ESPERION THERAPEUTICS INC/MI - 10-K Annual 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.

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

The aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant as of March 1, 2002, computed by reference to the closing price on The Nasdaq National Market® on such date, was approximately $161,591,764.

The number of outstanding shares of the registrant’s common stock, as of March 1, 2002, was 29,198,816.

Portions of the Proxy Statement for the 2002 Annual Meeting of Stockholders are incorporated by reference into Part III and certain documents are incorporated by reference into Part IV.

The information contained in this report includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as “hope,” “may,” “believe,” “anticipate,” “plan,” “expect,” “require,” “intend,” “assume” and similar expressions. The Company cautions readers that forward-looking statements, which speak only as of the date of this filing, are based on management’s current expectations, estimations and projections and involve certain factors, such as risks and uncertainties, which may cause our actual results, performance or achievements to be far different from that suggested by our forward-looking statements. These factors include, but are not limited to, risks associated with: the progress and cost of development of our product candidates; risks associated with the extent and timing of market acceptance of new products by the Company or its competitors; dependence on third parties to conduct clinical trials for our product candidates; the extent and timing of regulatory approval, as desired or required, for our product candidates; dependence on licensing arrangements and other strategic relationships with third parties for the research, development, manufacturing and commercialization of our products; risks related to clinical trials and manufacturing; dependence on patents and proprietary rights; procurement, maintenance, enforcement and defense of the Company’s patents and proprietary rights; competitive conditions in the industry; business cycles affecting the markets in which the Company’s products may be sold; extraordinary events, such as litigation; risks inherent in seeking and consummating acquisitions, including the diversion of management attention to the assimilation of the operations and personnel of the acquired business; risks relating to the timing and extent of the Company’s financing needs; fluctuations in foreign exchange rates; and economic conditions generally or in various geographic areas. All of the foregoing factors are difficult to forecast. These risks and uncertainties are discussed below in the section entitled Factors Affecting our Future Prospects. We do not intend to update any of these factors or to publicly announce the results of any revisions to any of these forward-looking statements.

Esperion Therapeutics, Inc. is a biopharmaceutical company dedicated to the discovery and development HDL-targeted therapies for the treatment of cardiovascular and metabolic diseases. We have focused our initial drug development and discovery activities on a novel class of drugs to treat acute and chronic cardiovascular and metabolic diseases. We intend to commercialize a novel class of drugs that focuses on a new treatment approach we call “HDL Therapy,” which is based upon our understanding of high density lipoprotein, or HDL, function. Through HDL Therapy, we intend to exploit the beneficial properties of HDL in cardiovascular and metabolic diseases with a portfolio of product candidates.

We are currently developing five product candidates, including four biopharmaceuticals: ETC-588, or LUV; ETC-216, or AIM; ETC-642, or RLT Peptide; and ETC-276, or ProApoA-I; and one small molecule, ESP 31015. The biopharmaceuticals are currently being developed for the treatment of acute coronary syndromes, while the small molecule will target chronic treatment of risk factors associated with cardiovascular diseases. Each of these product candidates, as explained in detail under “Our Products in Development,” is designed to enhance the naturally occurring processes in the body that remove excess cholesterol from arterial walls. We currently have three product candidates in the clinical phase of development. The first Phase II clinical trial for ETC-588 in patients with stable atherosclerosis was completed and an additional Phase II trial will be initiated in 2002. We are currently enrolling patients in the first Phase II clinical trial for ETC-216 in patients with acute coronary syndromes. Results from this trial are expected in the second half of 2002. A Phase I clinical trial was commenced for ETC-642 in patients with existing cardiovascular disease and data from this trial are expected in the second half of 2002. We expect to continue clinical testing of these three product candidates during 2002, and are preparing to bring additional product candidates into clinical development.

Our product development to date has used in vitro assays, testing procedures performed outside the body, animal models, which we believe are appropriate at this stage of development and, in several cases, human clinical testing. Clinical and preclinical studies suggest that our product candidates increase HDL-cholesterol, or HDL-C, or its function, and enhance the removal of excess cholesterol and lipids from the walls of arteries. Preliminary results in early clinical trials suggest that ETC-588 and ETC-216 increase the mobilization of cholesterol, as evidenced by measurements of the amount of cholesterol in the blood both before and after administrations. Third-party published reports of preliminary human clinical studies of products that are similar to some of our product candidates suggest that these compounds may increase elimination of cholesterol from the body by enhancing the efficiency of the reverse lipid transport, or RLT, pathway. We believe that the biopharmaceutical therapies that we are developing could potentially enhance the naturally occurring processes in the body for the removal of excess cholesterol and other lipids from arterial walls. We believe that this removal of excess cholesterol from the body will lead to improvements in vascular structure and function, which will ultimately lead to a reduction in clinical events resulting from cardiovascular disease and atherosclerosis. Our clinical development plan is focused on planning and conducting clinical trials to demonstrate these benefits.

We are also pursuing the discovery and development of orally active, organic small molecules designed to increase HDL-C levels and/or enhance its function to stimulate the RLT pathway. We believe that some of these small molecules may also possess anti-diabetic, anti-obesity and/or lipid management properties. We have implemented several strategies to develop these potential product candidates based on well-known mechanisms by which HDL is produced in the body. One strategy has yielded several classes of active molecules. We believe that our drug discovery technologies and scientific and drug development expertise have potential applicability to a broad range of cardiovascular and metabolic diseases, including treatments for heart disease, diabetes and obesity.

We were incorporated in Delaware and commenced operations in May 1998. We became a public company in August 2000 with the closing of our initial public offering and our common stock trades on The Nasdaq National Market under the symbol “ESPR.” Our executive offices and primary research facility are located at 3621 South State Street, 695 KMS Place, Ann Arbor, Michigan 48108, and our telephone number is (734) 332-0506.

The cardiovascular system is comprised of the heart and blood vessels and delivers oxygen and other nutrients to the tissues and organs of the body, such as the brain, kidneys and lungs; in addition, it is able to remove waste products. The heart propels blood through a network of arteries and veins. The kidneys regulate the blood volume, and the lungs put oxygen in the blood and remove carbon dioxide. To accomplish these tasks, the cardiovascular system must maintain adequate blood flow, which can be dramatically reduced by the excessive deposit of a fat called “cholesterol” within the arterial walls. Cholesterol is essential for cells to function normally. Our bodies obtain cholesterol both through the foods we eat and by manufacturing cholesterol inside some of our cells and organs. Cholesterol either remains within the cell or is transported by the blood to various organs. The major carriers for cholesterol in the blood are lipoproteins, which are particles composed of fat and protein, including low density lipoprotein, or LDL, and high density lipoprotein, or HDL. LDL delivers cholesterol to organs where it can be used to produce hormones, maintain healthy cells or be transformed into natural products that assist in the digestion of other lipids. HDL removes excess cholesterol from arteries and tissues and transports it back to the liver for elimination.

The RLT pathway consists of a four-step process responsible for removing excess cholesterol from arteries and transporting it to the liver for elimination from the body. The first step is the removal of cholesterol from arteries by HDL in a process called “cholesterol removal.” In the second step, cholesterol is converted to a new form that is more tightly associated with HDL as it is carried in the blood; this process is called “cholesterol conversion.” The third step is the transport and delivery of that converted cholesterol to the liver in a process known as “cholesterol transport.” The final step is the transformation and discarding of

cholesterol by the liver in a process called “cholesterol elimination.” We believe our product candidates have the potential to enhance the effectiveness of these four steps in the RLT pathway in humans.

