Item 1: Business
THE COMPANY
Overview
Interleukin
Genetics, Inc. is a functional genomics company focused on personalized
medicine. We develop genetic tests that
identify patients at risk for some diseases and patients most likely to respond
to particular therapeutic interventions.
We also optimize nutritional and therapeutic compounds for strategic
partners using our genotype-specific cell lines. We believe that by identifying individuals at risk for certain
diseases and combining this knowledge with specific therapeutic interventions,
better healthcare decisions can be made, reducing costs and greatly improving
patient health outcomes. We have a growing portfolio of patents covering the
genetics of a number of common diseases and conditions.
We believe
that one of the great challenges confronting medicine today is to find the key
to understanding why some people are more prone than others to developing
serious chronic diseases and why some people respond to treatments for those
diseases
differently than others. Until doctors are able to understand the
underlying causes for such variability in chronic diseases, the practice of
medicine will remain largely constrained to the current approach of prescribing
therapies based on broad, sweeping recommendations in which very large groups
of people with the same stage of disease all receive the same treatment. This
approach to medicine is, in many ways, often ineffective.
Until now,
scientific study of chronic diseases has largely focused on identifying factors
that initiate or “cause” a disease. Common examples of such factors include
cholesterol in the case of heart disease, bacteria of the mouth in the case of
periodontal disease and reduced estrogen levels in the case of osteoporosis.
However, the mere presence of these initiating factors does not always mean a
person will develop a disease. For example, everyone with a cholesterol level
considered high does not develop heart disease nor does everyone with a normal
cholesterol level avoid heart disease. Rather, the common diseases as we know
them only develop when our bodies respond to the initiating factors in a way
that results in a problem.
We believe that the recent expansion in understanding of human genetic
information coming from programs such as the Human Genome Project will likely
change the way medicine is practiced.
This is because the response of an individual’s body to the common disease
initiating factors is largely determined by their specific genes. By using the
new tools of the genomic era, scientists will be able to study how differences
in a specific individual’s genetic information direct their body to respond to
these disease initiating factors in different ways. This is likely to be true
for identifying both who is most likely to develop one disease or another but
also for who is most likely to respond to one or another medicine, nutritional
product or lifestyle choice. It has long been recognized that individual
responses to many drugs vary from person to person in ways that may be
clinically very important yet are usually unpredictable. While one person may receive great benefit
from a drug at one dose, a second person may require 2-3 times that dose, while
yet another may be unable to tolerate treatment due to side effects even at the
lowest dose. Similarly, individual
response to nutrition may vary significantly.
A diet that for one person might cause obesity, diabetes or high
cholesterol might have no ill effects on another. Until recently, the tools to unravel the biological basis for
this wide variability of responses have been very limited. In fact, doctors and their patients have
been forced to accept that a simple “trial and error” approach was the only
effective way to select the most appropriate therapy. However, because the ways that our bodies respond to drugs and
diets are ultimately determined by our genes, a better understanding of the
interactions between our genes and the products we use holds the promise of
ending this non-specific way of promoting health. Since it is our genes that
make us unique, at least in the biologic sense, we believe that tailoring
medical therapies and nutritional regimens based on knowledge of our genetic
tendencies will enable individuals to move beyond the one-size-fits-all
approach to health maintenance to an approach that is more “personalized” to
each of us based upon our unique genetic make-up.
Alliance with Alticor Inc.
On March 5, 2003, we entered into a broad strategic alliance with
several affiliates of the Alticor Inc. family of companies to develop and
market novel nutritional and skin care products. The alliance will utilize our intellectual property and expertise
in genomics to develop personalized consumer products.
The alliance includes an equity investment, a multi-year research and
development agreement, a licensing agreement with royalties on marketed
products, the deferment of outstanding loan repayment and the refinancing of
bridge financing obligations. The
financial elements of this alliance are described in greater detail in the
section titled “Current Financial Condition”
beginning on page 3.
This alliance will open our research and development products to our
strategic partner’s proven distribution channel. We believe that the benefits derived from nutritional supplements
that are being developed by this strategic partner will be greatly enhanced by
applying our deeper understanding of the underlying human genetics. Further, we believe that the future of
personalized nutritional supplementation and skin care will be based on an
individual’s genetic makeup. This
alliance will focus on developing genetic tests to determine a genetic profile
of an individual and nutritional supplements and skin care products that will
benefit individuals of that genetic profile.
The initial focus of this alliance will be to bring to market tests to
assess an individual’s health risks and nutritional products to provide a personalized
nutritional supplementation regimen to reduce those health risks.
Existing Technology and Distribution
Our first
genetic test, PST®, a test predictive of risk for rapid progression of
periodontal disease, is currently marketed in the United States and Europe.
Other products under development include tests predictive of risk for
osteoporosis, coronary artery disease and a test to determine the best drug
treatment for advanced cases of rheumatoid arthritis.
During 2000,
we changed our strategy for marketing and distributing PST. We no longer
market, distribute or process PST ourselves. We now use third party marketers
and distributors from whom we earn royalties. We believe that while this has
reduced revenues in the short-term it has also improved margins and reduced
operating costs.
In December
2000, we entered into an exclusive seven-year license agreement with Hain
Diagnostika/ADS GmbH (“Hain”) for the marketing, distribution and processing of
the PST test in all countries outside of North America and Japan. Hain has
extensive experience in commercializing genetic tests on its DNA-STRIP
Technology Platform in several fields as well as a specific commitment to
marketing products directly to dentists. Hain’s central facility offers
excellent turnaround times, high quality laboratory operations and a sales and
technical staff to support clinical users.
We can terminate this agreement if certain minimum sales levels are not
met. Sales of PST in Europe have not
been significant to date. Since
December 2001, Kimball Genetics, Inc. has been our sole marketing partner
within the United States.
We have
followed a strategy of working with strategic partners at the fundamental
discovery stage. This strategy has given us access to discoveries while
reducing up-front research expenses. Since 1994, we have had a strategic
alliance with the Department of Molecular and Genetic Medicine at the
University of Sheffield (“Sheffield”) in the United Kingdom. Under this
alliance, Sheffield has provided us with the fundamental discovery and genetic
analysis from their research laboratories, and we have focused on product
development, including clinical trials, and the commercialization of these
discoveries.
Our executive
offices are located at 135 Beaver Street, Waltham, Massachusetts 02452, and our
telephone number is 781/398-0700. We were incorporated in Texas in 1986 and we
re-incorporated in Delaware in March 2000. We maintain a website at
www.ilgenetics.com. The information
contained on our website is not incorporated by reference into this Form
10-K. We have included our website
address only as an inactive textual reference and do not intend it to be an
active link to our website.
Current Financial Condition
Since
inception, we have accumulated a deficit of approximately $40.8 million,
including losses of approximately $5.3 million during 2002. For the year ended
December 31, 2002, we had negative cash flows from operating activities of
approximately $5.0 million and at December 31, 2002 we had cash and cash
equivalents of approximately $734,000.
In a private
placement on March 5, 2003, we entered into a Purchase Agreement with Pyxis
Innovations Inc., or Pyxis, pursuant to which Pyxis purchased from us Series A
Preferred Stock for $7,000,000 in cash and an additional $2,000,000 in cash to
be paid, if at all, upon our reaching a certain milestone pursuant to the terms
of the Purchase Agreement. The offering
was made to Pyxis by way of a private placement exempt from registration under
the Securities Act.
The Series A Preferred Stock issued in the private placement is
initially convertible into 28,157,683 shares of our common stock reflecting a
conversion price of $.2486 per share (or $.3196 per share if the milestone
payment is received), subject to weighted average antidilution
adjustments. If all the shares of
Series A Preferred Stock were converted to common stock, these shares would
represent 54.91% of the outstanding shares of our common stock.
As part of
this agreement, Pyxis has agreed to refinance certain of our indebtedness held
by Pyxis and others in the form of previously issued promissory notes. Upon the
closing of the Purchase Agreement, we amended and reissued the promissory notes
previously issued to Pyxis, with an aggregate principal amount of $2,000,000,
with new promissory notes carrying a variable interest rate equal to one
percent above the “prime rate,” payable on a quarterly basis in cash. These
amended and reissued notes have a maturity date of December 31, 2007 and are
convertible at the option of Pyxis into shares of our common stock at a
conversion price of two times the then applicable conversion price of the
Series A Preferred Stock. As of March 5, 2003, outstanding principal and interest
under these notes would be convertible into 4,075,811 shares of common
stock. The notes are secured by all of
our intellectual property except intellectual property relating to periodontal
disease and sepsis.
The Purchase
Agreement with Pyxis also provided a $1,500,000 working capital credit line to
initiate selected research agreements with third party entities approved by our
board of directors and a $525,000 plus interest refinancing of bridge financing
notes currently held by third parties. The
notes to be issued for the credit line and refinancing will have the same terms
as the notes described in the preceding paragraph.
Concurrent
with the closing of the Purchase Agreement, we entered into a Research
Agreement with an affiliate of Pyxis, governing the terms of developing and
validating nutrigenomic and dermagenomic tests and products. Pyxis has agreed to provide us
with $5,000,000 over the first twenty-four months following the signing
of this agreement, to conduct certain research projects. We will also receive a royalty payment based
upon sales of any resulting products.
We entered into a License Agreement with another affiliate of Pyxis,
granting an exclusive, world-wide license of all of our current and future
intellectual property, limited to the field of nutrigenomics and dermagenomics,
in exchange for royalty payments based upon the sales of the products derived
from that intellectual property.
On October 22,
2002, as a condition for the interim financing with Pyxis noted above, we
entered into separate agreements with the purchasers in the December 2000 and
January 2001 private placements, described below, to temporarily waive certain
provisions of these private placement agreements. Specifically, the purchasers
temporarily waived their right, through March 31, 2003, to receive cash
payments of up to $100,000 per month upon our delisting from the Nasdaq
SmallCap Market. The purchasers also
waived through March 31, 2003 their right to receive additional shares of our
common stock for no additional consideration if we issue shares of our common
stock at a price below $2.50 per share.
For the purchaser in the December 2000 private placement this waiver is
permanent, since its rights expired on February 9, 2003. Under these agreements
the purchasers have also agreed to cancel warrants to purchase an aggregate of
864,407 shares of common stock. In exchange, we issued an aggregate of
1,676,258 shares of our common stock to the purchasers for no additional cash
consideration. These temporary waivers became permanent when we received an
equity investment from Pyxis on March 5, 2003.
On
August 9, 2002, we received approximately $475,000, net proceeds, from the sale
of term promissory notes with an aggregate original principal amount of
$525,000. These notes mature in one year and pay interest at a rate of
15%. The principal and all interest, a
total of $603,750, are to be paid on August 9, 2003. We can prepay the
principal and accrued interest without penalty. Pyxis has agreed, prior to the
maturity of these promissory notes, to advance us the cash required to repay
the principal and interest due. At that
time we will issue to Pyxis a promissory note with the same terms as the
promissory notes due to Pyxis that are discussed above. The promissory notes purchasers received
warrants to purchase one share of stock for a purchase price of $2.50 for every
dollar invested in the promissory notes. In total warrants to purchase 525,000
shares of stock were issued. These warrants expire in ten years.
In January
2001, we sold in a private placement 1.2 million shares of common stock for
$2.50 per share. The purchasers of the common stock also received warrants to
purchase 600,000 shares of common stock exercisable at $3.00 per share. We
generated net proceeds of approximately $2.9 million from this
transaction. Under the terms of this
private placement we are required to adjust downward the price per share paid
in the offering, by issuing additional shares, to match any offering price paid
in subsequent offerings until May 9, 2003.
The warrants issued to those purchasers were canceled on October 22,
2002, and 670,588 additional shares were issued to the purchasers of this
private placement.
In December
2000, we sold in a private placement 542,373 shares of common stock at $3.69
per share. The purchasers of the common stock also received warrants to
purchase 135,593 shares of common stock exercisable at $4.83 per share. We
generated net proceeds of approximately $1.9 million from this transaction.
Under the terms of this private placement we were required to adjust downward
the price per share paid in the offering, by issuing additional shares, to
match any offering price paid in subsequent offerings until February 2003.
Following the January 2001 offering, described above, we issued an additional
257,627 shares of common stock to the purchasers in the December 2000 offering,
and new warrants to purchase 264,407 shares of common stock exercisable at a
price of $3.13 to replace the previously issued warrants to purchase 135,593
shares of common stock. These warrants were canceled on October 22, 2002, and
1,005,670 additional shares were issued to the purchasers of this private
placement.
Strategy
Our objective
is to be a leading provider of genetic tests and services. Our research and development focuses on the
discovery and development of genetic risk assessment and risk stratification
tests and the improvement of health outcomes by linking these tests to
therapeutic and nutritional interventions. We are also focused on developing
genetic tests that help identify patients most likely to respond to a specific
drug or a specific nutritional product.
Our strategy is to develop products for clinical use and to
commercialize these products through strategic partners. We intend to generate
testing revenues, licensing fees, and royalty revenues from the sale of
products developed with our collaborative partners, and fee-for-service or
participatory revenues pursuant to contracts with our collaborative partners.
We believe that this strategy allows us to generate near-term revenues and
diversify risk, while building a proprietary product portfolio with significant
long-term potential. We believe one of our core strengths is our ability to
identify genetic variations, or markers, and correlate them to clinical utility
in a wide range of common chronic diseases.
Development System and Approach
Many
factors, both environmental and genetic, contribute to most common diseases.
Importantly, some genetic factors are sufficiently strong that they influence
the onset and progression of a disease despite many other variables. These
genetic factors strongly influence aspects of the biology that are central to
the disease process. We have focused our research and product development
efforts on genetic factors that significantly influence the clinical course of
common, chronic diseases.
The body
responds to various challenges by means of chemicals produced by the cells. One
of the first proteins produced following any stimulus is IL-1. It then
activates multiple biochemical reactions that lead to inflammation, wound
healing, bone and tissue growth and repair, and many other biological
processes. IL-1 therefore greatly affects the development and maintenance of
chronic inflammation. We have
identified variations in the IL-1 genes that either amplify or decrease the
biological processes that are switched on by IL-1, thereby providing ways to
predict who is more susceptible to certain chronic diseases and providing novel
opportunities to select optimal drug or nutritional therapy.
Product Pipeline and Proprietary Position
Genetic Testing
Risk Assessment and Stratification Tests
We have
completed clinical trials and patent applications have been filed or patents
have been issued on the role of genetic factors in several diseases.
Nevertheless, in the short-term we are focusing our development efforts only in
the areas of cardiovascular disease and osteoporosis. We introduced PST commercially in the United States as a test
that is predictive of disease risk for severe gum diseases, or
periodontitis. The test is currently
being repositioned in the marketplace as a test predictive of patients with
early periodontitis who are at risk for rapid progression of the disease. Clinical trials are ongoing in the area of
cardiovascular disease and osteoporosis.
We expect one or more of these studies will be completed by the end of
2003.
Pharmacogenetics Tests
Pharmacogenetics
is the linking of specific therapies to a patient’s response based upon their
specific genetic code. We believe that
pharmacogenetics represents the future of medicine. With pharmacogenetics, in the future, instead of all patients at
a specific stage of disease receiving the same treatment, a patient may be able
to first receive a genetic test to predict which treatment will be most
effective.
We are
currently developing a test to determine the best treatment for patients in
advanced stages of rheumatoid arthritis.
We intend to continue this work with a large health management
organization and other academic institutions during 2003.
Nutrigenomic and Dermagenomic Products
On March 5, 2003, we entered into a Research Agreement with an
affiliate of Pyxis governing the terms of developing and validating
nutrigenomic and dermagenomic tests and products. Pyxis has agreed to provide us with $5,000,000 over the first
twenty-four months of this agreement to conduct certain research projects. We will also receive a royalty payment based
upon sales of any resulting products.
The initial focus of our research effort will be the screening of
nutritional products to link efficacy of these products to specific genetic variations. It is expected that these products and
genetic tests to help assess wellness will be marketed through Alticor’s direct
to consumer distribution network.
Our research in genomics has opened up new possibilities for using
genetic information to choose nutritional products that promote wellness. We believe that the benefits derived from
nutritional supplements will be greatly enhanced by applying a deeper
understanding of underlying human genetics.
Further, we believe that the future of personalized nutritional
supplementation and skin care will be based on an individual’s genetic makeup.
Therapeutics
We are very interested in the prospect of developing therapeutics that
will be effective in the treatment of persons of a particular genotype. We are actively pursuing collaborative
relationships to in-license possible candidate compounds for those that may be
most promising to bring to market.
These compounds may come from several sources, including, (i) off-patent
drugs that can be re-patented as a treatment for a specific genotype, (ii)
drugs that have failed their Phase III clinical trials because they did not
prove efficacious for the general population but might gain approval if we were
able to identify the specific patients for whom it will work or (iii) new
chemical entities which our greater understanding of genetics may allow us to
develop.
Pharmacogenetic Tools
We believe
that the knowledge we have developed over the past several years regarding the
IL-1 gene cluster and other gene clusters can be developed into a tool for
researchers involved in study of inflammation and genetics and how they relate
to risk of disease and drug responses.
We have developed and licensed medical research tools, including our
proprietary BioFusion system, our biologic modeling software, to pharmaceutical
and biotech companies. We are currently
receiving license and royalty revenues from the sale of BioFusion.
We have spent
$3,082,000, $2,687,000 and $2,167,000 on research and development during the
years ended December 31, 2002, 2001 and 2000, respectively.
Clinical Utility
We believe in
the advantages a genetic approach to medicine offers in the prevention,
management and treatment of disease. We believe our predictive tests and
research tools are of value to:
• Nutritional or
pharmaceutical companies, which may use them to speed new product and drug
development, to improve the efficacy of their products and drugs, to develop
new therapeutics and to target patients most likely to respond to their
products and drugs.
• Payors and
organizations that provide health care services, which may use them to stratify
patients by risk and more effectively allocate resources for the greatest
benefit.
• Physicians and
other healthcare professionals, who may use this information to assess the risk
involved for their patients and adopt appropriate treatments or preventive
strategies.
• Individual
consumers committed to staying healthy, who may use this information to make
better choices and set priorities based on personal knowledge of their
individual risk for common diseases.
Product on the Market
Test Predictive of Risk for Periodontal
Disease
Our first
genetic susceptibility test, PST, identifies patients at risk for rapid
progression of periodontitis. Periodontitis is a bacterially induced chronic
inflammation that destroys the collagen fibers and bone that surround and
support the teeth. Untreated, periodontitis will eventually result in tooth
loss. Individuals who test positive for this genotype will normally have more
frequent checkups with their dental provider, and would be candidates for more
aggressive treatment.
PST is the
result of a scientific breakthrough in which an association was discovered
between a specific IL-1 genetic marker (i.e., a genetic variation or
polymorphism associated with increased disease incidence or severity) and
severe periodontal disease. IL-1 is a cytokine or protein that is known to play
a role in inflammation and the expression of periodontal disease. Patients with
this specific genotype have been found to progress more rapidly towards severe
periodontal disease. It has also been determined that cells with this genotype
produce as much as four times more IL-1 in response to the same bacterial
challenge. Prevention or therapeutic intervention aimed at reducing the
bacterial challenge should decrease the stimulus for IL-1 production and could
thereby protect the patient against the potentially destructive effects of this
genotype. Based on clinical trials we have conducted and our experience to
date, we estimate that approximately 30% of the population will test positive
for this genotype.
We have
developed PST under the terms of a project agreement with the University of
Sheffield. In November 1997, a patent
related to the detection of genetic predisposition to periodontal disease was
issued to us. We initiated commercial sales of PST in October 1997. In December
1998, we entered into an agreement with Washington Dental Service, a member of
Delta Dental Plans Association, for the purchase of 1,200 PST tests to be used
in a study sponsored by Washington Dental Service, in collaboration with the
University of Washington School of Dentistry. The study was designed to
quantify the relationship between PST genotype status and the utilization of
dental services by patients in a dental plan.
The study was completed during 2001.
It found no direct correlation between IL-1 genotype status and
utilization of dental services.
We are
currently evaluating the use of PST as a tool to determine which patients with
gingivitis or early periodontitis should increase their frequency of dental
visits. We believe that not all
patients with early signs of disease will develop the full level of
periodontitis in a short period of time.
We believe that PST can identify the patients most likely to have a
rapid progression of the disease.
We are
currently marketing PST, through a distributor, to dental care providers. We hope to market PST through dental
insurance payers as means of stratifying patients for risk of periodontal
disease. Those at high risk will
receive extra preventative services that we anticipate would save dental payers
from the expense of more costly procedures.
Products Under Development
Test Predictive of Disease Risk for
Osteoporosis
Osteoporosis,
the most common age-related bone disease, results in a decrease in the strength
of the bone that leaves the affected individual more susceptible to fractures.
According to the National Institute of Health 10 million Americans suffer from
the disease and another 34 million have low bone mass, placing them at
increased risk for the disease. Although,
osteoporosis occurs in both men and women, it begins earlier and progresses
more rapidly in women, after menopause.
The consequences of osteoporosis can be both physical and
financial. Hip and vertebral fractures,
which are commonly associated with osteoporosis, have a profound impact on quality
of life. The National Institute of
Health estimates that direct financial expenditures for the treatment for
osteoporotic fractures is $17 billion annually in the United States alone.
We have conducted several collaborative research projects with major
osteoporosis epidemiologic centers. Results of these studies have indicated a
number of small variations in the IL-1 gene cluster, referred to as
polymorphisms, are associated with a more rapid rate of bone loss and an
increased risk of fracture in post-menopausal women. A genetic predisposition test could identify women at elevated
risk for developing osteoporosis-related vertebral fracture early in the course
of the disease and allow these women and their physicians to practice
preventive medicine. This will enable nutritional or therapeutic intervention
or recommendations for changes in lifestyle or diet at an early stage, so that
bone loss and fracture is minimized or prevented.
