stock purchase plans. The adoption of SFAS No. 123R will materially and adversely impact our financial position and results of operations.

 

Our business is subject to changing regulation of corporate governance and public disclosure that has increased both our costs and the risk of noncompliance.

 

We are subject to rules and regulations of federal, state, and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC and NASDAQ, have recently issued new requirements and regulations and continue to develop additional regulations and requirements in response to recent laws enacted by Congress, most notably The Sarbanes-Oxley Act of 2002 (“SOX”). Our efforts to comply with these new regulations have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention to SOX compliance activities.

 

In particular, our efforts to comply with Section 404 of SOX and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. Our management has determined, as of the year ended December 31, 2004, that we had a material weakness in our internal control over financial reporting and that our disclosure controls and procedures were not effective. Efforts to remedy these deficiencies may require significant additional financial and managerial resources. In addition, such deficiencies may result in a loss of investor confidence and may adversely affect the price of our common stock. We are searching for additional finance staff, including a Chief Financial Officer. This effort may be time-consuming, expensive, and ultimately not successful.

 

Moreover, because these laws, regulations, and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices. The continuing uncertainty that we will meet or continue to meet the requirements of these laws, regulations, and standards, may negatively impact our business operations and financial position.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Our market risks at June 30, 2005 have not changed significantly from those discussed in Item 7A of our Annual Report on Form 10-K/A, as amended, for the year ended December 31, 2004 on file with the Securities and Exchange Commission.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as a result of the material weakness in our financial statement close process as disclosed in our Annual Report on Form 10-K/A, as amended, for the year ended December 31, 2004, our disclosure controls and procedures were not effective as of the end of the period covered by this quarterly report.

 

Changes in Internal Controls. We intend to continue to improve our financial statement close process in 2005 to address and attempt to remediate the material weakness disclosed in our Annual Report on Form 10-K/A, as amended, for the year ended December 31, 2004 by identifying, recruiting, and training personnel with the appropriate accounting skills. In addition, we plan to further enhance our technical accounting review process for non-routine and complex transactions by identifying and defining non-routine and complex transactions on a regular basis and by researching, identifying, analyzing, documenting, and reviewing applicable accounting principles. Other than as described above, there have been no changes in our internal control over financial reporting during the three-month period ended June 30, 2005 that have materially affected, or are reasonable likely to materially affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Controls. Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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PART II: OTHER INFORMATION

 

Item 1. Legal Proceedings

 

On July 12, 2005, a complaint was filed by The Board of Trustees of the University of Alabama (“UAH”) against Nektar Therapeutics AL, Corporation, and Nektar Therapeutics, Inc., (“Defendants”) in the United States District Court for the Northern District of Alabama. Among other things, the complaint alleges patent infringement, breach of contract license, violation of the Alabama Trade Secrets Act and unjust enrichment. Generally, the complaint alleges that Defendants’ refusal to pay royalties based upon UAH patented and licensed technology represents a breach of an exclusive license agreement between UAH and Nektar Therapeutics AL, Corporation (formerly Shearwater Corporation) and that Defendants have infringed and are infringing UAH’s patent. The complaint seeks certain monetary damages and other relief. The action is in a very early stage and we have not responded to the complaint. We intend to vigorously defend ourselves in this litigation.

 

On September 3, 2004, a purported securities class action complaint styled Norman Rhodes, et al. v. Nektar Therapeutics, Ajit Gill, J. Milton Harris, and Robert B Chess, Case No. C 04-03735 JSW, was filed in the United States District Court for the Northern District of California against the Company and certain of its current officers and directors. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 based on statements made between March 4, 2004 and August 4, 2004 (the “Class Period”)regarding Exubera®. On May 9, 2005, the plaintiff dismissed the complaint in its entirety without prejudice. The action is no longer pending.

 

From time to time, we are party to various other litigation matters, including several that relate to our patent and intellectual property rights. We cannot predict with certainty the eventual outcome of any pending litigation or potential future litigation, and we might have to incur substantial expense in defending these or future lawsuits or indemnifying third parties with respect to the results of such litigation. In accordance with the SFAS No. 5, Accounting for Contingencies, we make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impact of negotiations, settlements, ruling, advice of legal counsel, and other information and events pertaining to a particular case. Litigation is inherently unpredictable. If any unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations of that period or on our cash and/or liquidity.

