Zacks Investment Research



|Arena Pharmaceuticals |(ARNA – NASDAQ) |12.94 |

Note: This report contains substantially new material. Subsequent report will have changes highlighted.

Reason for Report: 2Q07 Earnings Update Prev. Ed.: June 13, 2007

Recent Events

On July 19, 2007, ARNA reported financial results for the second quarter of 2007. The company generated total revenue of $4.8M and pro forma loss of $0.64 per share for 2Q07.

On July 18, 2007, ARNA announced initiation of Phase I clinical trial program of APD 791 for the treatment of Arterial Thrombosis.

Overview

Based in San Diego, California, Arena Pharmaceuticals, Inc. (ARNA), a clinical-stage biopharmaceutical company, focuses on the discovery, development, and commercialization of drugs in the therapeutic areas of metabolic, cardiovascular, inflammatory, and central nervous system diseases in the United States. Its pipeline products include Lorcaserin – a Phase III clinical trial product, which would be used for the treatment of obesity, APD 668 – a Phase I clinical trial product for the treatment of diabetes, APD 125 – a Phase II clinical trial product for the treatment of insomnia, and Niacin – a Phase I clinical trial product for the treatment of raised HDL/atherosclerosis.

Analysts have identified the following investment merits and demerits of ARNA stock:

|Key Positive Arguments |Key Negative Arguments |

|Strong Cash position: A strong cash position gives ARNA an aggressive edge|Clinical & Regulatory Risks: ARNA’s drugs are still in clinical trials, and a |

|over its competitors. It helps the Company to focus more on R&D |majority of drugs entering trials have historically failed to obtain approval |

|activities, thereby accelerating drug development programs. |because of inadequate safety, efficacy, or economics. |

| | |

|Compelling Fundamentals: ARNA is a development-stage biopharmaceutical |Competition: Analysts expect many public and private companies to offer |

|company in the forefront of small-molecule technology for large diseases, |competition to ARNA. The Company’s obesity and insomnia drugs face competition |

|excellent management, and a keen focus on bettering current therapies. |from Eli Lily, Sanofi-Aventis, and Merck. |

| | |

|Large Market Opportunity: The company is building a pipeline of wholly |Partnership Risks: Arena will probably depend on commercial expertise of its |

|owned and partnered drugs with large market opportunities. |partners who may be unable or unwilling to penetrate the markets adequately. |

| | |

|Upcoming Catalysts: Arena has multiple clinical catalysts upcoming |Pipeline Risks: Arena has never commercialized a product and as such depends |

|throughout 2007, such as lorcaserin, APD 125 are progressing well. |heavily on successful outcome of current pipeline candidates. Failure in |

| |clinical development, especially lead drug lorcaserin, could be detrimental for |

| |Arena’s stock price. |

Note: The Company’s fiscal year coincides with the calendar year.

Arena Pharmaceuticals formed research alliance and licensing relationships with large pharmaceuticals players such as Merck & Co., Inc., Ortho-McNeil, a Johnson & Johnson Company, Eli Lilly, and Fujisawa. For more information on ARNA visit the Company website at .

Revenue

According to the Zacks Digest report, total revenue in 2Q07 was $4.8M, down 48.4% versus 2Q06. Total revenue in 1H07 was $9.7M versus $21.4M in the 1H06.

Total revenues were derived via payments from collaboration partners J&J at 60% and Merck at 40%.

Provided below is the summary of total revenues as per the Zacks Research Digest:

|($ in M) |2006A |1Q07A |2Q07A |3Q07E |4Q07E |

APD 125

Indication: Insomnia

Stage of development: Currently in Phase II

Importance: APD 125 is a novel oral 5-HT2A agonist serotonin receptor developed to treat insomnia. A few analysts believe APD 125 clearly improves sleep maintenance, but questions remain about the speed of onset of sleep. Therefore, clinical signals from other studies, especially the Phase II study are awaited.

Safety Issues: By selectively targeting the 5-HT2A receptor, APD 125 acts through a different mechanism than currently marketed insomnia drugs and blocks a general CNS activating effect. Because of the different mechanism of action, APD 125 may not have the side effects generally associated with the currently marketed drugs. Additionally, APD 125 has the potential to improve sleep quality by increasing time spent in slow wave sleep and also improve sleep maintenance.

Sales: As many as 70M Americans suffer from a chronic disorder of sleep and wakefulness, according to a report from the Institute of Medicine. Patients with such disorders are at higher risk of a range of health effects, from diabetes to depression to stroke. The report states that insomnia is a multi-billion dollar market despite low awareness about the burden of sleep loss among the general public. Hence, adequate scope for gaining the market exists, thereby driving total sales of ARNA in the long term.

