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ARCA BIOPHARMA, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 13, 2014

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995. These statements include, but are not limited to, statements regarding the Company's anticipated timing for initiation or completion of its clinical trials for any of its product candidates; the potential for Gencaro to be an effective potential treatment for atrial fibrillation and, the Company's ability to fund future operations. Such statements are based on management's current expectations and involve risks and uncertainties. Actual results and performance could differ materially from those projected in the forward-looking statements as a result of many factors, including, without limitation, the risks and uncertainties associated with: the Company's financial resources and whether they will be sufficient to meet the Company's business objectives and operational requirements; and/or obtain additional financing; the Company's anticipated timing for initiation or completion of its clinical trials for any of its product candidates; the Company's ability to identify, develop and achieve commercial success for products and technologies; drug discovery and the regulatory approval process; estimated timelines for regulatory filings and the implications of interim or final results of the Company's clinical trials; the extent to which the Company's issued and pending patents may protect its products and technology; the potential of the Company's clinical development program to lead to the approval of the Company's New Drug Application for Gencaro; and, the impact of competitive products and technological changes. Actual results and performance could differ materially from those projected in the forward-looking statements as a result of many factors discussed herein and elsewhere. These and other factors are identified and described in more detail in ARCA's filings with the SEC, including without limitation the Company's annual report on Form 10-K for the year ended December 31, 2012, as amended, the Company's Registration Statement on Form S-1 (Registration No. 333-187508), and subsequent filings. Forward-looking statements may be identified by words including "will," "plan," "anticipate," "believe," "intend," "estimates," "expect," "should," "may," "potential" and similar expressions. The Company disclaims any intent or obligation to update these forward-looking statements.

The terms "ARCA," "we," "us," "our" and similar terms refer to ARCA biopharma, Inc.

Overview

We are a biopharmaceutical company principally focused on developing genetically-targeted therapies for cardiovascular diseases. Our lead product candidate is Gencaro™ (bucindolol hydrochloride), a pharmacologically unique beta-blocker and mild vasodilator that we plan to evaluate in a clinical trial for the treatment of atrial fibrillation, or AF, in patients with heart failure and/or left ventricular dysfunction, or HFREF. We have identified common genetic variations in receptors in the cardiovascular system that we believe interact with Gencaro's pharmacology and may predict patient response to the drug.

AF is considered an epidemic cardiovascular disease. The estimated number of individuals with AF globally in 2010 was 33.5 million. According to the 2014 American Heart Association report on Heart Disease and Stroke Statistics, the estimated number of individuals with AF in the U.S. in 2010 ranged from 2.7 million to 6.1 million people. AF is a disorder in which the normally regular and coordinated contraction pattern of the heart's two small upper chambers (the atria) becomes irregular and uncoordinated. The irregular contraction pattern associated with AF causes blood to pool in the atria, predisposing the formation of clots potentially resulting in stroke. AF increases the risk of stroke and may also contribute to worsening heart failure. The approved therapies for the treatment or prevention AF have certain disadvantages in HFREF patients, such as toxic or cardiovascular adverse effects, and most of the approved drugs for AF are contra indicated or have warnings in their prescribing information for such patients. We believe there is an unmet medical need for new AF treatments that have fewer side effects than currently available therapies and are more effective, particularly in HFREF patients.

Our GENETIC-AF clinical trial is a multi-center, randomized, double-blind clinical trial designed to compare the safety and efficacy of Gencaro to an active comparator, the beta-blocker Toprol XL (metoprolol succinate), in HFREF patients recently diagnosed with persistent AF and having beta-1 389 arginine homozygous genotype, the genotype we believe responds most favorably to Gencaro. The primary endpoint of GENETIC-AF, time to recurrent symptomatic AF/atrial flutter (AFL) or all-cause mortality, will be measured over a twenty-four week period after a patient has been electrically cardioverted to restore normal heart rhythm.