We have completed a preliminary market research analysis, involving
women’s focus groups, physicians and consumers, which show there is enthusiasm
for such a test.
Test Predictive of Cardiovascular Disease
Risk
The causes and mechanisms of coronary artery disease, or CAD, are
complex and incompletely understood. Consequently, prediction, diagnosis and
treatment of coronary artery disease has focused on the development of a set of
risk factors that help to identify those individuals who are most at risk. Nutritional and medical treatment centers on
control of any of the risk factors that can be modified. Alternatively, mechanical revascularization
of vessels may need to take place when the disease has reached a critical
clinical threshold. Recently, interest has intensified in the early lowering of
cholesterol and other risk factors modifiable through diet and nutrition as
proactive approaches to improve long-term cardiovascular wellness. In fact,
recent revisions to the Adult Treatment Panel III (ATP-III) of the National
Cholesterol Education Program (NCEP) guidelines have suddenly increased the
population for whom cholesterol lowering approaches should be considered.
The traditional CAD risk factors, such as high cholesterol, diabetes
and smoking, only account for slightly over half of CAD cases. When this fact is considered together with
the enormous cost to the healthcare system of simply treating all
high-cholesterol individuals with cholesterol-lowering prescription drugs to
prevent CAD, it is easy to understand why there is great interest in developing
new tests to more precisely stratify individuals’ risk of CAD. Likewise, there is already a bewildering
array of nutritional products confronting consumers who wish to take control of
their own cardiovascular health through non-prescription dietary and
nutritional approaches.
Fortunately, the rapid explosion in knowledge about variation in the
human genome holds great promise for providing the scientific basis for a test
that can help the health care practitioner and consumer better understand
individual risk and make more informed decisions among medical and nutritional
products.
Chronic
inflammation is now a well-recognized risk factor in the development of CAD and
for subsequent heart attacks. We have
conducted studies that demonstrate certain variations, or SNPs, in the IL-1
genes contribute to a pro-inflammatory state.
One pattern of IL-1 SNPs leads to increased levels of inflammation and
an increased risk of an acute myocardial infarction. A second pattern of IL-1 SNPs leads to qualitative differences in
inflammation and is associated with an increased risk of clogged heart arteries
that produce pain on exercise (angina). Since the IL-1 SNPs that an individual
is born with do not change, they may be used to predict risk for specific types
of heart disease and to guide preventive therapies. We expect to have a test to identify a risk factor for
cardiovascular disease on the market by the beginning of 2005.
Test to Determine the Most Effective
Treatment for Rheumatoid Arthritis
Rheumatoid
Arthritis is a disease that affects approximately 2.1 million Americans
according to the Arthritis Foundation.
The most common sufferers are women between the ages of 25 and 40 years
old. The Arthritis Foundation estimates
50% of people with rheumatoid arthritis are on disability within ten years of
the conditions onset. The final drug
treatments that are usually prescribed by physicians for patients with RA are
anticytokine treatments.
We are
currently developing a test that we believe may help rheumatologists select the
best anticytokine therapy for each rheumatoid patient. Different anticytokine therapies act very
differently on a patient’s biology. Two
of the three anticytokine therapies used to treat Rheumatoid Arthritis are
anti-tumer necrosis factor alpha, or anti- TNFa drugs; the other affects the
IL-1 gene. We believe that depending
upon the specific genetics of individual patients, it can be predicted which
class of drug would be most effective.
Neither class of drug works for all individuals and the cost of
prescribing the incorrect drug is very high in terms of both pain and suffering
for the patient and increased cost of medical
intervention. We are currently
conducting a study to identify gene polymorphisms associated with anti-cytokine
therapies. We expect to complete this
study by the end of 2003.
Nutrigenomic and Dermagenomic Products
We are developing technology for screening nutrigenomic and
dermagenomic products for efficacy within individuals with certain genetic
variations. A variety of nutritional
ingredients including n-3-polyunsaturated fatty acids and alpha-tocopherols,
have been shown to reduce levels of IL-1 and TNFα. Recently it has been shown that the
magnitude of nutrient benefit on TNFα levels is influenced by genetic
variations.
Given the biological mechanisms that the IL-1 and TNFα gene
variations use to alter inflammation, we believe that proprietary mixtures of
nutrients can be identified to modulate inflammation in individuals who are on
a rapid path to chronic disease complications.
Testing Procedure
Each of our
genetic susceptibility tests requires consumers, dentists or physicians to
follow a specific protocol. To conduct a genetic susceptibility test, the
doctor does a sample cheek swab and submits it to the laboratory that has been
selected to perform the test. The laboratory then performs the test following
our specific protocol and informs the dentist or physician of the results. The
dentist/physician in turn, informs the patient and determines the appropriate
course of action.
Pre-Marketing Trials/Status of Predictive
Tests
As an internal
procedural standard, we conduct three categories of clinical trials in
developing our genetic susceptibility tests. The first trial is called a proof
of principle trial, used to prove a laboratory finding. The results of this
trial are utilized to support the initial patent application and therefore the
trial needs to be completed before the patent application can be filed. The
second trial is a confirmatory trial. The purpose of the confirmatory trial is
to independently confirm the results of the proof of principle trial. The third
category of trial relates to clinical utility. The clinical utility trial is
conducted to learn what is the most effective utilization of the test in actual
clinical practice.
Following
confirmatory studies, additional trials are completed on larger populations to
help develop broad scientific evidence supporting the clinical utility of each
of our tests. Such additional trials not only strengthen the support for each
test’s known use (i.e., detecting genetic susceptibility) but also lead to
additional practical uses of the susceptibility tests (e.g., use of the
susceptibility tests to determine a patient’s responsiveness to a given
drug). Our work in coronary artery
disease risk testing has been conducted in all three categories of all clinical
trials. Our work in osteoporosis will
soon enter the second category. We
expect the rheumatoid arthritis project will enter the proof of principal trial
by the summer of 2003.
Strategic Alliances and Collaborations
Our strategy
is to develop products for research and clinical use and commercialize such
products through strategic alliances. We have followed a strategy of working
with strategic partners at the fundamental discovery stage in product
development and in sales and marketing. This strategy has given us access to
discoveries while reducing up-front research expenses and will give us access
to markets without committing to the high costs of selling and advertising.
Pyxis Innovations, Inc
On March 5,
2003, we announced that we entered into a broad strategic alliance with several
affiliates of the Alticor family of companies to develop and market novel
nutritional and skin care products. The
alliance will utilize Interleukin Genetics’ intellectual property and expertise
in genomics to develop personalized consumer products.
The alliance includes an equity investment, a multi-year research and
development agreement, a licensing agreement with royalties on marketed
products, the deferment of outstanding loan repayment and the refinancing of
bridge financing obligations. The
financial elements of this alliance are described in greater detail in the
section titled “Current Financial Condition”
beginning on page 3.
In broad terms, we believe that this alliance will open our research
and development products to our partner’s proven distribution channel. We believe that the benefits derived from
nutritional products that are being developed by this partner will be greatly
enhanced by applying our deeper understanding of the underlying human
genetics. Further, we believe that the
future of personalized nutritional supplementation and skin care will be based
on an individual’s genetic makeup. This
alliance will focus on developing genetic tests to determine a genetic profile
of an individual and developing nutritional supplements and skin care products
that will benefit individuals of that genetic profile.
The University of Sheffield
Since 1994, we
have had a strategic alliance with the Department of Molecular and Genetic
Medicine at the University of Sheffield in the United Kingdom (“Sheffield”).
Sheffield is a world leader in the genetic aspects of common diseases with an
inflammatory component. Under this alliance, Sheffield has provided to us the
fundamental discovery and genetic analysis from Sheffield’s research
laboratories and we have focused on product development, including clinical
trials, and the commercialization of these discoveries.
In October
1999 we entered into a new arrangement with Sheffield and its investigators
replacing the research and development agreement that had been in place with
Sheffield since 1996. Pursuant to this new arrangement, we issued an aggregate
of 475,000 shares of our common stock to Sheffield and one of its investigators
in exchange for the relinquishment by Sheffield of its interests under certain
previous agreements with us. In addition, this agreement requires us to issue
to Sheffield and certain of its investigators options to purchase an aggregate
of 50,000 shares of stock at the current market price each year during the
period of time the arrangement is in place for an aggregate of 200,000 shares.
Sheffield is entitled to additional options to purchase 10,000 shares of stock
at the current market price each June 30th for each patent that is filed on our
behalf during the previous twelve months.
Kaiser Permanente
In December
2001, we entered into a research collaboration with Kaiser Permanente’s Center
for Health Research to study genetic risk factors for chronic diseases that are
affected by inflammation. We believe
that knowledge resulting from this work will enable us to develop new
diagnostic tools that physicians and health care organizations can use to
assess their patients’ genetic risk for many diseases. The first clinical study under this
collaboration was a study designed to investigate the importance of genetic
differences among patients with type II diabetes in determining their risk for
developing cardiovascular disease. This
study is currently completed and the data analysis is ongoing. We expect that we will be performing
additional studies assessing patient’s genetic risk for cardiovascular risk
with Kaiser during 2003.
Unitedhealth Group
In March 2002,
we entered into a research collaboration agreement with UnitedHealth Group’s
research arm, the Center for Healthcare Policy and Evaluation, to study how
commonly inherited gene variants affect the response of patients with certain
inflammatory diseases to specific drugs. Knowledge resulting from this work
will help us develop pharmacogenetic tests that physicians and managed care
organizations can use to assist in the selection of the optimal drug for an
individual patient. In our initial study with UnitedHealth Group, we are
conducting a study to determine whether analysis of genotype will be useful to
predict responses to anti-cytokine therapy for individuals with rheumatoid
arthritis. Different anti-cytokine therapies act very differently on a
patient’s biology. Two of the three anti-cytokine therapies used to treat
rheumatoid arthritis are anti TNFa drugs; the other acts upon the IL-1 gene. We
believe that depending upon the specific genetics of individual patients, we
might be able to predict which class of drugs would be most effective. We expect to have results from this study by
the end of 2003.
PST Commercial Partnerships
In December
2000, we entered into an exclusive seven-year license agreement with Hain
Diagnostika/ADS GmbH (“Hain”) for the marketing, distribution and processing of
PST in all countries outside of North America and Japan. Hain has extensive
experience in commercializing genetic tests on its DNA-STRIP Technology
Platform in several fields as well as a specific commitment to marketing
products directly to dentists. Hain’s central facility offers excellent
turnaround times, high quality laboratory operations and a sales and technical
staff to support clinical users. We can
terminate this agreement if certain minimum sales levels are not met. Since December 2001, Kimball Genetics, Inc.
has been our sole marketing partner within the United States.
Intellectual Property
Our commercial
success may depend at least in part on our ability to obtain appropriate patent
protection on our drug discovery and diagnostic products and methods. We
currently own exclusive rights in twelve issued U.S. patents, which have
projected expiration dates between 2015 and 2020. We have received notices of allowances on three U.S. patent
applications and have thirteen additional pending U.S. patent applications, which
are based on novel genes or novel associations between particular gene
sequences and certain inflammatory diseases, and disorders. Of the twelve
issued patents, eight relate to genetic tests for periodontal disease,
osteoporosis, asthma, coronary artery disease, sepsis and disease associated
with IL-1 inflammatory haplotypes, three relate to BioFusion, our biologic
modeling software, and one relates to a transgenic mouse model.
We have been
granted a number of corresponding foreign patents and have a number of foreign
counterparts of our U.S. patents and patent applications pending.
We have
received trademark protection for PST, our periodontal susceptibility test. Our
proprietary technology is subject to numerous risks, which we discuss in
“Factors That May Affect Our Future Performance” beginning on page 12 of this
report.
Competition
The genetics
field is broad with diverse business segments.
The field may be generally segmented into: a) services, including
sequencing and informatics; b) technology platforms, including chip makers and genotyping
equipment; c) drug target and drug development companies; d) diagnostic
companies that will distribute DNA tests; and e) content companies that will
discover genes and gene variations that influence diseases and drug responses.
We are
involved in the discovery and commercialization of genetic variations that
influence inflammatory diseases and the therapeutic responses to these
diseases. Despite this segment’s
relatively young age, other companies do exist which have research programs
seeking disease related genes for therapeutic and susceptibility testing
purposes, including some that involve treatable/preventable disease. The
technologies for discovering genes which predispose individuals to major
diseases and approaches for commercializing those discoveries are new and
rapidly evolving. Rapid technological developments could result in our
potential services, products, or processes becoming obsolete before we recover
a significant portion of the related research and development costs and capital
expenditures.
Our
competitors in the United States and abroad are numerous and include, among
others, major pharmaceutical and diagnostic companies, specialized
biotechnology firms, universities and other research institutions, including
those receiving funding from the
Human Genome Project. Many of
our potential competitors have considerably greater financial, technical,
marketing and other resources than us, which may allow these competitors to discover
important genes or successfully commercialize these discoveries before us. If
we do not discover disease-predisposing genes, characterize their functions,
develop genetic tests and related information services based on such
discoveries, obtain regulatory and other approvals, and launch these services
or products before competitors, we could be adversely affected.
Additionally,
some of our competitors receive data and funding from the Human Genome Project.
The Human Genome Project is a federally funded program focused on sequencing
the human DNA and enriching the sequence data with information about its
biological function. To the extent our competitors receive data and funding
from the Human Genome Project at no cost to them, they may have a competitive
advantage over us.
In the case of
newly introduced products requiring “change of behavior” (such as genetic
susceptibility tests), multiple competitors may accelerate market acceptance
and penetration through increasing awareness. Moreover, two different genetic
susceptibility tests for the same disease may in fact test or measure different
components, and thus actually be complementary when given in parallel as an
overall assessment of risk, rather than being competitive with each other.
Furthermore,
the primary focus of most companies in the field is performing
gene-identification research for pharmaceutical companies for therapeutic
purposes, with genetic susceptibility testing being a secondary goal. In
contrast, our primary business focus is developing and commercializing genetic
susceptibility tests for common diseases, with only an ancillary drug discovery
program.
Government Regulation
The sampling
of blood, saliva or cheek scrapings from patients and subsequent analysis in a
central clinical laboratory does not, at the present time, require Federal Drug
Administration (“FDA”) or regulatory authority approval inside the U.S. for
either the sampling procedure or the analysis itself. The samples are collected
using standard materials previously approved as medical devices, such as
sterile lancets and swabs. The testing procedure itself is performed in one or
more registered, certified clinical laboratories under the auspices of the
Clinical Laboratory Improvement Act of 1988 (“CLIA”), administered by the
Centers of Medicare and Medicaid Services.
The federal regulations governing approval of the laboratory facilities
and applicable state and local regulations governing the operation of clinical
laboratories would also apply to the laboratories performing tests for us.
Changes in such regulatory schemes could require advance regulatory approval of
genetic susceptibility tests sometime in the future and could have a material
adverse effect on our business. In addition, certain billing practices require
that we, a subsidiary, or a third party test provider that we license, be
licensed and regulated under CLIA.
In addition,
while our main focus is on genetic susceptibility testing, we may, in the
future, endeavor to partner with pharmaceutical companies in the area of drug
development. Any drug products developed by us or our future collaborative
partners, would be required to undergo an extensive regulatory approval process
by the FDA prior to marketing in the United States. The regulatory process, which
includes preclinical testing and clinical trials of each therapeutic product in
order to establish its safety and efficacy, can take many years and requires
the expenditure of substantial resources. Data obtained from preclinical and
clinical activities are susceptible to varying interpretations which could
delay, limit or prevent regulatory agency approval. In addition, delays or
rejections may be encountered during the period of therapeutic development,
including delays during the period of review of any application. Delays in
obtaining regulatory approvals could adversely affect the marketing of any
therapeutics developed by us or our collaborative partners, impose costly
procedures upon us and our collaborative partners’ activities, diminish any competitive
advantages that we and our collaborative partners may attain and adversely
affect our ability to receive royalties. Once regulatory approval of a product
is granted, the approval may impose limitations on the indicated uses for which
it may be marketed. Further, even if such regulatory approval is obtained, a
marketed product and its manufacturer are subject to continuing review. The
discovery of previously unknown problems with a product or manufacturer may
result in restrictions on such product or manufacturer. Such restriction could
include withdrawal of the product from the market.
Employees
As of March
27, 2003, we had 19 full-time and part-time employees. Of our employees, 13 are
engaged directly in the research, development and commercialization of tests
and 6 are engaged in administrative or managerial activities. Our employees are
not covered by a collective bargaining agreement, and we consider our relations
with our employees to be good.
Factors
That May Affect Our Future Performance
We have a
history of operating losses and expect these losses to continue in the future.
We have
experienced significant operating losses since our inception and expect these
losses to continue for some time. We incurred losses from operations of $5.2
million in 2000, $4.8 million in 2001 and $5.1 million in 2002. As of December
31, 2002, our accumulated deficit was $40.8 million. Our losses result
primarily from research and development and selling, general and administrative
expenses. We have not generated significant revenues from product sales, and we
do not know if we will ever generate significant revenues from product sales.
We will need to generate significant revenues to continue our research and development
programs and achieve profitability. We cannot predict when, if ever, we will
achieve profitability.
The market
for genetic susceptibility tests is unproven.
The market for
genetic susceptibility tests is at an early stage of development and may not
continue to grow. The general scientific community, including us, has only a
limited understanding of the role of genes in predicting disease. When we
identify a gene or genetic marker that may predict disease, we conduct clinical
trials to confirm the initial scientific discovery and to establish the
scientific discovery’s clinical utility in the marketplace. The results of
these clinical trials could limit or delay our ability to bring the test to
market, reduce the test’s acceptance by our customers or cause us to cancel the
program, any of which limit or delay sales and cause additional losses. The
only genetic susceptibility test we currently market is PST, and it has
produced only minimal revenues to date. The marketplace may never accept our products,
and we may never be able to sell our products at a profit. We may not complete
development of or commercialize our other genetic susceptibility tests.
The success of
our genetic susceptibility tests will depend upon their acceptance as medically
useful and cost-effective by patients, physicians, dentists, other members of
the medical and dental community and by third-party payors, such as insurance
companies and the government. We can achieve broad market
acceptance only with substantial education about the benefits and limitations
of genetic susceptibility tests. Our tests may not gain market acceptance on a
timely basis, if at all. If patients, dentists and physicians do not accept our
tests, or take a longer time to accept them than we anticipate, then it will
reduce our sales, resulting in additional losses.
We rely
heavily on third parties to perform sales, marketing and distribution functions
on our behalf, which could limit our efforts to successfully market products.
We have
limited experience and capabilities with respect to distributing, marketing and
selling genetic susceptibility tests. We have relied and plan to continue to
rely significantly on sales, marketing and distribution arrangements with third
parties, over which we have limited influence. If these third parties do not
successfully market our products, it will reduce our sales and increase our
losses. If we are unable to negotiate acceptable marketing and
distribution agreements with future third parties, or if in the future we elect
to perform sales, marketing and distribution functions ourselves, we will incur
significant costs and face a number of additional risks, including the need to
recruit experienced marketing and sales personnel. On March 5, 2003, we signed a strategic alliance with Alticor
Inc. As part of this alliance, Alticor
and Alticor’s affiliates will conduct some sales, marketing and distribution
functions on our behalf. While Pyxis and
these affiliates have far more experience and success in marketing, selling and
distributing products than we do, we could become very dependent upon their
efforts and their failure to successfully market our products could reduce our
sales and increase our losses.
If we fail
to obtain additional capital, or obtain it on unfavorable terms, then we may
have to end our research and development programs and other operations.
We anticipate
that our current and anticipated financial resources are adequate
to maintain our current and planned operations through early 2005. If we are
not generating sufficient cash or cannot raise additional capital prior to this
date, we will be unable to fund our business operations and will be required to
seek other strategic alternatives and may be required to declare bankruptcy.
Any future issuances of equity securities by us will require stockholder
approval for an increase in authorized shares. If we are unable to obtain such
approval, we will be required to seek other strategic alternatives and may be
required to declare bankruptcy. We have
the right to receive an additional two million dollars from Pyxis pursuant the
Purchase Agreement we signed with them on March 5, 2003 for no additional
consideration if we enter into a genetics testing agreement with one or more
customers of such size that the projected internal rate of return with respect
to the project is at least twenty percent with a payback period of three years
or less. We may never be able enter
into such an agreement.
Our future
financial needs depend on many factors. We will need capital for the commercial
launch of additional genetic tests, continued research and development
efforts, obtaining and protecting patents and administrative expenses.
Additional financing may not be available when needed, or, if available, it may
not be available on favorable terms. If we cannot obtain additional funding on
acceptable
terms when needed, we may have to discontinue operations, or, at a minimum,
curtail one or more of our research and development programs.
Because
Pyxis has a controlling percentage of the voting power of our outstanding
stock, other stockholders’ voting power is limited.
On matters for
which the holder of our preferred stock, Pyxis, votes on an as converted basis
with holders of common stock, Pyxis would have approximately 54.91% of shares
of common stock deemed entitled to vote.
Accordingly, Pyxis will be able to determine the outcome of stockholder
votes, including votes concerning the election of directors, the adoption or
amendment of some provisions in our Certificate of Incorporation or By-Laws and
the approval of mergers and other significant corporate transactions, including
a sale of substantially all of our assets. Pyxis may make decisions that are
adverse to other stockholders’ or warrantholders’ interests. This ownership
concentration may also adversely affect the market price of our common
stock. Pyxis has the right to designate
four of our five directors and the four directors designated by Pyxis are all
employees of Pyxis or its affiliates.
The Series
A Preferred Stock has rights which are senior to common stockholder rights and
this may reduce the value of the common stock.