Competitors: Currently, marketed therapies for insomnia include Ambien, marketed by Sanofi-Aventis, zaleplon, an off-patent compound, and various benzodiazepines, including Valium. These generally work by activating the GABA-A receptor in the brain and cause a CNS-suppressive effect. While being effective, they have side effects including the risk of developing tolerance to the drug and the potential for causing a sensation of dullness and lethargy upon awakening. This gives APD 125 a cutting edge. However, the drug is likely to encounter competition from a new generation of drugs, such as Takeda's Ramelteon and Sanofi/Lilly's 5-HT2A drug that is currently more than a year ahead of Arena's.

New Data: On March 5, 2007, ARNA announced initiation of dosing in a Phase II clinical trial of APD 125 in chronic insomnia patients. ARNA completed patient enrollment in a Phase II trial of APD125, a randomized, double-blinded, placebo-controlled study evaluating the safety and efficacy of nighttime dosing in patients with chronic insomnia. The process was conducted at approximately 25 clinical sites in the United States. One firm (UnionBankSwitz.) anticipates data from APD 125 Phase II study in the third quarter of 2007, probably in September.

This trial employs a cross-over design, which means that every patient receives both active doses of APD 125 (10 mg and 40 mg) and placebo in random order, for one week, separated by at least one week to allow for wash out of the study drug.

APD 668

Indication: Type II Diabetes.

Stage of Development: A Phase I trial on APD 668 initiated in February 2006 and expected to be completed by third quarter of 2007.

Importance: It is a potential treatment of Type II diabetes utilizing the glucose-dependent insulinotropic (GDI) receptor discovered by Arena. The GDI is a novel receptor that has the potential to stimulate insulin production in response to an increase in blood glucose. The Company has a patent from the European Patent Office for screening drugs utilizing the GDI receptor.

Safety Issues: The clinical trial will evaluate the safety, tolerability, pharmacokinetics, and pharmacodynamics of single escalating doses of APD 668. The Phase I trial will also measure responses to a glucose challenge to examine early evidence of potential efficacy in treating Type II diabetes. Current oral medications for Type II diabetes have a number of side effects, including hypoglycemia, weight gain, and edema.

Competitors: Current oral medications for Type II diabetes include insulin releasers such as Glyburide, insulin sensitizers such as Actos and Avandia and agents that are already in an advanced stage, and could pose stiff competition to APD 668.

Partner: In December 2004, Arena entered into a collaboration and license agreement with Ortho-McNeil, a Johnson & Johnson company, to further develop compounds for the potential treatment of Type II diabetes and other disorders. In September 2006, Ortho extended the collaboration for an additional year.

Collaboration Revenue: ARNA received a $17.5M upfront payment and two milestones payments of $2.5M each. The company is eligible to receive up to $295.0M in milestone payments, as well as royalty payments associated with Ortho-McNeil's commercialization of any drug discovered under the agreement. These milestone payments include development and approval milestone payments of up to $132.5M for the first indication and $62.5M for the second indication, and up to $100.0M in sales milestone payments resulting from the collaboration.

APD 791

Indication: Cardiovascular disease, particularly thrombosis

Stage of Development: On July 18, 2007, ARNA announced that it initiated dosing in a Phase 1 clinical trial evaluating APD791 for the treatment of arterial thrombo-embolic diseases. One firm (CIBC) believes that data from the first Phase I trial should be available by early 2008. The Phase I trial will seek to enroll 72 healthy adult volunteers and primarily intended to evaluate the safety and tolerability of single ascending doses of APD791. The trial will also evaluate the pharmacokinetics and pharmacodynamics of APD791. Arena plans to initiate a second Phase I multiple ascending dose trial on APD791 once the first trial is complete.

Importance: It is a novel, oral selective inverse agonist of the 5-HT2A serotonin receptor that selectively inhibits the activation of 5-HT2A serotonin receptors on platelets and vascular smooth muscle. APD 791 may reduce the risk of arterial thrombosis, acute coronary syndrome, myocardial infarction, and stroke, without increased risk of bleeding.

Niacin

Indication: Atherosclerosis and related disorders

Stage of Development: The drug is currently in Phase II trial.

Importance: There are drugs available for lowering LDL cholesterol. However, development of novel, effective therapies to increase HDL cholesterol remains a major focus of ARNA’s research. The collaboration with Merck validates ARNA’s technology platform, and should garner increased big pharma interest in the company’s unpartnered small molecule product candidates.