In a healthy human body, there is a balance between the delivery and removal of cholesterol. Over time, however, an imbalance can occur in our bodies in which there is too much cholesterol delivery by LDL and too little removal by HDL. When people have a high level of LDL cholesterol, or LDL-C, and a low level of HDL-C, the imbalance results in more cholesterol being deposited in arterial walls than being removed. This imbalance can also be exaggerated by, among other factors, age, gender, high blood pressure, smoking, diabetes, obesity, genetic factors, physical inactivity and consumption of a high-fat diet. The excess cholesterol carried in the blood in LDL particles can be deposited throughout the body, but frequently ends up in arterial walls, especially those found in the heart. As a consequence, repeated deposits of cholesterol, called plaque, form and can narrow or block the arteries, possibly leading to a heart attack or stroke.

According to the American Heart Association, cardiovascular disease is the number one killer of American men and women. In 2002, the direct and indirect annual cost of cardiovascular disease was estimated to be $325 billion, of which approximately $32 billion is spent annually on drug therapy. The most prominent form of cardiovascular disease is atherosclerosis, a systemic disease that includes the buildup of plaque in arterial walls limiting blood flow to the heart, brain, other vital organs and extremities. Atherosclerosis can result in heart attacks, chest pain, known as angina, and a variety of other complications, and is responsible for over half of all deaths from cardiovascular disease.

Physicians recognize high LDL-C and low HDL-C levels as risk factors for cardiovascular disease. In addition, high HDL-C levels generally are associated with lower incidence of cardiovascular disease. Clinical studies have suggested that:


	•	Low levels of HDL-C are a risk factor for coronary heart disease. The first study suggesting that people with low HDL-C had increased risk of atherosclerotic cardiovascular disease was reported in 1951. Since that time, a number of studies have confirmed that low HDL-C levels are a risk factor for coronary heart disease.

	•	Increasing HDL-C reduces risk of coronary heart disease. The Helsinki Heart Study, completed in 1987, suggested that increasing HDL-C levels reduced the risk of coronary heart disease in individuals at risk due to low HDL-C, high LDL-C, and high triglycerides, another type of lipid.

	•	Increasing HDL-C levels reduces the risk of death from coronary artery disease, heart attack or stroke. The Veterans Affairs Cooperative Studies Program High Density Lipoprotein Cholesterol Intervention Trial, completed in 1999, suggested that men with coronary artery disease who took a lipid regulating drug for five years experienced on average a 6% increase in HDL-C, resulting in a 24% risk reduction in death due to coronary artery disease, heart attack or stroke.

	•	Low levels of HDL-C translate to a low survival rate following coronary bypass surgery. A 20-year study completed by The Cleveland Clinic Foundation in 1999 suggested that people with low HDL-C levels have a lower survival rate following coronary bypass surgery. This study suggests the importance of HDL-C in minimizing the necessity of post-operative treatments.

In addition, published pre-clinical studies by third parties suggest other protective properties of HDL, such as reducing inflammation in arteries.

Treatments are either short-term solutions, termed “acute” by physicians, or long-term solutions, termed “chronic.” Acute treatments are reserved for more life-threatening cardiovascular conditions, such as a heart attack, a condition where there is a shortage of oxygen-rich blood available to the heart. In contrast, chronic

treatments are used to prevent cardiovascular disease from growing worse and having to resort to acute treatments. Current acute treatments may include costly invasive procedures, while chronic treatments are usually in tablet or pill form. Chronic treatments have focused more on “stable” atherosclerosis and have been successful at showing benefits over long periods of time (i.e., months or years). We believe that current trends indicate a growing interest in finding successful treatments for “unstable” acute coronary syndromes and looking for clinical benefits in short periods of time (i.e., days or weeks) rather than months or years.

Acute treatments are required when blood flow to the heart is severely restricted and the patient is at immediate risk for further complications. Two of the most common invasive procedures used to restore blood flow are bypass surgery and percutaneous coronary intervention (PCI) (i.e., balloon angioplasty, with or without stents). In bypass surgery, a cardiovascular surgeon redirects blood flow around the blocked arteries by grafting a healthy vessel removed from another location in the patient. In PCI, a thin flexible tube with an inflatable balloon at its end is positioned in the artery at the point of blockage. The balloon is then inflated and this pushes aside the plaque that causes the blockage, resulting in a reopening of the artery to allow greater blood flow. Frequently, a cardiologist reinforces the newly opened artery with a wire-mesh cylinder called a stent. In addition, these patients with acute coronary syndromes may be prescribed aspirin, clopidogrel, heparin, nitrates, IIb/ IIIa inhibitors, beta-blockers, fibrinolytic therapy, statins and ACE inhibitors. Despite these many treatments and/or procedures, there still exists a short-term risk for recurrent clinical events.

The primary benefit of successful acute treatments is the immediate restoration of oxygen-rich blood flow to the heart. However, the major drawbacks are that:


	•	These procedures are invasive to the patient and involve opening up the chest cavity to expose the heart, as in coronary bypass surgery, or inserting a thin flexible tube through a leg artery and advancing it to the heart, as in PCI. Invasive procedures by their nature involve a risk of complications, including death. For example, up to 3.5% of coronary bypass patients die from post-operative complications.

	•	There is significant recovery time after coronary bypass surgery.

	•	These invasive procedures are very costly, averaging several tens of thousands of dollars each.

	•	Many patients are not eligible for invasive surgical procedures due to their medical and/or treatment history and physical condition.

	•	Atherosclerosis affects the entire cardiovascular system and since acute procedures are localized and treat only one segment of a diseased artery at a time, many diseased arteries are left untreated after using these localized invasive procedures.

According to the American Heart Association, it is estimated that in 1999, 557,000 coronary bypass surgeries were performed on 355,000 patients in the United States with an average cost of about $45,000. In 1999, approximately 601,000 PCI procedures were performed in the United States. The average cost of a PCI is $20,000 and more when a stent is used.

The initial recommendation for a patient with elevated LDL-C, a well-known risk factor, is frequently a change in lifestyle involving exercise combined with a low-fat, low-cholesterol diet. If a patient’s cholesterol level does not improve, then a physician moves to the next step of treatment to achieve acceptable levels of cholesterol in the blood.

Chronic treatments for cardiovascular disease have the goal of preventing or limiting progression of the disease to reduce risk of heart disease, disability or death. Physicians frequently will prescribe a statin drug that lowers the level of LDL-C in the blood by inhibiting cholesterol production in the body. These drugs can also lower triglycerides, a type of lipid, and have the ability to slightly raise HDL-C. Recent studies have shown that the statins reduce the risk of illness or death from cardiovascular disease by approximately 30%.

These drugs reduce the rate of progression of atherosclerosis in a majority of patients. However, statins have not been consistent in demonstrating regression of atherosclerotic disease.

We are taking a product-focused approach towards drug development. The key elements of our business strategy are as follows:


	•	Develop several different drug candidates for HDL Therapy. Based on our understanding of the RLT pathway, we have identified a portfolio of product candidates that we believe could provide a broad spectrum of treatment options for cardiovascular and metabolic diseases. These product candidates are focused on improving HDL function in the RLT pathway and removing excess cholesterol from the walls of arteries. Our portfolio currently consists of three distinct types of HDL therapies: HDL mimetics, “cholesterol sponges” and small molecules that stimulate the RLT pathway. Each of these therapies is described in more detail in the section below entitled Our Products in Development.

	•	Leverage experienced scientific and drug development expertise. We are managed by an experienced group of drug developers with significant expertise in cardiovascular research and drug development. Roger S. Newton, Ph.D., President and Chief Executive Officer of Esperion, was the co-discoverer, chairman of the discovery team and a member of the development team for the drug atorvastatin (Lipitor®). Sales of Lipitor exceeded $6.4 billion in 2001. Other members of our management team have participated in the discovery, clinical development and/or commercialization of many other high profile therapies, including Lipitor®, Lopid®, Pravachol®, Glucophage® and Plavix®. In addition, we have discovered HDL elevators and have successfully recruited the inventors of two of our drug candidates.