The Series A
Preferred Stock, which was issued to Pyxis on March 5, 2003, accrues dividends
at the rate of 8% of the original purchase price per year, payable only when,
as and if declared by the Board of Directors and are non-cumulative. If we declare a distribution,
with certain exceptions, payable in securities of other persons, evidences of
indebtedness issued by us or other persons, assets (excluding cash dividends)
or options or rights to purchase any such securities or evidences of
indebtedness, then, in each such case the holders of the Series A Preferred
Stock shall be entitled to a proportionate share of any such distribution as
though the holders of the Series A Preferred Stock were the holders of the
number of shares of our common stock into which their respective shares of
Series A Preferred Stock are convertible as of the record date fixed for the
determination of the holders of our common stock entitled to receive such
distribution.
In the event
of any liquidation, dissolution or winding up of Interleukin, whether voluntary
or involuntary, the holders of the Series A Preferred Stock shall be entitled
to receive, prior and in preference to any distribution of any of our assets or
surplus funds to the holders of our common stock by reason of
their ownership thereof, the amount of two times the then-effective purchase
price per share, as adjusted for any stock dividends, combinations or splits
with respect to such shares, plus all declared but unpaid dividends on such
share for each share of Series A Preferred Stock then held by them. After receiving this amount, the holders of
the Series A Preferred Stock shall participate on an as-converted basis with
the holders of common stock in any of our remaining assets.
The preferential
treatment accorded the Series A Preferred Stock might reduce the value of the
common stock.
In a circumstance in which Pyxis enters a
business in competition with our own, we have agreed with Pyxis that the four
directors appointed by Pyxis do not need to present potential transactions or
other corporate opportunities to us.
In conjunction
with our strategic alliance with Pyxis, we have agreed to certain terms for
allocating opportunities as permitted under Section 122(17) of the Delaware
General Corporation Law. This agreement, as set forth in the Purchase
Agreement, regulates and defines the conduct of our affairs as they may involve
Pyxis as our majority stockholder and its affiliates, and the powers, rights,
duties and liabilities of us and our officers and directors in connection with
corporate opportunities.
Except under
certain circumstances, Pyxis and its affiliates have the right to engage in the
same or similar activities or lines of business or have an
interest in the same classes or categories of corporate opportunities as we
do. We have agreed with Pyxis that if
Pyxis, or one of our directors appointed by Pyxis, and Pyxis’ affiliates
acquire knowledge of a potential transaction or matter that may be a corporate
opportunity for both Pyxis and its affiliates and us, to the fullest extent
permitted by law, Pyxis and its affiliates will not have a duty to inform us
about the corporate opportunity or be liable to us or to you for breach of any
fiduciary duty as a stockholder of ours for not informing us of the corporate
opportunity, keeping it for its own account, or referring it to another person.
Additionally, except
under limited circumstances, if an officer or employee of Pyxis who is also one
of our directors is offered a corporate opportunity, such opportunity shall not
belong to us. In addition, we agreed that such director will have satisfied his
duties to us and not be liable to us or to you in connection with such
opportunity. This policy may make it
more difficult for us to learn of or benefit from significant opportunities for
strategic alliances, research agreements, distribution agreements, licenses or
new technology.
We rely
heavily on third parties to perform research and development on our behalf,
which could limit our efforts to successfully develop products.
Reliance on
third-party research and development entails risks we would not be subject to
if we performed this function ourselves. These risks include reliance
on the third party for regulatory compliance and quality assurance and the
possibility of breach of agreements by third parties because of factors beyond
our control. We may in the future elect to perform all research and development
ourselves, which will require us to raise substantial additional funds and
recruit additional qualified personnel.
We also face
the possibility of terminations or nonrenewals of agreements by third parties,
based on their own business priorities, at times that are costly or
inconvenient for us. Our Research and
Technology Transfer Agreement with the University of Sheffield, and our consulting
agreement with Dr. Gordon Duff, who leads our research at Sheffield, expire on
June 30, 2004. The Sheffield agreement
automatically renews for one-year periods unless one party gives six month’s
notice to the other party. We will
negotiate for a new agreement with Dr. Duff and will work with Sheffield to
continue our existing agreement or negotiate a new one for the period after
June 30, 2004. Our research and
development activities will be delayed if our relationship with the University
of Sheffield and Dr. Duff were to terminate, as much of our research and
development has been conducted, and we expect it will continue to be conducted
in the foreseeable future, at the University of Sheffield.
If we are
unsuccessful in establishing additional strategic alliances, our ability to
develop and market products and services will be damaged.
Entering into
strategic alliances for the development and commercialization of products and
services based on our discoveries is an important element of our business strategy.
We anticipate entering into additional collaborative arrangements with Alticor
affiliates and other parties in the future. We face significant
competition in seeking appropriate collaborators. In addition, these alliance
arrangements are complex
to negotiate and time-consuming to document. If we fail to maintain existing
alliances or establish additional strategic alliances with Alticor affiliates
and others, then our ability to develop and market products and services will
be damaged. In addition, the terms of any future strategic alliances may be
unfavorable to us or these strategic alliances may be unsuccessful.
If we fail
to obtain an adequate level of reimbursement for our products or services by
third-party payors, then some of our products and services will not be
commercially viable.
The
availability and levels of reimbursement by governmental and other third-party
payors affect the market for any healthcare service. These third-party payors
continually attempt to contain or reduce the costs of healthcare by challenging
the prices charged for medical products and services. Our ability to
successfully commercialize our existing genetic susceptibility test and others
that we may develop depends on obtaining adequate reimbursement
from third-party payors. The extent of third-party payor reimbursement will
likely heavily influence physicians’ and dentists’ decisions to recommend
genetic susceptibility tests, as well as patients’ elections to pursue testing.
If reimbursement is unavailable or limited in scope or amount, then we cannot
sell our products and services profitably. In particular, third-party payors
tend to deny reimbursement for services which they determine to be
investigational in nature or which are not considered “reasonable and necessary”
for diagnosis or treatment. To date, few third-party payors have agreed to
reimburse patients for genetic susceptibility tests, and we do not know if
third-party payors will, in the future, provide full reimbursement coverage for
these genetic tests. If third-party payors do not provide adequate
reimbursement coverage, then individuals may choose to directly pay for the
test. If both third-party payors and individuals are unwilling to pay for the
tests, then the number of tests we can sell will be significantly decreased,
resulting in reduced revenues and additional losses.
If we fail
to obtain patent protection for our products and preserve our trade secrets,
then competitors may develop competing products and services, which will
decrease our sales and market share.
Our success
will partly depend on our ability to obtain patent protection, in the United
States and in other countries, for our products and services. In addition, our
success will also depend upon our ability to preserve our trade secrets and to
operate without infringing upon the proprietary rights of third parties.
We own
exclusive rights in twelve issued U.S. patents, we have received notices of
allowance on three U.S. patent applications and have thirteen U.S. patent
applications pending. We have also been granted a number of corresponding foreign
patents and have a number of foreign counterparts of our U.S patents and patent
applications pending. Our patent positions, and those of other
pharmaceutical and biotechnology companies, are generally uncertain and involve
complex legal, scientific and factual questions. Our ability to develop and
commercialize products and services depends on our ability to:
• Obtain patents;
• Obtain licenses to the proprietary rights of others;
• Prevent others from infringing on our proprietary rights; and
• Protect trade secrets.
Our pending
patent applications may not result in issued patents and any issued patents may
never afford meaningful protection for our technology or products. Further,
others may develop competing products which avoid legally infringing upon, or
conflicting with, our patents. In addition, competitors may challenge any
patents issued to us, and these patents may subsequently be narrowed,
invalidated or circumvented.
We also rely
on trade secrets and proprietary know-how that we seek to protect, in part, by
confidentiality agreements. The third parties we contract with may breach
these agreements, and we might not have adequate remedies for any breach.
Additionally, our competitors may discover or independently develop our trade
secrets.
Third
parties may own or control patents or patent applications and require us to
seek licenses, which could increase our costs or prevent us from developing or
marketing our products or services.
We may not
have rights under patents or patent applications that are related to our
current or proposed products. Third parties may own or control these patents
and patent applications in the United States and abroad. Therefore, in some
cases, to develop or sell any proposed products or services, with patent rights
controlled by third parties, our collaborators or we may seek, or may be
required to seek, licenses under third-party patents and patent applications.
If this occurs, we will pay license fees or royalties or both to the licensor.
If licenses are not available to us on acceptable terms, we or
our collaborators may be prohibited from developing or selling our products or
services.
If third
parties believe our products or services infringe upon their patents, they
could bring legal proceedings against us seeking damages or seeking to enjoin
us from testing, manufacturing or marketing our products or services. Any
litigation could result in substantial expenses to us and significant diversion
of attention by our technical and management personnel. Even if we prevail, the
time, cost and diversion of resources of patent litigation would
likely damage our business. If the other parties in any patent litigation
brought against us are successful, in addition to any liability for damages, we
may have to cease the infringing activity or obtain a license.
Technological
changes may cause our products and services to become obsolete.
Our
competitors may develop susceptibility tests that are more effective than our
technologies or that make our technologies obsolete. Innovations in the
treatment of the diseases in which we have products or product candidates could
make our products obsolete. These innovations could prevent us from selling,
and significantly reduce or eliminate the markets for, our products.
We may be
prohibited from fully using our net operating loss carryforwards, which could
affect our financial performance.
As a result of the losses
incurred since inception, we have not recorded a federal income tax provision
and have recorded a valuation allowance against all future tax benefits. As of
December 31, 2002, we had net operating loss carryforwards of approximately
$33.8 million for federal and state income tax purposes, expiring in varying
amounts through the year 2022. We also had a research tax credit of
approximately $369,000 at December 31, 2002, that expires in varying amounts
through the year 2022. Our ability to use these net operating loss and credit
carryforwards is subject to restrictions contained in the Internal Revenue Code
which provide for limitations on our utilization of our net operating loss and
credit carryforwards following a greater than 50% ownership change during the
prescribed testing period. We have experienced two such ownership changes. One change came subsequent to the end of our
2002 fiscal year, in March 2003, and the other was in June 1999. As a result,
all of our net operating loss carryforwards will be limited in
utilization. The annual limitation may
result in the expiration of the carryforwards prior to utilization. In
addition, in order to realize the future tax benefits of our net operating loss
and tax credit carryforwards, we must generate taxable income, of which there
is no assurance.
We are
subject to intense competition from other companies, which may damage our
business.
Our industry
is highly competitive. Our competitors in the United States and abroad are
numerous and include major pharmaceutical and diagnostic companies, specialized
biotechnology firms, universities and other research institutions, including
those receiving funding from the Human Genome Project. Many of our competitors
have considerably greater financial resources, research and development staffs,
facilities, technical personnel, marketing and other resources than we do.
Furthermore, many of these competitors are more experienced than we are in
discovering, commercializing and marketing products. These greater resources
may allow our competitors to discover important genes or genetic markers before
we do. If we, in conjunction with the University of Sheffield, do not discover
disease predisposing genes and commercialize these discoveries before our
competitors, then our ability to generate sales and revenues will be reduced or
eliminated, and could make our products obsolete. We expect competition to
intensify in our industry as technical advances are made and become more widely
known.
We are
subject to government regulation which may significantly increase our costs and
delay introduction of future products.
The sale,
performance or analysis of our genetic tests do not currently require FDA
approval. At both the federal and state level, there is limited regulation of
genetic testing laboratories. Changes
in existing regulations could require advance regulatory approval of genetic
susceptibility tests, resulting in a substantial curtailment or even
prohibition of our activities without regulatory approval. If our genetic tests
ever require regulatory approval, on either a state or federal level, then the
costs of introduction will increase and marketing and sales of products may be
significantly delayed.
We may be
subject to product liability claims that are costly to defend and that could
limit our ability to use some technologies in the future.
The design,
development, manufacture and use of our genetic susceptibility tests involve an
inherent risk of product liability claims and associated adverse
publicity. Producers of medical products face substantial liability for damages
in the event of product failure or allegations that the product caused harm. We
currently maintain product liability insurance, but it is expensive and
difficult to obtain, may not be available in the future on economically
acceptable terms and may not be adequate to fully protect us against all
claims. We may become subject to product liability claims that, even if they
are without merit, could result in significant legal defense costs. We could be
held liable for damages in excess of the limits of our insurance coverage, and
any claim or resulting product recall could create significant adverse
publicity.
Ethical,
legal and social issues related to genetic testing may reduce demand for our
products.
Genetic
testing has raised issues regarding the appropriate utilization and the
confidentiality of information provided by genetic testing. Genetic tests for
assessing a person’s likelihood of developing a chronic disease have focused
public attention on the need to protect the privacy of genetic assessment
medical information. For example, concerns have been expressed that insurance
carriers and employers may use these tests to discriminate on the basis of
genetic information, resulting in barriers to the acceptance of genetic tests
by consumers. This could lead to governmental authorities prohibiting genetic
testing or calling for limits on or regulating the use of genetic testing,
particularly for diseases for which there is no known cure. Any of these
scenarios would decrease demand for our products and result in substantial
losses.
Our
dependence on key executives and scientists could adversely impact the
development and management of our business.
Our success
substantially depends on the ability, experience and performance of our senior
management and other key personnel. If we lose one or more of the members of
our senior management or other key employees, it could damage our development
programs and our business. In addition, our success depends on our ability to
continue to hire, train, retain and motivate skilled managerial and scientific
personnel. The pool of personnel with the skill that we require is limited.
Competition to hire from this limited pool is intense. We compete with numerous
pharmaceutical and health care companies, as well as universities and nonprofit
research organizations in the highly competitive Boston, Massachusetts business
area. Loss of the services of Dr. Philip R. Reilly, our Chairman and CEO, Dr.
Kenneth Kornman, our President, or Dr. Paul M. Martha, our Chief Medical
Officer, could delay our research and development programs and damage our
business. We have entered into employment agreements with three year terms with
Drs. Reilly, Kornman and Martha. Any of these employees can terminate his
employment upon 30 days’ notice. We do not maintain key man life insurance on
any of our personnel.
There
is a limited market for our common stock and we cannot be sure that even this
limited market will be maintained.
Currently only a very limited
trading market exists for Interleukin common stock. Our common stock trades on the Boston Stock Exchange and the OTC
Bulletin Board under the symbol “ILGN.”
The OTC Bulletin Board is a limited market and subject to substantial
restrictions and limitations in comparison to the Nasdaq system. Any broker/dealer that makes a market in our
stock or other person that buys or sells our stock could have a significant
influence over its price at any given time.
Effective as soon as early 2004 the OTC Bulletin Board will no longer
offer companies a market on which to trade.
Management intends to apply to be listed on the BBX Exchange, which is intended
to replace the OTC Bulletin Board, however we do not currently meet the
stricter minimum listing criteria proposed for the BBX Exchange because none of
the members of our audit committee is independent as defined in the NASD rules. Additionally, the SEC has recently adopted
rules that will require the Boston Stock Exchange to impose new requirements on
the audit committees of listed companies, including that all of their members
must be “independent” by the time of their annual meeting in 2004. We cannot be certain that any of our current
directors will meet the definition of independence eventually adopted by the
Boston Stock Exchange, therefore we may fail to satisfy the listing
requirements for the Boston Stock Exchange.
As a result we are likely to be unable to become listed on the BBX
Exchange, unless we add at least one independent director, and may be subject
to delisting from the Boston Stock Exchange.
If we are delisted from the Boston Stock Exchange and fail to meet the
BBX Exchange listing requirements, then we will be forced to trade solely on
the pink sheets, a market with very limited liquidity. We cannot assure our shareholders that a
market for our stock will be sustained.
There is no assurance that our shares will have any greater liquidity
than shares which do not trade on any public market.
Our business involves environmental risks that may
result in liability for us.
Our business is also
subject to regulation under federal, state and local laws regarding
environmental protection and hazardous substances control, including the
Occupational Safety and Health Act, the Environmental Protection Act and the
Toxic Substance Control Act, which govern the use, generation, manufacture,
storage, discharge, handling and disposal of low-level radioactive material,
biological specimens and other substances. We believe that we are in material
compliance with these and other applicable laws and that our ongoing compliance
will not have a material adverse effect on our business. However, statutes or
regulations applicable to our business may be adopted which impose substantial
additional costs to assure compliance or otherwise materially adversely affect
our operations. In the event of
accidental contamination or injury from these materials, we could be held
liable for any damages that result and any such liability could exceed our
resources.
We do not
expect to pay dividends for the foreseeable future and you should not expect to
receive any funds without selling your shares of common stock, which you may
only be able to do at a loss.
We have never
declared or paid any cash dividends on our capital stock. We currently intend
to retain any earnings for use in the operation and expansion of
our business and do not anticipate paying any cash dividends on our common
stock in the foreseeable future. Therefore, you should not expect to receive
any funds without selling your shares, which you may only be able to do at a
loss.
Our former
use of Arthur Andersen LLP as our independent auditors may pose risk to us and
will limit your ability to seek potential recoveries from them related to their
work.
On June 15,
2002, Arthur Andersen LLP, our former independent auditor, was convicted on a
federal obstruction of justice charge. Some investors, including institutional
investors, may choose not to invest in or hold securities of a company whose
financial statements were audited by Arthur Andersen, which may serve to, among
other things, depress the price of our common stock. In July and August 2002,
our board of directors decided to no longer engage Arthur Andersen and engaged
Grant Thornton LLP to serve as our independent auditors.
SEC rules
require us to present our audited financial statements in various SEC filings,
along with Arthur Andersen’s consent to our inclusion of its audit report in
those filings. The SEC recently has provided regulatory relief designed to
allow companies that file reports with the SEC to dispense with the requirement
to file a consent of Arthur Andersen in certain circumstances. Notwithstanding
the SEC’s regulatory relief, the inability of Arthur Andersen to
provide its consent or to provide assurance services to us could negatively
affect our ability to, among other things, access the public capital markets.
Any delay or inability to access the public markets as a result of this
situation could have a material adverse impact on our business. Also, an
investor’s ability to seek potential recoveries from Arthur Andersen related to
any claims that an investor may assert as a result of the work performed by
Arthur Andersen will be limited significantly in the absence of a consent and
may be further limited by the diminished amount of assets of Arthur Andersen
that are or may in the future be available for claims.
Item 2.
Item 2. Properties
In 2000 we
completed a move of our Corporate and Research and Development offices from San
Antonio, Texas to Waltham Massachusetts. Our offices are located at 135 Beaver
Street and contain approximately 6,000 square feet of space. Our lease on this space expires in June
2006.
Our former
corporate headquarters and research and development offices, located at 100
N.E. Loop 410, Suite 820, San Antonio, Texas, contain 8,131 usable square feet
held under a lease expiring May 31, 2003 and has been subleased by us until the
expiration of this lease.
Item 3.
Item 3. Legal Proceedings
We are not
currently a party to any material legal proceedings.
Item
4.
Item
4. Submission of Matters to a Vote of Security Holders
No matters
were submitted to a vote of security holders during the fourth quarter of the
year ended December 31, 2002.
PART II
Item
5.
Item
5. Market for Registrant’s Common Equity and Related
Stockholder Matters
Market Information
Our common
stock began trading on The Nasdaq SmallCap Market on November 26, 1997 under
the symbol “MSSI” and on the Boston Stock Exchange under the symbol “MSI.” In
August 1999, our common stock symbol changed to “ILGN” on the Nasdaq SmallCap
Market and “ILG” on the Boston Stock Exchange.
On December 10, 2002 our common stock was delisted from the Nasdaq
SmallCap Market and began trading on the OTC Bulletin Board under the symbol
ILGN. We intend to apply for listing on
the new BBX exchange, as proposed by The Nasdaq Stock Market, Inc., when it
becomes operational. Prior to November
1997, there was no established trading market for the common stock. The
following table sets forth, for the periods indicated, the high and low bid
prices for the common stock, as reported by the Nasdaq SmallCap Market and the
OTC Bulletin Board.
Stockholders
As of March
27, 2003, there were approximately 137 record holders of our common stock.
Dividends
We have not
declared any dividends to date and do not plan to declare any dividends on our
common stock in the foreseeable future.
Sale of Unregistered Securities
On December 6,
2002, we issued an option to purchase 35,000 shares of common stock, $.001 par
value, the Sheffield Option, at a per share exercise price of $0.79 to the
University of Sheffield, U.K. (“Sheffield”) and an option to purchase 25,000
shares of common stock, $.001 par value, the Duff option, at a per share
exercise price of $0.79 to Sheffield’s key investigator, Dr. Gordon Duff. The Sheffield option was issued pursuant to
our collaborative arrangement with Sheffield and the Duff option was issued
pursuant to a consulting agreement between Interleukin and Dr. Duff. Under the terms of the arrangement with
Sheffield, we are to grant to Sheffield on each July 1 during the term of the
arrangement options to purchase 25,000 shares of our common stock and options
to purchase an additional 10,000 shares of our common stock for each patent
application filed during the preceding 12 months. Under the terms of the consulting agreement with Dr. Duff, we are
obligated to grant Dr. Duff on each July 1 during the term of the agreement
options to purchase 25,000 shares of our common stock. The Sheffield option and the Duff option are
exercisable for a period of five years from the date of grant. The Sheffield option and Duff option were
not registered under the Securities Act of 1933, as amended (the “Securities
Act”), pursuant to Section 4(2) of the Securities Act and Regulation D
promulgated thereunder, and pursuant to Rule 903 and Rule 904 of regulation
S. We relied on certain representations
and warranties of Sheffield and Dr. Duff, including among other things, their
ability to evaluate the merits and risks of an investment in our securities,
their status as “accredited investors” (as that term is defined in Rule 501 (a)
of Regulation D), that their residence, domicile and/or principal corporate
office is Sheffield, England and the securities were acquired solely for their
own account for investment and not with a view to distribution.
Item
6.