Partner: In October 2002, ARNA entered into a research and licensing agreement with Merck to collaborate on three GPCRs to develop therapeutics for atherosclerosis and related disorders. In October 2004, Merck extended and expanded this collaboration and selected the above-mentioned compound for preclinical development. The Phase II trial of an oral Niacin GPCR compound was initiated by Merck in May 2006, which triggered a $4.0M milestone payment to ARNA. However, Merck discontinued the development of the drug in the atherosclerosis indication in September 2006. However, it is being further evaluated in preclinical studies for continued development in an undisclosed indication.

Collaboration Revenue: Through July 2005, the company received $21.5M from Merck in upfront and milestone payments and an equity investment. It may receive additional milestone payments of up to $34.0M for Merck’s clinical and marketing achievements, as well as royalty payments associated with Merck’s commercialization of any drugs discovered under the agreement. In addition, ARNA received research funding from Merck since the inception of the collaboration, and Merck has agreed to pay $5.7M a year for collaboration research through October 2007.

Collaboration and Milestone Payments

Arena intends to commercialize its product candidates independently and with partners. The company has retained commercial rights for most of its advanced development programs, except for its diabetes partnership with Ortho-McNeil Pharmaceutical, Inc., a Johnson & Johnson Company, and the cardiovascular collaboration with Merck & Co., Inc. As such, it makes a smooth stream of revenue from royalty and upfront milestone payments. In 2Q07, total collaboration and milestone payments amounted to $4.8 M, down 48.4% YoY, versus $9.3M in 2Q06.

In September 2006, Ortho-McNeil extended the collaboration for an additional year and entered into an agreement with ARNA in December 2004 to develop compounds for treatment of Type II diabetes using the Glucose-Dependent Insulin tropic Receptor, or GDIR, for one additional year. The GDIR is a novel receptor discovered by Arena that has the potential to stimulate insulin production in response to increases in blood glucose. By extending the research term for an additional year, Ortho-McNeil is committed to provide research funding to Arena in the amount of $2.4M.

Recent results demonstrate that the two high-profile collaborations mentioned above are progressing well. Analysts believe that besides the partnered programs, Arena Pharmaceuticals intends to bring another compound into the clinics by 2007. The company is currently filing an investigational new drug (IND) application for this new compound. Other drugs in the pipeline (still in research stage) include drugs for diabetes, wakefulness promotion, cardio protection, and to treat inflammation (cytokine modulators and T&B cell modulators).

Margins

As no drug in the pipeline is marketed yet, cost of goods sold was $0.0M for 2Q07 and also for the year, gross profit was equal to total revenue for both 2006 and 2007. According to analysts, cost of goods sold is expected to be nil for some years in the future.

According to the Zacks Digest report, R&D expense totaled $40.6M in 2Q07, up 85.6% YoY versus $21.9M in 2Q06. The company indicated that the increase in R&D expenses in 2Q07 as compared to the 2Q06 was primarily due to an increase in clinical development expenses associated with the Phase III Locarserin BLOOM trial and the Phase II APD125 trial for the treatment of insomnia.

According to the Zacks Digest report, SG&A expense in 2Q07 was $6.5M, up 83.5% YoY versus $3.5M in 2Q06. SG&A expenses in 1H07 totaled $11.8M versus $9.3M in 1H06. The company indicated the increase in SG&A expenses is due to personal related expenses, primarily non-cash, stock based compensation expense.

The company has no tax liability so far, and has a negative pre-tax income. Some analysts expect tax liability to accrue from the year 2008.

Check the tab

|FY ends Dec |

|Positive |80.0%↓ |

|Neutral |20.0%↑ |

|Negative |0.0% |

|Avg. Target Price |$20.17↑ |

Long-Term Growth

Arena Pharmaceuticals is seeking to enter highly contested markets in metabolic, cardiovascular, central nervous system, and inflammatory disorders. Many companies are working on compounds for obesity, sleep disorders, cholesterol management, and Type II diabetes. Arena’s expertise in G protein-coupled receptors (GPCRs) may eventually bring some relief for patients suffering from the above-mentioned diseases and disorders. More results on the two most significant compounds (APD 125 and APD 356) will help analysts assess the company’s competitive strength and eventually the possibility of its success on launch. A strong cash position helps the company to focus more on research and development activities, which, in turn, helps to accelerate the drug development programs, giving it an extra edge over its competitors. Progress with existing partnerships and ARNA’s pipeline should provide additional catalysts to the company’s long-term growth.

Potentially Severe Problems

None other than those discussed in other sections of this report.

