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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 28, 2002
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No: 0-10824
GENOME THERAPEUTICS CORP.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2297484
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification no.)
100 BEAVER STREET
WALTHAM, MASSACHUSETTS 02453
(Address of principal executive offices) (Zip code)
Registrant's telephone number: (781) 398-2300
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act. Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
COMMON STOCK 23,066,072 Shares
$0.10 PAR VALUE Outstanding November 8, 2002
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GENOME THERAPEUTICS CORP. AND SUBSIDIARY
INDEX TO FINANCIAL INFORMATION AND OTHER INFORMATION
Page
----
Part I
Financial Information (unaudited):
Consolidated Condensed Balance Sheets as of December 31, 2001 and September 28, 2002 3
Consolidated Statements of Operations for the thirteen and thirty-nine week periods ended
September 29, 2001 and September 28, 2002 4
Consolidated Statements of Cash Flows for the thirty-nine week periods ended September 29, 2001
and September 28, 2002 5
Notes to Consolidated Condensed Financial Statements 6-13
Management's Discussion and Analysis of Financial Condition and Results of Operations 14-19
Quantitative and Qualitative Disclosures about Market Risk 20
Controls and Procedures 20
Part II
Other Information:
Other Information 21
Signature 22
Certifications 23-24
Exhibit Index 25
2
GENOME THERAPEUTICS CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (unaudited)
------------------------------------------------------------------------------------------------------------
December 31, September 28,
2001 2002
------------------------------------------------------------------------------------------------------------
ASSETS:
Current Assets:
Cash and cash equivalents $24,805,385 $19,035,616
Short-term investments 29,961,540 34,717,428
Interest receivable 1,074,726 649,549
Accounts receivable 513,885 673,611
Unbilled costs and fees 164,465 594,252
Prepaid expenses and other current assets 1,583,320 750,623
--------------- ------------------
Total Current Assets 58,103,321 56,421,079
Property and Equipment, at cost:
Laboratory and scientific equipment 20,923,535 20,980,400
Leasehold improvements 8,793,842 8,922,391
Equipment and furniture 1,267,854 1,280,218
--------------- ------------------
30,985,231 31,183,009
Less--Accumulated depreciation 19,091,703 20,238,037
--------------- ------------------
11,893,528 10,944,972
Restricted Cash 200,000 -
Long-term Investments 12,374,324 4,628,375
Other Assets 168,425 941,522
--------------- ------------------
$82,739,598 $72,935,948
=============== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Current maturities of long-term obligations 3,571,578 2,958,950
Accounts payable 2,092,593 1,376,726
Accrued expenses 4,832,713 7,700,284
Deferred revenue 3,449,959 777,707
--------------- ------------------
Total Current Liabilities 13,946,843 12,813,667
Long-term obligations, net of current maturities 2,060,817 16,049,437
Shareholders' Equity 66,731,938 44,072,844
--------------- ------------------
$82,739,598 $72,935,948
=============== ==================
See Notes to Consolidated Condensed Financial Statements.
3
GENOME THERAPEUTICS CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
----------------------------------------------------------------------------------------------------------------------------------
Thirteen-Week Period Ended Thirty-nine Week Period Ended
September 29, 2001 September 28, 2002 September 29, 2001 September 28, 2002
----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Biopharmaceutical $ 2,917,389 $ 1,844,312 $ 13,934,438 $ 6,205,997
GenomeVision(TM) Services 4,460,646 3,155,353 12,923,724 10,942,853
-------------- --------------- -------------- ---------------
Total revenues 7,378,035 4,999,665 26,858,162 17,148,850
============== =============== ============== ===============
Costs and Expenses:
Cost of services 4,633,058 3,074,407 11,744,677 10,163,727
Research and development 5,247,912 9,211,517 13,509,062 25,309,217
Selling, general and administrative 2,559,004 2,629,129 6,384,359 6,874,944
-------------- --------------- -------------- ---------------
Total costs and expenses 12,439,974 14,915,053 31,638,098 42,347,888
-------------- --------------- -------------- ---------------
Loss from operations (5,061,939) (9,915,388) (4,779,936) (25,199,038)
============== =============== ============== ===============
Interest Income (Expense):
Interest income 1,055,631 400,636 3,186,149 1,426,240
Interest expense (174,269) (557,865) (555,734) (1,402,081)
-------------- --------------- -------------- ---------------
Net interest income (expense) 881,362 (157,229) 2,630,415 24,159
-------------- --------------- -------------- ---------------
Net loss $ (4,180,577) $ (10,072,617) $ (2,149,521) $ (25,174,879)
============== =============== ============== ===============
Net Loss per Common Share:
Basic and diluted $ (0.18) $ (0.44) $ (0.10) $ (1.10)
============== =============== ============== ===============
Weighted Average Common Shares Outstanding:
Basic and diluted 22,685,660 23,032,463 22,515,638 22,880,971
============== =============== ============== ===============
See Notes to Consolidated Condensed Financial Statements.
4
GENOME THERAPEUTICS CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
------------------------------------------------------------------------------------------------------------------------------
Thirty-nine Week Period Ended
September 29, 2001 September 28, 2002
------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net loss $ (2,149,521) $ (25,174,879)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 3,601,072 3,673,273
Non-cash interest expense - 357,424
(Gain) loss on disposal of equipment and leasehold improvements 22,083 (50,866)
Amortization of deferred compensation 418,079 362,622
Changes in assets and liabilities:
Interest receivable 596,052 425,177
Accounts receivable 538,660 (159,726)
Unbilled costs and fees 373,918 (429,787)
Prepaid expenses and other current assets (139,438) 832,697
Accounts payable 239,802 (715,867)
Accrued expenses (39,098) 2,898,401
Deferred revenue (2,131,670) (2,672,252)
------------------ -----------------
Net cash provided by (used in) operating activities 1,329,939 (20,653,783)
------------------ -----------------
Cash Flows from Investing Activities:
Purchases of investments (33,446,290) (32,186,896)
Proceeds from sale of short-term and long-term investments 49,983,000 34,809,258
Purchases of property and equipment (3,170,023) (2,741,451)
Proceeds from sale of property and equipment 5,000 67,600
Decrease in restricted cash - 200,000
Increase in other assets (18,682) (773,097)
------------------ -----------------
Net cash provided by (used in) investing activities 13,353,005 (624,586)
------------------ -----------------
Cash Flows from Financing Activities:
Issuance of common stock under convertible debt agreement - 288,494
Proceeds from sale of common stock 1,509,084 -
Proceeds from exercise of stock options 871,228 12,547
Proceeds from issuance of stock under the employee stock purchase plan 317,079 452,932
Gross proceeds from convertible notes payable - 15,000,000
Proceeds from borrowings on equipment financing arrangements 2,761,441 3,500,000
Payments on long-term obligations (4,090,341) (3,745,373)
------------------ -----------------
Net cash provided by financing activities 1,368,491 15,508,600
------------------ -----------------
Net Increase (Decrease) in Cash and Cash Equivalents 16,051,435 (5,769,769)
Cash and Cash Equivalents, beginning of period 10,095,817 24,805,385
------------------ -----------------
Cash and Cash Equivalents, end of period $ 26,147,252 $ 19,035,616
================== =================
Supplemental Disclosure of Cash Flow Information:
Interest paid during period $ 555,734 $ 839,008
================== =================
Income tax paid during period $ 50,000 $ 37,503
================== =================
Supplemental Disclosure of Non-cash Investing and Financing Activities:
Equipment acquired under capital leases $ 2,761,441 $ -
================== =================
Unrealized loss on marketable securities $ - $ 367,699
================== =================
Issuance of warrant in connection with convertible notes payable $ - $ 1,735,059
================== =================
See Notes to Consolidated Condensed Financial Statements.