 

Item 2. Changes in Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

  A. The annual meeting of the stockholders was held on June 2, 2005.

 

  B. The following matters were voted upon at the annual meeting:

 

  1. To elect the following directors to hold office until the 2007 annual meeting of stockholders:

 

Nominee


   In Favor

   Withheld

Michael A. Brown

   58,516,719    14,636,648

Ajit S. Gill

   59,835,647    13,317,720

Joseph J. Krivulka

   59,872,081    13,281,286

 

In addition to the directors elected above, Robert B. Chess, Susan Wang, Roy A. Whitfield, Christopher A. Kuebler, Irwin Lerner, and John S. Patton, Ph.D. continued to serve as directors after the annual meeting.

 

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  2. To ratify the selection by the audit committee of the board of directors of Ernst &Young LLP as our independent auditors for the fiscal year ending December 31, 2005.

 

For


 

Against


 

Abstain


71,107,895

  2,011,263   34,209

 

Item 5. Other Information

 

We file electronically with the Securities and Exchange Commission (“SEC”) our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, pursuant to Section 13(a) or 15(d) of the 1934 Act. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http:// www.sec.gov.

 

You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports on the day of filing with the SEC on our website at http://www.nektar.com, by contacting the Investor Relations Department at our corporate offices by calling (650) 631-3100 or by sending an e-mail message to investors@nektar.com.

 

Disclosure regarding the operations of our board of director nominating committees and the means by which security holders may communicate with directors can be found in the definitive proxy statement for our 2005 Annual Meeting of Stockholders filed with the SEC on April 14, 2005 (the “Proxy Statement”) under the heading Nominating and Corporate Governance Committee.

 

As permitted by SEC Rule 10b5-1, certain of our executive officers, directors and other employees have set up a predefined, structured stock trading program with his/her broker to sell our stock. The stock trading program allows a broker acting on behalf of the executive officer, director or other employee to trade our stock during blackout periods or while such executive officer, director or other employee may be aware of material, nonpublic information, if the trade is performed according to a pre-existing contract, instruction or plan that was established with the broker during a non-blackout period and when such executive officer, director or employee was not aware of any material, nonpublic information. Our executive officers, directors and other employees may also trade our stock outside of the stock trading programs set up under Rule 10b5-1 subject to our blackout periods and insider trading rules.

 

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Item 6. Exhibits and Reports on Form 8-K

 

  (a)     Exhibits

 

Except as so indicated in Exhibit 32.1, the following exhibits are filed as part of, or incorporated by reference into, this Quarterly Report on Form 10-Q.

 

Exhibit

Number


       

Description of Documents


2.1    (1)    Agreement and Plan of Merger, dated June 4, 1998, by and between Inhale Therapeutic Systems, a California corporation, and Inhale Therapeutic Systems (Delaware), Inc., a Delaware corporation.
2.2    (5)    Recommended Offer, dated December 21, 2000, by Cazenove & Co. on behalf of Nektar Therapeutics for Bradford Particle Design plc.
2.3    (8)    Agreement and Plan of Merger and Reorganization, dated May 22, 2001, by and among Nektar Therapeutics, Square Acquisition Corp., Shearwater Corporation, Certain Shareholders of Shearwater Corporation and J. Milton Harris as Shareholders’ Agent.
2.4    (8)    Amendment to Agreement and Plan of Merger and Reorganization, dated June 21, 2001, by and among Nektar Therapeutics, Square Acquisition Corp., Shearwater Corporation, J. Milton Harris, as Shareholders’ Agent and a Designated Shareholder, and Puffinus, L.P.
3.1    (1)    Certificate of Incorporation of Inhale Therapeutic Systems (Delaware), Inc.
3.2    (1)    Bylaws of Nektar Therapeutics.
3.3    (3)    Certificate of Amendment of the Amended Certificate of Incorporation of Nektar Therapeutics.
3.4    (7)    Certificate of Designation of Series A Junior Participating Preferred Stock of Nektar Therapeutics.
3.5    (9)    Certificate of Designation of Series B Convertible Preferred Stock of Nektar Therapeutics.
3.6    (10)    Certificate of Ownership and Merger of Nektar Therapeutics.
4.1         Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5 and 3.6.
4.2    (2)    Indenture, dated February 8, 2000, by and between Nektar Therapeutics, as Issuer, and Chase Manhattan Bank and Trust Company, National Association, as Trustee.
4.3    (10)    Specimen Common Stock certificate.
4.4    (4)    Specimen warrants to purchase shares of Common Stock.
4.5    (6)    Indenture, dated October 17, 2000, by and between Nektar Therapeutics, as Issuer, and Chase Manhattan Bank and Trust Company, National Association, as Trustee.
4.6    (7)    Rights Agreement, dated as of June 1, 2001, by and between Nektar Therapeutics and Mellon Investor Services LLC., as Rights Agent.
4.7    (7)    Form of Right Certificate.
4.8    (11)    Resale Registration Rights Agreement, dated June 30, 2003, by and among Nektar Therapeutics, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Deutsche Bank Securities Inc., Lehman Brothers Inc., Friedman, Billings, Ramsey & Co. Inc. and SG Cowen Securities Corporation
4.9    (12)    Resale Registration Rights Agreement, dated October 9, 2003, by and among Nektar Therapeutics and the entities named therein.
31.1    (13)    Certification of Nektar Therapeutics’ principal executive officer required by Rule 13a-14(a) or Rule 15d-14(a).
31.2    (13)    Certification of Nektar Therapeutics’ principal financial officer required by Rule 13a-14(a) or Rule 15d-14(a).
32.1    (13)    Section 1350 Certifications.