The AF indication for Gencaro was chosen based on clinical data from the previously conducted Phase 3 heart failure trial of 2,708 patients, or the BEST trial. We believe data from the BEST trial indicate that Gencaro may have a genetically regulated effect in reducing or preventing AF, whereas we believe the therapeutic benefit of Toprol XL does not appear to be enhanced in patients with this genotype. A retrospective analysis of data from the BEST trial shows that the entire cohort of patients in the BEST trial treated with Gencaro had a 41% reduction in the risk of new onset AF (time-to-event) compared to placebo (p = 0.0004). In the BEST DNA substudy, patients with the beta-1 389 arginine homozygous genotype experienced a 74% (p = 0.0003) reduction in risk of AF when receiving Gencaro, based on the same analysis. The beta-1 389 arginine homozygous genotype was present in about 47% of the patients in the BEST pharmacogenetic substudy, and we estimate it is present in about 50% of the US general population.

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We have created an adaptive design for GENETIC-AF. We have initiated screening of patients for the Phase 2B study of approximately 200 HFREF patients with recent onset, persistent AF who have the beta-1 389 arginine homozygous genotype that we believe responds most favorably to Gencaro. In addition to measuring the primary endpoint of recurrent symptomatic AF/atrial flutter (AFL) or all-cause mortality, an additional efficacy measure in the Phase 2B portion of GENETIC-AF is AF burden, defined as a patient's percentage of time in AF per day, regardless of symptoms. Certain patients in the Phase 2B portion of the trial will have either a newly or previously implanted Medtronic device that measures and records AF burden. The GENETIC-AF Data Safety Monitoring Board (DSMB) will analyze certain data from the Phase 2B portion of the trial and recommend, based on a comparison to our pre-trial statistical assumptions, whether the trial should proceed to Phase 3 and seek to enroll an additional 420 patients. The DSMB will make their recommendation based on analysis of certain trial data after 200 patients have been enrolled and have completed 24 weeks of follow-up, the period for measuring the trial's primary end-point. The interim analysis will focus on available data regarding the trial's primary endpoint, AF event rates, AF burden, and safety. Should the DSMB interim analysis conclude that the interim data is consistent with pre-trial statistical assumptions, including the potential for achieving statistical significance for the Phase 3 endpoint, then the DSMB may recommend the study proceed to Phase 3. The DSMB may also recommend changes to the study design before the trial proceeds to Phase 3, or it may recommend that the study not proceed to Phase 3. Based on the DSMB recommendation, and other factors, the Company, in consultation with the trial's clinical steering committee, will make the final determination on the trial's development steps. The full Phase 2B/3 trial is designed for 90 percent power at a p-value of less than 0.01 significance level to detect a 25 percent reduction in the risk of AF/AFL recurrence or death in patients in the Gencaro arm compared to patients in the Toprol XL arm. The Company believes the Phase 2B portion of the study will take approximately two and one-half years to complete from the time the first patient is enrolled until the planned DSMB interim analysis of data from the initial 200 patients.

Our GENETIC-AF clinical trial of Gencaro requires a companion diagnostic test to identify the patient's receptor genotype. Accordingly, the GENETIC AF trial requires the use of a third party diagnostic service to perform the genetic testing. We have an agreement with Laboratory Corporation of America, or LabCorp, to provide the companion diagnostic test and services to support our GENETIC-AF trial. LabCorp has developed the genetic test and obtained an Investigational Device Exemption, or IDE, from the FDA for the companion diagnostic test which is being used in our GENETIC-AF clinical trial.