5
GENOME THERAPEUTICS CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation
These consolidated condensed financial statements have been prepared by
the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. In the opinion of the Company's management,
unaudited consolidated condensed financial statements have been prepared on the
same basis as the audited consolidated financial statements and include all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of results for the interim period. Certain information and
footnote disclosures normally included in consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. The Company
believes, however, that its disclosures are adequate to make the information
presented not misleading. The accompanying consolidated condensed financial
statements should be read in conjunction with the Company's audited financial
statements and related footnotes for the year ended December 31, 2001, which are
included in the Company's Annual Report on Form 10-K. Such Annual Report on
Form 10-K was filed with the Securities and Exchange Commission on April 1,
2002 and amended on June 24, 2002.
(2) Summary of Significant Accounting Policies
The accompanying consolidated condensed financial statements reflect the
application of certain accounting policies, as described in this note and
elsewhere in the accompanying notes to the consolidated condensed financial
statements.
(a) Principles of Consolidation
The accompanying consolidated condensed financial statements include the
accounts of the Company and its wholly owned subsidiary, Collaborative
Securities Corp. (a Massachusetts Securities Corporation). All intercompany
accounts and transactions have been eliminated in consolidation.
(b) Revenue Recognition
Biopharmaceutical revenues consist of license fees, contract research
and milestone payments from alliances with pharmaceutical companies.
GenomeVision(TM) Services revenues are from government grants, fees received
from custom gene sequencing and analysis services and subscription fees from the
PathoGenome(TM) Database. Revenues from contract research, government grants,
the PathoGenome Database subscription fees, and custom gene sequencing and
analysis services are recognized over the respective contract periods as the
services are provided. License fees and milestone payments are recognized in
accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition.
Milestone payments will be recognized upon achievements of the milestone as long
as the milestone is deemed to be substantive and the Company has no other
performance obligations related to the milestone. License fees are recognized
ratably over the term of the license. Unbilled costs and fees represent revenue
recognized prior to billing. Deferred revenue represents amounts received prior
to revenue recognition.
(c) Net Loss Per Share
The Company follows the provisions of SFAS No. 128, Earnings per Share,
which establishes standards for computing and presenting earnings per share.
Basic and diluted earnings per share were determined by dividing net loss by the
weighted average common shares outstanding during the period. Diluted loss per
share is the same as basic loss per share for the thirteen-week and thirty-nine
week periods ended September 28, 2002, as the effect of the potential common
stock is antidilutive. Antidilutive securities, which consist of stock options,
warrants, directors' deferred stock and unvested restricted stock, that are not
included in diluted net loss per share were 4,541,947 shares at September 28,
2002.
6
(d) Concentration of Credit Risk
SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. The Company has no off-balance-sheet or concentrations of credit
risk such as foreign exchange contracts, options contracts or other foreign
hedging arrangements. The Company maintains its cash and cash equivalents and
investment balances with several nonaffiliated institutions.
The Company maintains reserves for the potential write-off of accounts
receivable. To date, the Company has not written off any significant accounts
receivable.
The following table summarizes the number of customers that individually
comprise greater than 10% of total revenues and their aggregate percentage of
the Company's total revenues:
Number of
Significant
Customers A B C
--------- --- --- ---
Thirteen-week period ended:
September 29, 2001 2 53% 31% --
September 28, 2002 2 46% 26% --
Thirty-nine week period ended:
September 29, 2001 3 36% 30% 18%
September 28, 2002 2 45% 26% --
The following table summarizes the number of customers that individually
comprise greater than 10% of total accounts receivable and their aggregate
percentage of the Company's total accounts receivable:
Percentage of Total Accounts Receivable
------------------------------------------------
A B C D E F G H
------------------------------------------------
As of:
December 31, 2001 -- -- -- 37% 29% -- -- --
September 28, 2002 -- 5% -- -- -- 37% 25% 18%
(e) Use of Estimates
The preparation of consolidated condensed financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated condensed financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
(f) Comprehensive Income (Loss)
The Company follows the provisions of SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires disclosure of all components of
comprehensive income (loss) on an annual and interim basis. Comprehensive income
(loss) is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from nonowner
sources. During the thirty-nine week period ended September 28, 2002, the
Company recorded approximately $368,000 to comprehensive loss related to the
decrease in the fair market value of common shares received from Versicor, Inc.
in connection with the exercise of a warrant, which are classified as short-term
investments in the accompanying balance sheet. See Note 3 for further
discussion.
(g) Segment Reporting
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for reporting information regarding operating segments in
7
annual financial statements and requires selected information for those segments
to be presented in interim financial reports issued to stockholders. SFAS No.
131 also establishes standards for related disclosures about products and
services and geographic areas. Operating segments are identified as components
of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision maker, or
decision-making group, in making decisions as to how to allocate resources and
assess performance. The Company's chief decision makers, as defined under SFAS
No. 131, are the chief executive officer and chief financial officer. To date,
the Company has viewed its operations and manages its business as principally
two operating segments: GenomeVision Services and Biopharmaceutical. As a
result, the financial information disclosed herein represents all of the
material financial information related to the Company's two operating segments.
All of the Company's revenues are generated in the United States and all assets
are located in the United States.
GenomeVision(TM)
Services Biopharmaceutical Total
---------------- ----------------- -------------
Thirty-nine week period ended September 29, 2001--
Revenues $ 12,923,724 $ 13,934,438 $ 26,858,162
Gross profit* 1,179,047 8,459,533 9,638,580
Company-funded research & development -- 8,034,157 8,034,157
Thirty-nine week period ended September 28, 2002--
Revenues $ 10,942,853 $ 6,205,997 $ 17,148,850
Gross profit* 779,126 2,327,619 3,106,745
Company-funded research & development -- 21,430,839 21,430,839
* Gross profit was determined by subtracting cost of revenues from revenues
during the period. Cost of revenues consists of labor, material and an
allocation of operations overhead expenses.
The Company does not allocate assets by operating segment.