	•	Optimize clinical and regulatory strategies. We believe that by initially focusing on acute treatments for our biopharmaceutical product candidates, we hope to achieve an abbreviated development time, as compared to what would be expected with chronic treatments. This may result in a faster time to market, which will benefit patients with cardiovascular disease. We intend to perform clinical trials on our biopharmaceutical product candidates to rapidly assess efficacy for well-defined cardiovascular endpoints in the treatment of acute coronary events. Concurrently, we are discovering and developing small molecules that we intend to use as a chronic therapy to complement the acute therapies of our biopharmaceuticals.

	•	Retain significant marketing rights to our product candidates. Our goal is to retain some or all of the marketing rights to our product candidates in order to maximize our financial return as well as to ensure that they will be successfully commercialized. By completing as much of the preclinical and clinical development work both independently and with contract research organizations as is feasible, we hope to be able to negotiate more favorable terms for any such partnering arrangements.

We anticipate that our most significant expenditures will be for further clinical development of our product candidates, payments under current licensing agreements, ongoing research, discovery and development activities, the manufacture of preclinical and clinical material, and general corporate and working capital purposes.

Our initial product development efforts are focused on developing a novel class of drugs designed to treat both acute and chronic atherosclerotic disease using HDL Therapy. Our product candidates are designed to enhance HDL function and the four steps of the RLT pathway. Our product development to date has used in vitro assays, testing procedures performed outside the body, animal models which we believe are appropriate at this stage of development and, in several cases, human clinical testing. We currently have three product candidates actively in the clinical phase of development. We expect to continue clinical testing of these three product candidates during 2002, and are preparing to bring additional product candidates into clinical development. Our human clinical trials may not commence or proceed as anticipated and we may not be able

to demonstrate the same levels of safety, efficacy or other results in clinical trials that have been suggested in our preclinical or early clinical trials, or in studies by third parties with products similar to ours.

We are developing ETC-588 (large unilamellar vesicles, or LUV), as an acute treatment for acute coronary syndromes, or reduced blood flow to the heart, caused by atherosclerosis. LUV are spherical particles made of naturally occurring lipids that can remove cholesterol from cells, including those in the arterial wall. In effect, these particles act as “cholesterol sponges” and can cycle back through arteries several times to remove more cholesterol. We believe that this process will allow the body to significantly increase the amount of cholesterol it is able to remove and improve cardiovascular health and function. We believe that LUV have a high capacity to transport cholesterol, the third step in the RLT pathway, and deliver it to the liver for elimination from the body.

Two third party preclinical animal studies were published involving the administration of LUV. These studies showed the removal of cholesterol from arteries and the regression of atherosclerosis, thereby helping arteries regain their flexibility and function. The material used in these studies was similar to the LUV that we are developing. None of the studies were conducted by us or on our behalf.

Phase I single and multiple dose tolerance studies in healthy volunteers were completed in 2000. Analysis of data from those studies suggests a dose-dependent cholesterol mobilization. In November 2001, we reported preliminary results from our Phase IIa clinical study and we expect to report more complete data during the second quarter of 2002 at a peer-reviewed scientific meeting. The preliminary findings from this study indicate that ETC-588 met the study’s primary endpoint of demonstrating safety and tolerability in patients with known vascular disease.

The Phase II a study was a double-blind, randomized, placebo-controlled, multiple-dose study designed to determine the optimal dose and dosing schedule and effect of ETC-588 in thirty-four evaluable patients with stable known vascular disease and HDL-C less than or equal to 45 milligrams per deciliter. Patients were administered one of three dose strengths (50, 100, 200 milligrams per kilogram) or placebo every four or seven days. Patients administered the 100 and 200 mg/kg doses each received seven doses for either four or six weeks, while the 50 mg/kg dose group received fourteen doses for either eight or thirteen weeks. In this study, ETC-588 was safe and well-tolerated at all dose levels and dose regimens. Based on the results of this study, an optimal dosing schedule of every seven days has been defined for future study of ETC-588. Patients administered ETC-588 also showed evidence of dose-related cholesterol mobilization.

In addition, we conducted a sub-study in this Phase IIa trial using magnetic resonance imaging (MRI) technology to assess its feasibility as an appropriate imaging modality. The Company believes that the findings from this study support the feasibility of utilizing MRI to assess the vascular structure of the carotid arteries. This technology will be utilized in future studies of ETC-588 to assess a primary endpoint of rapid changes in plaque volume and composition.

We will conduct a second Phase II clinical trial in 2002 to, among other things, use MRI technology to assess the amount and rapidity of changes in plaque volume. Additional efficacy endpoints may also be studied. The second Phase II study will be initiated in the first quarter of 2002.

We are developing ETC-216 (apolipoprotein A-I Milano, or AIM), for the treatment of acute coronary diseases caused by atherosclerosis. The clinical use of ETC-216 as a human recombinant protein complexed to phospholipid is to mimic HDL and/or enhance its function. AIM is a variant form of apolipoprotein A-I, the major protein component of HDL, and is present in a small population of Northern Italians with paradoxically low HDL-C levels. Low HDL-C levels normally would correlate with high risk for cardiovascular disease; however, those people with the Milano variant of apolipoprotein A-I tend to show a lower risk of cardiovascular disease, presumably due to enhanced reverse lipid transport.

We believe that infusion of ETC-216 in humans will enhance the RLT pathway. Published third-party reports in 1998, 1999 and 2001 have shown that in animal models, AIM reduced atherosclerotic lesions and their lipid content and prevented inflammation and clotting. A 1999 report of in vitro tests showed that AIM increased cholesterol removal. The 2001 report demonstrated stabilization of atherosclerotic lesions within 48 hours. Also, published third-party reports in 1994 and 1995 showed that AIM inhibited restenosis following balloon angioplasty in two animal models. The material used in these studies is similar to ETC-216 that we are currently developing. None of these studies were conducted for us or on our behalf.

We completed and reported positive data from a Phase I single-dose clinical trial of ETC-216 in Europe in the first quarter of 2001. We initiated a multiple-dose, multi-center Phase II clinical study in patients with acute coronary syndromes in the fourth quarter of 2001. The purpose of this study is to provide evidence that ETC-216 is effective in regressing coronary atherosclerosis by measuring changes in plaque size utilizing intravascular ultrasound (IVUS). The trial is a randomized, double-blind study that is evaluating the efficacy and safety of ETC-216 at two different dose levels of intravenous infusions, compared to placebo, administered every seventh day with a maximum of five doses. The study will evaluate fifty patients with acute coronary syndromes, who are scheduled to undergo coronary angiography and/or angioplasty. The primary endpoint is the effect of ETC-216 on plaque size of one targeted coronary artery, which will be measured by atheroma volume through the use of IVUS. In IVUS, a tiny ultrasound probe is inserted into the coronary artery to directly image atherosclerotic plaques.

We acquired exclusive worldwide rights for AIM from Pharmacia in July 1998. Under the license agreement with Pharmacia, at the completion of Phase II clinical trials, Pharmacia has the exclusive right of election to co-develop and the exclusive right to market products that include AIM as an active ingredient in countries outside of the United States and Canada. In addition, if we pursue a co-development and co-promotion arrangement in the United States and Canada, Pharmacia has the right of first negotiation.

We are developing ETC-642 (RLT Peptide) for the treatment of acute coronary diseases caused by atherosclerosis. ETC-642 mimics the biological properties of apolipoprotein A-I, to promote cholesterol removal from arterial walls and other tissues and enhance reverse lipid transport. ETC-642 is a complex of peptide and phospholipids that mimics the functions of HDL. ETC-642 has been shown in our preclinical studies to increase the HDL-C fraction and to enhance cholesterol mobilization. Because of these properties, we believe that administration of ETC-642 may stimulate cholesterol removal in patients.

