ITEM 1. BUSINESS
This Annual Report on Form 10-K contains, in addition to historical information, forward-looking statements that involve risks and uncertainty. Our actual results could differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include those discussed in "Factors That May Affect Our Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as those discussed elsewhere in this Annual Report on Form 10-K.
OVERVIEW
We are a leading genomics and biopharmaceutical company focused on therapeutic product development and functional analysis of genes using our proprietary technology platform. We discover, develop and intend to commercialize novel compounds for treating and diagnosing human disease based on the identification and study of genes. We focus our internal product development efforts on therapeutic proteins, antibodies, peptides and fusion proteins and we use collaborations for the development of gene therapy products and small molecule drugs. We have discovered a large number of genes through our genomics capabilities and have developed a rapidly evolving product pipeline based on our discoveries. We have seven products, including three therapeutic proteins, one antibody and three albumin fusion products that we have advanced into human clinical trials; two products are awaiting approval from FDA to enter human clinical trials; a tenth product, a gene therapy product based on a gene we discovered, has been licensed to Vascular Genetics, Inc. (VGI) and is in human clinical trials being conducted by VGI; an eleventh product, an enzyme that lowers levels of lipoprotein-associated phospholipase A2 (Lp-PLA2), was discovered by GlaxoSmithKline (GSK) as part of our collaboration with GSK and is also in human clinical trials being conducted by GSK. We have a number of additional products in preclinical development.
We have extensive capabilities in gene discovery, intellectual property protection and preclinical and clinical development and have established a manufacturing capability for the preparation of our proteins and other products for human studies. We intend to add sales and marketing when appropriate and are currently adding additional manufacturing capabilities. We have established strategic partnerships with a number of leading pharmaceutical and biotechnology companies to leverage our capabilities and gain access to complementary technologies and sales and marketing infrastructure. Some of these partnerships provide us with research funding and milestone payments, along with royalty payments as products are developed and commercialized. We are also entitled to certain co-promotion, co-development, revenue sharing and other product rights.
We have a growing intellectual property portfolio protecting our genomic discoveries and product pipeline.
STRATEGY
Our goal is to be an independent, global and fully-integrated biopharmaceutical company through the discovery, development, manufacture and commercialization of new gene-based products. As part of our strategy, we intend to continue to:
- Discover medically useful genes based on our proprietary technology platform;
- Develop, manufacture and commercialize our gene-based products on our own and with our strategic partners;
- Establish and enhance strategic alliances to provide access to the product development, clinical development and marketing expertise of our partners;
- Expand our technology platform to accelerate our product development activities;
- Pursue strategic acquisitions to augment our capabilities and provide access to complementary technologies; and
- Capitalize on and expand our intellectual property portfolio.
PRODUCTS
We have discovered a large number of medically useful genes which we are developing on our own. Currently, seven drugs from our technology are in human clinical trials including three therapeutic proteins, one antibody and three albumin fusion proteins. Our therapeutic proteins are: Mirostipen (MPIF-1), a protein designed to protect cells which develop into white blood cells, red blood cells and platelets from the toxic effects of chemotherapy, is in Phase II human clinical trials. Repifermin (KGF-2), a protein designed to speed the repair of damage to skin and other cells, is in Phase II human clinical trials for the treatment of venous ulcers and mucositis. BLyS(TM), an immune stimulant, is in Phase I human clinical trials for the treatment of common variable immunodeficiency and IgA deficiency. Our antibody is LymphoStat-B(TM) and is in Phase I human clinical trials in patients with autoimmune disease. We have three albumin fusion proteins that have been advanced to Phase I human clinical trials. These are: Albuferon(TM)-(alpha) for the treatment of chronic hepatitis C and chronic myelogenous leukemia (CML), Albutropin(TM) for the treatment of adult growth hormone deficiency and Albuleukin(TM) for the treatment of cancer. We have two products awaiting approval from FDA to enter human clinical trials. One of these is LymphoRad(131)(TM) is a radioiodinated form of BLyS and is awaiting FDA clearance to begin Phase I human clinical trials in patients with multiple myeloma.
Currently, there are two products being developed by partners that are in human clinical trials. We licensed VEGF-2 to Vascular Genetics, Inc. (VGI) for gene therapy. These clinical trials were on clinical hold until October 2001, but VGI expects to resume the trials during 2002. GlaxoSmithKline is evaluating an enzyme that lowers levels of lipoprotein-associated phospholipase A2 (Lp-PLA2) in Phase I human clinical trials.
We also have a rapidly evolving pipeline of additional products in preclinical development to treat diseases such as cancer, HIV, hepatitis, diabetes / metabolism, bone remodeling / osteoporosis, systemic lupus erythematosus, rheumatoid arthritis and vascular disease.
INDUSTRY BACKGROUND
Every living organism has a unique "genome," a master blueprint of all the cellular structures and activities required to build and support life. A genome is a map of the organism's DNA, which is in part comprised of segments called "genes." Genes contain the specific sequences of information responsible for particular physiological traits and processes. Each gene is comprised of a sequence of nucleotides which provide precise genetic instructions to create, or "express" a protein. Proteins are the primary building blocks of an organism's physiological characteristics. A typical human cell contains thousands of different proteins essential to its structure, growth and function. If even one gene is expressed abnormally, it can severely alter the cell's function and result in a disease condition.
Throughout the past decade, researchers have focused on discovering genes and sequencing the human genome to determine the order of nucleotides in a specific gene, permitting identification of the gene and the protein it produces using a variety of techniques. For example, scientists have used cDNA libraries, which contain copies of DNA with only the expressed portion of the gene, in conjunction with computer software to discern locations of genes within the genome. Recent advances have made these technologies operate in a high-throughput manner, causing the discovery of genes to become drastically more efficient and allowing researchers to focus on the functional aspects of genes. Understanding the functional aspects of genes allows for the correlation of those genes to medically relevant conditions. Armed with these data, researchers can more efficiently develop treatments for conditions of interest.
Gene research facilitates and greatly accelerates the development of a variety of therapeutic, diagnostic and other products and services. Development efforts can become more targeted as researchers develop compounds that affect the specific activity of an expressed gene product. Most therapeutic drugs act on proteins which cause or contribute to an illness or disorder. As a result, the identification of proteins through gene research can play an important role in the development of drugs and drug screens. Proteins themselves can also be used as drugs. Insulin, which regulates sugar metabolism, is a good example of a widely known protein drug. The identification of genes that code for proteins that may be missing or defective can enable the development of therapeutics for genetic diseases. In addition, identification of genes that may predispose a person to a particular disease may enable the development of diagnostic tests for the disease that will permit early diagnosis and more successful treatment. Genomic research has the potential to make the drug discovery process dramatically more time and cost efficient, as well as to enable the development of more targeted drugs.
OUR STRATEGY
Our goal is to become an independent, global and fully-integrated biopharmaceutical company through the discovery, development, manufacture and commercialization of new gene-based products. Our strategy consists of the following key elements:
- Discover medically useful genes. We intend to continue to discover medically useful genes using the strengths of our technology platform. We undertake discovery efforts based on our capabilities in gene sequencing, transcriptional profiling, creation of gene libraries and bioinformatics. We study our extensive genomic database for potentially medically useful genes and focus on discovering their functions.
- Develop, manufacture and commercialize our products. We seek to develop clinically the medically useful genes we discover. This may include using the protein product itself as a drug, using the protein as a target for a small molecule drug or creating antibodies targeted at the protein. We also intend to pursue drugs using proprietary protein fusion technology. This technology may provide longer acting forms of many important proteins, which may allow us to develop safer, more effective and more convenient versions of both existing and new products. We intend to manufacture proteins and commercialize the drugs we develop on our own or in conjunction with our partners.
- Establish and enhance strategic alliances. We intend to continue to establish alliances with leading pharmaceutical and biotechnology companies. These alliances will provide us with access to the expertise of our partners in areas such as product development, clinical development and sales and marketing, while allowing our partners to develop therapeutics based on our technologies. In addition, these alliances may generate research funding, milestone and royalty payments that will enable us to continually enhance our technology platform and to discover and develop new gene-based products. We may also seek to retain certain co-promotion, co-development, revenue sharing and other product rights.
- Expand our technology platform. We will continue to invest considerable resources to expand and enhance our proprietary technology platform. This will allow us to accelerate our discovery and product development activities and facilitate the formation of additional alliances with major biotechnology and pharmaceutical companies. We also intend to continue to establish collaborations with leading biotechnology companies to gain access to complementary technologies for our product development efforts.
- Pursue strategic acquisitions. We intend to continually evaluate potential acquisitions and joint ventures that would allow us to augment our technology, product development and commercialization capabilities, as well as provide access to complementary technological expertise.
- Capitalize on and expand our intellectual property portfolio. We vigorously pursue patents to protect our intellectual property and have developed a strong intellectual property portfolio. We intend to capitalize on and expand our portfolio as we make further discoveries. As of March 1, 2002, we had 205 U.S. patents covering human genes and proteins and had filed U.S. patent applications covering many more human genes and the proteins they encode.
PRODUCTS IN DEVELOPMENT
We have discovered a large number of medically useful genes which we are developing on our own or with our partners. A number of our and our partners' products have advanced to various stages of human clinical testing. Moreover, we have a rapidly evolving pipeline of products in preclinical development.
(1) Drug development costs for these drugs are the sole responsibility of the licensee.
(2) VEGF-2 trials were released from clinical hold in October 2001 by the Food and Drug Administration (FDA). See "Risk Factors."
CLINICAL PROGRAMS
Repifermin (Keratinocyte Growth Factor-2, KGF-2)
We have shown in animal studies that repifermin speeds the repair of damage to the cells lining the mouth, throat, gastrointestinal tract and related tissues and heals serious chronic wounds to the skin. Repifermin may also be useful in treating a number of other conditions involving injury to skin cells, including skin ulcers, burns and surgical and other wounds. In addition, repifermin may be useful in the treatment of mucositis, an injury to the lining of the mouth and intestinal tract which can be caused by some cancer treatments. GlaxoSmithKline exercised its co-right option to jointly develop and commercialize repifermin. We expect to share equally in clinical development costs for Phase III trials and beyond. We will co-promote repifermin upon achieving regulatory approvals.