(3) Cash Equivalents and Investments
The Company applies the provisions of SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. At December 31, 2001 and September
28, 2002, the Company's investments primarily include short-term and long-term
investments which are classified as held-to-maturity, as the Company has the
positive intent and ability to hold these securities to maturity. Cash
equivalents are short-term, highly liquid investments with original maturities
of 90 days or less. The Company's short-term and long-term investments include
marketable securities with original maturities of greater than 90 days. Cash
equivalents are carried at cost, which approximates market value, and consist of
debt securities. Short-term and long-term investments are recorded at amortized
cost, which approximates market value, and consist of commercial paper and U.S.
government debt securities. The average maturity of the Company's investments
was approximately 7.5 months and 6.8 months at December 31, 2001 and September
28, 2002, respectively. At September 28, 2002, the Company had a gross
unrealized gain of approximately $104,000, which is the difference between the
amortized cost and the fair market value of the held-to-maturity investments.
The Company's investments also include the purchase, pursuant to the
exercise of a warrant, of 45,000 shares of common stock of Versicor, Inc. in
connection with its collaboration agreement with Versicor, Inc. dated March 10,
1997. The Company is accounting for the shares in accordance with SFAS No. 115
as available-for-sale securities and as a result, the shares are recorded at
fair value. The shares are subject to restrictions under the securities
regulations and cannot be liquidated until March 2003. At September 28, 2002,
the Company had recorded an unrealized gain of approximately $168,000 in
accumulated other comprehensive income in its consolidated statements of
shareholders' equity related to the value of the shares.
At December 31, 2001 and September 28, 2002, the Company's cash and cash
equivalents and investments consisted of the following:
December 31, September 28,
2001 2002
-------------- --------------
Cash and cash equivalents:
Cash $ 21,801,201 $ 14,035,616
Debt securities 3,004,184 5,000,000
-------------- --------------
Total cash and cash equivalents $ 24,805,385 $ 19,035,616
============== ==============
Investments:
Short-term investments $ 29,961,540 $ 34,717,428
Long-term investments 12,374,324 4,628,375
-------------- --------------
Total investments $ 42,335,864 $ 39,345,803
============== ==============
8
The Company also had $200,000 in restricted cash at December 31, 2001 in
connection with certain capital lease obligations.
(4) Long-Term Obligations
On March 5, 2002, the Company sold convertible notes payable to two
institutional investors in a private placement transaction, raising $15 million
in gross proceeds. The convertible notes payable may be converted into shares of
the Company's common stock at the option of the holder, at a price of $8.00 per
share, subject to certain adjustments. The maturity date of the convertible
notes payable is December 31, 2004, provided, that if any time on or after
December 31, 2003, the Company maintains a net cash balance (i.e., cash and cash
equivalents less obligations for borrowed money bearing interest) of less than
$35 million, then the holders of the convertible notes payable can require that
all or any part of the outstanding principal balance of the convertible notes
payable plus all accrued but unpaid interest be repaid. Interest on the
convertible notes payable accrues at 6% annually and the interest is payable, in
cash or in stock, semi-annually on June 30 and December 31 of each year. On June
30, 2002, the first interest payment on the convertible notes payable was due
and was paid by issuing 120,986 shares of the Company's common stock to the
holders of the notes payable. The investors also received a warrant to purchase
up to an aggregate of 487,500 shares of common stock at an exercise price of
$8.00 per share, subject to certain adjustments. The warrant is exercisable at
the time the convertible notes payable are converted or if certain other
redemptions or repayments of the convertible notes payable occur and will
terminate upon the earlier of four years from the date of such conversion or
December 31, 2008. The warrant was valued, using the Black-Scholes option
pricing model, at approximately $1,736,000. The amount was recorded as a
discount to long-term obligations and will be amortized to interest expense over
the term of the convertible notes payable. Additionally, the Company is
obligated to issue a warrant to purchase up to 100,000 shares of common stock at
an exercise price of $15.00 per share to its placement agent. The warrant is
exercisable over a three-year term commencing upon issuance. This warrant was
valued, using the Black-Scholes option pricing model, at $244,000. This amount
is included in deferred issuance costs and will be amortized to interest expense
over the term of the convertible notes payable.
In February 2002, the Company entered into an additional line of credit
for $3,500,000, of which $500,000 was used to refinance a portion of an existing
line of credit. This line of credit is payable in twelve consecutive quarterly
payments at the prevailing LIBOR rate (2.06% at September 28, 2002) plus 1 1/2%.
The Company is required to maintain certain financial covenants pertaining to
minimum cash balances. As of September 28, 2002, $2.9 million was outstanding
under the credit line, and the Company was in compliance with all of the
covenants.
In February 2000, the Company entered into an equipment line of credit
under which it may finance up to $4,000,000 of laboratory, computer and office
equipment. In December 2000, the Company increased the line of credit by
$2,712,000 to $6,712,000. The Company, at its discretion, can enter into either
operating or capital leases. The borrowings under the operating leases are
payable in 24 monthly installments and capital leases are payable in 36 monthly
installments. As of September 28, 2002, the Company had approximately $19,000
outstanding under operating leases and approximately $2,470,000 outstanding
under capital leases. The interest rates under the capital leases range from
7.50% to 10.37%. The Company had no additional borrowing capacity under this
line of credit at September 28, 2002. There are no financial covenants related
to this agreement.
(5) Alliances--Biopharmaceutical
(a) AstraZeneca
In August 1995, the Company entered into a strategic alliance with
AstraZeneca (Astra), formerly Astra Hassle AB, to develop drugs, vaccines and
diagnostic products effective against peptic ulcers or any other disease caused
by H. pylori. The Company granted Astra exclusive access to the Company's H.
pylori genomic sequence database and exclusive worldwide rights to make, use and
sell products based on the Company's H. pylori technology. The agreement
provided for a four-year research alliance (which ended in August 1999) to
further
9
develop and annotate the Company's H. pylori genomic sequence database, identify
therapeutic and vaccine targets, and develop appropriate biological assays.
Under this agreement, Astra agreed to pay the Company, subject to the
achievement of certain product development milestones, up to $23.3 million (and
possibly a greater amount if more than one product is developed under the
agreement) in license fees, expense allowances, research funding and milestone
payments. The Company has received a total of $13.7 million in license fees,
expense allowances, milestone payments, maintenance fees and research funding
under the Astra agreement through September 28, 2002.
The Company will also be entitled to receive royalties on Astra's sale of
products protected by the claims of patents licensed to Astra by the Company
pursuant to the agreement or the discovery of which was enabled in a significant
manner by the genomic database licensed to Astra by the Company. In its
development of new anti-ulcer products, Astra has advanced for optimization a
small molecule compound series selected using genomic targets from the
Company's H. pylori database. As of March 31, 2003, Astra's exclusive access
rights to the Company's H. pylori genomic sequence technology will terminate and
the Company will be able to enter into alliances with other partners to develop
drugs, vaccines and diagnostic products effective against peptic ulcers or any
other disease caused by H. pylori.