(1) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.

 

(2) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Annual Report on Form 10-K for the year ended December 31, 1999.

 

(3) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.

 

(4) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended September 30, 2000.

 

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(5) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on January 11, 2001.

 

(6) Incorporated by reference to Nektar Therapeutics’ Registration Statement on Form S-3 (No. 333-53678), filed on January 12, 2001.

 

(7) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on June 4, 2001.

 

(8) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on July 10, 2001.

 

(9) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on January 8, 2002.

 

(10) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on January 23, 2003.

 

(11) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on July 2, 2003.

 

(12) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on November 3, 2003.

 

(13) Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

By:  

/s/ AJIT S. GILL


    Ajit S. Gill
    Chief Executive Officer, President and Director
Date:   August 5, 2005
By:  

/s/ AJAY BANSAL


    Ajay Bansal
    Chief Financial Officer and Vice President, Finance and Administration
Date:   August 5, 2005

 

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EXHIBIT INDEX

 

Except as so indicated in Exhibit 32.1, the following exhibits are filed as part of, or incorporated by reference into, this Quarterly Report on Form 10-Q.

 

Exhibit

Number


     

Description of Documents


2.1   (1)   Agreement and Plan of Merger, dated June 4, 1998, by and between Inhale Therapeutic Systems, a California corporation, and Inhale Therapeutic Systems (Delaware), Inc., a Delaware corporation.
2.2   (5)   Recommended Offer, dated December 21, 2000, by Cazenove & Co. on behalf of Nektar Therapeutics for Bradford Particle Design plc.
2.3   (8)   Agreement and Plan of Merger and Reorganization, dated May 22, 2001, by and among Nektar Therapeutics, Square Acquisition Corp., Shearwater Corporation, Certain Shareholders of Shearwater Corporation and J. Milton Harris as Shareholders’ Agent.
2.4   (8)   Amendment to Agreement and Plan of Merger and Reorganization, dated June 21, 2001, by and among Nektar Therapeutics, Square Acquisition Corp., Shearwater Corporation, J. Milton Harris, as Shareholders’ Agent and a Designated Shareholder, and Puffinus, L.P.
3.1   (1)   Certificate of Incorporation of Inhale Therapeutic Systems (Delaware), Inc.
3.2   (1)   Bylaws of Nektar Therapeutics.
3.3   (3)   Certificate of Amendment of the Amended Certificate of Incorporation of Nektar Therapeutics.
3.4   (7)   Certificate of Designation of Series A Junior Participating Preferred Stock of Nektar Therapeutics.
3.5   (9)   Certificate of Designation of Series B Convertible Preferred Stock of Nektar Therapeutics.
3.6   (10)   Certificate of Ownership and Merger of Nektar Therapeutics.
4.1       Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, 3.5 and 3.6.
4.2   (2)   Indenture, dated February 8, 2000, by and between Nektar Therapeutics, as Issuer, and Chase Manhattan Bank and Trust Company, National Association, as Trustee.
4.3   (10)   Specimen Common Stock certificate.
4.4   (4)   Specimen warrants to purchase shares of Common Stock.
4.5   (6)   Indenture, dated October 17, 2000, by and between Nektar Therapeutics, as Issuer, and Chase Manhattan Bank and Trust Company, National Association, as Trustee.
4.6   (7)   Rights Agreement, dated as of June 1, 2001, by and between Nektar Therapeutics and Mellon Investor Services LLC., as Rights Agent.
4.7   (7)   Form of Right Certificate.
4.8   (11)   Resale Registration Rights Agreement, dated June 30, 2003, by and among Nektar Therapeutics, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Deutsche Bank Securities Inc., Lehman Brothers Inc., Friedman, Billings, Ramsey & Co. Inc. and SG Cowen Securities Corporation
4.9   (12)   Resale Registration Rights Agreement, dated October 9, 2003, by and among Nektar Therapeutics and the entities named therein.
31.1   (13)   Certification of Nektar Therapeutics’ principal executive officer required by Rule 13a-14(a) or Rule 15d-14(a).
31.2   (13)   Certification of Nektar Therapeutics’ principal financial officer required by Rule 13a-14(a) or Rule 15d-14(a).
32.1   (13)   Section 1350 Certifications.