Medtronic, Inc., a leader in medical technologies to improve the treatment of chronic diseases including cardiac rhythm disorders is collaborating with us on the GENETIC-AF trial. Under the collaboration with Medtronic, we plan to conduct a substudy that will include continuous monitoring of the cardiac rhythms of certain patients enrolled during the Phase 2B portion of the trial and approximately 100 additional patients in the Phase 3 portion of GENETIC-AF. The collaboration is being administered by a joint ARCA-Medtronic committee. Medtronic will use its proprietary CareLink System to collect and analyze the cardiac rhythm data from the implanted Medtronic devices and the data will be used by the DSMB as part of the interim analysis. Medtronic will support the reimbursement process for patients enrolled in the Phase 2B portion, and agreed to provide financial support of unreimbursed costs for a certain number of patients in the Phase 2B portion up to a certain maximum amount per patient. If GENETIC-AF proceeds to Phase 3, we will seek to enroll an additional 100 patients with Medtronic devices for monitoring and recording AF burden. Medtronic will provide the agreed-on CareLink System cardiac rhythm data collection and analysis for the Phase 3 portion of the substudy and support the reimbursement process.

We have been granted patents in the U.S., Europe, and other jurisdictions for methods of treating AF and HF patients with Gencaro based on genetic testing, which we believe may provide market exclusivity for these uses of Gencaro into at least 2026 in the US and into 2025 in Europe. In addition, we believe that if Gencaro is approved, a Gencaro patent will be eligible for patent term extension based on our current clinical trial plans which, if granted, may provide market exclusivity for Gencaro into 2029 or 2030 in the US and Europe.

To support the continued development of Gencaro, we completed a public equity offering in February 2014 that raised approximately $7.9 million of net proceeds as additional funds for the Phase 2B portion of the GENETIC-AF trial and to support our ongoing operations. In light of the significant uncertainties regarding clinical development timelines and costs for developing drugs such as Gencaro, we will need to raise a significant amount of additional capital to finance the completion of GENETIC-AF and our ongoing operations. We anticipate that our current cash and cash equivalents will be sufficient to fund our operations, at our projected cost structure, through at least the end of 2015. However, changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate. We have based these estimates on assumptions that may prove to be wrong, and we could exhaust our available financial resources sooner than we currently anticipate.

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Results of Operations

Research and Development Expenses

Research and development, or R&D, expense is comprised of clinical, regulatory, and manufacturing process development activities and costs. Our R&D expense continues to be almost entirely generated by our activities relating to the development of Gencaro.

R&D expense for the three months ended March 31, 2014 was $1.3 million compared to $181,000 for the corresponding period of 2013, an increase of approximately $1.1 million.

Clinical expense increased approximately $563,000 for the three months ended March 31, 2014. The increase in the three month period is primarily due to costs incurred through clinical research organizations (CRO's) and related support services in preparing for and initiating our GENETIC-AF trial as well as increased personnel costs. During the comparative three months of 2013 we had no clinical staff or clinical trial expenses. The clinical staff roles were added in the latter part of 2013 as we began preparing to initiate our GENETIC-AF clinical trial.

Regulatory and manufacturing process costs increased $419,000 for the three months ended March 31, 2014 compared to the corresponding period of 2013. The increase in the three month period ended March 31, 2014 compared to the corresponding period of 2013 is primarily due to costs of production, packaging and distribution of clinical trial drug materials for our GENETIC-AF clinical trial. A portion of the increase is also attributable to increased personnel costs as we increased staff in the latter part of 2013 in preparation of the clinical trial.

R&D expenses for the remainder of 2014 are expected to increase as our GENETIC-AF trial begins enrolling and treating patients.

General and Administrative Expenses

General and administrative expenses, or G&A, primarily consist of personnel costs, consulting and professional fees, insurance, facilities and depreciation expenses, and various other administrative costs.

G&A expense was $1.1 million for the three months ended March 31, 2014 as compared to $889,000 for the corresponding period in 2013, an increase of $193,000. The increase in the three months ended March 31, 2014 as compared to the corresponding period of 2013 is comprised of increased personnel costs of approximately $266,000, primarily attributable to personnel returned from furlough and salary changes for executives and other administrative employees. During the first quarter of 2013, employees were working at reduced levels and salaries or were furloughed. In the latter part of 2013 we returned personnel to work to support initiating our GENETIC-AF clinical trial. A portion of the personnel cost is attributable to increased non-cash, stock-based compensation for stock awards made during the third quarter of 2013 and the first quarter of 2014.