(b) Schering-Plough
In December 1995, the Company entered into a strategic alliance and license
agreement (the December 1995 agreement) with Schering Corporation and
Schering-Plough Ltd. (collectively, Schering-Plough) providing for the use by
Schering-Plough of the genomic sequence of Staph. aureus to identify and
validate new gene targets for development of drugs to target Staph. aureus and
other pathogens that have become resistant to current antibiotics. As part of
this agreement, the Company granted Schering-Plough exclusive access to the
Company's proprietary Staph. aureus genomic sequence database. The Company
agreed to undertake certain research efforts to identify bacteria-specific genes
essential to microbial survival and to develop biological assays to be used by
Schering-Plough in screening natural product and compound libraries to identify
antibiotics with new mechanisms of action.
Under this agreement, Schering-Plough paid an initial license fee and
agreed to fund the research program through March 31, 2002. Schering-Plough
agreed to pay the Company a minimum of $21.4 million in an up-front license fee,
research funding and milestone payments. Subject to the achievement of
additional product development milestones, Schering-Plough agreed to pay the
Company up to an additional $24.0 million in milestone payments.
The agreement grants Schering-Plough exclusive worldwide rights to make,
use and sell pharmaceutical and vaccine products based on the genomic sequence
databases licensed to Schering-Plough and on the technology developed in the
course of the research program. The Company will be entitled to receive
royalties on Schering-Plough's sale of therapeutic products and vaccines
developed using the technology licensed. As of March 30, 2002, the Company had
completed its research obligations under this alliance and had turned over
validated drug targets and assays to Schering-Plough for high-throughput
screening. A total of $21.5 million has been received through September 28,
2002.
Under the December 1995 agreement, the Company recognized revenue of
approximately $426,000 and $0 during the thirteen-week periods ended September
29, 2001 and September 28, 2002, respectively, which consisted of alliance
research revenue. For the thirty-nine week periods ended September 29, 2001 and
September 28, 2002, the Company recognized revenue of approximately $1,257,000
and $127,000, respectively, which consisted of alliance research revenue.
In December 1996, the Company entered into its second strategic alliance
and license agreement (the December 1996 agreement) with Schering-Plough. This
agreement calls for the use of genomics to discover new pharmaceutical products
for treating asthma. As part of the agreement, the Company will employ its
high-throughput disease gene identification, bioinformatics, and genomics
sequencing capabilities to identify genes and associated proteins that can be
utilized by Schering-Plough to develop pharmaceuticals and vaccines for treating
asthma. Under this agreement, the Company has granted Schering-Plough exclusive
access to (i) certain gene sequence databases made available under this research
program, (ii) information made available to the Company under certain
third-party research agreements, and (iii) an exclusive worldwide right and
license to make, use and sell pharmaceutical and vaccine products based on the
rights to develop and commercialize diagnostic products that may result from
this alliance.
10
Under this agreement (and subsequent extensions), Schering-Plough paid an
initial license fee and an expense allowance to the Company and agreed to fund
the research program through at least December 2002. In addition, upon
completion of certain scientific developments, Schering-Plough has made or will
potentially make milestone payments, as well as pay royalties based upon sales
of therapeutic products developed from this collaboration. If all milestones are
met and the research program continues for its full term, total payments to the
Company will approximate $81.0 million, excluding royalties. Of the total
potential payments, approximately $36.5 million represents license fees and
research payments, and $44.5 million represents milestone payments based on
achievement of research and product development milestones. A total of $41.1
million has been received through September 28, 2002.
Under the December 1996 agreement, the Company recognized revenue of
approximately $1,494,000 and $1,112,000 for the thirteen-week periods ended
September 29, 2001 and September 28, 2002, respectively, which consisted of
alliance research revenue. For the thirty-nine week period ended September 28,
2001, the Company recognized revenue of approximately $4,555,000, which
consisted of alliance research revenue and a milestone payment. For the
thirty-nine week period ended September 28, 2002, the Company recognized revenue
of approximately $4,202,000, which consisted of alliance research revenue.
In September 1997, the Company entered into a third strategic alliance and
license agreement (the September 1997 agreement) with Schering-Plough to use
genomics to discover and develop new pharmaceutical products to treat fungal
infections.
Under this agreement, the Company employed its bioinformatics,
high-throughput sequencing and functional genomics capabilities to identify and
validate genes and associated proteins as drug discovery targets that can be
utilized by Schering-Plough to develop novel antifungal treatments.
Schering-Plough has received exclusive access to the genomic information
developed in the alliance related to two fungal pathogens, Candida albicans and
Aspergillus fumigatus. Schering-Plough has also received exclusive worldwide
rights to make, use and sell products based on the technology developed during
the course of the research program. In return, Schering-Plough agreed to fund a
research program through March 31, 2002. If all milestones are met, total
payments to the Company will approximate $33.2 million, excluding royalties. Of
the total potential payments, approximately $10.2 million represents contract
research payments and $23.0 million represents milestone payments based on
achievement of research and product development milestones. As of March 30,
2002, the Company had completed its research obligations under this alliance and
had turned over validated drug targets and assays to Schering-Plough for
high-throughput screening. A total of $12.2 million has been received through
September 28, 2002.
Under the September 1997 agreement, the Company recognized approximately
$356,000 and $0 in revenue during the thirteen-week periods ended September 29,
2001 and September 28, 2002, respectively, which consisted of alliance research
revenue. For the thirty-nine week periods ended September 29, 2001 and September
28, 2002, the Company recognized revenue of approximately $1,151,000 and $6,000,
respectively, which consisted of alliance research revenue.
Under certain circumstances, the Company may have an obligation to give
Schering-Plough a right of first negotiation to develop with the Company certain
of its asthma and infectious disease related discoveries if it decides to seek a
third party collaborator to develop such discovery.
(c) bioMerieux
In September 1999, the Company entered into a strategic alliance with
bioMerieux to develop, manufacture and sell in vitro diagnostic products for
human clinical and industrial applications. As part of the alliance, bioMerieux
purchased a subscription to the Company's PathoGenome Database (see Note 6(a)),
paid an up-front license fee, agreed to fund a research program for at least
four years and pay royalties on future products. In addition, bioMerieux
purchased $3.75 million of the Company's common stock. The total amount of
research and development funding, excluding subscription fees, approximates $5.2
million for the four-year term of this agreement. The research and development
funding will be recognized as the research services are performed over the
four-year term of the agreement. Approximately $4.2 million has been received
through September 28, 2002.
The Company recognized approximately $297,000 in revenue during both
thirteen-week periods ended September 29, 2001 and September 28, 2002, which
consisted of alliance research revenue and amortization of the
11
up-front license fees. The Company recognized approximately $876,000 and
$891,000 in revenue during the thirty-nine week periods ended September 29, 2001
and September 28, 2002, respectively, which consisted of alliance research
revenue and amortization of the up-front license fees.