The patent applications that were filed in 1997 for the technology relating to series of RLT peptides describe experiments of the compound in vitro and in vivo, including in human blood samples. These experiments showed that RLT peptides similar to the RLT Peptide that we are developing interact with and activate important enzymes in the RLT pathway and stimulate cholesterol removal. The results of a preclinical animal model study described in the patents showed that the administration of an RLT peptide complexed to phospholipids increased HDL-C levels in the blood. The RLT peptide complex used in this study is similar to the RLT Peptide that we are developing. This study was not conducted for us or on our behalf.

Our goal is to establish in human clinical trials that intravenous infusions of ETC-642 are safe and can remove cholesterol from the walls of arteries, thus increasing blood flow and reducing the death and disability associated with atherosclerosis. During 2001, we initiated a Phase I clinical study of ETC-642 in patients with existing cardiovascular disease. The Phase I clinical trial is a single-dose study in patients with stable atherosclerosis to determine the safety, tolerability, pharmacokinetic and cholesterol mobilization properties of ETC-642. We expect to report results from this Phase I clinical trial in the middle of 2002. Following the completion of this Phase I trial and review of the data, the Company expects to conduct a multiple-dose study in patients beginning in the second half of 2002 to examine dosing regimens and certain efficacy parameters.

We are developing ETC-276 (ProapolipoproteinA-I, or ProApoA-I), for the treatment of acute coronary diseases caused by atherosclerosis. ProApoA-I is a naturally occurring protein found in all humans that forms particles with lipids similar to HDL.

In the blood, ProApoA-I is converted to ApoA-I, which is responsible for all four steps of the RLT pathway. A 1995 published report of in vitro tests showed that ProApoA-I had properties important for the removal of cholesterol from cells. Results from animal studies in several species demonstrated that ProApoA-I activated the RLT pathway. A third-party published report showed that when ProApoA-I was infused into people with high cholesterol levels ProApoA-I increased elimination of cholesterol from the body by enhancing the RLT pathway. The material used in these studies is similar to the ProApoA-I that we are currently developing. None of the studies noted were conducted for us or on our behalf.

Our goal is to show that intravenous infusions of ETC-276 can help remove cholesterol from arteries, thus increasing blood flow and reducing the symptoms associated with atherosclerosis. The Company’s patent coverage for ETC-276 only extends to 2008; therefore, we are looking at alternatives to enhance the intellectual property protection for this product candidate. In addition, during 2002, the Company will continue pre-clinical development activities in the ProApoA-I program and will be evaluating various strategies related to the production of ProApoA-I. As these goals are achieved, we intend to continue the clinical development of this product candidate as a second generation to our other product candidates that mimic the properties and function of HDL.

We are pursuing the discovery and development of orally active, organic small molecules designed to increase HDL-C levels and/or enhance their function to stimulate the RLT pathway. We believe that some of these small molecules may also possess anti-diabetic, anti-obesity and/or lipid management properties. We have implemented several strategies to develop these product candidates based on well-known mechanisms by which HDL is produced in the body. One strategy has yielded several classes of active molecules.

Our preclinical studies demonstrated that several classes of molecules elevate HDL-C in animal models. These molecules can also control lipid production and digestion in cells from rats, rabbits, hamsters and humans, and inhibit the progression of atherosclerosis in an animal model. We believe that these classes of molecules may also possess anti-diabetic and anti-obesity properties. Our goal is to establish in human clinical trials that orally administered small molecules are a safe chronic treatment to enhance the RLT pathway while simultaneously treating conditions affecting the diabetic or obese patient.

We have identified a lead candidate from our small molecule discovery program, which we designate ESP 31015. Upon completion of certain pre-clinical and toxicology studies, the Company intends to file an Investigational New Drug application, or IND, late in 2002 and begin Phase I clinical testing on ESP 31015 in the first half of 2003. In the meantime, other small molecule candidates are being evaluated for potential development in the future.

We have devoted substantially all of our resources since we began our operations in May 1998 to the research and development of pharmaceutical product candidates for cardiovascular and metabolic diseases. Our research and development expenses were $21.5 million, $22.6 million and $8.5 million in 2001, 2000 and 1999, respectively. Research and development expenses include both external and internal costs related to the research and development activities of our existing product candidates as well as discovery efforts on potential new product candidates. External costs include costs related to manufacturing, clinical trials, toxicology or pharmacology studies performed by third parties, milestone payments under certain license agreements and other related expenses. Internal costs include all payroll and related costs attributable to research and development activities, as well as an allocation of overhead expenses incurred by the Company. Some of these

research and development expenses funded research to study the potential connection between the presence of low HDL-C levels and the incidence of metabolic disorders such as diabetes and obesity.

We have implemented strategies in research and development, which we believe will generate a pipeline of new drugs for the treatment of cardiovascular and metabolic diseases including lipid disorders, diabetes, obesity, and related complications. These strategies include an intensive effort to identify both orally active small molecules and novel biopharmaceuticals.

Small molecule discovery efforts, focused on lipid disorders, are aimed to identify drugs that increase HDL-C levels and/or enhance their function to stimulate the RLT pathway. HDL or its lipid and protein components are synthesized and replenished via three pathways in the body:


	•	digestion of triglycerides in triglyceride — rich lipoproteins;

	•	synthesis of apolipoprotein A-I; and

	•	effluxing of cell-derived cholesterol into pre-existing HDL.

We have implemented approaches to identify drugs that stimulate these pathways, which we believe will result in the synthesis of more HDL or the rapid replenishment of HDL components.

Small molecule discovery efforts focused on diabetes and obesity are aimed to improve the insulin sensitivity of resistant tissues and to enhance the breakdown of fat from adipose tissue, the storage site for fat. We believe that some pathways involved in HDL synthesis and replenishment intersect with pathways affecting insulin resistance and the breakdown of fat. We believe that identifying those points of intersection will accomplish two goals:


	•	accelerate our discovery process by helping us define new chemical structures; and

	•	provide novel, validated molecular targets for in-house drug discovery efforts and/or assets for industry collaborations.

To identify those points of intersection, we intend to capitalize on our knowledge of chemistry, drug action, and biological models by integrating that knowledge with genomics tools and techniques. We believe our product candidates and active small molecules provide a proprietary platform, which will help us to improve our prediction of clinical success with drug candidates.

We do not have the ability to independently conduct all aspects of our clinical studies and obtain regulatory approvals for our product candidates. We rely on third-party contract research organizations, or CROs, to perform many of these functions.

We believe that the clinical development plan for our product candidates can be achieved by the following:


	•	Phase I. We need to prove the safety and tolerability of our product candidates. In addition, we begin to look at dose levels and dosing regimens; that is, how much drug should be administered and how often. Finally, in Phase I, we look for evidence of cholesterol mobilization in humans. Mobilization can be measured using various clinical chemistry tests such as the level of cholesterol in the blood both before and after treatment.

	•	Phase II. We will continue to monitor safety and tolerability in patient populations. We will identify optimal dose and dose regimens including the number of treatments and length between treatments. Finally, we will examine efficacy parameters including changes in vascular structure and function. We can look at plaque structure and volume changes using various imaging modalities such as MRI or IVUS and study vascular function using brachial artery ultrasound. These measurements will provide evidence as to whether our product candidates are having an impact on the plaque in the walls of the arteries.


	•	Phase III. During Phase III, we believe that we will need to show evidence of clinical benefit and establish effectiveness of our product candidates through improvements in cardiovascular clinical outcomes such as morbidity, mortality, heart attacks, hospitalizations, revascularizations and other clinical events. Because we are targeting acute treatments with our biopharmaceuticals, we need to show an impact on these clinical events in a short period of time following treatment.

We currently have no sales or distribution capabilities. In order to successfully commercialize any of our product candidates, we must either internally develop full sales, marketing and distribution capabilities or make arrangements with third parties to perform these services. We intend to sell, market and distribute some products directly and rely on relationships with third parties to sell, market and distribute other products. To market any of our products directly, we must develop a marketing and sales force with technical expertise and with supporting distribution capabilities. Since 2000, we have had a marketing director to develop commercialization strategies for our product candidates and to conduct market research on the target indications for our product candidates.