Three Phase I studies to evaluate the safety of repifermin in healthy volunteers have been completed. In 2000, we completed a Phase II human study of repifermin for the treatment of chronic venous ulcers, in which repifermin was shown to be well tolerated and capable of accelerating wound healing by a number of partial healing parameters. A large Phase II study to determine the safety and efficacy of repifermin for complete healing of chronic venous ulcers began in early 2001. Two different Phase II studies were also initiated to evaluate repifermin in the treatment of mucositis in patients undergoing bone-marrow transplantation. The results from a mucositis trial relating to repifermin administration following transplantation were announced in 2001 and indicated that while repifermin was safe and well tolerated in patients, no evidence was shown that repifermin was active in reducing the incidence or severity of mucositis. The mucositis trial relating to repifermin administration prior to and following transplantation is ongoing. A third Phase II study was also initiated to evaluate repifermin in the treatment of ulcerative colitis, an inflammatory bowel disease. The results from the ulcerative colitis trials showed that repifermin was safe and well-tolerated, but not shown to be effective. We are continuing to analyze these final results to determine how to proceed with this indication. The trials are being conducted at leading research centers in the U.S.
Mirostipen (Myeloid Progenitor Inhibitory Factor-1, MPIF-1)
Myeloid progenitor cells, which develop into white blood cells, red blood cells and platelets, are destroyed by many forms of cancer chemotherapy, resulting in a decrease in these cells. We have shown in laboratory and animal studies that MPIF-1 inhibits the differentiation and growth of certain bone marrow cells, including myeloid progenitor cells. By preventing the growth of myeloid progenitor cells during aggressive chemotherapy, it may be possible to reduce the destruction of these cells and allow the more rapid repopulation of red and white blood cells in circulation. This, in turn, may reduce the incidence of serious infection, anemia and coagulation disorders associated with chemotherapy.
A Phase I study to evaluate MPIF-1 safety in healthy volunteers was completed in 1998. Two Phase II studies are being conducted to evaluate MPIF-1 in shielding myeloid progenitor cells from the harmful effects of chemotherapy. These studies tested various doses of MPIF-1 in cancer patients undergoing chemotherapy treatment for various cancers. Trials are being conducted at leading cancer research centers in the U.S. and completed enrollment in 2001. We expect results from the trials to be available in mid-2002.
BLyS (B Lymphocyte Stimulator)
BLyS is a novel immune stimulant. We have shown in laboratory studies that BLyS stimulates B lymphocytes to produce high levels of antibodies. BLyS has the potential to improve treatments for certain immune deficiency syndromes. In addition, BLyS could boost immune systems depleted by organ transplantation, chemotherapy and bone-marrow transplantation. BLyS could also enhance the performance of traditional vaccines.
We are currently testing BLyS in patients with common variable immunodeficiency, a disorder that leaves individuals susceptible to infection. In February 2001, BLyS received "orphan" drug designation from the FDA for the treatment of common variable immunodeficiency. A Phase I study with increasing doses of BLyS is ongoing. For this trial, BLyS had been produced in an insect cell culture. A Phase I study has also been initiated to evaluate BLyS in the treatment of Immunoglobulin-A (IgA) deficiency, an immune disorder. In this trial, we received approval from the FDA to begin manufacturing BLyS in E. coli, which will allow us to increase production scale to support the needs of the clinical program, and ultimately, to supply commercial needs.
LymphoRad(131)
LymphoRad(131) is a radioiodinated form of B-Lymphocyte Stimulator (BLyS). We have found in preclinical studies that LymphoRad(131) binds to receptors found on B cells and B-cell tumors, delivering low doses of radiation that cause cell death. Such studies also showed that treatment with LymphoRad(131) resulted in inhibition of tumor growth and prolonged survival. In January 2002, we filed an Investigational New Drug (IND) application for this drug. Upon receiving clearance from the FDA, we plan to initiate Phase I clinical trials in patients with multiple myeloma.
LymphoStat-B
LymphoStat-B is the first antibody drug to emerge from our human antibody drug discovery program. The drug inactivates the B-Lymphocyte Stimulator protein (BLyS). We have found in laboratory studies that LymphoStat-B can reverse the immune stimulatory effects of BLyS. Many patients that suffer from systemic lupus erythematosus and rheumatoid arthritis have elevated levels of BLyS in their blood or joint fluid. In November 2001, we received approval from the FDA to proceed with a Phase I clinical trial in patients with systemic lupus erythematosus and have begun enrollment in this trial.
Fusion Proteins
Using our proprietary recombinant protein fusion technology, we are genetically fusing proteins to albumin, a very abundant, natural and long-lived protein in the blood. We have begun Phase I human clinical studies of several albumin fusion proteins. These include Albuferon-alpha (hepatitis C and chronic myelogenous leukemia - CML), Albutropin (growth hormone deficiency) and Albuleukin (cancer).
Albuferon-alpha is created by fusing the gene for a human protein, interferon alpha, an approved drug, to the human protein, albumin. Based on preclinical studies, Albuferon-alpha should provide patients infected with Hepatitis C with longer acting therapeutic activity and may offer an improved side-effect profile. In March 2001, we received approval from the FDA to proceed with a Phase I clinical trial in patients with hepatitis C. We have begun enrolling patients in this trial. We are in the process of initiating a second trial in patients with chronic myelogenous leukemia (CML).
Albutropin is created by fusing the gene for a human protein, human growth hormone, an approved drug, to the human protein, albumin. Based on preclinical studies, Albutropin may offer sustained therapeutic activity, which is accomplished by using recombinant human albumin as a carrier molecule. Preclinical data suggest that Albutropin is eliminated from the body fifty times more slowly than regular growth hormone and is detectable in the blood for at least a week after dosing. Therefore, Albutropin may offer patients a more convenient administration schedule when compared to the existing short-acting therapies. In June 2001, we received approval from the FDA to proceed with a Phase I clinical trial in adult patients with growth hormone deficiency. We have begun enrolling patients in this trial.
Albuleukin is created by fusing interleukin-2, a drug approved for cancer treatment, to the human protein, albumin. Albuleukin is expected to activate a type of immune cell called a T cell. T cells have the potential to identify and kill cancer cells. Based on preclinical studies, Albuleukin is longer-acting and is better tolerated, as compared with interleukin-2 itself. In January 2002, we received approval from the FDA to proceed with a Phase I clinical trial in patients with certain types of cancer. We have begun screening patients in this trial.
VEGF-2 (Vascular Endothelial Growth Factor-2)
Laboratory studies have shown that VEGF-2 promotes the growth of certain subsets of vascular endothelial cells, which form the lining and surface of blood vessels. Thus, it may have potential as a treatment for coronary artery disease and peripheral arterial disease. We have licensed the gene that encodes VEGF-2 to Vascular Genetics, Inc., a company in which we have approximately a 27% equity position.
Vascular Genetics initiated clinical trials on the use of the VEGF-2 gene in the treatment of critical limb ischemia and refractory coronary artery disease. In February 2000, these studies were halted in response to questions raised by the FDA. Three Phase II studies of VEGF-2 were completed prior to the halt. Results from one trial are available
and were presented at the American College of Cardiology in March 2000. In October 2001, the FDA removed these studies from clinical hold. VGI expects to resume human clinical trials in 2002.
Small Molecule Inhibitor of lipoprotein-associated phospholipase A2 (Lp-PLA2).
In February 2001, GlaxoSmithKline announced the results of human testing of a small-molecule inhibitor of a gene we discovered, lipoprotein-associated phospholipase A2 (Lp-PLA2), as a treatment for cardiovascular disease. In September 2001, we received a $1.0 million payment from GSK in connection with a development milestone met by GSK during 2001.
PRECLINICAL AND OTHER PROGRAMS
In addition to the products in clinical development, our research and development efforts have generated numerous other product possibilities, many of which are in preclinical development. We and our partners are focused on developing potential products in the following areas:
- Therapeutic Proteins. Therapeutic proteins are human proteins that, in natural or modified form, have medically useful physiologic or pharmacologic effects. Therapeutic proteins may be useful for the treatment of a variety of diseases, including autoimmune, neurodegenerative and cardio-pulmonary diseases. Therapeutic proteins currently in broad clinical use include interferon, insulin and human growth hormone. We have conducted development studies on a number of potential therapeutic proteins, including MPIF-1, KGF-2 and BLyS. We have also identified thousands of what we believe to be new secreted proteins. We are expressing and evaluating these proteins and assessing their activity using laboratory and animal studies. Current therapeutic proteins in preclinical development include FasTR, a novel interferon licensed to Schering-Plough, GMAD-1, DP-18, and Osteostat.
- Antibodies and Peptides. Antibodies and peptides are proteins that bind in a highly specific manner to molecules, including other proteins, and distinct sites on cell surfaces called receptors. By attaching to them, antibodies and peptides can be used to neutralize specific proteins and block specific receptors. We are undertaking the development of antibodies and peptides that act on many of our newly discovered proteins. We have entered into collaborations with Abgenix, Cambridge Antibody Technology, Dyax and Medarex to enhance our antibody and peptide development efforts. Antibody-based drugs currently in broad clinical use include Herceptin, Rituxan and ReoPro. The antibodies and peptides we are currently developing may be useful in the treatment of diseases such as systemic lupus erythematosus, rheumatoid arthritis, cancer and certain viral infections. Current antibodies in preclinical development include CCR5-mAB, LymphoStat-B for rheumatoid arthritis, TRAIL R1 Receptor Antibody, TRAIL R2 Receptor Antibody, VEGF-2 Antibody and GMAD-2.
- Fusion Proteins. We are using our recombinant protein fusion technology to provide longer acting forms of many important proteins used in the treatment of disease. This technology genetically fuses a protein to albumin, a very abundant, natural and long-lived protein in the blood. When albumin is fused to a therapeutic protein, the active protein is expected to have the longer circulating life of albumin. Prolonging the activity of the therapeutic protein in this manner may offer a reduced dosing frequency and could lead to reduced side effects in patients. Using this technology, we expect to develop safer, more effective and more convenient protein therapeutics and biopharmaceuticals for certain diseases, as well as develop longer-acting forms of many existing proteins. Current fusion proteins in preclinical development include Albuferon-(beta), Albupoietin, Albugranin, Albulin, Albugon, HGS-B 14, Albuthyrin and Albutonin.