(d) Wyeth
In December 1999, the Company entered into a strategic alliance with Wyeth
to develop novel therapeutics for the prevention and treatment of osteoporosis.
The alliance will focus on developing therapeutics, utilizing targets based on
the characterization of a gene associated with a unique high bone mass trait.
The agreement provides for the Company to employ its established
capabilities in positional cloning, bioinformatics and functional genomics in
conjunction with Wyeth's drug discovery capabilities and its expertise in bone
biology and the osteoporotic disease process to develop new pharmaceuticals.
Under the terms of the agreement, Wyeth paid the Company an up-front license fee
and funded a multi-year research program, which includes milestone payments and
royalties on sales of therapeutics products developed from this alliance. If the
research program continues for its full term and substantially all of the
milestone payments are met, total payments to the Company, excluding royalties,
would exceed $118 million. Approximately $8.9 million has been received through
September 28, 2002.
The Company recognized revenue of approximately $375,000 for the
thirteen-week period ended September 29, 2001, which consisted of alliance
research revenue and amortization of a license fee. The Company recognized
revenue of approximately $261,000 for the thirteen-week period ended September
28, 2002, which consisted of alliance research revenue.
The Company recognized revenue of approximately $6,110,000 for the
thirty-nine week period ended September 29, 2001, which consisted of alliance
research revenue, milestone payments and amortization of a license fee. The
Company recognized revenue of approximately $784,000 for the thirty-nine week
period ended September 28, 2002, which consisted of alliance research revenue.
(6) GenomeVision(TM)Services
GenomeVision Services revenues are from government grants, fees received
from custom gene sequencing and analysis and subscription fees from the
PathoGenome(TM) Database.
(a) Database Subscriptions
The Company has entered into a number of PathoGenome Database
subscriptions. The database subscriptions provide nonexclusive access to the
Company's proprietary genome sequence database, PathoGenome Database, and
associated information relating to microbial organisms. These agreements call
for the Company to provide periodic data updates, analysis tools and software
support. Under the subscription agreements, the customer pays an annual
subscription fee and will pay royalties on any molecules developed as a result
of access to the information provided by the PathoGenome Database. The Company
retains all rights associated with protein therapeutic, diagnostic and vaccine
use of bacterial genes or gene products.
(b) National Human Genome Research Institute
In July 1999, the Company was named as one of the nationally funded DNA
sequencing centers of the international Human Genome Project. The Company is
entitled to receive funding from the National Human Genome Research Institute
(NHGRI) of up to $17.4 million through February 2003, of which all funds have
been appropriated.
In October 1999, the NHGRI named the Company as a pilot center to the
Mouse Genome Sequencing Network. The Company is entitled to receive $14.8
million in funding through February 2003 with respect to this agreement, of
which approximately $13.4 million has been appropriated. In August 2000, the
Company was named one of two primary centers for the Rat Sequencing Program from
NHGRI. As part of the agreement, the Company will use remaining funding under
the mouse award, as well as a portion of the remaining funding under the human
award, to participate in this rat genome initiative.
12
Funding under our government grants and research contracts is subject to
appropriation each year by the U.S. Congress and can be discontinued or reduced
at any time. In addition, we cannot be certain that we will receive additional
grants or contracts in the future.
(7) Product Development
In October 2001, the Company acquired an exclusive license in the United
States and Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia
S.p.A (Biosearch Italia). The Company has assumed responsibility for the product
development in the United States of Ramoplanin, currently in a Phase III
clinical trial. The agreement provides the Company with exclusive rights to
develop and market oral Ramoplanin in the U.S. and Canada. Biosearch Italia will
provide the bulk material for manufacture of the product and will retain all
other rights to market and sell Ramoplanin.
Under the terms of this agreement, the Company paid Biosearch Italia an
initial license fee of $2 million and is obligated to make payments of up to $8
million in a combination of cash and notes convertible into Company stock upon
the achievement of specified milestones. In addition, the Company is obligated
to purchase bulk material from Biosearch Italia, fund the completion of clinical
trials and pay a royalty on product sales. The combined total of bulk product
purchases and royalties is expected to be approximately 26% of the Company's
net product sales.
The Company expended approximately $4.5 million and $10.9 million during
the thirteen and thirty-nine week periods ended September 28, 2002,
respectively, on clinical development expenses and milestone payments related to
Ramoplanin.
13
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
We are a biopharmaceutical company focused on the discovery and
development of pharmaceutical and diagnostic products. We have seven established
product development programs. Our lead product candidate, Ramoplanin, is in a
Phase III clinical trial for the prevention of bloodstream infections caused by
vancomycin-resistant enterococci (VRE). We have six major product discovery
alliances with several pharmaceutical companies including Schering-Plough,
AstraZeneca, Wyeth and bioMerieux. In addition to these seven programs, we have
a portfolio of earlier stage internal drug discovery programs. We also maintain
an active service business, GenomeVision(TM) Services, providing drug discovery
services to pharmaceutical and biotechnology companies and to the National Human
Genome Research Institute.
We receive payments under our Biopharmaceutical business from our product
discovery alliances based on license fees, contract research and milestone
payments during the term of the alliance. We also receive payments under our
GenomeVision Services business from selling, as a contract service business,
high quality genomic sequencing information to our customers, including
pharmaceutical companies, biotechnology companies, governmental agencies and
academic institutions. In addition, under our GenomeVision Services business,
subscribers to our PathoGenome(TM) Database pay access fees for the information
they obtain. We anticipate that our alliances will result in the discovery and
commercialization of novel pharmaceutical, vaccine and diagnostic products. In
order for a product to be commercialized based on our research, it will be
necessary for our product discovery partner to conduct preclinical tests and
clinical trials, obtain regulatory clearances, manufacture, sell, and distribute
the product. Accordingly, we do not expect to receive royalties based upon
product revenues for many years, if at all.
Our primary sources of revenue are from alliance agreements with
pharmaceutical company partners, subscription agreements to our PathoGenome
Database and government research grants and contracts. Currently, we have six
major product discovery alliances, of which we currently receive contract
research funding from three of these alliances. In August 1995, we entered into
an alliance with AstraZeneca to develop pharmaceutical, vaccine and diagnostic
products effective against gastrointestinal infections or any other disease
caused by H. pylori. In August 1999, the contract research under the alliance
concluded and the program transitioned into AstraZeneca's pipeline. We are
entitled to receive additional milestone payments and royalties based upon the
development by AstraZeneca of any products from the research alliance. In
December 1995, we entered into an alliance with Schering-Plough. Under this
alliance, Schering-Plough can use our Staph. aureus genomic database to identify
new gene targets for the development of novel antibiotics. As of March 30, 2002,
we had completed our research obligations under this alliance and had turned
over validated drug targets and assays to Schering-Plough for high-throughput
screening. In December 1996, we entered into our second research alliance with
Schering-Plough to identify genes and associated proteins that Schering-Plough
can utilize to develop new pharmaceuticals for treating asthma. In September
1997, we established our third research alliance with Schering-Plough for the
development of new pharmaceutical products to treat fungal infections. As of
March 30, 2002, we had completed our research obligations under this alliance
and had turned over validated drug targets and assays to Schering-Plough for
high-throughput screening. In September 1999, we entered into a strategic
alliance with bioMerieux to develop, manufacture and sell in vitro pathogen
diagnostic products for human clinical and industrial applications. As part of
the strategic alliance, bioMerieux purchased a subscription to our PathoGenome
Database and made an equity investment. In December 1999, we entered into a
strategic alliance with Wyeth to develop drugs based on our genetic research to
treat osteoporosis.