Our licensors have granted us exclusive rights to market our product candidates, except for ETC-216. We acquired exclusive worldwide rights for AIM from Pharmacia in July 1998. Under this agreement, at the completion of Phase II clinical trials, Pharmacia has the exclusive right of election to co-develop and the exclusive right to market products that include AIM as an active ingredient in countries outside of the United States and Canada. In addition, if we pursue a co-development and co-promotion arrangement in the United States and Canada, Pharmacia has the right of first negotiation.

In the United States, we do not intend to enter into co-development, co-promotion or out-licensing arrangements for our biopharmaceutical product candidates until they are in clinical development. We believe the preferred partnering deal would occur after Phase I/ II and would consist of a co-development and co-promotion relationship with one or more companies that have established distribution systems and direct sales forces. In international markets, we intend initially to seek strategic relationships to market, sell and distribute our product candidates, but we may eventually become involved in direct sales and marketing activities internationally.

We currently rely, and will continue to rely for at least the next few years, on contract manufacturers to produce sufficient quantities of our product candidates for use in our preclinical and clinical trials and ultimately for commercial purposes. We also rely, and intend to continue to rely, on third parties to provide the components of these product candidates, such as proteins, peptides, phospholipids and bulk chemical materials.

There is currently a limited supply of some of the components needed to manufacture our product candidates. In particular, the production capacity available in the world for the proteins contained in ETC-216 and ETC-276 is currently limited. Furthermore, the contract manufacturers that we have identified and worked with to date only have limited experience at manufacturing, formulating, analyzing, and filling and finishing our product candidates in quantities sufficient for conducting clinical trials or for commercialization. There are companies throughout the world that have begun to make investments in additional capacity through the construction of new facilities or renovation of existing facilities; however, these facilities will take time to construct, require a significant capital investment and must comply with regulatory specifications.

The process for manufacturing proteins and formulating them into protein/lipid complexes is complicated. We do not have any experience in the commercial-scale manufacturing of any of ETC-588, ETC-216, ETC-642, ETC-276 or ESP 31015. Each of these product candidates has a unique manufacturing process. Our product candidates will need to be manufactured in facilities and using processes that comply with current Good Manufacturing Practices, or cGMP requirements and other similar regulations, including those from

outside the United States. It takes a substantial period of time to produce proteins, peptides, phospholipids and certain small molecules in compliance with such regulations. If we are unable to establish and maintain relationships with third parties for manufacturing sufficient quantities of our product candidates and their components that meet our planned time and cost parameters, the development and timing of our clinical trials and commercialization strategy may be adversely affected.

Our ability to protect and use our intellectual property rights in the development and commercialization of our product candidates is crucial to our continued success. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets, or other proprietary information or know how. We currently rely on a combination of patents and pending patent applications, some of which we license and some of which have been assigned to us, proprietary information, trade secrets and know how to protect our interests in developing and commercializing our product candidates and technologies.

In connection with the agreements described below, we may be obligated to make various milestone payments which could amount to $28.3 million and future royalty payments, pursuant to formulas in the agreements, over the next several years. At the present time, it is uncertain as to whether we will be required to make any of these additional payments.

In March 1999, we exclusively licensed certain LUV technology from Inex Pharmaceuticals Corp., or Inex, on a worldwide basis. Inex owns granted patents in 13 European countries covering the LUV technology and exclusively licenses, from the University of British Columbia, two issued U.S. patents and one pending U.S. patent application. The European patents claim methods for treatment of atherosclerosis using liposomes. The U.S. patents and patent application claim liposome structure and chemical makeup and methods for treatment of disease, including atherosclerosis. The U.S. patents expire no earlier than 2014. The European patents expire in 2011.

We paid Inex $250,000 at the time we entered into the license agreement with Inex for LUV in March 1999. Our license agreement with Inex, as amended, requires us to make payments to Inex as milestones are achieved, and to pay Inex royalties on sales of products that are covered by the licensed patents or developed using the licensed technology. The first milestone payment of $100,000 was paid to Inex in the first quarter of 2001, based upon enrollment of our first patient in a Phase II clinical trial. Additional milestone payments will be paid to Inex if and when we achieve future development milestones as defined in the agreement, up to an aggregate amount of $6.2 million. This license continues until the later of ten years from the first commercial sale of a product covered by this license or the last expiration date of any patent rights covered by this license, unless earlier terminated by a party in accordance with the terms of the license.

In September 2000, we acquired Talaria Therapeutics, Inc., or Talaria, through which we acquired additional LUV technology, which now includes seven U.S. patents, one allowed U.S. patent application, eight pending U.S. patent applications and corresponding foreign pending patent applications claiming methods and compositions for use in treating atherosclerosis and other related disorders and angina. The issued U.S. patents expire in 2016. Under our license agreement with Inex, as amended, we are also required to pay Inex royalties on sales of products that are covered by this LUV technology.

Our merger agreement with Talaria required us to issue 813,008 shares of common stock to former Talaria stockholders and requires us to pay: (i) up to $6.3 million in cash and/or common stock based on the achievement of four development milestones; and (ii) royalties in cash and/or common stock based on net annual sales of LUV products in North America. The combined milestone payments and royalties are subject to a maximum aggregate ceiling of $20.0 million. The first milestone was achieved in the first quarter of 2001 upon the enrollment of our first patient in a Phase II clinical trial. This milestone was paid in 2001 through the issuance of 58,626 shares of common stock. 10,127 of the initial 813,008 shares of common stock that were

issued were retired in 2001 in satisfaction of an indemnity obligation of the former Talaria stockholders under the merger agreement and related documents.

In June 1998, we acquired exclusive, worldwide rights to AIM from Pharmacia Corporation, subject to Pharmacia’s exclusive right to co-develop and market AIM in countries other than the United States and Canada. Under our license agreement with Pharmacia, subject to Pharmacia’s exclusive right to co-develop and market products that include AIM as an active ingredient in countries other than the United States and Canada, we acquired what is now four U.S. patents and four pending U.S. patent applications, and other related foreign patents and patent applications, covering various aspects of AIM. These patents and patent applications claim methods and materials for producing AIM in bacteria and yeast, methods for purification and methods for treating atherosclerosis and other forms of cardiovascular disease with AIM. Two of the issued U.S. patents expire in 2015 and the other two issued U.S. patents expire in 2016. Corresponding patents are in effect and patent applications are pending in other countries where we believe the market potential for ETC-216 is significant, including most of the European countries and some Asian countries, including Japan.

We paid Pharmacia $750,000 at the time we entered into our license agreement in June 1998. Our license agreement with Pharmacia requires us to make payments to Pharmacia as milestones are achieved, and to pay Pharmacia royalties on sales of products that are covered by the Pharmacia patents or developed using the Pharmacia technology. The first milestone payment of $1.0 million will be paid in cash or by issuance of a promissory note to Pharmacia if and when we have completed clinical trials showing preliminary safety and initial proof-of-concept (which may include the Phase II study that we expect to report on in the second half of 2002). We believe that this would mean clinical trials that show statistically significant results in safety and efficacy, allowing us to better define the details of any potential Phase III pivotal trials.

If Pharmacia exercises its exclusive right to co-develop and market AIM in countries other than the United States and Canada, we will make additional milestone payments, up to an aggregate of $2.5 million, to Pharmacia. If Pharmacia does not exercise its right to co-develop and market AIM in countries other than the United States and Canada, we will make additional milestone payments, up to an aggregate of $13.5 million, to Pharmacia starting if and when we enroll the first patient in the first Phase III clinical trial for an AIM product in the United States. Instead of paying milestones in cash, if the milestone payments are greater than 10% of our cash reserves at the time of payment, we may instead make these payments by issuing to Pharmacia a promissory note.