- Gene Therapy. We believe that our gene discovery technology may identify genes that can be introduced into the body through the use of gene therapy. Many diseases are caused by overproduction, underproduction or defective production of specific proteins. Gene therapy is an approach to the treatment of disease in which scientists insert genes into a patient's cells for the purpose of inducing these cells to produce therapeutic proteins or to replace defective or missing genes. In other applications, we believe that gene therapy may induce cells to secrete proteins that enhance the immune system's ability to recognize and attack a specific disease. Gene therapy might also allow localized delivery of proteins that cannot reach the appropriate site through conventional methods of administration. There are currently no gene therapy products on the market although several are undergoing clinical trials. We have entered into agreements with Schering-Plough, Vascular Genetics, Transgene and Vical granting them the right to use our technologies for gene therapy. Vascular
Genetics has conducted gene therapy clinical studies of VEGF-2. These studies were placed on hold by the FDA in February 2000 and were released from clinical hold in October 2001. In July 2000, Transgene selected two genes from our database, CTGF-2 and TIMP-4, as its first two exclusive gene therapy products, both as a potential treatment for severe cardiovascular conditions.
- Small Molecule Drugs. We believe that more complete knowledge of genes and the proteins they express will enable traditional pharmaceutical companies to design and screen pharmaceutical products in a more efficient fashion by providing specific targets for drug discovery. The discovery of new drugs often involves screening a large family of synthetic and natural products to determine their impact on proteins expressed by genes. Increasingly, automated biochemical tests that assess the ability of chemical compounds to bind to and modify the activity of purified proteins are used to test the efficacy and selectivity of new drugs. A drug's selectivity is its ability to affect only the desired protein targets and not other proteins expressed in the human body. The undesired binding of a drug to other proteins not detected by a screening test can result in toxicity or other undesirable side effects. We believe that the genes we discover may contribute to screening tests by permitting more complete sets of target proteins to be assembled for a test. GlaxoSmithKline and our other collaboration partners are currently using proteins expressed by genes identified by us in a number of screening tests. We may pursue small molecule drug development on our own or continue to leverage the expertise of our partners in this area.
- Other. We believe that our genetic data could be applied also to the development of diagnostic tests and antimicrobial agents and vaccines. For the development of antimicrobial agents and vaccines, analysis of the total genome of a microorganism should provide a complete picture of all genes encoded by the microorganism. With this information, we believe it may be possible to choose protein candidates that may be useful as vaccine components or antigens required for the development of products to enhance the immune system. We also believe that a high-throughput approach of gene identification may identify new genes capable of producing antibiotics and other useful secondary metabolites. In the future we may pursue these developments on our own or through strategic alliances.
RESEARCH AND DEVELOPMENT CAPABILITIES
Our product development efforts are supported by our extensive research and development capabilities and are substantially augmented by those of our partners. We exploit the power of modern computers, automated laboratory instruments and advances in biology to discover the structure and function of new genes and to understand their potential medical applications. As part of this process we cover all stages of development, from the discovery of new human genes to human clinical trials of the new drugs. We continually seek to upgrade our technologies and integrate new and more efficient technologies into our development efforts. We believe this discovery process is responsible for our success in translating genomic information into new drug candidates.
Our technology platform is based on various methods that we integrate in a high-throughput fashion to enable the rapid progression from gene discovery to clinical trials.
- Gene Isolation is the process of deciphering the sequence of a gene. We believe we have isolated the messenger RNA from more than 95% of all human genes. Of these, we believe that between 75% and 80% are fully functional, as they contain all the instructions necessary to produce an active protein.
- Secreted Protein Identification refers to the elucidation of secreted proteins which are often involved in disease processes. We believe we have identified several thousand human genes that encode signaling proteins. We believe that this collection represents the majority of human signaling proteins.
- Expression Profiling and Mapping refers to the comparison of messenger RNA levels in diseased and healthy tissues. Our scientists use gene chips and proprietary methods to analyze gene expression profiles in a wide variety of tissues and cells. They also use a variety of techniques to map chromosome location, which generally allow our scientists to map any gene within two or three weeks.
- Proteomics is the analysis of proteins correlated with a particular disease. In this step we map out the physical properties of each signaling protein. We attempt to determine the molecular weight, amino acid composition and amino acid sequence of the majority of the newly discovered signaling proteins.
- Use of Antibodies. Antibodies are proteins that bind in a highly specific manner to molecules. Antibodies are used to block the effects of proteins and to determine the location of a protein in tissues. We are working to produce antibodies to many of our discovered secreted proteins.
- High-Throughput Biological Screening. We have developed a reliable high-speed robotic cloning method to produce each newly discovered signaling protein for biological studies. To date, we have cloned many proteins.
- Biological Activity and Specificity. Our scientists can simultaneously monitor changes in the expression of about 100 representative genes through the use of an automated, high-throughput biological screening system. We analyze the activity of the proteins on a wide variety of different types of cells to assess their specificity of action, or the range of circumstances in which they act, and the number of characteristics they can influence. Only proteins that are highly specific in their activity are selected for further development.
- Animal Models refer to producing animals with the human disease equivalent. We test proteins that are highly specific in their activity with animal models of human disease. Where possible, we compare the results for each tested protein to the best existing therapy. Proteins which prove to be active in these models are selected for extensive laboratory studies.
- Preclinical Studies and Manufacturing. In this step we develop protocols for human testing based on extensive laboratory toxicology and pharmacokinetic studies. A toxicological study tests whether and how the therapy could be harmful to humans. Pharmacokinetic studies analyze how the drug will be absorbed, metabolized and stored by, distributed throughout and excreted from the body. We are developing techniques for measuring blood and tissue levels of each protein to enable measurements within human subjects. We need to develop manufacturing methods for large-scale production of each protein. We lease a 127,000 square foot process development and manufacturing facility to support Phase I, II and III human clinical studies and the North American launch of novel protein and gene products. We are currently designing a 405,000 square foot manufacturing facility adjacent to our current manufacturing facility. We expect this new leased facility to be ready for occupancy in 2004.
- Clinical Development is the process of conducting human clinical trials and gaining the necessary approval from regulatory agencies. The goal of clinical development is to establish the safety and efficacy of our drugs for the treatment of human disease. Multiple products discovered by us have advanced to clinical trials for multiple indications.
- Bioinformatics refers to the use of computers to process, analyze, store and retrieve biological information. Our high capacity computer system has been designed for ease of use by research scientists, who readily access the system through desktop computers. We believe that our proprietary bioinformatics system is an important asset for the identification and creation of gene-based product opportunities.
COLLABORATIVE ARRANGEMENTS
Forming strategic alliances with leading pharmaceutical and biotechnology companies is a key element of our strategy. We currently have three major types of collaborations:
- Drug Discovery. These are collaborations in which we provide our drug discovery capabilities in exchange for access to our partners' drug development and commercialization expertise as well as research funding and long-term value creation through potential milestone and royalty payments. We are also entitled to certain co- promotion, co-development, revenue sharing and other product rights. Between 1993 and 1997, we entered into major collaborations with GlaxoSmithKline, Takeda, Schering-Plough, Merck KGaA and Sanofi-Synthelabo. These collaborations ended in June 2001, a period described as the initial research term, although certain aspects of these arrangements continue.
- Technology. These are collaborations in which we gain access to our partners' technology to complement our own drug discovery and development capabilities in exchange for license fees, potential milestone and royalty payments as well as equity investments.
- Microbial. These are collaborations in which we provide access to gene sequence data for specific microbial organisms to biopharmaceutical companies in exchange for license fees and royalty payments.
A summary of our most important collaborations is provided below:
DRUG DISCOVERY COLLABORATIONS
General. We entered into collaboration agreements with GlaxoSmithKline in May 1993, which we amended in June 1996 and July 1997. The initial term of these agreements continued through June 2001, which was the conclusion of the initial research term. Under these agreements, we granted GlaxoSmithKline rights to develop and commercialize therapeutic and diagnostic products based on human genes discovered by us in GlaxoSmithKline's field, which is the field of human and animal health care, including gene therapy vaccines but excluding other gene
therapy products, antisense products and the use of genes for synthesizing drugs that were known in May 1993. Pursuant to the collaboration agreements GlaxoSmithKline initially paid us an aggregate of $125.0 million, of which $55.0 million was allocated to the purchase of shares of our common stock. We and GlaxoSmithKline jointly entered into collaboration agreements with four additional pharmaceutical companies: Takeda, Schering-Plough, Merck KGaA and Sanofi-Synthelabo.
Post-Initial Research Term. The initial research term under our collaboration agreements with GlaxoSmithKline and the other four collaboration partners expired on June 30, 2001. At that time, our partners were pursuing approximately 430 research programs involving approximately 280 different genes for the creation of small molecule and antibody drugs. They also were developing approximately 30 therapeutic protein drugs. We cannot assure you that any of these programs will be continued or result in any approved drugs.
GlaxoSmithKline. We share equally with GlaxoSmithKline any license fees and product-development milestone payments made under the four additional collaboration agreements, but we receive all royalty and research support payments under those agreements. GlaxoSmithKline has granted us royalty payments, based on net sales of products developed from any of our patents or technologies that fall within GlaxoSmithKline's field, for any sales made by GlaxoSmithKline or its licensees. We are also entitled to milestone payments in connection with the development of these products. In 2001, we received a $1.0 million payment from GlaxoSmithKline for Lp-PLA2 in connection with a development milestone met by GlaxoSmithKline. We hold an option to co-promote any products sold by GlaxoSmithKline in the U.S., Canada, Mexico and Europe, subject to the rights granted to Takeda and other collaborators. If we develop and market or license to a third party any product in GlaxoSmithKline's field pursuant to our rights under these agreements, GlaxoSmithKline will usually be entitled to royalty payments from, or to share in milestone payments and license fees we receive with respect to, those products.
Our collaboration agreements with GlaxoSmithKline include an option for GlaxoSmithKline to co-develop and co-commercialize products in GlaxoSmithKline's field to which we have exclusive development and commercialization rights under our collaboration agreements with GlaxoSmithKline and for which Schering-Plough has not exercised its option. In 2000, GlaxoSmithKline exercised its option to jointly develop and commercialize repifermin. GlaxoSmithKline is also entitled to royalty payments on and an option to co-promote products outside GlaxoSmithKline's field sold by us which are based on or incorporate patents or information developed by GlaxoSmithKline using our human gene technology.