In May 1997, we introduced our PathoGenome Database and sold our first
subscription. Since that date, we have continued to contract with subscribers on
a non-exclusive basis, and, as of September 28, 2002, we had seven subscribers.
Under our agreements, the subscribers receive non-exclusive access to
information relating to microbial organisms in our PathoGenome Database.
Subscriptions to the database generate revenue over the term of the subscription
with the potential for royalty payments to us from future product sales. We do
expect to see a revenue decline in subscription fees over the next year as
subscribers substantially complete data mining of the PathoGenome Database.
14
Since 1989, the United States government has awarded us a number of
research grants and contracts related to government genomics programs. The scope
of the research covered by grants and contracts encompasses technology
development, sequencing production, technology automation and disease gene
identification. These programs strengthen our genomics technology base and
enhance the expertise of our scientific personnel. In July 1999, we were named
as one of the nationally funded DNA sequencing centers of the international
Human Genome Project. We are entitled to receive funding from the National Human
Genome Research Institute (NHGRI) of up to $17.4 million through February 2003,
of which all funds have been appropriated and $16.1 million has been received
through September 28, 2002. In October 1999, the NHGRI named us as a pilot
center to the Mouse Genome Sequencing Network. We are entitled to receive $14.8
million in funding over forty-one months with respect to this agreement, of
which $13.4 million has been appropriated and $13.3 million had been received
through September 28, 2002. In August 2000, we were named one of two primary
centers for the Rat Sequencing Program from NHGRI. As part of the agreement, we
will use remaining funding under the mouse award, as well as a portion of the
remaining funding under the human award, to participate in this rat genome
initiative.
In October 2001, we acquired an exclusive license in the United States and
Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia S.p.A
(Biosearch). We have assumed responsibility for the product development in the
United States of Ramoplanin, currently in a Phase III clinical trial. The
agreement provides us with exclusive rights to develop and market oral
Ramoplanin in the U.S. and Canada. Biosearch will retain all other rights to
market and sell Ramoplanin. In addition, we are obligated to purchase bulk
material from Biosearch, fund the completion of clinical trials and pay a
royalty on product sales. The combined total of bulk product purchases and
royalties is expected to be approximately 26% of our net product sales.
We have incurred significant operating losses since our inception. As of
September 28, 2002, we had an accumulated deficit of approximately $116.9
million. Our losses are primarily from costs associated with prior operating
businesses and research and development expenses. These costs have often
exceeded our revenues generated by our alliances, subscription agreements and
government grants. Our results of operations have fluctuated from period to
period and may continue to fluctuate in the future based upon the timing, amount
and type of funding. We expect to incur additional operating losses in the
future.
On September 25, 2002, we announced that we were implementing a plan to
reduce early stage target discovery research and general administrative expenses
by eliminating 34 full-time staff positions. We expect this reduction to result
in annualized savings of approximately $6 million. In addition, this action
resulted in a one-time charge in the third quarter of approximately $350,000.
We are subject to risks common to companies in our industry. For
discussion of these risks, please see "Special Note Concerning Forward-Looking
Statements" below.
Critical Accounting Policies
We considered the disclosure requirements of FR-60 regarding critical
accounting policies and FR-61 regarding liquidity and capital resources, certain
trading activities and related party/certain other disclosures, and concluded
that there were no material changes during the quarter that would warrant
further disclosure under these releases.
Results of Operations
Thirteen-Week Periods Ended September 29, 2001 and September 28, 2002
Revenues
Total revenues decreased 32% from $7,378,000 for the thirteen-week period
ended September 29, 2001 to $5,000,000 for the thirteen-week period ended
September 28, 2002. Biopharmaceutical revenues decreased 37% from $2,917,000 for
the thirteen-week period ended September 28, 2001 to $1,844,000 for the
thirteen-week period ended September 28, 2002 primarily due to a decline in
contract research revenue recognized under our existing strategic alliances with
Schering-Plough.
15
Revenues from GenomeVision Services decreased 29% from $4,461,000 for the
thirteen-week period ended September 29, 2001 to $3,155,000 for the
thirteen-week period ended September 28, 2002. The decrease in revenues from
GenomeVision Services was primarily due to lower revenues recognized under our
government grants with the National Human Genome Research Institute to
participate in the Human Genome and Mouse (Rat) Genome sequencing projects.
Costs and Expenses
Total costs and expenses increased 20% from $12,440,000 for the
thirteen-week period ended September 29, 2001 to $14,915,000 for the
thirteen-week period ended September 28, 2002 primarily due to an increase in
our research and development expenses as explained. Cost of services decreased
34% from $4,633,000 for the thirteen-week period ended September 29, 2001 to
$3,074,000 for the thirteen-week period ended September 28, 2002 primarily due
to the decreased cost and expenses associated with the decrease in GenomeVision
Services revenue, as mentioned above.
Research and development expenses include internal research and
development, research funded pursuant to arrangements with our strategic
alliance partners, as well as clinical development costs and expenses. Research
and development expenses increased 76% from $5,248,000 for the thirteen-week
period ended September 29, 2001 to $9,212,000 for the thirteen-week period ended
September 28, 2002. This planned increase was primarily due to an increase in
expenses incurred in the clinical development of Ramoplanin of approximately
$4,525,000, as well as increased investment in our internal drug discovery
programs, specifically in the area of anti-infectives and chronic human
diseases, of $248,000. These increases in research and development expenses were
partially offset by a decline in research funded under our product discovery
alliances of approximately $809,000.
Selling, general and administrative expenses increased slightly from
$2,559,000 for the thirteen-week period ended September 29, 2001 to $2,629,000
for the thirteen-week period ended September 28, 2002.
Interest Income and Expense
Interest income decreased 62% from $1,056,000 for the thirteen-week period
ended September 29, 2001 to $401,000 for the thirteen-week period ended
September 28, 2002 reflecting fluctuations in interest rates, as well as lower
levels of funds available for investment.
Interest expense increased 220% from $174,000 for the thirteen-week period
ended September 29, 2001 to $558,000 for the thirteen-week period ended
September 28, 2002. The increase was due to an increase in our outstanding
balances under long-term obligations from approximately $6.5 million at
September 29, 2001 to $19.0 million at September 28, 2002. The increase in our
long-term obligations resulted primarily from the March 2002 sale of convertible
notes payable in a private placement transaction, which resulted in gross
proceeds of $15 million. Interest expense also includes approximately $241,000
related to the amortization of deferred issuance costs and warrants issued in
connection with the convertible notes payable.