Item
6. Selected Financial Data
The following
table sets forth financial data with respect to Interleukin as of and for each
of the five years ended December 31, 2002. The selected financial data as of
and for each of the five years ended December 31, 2002 have been derived from
our financial statements. The financial
statements and the related reports as of December 31, 2002 and 2001 and for the
years ended December 31, 2002, 2001 and 2000 are included elsewhere in this
Annual Report on Form 10-K. The information below should be read in
conjunction with the financial statements and Management’s Discussion
and Analysis of Financial Condition and Results of Operations included in Item
7.
Item
7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
General Overview
Interleukin
Genetics, Inc., a Delaware corporation, is a functional genomics company
focused on personalized medicine. We believe that by identifying individuals at
risk for certain diseases and combining this knowledge with specific
therapeutic interventions, better healthcare decisions can be made, reducing
costs and greatly improving patient health outcomes. We have a growing
portfolio of patents covering the genetics of a number of common diseases and
conditions.
Our first
genetic test, PST®, a test predictive of risk for periodontal disease, is currently
marketed in the United States and Europe. Other products under development
include tests predictive of risk for osteoporosis, coronary artery disease and
a test to determine the best drug treatment for advanced cases of rheumatoid
arthritis.
During 2000,
we changed our strategy for marketing and distributing PST. We no longer
market, distribute or process the PST tests ourselves. We now use third party
marketers and distributors from whom we earn royalties. We believe that while
this has reduced revenues in the short-term it has also improved margins and
reduced operating costs. In December
2000, we entered into an exclusive seven-year license agreement with Hain
Diagnostika/ADS GmbH (“Hain”) for the marketing, distribution and processing of
PST in all countries outside of North America and Japan. Hain has extensive
experience in commercializing genetic tests on its DNA-STRIP Technology
Platform in several fields as well as a specific commitment to marketing
products directly to dentists. Hain’s central facility offers excellent
turnaround times, high quality laboratory operations and a sales and technical
staff to support clinical users. We can
terminate this agreement if certain minimum sales levels are not met. Since December 2001, Kimball has been our
sole marketing partner within the United States. We believe that through our partners we have adequate coverage in
the sales, distribution and processing of PST.
Revenue for PST sales has been $24,000, $186,000 and $237,000 for the
years ended December 31, 2002, 2001 and 2000 respectively.
We have
followed a strategy of working with strategic partners at the fundamental
discovery stage. This strategy has given us access to discoveries while
reducing up-front research expenses. Since 1994, we have had a strategic
alliance with the Department of Molecular and Genetic Medicine at the
University of Sheffield (“Sheffield”) in the United Kingdom. Under this
alliance, Sheffield has
provided us with the fundamental discovery and genetic analysis from
their research laboratories, and we have focused on product development,
including clinical trials, and the commercialization of these discoveries. We
issued 475,000 shares of common stock to Sheffield and its investigators, which
was valued at $1,128,125 and was charged to research and development expense in
the third quarter of 1999. In addition, we are required to issue Sheffield and
its investigators 50,000 options to purchase common stock each June 30th during
the period of time the arrangement is in place, and 10,000 additional options
to purchase common stock each June 30th for each patent that is approved during
the previous twelve months.
On March 5,
2003, we entered into a broad strategic alliance with several affiliates of the
Alticor family of companies to develop and market novel nutritional and skin
care products. The alliance will
utilize Interleukin Genetics’ intellectual property and expertise in genomics
to develop personalized consumer products.
The alliance
includes an equity investment, a multi-year research and development agreement,
a licensing agreement with royalties on marketed products, the deferment of
outstanding loan repayment and the refinancing of bridge financing obligations.
The financial elements of this alliance
are described in greater detail below in the section titled: “Liquidity
and Capital Resources.”
We believe
this alliance will open our research and development products to our partner’s
proven distribution channel. We believe
that the benefits derived from nutritional supplements that are being developed
by this partner, will be greatly enhanced by applying our deeper understanding
of the underlying human genetics.
Further, we believe that the future of personalized nutritional
supplementation and skin care will be based on an individual’s genetic
makeup. This alliance will focus on
developing genetic tests to determine a genetic profile of an individual,
nutritional supplements and skin care products that will benefit individuals of
that genetic profile.
Critical Accounting Policies
Our
significant accounting policies are described in Note 2 to the consolidated
financial statements included in this report.
We believe our most critical accounting policies are in the areas of
revenue recognition, cost estimations of certain ongoing research contracts,
the expensing of employee stock options, and the expensing of all patent
related costs as incurred.
Revenue recognition:
Revenue from
genetic susceptibility tests is recognized when the tests have been completed
and the results reported to the doctors.
To the extent test kits have been purchased but not yet submitted for
test results, we defer recognition of revenue.
This amount is presented on our balance sheet as deferred revenue. Contract revenues are recognized ratably as
services are provided based on a fixed contract price or on negotiated hourly
rates. Fees for the sale or licensing
of product rights are recorded as deferred revenue upon receipt and recognized
as revenue on the straight-line basis over the period that the related products
or services are delivered or obligations as defined in the agreement are
performed.
Cost estimates:
Much of our
research and development is done on contract by outside parties. It is not unusual that at the end of an
accounting period we need to estimate both the total cost of these projects and
the percent of that project which was completed as of the accounting date. We then need to adjust those estimates when
actual final costs are known. To date,
these adjustments have not been material to our financial statements, and we
believe that the estimates that we made as of December 31, 2002 are reflective
of the actual expenses incurred as of that date. However, the possibility exists that certain research projects
might cost more than we have estimated and that these higher costs will be
reflected in future periods.
Patent expenses:
Patent costs
are expensed as incurred due to the possibility that we will never be able to
derive any benefits from our patents.
As noted in the section titled Intellectual Property on page 10 of this
report we have exclusive rights in twelve issued U.S. patents, we have received
notices of allowance on three U.S. patent applications and have thirteen
additional pending U.S. patents applications.
We have also been granted a number of corresponding foreign patents and
we have a number of foreign counterparts of our U.S. patents and patent
applications pending. Since inception
we have expensed approximately $2.3 million in the effort to obtain patent
protection for our intellectual property including $370,000 during the year
ended December 2002. Due to the
alliance with Alticor Inc. that was announced subsequent to year-end, on March
5, 2003, we expect to begin to capitalize certain patent costs as the prospect
of deriving benefits from some of these patents becomes more certain.
Stock-Based Compensation
Stock options
issued to employees under our stock option and stock purchase plans are
accounted for under Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. All stock-based awards to non-employees are
accounted for at their fair value in accordance with SFAS No. 123, Accounting for Stock-Based Compensation,
and Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to
Other than Employees.
Had
compensation cost for employee stock awards been determined consistent with
SFAS 123, our net loss applicable to common stock and net loss per share would
have been as follows:
Results of Operations
Comparison of Year Ended December 31, 2002 to
Year Ended December 31, 2001
Revenue for
the year ended December 31, 2002 was $289,908 as compared to $202,942 for the
year ended December 31, 2001, representing an increase of $86,966 or 43%. The totals for 2002 include the receipt of
a $250,000 option fee from Pyxis
Innovations Inc.. Excluding this
one-time fee, revenue declined $163,304 or 80%. In the year ended December 31, 2002, we recorded revenue based on
1,400 PST tests processed compared to 4,012 PST tests processed during the year
ended December 31, 2001. Gross profit
margin in 2002 was approximately 99% compared to 76% for the year earlier
period.
The decrease
in test revenue was the result of (i) the inclusion in last year’s revenue
totals of $101,520 for the processing of 1,128 tests in association with
a single clinical trial that was conducted by Washington Delta Dental, (ii) a
decrease in the number of PST tests processed, exclusive of the clinical trial
mentioned above, and (iii) the replacement of our prior PST distributor,
Straumann Company, with our current distributor, Kimball Genetics, as our
primary distributor within the United States. We receive less revenue per test
from Kimball than we had from Straumann but we do not need to pay a processing
fee back to them. This change in distributors has reduced our revenue but
improved our gross margin percentage.
For the year ended December 31, 2002, we had research and development
expenses of $3,082,484 compared with $2,686,621 for the same period in 2001,
representing an increase of $395,863 or 15%.
The
increase was primarily the result of increases in personnel costs associated
with an increased number of ongoing clinical projects and with staffing of our
new research laboratory and the cost of supplying the laboratory.
We are
currently conducting several research and clinical projects both in-house and
through collaborative partners. The most significant projects are the
following:
CARDIOVASCULAR DISEASE: We
are working with Kaiser Permanente’s Center for Health Research to investigate
the value of testing for genetic differences among diabetic patients to further
stratify them based upon their relative risk of developing cardiovascular
disease. It is hoped that this program will enable us to develop new diagnostic
tools for assessing diabetic patients’ genetic risk for heart disease. We have
completed one study with Kaiser and anticipate a new study during 2003. We expect to have a test predictive of
cardiovascular disease on the market by the beginning of 2005.
RHEUMATOID ARTHRITIS: In
collaboration with United Health Group, we are conducting a study to determine
whether analysis of genotype will be useful to predict responses to
anti-cytokine therapy for individuals with rheumatoid arthritis. Different
anti-cytokine therapies act very differently on a patient’s biology. Two of the
three anti-cytokine therapies used to treat rheumatoid arthritis are anti TNFa
drugs; the other acts upon the IL-1 gene. We believe that depending upon the
specific genetics of individual patients, we might be able to predict which
class of drugs would be most effective.
In collaboration with the
University of Sheffield School of Health and Related Research (ScHARR), we are
conducting a study to determine if it is cost effective to analyze patient
genotypes prior to the use of Kineret in the treatment of Rheumatoid Arthritis.
The preliminary results of this study were announced at the American College of
Rheumatoid meeting on October 26, 2002. The results of the economic modeling
indicate that use of a pharmacogenetic test prior to prescribing Kineret could
potentially be cost-effective, producing higher response rates and potential
cost savings.
ALZHEIMER’S DISEASE: We are
working with the University of Arkansas for Medical Sciences to study the
genetic causes of inflammation in relation to Alzheimer’s Disease. This study
will focus on how IL-1 genetic variations alter inflammation in the brain
leading to Alzheimer’s Disease. This information, together with other genetic
data, might be used to develop new drug targets and help in the development of
therapeutics for individuals with genetic differences in their inflammatory
mechanisms.
SHEFFIELD STUDIES: We are
funding research at the University of Sheffield in support of several research
projects including the following: A study to determine the haplotypes, or sets
of genetic variations that are inherited together, that exist within the
IL-1gene cluster; A study to discover novel drug targets for inflammatory
diseases by discovering genes involved in the responses of cells after they
have been activated by IL-1; the development of a system that measures the net
IL-1 biologic activity of blood or any tissue fluid and the discovery of the
genetic variations that control patient to patient differences in inflammatory
mechanisms. We believe that the completion of these studies will greatly
enhance our understanding of the IL-1 gene cluster and the relationship of this
gene cluster to inflammatory responses and disease risk.
FUNCTIONAL GENETICS
RESEARCH: We are currently conducting the following studies at our research
center in Waltham, Massachusetts:
• Produce screening assays for nutrition or
skin care products to be used to determine if genetic variations can predict
the effectiveness of these products.
• Identify biomarkers that can be used in
conjunction with nutrition or skin care products to monitor effectiveness of
these products.
• Identify functional SNPs: A project to
determine which of the SNPs, within the IL-1 gene cluster, leads to an
alteration in the expression of the IL-1 genes.
• Create IL-1 genotype and haplotype specific
cell models that can be used for studying drug responses. It is hoped that
these models will be critical to the analyses of drug or nutriceutical product
response for use in future partnerships and collaborative projects in support
of the development of new drugs or nutriceuticals.
• Investigate IL-1 genotype and haplotype
influences on the expression of inflammatory response genes derived from normal
and disease tissues.
We expect total research and
development costs, including clinical costs, to be between approximately $1 and
$2 million for the calendar year 2003. Actual costs may vary from this estimate
as a result of our ability to raise additional new capital, changes in
technology, the success of current and future research projects, the success or
failure of our current or future strategic alliances and collaborations and the
identification of new business opportunities.
We have not made an attempt
to finalize an estimate of our research and development expenses beyond 2003
due to the factors listed above.
Selling,
general and administrative expenses were $2,333,314 during the year ended
December 31, 2002 compared to $2,244,274 during the same period last year, an
increase of $89,040 or 4%. Increases
in legal expenses, rent and expenses related to our business development effort
were partially offset by decreases in travel, consulting and reductions in
administrative, sales and marketing expense related to the sale and
distribution of PST.
Interest
income during 2002 was $26,784 compared to $263,435 during 2001, a decrease of $236,651
or 90%. This decrease was primarily due
to the lower cash balances we held during 2002 and a decrease in interest
rates. Interest expense of $71,894 was
incurred during the year ended December 31, 2002, compared to $9,818 during
2001. This increase was due to interest
expense on the various interim financing arrangements we made during 2002. We had expense of $150,082 for the
amortization of a discount on a note payable incurred during 2002.
Comparison of Year Ended December 31, 2001 to
Year Ended December 31, 2000
Revenue for
the year ended December 31, 2001 was $202,942 as compared to $256,387 for the
year ended December 31, 2000, representing a decrease of $53,445 or 21%. In the year ended December 31, 2001, we
recorded revenue based on 4,012 PST tests processed compared to 1,209 PST tests
processed during the year ended December 31, 2000. Gross profit margin in 2001 was 76% compared to 28% for the year
earlier period.
The decrease
in revenue and cost of revenue and the improvement in gross margin was the
result of a change in our strategy for marketing, distributing and processing
PST in 2000. We no longer market,
distribute or process PST tests ourselves. We now use third parties to perform
these functions on our behalf and we earn a royalty on end-user sales. The decrease in revenue was partially offset
by revenue produced by a study of PST that was conducted by Washington Dental
University. The number of processed
tests associated with this study was 1,150.
This study ended in July 2001 and revenue from this source has not
continued after that time.
For the year
ended December 31, 2001, we had research and development expenses of $2,686,621
compared with $2,167,409 for the same period in 2000, representing an increase
of $519,212 or 24%. The increase was
due to increases in personnel costs and increases in the cost of outside
research projects. The 2001 expense
included approximately $597,000 for outside research projects.
These projects related to DNA sequencing and an investigation of the
genetic control of inflammatory responses.
The total compares to approximately $354,000 for outside research
projects during the same period of 2000.
During 2001,
we completed a research project with Genome Therapeutics, Inc. to provide us
with DNA sequencing information, including identifying SNP (Single Nucleotide
Polymorphism) variations in the region of the IL-1 genes. The program focused on those key genes in
this very specific chromosomal region that we and others have shown to be
associated with risk for inflammatory diseases, including Alzheimer’s disease,
asthma, cardiovascular disease, diabetes, gastric cancer and osteoporosis.
We completed
in 2002 a research project with Genome Therapeutics to provide DNA sequencing
information within the TNFa
(Tumor Necrosis Factor alpha) gene. We
believe that the understanding of variations within this gene group will
further our understanding of how a small area of genetic code, which primarily
relates to diseases of inflammation, affects individual risk of specific common
diseases.
We are also
funding research at the University of Sheffield in support of several research
projects including the following: A
study to determine the haplotypes, or sets of genetic variations that are
inherited together, that exist within the IL-1 gene cluster; A study to
discover novel drug targets for inflammatory diseases by discovering genes
involved in the responses of cells after they have been activated by IL-1; the
development of a system that measures the net IL-1 biologic activity of blood
or any tissue fluid and the discovery of the genetic variations that control
patient to patient differences in inflammatory mechanisms. We believe that the completion of these
studies will greatly enhance our understanding of the IL-1 gene cluster and the
relationship of this gene cluster to inflammatory responses and disease
risk. During 2001, we funded $244,000
for research completed at Sheffield, including related payments to
collaborators at Sheffield, compared to $273,000 in 2000.
During 2001,
we substantially completed the physical construction of our new research
laboratory located at our corporate offices at 135 Beaver Street in Waltham,
Massachusetts. The lab became
operational during February of 2002.
The cost of construction of the laboratory was approximately $250,000.
Selling,
general and administrative expenses were $2,244,274 during the year ended
December 31, 2001 compared to $3,093,379 during the same period last year, a
decrease of $849,105 or 27%. The
decrease was primarily the result of a reduction in administrative, sales and
marketing expense related to the sale and distribution of PST. As mentioned above, we no longer market,
sell, distribute or process PST directly. We now use third parties to perform
these activities on our behalf. This
has significantly reduced our operating expenses as they relate to PST.
Interest
income during 2001 was $263,435 compared to $280,298 during 2000. This decrease was due entirely to the lower
interest rates in 2001 in comparison with 2000. Interest expense of $9,818 was incurred during the year ended
December 31, 2001, compared to $22,514 during 2000.
Liquidity and Capital Resources
As of December
31, 2002, we had cash and cash equivalents of $733,848. Cash and cash
equivalents generated interest income of $26,784 for the year ended December
31, 2002. Net cash used in operating
activities was $5,020,982 during the year ended December 31, 2002 as compared to
$4,545,967 used during 2001. Cash was used primarily to fund operating losses.
Investing
activities used cash of $160,863 in 2002 and provided cash of $2,736,973 in
2001. During 2002 cash was used to purchase fixed assets, primarily for use in
our new research laboratory. During the
year ended December 31, 2001, cash was provided from the maturity of marketable
securities.
Financing
activities provided cash of $1,992,957 for the year ended December 31, 2002 and
$3,340,169 for the year ended December 31, 2001. During 2002, we received
$2,025,000 from the issuance of term promissory notes. These notes are discussed below. During 2001, we received $2,911,267 in net
proceeds from the issuance of common stock and warrants, net of expenses and
$476,199 from the exercise of warrants and employee stock options. We made capital lease payments of $40,650 in
2002 and $54,342 in 2001.
We currently
do not have any commitments for material capital expenditures. Our obligations
at December 31, 2002 for capital lease payments totaled $42,895, of which
$18,322 is classified as long-term and $24,573 is classified as current. These
capital lease obligations mature through February 2005 at various interest
rates.
In a private
placement on March 5, 2003, we entered into the Purchase Agreement with Pyxis,
pursuant to which Pyxis purchased from us the Series A Preferred Stock for
$7,000,000 in cash and an additional $2,000,000 in cash to be paid, if at all,
upon our reaching a milestone pursuant to the terms of Purchase Agreement. The offering was made to Pyxis by way of a
private placement exempt from registration under the Securities Act. We have been advised by Pyxis that the
source of the cash paid and to be paid was and will be capital contributions
from its sole stockholder, Alticor Inc.
The Series A Preferred Stock issued in the private placement is
initially convertible into 28,157,683 shares of our common stock reflecting a
conversion price of $.2486 per share (or $.3196 per share if the milestone
payment is received), subject to weighted average antidilution
adjustments. Assuming the conversion of
all shares of Series A Preferred Stock, such shares represent 54.91% of the
outstanding shares of our common stock.
Concurrent
with the closing of the Purchase Agreement, we entered into a Research
Agreement with an affiliate of Pyxis, governing the terms of developing and
validating nutrigenomic and dermagenomic tests and products. Pursuant to the Research Agreement, Pyxis is
required to provide us with $5,000,000 over the next twenty-four months, to
conduct certain research projects. We
will also receive a royalty payment based upon sales of any resulting products. We also entered into a License Agreement
with another affiliate of Pyxis, granting an exclusive, world-wide license of
all of our current and future intellectual property, limited to the field of
nutrigenomics and dermagenomics in exchange for royalty payments based upon the
sales of these products.
On October 23,
2002, November 15, 2002, December 16, 2002, and January 29, 2003, we received
four separate $500,000 promissory notes pursuant to an interim financing
agreement with Pyxis. Pursuant to the
terms of the Purchase Agreement noted above, the maturity of these notes has
been extended to December 31, 2007 and they are convertible at the option of
Pyxis into shares of our common stock at a conversion price of two times the
then applicable conversion price of the Series A Preferred Stock. As of March 5, 2003, outstanding principal
and interest under these notes would be convertible into 4,075,811 shares of
common stock. The interest rate has
been changed to a rate equal to one percent above the prime rate and is payable
on a quarterly basis in cash. These
notes are secured by all of our intellectual property except intellectual
property relating to periodontal disease and sepsis.
On October 22,
2002, as a condition for the interim financing with Pyxis noted above, we
entered into separate agreements with the purchasers in the December 2000 and
January 2001 private placements, described below, to temporarily waive certain
provisions of these private placement agreements. Specifically, the purchasers
temporarily waived their right, through March 31, 2003, to receive cash
payments of up to $100,000 per month when our common stock was delisted from
the Nasdaq SmallCap Market on December 10, 2002. The purchasers also waived, through March 31, 2003, their right
to receive additional shares of our common stock for no additional
consideration if we issue shares of our common stock at a price below $2.50 per
share (for the purchaser in the December 2000 private placement this waiver is
permanent, since its rights expired on February 9, 2003). Under these agreements
the purchasers have also agreed to cancel warrants to purchase an aggregate of
864,407 shares of common stock. In exchange, we are required to issue an
aggregate of 1,676,258 shares of our common stock to the purchasers for no
additional cash consideration. These temporary waivers became permanent when we
received an equity investment from Pyxis on March 5, 2003.
On August 9,
2002, we received approximately $475,000, net proceeds, from the sale of term
promissory notes with an aggregate original principal amount of $525,000. These
notes mature in one year and pay interest at a rate of 15%. The principal and all interest, a total of
$603,750, are to be paid upon maturity. We can prepay the principal and accrued
interest without penalty. Pyxis has agreed,
prior to the maturity of these promissory notes, to advance us the cash
required to repay the principal and interest due. At that time we will issue to Pyxis a promissory note with the
same terms as the convertible promissory notes discussed above. The promissory notes purchasers received
warrants to purchase one share of stock for a purchase price of $2.50 for every
dollar invested in the promissory notes. In total warrants to purchase 525,000
shares of stock were issued. These warrants expire in ten years.