Takeda. GlaxoSmithKline and Takeda entered into a license agreement relating to the development and sale of products in GlaxoSmithKline's field based upon rights licensed from us. We are entitled to all royalty payments and one-half of the milestone payments due from Takeda to GlaxoSmithKline under this license agreement on sales of products developed by Takeda. We entered into an option and license agreement with Takeda pursuant to which we granted Takeda an exclusive option to license rights under our patents and technology in the field of human health care, other than gene therapy, antisense and diagnostics, in order to make and sell up to three products in Japan. In consideration of the grant of the option, Takeda paid us $5.0 million and agreed to pay to us milestone payments and royalties based on the sale of Takeda products covered by the option and license agreement. The option period terminates on June 30, 2004. Takeda has exercised one of its options with the selection of MPIF-1. In 2001, Takeda selected approximately 100 targets for use in small molecule and antibody discovery.
Schering-Plough. In June 1996, we entered into a collaboration agreement with Schering-Plough. Under this agreement, Schering-Plough has the right to use our human gene technology and biological information developed by us and GlaxoSmithKline to discover, develop and commercialize products. Schering-Plough was also granted an option to co-develop and co-commercialize up to two of our therapeutic protein products to which we have exclusive development and commercialization rights under our agreements with GlaxoSmithKline. This option can also be exercised with respect to proteins we elect to license to third parties. In 2000, Schering-Plough exercised one of its two options with the selection of a novel interferon discovered by us. We will receive milestones and royalty payments for any product developed from this protein. Schering-Plough is obligated to pay license fees, research payments and milestone payments in connection with the development of products. Schering-Plough has paid us $32.5 million under this agreement. We also have a collaboration with Schering-Plough related to gene therapy by which Schering-Plough was granted a non-exclusive license to use our human gene technology to conduct research and an option to obtain an exclusive license to specific genes in the field of gene therapy. Schering-Plough has paid us $5.0 million under this second collaboration agreement.
Merck KGaA. In July 1996, we entered into a collaboration agreement with Merck KGaA. Under this agreement, Merck KGaA has the right to use our human gene technology and biological information developed by us and GlaxoSmithKline to discover, develop and commercialize products. Merck KGaA is obligated to pay license fees, research payments, and milestone payments in connection with the development of products. Merck KGaA has paid us an aggregate of $32.5 million under this agreement.
Sanofi-Synthelabo. In July 1996, we entered into a collaboration agreement with Sanofi-Synthelabo. Under this agreement, Sanofi-Synthelabo has the right to use our human gene technology and biological information developed by us and GlaxoSmithKline to discover, develop and commercialize products. Sanofi-Synthelabo is obligated to pay license fees, research payments and milestone payments in connection with the development of products. Sanofi-Synthelabo has paid us an aggregate of $22.5 million under this agreement.
TECHNOLOGY COLLABORATIONS
Antibodies and Peptides
Abgenix. In November 1999, we entered into a collaboration and license agreement with Abgenix relating to the field of fully human antibody drug candidates, which was amended in 2001. Pursuant to this agreement, as amended, we licensed technology from Abgenix that we will use to generate fully human antibody drug candidates. We will independently develop and seek to commercialize antibody-based drugs from this collaboration. Abgenix also has an option to develop and commercialize products derived from our antigens. We and Abgenix will pay reciprocal milestone and royalty payments for products developed and commercialized.
Cambridge Antibody Technology (CAT). In August 1999, we entered into an antibody license agreement with CAT for the development of fully human antibody therapeutics for up to three of our target human proteins. Pursuant to this agreement, we have entered into an exclusive license agreement to an anti-BLyS antibody discovered in collaboration with CAT. Under this 1999 agreement, we have paid CAT $0.8 million towards the achievement of the first contractual milestone through the end of 2001. In February 2000, we entered into a broader agreement with CAT that provides us with the right to use their technology to develop and sell an unlimited number of fully human antibodies for therapeutic and diagnostic purposes. Under this 2000 agreement, we paid CAT $12.0 million for ten years of committed research support. We also plan to combine our resources to develop and sell a significant number of therapeutic antibody products. CAT has the right to select up to twenty-four of our proprietary antigens for preclinical development. We have the option to share clinical development costs and to share the profits equally with them on up to eighteen such products. CAT has rights to develop six such products on their own. We are entitled to clinical development milestone and royalty payments on those six products. Under the 2000 agreement, we paid CAT $1.0 million in December 2001 to exercise our option with respect to TRAIL Receptor 1, an antibody product. We also invested approximately $54.7 million for ordinary shares of CAT. In November 2000, we sold a portion of our CAT holdings at a gain of approximately $5.9 million.
Dyax. In February 2000, we entered into a license agreement with Dyax relating to Dyax' phage display and peptide technology, which was amended in 2001. Under the agreement, as amended, we have the right to use Dyax' phage display technology to develop an unlimited number of therapeutic and diagnostic products that we may sell or outlicense. In 2000, we paid Dyax $6.0 million for the technology license. Through 2001, we have paid $4.7 million for research support. Over the next year, we will pay Dyax approximately $1.3 million for committed research support. We will provide milestone and royalty payments to Dyax on products we develop and sell or will share revenue we receive from outlicensees. The licensed technologies include Dyax' phage display technology to create peptide drugs, human monoclonal antibody drugs and in vitro diagnostic products. In addition, we have the right to require that Dyax perform research in the fields of protein separation and high-throughput screening technology. We also have rights to improvements in Dyax' phage display technology.
Praecis. In February 2000, we entered into a collaboration agreement with Praecis relating to the field of small molecule drugs, including peptides. Under the agreement, Praecis will screen two of our targets to identify novel small molecule drugs to combat metabolic disorders and infectious diseases.
Medarex. In July 2001, we entered into a collaboration agreement with Medarex relating to the creation of fully human antibodies. Under the agreement, Medarex plans to use its technology to create antibody leads that are specific for target proteins that we discovered. We have the option to exclusively license therapeutic and diagnostic
antibody products and Medarex is entitled to receive license fees, milestone payments and royalties on any commercial sales of products resulting from the collaboration.
Gene Therapy
Transgene. In February 1998, we entered into an agreement with Transgene relating to the field of human gene therapy, including gene therapy vaccines to the extent it will not conflict with our other collaboration agreements. Under this agreement, we granted Transgene the right to license exclusively up to 10 genes. We obtained a 10% equity interest in Transgene and certain co-development and co-marketing rights. Transgene selected two genes from our database, CTGF-2 and TIMP-4, as its first two exclusive gene therapy products. CTGF-2 stimulates the formation of blood vessels and could be an effective tool in the control of coronary artery disease. TIMP-4 prevents restenosis, which is the growth of blood-vessel obstruction following an angioplasty. Our collaboration with Transgene will end in 2008.
Vical. In February 2000, we entered into a license agreement with Vical relating to the field of gene therapy. Under this agreement, we licensed technology from Vical and granted Vical the right to license up to three genes. The agreement provides for reciprocal royalty payments. Our collaboration with Vical will end in 2004.
Vascular Genetics. In November 1997, we entered into an agreement with Vascular Genetics whereby we granted Vascular Genetics an exclusive license in the field of gene therapy for our VEGF-2 gene. As of December 31, 2001, we held an approximately 27% equity interest in Vascular Genetics. We are also entitled to receive up to 10% royalties on net sales.
Fusion Technology
Aventis Behring. In October 2000, we entered into a joint development and commercialization agreement with Aventis Behring to co-develop and jointly market an Aventis Behring plasma protein product.
Other
Dow Chemical. In October 2000, we entered into an agreement with Dow Chemical Company to develop a drug for the treatment of B-cell malignancies. This agreement combines one of Dow's patented technologies, bifunctional chelation agents (BFCA) with BLyS, one of our protein discoveries. Dow's BFCA technology is capable of attaching a variety of radioactive metals to BLyS, resulting in a "radiolabeled" version of the protein.
MDS Nordion. In October 2001, we entered into an agreement with MDS Nordion, a unit of MDS Inc., whereby MDS Nordion will manufacture LymphoRad(131) at a GMP manufacturing suite under construction at its Ottawa, Canada facility. We will supply MDS Nordion with the targeting protein, B Lymphocyte Stimulator (BLyS) and MDS Nordion will use a process it developed for us that covalently binds the radioactive isotope iodine(131) to the BLyS protein.
MICROBIAL COLLABORATIONS
MedImmune. We entered into a collaboration and license agreement with MedImmune in July 1995, which we amended in March and December 1997. This agreement is related to the development of drugs based upon certain infectious agents sequenced by us or The Institute For Genomic Research (TIGR) or as to which we hold licenses. Programs under this agreement include the creation of vaccines and immunotherapeutics for non-encapsulated Haemophilus influenzae, Streptococcus pneumoniae, Escherichia coli, Helicobacter pylori and Borrelia burgdorferi. MedImmune sub-licensed the Streptococcus pneumoniae vaccine technology to GlaxoSmithKline. We are entitled to a portion of the payments received by MedImmune under its sub-license. In 2000, we received $1.0 million from MedImmune.
Pharmacia. In October 1996, we entered into an agreement with Pharmacia in which we granted to Pharmacia a nonexclusive license to conduct research and to make, use and sell products based on genes of Staphylococcus aureus and the pathogenicity islands of Escherichia coli sequenced by us.
PATENTS AND PROPRIETARY RIGHTS
Our commercial success depends in large part on our ability to obtain patent or other intellectual property protection for genes we discover. The patent protection available to biotechnology firms is highly uncertain and involves complex legal and factual questions that will determine who has the right to develop a particular product. There have been, and continue to be, intensive discussions on the scope of patent protection for both partial gene sequences and full-length genes. The Patent and Trademark Office issued new guidelines for patents in 2001 which clarify certain requirements for obtaining a patent on a gene sequence. The biotechnology patent situation outside the U.S. is even more uncertain and is currently undergoing review and revision in many countries. Changes in, or different interpretations of, patent laws in the U.S. and other countries may result in patent laws that allow others to use our discoveries or develop and commercialize our products.