Under this license agreement, at the completion of Phase II clinical trials, Pharmacia has the exclusive right of election to co-develop and the exclusive right to market AIM in countries outside of the United States and Canada. In addition, if we pursue a co-development and co-promotion arrangement in the United States and Canada with a third party, Pharmacia has the right of first negotiation to co-develop and co-promote in the United States and Canada. This license expires on the latter of 2018 or upon the last of the Pharmacia patents to expire, unless terminated earlier by a party in accordance with the terms of the license.

Under the agreement entered into in September 1999, we exclusively licensed from a group of inventors the RLT Peptide technology, which now includes four issued U.S. patents and eleven pending U.S. and corresponding foreign, pending patent applications. The RLT Peptide technology relates to peptides and proteins that have activity equal to or greater than, ApoA-I. The issued U.S. patents expire in 2017 and are directed to peptides having ApoA-I activity, pharmaceutical compositions thereof and methods for their use. The pending patent applications are directed to peptides, drug forms containing the peptides, methods of using the peptides, pharmaceutical dosage forms of the peptides, and methods for preparing the dosage forms.

We paid the inventors of our RLT Peptide an initial license fee of $50,000 in January 2000. Our license agreement with the inventors requires us to make payments to them as milestones are achieved, and to pay them royalties on sales of products that are covered by the inventors’ patents or developed using the inventors’ technology. The first milestone payment of $50,000 was paid to the inventors in 2001. Additional milestone

payments, up to an aggregate of $2.1 million, will be paid to the inventors if and when we achieve future development milestones as defined in the agreement with the inventors. This license continues until ten years from the date of license execution or the last to expire of any of the inventors’ patents, unless terminated earlier by a party in accordance with the terms of the license.

In February 2000, we entered into a license agreement with Region Wallonne to obtain exclusive, worldwide rights to its patents, proprietary information and know-how concerning a precursor protein known as proapolipoprotein A-I, or ProApoA-I. We have an exclusive license to a United States patent relating to a gene sequence for ProApoA-I; expression vectors, which are the DNA sequences for the purpose of bacterial production; and a process for producing ProApoA-I. This patent expires in 2008. The agreement continues until the latter of December 2012 or the last to expire of the patents covered by the license, unless terminated earlier by a party in accordance with the terms of the license.

We paid Region Wallonne $25,000 at the time we entered into this license agreement. We are further obligated to pay Region Wallonne royalties on sales of products that are covered by its patents. As part of this license, we agreed to purchase supplies of ProApoA-I from a manufacturer in, and entered into a research collaboration with investigators in, Region Wallonne.

We are also in the process of researching and developing small organic molecules that increase HDL-C levels and also molecules that possess anti-diabetic and anti-obesity and/or lipid management properties. We have filed eight United States patent applications and five international applications directed to classes of compounds having this activity, the use of these compounds and compositions containing these compounds and related to their preparation. We are also pursuing, and will continue to pursue, patent protection for other classes of compounds having this activity, which have been or will be identified in our laboratories. During 2001, we identified a lead candidate from this class of compounds — ESP 31015.

The U.S. Food and Drug Administration, or FDA, and comparable regulatory agencies in state and local jurisdictions and in countries outside of the United States impose substantial requirements on the preclinical and clinical development, manufacture and marketing of pharmaceutical product candidates. These agencies and other federal, state and local governmental entities regulate research and development activities and the testing, manufacture, quality control, safety, effectiveness, labeling, storage, record-keeping, approval and promotion of our product candidates. All of our product candidates will require regulatory approval before commercialization. In particular, therapeutic product candidates for human use are subject to rigorous preclinical and clinical testing and other requirements of the Federal Food, Drug, and Cosmetic Act, or FDC Act, implemented by the FDA, as well as similar statutory and regulatory requirements of countries outside the United States. Obtaining these marketing approvals and subsequently complying with ongoing statutory and regulatory requirements is costly and time-consuming. Any failure by us or our collaborators, licensors or licensees to obtain, or any delay in obtaining regulatory approvals or in complying with other requirements could adversely affect the commercialization of product candidates and our ability to receive product or royalty revenues.

The steps required before a new drug product candidate may be distributed commercially in the U.S. generally include:


	•	conducting appropriate preclinical laboratory evaluations of the product candidate’s chemistry, formulation and stability, and preclinical studies to assess the potential safety and efficacy of the product candidate;

	•	submitting the results of these evaluations and tests to the FDA, along with manufacturing information and analytical data, in an Investigational New Drug application, or IND;


	•	initiating clinical trials under the IND after the resolution of any safety or regulatory concerns of the FDA;

	•	obtaining approval of Institutional Review Boards, or IRBs, to introduce the drug into humans in clinical studies;

	•	conducting adequate and well-controlled human clinical trials that establish the safety and efficacy of the product candidate for the intended use, typically in the following three sequential, or slightly overlapping, stages:


	Phase I: The product candidate is initially introduced into healthy human subjects or patients and tested for safety, dose tolerance, absorption, metabolism, distribution and excretion;

	Phase II: The product candidate is studied in patients to identify possible adverse effects and safety risks, to determine dosage tolerance and the optimal dosage, and to collect efficacy data; and

	Phase III: The product candidate is studied in an expanded patient population at multiple clinical study sites, to confirm efficacy and safety at the optimized dose, by measuring a primary endpoint established at the outset of the study;


	•	submitting the results of preliminary research, preclinical studies, and clinical trials as well as chemistry, manufacturing and control information on the product candidate to the FDA in a New Drug Application, or NDA or Biologics Licensing Application “BLA”; and

	•	obtaining FDA approval of the NDA or BLA and final product labeling prior to any commercial sale or shipment of the product candidate.

Each NDA or BLA must be accompanied by a user fee, pursuant to the requirements of the Prescription Drug User Fee Act (PDUFA) and its amendments. According to the FDA, in 2002 the user fee for an application requiring clinical data, such as a full NDA or BLA, is $313,320. The FDA adjusts the PDUFA user fees on an annual basis. PDUFA is up for reauthorization and will sunset on October 1, 2002, unless reauthorized by Congress.

This process can take a number of years and requires substantial financial resources. There are no assurances that NDAs or BLAs for the product candidates will be accepted or approved. The results of preclinical studies and initial clinical trials are not necessarily predictive of the results of these specific formulations or the results of large-scale clinical trials, and clinical trials may be subject to additional costs, delays or modifications due to a number of factors, including the difficulty in obtaining enough patients, clinical investigators, product candidate supply, or financial support. The FDA may also require testing and surveillance programs to monitor the effect of approved product candidates that have been commercialized, and the FDA has the power to prevent or limit further marketing of a product candidate based on the results of these post-marketing programs. Upon approval, a product candidate may be marketed only in those dosage forms and for those indications approved in the NDA or BLA. However, if approved by the FDA, drug marketers in some limited circumstances may be permitted to distribute published peer-reviewed scientific materials to physicians concerning indications outside of the FDA labeling.

In addition to obtaining FDA approval for each product candidate, the manufacturing establishments for each product must register with the FDA, list products with the FDA, comply with the applicable FDA cGMP regulations and permit and pass manufacturing plant inspections by the FDA. Moreover, the submission of applications for approval may be delayed because of the need for additional time to complete the required manufacturing stability studies. Companies from outside the United States that manufacture products for distribution in the United States also must list their products with the FDA and comply with cGMPs. They are also subject to periodic inspection by the FDA or by local authorities under agreement with the FDA.