We anticipate
that our existing cash and cash equivalents, together with anticipated revenue,
will be sufficient to conduct operations as planned into early 2005. Our future
capital requirements are anticipated to be substantial, and we do not have
commitments for additional capital at this time. Such capital requirements are
expected to arise from the commercial launch of additional genetic tests,
continued research and development efforts, the protection of our intellectual
property rights (including preparing and filing of patent applications), as
well as operational, administrative, legal and accounting expenses. There is no assurance that we will be able
to raise additional capital on terms acceptable to us, or at all. If additional amounts cannot be raised and
we are unable to substantially increase our revenue or reduce our expenses, we
would suffer material adverse consequences to our business, financial condition
and results of operations and would likely be required to seek other alternatives
up to and including protection under the United States Bankruptcy laws.
Item
7A.
Item
7A. Quantitative and Qualitative Disclosure about Market
Risk
As of December
31, 2002, the only financial instruments we carried were cash and cash
equivalents. We believe the market risk arising from holding these financial
instruments is not material.
Some of our
sales occur outside the United States and are transacted in foreign currencies.
Accordingly, we are subject to exposure from adverse movements in foreign
currency exchange rates. At this time we do not believe this risk is material
and we do not currently use derivative financial instruments to manage foreign
currency fluctuation risk. However, if foreign sales increase and the risk of
foreign currency exchange rate fluctuation increases, we may in the future
consider utilizing derivative instruments to mitigate these risks.
Item
8.
Item
8. Financial Statements and Supplementary Data
Consolidated
Financial Statements, together with the Reports of the Independent Public
Accountants, are included herein by reference, see the “Index to Financial
Statements” on page of this report.
Item
9.
Item
9. Changes and Disagreements with Accountants on
Accounting and Financial Disclosure
On June 28,
2002, Interleukin , upon the approval of our Audit Committee and our Board of
Directors, dismissed Arthur Andersen LLP (“Arthur Andersen”) as our independent
public accountants. Arthur Andersen’s
report on our consolidated financial statements for the years ended December
31, 2001 and 2000 did not contain an adverse opinion or disclaimer of opinion,
nor were they qualified or modified as to uncertainty, audit scope or
accounting principles, except for a going concern qualification with respect to
their audit report on our financial statements for the fiscal year ended
December 31, 2001.
In connection
with its audits for our fiscal years ended December 31, 2001 and 2000, its
review of our financial statements for the quarter ending March 31, 2002 and
through July 3, 2002, there were no disagreements between Interleukin and
Arthur Andersen on any matter of accounting principle or practice, financial
statement disclosure, or auditing scope or procedure which, if not resolved to
Arthur Andersen’s satisfaction, would have caused Arthur Andersen to make
reference to the subject matter in connection with Arthur Andersen’s report on
our consolidated financial statements for such years; and there were no
reportable events as defined in Item 304(a)(1)(v) of Regulation S-K through the
date of this report.
On July 3,
2002 we filed a report on Form 8-K to disclose the dismissal of Arthur Andersen
LLP as independent public accountants.
On August 5, 2002 we filed a report on Form 8-K to disclose the engagement
of Grant Thornton LLP as our independent public accountants for the year ending
December 31, 2002.
PART III
Item 10.
Item 10.
Directors,
Executive Officers, Promoters and Control Persons; Compliance with Section
16(a) of the Exchange Act.
MANAGEMENT
We have
entered into a Stock Purchase Agreement with Pyxis Innovations, Inc., pursuant
to which we agreed to reduce the number of directors on our Board of Directors
from six to five and granted Pyxis, as the sole holder of Series A Preferred
Stock, the right to appoint four out of five members of our Board of
Directors. Bert Crandell, George D.
Calvert, Beto Guajardo and Thomas R. Curran, Jr., the Series A Directors, have
been elected to our Board of Directors by the holder of our Series A Preferred
Stock. Philip Reilly, our Chief
Executive Officer, continues to serve as a Director.
The following
information relates to our executive officers and the members of our Board of
Directors:
Our Board of
Directors is divided into three classes, Class I, Class II and Class III.
Philip R. Reilly, a Class I director, has been elected to serve until our 2004
Annual Meeting of Stockholders or until his successor is elected and qualified.
The Series A Directors will not be apportioned among classes. Each of the four
Series A Directors is nominated and elected by Pyxis, as the sole holder of
shares of our Series A Preferred Stock. Our officers serve at the discretion of
the Board of Directors.
BUSINESS EXPERIENCE
PHILIP R.
REILLY, M.D., J.D., became our Chief Executive Officer in December 1999. In
June 1999, Dr. Reilly had accepted the positions as our Chairman of the Board
of Directors and Interim Chief Executive Officer. He became a Director in 1998. Prior to joining us as Chief
Executive Officer, Dr. Reilly held the position of Executive Director of the
Eunice Kennedy Shriver Center for Mental Retardation, Inc., a not-for-profit
organization located in Massachusetts, a position he had held since 1990. Dr.
Reilly has held numerous teaching positions, including Assistant Professor of
Neurology at Harvard Medical School and Adjunct Professor of both Legal Studies
and Biology at Brandeis University. He served as President of the American
Society of Law, Medicine, and Ethics in 2000 and is serving a second term in
2003. From 1994-1997, he was on the Board of Directors of the American Society
of Human Genetics. He is a current member of the American College of Medical
Genetics, Massachusetts Bar Association, and American Association for the
Advancement of Science. Dr. Reilly has served on many national committees
chartered to explore public policy issues raised by advances in genetics. He is
the author of four books and has published more than 100 articles in scholarly
journals. Dr. Reilly holds a BA from Cornell University, a J.D. from Columbia
University and an M.D. from Yale University.
KENNETH S.
KORNMAN, D.D.S., PH.D. is a co-founder and officer of Interleukin and currently
holds the positions of President and Chief Scientific Officer. Dr. Kornman
resigned as a director effective March 21, 2003 in connection with our
transactions with Pyxis. Prior to founding Interleukin in 1986, he was a
Department Chair and Professor at The University of Texas Health Science Center
at San Antonio. He has also been a consultant and scientific researcher for
many major oral care and pharmaceutical companies. Dr. Kornman currently holds
academic appointments at The University of Texas Health Science Center and
Harvard University. Dr. Kornman holds six patents in the pharmaceutical area,
has published three books and more than 100 articles and abstracts and has
lectured and consulted worldwide on the transfer of technology to clinical
practice. Dr. Kornman holds a BA in Economics from Duke University. He obtained
a D.D.S. from Emory University. Dr. Kornman also holds an MS (Periodontics) and
a Ph.D. (Microbiology-Immunology) from the University of Michigan.
FENEL M. ELOI
is currently our Chief Operating Officer and Chief Financial Officer, positions
he has held since June of 2000. Prior to joining us, Mr. Eloi was Senior Vice
President and Chief Financial Officer for LifeCell Corporation since 1999.
Before joining LifeCell, he was employed at Genome Therapeutics Corporation,
where he served as Senior Vice President and Chief Financial Officer from 1991
to 1999, and Corporate Controller from 1989 to 1991. From 1984 to 1989, Mr.
Eloi held the position of Business Unit Financial Manager at GTE/Verizon
Corporation. He also held various positions at Haemonetics Corporation and
Simplex Corporation. Mr. Eloi has an MBA from Anna Maria College in Paxton,
Massachusetts, as well as a BA from Lee University in Cleveland, Tennessee.
PAUL (KIP) M.
MARTHA, JR., M.D., joined us in November 2000 and currently serves as our Chief
Medical and Regulatory Officer. Prior to joining us, Dr. Martha served as Vice
President in the Department of Clinical R&D at PRAECIS Pharmaceuticals,
Inc., a position he held for almost three years. From 1993-1998, he held various
senior-level positions at Genentech, Inc., including Director of Endocrinology,
one of the company’s four therapeutic focus areas. Prior to joining Genentech,
Dr. Martha served on the medical school faculties of the Tufts University
School of Medicine, and the University of Virginia Health Sciences Center. The
author or co-author of over 100 published articles, book chapters and abstracts
in the medical literature, Dr. Martha has also delivered invited presentations
and lectures at numerous medical schools, hospitals, and scientific meetings
throughout the United States and Europe. He received his M.D. from the
University of Connecticut School of Medicine and his BS from Trinity College.
BERT CRANDELL
is the Vice President and Chief Marketing Officer of Alticor Inc., a company
engaged in the principal business, through its affiliates, of offering
products, business opportunities, and manufacturing and logistics services in
more than 80 countries and territories worldwide, and which is the parent of Pyxis
Innovations Inc. He has held this position for the past five years. He also
holds the titles of Vice President/Chief Marketing Officer of Alticor Holdings
Inc., a holding company, and Vice President of Pyxis Innovations Inc. and
Access Business Group LLC, a manufacturing and distribution company and wholly
owned subsidiary of Alticor Inc. Mr. Crandell has held various marketing and
product development related positions in Alticor Inc. which included Vice
President - Corporate Marketing, Vice President - Regional Sales Development,
Director - Amway Canada Ltd., Director of Marketing at Tokyo based Amway Japan
Ltd, and Senior Manager of Engineering Research and Development. Mr. Crandell
holds a Bachelor of Science degree from Michigan State University. He joined
the Board of Directors as a Series A Director in connection with our
transactions with Pyxis effective March 24, 2003.
GEORGE D.
CALVERT is the Vice President, Research & Development/Quality Assurance of
Access Business Group LLC, a manufacturing and distribution company and wholly
owned subsidiary of Alticor Inc. He has held this position for the past five
years. Dr. Calvert has previously held the positions of Director Quality
Assurance/Analytical Services with Access Business Group LLC, and Senior
Manager Home Tech Research & Development with Amway Corporation. Dr.
Calvert earned a Ph.D. in Analytical Chemistry from the University of South
Carolina and a Bachelor of Science degree in Chemistry from the College of
William and Mary. He joined the Board of Directors as a Series A Director in
connection with our transactions with Pyxis effective March 24, 2003.
BETO GUAJARDO
is the Vice President of Strategic Planning and Mergers & Acquisitions of
Alticor Inc., a company engaged in the principal business, through its
affiliates, of offering products, business opportunities, and manufacturing and
logistics services in more than 80 countries and territories worldwide, and
which is the parent of Pyxis Innovations Inc. Prior to joining Alticor Inc. in
October 2000, Mr. Guajardo held the position of Senior Manager at Deloitte
Consulting, a professional services company. Mr. Guajardo earned an MBA in
Management Strategy and Finance degree from Northwestern University J.L.
Kellogg Graduate School of Management and a Bachelor of Science in Business
Administration and Marketing from the University of Illinois. He joined the
Board of Directors as a Series A Director in connection with our transactions
with Pyxis effective March 24, 2003.
THOMAS R.
CURRAN, JR. is the Associate General Counsel/Corporate Development and
Commercial Transactions of Alticor Inc., a company engaged in the principal
business, through its affiliates, of offering products, business opportunities,
and manufacturing and logistics services in more than 80 countries and
territories worldwide, and which is the parent of Pyxis Innovations Inc. He has
held this position for the past five years. He also holds the position of Chief
Legal Officer for Access Business Group LLC, a manufacturing and distribution
company and wholly owned subsidiary of Alticor Inc. Prior to joining Alticor,
Mr. Curran was a partner in the law firm of Howard & Howard in Bloomfield
Hills, Michigan. From 1982 to 1991, Mr. Curran worked for the Polaroid
Corporation in various domestic and international financial and managerial
positions. Mr. Curran holds a Bachelor of Arts from Providence College, a
Master of International Management from the American Graduate School of
International Management, and a Juris Doctorate from Suffolk University Law
School. He joined the Board of Directors as a Series A Director in connection
with our transactions with Pyxis effective March 24, 2003.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING
COMPLIANCE
Section 16(a)
of the Exchange Act requires our directors and officers, and persons who own
more than 10% of the common stock, to file with the SEC initial reports of
beneficial ownership and reports of changes in beneficial ownership of the
common stock and other equity securities.
Officers, directors and greater than 10% beneficial owners are required
by SEC regulation to furnish us with copies of all Section 16(a) forms they
file.
To our
knowledge, based solely on review of the copies of such reports furnished to us
and written representations that no other reports were required, during the
fiscal year ended December 31, 2002, all Section 16(a) filing requirements
applicable to our officers, directors and greater than 10% beneficial owners
were met.
Item 11.
Item 11.
Executive
Compensation
EXECUTIVE COMPENSATION
The following
table provides, for the periods shown, summary information concerning
compensation paid or accrued by us to or on behalf of our Chief Executive
Officer and each of other executive officers who received in excess of $100,000
in salary and bonus during fiscal year 2002 (collectively referred to as the
“named executive officers”).
SUMMARY COMPENSATION TABLE
(1) Represents an automobile allowance paid
to Dr. Reilly.
(2) Represents moving expenses we paid on
behalf of Dr. Kornman in the amount of $15,420 and an automobile allowance in
the amount of $7,200 paid by us.
(3) Represents life insurance premiums paid
for by us.
(4) Represents moving expenses we paid on
behalf of Dr. Kornman in the amount of $23,684 and an automobile allowance in
the amount of $7,200 paid by us.
(5) Represents moving expenses we paid on
behalf of Dr. Kornman in the amount of $74,932 and an automobile allowance in
the amount of $7,200 paid by us.
STOCK OPTION GRANTS IN FISCAL 2002
The following
table provides information regarding stock options granted to the named
executive officers during fiscal year 2002.
(1) The options were granted pursuant to our 2000 Employee Stock
Compensation Plan. The options granted to the named executive officers are
non-qualified stock options and vest fully one year from the date of grant.
(2) Amounts represent hypothetical gains that could be achieved for the
options if exercised at the end of the option term. Those gains are based on
assumed rates of stock price appreciation of 5% and 10% compounded annually
from the date the respective options were granted to their expiration dates.
The gains shown are net of the option exercise price, but do not include
deductions for taxes or other expenses associated with the exercise. Actual
gains, if any, on stock option exercises will depend on the future performance
of our common stock, the optionee’s continued employment through the option
period and the date on which the options are exercised.
AGGREGATED OPTION EXERCISES IN FISCAL 2002
AND FISCAL YEAR-END OPTION VALUES
The following
table provides information regarding the exercises of stock options by each of
the named executive officers during fiscal year 2002 and the number and value
of options held at fiscal year end. In addition, the table includes the number
of shares covered by both exercisable and unexercisable stock options as of
December 31, 2002 and the values of
“in-the-money” options, which values represent the positive spread
between the exercise price of any such option and the fiscal year-end value of
the common stock.
(1) Represents the product of (a) the number of shares underlying
options granted multiplied by (b) the difference between (i) the closing price
of our common stock on the OTC Bulletin Board on December 31, 2002 ($0.51), and
(ii) the exercise price of the options.
COMPENSATION OF DIRECTORS
We do not
currently pay compensation to members of the Board for attendance at Board or
committee meetings. During 2002 and up to March 5, 2003, we paid non-employee
Directors $500 in cash compensation for each meeting of the Board of Directors
attended in person and 25,000 fully vested stock options each year.
EMPLOYMENT AGREEMENTS AND CHANGE-OF-CONTROL
ARRANGEMENTS
In connection
with the private placement of our Series A Preferred Stock, we agreed to amend
the existing employment agreements described below with our named executive
officers. Effective as of March 5, 2003 (the date of the closing of the
Purchase Agreement), the terms of our employment agreements with each of Philip
R. Reilly, our Chief Executive Officer, Kenneth S. Kornman, our President and
Chief Scientific Officer, and Paul Martha, M.D., our Chief Medical and
Regulatory Officer, were each extended until March 5, 2006, and the term of our
employment agreement with Fenel Eloi, our Chief Financial Officer and Chief
Operating Officer, was extended until March 5, 2004. The employment agreements
were also amended to provide that each of these individuals will be entitled to
receive: (i) a retention bonus of $25,000 if he is still employed by us six
months after the closing of the Purchase Agreement and an additional $25,000 if
he is still employed by us twelve months after the closing; (ii) the severance
benefits set forth in his original agreement upon expiration of the term of the
agreement; and (iii) an extension of the period in which he may exercise his
stock options if his employment is terminated for good reason or without cause
(as defined in the agreement) to two years following such termination. In
addition, Dr. Reilly’s and Dr. Martha’s agreements were amended to make their
severance benefits consistent with the other executive employment agreements
described below; Dr. Reilly’s agreement was amended to include the same
non-competition provisions contained in the agreements described below; and Mr.
Eloi’s agreement was amended to provide that all of his unvested stock options
will vest on the involuntary termination of his employment if the termination is
at the end of the term of his employment agreement.
In December
1999, we entered into an employment agreement with Kenneth S. Kornman which
provides for a three-year initial term, subsequently extended until March 31,
2003. This employment agreement is subject to early termination by Dr. Kornman
upon one month prior written notice and by us for cause. The employment
agreement provides for a minimum base salary of $276,250 per year. The
agreement also provides that if he is terminated without cause, he shall have
the right to receive severance benefits in the amount of his then current base
salary and health insurance benefits for twelve months following the date of
termination. In addition, the agreement provides that he will be prohibited,
for a period of twelve months following the date of termination of the
employment agreement, from accepting employment, or otherwise becoming
involved, in any manner, with one of our direct competitors, or from providing
services to any person or entity that might conflict with our interests or the
interests of our customers or clients.
In April 2000,
we entered into an employment agreement with Philip R. Reilly which provides
for a minimum annual base salary of $325,000 and an award of options to
purchase 500,000 shares of common stock at a per share exercise price of $2.875
(awarded in fiscal 1999). These options vest over a period of 36 months in
equal increments commencing December 1, 1999, unless Dr. Reilly’s employment is
terminated prior to expiration of the 36-month period. This employment
agreement is terminable by Dr. Reilly upon
one month prior written notice and by us for cause.
The agreement also provides that if he is terminated without cause, he shall
have the right to receive severance benefits in the amount of his then
current base salary and health insurance benefits until the earlier to occur of
the expiration of the term of the agreement or twelve months following the date
of termination. Finally, the agreement provides that all of Dr. Reilly’s
outstanding options will immediately vest upon a change of control of
Interleukin, where “change of control” is defined in the agreement as “a
purchase of the majority of the outstanding common stock of Interleukin by an
outside entity not organized solely for the purposes of investment.” Under this
definition, the issuance of the Series A Preferred Stock did not constitute a
change of control of Interleukin.
In June 2000,
we entered into an employment agreement with Fenel M. Eloi which provides for a
minimum annual base salary of $195,000 and an award of options to purchase an
aggregate of 200,000 shares of Common Stock as follows: 105,828 shares at a per
share exercise price of $3.75 and 94,172 shares at a per share exercise price
of $4.72. These options vest over a period of 48 months unless Mr. Eloi’s
employment is terminated prior to the end of the 48-month period. This
employment agreement is terminable by Mr. Eloi upon one month prior written
notice and by us for cause. The agreement also provides that if he is
terminated without cause, he shall have the right to receive severance benefits
in the amount of his then current base salary and health insurance benefits for
twelve months following the date of termination. In addition, the agreement
provides that he will be prohibited, for a period of twelve months following
the date of termination of the employment agreement, from accepting employment,
or otherwise becoming involved, in any manner, with one of our direct
competitors, or from providing services to any person or entity that might
conflict with our interests or the interests of our customers or clients.
Finally, the agreement provides that all of Mr. Eloi’s outstanding options will
immediately vest upon a change of control of Interleukin, where “change of
control” is defined in the agreement as “a purchase of the majority of the
outstanding Common Stock of the Company by an outside entity not organized
solely for the purposes of investment.” Under this definition, the issuance of
the Series A Preferred Stock did not constitute a change of control of
Interleukin.
In November
2000, we entered into an employment agreement with Dr. Paul (Kip) Martha which
provides for a minimum annual base salary of $195,000 and an award of options
to purchase an aggregate of 200,000 shares of common stock as follows: 106,665
shares at per share exercise price of $3.75 and 93,335 shares at a per share
exercise price of $4.63. These options vest over a period of 48 months unless
Dr. Martha’s employment is terminated prior to the end of the 48-month period.
This employment agreement is terminable by Dr. Martha upon one month prior
written notice and by us for cause. The agreement also provides that if he is
terminated without cause, he shall have the right to receive severance benefits
in the amount of his then current base salary and health insurance benefits
until the earlier to occur of the expiration of the term of the agreement or
twelve months following the date of termination. In addition, the agreement
provides that he will be prohibited, for a period of twelve months following
the date of termination of the employment agreement, from accepting employment,
or otherwise becoming involved, in any manner, with one of our direct
competitors, or from providing services to any person or entity that might
conflict with our interests or the interests of our customers or clients.
Finally, the agreement provides that all of Dr. Martha’s outstanding options
will immediately vest upon a change of control of Interleukin, where “change of
control” is defined as set forth in our 2000 Employee Stock Compensation Plan,
as further described below.
Additionally,
pursuant to the form of incentive stock option agreement and non-qualified
stock option agreement under our 2000 Employee Stock Compensation Plan, stock
options granted under that plan to our named executive officers and other
employees will immediately vest upon a “change of control” of Interleukin, as
defined in the Plan as follows:
the consummation of: (x) a merger, consolidation or reorganization of
the Company with or into any other person if as a result of such merger,
consolidation or reorganization, 50 percent or less of the combined voting
power of the then-outstanding securities of the continuing or surviving entity
immediately after such merger, consolidation or reorganization are held in the
aggregate by the holders of Voting Stock immediately prior to such merger,
consolidation or reorganization; (y) any sale, lease, exchange or other
transfer of all or substantially all the assets of the Company and its
consolidated subsidiaries to any other person if as a result of such sale,
lease, exchange or other transfer, 50 percent or less of the combined voting
power of the then-outstanding securities of such other person immediately after
such sale, lease, exchange or other transfer are held in the aggregate by the
holders of Voting Stock immediately prior to such sale, lease, exchange or
other transfer; or (z) the stockholders of the Company approve the dissolution
of the Company. A transaction shall not constitute a Change in Control if its
sole purpose is to change the state of the Company’s incorporation or to create
a holding company that will be owned in substantially the same proportions by
the persons who held the Company’s securities immediately before such
transaction.