As of March 1, 2002, we had filed U.S. patent applications with respect to many human genes and their corresponding proteins. We have also filed U.S. patent applications with respect to all or portions of the genomes of eight infectious microorganisms and one non-infectious microorganism. As of March 1, 2002, we had 205 U.S. patents covering human genes and proteins. The remaining applications covering full-length genes and their corresponding proteins may not result in the issuance of any patents. Our applications may not be sufficient to meet the statutory requirements for patentability in all cases. In certain instances, we will be dependent upon our collaborators to file and prosecute patent applications.
Washington University has identified genes through partial sequencing funded by Merck & Co. and has deposited those partial sequences in a public database. In January 1997, TIGR, in collaboration with the National Center for Biological Information, disclosed full-length DNA sequences which are reportedly in excess of 35,000 sequences that were assembled from partial gene sequences available in publicly accessible databases or sequenced at TIGR. In addition, the Human Genome Project and Celera Genomics Corporation have completed an initial sequencing of the human genome, and have published papers on this sequencing in February 2001. All of this public disclosure might limit the scope of our claims or make unpatentable subsequent patent applications on full-length genes we file.
Other companies or institutions have filed, and may file patent applications in the future, which attempt to patent genes similar to those covered in our patent applications, including applications based on our potential products. The Patent and Trademark Office would decide which applications merit a patent and the priority of competing patent claims. Any patent application filed by a third party may prevail over patent applications we filed, in which event the third party may require us to stop pursuing a potential product or to negotiate a royalty arrangement to pursue the potential product.
Other parties may claim that our potential products infringe their patents. This risk will increase as the biotechnology industry expands and as other companies obtain more patents and attempt to discover genes through the use of high-speed sequencers. Other persons could bring legal actions against us to claim damages or to stop our manufacturing and marketing of the affected products. If any of these actions is successful, in addition to demanding monetary damages, these persons may require us to obtain a license in order to continue to manufacture or market the affected products. We believe that there will continue to be significant litigation in our industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our resources.
Issued patents may not provide commercially meaningful protection against competitors. Any issued patent may not provide us with competitive advantages. Others may challenge our patents or independently develop similar products that could result in an interference proceeding in the Patent and Trademark Office. Others may be able to design around our issued patents or develop products providing effects similar to our products. In addition, others may discover uses for genes or proteins other than those uses covered in our patents, and these other uses may be separately patentable. The holder of a patent covering the use of an invention which we have a patent claim could exclude us from selling a product for a use covered by its patent.
We rely on trade secret protection to protect our confidential and proprietary information. We believe we have developed proprietary procedures for making libraries of DNA sequences and genes. We have not sought patent protection for these procedures. We have developed a substantial database concerning genes we have identified. We have taken security measures to protect our data and continue to explore ways to further enhance the security for our
data. However, we may not be able to meaningfully protect our trade secrets. While we have entered into confidentiality agreements with employees and academic collaborators, we may not be able to prevent their disclosure of these data or materials. Others may independently develop substantially equivalent information and techniques.
COMPETITION
We are in a race to identify, establish uses for and patent as many genes as possible and to commercialize the products we develop. Many of our potential competitors have substantially greater research and product development capabilities and financial, scientific, marketing and human resources. The Human Genome Project and Celera Genomics Corporation have claimed to have mapped the complete human genome, and have made their findings available to the public. We face competition from other entities using high-speed gene sequencers to discover genes, such as Incyte Genomics, Inc. and Celera Genomics Corporation. We also face competition from entities using more traditional methods to discover genes related to particular diseases, such as Amgen, Inc., Genentech, Inc., Millennium Pharmaceuticals, Inc. and other large biotechnology and pharmaceutical companies. We expect that competition in our field will continue to be intense.
Research to identify genes is also being conducted by various institutes and U.S. and foreign government-financed entities, including British, French, German and Japanese efforts, as well as numerous smaller laboratories associated with universities or other not-for-profit entities. In addition, a number of pharmaceutical and biotechnology companies and government-financed programs are engaged or have announced the intention to engage in areas of human genome research similar to or competitive with our focus on gene discovery, and other companies are likely to enter the field.
We face significant competition in our product development and commercialization efforts. Although we believe that there are significant product development opportunities for both us and our collaborators based on our gene databases, competition exists among us and our collaborators to develop and commercialize products. In addition, our competitors may succeed in developing products before we do, obtaining approvals from the FDA or other regulatory agencies for such products more rapidly than we do, or developing products that are more effective than those proposed to be developed by us. Similarly, while we will share any success of our collaborators in identifying and commercializing products through royalties and co-payment arrangements, our collaborators face similar competition from other competitors who may succeed in developing products more quickly, or developing products that are more effective, than those developed by our collaborators. Certain of these competitors may be further advanced than us in developing potential products. Research and development by others may render the products that we or our collaborators may seek to develop obsolete or uneconomical or result in treatments, cures or diagnostic tests superior to any therapy or diagnostic test developed by us or our collaborators. In addition, therapies or diagnostic tests developed by us or our collaborators may not be preferred to any existing or newly developed technologies.
GOVERNMENT REGULATION
Regulation of Pharmaceutical Products. New drugs and biologics are subject to regulation under the Federal Food, Drug, and Cosmetic Act. In addition to being subject to certain provisions of that Act, biologics are also regulated under the Public Health Service Act. We believe that the pharmaceutical products developed by us or our collaborators will be regulated either as biological products or as new drugs. Both statutes and their corresponding regulations govern, among other things, the testing, manufacturing, distribution, safety, efficacy, labeling, storage, record keeping, advertising and other promotional practices involving biologics or new drugs. FDA approval or other clearances must be obtained before clinical testing, and before manufacturing and marketing, of biologics and drugs.
In addition, any gene therapy products developed by us will require regulatory approvals prior to human trials and additional regulatory approvals prior to commercialization. New human gene therapy products are subject to extensive regulation by the FDA and the Center for Biological Evaluation and Research and comparable agencies in other countries. Currently, each human-study protocol is reviewed by the FDA and, in some instances, the National Institutes of Health, on a case-by-case basis. The FDA and the National Institutes of Health have published guidance documents with respect to the development and submission of gene therapy protocols.
Obtaining FDA approval has historically been a costly and time-consuming process. We may not obtain FDA approvals in a timely manner, or at all. We and our collaborators may encounter significant delays or excessive costs in our efforts to secure necessary approvals or licenses. Generally, in order to gain FDA pre-market approval, a developer first must conduct laboratory studies and animal-model studies to gain preliminary information on an agent's efficacy and to identify any safety problems. The results of these studies are submitted as a part of an investigational new drug application, which the FDA must review before human trials of an investigational drug can start. The investigational new drug application includes a detailed description of the initial animal studies and human investigation to be undertaken.
Laboratory studies can take several years to complete, and there is no assurance that an investigational new drug application based on such studies will ever become effective so as to permit human testing to begin. A 30-day waiting period after the receipt of each investigational new drug application is required by the FDA prior to the commencement of human testing. If the FDA has not commented on or questioned the investigational new drug application within this 30-day period, human studies may begin. If the FDA has comments or questions, it places the studies on clinical hold and the questions must be answered to the satisfaction of the FDA before human testing may begin.
In order to commercialize pharmaceutical products, we or one of our collaborators must sponsor and file an investigational new drug application and be responsible for initiating and overseeing the human studies to demonstrate the safety and efficacy and, for a biologic product, the potency, which are necessary to obtain FDA approval of any such products. For our or our collaborator-sponsored investigational new drug applications, we or our collaborator will be required to select qualified investigators (usually physicians within medical institutions) to supervise the administration of the products, and ensure that the investigations are conducted and monitored in accordance with FDA regulations and the general investigational plan and protocols contained in the investigational new drug application. Human trials are normally done in three phases, although the phases may overlap. Phase I trials are concerned primarily with the safety and pharmacology of the drug, involve fewer than 100 subjects and may take from six months to over a year to complete. Phase II exploratory trials normally involve a few hundred patients, but in some cases may involve fewer. Phase II trials are designed primarily to demonstrate safety and preliminary effectiveness in treating or diagnosing the disease or condition for which the drug is intended. Phase III trials are expanded trials with larger numbers of patients which are intended to gather the additional information for proper dosage and labeling of the drug and demonstrate its overall safety and effectiveness. All three phases generally take three to five years, but may take longer, to complete. Regulations promulgated by the FDA may shorten the time periods and reduce the number of patients required to be tested in the case of certain life-threatening diseases which lack available alternative treatments.
The FDA receives reports on the progress of each phase of testing, and it may require the modification, suspension, or termination of trials if an unwarranted risk is presented to patients. If the FDA imposes a clinical hold, trials may not recommence without FDA authorization and then only under terms authorized by the FDA. The investigational new drug application process can thus result in substantial delay and expense. Human gene therapy products (which is one of the areas in which we are seeking to develop products) are a new category of therapeutics. Because this is a relatively new and expanding area of novel therapeutic interventions, there can be no assurance as to the length of the trial period, the number of patients the FDA will require to be enrolled in the trials in order to establish the safety, efficacy and potency of human gene therapy products, or that the data generated in these studies will be acceptable to the FDA to support marketing approval.
After completion of trials of a new drug or biologic product, FDA marketing approval must be obtained. If the product is regulated as a biologic, the Center for Biological Evaluation and Research will require the submission and approval, depending on the type of biologic, of either a biologic license application or, in some cases, a product license application and an establishment license application before commercial marketing of the biologic. If the product is classified as a new drug, we must file a new drug application with the Center for Drug Evaluation and Research and receive approval before commercial marketing of the drug. The new drug application or biologic license applications must include results of product development, laboratory, animal and human studies, and manufacturing information. The testing and approval processes require substantial time and effort and there can be no assurance that the FDA will accept the new drug application or biologic license applications for filing and, even if filed, that any approval will be granted on a timely basis, if at all. In the past, new drug applications and biologic license applications submitted to the FDA have taken, on average, one to two years to receive approval after submission of all test data. If questions arise during the FDA review process, approval can take more than two years.