(1) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.

 

(2) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Annual Report on Form 10-K for the year ended December 31, 1999.

 

(3) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.

 

(4) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Quarterly Report on Form 10-Q for the quarter ended September 30, 2000.

 

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(5) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on January 11, 2001.

 

(6) Incorporated by reference to Nektar Therapeutics’ Registration Statement on Form S-3 (No. 333-53678), filed on January 12, 2001.

 

(7) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on June 4, 2001.

 

(8) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on July 10, 2001.

 

(9) Incorporated by reference to Nektar Therapeutics’ Current Report on Form 8-K, filed on January 8, 2002.

 

(10) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on January 23, 2003.

 

(11) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on July 2, 2003.

 

(12) Incorporated by reference to the indicated exhibit in Nektar Therapeutics’ Current Report on Form 8-K, filed on November 3, 2003.

 

(13) Filed herewith.

 

50

Certification of Chief Executive Officer pursuant to Section 302

Exhibit 31.1

 

CERTIFICATIONS

 

I, Ajit S. Gill, certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q of Nektar Therapeutics;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)), for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 5, 2005

/s/ AJIT S. GILL


Ajit S. Gill

Chief Executive Officer, President

and Director

Certification of Chief Financial Officer pursuant to Section 302

Exhibit 31.2

 

CERTIFICATIONS

 

I, Ajay Bansal, certify that:

 

1. I have reviewed this Quarterly Report on Form 10-Q of Nektar Therapeutics;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)), for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 5, 2005

 

/s/ AJAY BANSAL


Ajay Bansal

Chief Financial Officer and Vice

President, Finance and

Administration

Certification of Chief Executive and Financial Officers pursuant to Section 906

Exhibit 32.1

 

SECTION 1350 CERTIFICATIONS*

 

Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350), Ajit S. Gill, Chief Executive Officer, President and Director of Nektar Therapeutics (the “Company”), and Ajay Bansal, Chief Financial Officer and Vice President, Finance and Administration of the Company, each hereby certifies that, to the best of his knowledge:

 

1. The Company’s Quarterly Report on Form 10-Q for the three-month period ended March 31, 2005, to which this Certification is attached as Exhibit 32.1 (the “Periodic Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Exchange Act; and

 

2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of the Company

 

Dated: August 5, 2005

 

/s/ AJIT S. GILL


 

/s/ AJAY BANSAL


Ajit S. Gill   Ajay Bansal
Chief Executive Officer, President and Director  

Chief Financial Officer and Vice President,

Finance and Administration

 

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this statement required by section 906, has been provided to Nektar Therapeutics and will be retained by Nektar Therapeutics and furnished to the Securities and Exchange Commission (“SEC”) or its staff upon request.


* This certification accompanies the Form 10-Q to which it relates, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such filing.