The increased personnel costs were partially offset by decreased consulting, legal, accounting and other professional services of approximately $130,000. During the first quarter of 2013 we incurred additional costs for a special proxy and shareholder meeting. These activities and related costs were not recurring in the first quarter of 2014.

G&A expenses for the remainder of 2014 are expected to increase as we increase our activities to support our GENETIC-AF clinical trial.

Interest and Other Income

Interest and other income was $2,000 in the three months ended March 31, 2014. Interest and other income for the comparative three month period ended March 31, 2013 was less than $1,000. We expect interest income to continue to be nominal for 2014 due to low investment yields and utilizing our cash and cash equivalents to fund our operations.

Interest and Other Expense

Interest and other expense was less than $1,000 in the three months ended March 31, 2014 and in the three months ended March 31, 2013. Based on our current capital structure, interest expense for the remainder of 2014 is expected to be minimal.

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Liquidity and Capital Resources

Cash and Cash Equivalents March 31, December 31, 2014 2013 Cash and cash equivalents $ 21,202$ 16,756



As of March 31, 2014, we had total cash and cash equivalents of approximately $21.2 million, as compared to $16.8 million as of December 31, 2013. The net increase of $4.4 million in the three month period reflects the $8.1 million of net proceeds from our equity offering and proceeds from common stock issued for warrant exercises less approximately $3.7 million of cash used to fund operating activities and approximately $51,000 in payments on a vendor financing arrangement during the three months ended March 31, 2014.

Cash Flows from Operating, Investing and Financing Activities

Three Months Ended March 31, 2014 2013 Net cash (used in) provided by: Operating activities $ (3,687 )$ (764 ) Investing activities - (9 ) Financing activities 8,133 1,390 Net increase in cash and cash equivalents $ 4,446 $ 617



Net cash used in operating activities for the three months ended March 31, 2014 increased approximately $2.9 million compared with the same period in 2013 primarily due to trial initiation activities and increased expenses discussed above.

Net cash used in investing activities for the three months ended March 31, 2014 was $0 compared to $9,000 used in investing activities in the three months ended March 31, 2013.

Net cash provided by financing activities was $8.1 million for the three months ended March 31, 2014 representing approximately $7.9 million of net proceeds from our stock offering completed in February 2014, plus approximately $318,000 of net proceeds from common stock issued for warrant exercises, less approximately $51,000 in payments on a vendor financing arrangement.

Sources and Uses of Capital

Our primary sources of liquidity to date have been capital raised from issuances of shares of our preferred and common stock and funds provided by the merger with Nuvelo. The primary uses of our capital resources to date have been to fund operating activities, including research, clinical development and drug manufacturing expenses, license payments, and spending on capital items.

On February 3, 2014, we agreed to sell to certain investors an aggregate of 5,116,228 shares of our common stock and warrants to purchase an aggregate of 1,279,057 shares of our common stock at a purchase price of $1.70 per share of common stock, for aggregate gross proceeds of approximately $8.7 million, before deducting placement agent fees and other offering related expenses. The offering closed on February 7, 2014, and the net proceeds to us were approximately $7.9 million.

The common stock and warrants were sold in combination consisting of one share of common stock and a warrant to purchase 0.25 shares of common stock. The warrants were exercisable upon issuance, expire five years from the date of issuance, and have an exercise price of $2.125 per share, equal to 125% of the closing bid price of our common stock on the Nasdaq Capital Market on February 3, 2014. The offering was effected as a takedown off our Registration Statement on Form S-3, as amended, which became effective on April 4, 2011, pursuant to a prospectus supplement filed with the Securities and Exchange Commission on February 4, 2014. The warrants provide for cashless exercise and settlement in unregistered shares if there is no effective registration statement registering, or the prospectus contained therein is not available for, the issuance of the shares of common stock underlying the warrants at the time of exercise. The common stock and warrants were sold pursuant to a placement agency agreement dated January 21, 2014, as amended.