Notwithstanding the submission of relevant data, the FDA may ultimately decide that the new drug application or biologic license application does not satisfy its regulatory criteria for approval and require additional studies. In addition, the FDA may condition marketing approval on the conduct or specific post-marketing studies to further evaluate safety and effectiveness. Rigorous and extensive FDA regulation of pharmaceutical products continues after approval, particularly with respect to compliance with current good manufacturing practices, or cGMPs, reporting of adverse effects, advertising, promotion and marketing. Discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or withdrawal of the product from the market as well as possible civil or criminal sanctions.
If a developer obtains designation by the FDA of a biologic or drug as an "orphan" drug for a particular use, the developer may request small grants from the federal government to help defray the costs of qualified testing expenses in connection with the development of such drug. Orphan drug designation may be granted to drugs for rare diseases, typically defined as a disease or condition that affects populations of fewer than 200,000 individuals in the United States, and includes many genetic diseases. The first applicant who has obtained designation of a drug for a particular use as an orphan drug and then obtains approval of a marketing application for such drug for the particular use is entitled to marketing exclusivity for a period of seven years, subject to certain limitations.
Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory approval process. Although obtaining FDA approval to market a product with an orphan drug designation can be advantageous, there can be no assurance that the scope of protection or the level of marketing exclusivity that is currently afforded by orphan drug designation will remain in effect in the future. In February 2001, BLyS received "orphan" drug designation from the FDA for the treatment of common variable immunodeficiency.
Moreover, several areas in which we or our collaborators may develop products involve relatively new technology and have not been the subject of extensive product testing in humans. The regulatory requirements governing these products and related testing procedures remain uncertain. In addition, these products may be subject to substantial review by foreign governmental regulatory authorities that could prevent or delay approval in those countries. Regulatory requirements ultimately imposed on our products could limit our ability to test, manufacture and, ultimately, commercialize our products.
Other. Ethical, social and legal concerns about gene therapy, genetic testing and genetic research could result in additional regulations restricting or prohibiting the processes we or our suppliers may use. Federal and state agencies, congressional committees and foreign governments have expressed interest in further regulating biotechnology. More restrictive regulations or claims that our products are unsafe or pose a hazard could prevent us from commercializing any products.
In addition to the foregoing, state and federal laws regarding environmental protection and hazardous substances, including the Occupational Safety and Health Act, the Resource Conservation and Recovery Act and the Toxic Substances Control Act, affect our business. These and other laws govern our use, handling and disposal of various biological, chemical and radioactive substances used in, and wastes generated by, our operations. If our operations result in contamination of the environment or expose individuals to hazardous substances, we could be liable for damages and governmental fines. We believe that we are in material compliance with applicable environmental laws and that our continued compliance therewith will not have a material adverse effect on our business. We cannot predict, however, how changes in these laws may affect our future operations.
SOURCES OF SUPPLY
We currently are able to obtain our chemicals and equipment from various sources, and therefore, have no dependence upon a single supplier. We are currently dependent upon one manufacturer, MDS Nordion of Ottawa, Canada, for the radiolabeling of LymphoRad(131), a product for which we have filed an Investigation New Drug application with the FDA. If we are unable to secure an adequate supply of this product at commercially reasonable rates, our ability to continue with the intended human clinical trials would be adversely affected.
MANUFACTURING
We have developed in-house capabilities for the production and purification of laboratory-produced proteins for use in our research activities, but do not have any manufacturing facilities licensed to supply materials suitable for
commercial sale, or any experience in manufacturing materials suitable for commercial sale. From time to time, we may depend on third parties for manufacturing. If we need others to manufacture our products, we will depend on those third parties to comply with cGMPs, and other regulatory requirements and to deliver materials on a timely basis. These third parties may not perform adequately. Any failures by these third parties may delay our development of products or the submission of these products for regulatory approval.
During 1997 and 1998, we designed and the Maryland Economic Development Corporation (MEDCO) constructed an 84,000 square foot process development and manufacturing facility for the preparation of our proteins for human studies. The facility now comprises approximately 127,000 square feet, including a 43,000 square foot expansion completed in 2000, and is located in the Johns Hopkins Belward Research Campus near our offices and research laboratories. The original facility was completed in 1999. We designed the facility to allow for the production and purification of multiple laboratory-produced proteins. We are using the facility for production of laboratory and human study supplies of our therapeutic proteins under cGMP requirements and for process development and scale-up. The FDA must inspect and license this facility to determine compliance with cGMP requirements for commercial production. A delay in licensing of the facility could delay or increase the cost of regulatory approval. We have entered into long-term lease arrangements with MEDCO for the facility and the expansion. Under these lease agreements, which we have accounted for as operating leases, we have the option to purchase the properties, during and at the end of the lease term. Our option to purchase these facilities is at declining, pre-determined amounts during the lease term and is approximately $19.4 million at the end of the lease term. Alternatively, we can vacate the facilities. We are not contingently liable for any residual value guarantee associated with these properties. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for additional discussion.
Our long-range plan is to establish additional manufacturing capabilities to allow us to meet our full commercial manufacturing requirements. We are currently designing a large-scale manufacturing facility to allow for the production of proteins and antibodies to be used for both clinical and commercial use. This 405,000 square foot facility will be located adjacent to the existing process development and manufacturing facility and is expected to be available for occupancy in 2004. The FDA must inspect and license this facility to determine compliance with cGMP requirements for commercial production. A delay in licensing of the facility could delay or increase the cost of regulatory approval. During 2001, we entered into a seven-year lease agreement relating to this facility. As part of this agreement, we are required to maintain collateral with the lending institutions in amounts equal to 100% of the financed project cost of approximately $226.0 million for the duration of the lease. Under this lease agreement, which we have accounted for as an operating lease, we have the option to purchase the property, during and at the end of the lease term, for approximately $226.0 million. Alternatively, we can cause the property to be sold to third parties. We are contingently liable for the residual value guarantee associated with the property in the event the net sale proceeds are less than the original financed costs of the facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for additional discussion.
While we are expanding our manufacturing capabilities, we may contract with third party manufacturers or may develop products with partners and take advantage of such partner's manufacturing capabilities. We may not be able to successfully establish manufacturing capabilities or manufacture our products economically or in compliance with cGMPs and other regulatory requirements.
MARKETING
We do not currently have any marketed products. We expect that in the future we will rely at least partially on collaborators or on third parties with whom we may contract to market any products that we may develop. Our collaborators or other third parties may not be successful in marketing our products. To date, we have collaborated with GlaxoSmithKline, Schering-Plough and others. However, we also may co-promote or retain North American rights to certain of our products. If we decide to market products directly, we will incur significant additional expenditures and commit significant additional management resources to develop an external sales force in order to implement our marketing strategy. We may not be able to establish a successful marketing force.
EMPLOYEES
As of March 1, 2002, we had 1,010 full-time employees, of whom 836 were in research and development, including 153 scientists holding doctoral degrees. We anticipate hiring approximately 150 additional employees
during the next six months, including research and development staff, process development and manufacturing personnel, and medical and regulatory affairs and strategic marketing staff. None of our employees is covered by a collective bargaining agreement and we consider relations with our employees to be good.
FACTORS THAT MAY AFFECT OUR BUSINESS
There are a number of important factors that could cause our actual results to differ materially from those that are indicated by forward-looking statements. Those factors include, without limitation, those listed below and elsewhere herein.
BECAUSE OUR BUSINESS STRATEGY IS STILL LARGELY UNTESTED, WE DO NOT KNOW WHETHER WE WILL BE ABLE TO COMMERCIALIZE ANY OF OUR PRODUCTS OR TO WHAT EXTENT WE WILL GENERATE REVENUE.
We do not know whether we can implement our business strategy successfully because we are in the early stages of development. We initially set out to find as many genes as possible and are now using that information to develop medical and pharmacological products. We use automated high-speed technology to:
- rapidly identify the function of and obtain proprietary rights to a substantial number of genes; and
- select genes with the greatest potential for the treatment and diagnosis of human disease.
Nobody has tested our strategy. Other companies first target particular diseases and try to find cures for them through gene-based therapies. If our strategy does not result in the development of products that we can sell profitably, we will be unable to generate revenue.
IF WE ARE UNABLE TO IDENTIFY GENES WITH POTENTIAL VALUE, WE MAY NOT BE ABLE TO RECOVER OUR INVESTMENT IN OUR GENE DISCOVERY EFFORT.
We invested significant time and resources to isolate and study genes and determine their functions. We now devote an ever-increasing portion of our resources to identifying and developing proteins, antibodies and other compounds for the treatment of human disease. We have recently made substantial capital expenditures and hired additional personnel to foster these activities. Before we can commercialize a product, we must rigorously test the product in the laboratory and complete extensive human studies. We cannot assure you that expenses for testing and study will yield profitable products or even products approved for marketing by the FDA. We will incur additional costs to continue these activities. If we are not successful in identifying products which we can develop commercially, we may be unable to recover the large investment we make in research and development.
BECAUSE OUR PRODUCT DEVELOPMENT EFFORTS DEPEND ON NEW AND RAPIDLY-EVOLVING TECHNOLOGIES, WE DO NOT KNOW WHETHER OUR EFFORTS WILL BE SUCCESSFUL.
To date, companies have developed and commercialized relatively few gene-based products. Our work depends on new, rapidly-evolving technologies and on the marketability and profitability of innovative products. Commercialization involves risks of failure inherent in the development of products based on innovative technologies and the risks associated with drug development generally. These risks include the possibility that:
- these technologies or any or all of the products based on these technologies will be ineffective or toxic, or otherwise fail to receive necessary regulatory clearances;
- the products, if safe and effective, will be difficult to manufacture on a large scale or uneconomical to market;
- proprietary rights of third parties will prevent us or our collaborators from exploiting technologies or marketing products;
- third parties will market superior or equivalent products; and
- we may not be able to obtain or exploit new and superior technology which could render obsolete the technologies we use.
BECAUSE WE ARE AN EARLY STAGE COMPANY, WE DO NOT KNOW WHETHER WE CAN DEVELOP OUR BUSINESS OR ACHIEVE PROFITABILITY.
We expect to continue to incur increasing losses and we cannot assure you that we will ever become profitable. We are in the early stages of development, and it will be a number of years, if ever, before we are likely to receive revenue from product sales or royalty payments. We will continue to incur substantial expenses relating to research and development efforts. We anticipate that we will increase these efforts as we focus on the laboratory and human studies that are required before we can sell a product. The development of our products requires significant further research, development, testing and regulatory approvals. We may not be able to develop products that will be commercially successful or that will generate revenue in excess of the cost of development.