Under this
definition, the issuance of the Series A Preferred Stock did not constitute a
change of control of Interleukin.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION
During fiscal
year 2002, the Compensation Committee consisted of three members, Thomas A.
Moore, Edward M. Blair, Jr. and Gary L. Crocker. None of our executive officers
serve on the board of directors or compensation committee of any entity that
has one or more executive officers serving as a member of our Board of
Directors or Compensation Committee. There is no family relationship between or
among the directors (including the Series A Directors) and executive officers.
Item 12.
Item 12.
Security
Ownership of Certain Beneficial Owners and Management
The following
table sets forth certain information regarding the beneficial ownership of our
common stock as of March 31, 2003 by (i) each of our Directors; (ii) each of
our named executive officers (as that term is defined in Item 402(a)(3) of
Regulation S-K); (iii) each person who is known to us to be the beneficial
owner of more than five percent of our common stock based on a review of
filings made with the SEC on or before March 31, 2003; and (iv) our Directors
and executive officers as a group. Beneficial ownership is determined in accordance with the rules of the SEC and
includes voting or investment power with respect to the securities. We deem shares of common stock that may be
acquired by an individual or group within 60 days of March 31, 2003 pursuant to the exercise of options or warrants to
be outstanding for the purpose of computing the percentage ownership of such
individual or group, but are not deemed to be outstanding for the purpose of
computing the percentage ownership of any other person shown in the table. Except as otherwise indicated, to our
knowledge, the persons named in the table have sole voting and dispositive
power with respect to all shares beneficially owned, subject to community
property laws where applicable.
* Represents less than 1% of the issued and
outstanding shares.
(1) Unless otherwise indicated, the address for
each person is our address at 135 Beaver Street, Waltham, MA 02452.
(2) Beneficial ownership of our common stock is
determined in accordance with the rules of the SEC and includes shares for
which the stockholder has sole or shared voting or dispositive power. Shares of
our common stock subject to options, warrants or other convertible securities
currently exercisable or convertible, or which become exercisable or
convertible within 60 days after March 31, 2003, are deemed to be beneficially
owned and outstanding by the person holding the options, warrants or other convertible
securities and are included for purposes of computing the percentage ownership
of that person, but are not deemed outstanding for purposes of computing the
percentage ownership of any other person.
(3) Percentage ownership is based on a total of
23,118,249 shares of common stock issued and outstanding on March 31, 2003.
(4) Based solely on a Schedule 13D jointly filed
on March 14, 2003 with the SEC by Pyxis Innovations, Inc., Alticor Inc. and
Alticor Holdings Inc. Consists of
5,000,000 shares of Series A Preferred Stock presently convertible into
28,157,683 shares of common stock and convertible notes with an original
aggregate principal amount of $2,000,000, the principal and accrued interest of
which are convertible into 4,057,820 shares of common stock within 60 days of
March 31, 2003.
(5) Based
solely on a Schedule 13G filed on January 3, 2003 with the SEC by Valor Capital
Management, L.P.
(6) Based on information received by us from Mr.
Garofalo and on a Schedule 13G/A filed on February 10, 2003 with the SEC by Mr.
Garofalo Corp. (“First Global”). Mr. Garofalo is the controlling stockholder of
First Global Technology Corp ("First Global"), which owns 815,967 of
these shares. Mr. Garofalo has sole voting and dispositive power with respect
to 889,000 of these shares, and Mr. Garofalo and First Global have shared
voting and dispositive power with respect to all 1,704,967 shares.
(7) Based solely on information received by us
from Ms. Fine in February 2002.
(8) Includes 100,000 shares of common stock
issuable pursuant to options, and 50,000 shares of common stock issuable
pursuant to warrants held by Mr. Crocker.
(9) Includes 898,723 shares of common stock held
by a limited partnership of which Dr. Kornman is a general partner. As such,
Dr. Kornman may be deemed the beneficial owner of these shares. Dr. Kornman
disclaims beneficial ownership of these shares. Includes 224,031 shares of
common stock issuable pursuant to options held by Dr. Kornman.
(10) Includes 67,000 shares of common stock held
in trust for Dr. Reilly’s children and 863,000 shares of common stock issuable
pursuant to options held by Dr. Reilly and 25,000 shares of common stock
issuable pursuant to a warrant held by Dr. Reilly. Dr. Reilly disclaims
beneficial ownership of the shares held in trust for his children.
(11) Includes 241,668 shares of
common stock issuable pursuant to options held by Mr. Eloi.
(12) Consists of 216,668 shares of common stock
issuable pursuant to options held by Dr. Martha.
(13) Although appointed as a Series A director by
Pyxis Innovations Inc., we have been advised that Mr. Crandell does not,
directly or indirectly, have voting or investment power over the shares of
stock held by Pyxis.
(14) Although appointed as a Series A director by
Pyxis Innovations Inc., we have been advised that Dr. Calvert does not,
directly or indirectly, have voting or investment power over the shares of
stock held by Pyxis.
(15) Although appointed as a Series A director by Pyxis
Innovations Inc., we have been advised that Mr. Guajardo does not, directly or
indirectly, have voting or investment power over the shares of stock held by
Pyxis.
(16) Although appointed as a Series A director by
Pyxis Innovations Inc., we have been advised that Mr. Curran does not, directly
or indirectly, have voting or investment power over the shares of stock held by
Pyxis.
(17) See footnotes 9 through 16 above.
Equity
Compensation Plan Information
The following table provides certain aggregate
information with respect to all of our equity compensation plans in effect as
of December 31, 2002.
1. These plans consist of our 1996 Equity
Incentive Plan and our 2000 Employee Stock Compensation Plan. For additional information about these
plans, see note 10 to our financial statements in item 8.
2. These
plans consist of the Non-Qualified Stock Option Agreements, between Interleukin
and Philip R. Reilly, dated June 1, 1999 and November 30, 1999, the
Research Transfer Agreement between Interleukin and the University of
Sheffield, effective July 1, 1999 and the Consulting Agreement between
Interleukin and Gordon Duff, effective July 1, 1999.
Summary
Description of Our Non-Stockholder Approved Equity Compensation Plans
On June 1,
1999, we entered into a Non-Qualified Stock Option Agreement with Philip R.
Reilly to induce him to enter a consulting services agreement dated the same
day and to encourage him to become Chairman of the Board of Directors of
Interleukin. Pursuant to the Agreement,
we granted Mr. Reilly the option to purchase 240,000 shares of our common stock
at $.50 per share on or before the option’s expiration
date of June 1, 2009. These options
vested in equal increments of 8,000 shares per month over thirty months and
became fully vested on December 1, 2001.
Mr. Reilly has exercised this option with respect to 23,000 shares of
common stock. The options are
non-transferable.
On November
30, 1999, we entered into an additional Non-Qualified Stock Option Agreement
with Philip R. Reilly to further induce him to become Chairman of the Board of Directors of Interleukin. Pursuant to the Agreement, we granted Mr.
Reilly the option to purchase 351,394 shares of our common stock at $2.875 per
share on or before the option’s expiration date of December 31, 2010. These options vested in equal increments of
9,760 shares per month over a period of thirty-six months and became fully vested
on November 30, 2002. The options are
non-transferable.
Effective on
July 1, 1999, we entered into a five-year Research and Technology Transfer
Agreement with the University of Sheffield.
The agreement provides for the grant of options to purchase 100,000
shares of our common stock. Pursuant to
the agreement, we are required to grant options to purchase 25,000 shares
annually at the beginning of each year of the last four years of the five-year
arrangement. The options are granted with an exercise price
equal to the current market price of the common stock at the time of grant,
each June 30th, of the five-year arrangement. The options are fully vested when granted
and exercisable for a period of five years from each date of grant. The agreement further provides that the
University of Sheffield is to receive additional options to purchase 10,000
shares of stock at the current market price each June 30th for each patent that
is filed on our behalf during the previous twelve months. As of the date of this report options to
purchase 105,000 shares have been granted under this agreement.
Concurrent
with the execution of the Research and Technology Transfer Agreement with the
University of Sheffield, we entered into a five-year Consulting Services
Agreement with the university’s key collaborator, Gordon W. Duff. The agreement provides for the grant of
options to purchase up to a total of 100,000 shares of our common stock. Pursuant to the agreement, we are required
to grant options to purchase 25,000 shares annually at the beginning of each year
of the last four years of the five-year arrangement. The options are granted with an exercise price equal to the
current market price of the common stock at the time of grant, each June 30th,
of the five-year arrangement. The
options are fully vested when granted and exercisable for a period of five
years from each date of grant. As of
the date of this report, 75,000 options have been granted under this agreement.
Item 13.
Item 13.
Certain
Relationships and Related Transactions
Since January
1, 2002, we were not a party to any transaction or business relationship in
which the amount involved exceeded $60,000 involving any of our officers,
directors or five percent stockholders, except as described below.
Our Chief
Executive Officer purchased $25,000 and several other members of our Board of
Directors who have since resigned purchased an aggregate of $100,000 of notes
and warrants in our August 2002 private placement. For each $1 invested, the warrants permit the investor to
purchase one share of our common stock at a price of $2.50. The notes purchased in that offering are
being refinanced and repaid in connection with the Purchase Agreement as
described below. The warrants will
remain outstanding following the refinancing.
In a private
placement on March 5, 2003, we entered into the Purchase Agreement with Pyxis,
pursuant to which Pyxis purchased from us 5,000,000 shares of Series A
Preferred Stock for $7,000,000 in cash and $2,000,000 in cash to be paid, if at
all, upon our reaching a milestone pursuant to the terms of the Purchase
Agreement. The offering was made to
Pyxis by way of a private placement exempt from registration under the
Securities Act. The Series A Preferred
Stock issued in the private placement is initially convertible into 28,157,683
shares of our common stock reflecting a conversion price of $.2486 per share
(or $.3196 per share if the milestone payment is received), subject to weighted
average antidilution adjustments. Assuming the conversion of all shares of
Series A Preferred Stock, such shares would represent 54.9% of the outstanding
shares of our common stock.
Pursuant to
the terms of the Purchase Agreement, Pyxis also agreed to refinance an
aggregate of $2,525,000 principal amount of our indebtedness in the form of
previously issued promissory notes that are held by Pyxis and certain
individuals. As part of this
refinancing, we have issued secured convertible promissory notes in the
original aggregate principal amount of $2,000,000 to Pyxis that are convertible
into shares of common stock at any time at a conversion price equal to two
times the conversion price of the Series A Preferred Stock in effect at that
time. As of March 31, 2003, the principal and accrued interest under these
convertible promissory notes was convertible into 4,057,820 shares of common
stock. In addition, Pyxis agreed to
advance to us prior to August 9, 2003, cash required to repay principal and
interest due under promissory notes previously issued in the original aggregate
principal amount of $525,000, which accrue interest at an annual rate of 15%
and are due on August 9, 2003. Pyxis
has also agreed to advance us up to $1.5 million in connection with our
entering into certain strategic partnerships or research collaborations. We will issue additional secured convertible
promissory notes in connection with the refinancing and the $1.5 million
advance.
Concurrent
with the closing of the Purchase Agreement, we entered into a Research
Agreement with an affiliate of Pyxis, governing the terms of developing and validating nutrigenomic and
dermagenomic tests and products. Under
the Research Agreement, Pyxis will pay us a total of $5 million over two
years. We also entered into a License
Agreement with another affiliate of Pyxis, granting an exclusive license of all
of our current and future intellectual property, limited to certain uses within
the field of nutrigenomics and dermagenomics.
Pursuant to the terms of the Purchase Agreement, we reduced the number
of directors on our Board of Directors from six to five and granted Pyxis, as
the sole holder of shares of our Series A Preferred Stock, the right to appoint
four out of five members of our new Board of Directors. The election of these
Series A Directors was effective on March 24, 2003.
Item 14.
Item 14. Controls and
Procedures
(a) Evaluation of Disclosure Controls and Procedure. Our principal executive officer and
principal financial officer, after evaluating the effectiveness of our
disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c)
and 15d-14(c)) as of a date within 90 days of the filing date of this Annual
Report on Form 10-K, have concluded that, based on such evaluation, our disclosure
controls and procedures were adequate and effective to ensure that material
information relating to Interleukin, including our consolidated subsidiaries,
was made known to them by others within those entities, particularly during the
period in which this Annual Report on Form 10-K was being prepared.
(b) Changes in Internal Controls. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation, nor were there any significant deficiencies or
material weaknesses in our internal controls. Accordingly, no corrective
actions were required or undertaken.
In designing
and evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives, and our management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.
(a) Documents Filed as Part of
Report
1. Financial
Statements:
Our
Consolidated Financial Statements and the related report of our independent
public accountants thereon have been filed under Item 8 hereof.
2. Financial
Statement Schedules:
The
information required by this item is not applicable.
3. Exhibits:
The exhibits
listed below are filed as part of or incorporated by reference in this report.
Where such filing is incorporated by reference to a previously filed document,
such document is identified in parentheses. See the Index of Exhibits included
with the Exhibits filed as a part of this report.
Exhibit
No.
Identification of Exhibit
2.1
Plan of
Reorganization and Merger dated July 12, 2000 by and between Interleukin
Genetics, Inc., a Texas Corporation, and Interleukin Genetics, Inc., a
Delaware Corporation. (incorporated herein by reference to Exhibit 2.1 of the
Company’s Quarterly Report on Form 10-Q filed August 14, 2000).
3.1
Articles of
Incorporation of the Company, as amended (incorporated herein by reference to
Exhibit 3.1 the Company’s Quarterly Report on Form 10-Q filed August 14,
2000).
3.2
Bylaws of
the Company, as adopted on June 5, 2000 (incorporated herein by reference to
Exhibit 3.2 the Company’s Quarterly Report on Form 10-Q filed August 14,
2000).
3.3
Certificate
of Designations, Preferences and Rights of Series A Preferred Stock
(incorporated herein by reference to Exhibit 3.1 to the Company’s Current
Report filed on Form 8-K on March 5, 2003).
4.1
Form of
Stock Certificate representing common stock, $.001 par value, of the Company
(incorporated herein by reference to Exhibit 4.1 the Company’s Quarterly
Report on Form 10-Q filed August 14, 2000).
4.2
Form of
Warrant Agreement (incorporated herein by reference to Exhibit 4.5 of the
Company’s Registration Statement No. 333-37441 on Form SB-2 filed October 8,
1997).
4.3
Form of
Warrant Certificate (incorporated herein by reference to Exhibit 4.6 of the
Company’s Registration Statement No. 333-37441 on Form SB-2 filed October 8,
1997).
10.1
Lease
Agreement dated March 21, 1996, between the Company and Koll Center Newport
Number 9 (incorporated herein by reference to Exhibit 10.14 of the Company’s
Registration Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.2@
Interleukin
Genetics, Inc. 1996 Equity Incentive Plan (incorporated herein by reference
to Exhibit 10.17 of the Company’s Registration Statement No. 333-37441 on
Form SB-2 filed October 8, 1997).
10.3@
Amendment to
the Interleukin Genetics, Inc. 1996 Equity Incentive Plan (incorporated
herein by reference to Exhibit 10.18 of the Company’s Registration Statement
No. 333 - 37441 on Form SB-2 filed October 8, 1997).
10.4@
Form of
Stock Option Agreement (incorporated herein by reference to Exhibit 10.19 of
the Company’s Registration Statement No. 333-37441 on Form SB-2 filed October
8, 1997).
10.5@
Stock Option
Exercise Agreement (incorporated herein by reference to Exhibit 10.20 of the
Company’s Registration Statement No. 333-37441 on Form SB-2 filed October 8,
1997).
10.6@
Non-Qualified
Stock Option Agreement dated June 1, 1999, between the Company and Philip R.
Reilly (incorporated herein by reference to Exhibit 10.2 of the Company’s
Quarterly Report on Form 10-QSB filed August 16, 1999).
10.7+
Research and
Technology Transfer Agreement dated effective July 1, 1999, between the
Company and the University of Sheffield (incorporated herein by reference to
Exhibit 10.1 of the Company’s Quarterly Report on Form 10-QSB filed November
15, 1999).
10.8+
Research
Support Agreement dated effective July 1, 1999, between the Company and the
University of Sheffield (incorporated herein by reference to Exhibit 10.2 of
the Company’s Quarterly Report on Form 10-QSB filed November 15, 1999).
10.9+
Consulting
Agreement dated effective July 1, 1999, between the Company and Gordon Duff,
PhD, FRCP (incorporated herein by reference to Exhibit 10.3 of the Company’s
Quarterly Report on Form 10-QSB filed November 15, 1999).
10.10@
Non-Qualified
Stock Option Agreement dated November 30, 1999 between the Company and Philip
R. Reilly (incorporated herein by reference to Exhibit 4.5 to the Company’s
Registration Statement No. 333-32538 on Form S-8 filed March 15, 2000).
10.11@
Employment
Agreement dated December 1, 1999 between the Company and Kenneth S. Kornman
(incorporated herein by reference to Exhibit 10.25 of the Company’s Annual
Report on Form 10-K filed April 14, 2000).
10.12@*
Employment
Agreement dated April 1, 2000 between the Company and Philip R. Reilly.
10.13*
Form of
Gordon W. Duff / the University of Sheffield Option Agreement.
10.14
Lease
Agreement between the Company and Clematis LLC (incorporated herein by
reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-QSB
filed August 14, 2000).
10.15
First
Amendment to a Commercial Lease Between the Company and Clematis LLC
(incorporated herein by reference to Exhibit 10.2 of the Company’s Quarterly
Report on Form 10-QSB filed August 14, 2000).
10.16@
Employee Stock Compensation Plan for the Company (incorporated herein by
reference to Exhibit 10.3 of the Company’s Quarterly Report on Form 10-QSB
filed August 14, 2000).
10.17*
Form of
Non-Qualified Stock Option Agreement.
10.18@
Form of
Incentive Stock Option Agreement (incorporated herein by reference to Exhibit
10.5 of the Company’s Quarterly Report on Form 10-QSB filed August 14, 2000).
10.19@*
Employment
Agreement dated June 18, 2000 between the Company and Fenel Eloi.
10.20@
Employment
Agreement dated November 20, 2000 between the Company and Paul Martha
(incorporated herein by reference to Exhibit 10.24 of the Company’s Annual
Report on Form 10-K filed March 26, 2001).
10.21
Purchase
Agreement dated December 5, 2000 (incorporated herein by reference to Exhibit
10.1 of the Company’s Current Report on Form 8-K filed March 7, 2001).
10.22
Registration
Rights Agreement dated December 5, 2000 (incorporated herein by reference to
Exhibit 10.2 of the Company’s Current Report on Form 8-K filed March 7,
2001).
10.23
Purchase
Agreement dated January 26, 2001 (incorporated herein by reference to Exhibit
10.3 of the Company’s Current Report on Form 8-K filed March 7, 2001).
10.24
Registration
Rights Agreement dated January 26, 2001 (incorporated herein by reference to
Exhibit 10.4 of the Company’s Current Report on Form 8-K filed March 7,
2001).
10.25
Consent,
Waiver and Amendment Agreement dated January 26, 2001 (incorporated herein by
reference to Exhibit 10.7 of the Company’s Current Report on Form 8-K filed
March 7, 2001).
10.26@*
Amendment,
dated as of December 21, 2001, to Employment Agreement with Kenneth S.
Kornman.
10.27
Amendment to
the Lease Agreement between the Company and Clematis LLC (incorporated herein
by reference to Exhibit 10.34 of the Company’s Annual Report on Form 10-K
filed March 28, 2002).
10.28
Note
Purchase Agreement between the Company and Pyxis Innovations Inc. dated
October 22, 2002 (incorporated herein by reference to Exhibit 10.1 of the
Company’s Current Report on Form 8-K filed on October 28, 2002).
Exhibit
No.
Identification of Exhibit
10.29
Security
Agreement between the Company and Pyxis Innovations Inc. dated October 22,
2002 (incorporated herein by reference to Exhibit 10.2 of the Company’s
Current Report on Form 8-K filed on October 28, 2002).
10.30
Form of
Promissory Note with Pyxis Innovations Inc. (incorporated herein by reference
to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed on October
28, 2002).
10.31
Agreement
and Waiver between the Company and Tail Wind Fund LTD dated October 22, 2002
(incorporated herein by reference to Exhibit 10.4 of the Company’s Current
Report on Form 8-K filed on October 28, 2002).
10.32
Agreement
and Waiver between the Company and Special Situations Fund dated October 22,
2002 (incorporated herein by reference to Exhibit 10.4 of the Company’s
Current Report on Form 8-K filed on October 28, 2002).
10.33
Form of Note
and Warrant Subscription Agreement (incorporated herein by reference to
Exhibit 10.1 of the Company’s Quarterly Report on Form 10-QSB filed on
November 7, 2002).
10.34
Form of
Promissory Note (incorporated herein by reference to Exhibit 10.2 of the
Company’s Quarterly Report on Form 10-QSB filed on November 7, 2002).
10.35
Form of
Common Stock Purchase Warrant (incorporated herein by reference to Exhibit
10.3 of the Company’s Quarterly Report on Form 10-QSB filed on November 7,
2002).
10.36
Registration
Rights Agreement dated August 9, 2002 (incorporated herein by reference to
Exhibit 10.4 of the Company’s Quarterly Report on Form 10-QSB filed on
November 7, 2002).
10.37*
Amendment,
dated December 6, 2002, to Employment Agreement with Kenneth S. Kornman.
10.38
Stock
Purchase Agreement between the Company and Pyxis Innovations Inc. dated March
5, 2003 (incorporated herein by reference to Exhibit 10.1 of the Company’s
Current Report on Form 8-K filed on March 5, 2003).