Under the FDC Act and related statutes, developers of new drugs are afforded certain limited protections against competition from generic drug companies. Under the 1984 Drug Price Competition and Patent Term Restoration Act, drug companies can have certain product patents extended to counter balance, in part, the

duration of the FDA’s review of their marketing applications. This Act also provides for marketing exclusivity (i.e., protection from generic competition regardless of any available patent protection) for products for which clinical investigations are necessary to support FDA approval of a marketing application. Also, the FDA Modernization Act of 1997 permits under certain circumstances, an additional six months of marketing exclusivity (“pediatric exclusivity”) if the applicant files reports of investigations studying use of the drugs in the pediatric population. The pediatric exclusivity provision is scheduled to sunset on October 1, 2007 and there are no assurances that it will be reauthorized.

Any product candidates that we manufacture or distribute pursuant to FDA approvals are subject to extensive continuing regulation by the FDA, including record-keeping requirements and reporting adverse experiences with the product candidate. In addition to continued compliance with standard regulatory requirements, the FDA may also require further studies, including post-marketing studies and surveillance to monitor the safety and efficacy of the marketed product candidate. Results of post-marketing studies may limit or expand the further marketing of the products. Product candidate approvals may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the product candidate are discovered following approval. In addition, if a manufacturer proposes any modifications to a product, including changes in indication, manufacturing process, manufacturing facility or labeling, a supplement to its NDA may be required to be submitted to the FDA and approved.

The FDC Act also mandates that product candidates be manufactured consistent with cGMP. In complying with the FDA’s regulations on cGMP, manufacturers must continue to spend time, money and effort in production, recordkeeping, quality control, and auditing to ensure that the marketed product candidate meets applicable specifications and other requirements. The FDA periodically inspects manufacturing facilities to ensure compliance with cGMP. Failure to comply subjects the manufacturer to possible FDA action, such as warning letters, suspension of manufacturing, seizure of the product, voluntary recall of a product or injunctive action, as well as possible civil penalties. We currently rely on, and intend to continue to rely on, third parties to manufacture our compounds and product candidates. These third parties are required to comply with cGMP.

Many of our current third-party manufacturers are located outside of the U.S., resulting in the possibility of difficulties in importing our product candidates and/or their components into the U.S., as a result of, among other things, FDA import inspections, incomplete or inaccurate import documentations, or defective packaging.

Products manufactured in the U.S. for distribution abroad will be subject to FDA regulations regarding export, as well as to the requirements of the country to which they are shipped. These latter requirements are likely to cover the conduct of clinical trials, the submission of marketing applications, and all aspects of manufacturing and marketing. Such requirements can vary significantly from country to country. As part of our strategic relationships, our collaborators may be responsible for the foreign regulatory approval process for our product candidates, although we may be legally liable for noncompliance.

We are also subject to various federal, state and local laws, rules, regulations and policies relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances used in connection with our research work. Although we believe that our safety procedures for handling and disposing of such materials comply with current federal, state and local laws, rules, regulations and policies, the risk of accidental injury or contamination from these materials cannot be entirely eliminated.

The extent of government regulation that might result from future legislation or administrative action cannot be accurately predicted. In this regard, although the FDA Modernization Act of 1997 modified and created requirements and standards under the FDC Act with the intent of facilitating product candidate development and marketing, the FDA is still in the process of developing regulations implementing the FDA Modernization Act of 1997. Consequently, the actual effect of these developments on our business is uncertain and unpredictable.

The healthcare industry is changing rapidly as the public, government, medical professionals and the pharmaceutical industry examine ways to broaden medical coverage while controlling health care costs. Potential approaches that may affect us include managed care initiatives, pharmaceutical buying groups, formulary requirements, various proposals to offer an expanded Medicare prescription benefit, and efforts to regulate the prices of pharmaceuticals, which would include drugs for cardiovascular disease. We are unable to predict when any proposed healthcare reforms will be implemented, if ever, or the effect of any implemented reforms on our business.

The pharmaceutical and biopharmaceutical industries are intensely competitive and are characterized by rapid and significant technological progress. Our competitors include large integrated pharmaceutical companies, biotechnology companies, universities and public and private research institutions which currently engage in, have engaged in or may engage in efforts related to the discovery and development of new pharmaceuticals and biopharmaceuticals, some of which may be competitive. Almost all of these entities have substantially greater research and development capabilities and financial, scientific, manufacturing, marketing and sales resources than we do, as well as more experience in research and development, clinical trials, regulatory matters, manufacturing, marketing and sales.

We are aware of companies that are developing invasive procedures for the acute treatment of cardiovascular disease, such as atherosclerosis, that may compete with our product candidates for acute treatments. In addition, new non-invasive medical procedures and technologies are also under development for the acute treatment of cardiovascular disease. Another organization is purifying ApoA-I from outdated human blood, for the treatment of septic shock, which is a complication of severe infection. Other companies with substantially greater research and development resources may attempt to develop products that are competitive with our product candidates for the acute treatment of cardiovascular disease or seek approval for drugs in later stages of development that have similar effects on cardiovascular disease as our acute treatments.

We are also aware of companies that are developing products for the chronic treatment of cardiovascular or metabolic diseases that may compete with our HDL elevators. For example, several other companies have HDL elevators under development, which could compete with our HDL elevators. Other companies with substantially greater research and development resources may attempt to develop products that are competitive with our product candidates or seek approval for drugs in later stages of development that have similar effects as our product candidates.

If regulatory approvals are received, our products may compete with several classes of existing drugs for the treatment of atherosclerosis, some of which are available in generic form. For example, drugs available for the treatment of atherosclerosis include fibrates, statins and niacin, all of which are available in pill or tablet, as compared to the intravenous administration method we intend to use for most of our product candidates. There are also surgical treatments such as coronary bypass surgery and PCI that may be competitive with our products. For those patients, however, who do not respond adequately to existing therapies and remain symptomatic despite treatment with existing drugs and who are not candidates for these surgical procedures, there is no currently effective treatment.

Our product candidates are still under development, and it is not possible to predict our relative competitive position in the future. However, we think that the principal competitive factors in the markets for ETC-588, ETC-216, ETC-642, ETC-276 and ESP 31015 are the following:


	•	safety and efficacy profile;

	•	product price and degree of reimbursement;

	•	ease of administration;

	•	duration of treatment;

	•	product supply;


	•	enforceability of patent and other proprietary rights; and

	•	marketing and sales capability.


	•	attract qualified personnel;

	•	attract parties for acquisitions, joint ventures or other collaborations;

	•	license the proprietary technology that is competitive with the technology we are practicing; and

	•	attract funding.

As of December 31, 2001, we had 79 full-time employees. Of these employees, 59 were engaged in research, preclinical and clinical development, regulatory affairs, intellectual property activities, and/or manufacturing activities and 20 were engaged in finance, legal and general administrative activities.

We are a developmental stage biopharmaceutical company with a history of losses, and, even if our product candidates are approved and commercialized, we may never be profitable.

We have devoted substantially all of our resources since we began our operations in May 1998 to the research and development of product candidates for cardiovascular and metabolic diseases. We have incurred substantial losses since we began our operations. As of December 31, 2001, we had a cumulative net loss of approximately $65.3 million. These losses have resulted principally from costs incurred in our research and development programs, from our general and administrative expenses and from acquisition-related costs from the Company’s September 2000 acquisition of Talaria Therapeutics, Inc. To date, we have not generated revenue from product sales or royalties, and we do not expect to achieve any revenue from product sales or royalties until we receive regulatory approval and begin commercialization of our product candidates. We are not certain of when, if ever, that will occur. We expect to incur significant additional operating losses for at least the next several years and until we generate sufficient revenue to offset expenses. Research and development costs relating to product candidates will continue to increase. Manufacturing, sales and marketing costs will increase as we prepare for the commercialization of our products.

All of our product candidates are in early stages of development, and we face the risks of failure inherent in developing drugs based on new technologies. In addition, most of our product candidates were in-licensed from third parties. As a result, we have limited in-house experience with these product candidates. Our product candidates are not expected to be commercially available for several years, if at all.