PRODUCT DEVELOPMENT RISKS
BECAUSE WE HAVE LIMITED EXPERIENCE IN DEVELOPING AND COMMERCIALIZING PRODUCTS, WE MAY BE UNSUCCESSFUL IN OUR EFFORTS TO DO SO.
Our ability to develop and commercialize products based on proteins, antibodies and other compounds will depend on our ability to:
- develop products internally;
- complete laboratory testing and human studies;
- obtain and maintain necessary intellectual property rights to our products;
- obtain and maintain necessary regulatory approvals related to the efficacy and safety of our products;
- develop efficient production facilities meeting all regulatory requirements or enter into arrangements with third parties to manufacture our products on our behalf; and
- deploy sales and marketing resources effectively or enter into arrangements with third parties to provide these functions.
Although we have initiated human studies with respect to eight products, we have limited experience with these activities and may not be successful in developing or commercializing these or other products.
BECAUSE CLINICAL TRIALS FOR OUR PRODUCTS WILL BE EXPENSIVE AND PROTRACTED AND THEIR OUTCOME IS UNCERTAIN, WE MUST INVEST SUBSTANTIAL AMOUNTS OF TIME AND MONEY THAT MAY NOT YIELD VIABLE PRODUCTS.
Conducting clinical trials is a lengthy, time-consuming and expensive process. Before obtaining regulatory approvals for the commercial sale of any product, we must demonstrate through laboratory, animal and human studies that such product is both effective and safe for use in humans. We will incur substantial expense for and devote a significant amount of time to these studies.
The results of preliminary studies do not predict clinical success. A number of potential drugs have shown promising results in early testing but subsequently failed to obtain necessary regulatory approvals. Data obtained from tests are susceptible to varying interpretations, which may delay, limit or prevent regulatory approval. Regulatory authorities may refuse or delay approval as a result of many other factors, including changes in regulatory policy during the period of product development.
Completion of clinical trials may take many years. The length of time required varies substantially according to the type, complexity, novelty and intended use of the product candidate. Our rate of commencement and completion of clinical trials may be delayed by many factors, including:
- our inability to manufacture sufficient quantities of materials for use in clinical trials;
- variability in the number and types of patients available for each study;
- difficulty in maintaining contact with patients after treatment, resulting in incomplete data;
- unforeseen safety issues or side effects;
- poor or unanticipated effectiveness of products during the clinical trials; or
- government or regulatory delays.
Seven of our products, mirostipen, repifermin, BLyS, LymphoStat-B, Albuferon, Albutropin and Albuleukin have advanced to clinical trials. Two products are awaiting clearance from the FDA to enter human clinical trials. For all of our trials except the repifermin wound healing trial, only a limited number of patients is involved. To date, data obtained from these clinical trials have been insufficient to demonstrate safety and efficacy under applicable FDA guidelines and are not sufficient to support an application for regulatory approval without further studies. In two trials of repifermin, the drug was shown to be safe, but was not shown to be effective. Studies conducted by us or by third parties on our behalf may not demonstrate sufficient effectiveness and safety to obtain the requisite regulatory approvals for these or any other potential products. Regulatory authorities may not permit us to undertake any additional clinical trials.
BECAUSE THE CLINICAL TESTING OF VEGF-2 MUST RECEIVE FDA APPROVAL BEFORE VGI CAN RESUME ITS PHASE II TRIALS, THE CLINICAL SUCCESS OF VEGF-2 IS UNCERTAIN.
Clinical trials of VEG-2 by Vascular Genetics were placed on clinical hold by the FDA in February 2000. These trials were removed from clinical hold in October 2001. Prior to the hold, four clinical trials of VEGF-2 had been ongoing. Vascular Genetics announced the completion of three of these trials because enrollment and treatment were complete. In the fourth study, a majority of the target patients had been enrolled and treated. During the hold period, Vascular Genetics provided the FDA with results which were being compiled from the clinical trials, in addition to providing measurements of the amount of the VEGF-2 protein in patient blood samples. Vascular Genetics must receive approval from the FDA before it can initiate additional trials.
The trials of VEGF-2 are being conducted with patients for whom conventional treatments have been unsuccessful or for whom no conventional treatment exists. During the course of treatment, these patients could die or suffer adverse medical effects for reasons that may not be related to VEGF-2. Deaths in the patient population for the VEGF-2 trial did occur, in both active and placebo groups, and Vascular Genetics has reviewed the relevant data regarding these patients and provided an analysis of the reasons for these deaths to the FDA. These adverse effects may affect the interpretation of the clinical trial results and the success of the trials. Later clinical trials may be extensive, expensive and time-consuming. VEGF-2 may never be approved for use in humans.
BECAUSE NEITHER WE NOR ANY OF OUR COLLABORATION PARTNERS HAVE RECEIVED MARKETING APPROVAL FOR ANY PRODUCT RESULTING FROM OUR RESEARCH AND DEVELOPMENT EFFORTS, AND MAY NEVER BE ABLE TO OBTAIN ANY SUCH APPROVAL, WE MAY NOT BE ABLE TO GENERATE ANY PRODUCT REVENUE.
We have not completed development of any product based on our genetic research. It is possible that we will not receive FDA marketing approval for any of our products. Although a number of our potential products have entered clinical trials, we cannot assure you that any of these products will receive marketing approval. All the products being developed by our collaboration partners will also require additional research and development, extensive preclinical studies and clinical trials and regulatory approval prior to any commercial sales. In some cases, the length of time that it takes for our collaboration partners to achieve various regulatory approval milestones may affect the payments that we are eligible to receive under our collaboration agreements. We and our collaboration partners may need to successfully address a number of technical challenges in order to complete development of our products. Moreover, these products may not be effective in treating any disease or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.
RISKS FROM OUR COLLABORATION RELATIONSHIPS AND STRATEGIC ACQUISITIONS
OUR PLAN TO USE COLLABORATIONS TO LEVERAGE OUR CAPABILITIES AND TO GROW IN PART THROUGH THE STRATEGIC ACQUISITION OF OTHER COMPANIES AND TECHNOLOGIES WILL NOT BE SUCCESSFUL IF WE ARE UNABLE TO INTEGRATE OUR PARTNERS' CAPABILITIES OR THE ACQUIRED COMPANIES WITH OUR OTHER OPERATIONS OR IF THEY DO NOT MEET OUR EXPECTATIONS.
As part of our strategy, we intend to continue to evaluate strategic partnership opportunities and consider acquiring complementary technologies and businesses. In order for our future collaboration efforts to be successful, we must first identify partners whose capabilities complement and integrate well with ours. Technologies to which we gain access may prove ineffective or unsafe. Our partners may prove difficult to work with or less skilled than we originally expected. In addition, any past collaborative successes are no indication of potential future success in this area. In order to achieve the anticipated benefits of an acquisition, we must integrate the acquired company's business, technology and employees in an efficient and effective manner. The successful combination of companies in a rapidly changing biotechnology and genomics industry may be more difficult to accomplish than in other industries. The combination of two companies requires, among other things, integration of the companies' respective technologies and research and development efforts. We cannot assure you that this integration will be accomplished smoothly or successfully. The difficulties of integration are increased by the necessity of coordinating geographically separated organizations and addressing possible differences in corporate cultures and management philosophies. The integration of certain operations will require the dedication of management resources which may temporarily distract attention from the day-to-day operations of the combined companies. The business of the combined companies may also be disrupted by employee retention uncertainty and lack of focus during integration. The inability of management to successfully integrate the operations of the two companies, in particular, to integrate and retain key scientific personnel, or the inability to successfully integrate two technology platforms, could have a material adverse effect on our business, results of operations and financial condition.
BECAUSE WE DEPEND ON OUR COLLABORATION PARTNERS FOR REVENUE, WE MAY NOT BECOME PROFITABLE IF WE CANNOT INCREASE THE REVENUE FROM OUR COLLABORATION PARTNERS OR OTHER SOURCES.
We have received all our revenue from payments made under our collaboration agreements with GlaxoSmithKline and, to a lesser extent, other agreements. The GlaxoSmithKline collaboration agreement and many of our other collaboration agreements expired in 2001. None of these collaboration agreements was renewed. We may not be able to enter into additional collaboration agreements. We are entitled to certain milestone and royalty payments from the existing collaborators, but may not receive payments if our collaborators fail to:
- develop marketable products;
- obtain regulatory approvals for products; or
- successfully market products based on our research.
IF ONE OF OUR COLLABORATORS PURSUES A PRODUCT THAT COMPETES WITH OUR PRODUCTS, IT MAY HAVE A CONFLICT OF INTEREST AND WE MAY NOT RECEIVE THE MILESTONE OR ROYALTY PAYMENTS THAT WE EXPECT.
Each of our collaborators is developing a variety of products, some with other partners. Our collaborators may pursue existing or alternative technologies instead of products they are developing in collaboration with us. Our collaborators may also develop products that are similar to or compete with products they are developing in collaboration with us. If our collaborators pursue these other products instead of our products, we may not receive milestone or royalty payments.
FINANCIAL AND MARKET RISKS
BECAUSE OF OUR SUBSTANTIAL INDEBTEDNESS, WE MAY BE UNABLE TO ADJUST OUR STRATEGY TO MEET CHANGING CONDITIONS IN THE FUTURE.
As of December 31, 2001, we had long-term obligations of approximately $504.0 million. We also had future guarantee obligations of approximately $459.4 million under certain facility leases. Our substantial debt and future
guarantees will have several important consequences for our future operations. For instance:
- payments of interest on, and principal of, our indebtedness will be substantial, and may exceed then current revenues;
- we may be unable to obtain additional future financing for capital expenditures, acquisitions or general corporate purposes;
- we may be unable to withstand changing competitive pressures, economic conditions and governmental regulations; and
- we may be unable to make acquisitions or otherwise take advantage of significant business opportunities that may arise.
WE HAVE ENTERED INTO TWO FACILITY LEASE ARRANGEMENTS THAT ARE NOT REQUIRED TO BE REFLECTED ON OUR BALANCE SHEET BUT THAT CONSTITUTE SIGNIFICANT FINANCIAL OBLIGATIONS AND POSSIBLE RISKS.