Capital Structure/Solvency/Cash Flow/Governance/Other

Cash, cash equivalents, and short-term investments totaled $371.0M on June 30, 2007. Approximately 60.9M shares of common stock were outstanding on June 30, 2007. Arena reported that it is increasing its financial guidance for 2007 year-end cash, cash equivalents, and short-term investments to approximately $259 to $271 million from $211 to $223 million previously guided. The increase is due to the net proceeds of approximately $48 million Arena received in May from the sale and leaseback of properties to an affiliate of BioMed Realty Trust, Inc.

ARNA could move to partner either of these programs in 2007, but 2008 as more likely. A partnership is expected to bring more than 100M upfront milestone payments.

On May 03, 2007, ARNA announced the sale of three properties owned and occupied by Arena to an affiliate of BioMed Realty Trust, Inc. and the assignment to BioMed of an option to purchase a fourth property currently leased and primarily occupied by Arena. Total consideration received by Arena for the properties and the purchase option was $50.1 million.

Upcoming Events

|Date |Event |

|3Q07 |6-month interim safety analysis by DSMB in Phase III BLOOM trial |

|2H07 |Data from Phase I trials of APD668 |

|2H07 |Initiation of two additional Phase III clinical trials for Lorcaserin |

|2H07 |Topline results from APD 125 Phase II study |

Individual Analyst Opinions

POSITIVE RATINGS

Lazard Capital – Buy ($18 – target price): 07/20/07. INVESTMENT SUMMARY – The firm’s recommendation is based primarily on the potential for lorcaserin in treating obesity and on the company’s matured pipeline.

Leerink Swann – Outperform 07/20/07. INVESTMENT SUMMARY – The firm has faith in the robustness of the company’s discovery capabilities, which has been validated through partnerships with JNJ and Merck. The firm believes that despite the progress in the product pipeline it will take clean lorcaserin safety data to remove the overhang on the stock.

Maxim Group – Buy ($28 – target price): 07/20/07. INVESTMENT SUMMARY – The firm states that this is a low-risk event, and that the current valuation of the stock provides an attractive entry point. The firm believes that the stock to appreciate in value in a step function upon 6-month and 12-month DSMB results.

Mont&Co. – Buy ($25 – target price): 07/20/07. INVESTMENT SUMMARY – The firm believes that top four drugs in Arena’s pipeline target the large and growing market for obesity, insomnia, diabetes, and cholesterol. If Arena or its partners are able to bring any of these drugs to the market in the next 3–4 years, investors at current level can expect a good return on Arena shares.

AG Edwards - Buy ($18 – target price): 07/20/07. INVESTMENT SUMMARY – It believes that the market will assign a value of at least $200 million to Arena’s pipeline and drug development platform, APD125 for insomnia and ADP791 for thrombosis. The firm also views it as an attractive entry point for speculative investors who can afford risks. It additionally believes that the shares will appreciate ahead of the 6 month DSMB review expected in 3Q07.

Cowen – Outperform: 07/20/07. INVESTMENT SUMMARY – ARNA has a record of identifying novel and promising targets and many possible paths to become a $1B+ company. The firm expects ARNA shares to outperform the market by 25% over the next 12–18 months.

Merrill – Buy: 07/20/07. INVESTMENT SUMMARY – The firm believes that there could be a $5 swing for ARNA stock depending on the DSMB outcome at the current level.

Piper Jaffray – Outperform ($20 – target price): 07/20/07. INVESTMENT SUMMARY – The firm is encouraged by the prospects for Lorcaserin and the company’s platform technology for generating new drug candidates.

NEUTRAL RATINGS

Lehman – Equal weight ($14 – target price): 07/20/07. INVESTMENT SUMMARY – Though it remains impressed with ARNA’s pipeline progress, it believes there is some uncertainty on valve effects, so that a wait and watch approach is appropriate.

B. of America – Neutral ($16 – target price): 07/19/07. INVESTMENT SUMMARY – The firm expects positive analysis from the upcoming DSMB data in the third quarter of this year and believes that shares of Arena to trade upward based on the results.

NEGATIVE RATINGS

None

CEASED COVERAGE

Prudential – June 06, 2007 – The firm has discontinued coverage on the stock because of departure of the covering analyst from the firm.

Research Associate: Subhasish Mukherjee

Reviewed by:

Copy Editor: Salma Islam

Content Ed.: Shilpa Chandak

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July 20, 2007

Zacks Research Digest Research Associate: Subhasish Mukherjee, MBA (Fin.)

Editor: Shilpa Chandak, CA

Sr. Ed: Ian Madsen, CFA, imadsen@; 1-800-767-3771, x9417

111 N. Canal Street, Suite 1101 Chicago, IL 60606

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