Thirty-Nine Week Periods Ended September 29, 2001 and September 28, 2002
Revenues
Total revenues decreased 36% from $26,858,000 for the thirty-nine week
period ended September 29, 2001 to $17,149,000 for the thirty-nine week period
ended September 28, 2002. Biopharmaceutical revenues decreased 55% from
$13,934,000 for the thirty-nine week period ended September 29, 2001 to
$6,206,000 for the thirty-nine week period ended September 28, 2002 primarily
due to milestone payments earned in the thirty-nine week period of the last year
under our product discovery alliances with Schering-Plough and Wyeth and the
absence of such milestone payments in the corresponding period of the current
year.
Revenues from GenomeVision Services decreased 15% from $12,924,000 for the
thirty-nine week period ended September 29, 2001 to $10,943,000 for the
thirty-nine week period ended September 28, 2002 primarily due to lower revenues
recognized under our government grants with the National Human Genome Research
Institute to participate in the Human Genome and Mouse (Rat) Genome sequencing
projects, as well as lower subscription fees earned under our PathoGenome
Database business as a result of third parties not renewing their database
subscriptions.
16
Costs and Expenses
Total costs and expenses increased 34% from $31,638,000 for the
thirty-nine week period ended September 29, 2001 to $42,348,000 for the
thirty-nine week period ended September 28, 2002 2002 primarily due to an
increase in our research and development expenses as explained. Cost of services
decreased 13% from $11,745,000 for the thirty-nine week period ended September
29, 2001 to $10,164,000 for the thirty-nine week period ended September 28, 2002
primarily due to the decreased cost and expenses associated with the decrease in
GenomeVision Services revenue, as mentioned above.
Research and development expenses include internal research and
development, research funded pursuant to arrangements with our strategic
alliance partners, as well as clinical development costs and expenses. Research
and development expenses increased 87% from $13,509,000 for the thirty-nine week
period ended September 29, 2001 to $25,309,000 for the thirty-nine week period
ended September 28, 2002. This planned increase was primarily due to an increase
in expenses incurred in the clinical development of Ramoplanin of approximately
$10,863,000, as well as increased investment in our internal drug discovery
programs, specifically in the area of anti-infective and chronic human diseases,
of $2,534,000. These increases in research and development expenses were
partially offset by a decline in research funded under our product discovery
alliances of approximately $1,597,000.
Selling, general and administrative expenses increased 8% from $6,384,000
for the thirty-nine week period ended September 29, 2001 to $6,875,000 for the
thirty-nine week period ended September 28, 2002 reflecting an expansion in the
areas of corporate development and sales and marketing, as well as a one-time
charge of approximately $350,000 associated with our decision to reduce
expenditures by eliminating 34 full-time staff positions in the area of early
stage research and administration.
Interest Income and Expense
Interest income decreased 55% from $3,186,000 for the thirty-nine week
period ended September 29, 2001 to $1,426,000 for the thirty-nine week period
ended September 28, 2002 reflecting fluctuations in interest rates, as well as
lower levels of funds available for investment.
Interest expense increased 152% from $556,000 for the thirty-nine week
period ended September 29, 2001 to $1,402,000 for the thirty-nine week period
ended September 28, 2002. The increase was due to an increase in our outstanding
balances under long-term obligations from approximately $6.5 million at
September 29, 2001 to $19.0 million at September 28, 2002. The increase in our
long-term obligations resulted primarily from the March 2002 sale of convertible
notes payable in a private placement transaction, which resulted in gross
proceeds of $15 million. Interest expense also includes approximately $563,000
related to the amortization of deferred issuance costs and warrants issued in
connection with the convertible notes payable.
Liquidity and Capital Resources
Our primary sources of cash have been payments received from product
discovery alliances, subscription fees, government grants, borrowings under
equipment lending facilities and capital leases and proceeds from sale of debt
and equity securities.
As of September 28, 2002, we had cash, cash equivalents, and short-term
and long-term investments of approximately $58,381,000. On March 5, 2002, we
sold convertible notes payable to two institutional investors in a private
placement transaction, raising $15 million in gross proceeds. The convertible
notes payable may be converted into shares of our common stock at the option of
the holder, at a price of $8.00 per share, subject to certain adjustments. The
maturity date of the convertible notes payable is December 31, 2004, provided,
that if any time on or after December 31, 2003 we maintain a net cash balance
(i.e., cash and cash equivalents less obligations for borrowed money bearing
interest) of less than $35 million, then the holders of the convertible notes
payable can require that all or any part of the outstanding principal balance of
the notes payable plus all accrued but unpaid interest be repaid. Interest on
the notes payable accrues at 6% annually and the interest is payable, in cash or
in stock, semi-annually on June 30 and December 31 of each year. On June 30,
2002, the first interest payment on the convertible notes payable was due and
was paid by issuing 120,986 shares of the Company's common stock to the holders
of the notes payable. The investors also received a warrant to purchase up to an
aggregate of 487,500 shares of common stock at an exercise price of $8.00 per
share, subject to certain adjustments. The warrant is exercisable at
17
the time the convertible notes payable are converted or if certain other
redemptions or repayments of the convertible notes payable occur and will
terminate upon the earlier of four years from date of such conversion or
December 31, 2008. The warrant was valued, using the Black-Scholes option
pricing model, at $1,736,000. The amount was recorded as a discount to long-term
debt and will be amortized to interest expense over the term of the convertible
notes payable. Additionally, the Company is obligated to issue a warrant to
purchase up to 100,000 shares of common stock at an exercise price of $15.00 per
share to its placement agent in this transaction. The warrant is exercisable
over a three-year term commencing upon issuance. This warrant was valued, using
the Black-Scholes option pricing model, at $244,000. This amount is included in
deferred issuance costs and will be amortized to interest expense over the term
of the convertible notes payable.
As of September 28, 2002, we had various arrangements under which we
financed certain office and laboratory equipment and leasehold improvements. We
had an aggregate of approximately $5,387,000 outstanding under these borrowing
arrangements at September 28, 2002. This amount is repayable over the next 28
months, of which $2,959,000 is repayable over the next 12 months. Under these
arrangements, we are required to maintain certain financial ratios, including
minimum levels of unrestricted cash. We had no additional borrowing capacity
under these capital lease agreements at September 28, 2002.
Our operating activities used cash of approximately $20,654,000 for the
thirty-nine week period ended September 28, 2002 primarily due to an increase in
our net loss, accounts receivable, and unbilled costs and fees, as well as a
decrease in accounts payable and deferred revenue. These uses of cash were
partially offset by a decrease in interest receivable, prepaid expenses and
other current assets, as well as an increase in accrued liabilities. The
increase in accrued liabilities reflects primarily accrued expenses associated
with the clinical development of Ramoplanin. Our operating activities provided
cash of approximately $1,330,000 for the thirty-nine week period ended September
29, 2001.
