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Arena (ARNA: NASDAQ) Update from NAASO; Reiterate Buy (1) Rating and $14 Price Target

Biotechnology
Caroline Stewart (212) 218-3853
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Further details from the Phase IIa study of APD356 in obesity were provided during an oral presentation at the annual North
American Association for the Study of Obesity (NAASO) meeting in Vancouver by principal investigator Steven Smith. As a
reminder, in the Phase IIa study, approximately 60% of subjects in the 15 mg APD356 arms lost at least 1 kg and 25% lost up
to 1 kg. This was highly statistically significant.
Importantly, for the first time, further details were presented on the echocardiograms. Specifically, results demonstrated that
the drug was safe and that there was no apparent affect of the drug on heart valves or pulmonary artery pressure. Patients in
the placebo group actually had more ‘noise.’
Additionally, data were presented on the affect of APD356 on lipids. While the four-week dosing period is too short to
definitively demonstrate any improvements, we believe that the preliminary data show that APD356 has potential to improve
subjects’ total cholesterol and triglyceride levels.
Based on our discussions with physicians attending the conference, we believe that APD356 is a promising new agent for the
treatment of obesity. In our opinion, the agents currently on the market, as well as Acomplia (rimonabant) from Sanofi (SNY
- $40.75 - NYSE), are suboptimal in that they have comparable weight loss and undesirable side effects. Additionally, we
expect that combination therapy will allow for multiple players in the obesity market.
We continue to expect data from the Phase IIb study of APD356 to become available around year-end, as enrollment of 460
patients in this 12-week study was completed in August. We believe that the Phase IIb study is well over 90% powered to show
a 3 kg placebo-adjusted weight loss.
Valuation: Our price target is $14, derived by applying a 40x P/E multiple to our 2012 EPS projection of $1.68, discounted at
a rate of 30%. In our opinion, a 40x multiple is warranted given the large potential markets for the drugs in development.
We view the discount rate of 30% appropriate for what we consider relatively high clinical, regulatory and market risks
associated with the two lead drug candidates.
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The Disclosure Section can be found on page 7 of this report.
The Valuation Section can be found on page 1 of this report.
=============================================================================== Price (as of close 10/18/05)
EPS FY 12/31 2004A 2005E
52-Week Range
Shares Outstanding
Market Capitalization
3 Mo. Avg. Daily Volume
Book Value/Share (6/05)
Price/Book Value