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In addition to the cash compensation paid to the placement agent in conjunction with the transaction and pursuant to the placement agency agreement, we issued warrants to the placement agent to purchase 153,486 shares of our common stock, which have not been registered under the Securities Act of 1933, as amended. The warrants issued to the placement agent have substantially the same terms as the warrants issued to the purchasers in the offering, except that such warrants expire on April 4, 2016, or the five year anniversary of the effective date of the registration statement, and are restricted from transfer for a period of 180 days from the date of commencement of sales in connection with the offering.

Our ability to execute our GENETIC-AF Phase 2B trial in accordance with our projected time line depends on a number of factors, including, but not limited to, the following:

- recruitment of sufficient clinical trial sites, enrollment of patients and enrollment at a rate consistent with our projected timeline; - our ability to control costs associated with the clinical trial and our operations; - our ability to retain the listing of our common stock on the Nasdaq Capital Market; - the market price of our stock and the availability and cost of additional equity capital from existing and potential new investors; general economic and industry conditions affecting the availability and cost of capital; - the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and - the terms and conditions of our existing collaborative and licensing agreements.



The sale of additional equity or convertible debt securities will be necessary for us to complete both Phase 2B and Phase 3 of the GENETIC-AF clinical trial and submit for FDA approval of Gencaro. Such financing would likely result in additional dilution to our existing stockholders. If we raise additional funds through the incurrence of indebtedness, the obligations related to such indebtedness would be senior to rights of holders of our capital stock and could contain covenants that would restrict our operations. We anticipate that our current cash and cash equivalents will be sufficient to fund our operations, at our projected cost structure, through at least the end of 2015. However, our forecast of the period of time through which our financial resources will be adequate to support our current and forecasted operations could vary materially.

Critical Accounting Policies and Estimates

A critical accounting policy is one that is both important to the portrayal of our financial condition and results of operation and requires our management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our significant accounting policies are described in Note 1 of "Notes to Consolidated Financial Statements" included within our 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission. Following is a discussion of the accounting policies that we believe involve the most difficult, subjective or complex judgments and estimates.

Accrued Expenses

As part of the process of preparing our financial statements, we are required to estimate accrued expenses. This process involves identifying services that third parties have performed on our behalf and estimating the level of service performed and the associated cost incurred for these services as of the balance sheet date. Examples of estimated accrued expenses include contract service fees, such as fees payable to clinical research organizations and contract manufacturers in connection with the execution of our clinical trial program, and professional service fees, such as attorneys and consultants. We develop our estimates of liabilities using our judgment based upon the facts and circumstances known at the time.

Share-based Compensation

Our share-based compensation cost recognized includes: (a) compensation costs for current period vesting of all share-based awards granted prior to January 1, 2006, based on the intrinsic value method, and (b) compensation cost for current period vesting of all share-based awards granted or modified subsequent to January 1, 2006, based on the estimated grant date fair value. We recognize compensation costs for our share-based awards on a straight-line basis over the requisite service period for the entire award, as adjusted for estimated forfeitures.

From Inception through December 31, 2005, we accounted for issuances of share-based compensation under the intrinsic-value-based method of accounting. Under this method, compensation expense is generally recorded on the date of grant only if the estimated fair value of the underlying stock exceeds the exercise price.

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Off-Balance Sheet Arrangements

We have not participated in any transactions with unconsolidated entities, such as special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

Indemnifications

In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify certain parties from any losses incurred relating to the services they perform on our behalf or for losses arising from certain events as defined within the particular contract. Such indemnification obligations may not be subject to maximum loss clauses. We have entered into indemnity agreements with each of our directors, officers and certain employees. Such indemnity agreements contain provisions, which are in some respects broader than the specific indemnification provisions contained in Delaware law. We also maintain an insurance policy for our directors and executive officers insuring against certain liabilities arising in their capacities as such.


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