All of our current product candidates are designed to treat cardiovascular and/or metabolic disease by manipulating the beneficial properties of HDL. We may defer or cease development of one or more of our product candidates if a product candidate does not show favorable clinical results, if we decide to concentrate our resources on more promising product candidates, or for any other reason. Decisions regarding the selection of product candidates in development and the timing of the development of our product candidates may accelerate the preclinical or clinical testing of one or more product candidates while delaying or ceasing progress of one or more product candidates.

All of our product candidates must be tested and submitted to the FDA and other regulatory agencies for approval before we can sell them, and even if the FDA approves our product candidates, that approval may be limited.

Our product candidates must satisfy rigorous standards of safety and efficacy before they can be approved for commercial use by the FDA, and international regulatory authorities. We will need to conduct significant additional research, including clinical testing involving animals and humans, before we can file applications for product approval.

Many of the product candidates in the pharmaceutical industry do not successfully complete preclinical testing and clinical trials. Also, satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity, and novelty of the product and requires the expenditure of substantial resources. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. For example, a number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials and in interim analyses. In addition, delays or rejections may be encountered based upon additional government regulation, including any changes in FDA policy, during the process of product development, clinical trials and regulatory approvals.

In order to receive FDA approval or approval from foreign regulatory authorities to market a product, we must demonstrate through human clinical trials that the product candidate is safe and effective for the treatment of a specific condition. We do not know whether planned clinical trials will begin on time or will be completed on schedule or at all. If we experience significant delays in testing or approvals, or if we need to perform more or larger clinical trials than planned, our product development costs will increase. Any of our future clinical studies might be delayed or halted because the drug is not effective, or physicians think that the drug is not effective; patients experience severe side effects during treatment; patients die during a clinical study because their disease is too advanced or they experience medical problems that are not related to the drug being studied; patients do not enroll in the studies at the rate we expect; or drug supplies are not sufficient to treat the patients in the studies.

Our clinical studies may also be limited by, delayed or halted because of the nature of the clinical study; the size of the potential patient population; the distance between patients and the clinical trial sites; or the eligibility and exclusion criteria for patients in the trial.

Any product approvals we receive from the FDA in the future could also include significant restrictions on the use or marketing of our products. Product approvals, if granted, can be withdrawn for failure to comply with regulatory requirements or upon the occurrence of adverse events following commercial introduction of the products.

Approval of a product by comparable regulatory authorities may be necessary in foreign countries prior to the commencement of marketing of the product in those countries, whether or not FDA approval has been obtained. The approval procedure varies among countries and can involve additional testing. The time required may differ from that required for FDA approval. Although there are some procedures for unified filings for some European countries with the sponsorship of the country that first granted marketing approval, in general, each country has its own procedures and requirements, many of which are time consuming and expensive. Thus, there can be substantial delays in obtaining required approvals from foreign regulatory authorities after the relevant applications are filed.

Our product candidates may not be commercially successful because physicians, patients, and government agencies and other third-party payors may not accept them.

Even if regulatory authorities approve our product candidates, they may not be commercially successful. Third parties may develop superior products or less costly alternative products, or have proprietary rights that preclude us from marketing our products. We also expect that most of our product candidates will be very expensive, if approved. Patient acceptance of and demand for any product candidates for which we obtain regulatory approval will also depend upon acceptance by physicians of our products as safe and effective therapies and the extent, if any, of reimbursement of drug and treatment costs by government agencies and other third-party payors.

In addition, any of our product candidates could cause adverse events, such as immunologic or allergic reactions. These reactions may not be observed in clinical trials, but may nonetheless occur after commercialization. If any of these reactions occur, they may render any commercialized product ineffective in some patients.

If our current and future manufacturing and supply strategies are unsuccessful, then we may be unable to complete any future clinical trials and/or commercialize our product candidates in a timely manner, if at all.

Completion of our future clinical trials and commercialization of our product candidates will require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We do not have the resources, facilities or experience to manufacture our product candidates on our own and do not intend to develop or acquire facilities for the manufacture of product candidates for clinical trials or commercial purposes in the foreseeable future. We currently rely, and will continue to rely for at least the next few years, on contract manufacturers to produce sufficient quantities of our product candidates. Most of our contract manufacturers have limited experience at manufacturing, formulating, analyzing, filling and finishing our particular product candidates. Our manufacturing strategy presents the following risks:


	•	we may not be able to locate acceptable manufacturers or enter into favorable long-term agreements with them;

	•	third parties may not be able to successfully manufacture our product candidates in a cost effective and/or timely manner or in quantities needed for clinical trials or commercial sales;

	•	delays in scale-up to commercial quantities could delay clinical studies, regulatory submissions and commercialization of our product candidates;

	•	we may not have intellectual property rights, or may have to share intellectual property rights, to the manufacturing processes for our product candidates;

	•	manufacturing and validation of manufacturing processes and materials are complicated and time-consuming;

	•	because many of our current third-party manufacturers are located outside of the U.S., there may be difficulties in importing our product candidates and/or their components into the U.S. as a result of, among other things, FDA import inspections, incomplete or inaccurate import documentation, or defective packaging; and

	•	manufacturers of our product candidates are subject to the FDA’s current Good Manufacturing Practices regulations, the FDA’s current Good Laboratory Practices regulations and similar foreign standards and we do not have control over compliance with these regulations by our third-party manufacturers.

Even if we obtain regulatory approval of any of our product candidates, if we are unable to create sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to successfully commercialize any of our product candidates.

In order to successfully commercialize any of our product candidates, we must either internally develop full sales, marketing and distribution capabilities or make arrangements with third parties to perform these services.

If the third-party clinical research organizations we intend to rely on to conduct our future clinical trials do not perform in an acceptable and timely manner, our clinical trials could be delayed or unsuccessful.

We do not have the ability to independently conduct clinical trials and obtain regulatory approvals for our product candidates, and we currently rely and intend to continue to rely on clinical investigators and third-party contract research organizations to perform these functions. If we cannot locate acceptable contractors to run our clinical trials or enter into favorable agreements with them, or if these third parties do not successfully carry out their contractual duties or meet expected deadlines, we will be unable to obtain required approvals and will be unable to commercialize our product candidates on a timely basis, if at all.

In the near term, we expect our quarterly and annual operating results to fluctuate significantly, depending primarily on the following factors:


	•	timing of preclinical and clinical trials;

	•	interruption or delays in the supply of our product candidates or components;

	•	timing of payments to licensors, corporate partners and other third parties;

	•	timing of patent prosecution


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

		For the fiscal year ended: December 31, 2001, OR

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

		For the transition period from to


Delaware		38-3419139
(State of incorporation)		(I.R.S. Employer Identification No.)


PART I
PART II
INDEX TO FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF OPERATIONS
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PART III
PART IV
SIGNATURES
INDEX TO EXHIBITS
Memorandum of Understanding
Loan & Security Agreement
Loan Modification Agreement
Confirmation of Sublease Terms


		Page

	PART I
Item 1.	Business		1
Item 2.	Properties		23
Item 3.	Legal Proceedings		24
Item 4.	Submission of Matters to a Vote of Security Holders		24
	PART II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters		25
Item 6.	Selected Consolidated Financial Data		26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 7A	Quantitative and Qualitative Disclosures about Market Risk		33
Item 8.	Financial Statements and Supplementary Data		34
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		53
	PART III
Item 10.	Directors and Executive Officers of the Registrant		53
Item 11.	Executive Compensation		53
Item 12.	Security Ownership of Certain Beneficial Owners and Management		53
Item 13.	Certain Relationships and Related Transactions		53
	PART IV
Item 14.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		54
SIGNATURES			58

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	ETC-642 (RLT Peptide)


	ETC-276 (ProApoA-I)


	ESP 31015 (HDL Elevators)


	Manufacturing and Materials Supply