Update from NAASO
Further details from the Phase IIa study of APD356 in obesity were provided during an oral presentation at the annual North
American Association for the Study of Obesity (NAASO) meeting in Vancouver by principal investigator Steven Smith. As a
reminder, in the Phase IIa study, approximately 60% of subjects in the 15 mg APD356 arms lost at least 1 kg and 25% lost up to 1 kg.
This was highly statistically significant.
Importantly, for the first time, further details were presented on the echocardiograms. Results demonstrated that the drug was safe and
that there was no apparent affect of the drug on heart valves or pulmonary artery pressure. Specifically, mitral and tricuspid valves
were rated on a scale of 0 to 5 (0=absence to 5=severe) and comparisons were made for a 2-category increase in any valvular
insufficiency at Day 29 and Day 90. It is our understanding that this is a highly variable measurement and semi-objective. Therefore,
a 2-category change was measured in order to increase confidence that the movement was real.
Results showed that in the placebo group there were five patients who had six movements (i.e., one patient had at least a 2-category
movement both at Day 29 and Day 90). There were two patients who experienced movements at Day 29 and Day 90 in the 1 mg
APD356 group. No such movements were experienced by patients in the 5 mg APD356 group. In the 15 mg APD356 group, 1 patient
had a 2-category movement at Day 29 and two patients had a 2-category movement at Day 90. Thus, patients in the placebo group
actually had more ‘noise.’ We view these results as very positive. We note that no patients reached the severe 5 score.
Table 1: APD365-003 Echocardiography: Patients with 2-Category Increase in any Valvular Insufficiency from Screening
Source: NAASO 2005
Additionally, data were presented on the effect of APD356 on lipids. While the 4-week dosing period is too short to definitively
demonstrate any improvements, we believe that the preliminary data show that APD356 has potential to improve subjects’ total
cholesterol and triglyceride levels. Specifically, there was an 8.6 reduction in serum total cholesterol and 2.9 reduction in serum
triglycerides in the 15 mg APD356 group. We believe that these are important as metabolic syndrome becomes a tool by which
weight-loss drugs may potentially obtain reimbursement in the future.
Based on our discussions with physicians attending the conference, we believe that APD356 is a promising new agent for the
treatment of obesity. In our opinion, the agents currently on the market, as well as Acomplia from Sanofi, are suboptimal in that they
have comparable weight loss and undesirable side effects. Furthermore, we continue to believe that combination therapy is likely to
continue to expand and evolve in the future as more drugs are developed.
Orlistat and Xenical
In a poster titled “The Safety of Orlistat and Sibutramine: A Summary of the Prescription-Event Monitoring Data,” presented on
October 16, 2005, the observational safety profiles of Xenical and Meridia (the respective brand names), the only two drugs approved
in the UK for obesity, were examined. In this dataset, there were 16,021 Xenical subjects and 12,336 Meridia subjects. There were
368 adverse events (AE) in 315 subjects (2.0%) on Xenical, the most common being diarrhea (75) and flatulence (23). There were
445 AEs in 304 subjects (2.5%) on Meridia, the most common being headache/migraine (31) and malaise/lassitude (31). More
importantly, however, was the fact that approximately 30% of Orlistat subjects (n=4,854) and 42% of Meridia subjects (n=5,157)
stopped therapy within 3 months of initiation. The main reason cited for stopping therapy was lack of efficacy.
Combination Therapy
In our opinion, similar to hypertension, there will be considerable combination therapy for the treatment of obesity. Unfortunately,
however, multiple drug regimens are frequently not even additive, much less synergistic. We are aware of only one study suggesting
that the combination of Xenical and Meridia is slightly additive, although we have heard anecdotal accounts that the combination may
be more additive than the study suggests. We point out that the same can be said of the fen-phen combination. The published data for
fen-phen by Weintraub, in which the dose of each of the drugs was approximately halved, showed a comparable weight loss to
marketed drugs. However, it was the unpublished reports of subjects losing much more weight that led to the significant increase in
prescriptions. We are not aware if patients who took the fen-phen combination tended to take the lower doses of each drug or the full
doses, but regardless, the mechanisms of action of each drug are generally believed to have caused the sometimes fatal side effects. It
is our understanding, based on discussions with physicians at the NAASO meeting, that phentermine is not infrequently prescribed for
long-term use even though it is only approved for short-term use. The persistent popularity of phentermine, in our opinion, is due to
its positive effect on quality of life. Other weight-loss drugs tend to have side effects that are deleterious to quality of life.
Sibutramine and Rimonabant
Of interest was a poster presented on Monday titled “Additive Benefits of Combination Therapy with Sibutramine and Rimonabant on
Body Weight, Insulin Sensitivity and Lipoproteins in Diet-Induced Obese Mice.” Results showed that weight loss was superior
(nearly additive) with the combination vs. either drug therapy alone initially, but that after several weeks, this additive effect
dissipated. Neither sibutramine, rimonabant nor the combination suppressed caloric intake beyond Day 4. The combination therapy
was shown to improve insulin sensitivity, whereas neither of the two compounds alone was able to do this. Highly significant
decreases in total cholesterol were seen in all treatments.
Dose Increase
Interestingly, there was a poster presented on Monday by Dr. Nick Finer titled “The STORM Study: Analysis of Sibutramine 10 mg
and 15 mg Data.” The original STORM (Sibutramine Trial of Obesity Reduction and Maintenance) study was published in the Lancet
in 2000. STORM was a double-blind, placebo-controlled trial in which subjects who successfully lost at least 5% of their baseline
body weight at six months on 10 mg sibutramine were then randomized to continue receiving 10 mg sibutramine or switched to
placebo for another 18 months. Patients were allowed to escalate the dose to 15 mg or 20 mg upon weight regain.
There were 605 subjects at baseline, of which 499 completed the first six months of the study. The majority, 457 subjects, entered the
maintenance phase of the study (261 subjects, or 56%, actually completed the study). A total of 352 subjects were randomized to
drug, while the remaining 115 were switched to placebo. Among the subjects receiving the drug, 86 continued on the 10 mg dose for
18 months, while 266 titrated up to 15 mg (83 maintained at 15 mg), and 183 subjects went to 20 mg. Among those randomized to
placebo, 11 maintained the 10 mg placebo dose, 104 titrated to the 15 mg placebo dose (of which 20 maintained at this dose) and 84
titrated up to the 20 mg placebo dose.
Despite the data being old, we think that this newer analysis is important. It demonstrated that for responders Meridia works quite
well, but that for reasons unknown subjects who do not respond well to sibutramine continue to gain weight over time. In fact, their
weight approaches the weight of patients receiving placebo, despite increasing the dose of sibutramine to the unapproved dose level
of 20 mg. It again makes the point that there is no single drug that works in all obese patients.
Rimonabant
Hence, in our opinion, rimonabant is unlikely to have a severe negative impact on potential new entrants like APD356 to the obesity
space. In speaking with clinicians, there is a wide range of opinions on rimonabant, from enthusiasm to skepticism. Based on the
available data, we believe that rimonabant has comparable efficacy to currently marketed obesity drugs. In our opinion, the safety is
not alarming (topiramate would have been more concerning), but rimonabant has side affects, as do all drugs. We believe that, despite
the fact that some patients who developed depression/anxiety were removed from the studies, these were still not an overwhelming
number.
Background on the APD356-003 Study (Phase IIa)
Initiated in December 2004, this Phase IIa study was a double-blind, placebo-controlled, parallel-group four-week trial in 352 healthy
subjects. The average age of subjects in the study was 40 years (range 38-41), and 80% were women. The average weight was 101.4
kg (range 99.7-105.0) or 223.1 lbs (range 219.3-231.0), with a BMI (body mass index) of 36.3 (range 35.6-36.9). The subjects had to
be non-smokers and could not be on other medications. The study did not include any change in diet or exercise, with the exception
that they could not drink alcohol. Subjects were randomized to receive 1, 5 or 15 mg of APD356 or placebo. The primary endpoint of
the study was the relative weight loss at Day 29. The study was greater than 90% powered to show at least a 1 kg weight loss
difference relative to placebo. Additionally, echocardiograms were performed at baseline, Day 29 and Day 90.
In May 2005, the company announced that results from this trial showed highly statistically significant (p=0.0002) mean weight loss
of 2.9 pounds in patients taking the 15 mg dose of APD356 vs. 0.7 pounds for the placebo group over the four-week treatment period,
and that APD356 was generally well tolerated at all doses investigated.
Table 2: APD356-003 Weight Change: Day 29 - Baseline (Completers)
Mean Weight Change
P-value vs
# Subjects
Source: NAASO 2005