10.39
Amendment
No. 3 to Note Purchase Agreement between the Company and Pyxis Innovations
Inc. dated March 5, 2003
(incorporated herein by reference to Exhibit 10.2 of the Company’s
Current Report on Form 8-K filed on March 5, 2003).
10.40
Amendment
No. 2 to the Security Agreement between the Company and Pyxis Innovations
Inc., dated March 5, 2003 (incorporated herein by reference to Exhibit 10.3
of the Company’s Current Report on Form 8-K filed on March 5, 2003).
10.41
Form of
Amended and Restated Promissory Note (incorporated herein by reference to
Exhibit 10.4 of the Company’s Current Report on Form 8-K filed on March 5,
2003).
10.42
Amendment
No. 2 to Note Purchase Agreement between the Company and Pyxis Innovations
Inc. (incorporated herein by reference to Exhibit 10.5 of the Company’s
Current Report on Form 8-K filed on March 5, 2003).
10.43++
Research
Agreement between the Company and Access Business Group dated March 5,
2003 (incorporated herein by
reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed
on March 5, 2003).
10.44++
Exclusive
License Agreement between the Company and Access Business Group dated March
5, 2003 (incorporated herein by reference to Exhibit 10.7 of the Company’s
Current Report on Form 8-K filed on March 5, 2003).
10.45
Registration
Rights Agreement between the Company and Pyxis Innovations Inc. dated March
5, 2003 (incorporated herein by reference to Exhibit 10.8 of the Company’s Current
Report on Form 8-K filed on March 5, 2003).
10.46@
Amendment
No. 1 to the Employment Agreement with Philip R. Reilly (incorporated herein
by reference to Exhibit 10.9 of the Company’s Current Report on Form 8-K
filed on March 5, 2003).
10.47@
Amendment to
the Employment Agreement with Fenel Eloi (incorporated herein by reference to
Exhibit 10.10 of the Company’s Current Report on Form 8-K filed on March 5,
2003).
10.48
Amendment to
the Employment Agreement with Kenneth Kornman (incorporated herein by
reference to Exhibit 10.11 of the Company’s Current Report on Form 8-K filed
on March 5, 2003).
10.49
Amendment to
the Employment Agreement with Paul Martha, M.D. (incorporated herein by
reference to Exhibit 10.12 of the Company’s Current Report on Form 8-K filed
on March 5, 2003).
10.50@
Form of
Director’s Indemnity Agreement dated March 5, 2003 (incorporated herein by
reference to Exhibit 10.13 of the Company’s Current Report on Form 8-K/A
filed on March 11, 2003).
21.1*
Subsidiaries
of the Company.
23.1*
Consent of
Grant Thornton LLP.
23.2*
Notice
Regarding Consent of Arthur Andersen.
99.1*
Certification
pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
99.2*
Certification
of Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of
2002.
99.3*
Certification
of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of
2002.
* Filed herewith.
+ The
Securities and Exchange Commission previously granted confidential treatment
with respect to certain portions of this exhibit. Omitted portions have been
filed separately with the Securities and Exchange Commission.
++ Confidential
treatment requested as to certain portions of the document, which portions have
been omitted and filed separately with the Securities and Exchange Commission.
@ Management
contract or compensatory plan, contract or arrangement.
(b) Reports on Form 8-K
On October 9, 2002, we filed a report on Form 8-K under Item 5 to
announce the receipt of a Nasdaq delisting letter.
On October 28, 2002, we filed a report on Form 8-K under Item 5 to
announce the signing of a Note Purchase Agreement with a major consumer
products company.
On November 7, we filed a report on Form 8-K under Items 7 and 9 to
file a certification of our Form 10-Q for the quarter ended September 22, 2002,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
On December 10, 2002, we filed a report on Form 8-K under Item 5 to
announce that our common stock would be delisted from the Nasdaq Stock Market
effective that date.
SIGNATURES
In accordance
with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
In accordance
with the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the date indicated.
INTERLEUKIN GENETICS,
INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Reports of Independent Public Accountants
Consolidated
Balance Sheets
Consolidated
Statements of Operations
Consolidated
Statements of Stockholders’ (Deficit) Equity and Comprehensive Loss
Consolidated
Statements of Cash Flows
Notes
to Consolidated Financial Statements
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of
Directors
Interleukin
Genetics, Inc.:
We have
audited the accompanying consolidated balance sheet of Interleukin Genetics,
Inc. (the Company) (a Delaware corporation), as of December 31, 2002 and the
related consolidated statements of operations, shareholders’ (deficit) equity
and comprehensive loss, and cash flows for the period ended December 31, 2002.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
The consolidated financial statements of Interleukin Genetics, Inc. as
of December 31, 2001 and for the two years then ended were audited by other
auditors who have ceased operations.
Those auditors expressed an unqualified opinion with a modification
related to factors that raise substantial doubt about the Company’s ability to
continue as a going concern.
We conducted
our audit in accordance with auditing standards generally accepted in the
United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Interleukin Genetics,
Inc., and its subsidiaries as of December 31, 2002, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
REPORT OF INDEPENDENT
PUBLIC ACCOUNTANTS
To Interleukin
Genetics, Inc.:
We have
audited the accompanying consolidated balance sheets of Interleukin Genetics,
Inc. (a Delaware corporation), as of December 31, 2000 and 2001, and the
related consolidated statements of operations, stockholders’ equity and
comprehensive loss and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted
our audits in accordance with auditing standards generally accepted in the United
States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Interleukin Genetics, Inc., and
subsidiaries as of December 31, 2000 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States.
The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.
As discussed in Note 1 to the financial statements, the Company has
suffered recurring losses from operations and believes that its existing cash
resources, absent additional debt or equity financing, will be depleted by
September 2002. These factors raise
substantial doubt about the Company’s ability to continue as a going
concern. Management’s plans in regard
to these matters are also described in Note 1.
The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
NOTE: THIS IS A COPY OF THE
AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP (‘‘ANDERSEN’’) IN
CONNECTION WITH INTERLEUKIN GENETICS, INC. FORM 10-K FILING FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2001. THE INCLUSION OF THIS PREVIOUSLY ISSUED ANDERSEN
REPORT IS PURSUANT TO THE ‘‘TEMPORARY FINAL RULE AND FINAL RULE REQUIREMENTS
FOR ARTHUR ANDERSEN LLP AUDITING CLIENTS,’’ ISSUED BY THE SECURITIES AND
EXCHANGE COMMISSION IN MARCH 2002. NOTE THAT THE PREVIOUSLY ISSUED ANDERSEN
REPORT INCLUDES REFERENCES TO CERTAIN FISCAL YEARS, WHICH ARE NOT REQUIRED TO
BE PRESENTED IN THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS AS OF AND
FOR THE YEAR ENDED DECEMBER 31, 2002. THIS AUDIT REPORT HAS NOT BEEN REISSUED
BY ANDERSEN IN CONNECTION WITH THIS FILING ON FORM 10-K.
INTERLEUKIN GENETICS, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE
SHEETS
The accompanying notes are an integral part of
these consolidated financial statements.
INTERLEUKIN GENETICS, INC. AND
SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part
of these consolidated financial statements.
INTERLEUKIN
GENETICS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ (DEFICIT) EQUITY
AND COMPREHENSIVE LOSS
For the Years Ended
December 31, 2002, 2001 and 2000
The accompanying notes are an integral part
of these consolidated financial statements.
INTERLEUKIN GENETICS, INC. AND
SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part
of these consolidated financial statements.
Note 1 - Company
Background and Uncertainties
Organization and Line of Business
Interleukin
Genetics, Inc., a Delaware corporation (“ILGN” or the “Company”), is a
functional genomics company focused on personalized medicine. The Company develops genetic tests that
identify patients of risk for some diseases and patients most likely to respond
to particular therapeutic interventions.
The Company also optimizes nutritional and therapeutic compounds for
strategic partners using the Company’s genotype-specific cell lines. As of December 31, 2002, the Company has commercially
introduced one genetic test and is in various stages of development for several
others. Additionally, the Company provides research services under contract to
collaborative partners. Such research services contributed less than 10% of
total revenue to the Company in 2002, 2001 and 2000. In 2002, 86% of the Company’s revenue came a from an option fee
from Pyxis Innovations Inc. (“Pyxis”), which allowed Pyxis the right to
negotiate a research agreement or strategic partnership with the Company.
Commercial
success of genetic susceptibility tests will depend upon their acceptance as
medically useful and cost-effective by patients, physicians, dentists, other
members of the medical and dental community, and third-party payers and may in
the future require FDA approval. It is uncertain whether current genetic
susceptibility tests or others that the Company may develop will gain
commercial acceptance on a timely basis, if at all.
Research in
the field of disease predisposing genes and genetic markers is intense and
highly competitive. The Company has many competitors in the United States and
abroad that have considerably greater financial, technical, marketing, and
other resources available. If the Company does not discover disease
predisposing genes or genetic markers and develop susceptibility tests and
launch such services or products before their competitors, then revenues may be
reduced or eliminated.
The Company’s
ability to successfully commercialize genetic susceptibility tests to be sold
through the health care system depends on obtaining adequate reimbursement for
such products and related treatment from government and private health care
insurers and other third-party payers. Doctors’ decisions to recommend genetic
susceptibility tests will be influenced by the scope and reimbursement for such
tests by third-party payers. If both third-party payers and individuals are
unwilling to pay for the test, then the number of tests performed will
significantly decrease, therefore resulting in a reduction of revenues.
The Company
was incorporated in Texas in 1986 and re-incorporated in Delaware in March
2000.
Note 2 - Summary of Significant Accounting
Policies
Principles of Consolidation
The
consolidated financial statements include the accounts of the Interleukin
Genetics, Inc., and its wholly-owned subsidiary, Interleukin Genetics
Laboratory Services, Inc. All material
intercompany accounts and transactions have been eliminated.
Management Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements, as well as the reported amounts of revenues and
expenses during the reported periods. Actual results could differ from those
estimates. The Company’s most critical
accounting policies are in the area of revenue recognition, cost estimations of
certain ongoing research contracts and the Company’s decision to expense all
patent related costs as incurred. These
critical accounting policies are more fully discussed in these notes to financial
statements and in the section of the Company’s Form 10-K entitled Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
Revenue Recognition
Revenue from
genetic susceptibility tests is recognized when the tests have been completed
and the results reported to the doctors. To the extent test kits have been
purchased and paid for but not yet submitted for test results, the Company
defers recognition of all related revenue. These amounts are presented as
deferred revenue in the accompanying consolidated balance sheets. Contract
revenues
are recognized
ratably as services are provided based on a fixed contract price or on
negotiated hourly rates. Provision for anticipated losses on fixed-price
contracts is made in the period such losses are identified.
The Company
has entered into agreements with outside parties for the distribution of
genetic susceptibility tests, both domestically and internationally.
Distributor fees are received based on the terms of each agreement and are
recognized ratably over the applicable agreement period.
Fees for the
sale or licensing of product rights are recorded as deferred revenue upon
receipt and recognized as revenue on the straight-line basis over the period
that the related products or services are delivered or obligations as defined
in the agreement are performed.
Revenue from
milestone or other contingent payments is recognized when earned in accordance
with the terms of the related agreement. Royalties are recognized when earned
under the Company’s royalty agreements when amounts are fixed or determinable
and payment is reasonably assured.
Staff
Accounting Bulletin No. 101 (SAB No. 101), Revenue Recognition requires companies to
recognize certain up-front non-refundable fees and milestone payments over the
life of the related alliances when such fees are received in conjunction with
agreements that have multiple elements. The Company’s adoption of this new
accounting principle in fiscal 2000 had no impact on the Company’s consolidated
financial statements.
Research and Development
Research and
development costs are expensed as incurred.
Basic and Diluted Net Loss per Common Share
The Company
applies Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per
Share (“SFAS 128”), which establishes standards for computing and
presenting earnings per share. Basic and diluted net loss per share was
determined by dividing net loss applicable to common stockholders by the
weighted average number of shares of common stock outstanding during the
period. Diluted loss per share is the same as basic loss per share for all the
periods presented, as the effect of the potential common stock equivalents is
antidilutive due to the loss in each period. Potential common stock excluded
from the calculation of diluted net loss per share consists of stock options
and warrants as described in the table below:
Comprehensive Income (Loss)
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 years ended
December 31, 2001 and December 31, 2000, the Company had one item, other than
the reported net loss, of comprehensive income (loss), which was the unrealized
holding gains (losses) on marketable securities. During the year ended December
31, 2002, there was no item other than net loss included in the comprehensive
loss. Comprehensive income (loss) is
disclosed in the accompanying consolidated statements of stockholders’ (deficit)
equity and comprehensive loss.
Fair Value of Financial Instruments
The Company
using available market information has determined the estimated fair values of
financial instruments. The estimated fair values of cash and cash equivalents,
accounts receivable and accounts payable approximate fair value due to the
short-term nature of these instruments.
The carrying amounts of the Company’s capital lease obligations also
approximate fair value.
The fair value
of long-term debt is estimated using discounted cash flow analysis, based on
the Company’s current incremental borrowing rates for similar types of
borrowing arrangements. At December 31,
2002 the Company had long-term debt of $1,500,000. Management is unable to estimate the fair value of this debt due
to the difficulty the Company would have obtaining such debt on the open
market.
Cash Equivalents
Cash
equivalents consist of short-term, highly liquid investments purchased with
original maturities of 90 days or less. Investments with an original maturity
of greater than 90 days are classified as marketable securities.
Fixed Assets
Fixed assets
are stated at cost, less accumulated depreciation and amortization.
Depreciation and amortization are provided using the straight-line method over
estimated useful lives of three to five years. Leasehold improvements are
amortized over the life of the lease, or the estimated useful life of the
asset, whichever is shorter. (See Note
5).
Long-Lived Assets
The Company
applies the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No.
144 requires that the Company evaluate its long-lived assets for impairment
whenever events or changes in circumstances indicate that carrying amounts of
such assets may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to the
future undiscounted net cash flows expected to be generated by the asset. Any
write-downs, based on fair value, are to be treated as permanent reductions in
the carrying amount of the assets. The Company believes that no impairment
exists related to the Company’s long-lived assets at December 31, 2002.
Stock-Based Compensation
Stock options
issued to employees under the Company’s stock option and stock purchase plans
are accounted for under Accounting Principles Board Opinion No. 25 (APB 25), Accounting
for Stock Issued to Employees. All stock-based awards to
non-employees are accounted for at their fair value in accordance with SFAS No.
123, Accounting
for Stock-Based Compensation, and Emerging Issues Task Force (EITF)
Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than
Employees.
Had
compensation cost for employee stock awards been determined consistent with
SFAS 123, our net loss applicable to common stock and net loss per share would
have been as follows:
Indemnification
The Company indemnifies its officers and directors against costs and
expenses related to stockholder and other claims not covered by the Company’s
directors and officers insurance policy.
This indemnification is ongoing and does not include a limit on the
maximum potential future payments, nor are there any recourse provisions or
collateral that may offset the cost. As
of December 31, 2002, the Company has not recorded a liability for any
obligation arising as a result of indemnification.
Patent expenses
The Company has expensed patent expenses as incurred due to the
uncertainty that it will ever be able to derive any benefits from these
patents. As noted in the section titled
Intellectual Property on page 10 of this report, the Company has exclusive
rights in twelve issued U.S. patents, has received notices of allow on three
U.S. patent applications and has thirteen additional pending U.S. patents
applications. The Company has also been
granted a number of corresponding foreign patents and the Company has a number
of foreign counterparts of the U.S. patents and patent applications
pending. Since inception the Company
has expensed approximately $2.3 million in the effort to obtain patent
protection for its intellectual property, including $370,000 during the year
ended December 31, 2002. Due to
the alliance with Alticor Inc. that was signed subsequent to year-end on March
5, 2003, management expects to begin capitalizing certain patent costs as the
prospect of deriving benefit from some of these patents becomes more certain.
Recent Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB 13, and Technical Corrections”,
which is effective for fiscal years beginning after May 15, 2002. Upon adoption
of SFAS No. 145, companies will be required to apply the criteria in APB
Opinion No. 30, “Reporting the Results Operations - Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions” in determining the classification of
gains/losses resulting from the extinguishment of debt shall be classified
under the criteria in APB Opinion No. 30. Management does not expect Adoption
of SFAS No. 145 to have a material impact on the Company’s financial
statements.
In July 2002, FASB issued SFAS No. 146 “Accounting for Costs Associated
with Exit or Disposal Activities”, which became effective January 2003. SFAS
No. 146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of commitment. Management does not expect Adoption of SFAS
No. 146 to have a material impact on the Company’s financial statements.
In November 2002, FASB Interpretation 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others” (FIN 45), was issued.
FIN 45 requires a guarantor entity, at the inception of a guarantee
covered by the measurement provisions of the interpretation, to record a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The Company previously did
not record a liability when guaranteeing obligations unless it became probable
that the Company would have to perform under the guarantee. FIN 45 applies prospectively to guarantees
the Company issues or modifies subsequent to December 31, 2002, but has certain
disclosure requirements effective for interim and annual periods ending after
December 15, 2002. The Company
historically issued guarantees only on a limited basis and does not anticipate
FIN 45 will have a material effect on its 2003 financial statements.
In December 2002, FASB issued SFAS No. 148 “Accounting for Stock-Based
Compensation - Transition and Disclosure”.
SFAS No. 148 provides alternative methods of transition to a voluntary
change to the fair value based method of accounting for stock-based
compensation. In addition, this
Statement amends the disclosure requirements to require prominent disclosures
in both the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. Management
does not expect adoption of SFAS No. 148 to have a material impact on the
Company’s financial statements.
In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable
Interest Entities.” In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes
that either (a) does not have equity investors with voting rights or (b) has
equity investors that do not provide sufficient financial resources for the
entity to support its activities. FIN
No. 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The consolidation requirements of FIN No. 46 apply immediately to
variable interest entities created after January 31, 2003. The consolidation requirements apply to
older entities in interim periods beginning after June 15, 2003. Certain of the disclosure requirements apply
in all financial statements issued after January 15, 2003, regardless of when
the variable entity was formed. The
Company does not expect adoption of FIN No. 46 to have a material impact on the
Company’s financial statements.
Note 3 - Strategic Alliance with Alticor Inc.
On March 5, 2003, the Company announced a broad strategic alliance with
several affiliates of the Alticor family of companies to develop and market
novel nutritional and skin care products.
The alliance will utilize the Company’s intellectual property and
expertise in genomics to develop personalized consumer products.
The alliance includes an equity investment, a multi-year research and
development agreement, a licensing agreement with royalties on marketed
products, the deferment of outstanding loan repayment and the refinancing of
bridge financing obligations. The major
elements of the alliance are:
• The purchase by
Alticor of $7,000,000 of equity in the form of 5 million shares of Series A
Preferred Stock for $1.40 per share, convertible into approximately 28,157,683
shares of common stock at a conversion price equal to $0.2486, representing
54.91% of the Company’s common stock assuming conversion of the preferred stock
(without taking into account the conversion into common stock of current and
potential loans extended to Interleukin by Alticor). Upon achievement of a defined milestone, Alticor would contribute
an additional $2,000,000 to the Company, for no additional shares, for a total
equity funding of $9,000,000 and a conversion price of $0.3196.
• The right of the
Series A holders to nominate and elect four directors to a five person
board. To accommodate the election of
the four Series A directors, which occurred on March 24, 2003, all of
Interleukin’s previous directors, except for Philip Reilly, Interleukin’s Chief
Executive Officer, resigned.
• A research and
development agreement providing Interleukin with funding of $5,000,000, payable
over the next 24 months, to conduct certain research projects with a royalty on
resulting products.
• Credit
facilities in favor of Interleukin, as follows:
• $1,500,000
working capital credit line to initiate selected research agreements with third
party entities approved by the board of directors of Interleukin;
• $2,000,000 refinancing of notes
previously held by Pyxis, extending the maturity date and reducing the interest
rate; and
• $525,000 plus interest refinancing of
bridge financing notes currently held by third parties, extending the maturity
date and reducing the interest rate.
These credit
facilities will mature in December 2007, bear interest at 1% over the prime
rate, are secured by a security interest in Interleukin’s intellectual
property, and are convertible at the election of Pyxis into shares of common
stock at a conversion price initially equal to $0.4972 per share, subject to
future adjustment.
Note 4 - Research Agreements
In July 1999,
the Company entered into an agreement with the University of Sheffield, or
Sheffield, whereby the Company will undertake the development and
commercialization of certain discoveries resulting from Sheffield’s research.
For certain of the discoveries, the parties have reached a specific
non-cancelable agreement of development and commercialization. However, for new discoveries on which the
parties have not yet reached specific agreement, the agreement may be
terminated with or without cause by either party upon six months’ notice. If
Sheffield terminates the agreement, such termination could make the discovery
and commercial introduction of new products more difficult or unlikely.
The agreement
with Sheffield is a five-year agreement with an automatic yearly renewal.
During 1999, in accordance with this agreement, the Company issued 275,000
shares of common stock to Sheffield for transferring all rights and title of
certain patents. The value of the common stock of $653,125 was charged to
research and development expense in the third quarter of 1999. Additionally,
each year beginning July 1, 2000, Sheffield will receive 25,000 fully vested
options to purchase common stock at the then current market price, plus 10,000
fully vested options to purchase common stock for each new patent application
filed in the previous 12 months. During the year ended December 31, 2002,
35,000 fully vested options to purchase common stock were granted under this
agreement and the Company charged approximately $1,000 to research and
development expense based upon the fair value of the options determined using
the Black-Sholes option-pricing model. These options have a five-year exercise
period. In 1999, the Company signed another research agreement with Sheffield
that automatically renews in one-year increments. This agreement requires the
Company to pay the cost of agreed upon research projects conducted at
Sheffield. For the year ended December
31, 2002 the Company expensed approximately $344,000 for research conducted at
Sheffield. This includes funding to the
University and to collaborators at the University. Both agreements with Sheffield can be canceled if a certain key
collaborator leaves Sheffield.