Our investing activities used cash of approximately $625,000 for the
thirty-nine week period ended September 28, 2002 through the purchases of
marketable securities and equipment and additions to leasehold improvements and
an increase in other assets. The increase in other assets in 2002 reflects the
inclusion of deferred issuance costs associated with the convertible notes
payable, which will be amortized to interest expense over the term of the
convertible notes payable. These uses of cash were partially offset by the
conversion of marketable securities to cash and cash equivalents. Our investing
activities provided cash of approximately $13,353,000 for the thirty-nine week
period ended September 29, 2001 through the conversion of marketable securities
to cash and cash equivalents, partially offset by purchases of marketable
securities and equipment and additions to leasehold improvements.
Capital expenditures totaled approximately $2.7 million for the
thirty-nine week period ended September 28, 2002, consisting of leasehold
improvements and purchases of laboratory, computer, and office equipment. We
utilized an existing line of credit to finance all of these capital
expenditures. We currently estimate that we will acquire an additional $2.3
million in capital equipment in 2002 consisting primarily of computers,
laboratory equipment, and additions to leasehold improvements.
Our financing activities provided cash of approximately $15,509,000 for
the thirty-nine week period ended September 28, 2002 primarily from proceeds
received from the sale of convertible notes payable totaling $15 million in
gross proceeds, proceeds received from entering into an additional credit line
for $3,500,000, of which $500,000 was used to refinance a portion of an existing
line of credit, as well as proceeds received from issuance of stock under the
employee stock purchase plan. These proceeds from financing activities were
partially offset by payments of long-term obligations of $3,745,000. Our
financing activities provided cash of approximately $1,368,000 for the
thirty-nine week period ended September 29, 2001 primarily from proceeds
received from an equipment financing arrangement and the exercise of stock
options, partially offset by payments of long-term obligations and notes
receivable from an officer.
At December 31, 2001, we had net operating loss and tax credits
(investment and research) carryforwards of approximately $93,767,000 and
$6,642,000, respectively, available to reduce federal taxable income and federal
income taxes, respectively, if any. Net operating loss carryforwards are subject
to review and possible adjustment by the Internal Revenue Service and may be
limited, in the event of certain cumulative changes in ownership interests of
significant shareholders over a three-year period in excess of 50%.
Additionally, certain of these losses are expiring due to the limitations of the
carryforward period.
18
We believe that our existing capital resources are adequate for
approximately two years under our current rate of investment in research and
development. There is no assurance, however, that changes in our plans or events
affecting our operations will not result in accelerated or unexpected
expenditures.
We plan to continue to invest in our internal research and development
programs, including our lead candidate, Ramoplanin, currently in Phase III
clinical development.
We expect to seek additional funding in the future through public or
private financing. Additional financing may not be available when needed, or if
available, it may not be on terms acceptable to us. To the extent that we raise
additional capital by issuing equity or convertible debt securities, ownership
dilution to stockholders will result.
We generally place our marketable security investments in high quality
credit instruments, as specified in our investment policy guidelines; the policy
also limits the amount of credit exposure to any one issue, issuer, and type of
instrument. We do not expect any material loss from our marketable security
investments and therefore believe that our potential interest rate exposure is
limited.
Special Note Concerning Forward-Looking Statements
This Form 10-Q and documents we have filed with the Securities and
Exchange Commission contain forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements represent our management's judgment regarding future
events. Forward-looking statements typically are identified by use of terms such
as "may," "will," "should," "plan," "expect," "intend," "anticipate,"
"estimate," and similar words, although some forward-looking statements are
expressed differently. We do not plan to update these forward-looking
statements. You should be aware that our actual results could differ materially
from those contained in the forward looking statements due to a number of risks
affecting our business. These risk factors include risks related to our lead
product candidate, Ramoplanin, such as (i) our inability to obtain regulatory
approval to commercialize Ramoplanin due to negative, inconclusive or
insufficient clinical data and (ii) delays in the progress of our clinical trial
for Ramoplanin, and increased cost, due to the pace of enrollment of patients in
the trial or fluctuations in the infection rate of enrolled patients. We are
also subject to risks related to our inability or the inability of our alliance
partners to (i) successfully develop products based on our genomics information,
(ii) obtain the necessary regulatory approval for such products, (iii)
effectively commercialize any products developed before our competitors are able
to commercialize competing products or (iv) obtain and enforce intellectual
property rights. In addition, we are subject to the risk factors set forth in
Exhibit 99.1 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2001 and those set forth in other filings that we may make with the
Securities and Exchange Commission from time to time.
19
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk
Our market risks, and the ways we manage them, are summarized in
management's discussion and analysis of financial condition and results of
operations as of December 31, 2001, included in the Company's Form 10-K for the
year ended December 31, 2001. There have been no material changes in the first
nine months of 2002 to such risks or our management of such risks.
ITEM 4: CONTROLS AND PROCEDURES
Within the 90 days prior to the date of filing this Quarterly Report on
Form 10-Q, we carried out an evaluation, under the supervision and with the
participation of our management, including the Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
upon that evaluation, the Chief Executive Officer and the Chief Financial
Officer concluded that our disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company required to
be included in our periodic SEC filings. Subsequent to the date of that
evaluation, there have been no significant changes in our internal controls or
in other factors that could significantly affect internal controls, nor were any
corrective actions required with regard to significant deficiencies and material
weaknesses.
20
PART II
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
99.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act.
99.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act.
(b) Reports on Form 8-K
Report on Form 8-K/A filed July 2, 2002 to report the Company's
change in certifying accountant, as amended.
21
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized who also serves in the capacity of
principal financial officer.
GENOME THERAPEUTICS CORP.
/s/ Stephen Cohen
---------------------------------------
Stephen Cohen,
Senior Vice President & Chief Financial Officer
(Principal Financial Officer)
November 12, 2002
22
GENOME THERAPEUPITCS CORP. AND SUBSIDIARY
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Steven M. Rauscher, President and Chief Executive Officer of Genome
Therapeutics Corp., certify that:
1) I have reviewed this quarterly report on Form 10-Q of Genome
Therapeutics Corp.;
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 12, 2002 /s/ Steven M. Rauscher
----------------------------
Steven M. Rauscher
President & Chief Executive Officer
23
GENOME THERAPEUPITCS CORP. AND SUBSIDIARY
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen Cohen, Senior Vice President and Chief Financial Officer of Genome
Therapeutics Corp., certify that:
1) I have reviewed this quarterly report on Form 10-Q of Genome
Therapeutics Corp.;
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6) The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 12, 2002 /s/ Stephen Cohen
----------------------------
Stephen Cohen
Senior Vice President & Chief Financial Officer
24
GENOME THERAPEUTICS CORP. AND SUBSIDIARY
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
99.1 Certification of the Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act.
99.2 Certification of the Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act.
25