Table 3: APD356-003 Weight Change: Day 29 - Baseline (ITT/LOCF)
Mean Weight Change
P-value vs
# Subjects
Source: NAASO 2005

In terms of adverse events, the most commonly reported adverse event was nausea and headache, which were more frequent in the 15
mg dose group. Adverse events tended to occur early, were generally mild-to-moderate in nature, and continued for one-two days.
There were eight dropouts in the 15 mg group, two due to headaches possibly related to the drug, and one due to pregnancy. There
were two dropouts in the 5 mg group, one possibly related to the drug. There was one dropout in the 1 mg group that was unrelated to
the drug, and one dropout in the placebo group from nausea/dizziness.
In August 2005, Arena announced that an assessment of follow-up echocardiograms taken approximately 90 days after patients
received their first doses of APD356 indicated no apparent drug effect on heart valves or pulmonary artery pressure after four weeks
of dosing. We view safety of the drug as critical to its success given that the efficacy based on this Phase IIa study shows it to be
comparable to effective past and present drugs.
Currently Ongoing: APD356-004 (Phase IIb)
Similar to the Phase IIa study, this Phase IIb study is in four parallel groups of subjects who again receive no diet or exercise advice.
There is no run-in and the dosing regimen is 12 weeks. Subjects are randomized to receive 10 mg once daily (QD), 15 mg QD, 10 mg
twice-daily (BID) or placebo. The 10 mg BID regimen is designed to provide similar peak levels at the 15 mg QD regimen, but higher
trough levels. We note that in the Phase I study dose-limiting adverse effects were seen with single doses at 40 mg. Additionally, the
Phase IIb has a broader inclusion criterion vs. the Phase IIa study, which allows subjects to use medications for the treatment of
hypertension and high cholesterol, as well as subjects who have mild mitral insufficiency. Echoes are performed at screening and at
Day 90.
We expect an announcement of positive results from the Phase IIb study of APD356 in obesity around year-end. We believe that the
Phase IIb study is well over 90% powered to show a 3 kg placebo-adjusted weight loss. Assuming positive results in the Phase IIb
study, we expect the company to initiate Phase III studies in mid-2006. We expect that the Phase III trials will be 12-month treatment
studies, with a safety database of at least 1,500 subjects and echoes in a subset. Unlike the Phase II studies, Phase III studies should
also include diet and exercise counseling.