In September
1999, a five-year consulting agreement was entered into with Sheffield’s key
collaborator. In accordance with the consulting agreement, the key collaborator
received 200,000 shares of common stock for relinquishing interests in previous
research agreements. The value of the common stock of $475,000 was charged to
research and development expense in the third quarter of 1999. The key
collaborator will also receive 1% of the first $4 million of net sales under
the PST Technology and 2% for sales above $4 million. During 2002, this
collaborator received no significant royalty payments for sales of PST. On July
1, 2001 and 2002, in consideration for future services, the key collaborator
received 25,000 fully vested options to purchase common stock at the then
current market price. These options have a five-year exercise period from the
date of grant. During 2002, the Company charged to research and development
expense approximately $1,000 related to the issuance of these options based
upon the fair value determined using the Black-Sholes option-pricing model.
This collaborator will continue to receive 25,000 fully vested options to
purchase common stock each July 1 during the period that this agreement is in
effect.
In December 2001, the Company
entered into a research collaboration agreement with Kaiser Permanente’s Center
for Health Research (“Kaiser”), to study genetic risk factors for chronic
diseases that are affected by inflammation. This agreement requires the Company
to fund clinical trials completed at Kaiser per specific research study plans.
The first study plan that the Company is funding is a study to assess the
genetic risk that diabetic patients have of developing cardiovascular disease.
Management expects to announce additional studies with Kaiser. Management hopes
that knowledge resulting from this work will enable us to develop new
diagnostic tools that physicians and health care organizations can use to
assess their patients’ genetic risk for many diseases.
In March 2002, the Company
entered into a research collaboration agreement with UnitedHealth Group’s
research arm, the Center for Healthcare Policy and Evaluation, to study how
commonly inherited gene variants affect the response of patients with certain
inflammatory diseases to specific drugs.
The Company believes knowledge resulting from this work will help it
develop pharmacogenetic tests that physicians and managed care organizations
can use to assist in the selection of the optimal drug for an individual
patient.
Note 5 - Accounts Receivable
The changes in
the allowance for doubtful accounts consisted of the following:
Note 6 - Fixed Assets
The fixed
assets’ useful lives and balances at December 31, 2002 and 2001 consisted of
the following:
Note 7 - Income Taxes
The Company
accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes,
which requires the recognition of taxes payable or refundable for the current
year and deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the financial statements or tax returns.
The measurement of current and deferred tax liabilities and assets is based on
provisions of the enacted tax law; the effects of future changes in tax laws or
rates are not anticipated.
As of December
31, 2002, the Company had net operating loss (NOL) and research tax credit
carryforwards of approximately $33,800,000 and $369,000, respectively, for
federal and state income tax purposes, expiring in varying amounts through the
year 2021. The Company’s ability to use its NOL and tax credit carryforwards to
reduce future taxes is subject to the restrictions provided by Section 382 of
the Internal Revenue Code of 1986 (the “Code”). These restrictions provide for
limitations on the Company’s utilization of its NOL and tax credit
carryforwards following a greater than 50% ownership change during the
prescribed testing period. Subsequent to year-end, on March 5, 2003, the
Company has had such a change. As a result, all of the Company’s NOL
carryforwards are limited in utilization. The annual limitation may result in
the expiration of certain of the carryforwards prior to utilization.
As of December
31, 2002 and 2001, the approximate income tax effect of the Company’s deferred
tax assets (liabilities) consisted of the following:
Due to the
uncertainty regarding the timing and realization of the Company’s net deferred
tax asset, a full valuation allowance has been established against the
Company’s deferred tax assets.
Note 8 - Capital Stock
Authorized Common and Preferred Stock
At December
31, 2002, the Company had authorized 5,000,000 shares of undesignated preferred
stock of which none were outstanding. At December 31, 2002, the Company had
authorized 50,000,000 shares of $0.001 par value common stock of which
23,118,249 shares were outstanding, approximately 2,873,652 million shares were
reserved for issuance upon exercise of outstanding stock options, 745,113 were
reserved for issuance upon exercise of stock options available for grant under
existing plans, approximately 525,000 shares were reserved for the exercise of
authorized and outstanding warrants to purchase common stock and approximately
476,000 shares were reserved for issuance under the Employee Stock Purchase
Plan.
On March 5, 2003, the Company reserved all authorized but otherwise
unissued or unreserved shares of common stock for the conversion of the Series
A Preferred Stock (described below). The Company currently does not have sufficient shares of common
stock authorized under its Certificate of Incorporation to cover all shares of
common stock that the Company may be required to issue upon conversion of the
Series A Preferred Stock or any of the shares that the Company may be required
to issue upon the conversion of the promissory notes described below. The Company has agreed to take all such
corporate actions as may be necessary to increase the number of authorized but
unissued shares of common stock, including engaging in the Company’s best
efforts to obtain stockholder approval of the amendment of the Company’s
certificate of incorporation.
Series A Preferred Stock
In a private
placement on March 5, 2003, the Company entered into the Purchase Agreement
with Pyxis, pursuant to which Pyxis purchased from us the Series A Preferred
Stock for $7,000,000 in cash and an additional $2,000,000 in cash to be paid,
if at all, upon our reaching a certain milestone pursuant to the terms of
Purchase Agreement. The offering was
made to Pyxis by way of a private placement exempt from registration under the
Securities Act.
The Series A
Preferred Stock issued in the private placement is initially convertible into
28,157,683 shares of the Company’s common stock reflecting a conversion price
of $.2486 per share (or $.3196 per share if the milestone payment is received),
subject to weighted average antidilution adjustments. Assuming the conversion of all shares of Series A Preferred
Stock, such shares represent 54.91% of the outstanding shares of the Company’s
common stock.
The Series A Preferred Stock was issued in return for a capital
contribution of $7,000,000 and is convertible into shares of common stock at a
initial conversion price of $.2486 per share.
If the Company achieves the milestone of entering into a genetics
testing agreement with one or more customers with a projected internal rate of
return of at least twenty percent (20%) and a payback period of three (3) years
or less, Pyxis will make an additional capital contribution of $2,000,000. This subsequent milestone payment will
increase the effective conversion price per common stock equivalent share to
$.3196 per share. Alticor Inc., the
parent of Pyxis, has guaranteed this $2,000,000 payment if the milestone is
achieved.
The Series A Preferred Stock accrues dividends at the rate of 8% of the
original purchase price per year, payable only when, as and if declared by the
Board of Directors and are non-cumulative.
If the
Company declares a distribution, with certain exceptions, payable in securities
of other persons, evidences of indebtedness issued by us or other persons,
assets (excluding cash dividends) or options or rights to purchase any such
securities or evidences of indebtedness, then, in each such case the holders of
the Series A Preferred Stock shall be entitled to a proportionate share of any
such distribution as though the holders of the Series A Preferred Stock were
the holders of the number of shares of the Company’s common stock into which
their respective shares of Series A Preferred Stock are convertible as of the
record date fixed for the determination of the holders of the Company’s common
stock entitled to receive such distribution.
In
the event of any liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary, the holders of the Series A Preferred Stock shall be
entitled to receive, prior and in preference to any distribution of any of the
Company’s assets or surplus funds to the holders of the Company’s common stock
by reason of their ownership thereof, the amount of two times the
then-effective conversion price per share, as adjusted for any stock dividends,
combinations or splits with respect to such shares, plus all declared but
unpaid dividends on such share for each share of Series A Preferred Stock then
held by them. After receiving this
amount, the holders of the Series A Preferred Stock shall participate on an
as-converted basis with the holders of common stock in any of the Company’s
remaining assets.
Each share of Series A Preferred Stock is convertible at any time at
the option of the holder into a number of shares of the Company’s common stock
determined by dividing the then-effective purchase price (originally $1.40, or
$1.80 if the milestone payment is received, and subject to further adjustment)
by the conversion price in effect on the date the certificate is surrendered
for conversion. The initial conversion
price is $.2486 per share (or $.3196 per share if the milestone payment is
received), subject to weighted average antidilution adjustment.
Each holder of Series A Preferred Stock is entitled to vote its shares
of Series A Preferred Stock on an as-converted basis with the holders of common
stock as a single class on all matters submitted to a vote of the stockholders,
except as otherwise required by applicable law. This means that each share of Series A Preferred Stock will be
entitled to a number of votes equal to the number of shares of common stock
into which it is convertible on the applicable record date, except as otherwise
required by applicable law.
Private Placements of Common Stock
In January
2001, the Company sold in a private placement 1.2 million shares of common
stock for $2.50 per share. The purchasers of common stock also received
warrants to purchase 600,000 shares of common stock exercisable at $3.00 per
share. The Company generated net proceeds of approximately $2.9 million from
this transaction. Under the terms of
this private placement, the Company is required to adjust the price per share
paid in this offering, by issuing additional shares, to match any offering
price paid, if lower, in subsequent offerings prior to May 23, 2003. On October 22, 2002, this agreement was
amended. (See Note 9)
In December
2000, the Company sold in a private placement 542,373 shares of common stock
for $3.69 per share. The purchasers of common stock also received warrants to
purchase 135,593 shares of common stock exercisable at $4.83 per share. The
Company generated net proceeds of approximately $2.0 million from this
transaction. Under the terms of this private placement, the Company is required
to adjust the price per share paid in this offering, by issuing additional shares,
to match any offering price paid, if lower, in subsequent offerings prior to
February 9, 2003. Following the January 2001 offering described above, the
Company issued an additional 257,627 shares of common stock to the purchasers
in the December 2000 private placement, and a new warrant to purchase 264,407
shares of common stock exercisable at a price of $3.13 to replace the
previously issued warrant to buy 135,593 shares of common stock at a price of
$4.83 per share. On October 22, 2002
this agreement was amended. (See Note
9)
Employee Stock Purchase Plan
Effective
October 14, 1998, the Company’s Board of Directors approved an Employee Stock
Purchase Plan for qualified employees of the Company. Under the terms of the
Employee Stock Purchase Plan, an employee may purchase up to $25,000 per
calendar year of the Company’s stock at a price equal to 85% of the fair market
value of the stock (as quoted on the Nasdaq national quotation system) on
either the first or last day of a calendar quarter. The Company has reserved
500,000 shares of common stock for purchases to be made under the Employee
Stock Purchase Plan. During the years ended December 31, 2002, 2001, and 2000,
9,855, 5,206 and 1,559 shares were purchased under the Employee Stock Purchase
Plan at an average purchase price of approximately $0.54, $1.28 and $5.35,
respectively, per share.
Nasdaq Delisting
On October 9,
2002 the Company received a letter from Nasdaq stating that the Company did not
meet the criteria for the continued listing of the Company’s common stock on
the Nasdaq SmallCap Market. The letter stated that the common stock of the
Company was not in compliance with the $1 minimum bid price, that its
stockholders’ equity does not meet the $2.5 million minimum requirement, and that
the Nasdaq Staff rejected the Company’s plan to regain compliance with those
listing criteria. The Company appealed
the ruling and an appeals hearing was held on November 14, 2002. On December 9, 2002, the Company received
notification from the Nasdaq Listing Qualifications Panel that the panel had
denied the Company’s request for continued listing on the Nasdaq SmallCap
market. The Company was delisted from
Nasdaq on December 10, 2002. Since
December 10, 2002, the Company’s common stock has traded on the OTC Bulletin
Board (OTCBB) under the symbol ILGN. It
is not known when or if the Company’s common stock will again trade on the
Nasdaq SmallCap market.
Note 9 - Interim Financing
On August 9,
2002 the Company received approximately $475,000 in net proceeds from the sale
of term promissory notes with an original aggregate principal amount of
$525,000. These notes mature in August 2003 and accrue interest at a rate of
15%. The outstanding principal amount and all accrued interest are to be paid
upon maturity. The Company can prepay
the principal and accrued interest at any time without penalty. The purchasers
of the promissory notes received warrants to purchase one share of the
Company’s
common stock at a purchase price of $2.50 for every dollar invested in the
promissory notes. In total, warrants to purchase 525,000 shares of the
Company’s common stock were issued. These warrants expire in ten years. Interest expense was $33,000 for the year
ended December 31, 2002. Amortization
expense related to the discount of notes was $150,000 for the year ended
December 31, 2002.
On October 23,
2002, the Company entered into an interim financing agreement with Pyxis
Innovations Inc. to provide debt financing of up to $1.5 million. The agreement was subsequently amended to
provide for an aggregate of 2,000,000 in debt financing. On October 23, 2002, November 15,
2002, December 16, 2002 and January 29, 2003, the Company received
four separate $500,000 promissory notes pursuant to the agreement. These notes were to mature on December 31,
2003 and accrued interest at a rate of 15%. The outstanding principal amount
and all accrued interest were to be paid upon maturity. The Company can prepay the principal and
accrued interest at any time without penalty. These notes were secured by all
of the intellectual property of the Company except intellectual property
relating to periodontal disease and sepsis.
On March 5, 2003, these notes were amended and reissued. (See
Note 3)
On October 22, 2002, as a
condition for the interim financing with Pyxis noted above, the Company entered
into separate agreements with the purchasers in the December 2000 and January
2001 private placements to temporarily waive certain provisions of these
private placement agreements. Specifically, the purchasers temporarily waived
their right, through March 31, 2003, to receive cash payments of up to $100,000
per month if the Company’s common stock is delisted from the Nasdaq SmallCap
Market. Also waived through March 31, 2003 was the purchasers’ right to receive
additional shares of the Company’s common stock for no additional consideration
if the Company issued shares of its common stock at a price below $2.50 per
share (for the purchaser in the December 2000 private placement this waiver was
permanent, its right expired on February 9, 2003). Under these agreements the
purchasers also agreed to cancel warrants to purchase an aggregate of 864,407
shares of common stock. In exchange, the Company issued an aggregate of
1,676,258 shares of the Company’s common stock to the purchasers for no
additional cash consideration. The
purchasers also agreed that if the Company received an equity investment of at
least $3,000,000 from Pyxis prior to March 31, 2003, the temporary waivers of
rights by the purchasers would become permanent. If the Company did not receive
such an equity investment by that date, the temporary waivers would have
terminated and the Company would have been required to issue warrants to
purchase an aggregate of 864,407 shares of the Company’s common stock
exercisable at $1.70 per share, subject to any stockholder approvals required
by the Nasdaq SmallCap Market or any other market or exchange on which the
Company’s common stock was traded or quoted. Of these warrants, the exercise
price of warrants to purchase 600,000 shares of common stock would have been
subject to adjustment downward to equal 125% of the price per share at which
the Company sold any shares of its common stock (or securities convertible into
common stock) prior to May 23, 2003.
The March 5, 2003 sale of
Series A Preferred (See Note 3) stock satisfied the conditions necessary to
make permanent the temporary waivers discussed above.
Note 10 - Stock Option Plans
In June 2000,
the Company’s stockholders approved the adoption of the Interleukin Genetics,
Inc. 2000 Employee Stock Compensation Plan (the “2000 Plan”). The 2000 Plan
provides for the award of nonqualified and incentive stock options, restricted
stock, and stock awards to employees, directors, officers, and consultants of
the Company. A total of 2,000,000 shares of the Company’s common stock have
been reserved for award under the 2000 Plan of which approximately 680,000 were
available for future issuance at December 31, 2002.
In June 1996,
the Company’s stockholders approved the adoption of the 1996 Equity Incentive
Plan (the “1996 Plan”). The 1996 Plan provides for the award of nonqualified
and incentive stock options, restricted stock and stock bonuses to employees,
directors, officers and consultants of the Company. A total of 1,300,000 shares
of the Company’s common stock have been reserved for award under the 1996 Plan
of which approximately 170,000 were available for grant at December 31, 2002.
Nonqualified
and incentive stock options with a life of 10 years are generally granted at
exercise prices equal to the fair market value of the common stock on the date
of grant. Options granted to new employees generally vest over a period of
three to four years. Performance
options issued on the employee’s anniversary generally vest over a period of
one year.
A summary of
the status of the Company’s stock options, issued both under the 1996 and 2000
Plans and outside of these plans, at December 31, 2002, 2001 and 2000, and
changes during these years is presented in the tables below:
The following
table details all stock option activity:
The following
table details further information regarding stock options outstanding and
exercisable at December 31, 2002:
The Company
applies the disclosure-only alternative of SFAS No. 123, “Accounting for
Stock-Based Compensation” (SFAS 123), which defines a fair-value-based method
of accounting for employee stock options or similar equity instruments. Under
the fair-value-based method, compensation cost is measured at the grant date based
on the value of the award and is recognized over the service period of the
award, which is usually the vesting period. However, SFAS 123 also allows
entities to continue to measure compensation costs for employee stock
compensation plans using the intrinsic value method of accounting prescribed in
APB 25. The Company has elected to continue to follow the accounting prescribed
by APB 25 and has made the required disclosures prescribed by SFAS 123.
Had
compensation cost for the Company’s employee stock awards been determined
consistent with SFAS 123, the Company’s net loss applicable to common stock and
net loss per share would have been as follows:
The fair value
of each option grant is estimated on the date of grant using the Black-Sholes
option-pricing model, for a stock that does not pay dividends with the
following assumptions.
Using these
assumptions, the weighted average grant date fair value of options granted in
2002, 2001 and 2000 was $0.70, $1.31 and $4.28, respectively.
Note 11 - Employee Benefit Plan
In 1998, the
Company adopted a profit sharing plan covering substantially all of its
employees. Under the profit sharing plan, the Company may, at the discretion of
the Board of Directors, contribute a portion of the Company’s current or
accumulated earnings. In September 1998, the Company amended and restated the
profit sharing plan to include provisions for Section 401(k) of the Internal
Revenue Code, which allowed for pre-tax employee contributions to the plan.
Under the amended and restated plan, the Company may, at the discretion of the
Board of Directors, match a portion of the participant contributions. The
Company currently contributes 1% of any amount employees contribute. Company contributions, if any, are credited
to the participants’ accounts and vest over a period of four years based on the
participants’ initial service date with the Company. During the years ended December 31, 2002 and December 31, 2000,
$20,690 and $10,726 was contributed to the plan, respectively. During the year ended December 31, 2001 no
contributions were made to the plan.
Note 12 - Commitments and Contingencies
In July 2000,
the Company completed a move of its corporate and research and development
offices from San Antonio, Texas, to Waltham, Massachusetts. The Company leases
its office space under a non-cancelable operating lease expiring June 2006.
The Company’s
former corporate headquarters and research and development offices, located in
San Antonio, Texas, are held under a lease expiring May 31, 2003 and have been
subleased by the Company until the expiration of this lease. The sublease income is aggregated with the
net rent expense and included in other income and expense in the consolidated
statements of operations.
The Company
also leases certain office furniture and equipment under capital lease
obligations. Future minimum lease commitments, net of sublease income, under
lease agreements with initial or remaining terms of one year or more at
December 31, 2002, are as follows:
Rent expense,
net of sublease income, was $265,363, $190,163 and $138,064 for the years ended
December 31, 2002, 2001 and 2000, respectively.
Employment Agreements
The Company
has entered into employment agreements with certain key employees of the
Company which range from one to five years and provide for severance ranging
from three months to one year upon termination of employment.
Note 13 - Segment Information
The Company
follows SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131) which
establishes standards for reporting information about operating segments in
annual and interim financial statements, and requires that companies report
financial and descriptive information about its reportable segments based on a
management approach. SFAS 131 also establishes standards for related
disclosures about products and services, geographic areas and major customers.
In applying the requirements of this statement, each of the Company’s
geographic areas described below was determined to be an operating segment as
defined by the statement, but have been aggregated as allowed by the statement
for reporting purposes. As a result, the Company continues to have one
reportable segment, which is the development of genetic susceptibility tests
and identification of therapeutic targets for common diseases.
During 2000,
the Company closed its foreign operations. Therefore, the Company no longer
derives or reports any revenue or expense from outside of the United States. As
of December 31, 2002 and December 31, 2001, substantially all of the assets of
the Company were located in the United States.
Concentrations of Risk
During the
year ended December 31, 2002 one entity, Pyxis, which paid us for an option to
negotiate a strategic alliance, accounted for 86% of the total revenue, a
distributor accounted for 5% of total revenue and the Company’s other
distributor accounted for 3% of total revenue.
During the year ended December 31, 2001, one customer accounted for
56% of total revenue and another accounted for 22% of total revenue. During the year ended December 31, 2000, no
one customer accounted for more than 10% of total revenues. The increase in concentration of risk in
2001 was the result of the Company’s change in strategy in selling PST. The Company no longer markets PST directly;
the Company now sells to a few large distributors who market PST to individual
physicians and patients.
Note 14 - Accrued Expenses
Accrued
expenses consist of the following:
Note 15 - Selected Quarterly Financial Data
(Unaudited)
The following
are selected quarterly financial data for the years ended December 31, 2002 and
EXHIBIT INDEX
No.
Description
10.12@
Employment
Agreement dated April 1, 2000 between the Company and Philip R. Reilly.
10.13
Form of
Gordon W. Duff / the University of Sheffield Option Agreement.
10.17
Form of
Non-Qualified Stock Option Agreement.
10.19@
Employment
Agreement dated June 18, 2000 between the Company and Fenel Eloi.
10.26@
Amendment,
dated as of December 21, 2001 to Employment Agreement with Kenneth S.
Kornman.
10.37
Amendment,
dated December 6, 2002, to Employment Agreement with Kenneth S. Kornman.
21.1
Subsidiaries
of the Company.
23.1
Consent of
Grant Thornton LLP.
23.2
Notice
Regarding Consent of Arthur Anderson LLP.
99.1
Certification
pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
99.2
Certification
of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of
2002.
99.3
Certification
of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of
2002.
@ Management contract or
compensatory plan, contract or arrangement.