Market Opportunity
It is estimated that approximately 64% of US adults are overweight or obese, with 5% considered morbidly obese, making diet drugs
a multi-billion dollar market. Despite the enormous potential of the obesity market, it is unlikely, in our opinion, that a single drug can
eliminate obesity given the multiple metabolic pathways involved. Analogous to other chronic illnesses, combination regimens may
be required in order to successfully overcome obesity. We are therefore conservative in our projections for APD356. With a New
Drug Application (NDA) filing in 2009, we believe that APD356 could reach the market in 2010. We very conservatively (in our
view) project sales in the launch year of $200mm, growing to $300mm in 2011 and $400mm in 2012.
Table 4: Upcoming Milestones
APD125 (insomnia) Initiate Phase II trial Source: Company reports and Morgan Joseph & Co. Inc. estimates.

Risks
The major risks to our projected EPS and target stock price include:
Failure of lead drug candidate APD356 for the treatment of obesity in clinical trials. In our opinion, the greatest risk lies in the
safety of APD356. We believe the life-threatening heart valve problems with the popular “fen-phen” combination raises the bar for
safety that the FDA will want to see before approving similar diet drugs. In terms of efficacy, the potential for tolerance to develop to
5-HT agonists, possibly through receptor de-sensitization, has been well-documented. However, this may be dependent on dosing
regime, with higher, fluctuating plasma concentrations leading to tolerance. We point out that in pre-clinical animal models, APD356
has shown no propensity for de-sensitization with chronic dosing.
Failure of second clinical stage drug APD125 for the treatment of insomnia in clinical trials. While the early Phase I clinical data
for ADP125 appear promising, we note that the drug works by a new (i.e., unproven) mechanism of action.
Failure of partnered drug development candidates. These drug candidates are in even earlier stages of development, and therefore
the probability of success must be further handicapped.
The company will need to raise additional funds prior to attaining profitability. The company has provided guidance that it
intends to end the year with approximately $122mm in cash and cash equivalents. We estimate that the company will need to raise
additional funds in 2007.

Table 5: Arena Income Statements 2004A-2012E ($ in thousands)
Total revenue
13,685.8
21,752.7
47,583.2
63,848.0
86,000.0
94,000.0
162,500.0
221,000.0
291,000.0
(15,891.8) (15,637.4) (21,421.7) (70,252.4) Earnings after tax
15,667.8
51,696.3
95,749.2
Net loss to shareholders
(61,281.0) (25,035.0)
(16,349.4) (16,131.7) (21,921.7) (79,437.8)
(59,456.8)
(50,711.0)
(36,527.3)
(35,120.7)
15,497.8
51,696.3
95,749.2
Source: Company reports and Morgan Joseph & Co. Inc. estimates =============================================================================== Company Description: Arena Pharmaceuticals, Inc. (www.arenapharm.com) is a development-stage biopharmaceutical company with a pipeline of internally generated small molecule product candidates that target G protein-coupled receptors, or GPCRs. Three of these are in clinical development: APD356 for the treatment of obesity, APD125 for insomnia, and in collaboration with Merck, a product candidate for the treatment of atherosclerosis. The company also has a collaboration with Ortho-McNeil (a Johnson & Johnson company), in the area of type 2 diabetes Required Disclosures
I, Caroline Stewart, the author of this research report, certify that the views expressed in this report accurately reflect my personal
views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the
specific recommendations or views contained in this research report.
Research analyst compensation is dependent, in part, upon investment banking revenues received by Morgan Joseph & Co. Inc.
Morgan Joseph & Co. Inc. has managed or co-managed a public offering of securities or received compensation for investment
banking services from the subject company within the past 12 months.
Morgan Joseph & Co. Inc. expects to receive or intends to seek compensation for investment banking services from the subject
company within the next 3 months.
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Of the securities currently subject to research coverage by Morgan Joseph & Co. Inc., the percentage rated as a “Buy” is 60%; the
percentage rated as a “Hold” is 40%; and the percentage rated as a “Sell” is 0%.
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Copyright 2005 by Morgan Joseph & Co. Inc.

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