In the fourth quarter of 2001, we entered into two facility leases with respect to three facilities that are currently in design or under construction and one previously-constructed facility. We lease these facilities from trusts controlled by third parties established solely for the transactions. Under accounting principles generally accepted in the United States, these leases are treated as operating leases. Economically, we may be responsible for up to $526.0 million of the cost of these facilities because of guarantees we made in connection with the leases in the event we default on our obligations under the leases. These obligations are not required to be reflected as liabilities on our balance sheet, but are described in footnotes to our financial statements. We are required to pledge marketable securities as security for our obligations under the leases and the related documents. As of December 31, 2001, we included approximately $144.9 million of restricted investments on our balance sheet, of which approximately $132.1 million was held as restricted investments providing collateral for our obligations with respect to these facilities. As the facilities are constructed, we will be required to restrict additional cash or investments as collateral for our obligations under these leases in order to reach the full amount of collateralization, which will reduce our working capital. When the facilities are completed, we expect that we will include approximately $526.0 million in restricted investments on our balance sheet. If the value of our pledged investments declines, because of an increase in interest rates or otherwise, we would need to pledge additional investments which would further reduce our working capital. The rent under these leases is based on a floating interest rate, but the trusts at our request can lock in a fixed interest rate at an interest rate premium. To date, the trusts have fixed the interest rate for approximately $56.0 million of the financed project cost. To the extent the trusts do not lock in a fixed interest rate, if interest rates increase, our rent obligations would also increase. These leases have a term of seven years. If we desire to remain in the facilities upon lease expiration, we would need to refinance or buy the facilities at the financed project cost. We cannot assure you that refinancing will be available on comparable terms, if at all. Further, in the event the facilities are sold, we have guarantee obligations which make us responsible to the extent that the value of the facilities is less than the financed project cost and which reach a maximum guarantee obligation of approximately $459.4 million if the value of the facilities declined below approximately 15% of the financed project cost. While we believe that these leases provide a useful financing mechanism for the facilities, adverse public perception of such lease arrangements and the associated risks may cause our stock price to decline. In addition, we understand that the accounting treatment for these leases may be changed by the Financial Accounting Standards Board in 2002 and may require us to include these leased facilities and the related lease obligations on our balance sheet as assets and liabilities. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
IF WE DO NOT OBTAIN SUBSTANTIAL ADDITIONAL FUNDING ON ACCEPTABLE TERMS, WE MAY NOT BE ABLE TO CONTINUE TO GROW OUR BUSINESS AND GENERATE ENOUGH REVENUE TO RECOVER OUR INVESTMENT IN OUR PRODUCT DEVELOPMENT EFFORT.
Since inception we have expended, and will continue to expend, substantial funds to continue our research and development programs. If we incur unanticipated expenses or delays in receipt of revenue, we may need additional financing beyond that which we have projected to fund our operating expenses and capital requirements. We may not be able to obtain additional financing on acceptable terms. If we raise additional funds by issuing equity securities, the new securities may dilute the interests of our existing stockholders.
BECAUSE OUR STOCK PRICE HAS BEEN AND WILL LIKELY CONTINUE TO BE VOLATILE, THE MARKET PRICE OF OUR COMMON STOCK MAY BE LOWER OR MORE VOLATILE THAN YOU EXPECTED.
Our stock price, like the stock prices of other emerging and biotechnology companies, has been highly volatile. During 2001, the closing price of our common stock has been as low as $28.00 per share and as high as $75.31 per share. The market price of our common stock could fluctuate widely because of:
- future announcements about our company or our competitors, including the results of testing, technological innovations or new commercial products;
- regulatory actions and changes in government regulations;
- announcements relating to health care reform;
- our failure to acquire or maintain proprietary rights to the gene sequences we discover or the products we develop;
- litigation; and
- public concern as to the safety of our products.
The stock market has experienced extreme price and volume fluctuations that have particularly affected the market price for many emerging and biotechnology companies. These fluctuations have often been unrelated to the operating performance of these companies. These broad market fluctuations may cause the market price of our common stock to be lower or more volatile than you expected.
INTELLECTUAL PROPERTY RISKS
IF PATENT LAWS OR THE INTERPRETATION OF PATENT LAWS CHANGE, OUR COMPETITORS MAY BE ABLE TO DEVELOP AND COMMERCIALIZE OUR DISCOVERIES.
The patent protection available to biotechnology firms is highly uncertain and involves complex legal and factual questions that will determine who has the right to develop a particular product. There have been, and continue to be, intensive discussions on the scope of patent protection for both partial gene sequences and full-length genes. The Patent and Trademark Office issued new guidelines for patents in 2001 which clarify certain requirements for obtaining a patent on a gene sequence. The biotechnology patent situation is even more uncertain outside the U.S. and is currently undergoing review and revision in many countries. Changes in, or different interpretations of, patent laws in the U.S. and other countries may result in patent laws which allow others to use our discoveries or develop and commercialize our products.
IF OUR PATENT APPLICATIONS DO NOT RESULT IN ISSUED PATENTS, OUR COMPETITORS MAY OBTAIN RIGHTS TO AND COMMERCIALIZE THE DISCOVERIES WE ATTEMPTED TO PATENT.
Our pending applications covering full-length genes and their corresponding proteins may not result in the issuance of any patents. As of March 1, 2002, we had filed patent applications for many human genes and their corresponding proteins and all or portions of genomes of eight infectious microorganisms and one non-infectious microorganism. As of that date, we had only 205 U.S. patents covering human genes and proteins. Our applications may not be sufficient to meet the statutory requirements for patentability in all cases. As a result, we may not obtain enforceable patents on genes we may want to commercialize.
IF INFORMATION ABOUT THE GENES WE DISCOVER IS PUBLISHED BY OTHERS BEFORE WE APPLY FOR PATENT PROTECTION, WE MAY BE UNABLE TO OBTAIN PATENT PROTECTION, WHICH WOULD ENABLE OTHERS TO DEVELOP AND COMMERCIALIZE OUR DISCOVERIES.
Washington University has identified genes through partial sequencing funded by Merck & Co. and has deposited those partial sequences in a public database. In January 1997, The Institute for Genomic Research, or TIGR, in collaboration with the National Center for Biological Information, disclosed full-length DNA sequences
which are reportedly in excess of 35,000 sequences that were assembled from partial gene sequences available in publicly accessible databases or sequenced at TIGR. In June 2000, the Human Genome Project and Celera Genomics Corporation completed an initial sequencing of the human genome and published papers on this sequencing in February 2001. These public disclosures might limit the scope of our claims or make unpatentable subsequent patent applications on full-length genes we file. Any publication of sequence information may prevent us from obtaining patent protection for some genes in which we may have a scientific or commercial interest.
IF OTHERS FILE PATENT APPLICATIONS OR OBTAIN PATENTS SIMILAR TO OURS, THEN THE PATENT AND TRADEMARK OFFICE MAY DENY OUR PATENT APPLICATIONS, OR OTHERS MAY RESTRICT THE USE OF OUR DISCOVERIES.
Other companies or institutions have filed, and may file in the future, patent applications which attempt to patent genes similar to those covered in our patent applications. The Patent and Trademark Office will decide which applications merit a patent and the priority of competing patent claims. Any patent application filed by a third party may prevail over patent applications we filed, in which event the third party may require us to stop pursuing a potential product or to negotiate a royalty arrangement to pursue the potential product.
IF OUR POTENTIAL PRODUCTS CONFLICT WITH PATENTS THAT COMPETITORS, UNIVERSITIES OR OTHERS HAVE OBTAINED, THEN WE MAY BE UNABLE TO COMMERCIALIZE THOSE PRODUCTS.
Other parties may claim that our products infringe their patents. This risk will increase as the biotechnology industry expands and as other companies obtain more patents and attempt to discover genes through the use of high-speed sequencers. Other persons could bring legal actions against us to claim damages or to stop our manufacturing and marketing of the affected products. If any of these actions are successful, in addition to demanding monetary damages these persons may require us to obtain a license in order to continue to manufacture or market the affected products. We believe that there will continue to be significant litigation in our industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our resources.
BECAUSE ISSUED PATENTS MAY NOT FULLY PROTECT OUR DISCOVERIES, OUR COMPETITORS MAY BE ABLE TO COMMERCIALIZE PRODUCTS SIMILAR TO THOSE COVERED BY OUR ISSUED PATENTS.
Issued patents may not provide commercially meaningful protection against competitors and may not provide us with competitive advantages. Other parties may challenge our patents or independently develop similar products which could result in an interference proceeding in the Patent and Trademark Office. Others may be able to design around our issued patents or develop products providing effects similar to our products. In addition, others may discover uses for genes or proteins different from uses covered in our patents, and these other uses may be separately patentable. If another party holds a patent on the use of an invention, even if we hold the patent on the invention itself, that other party could prevent us from selling any product that involves the use.
WE RELY ON OUR COLLABORATION PARTNERS TO SEEK PATENT PROTECTION FOR THE PRODUCTS THEY DEVELOP BASED ON OUR RESEARCH.
Much of our future revenue may be derived from royalty payments from our collaboration partners. These partners face the same patent protection issues that we and other biotechnology firms face. As a result, we cannot assure you that any product developed by our collaboration partners will be patentable, and therefore, we may never receive any royalty payments. We also rely on our collaboration partners to effectively prosecute their patent applications. Their failure to obtain or protect necessary patents could also result in a loss of royalty revenue to us.
IF WE ARE UNABLE TO PROTECT OUR TRADE SECRETS, OTHERS MAY BE ABLE TO USE OUR SECRETS TO COMPETE MORE EFFECTIVELY.
We may not be able to adequately protect our trade secrets. We rely on trade secret protection to protect our confidential and proprietary information. We believe that we have developed proprietary procedures for making libraries of DNA sequences and genes. We have not sought process patent protection for these procedures. We have also developed a substantial database of genes we have identified. While we have entered into confidentiality agreements with employees and academic collaborators, we may not be able to prevent their disclosure of these data or materials. Others may independently develop substantially equivalent information and techniques.
REGULATORY RISKS
BECAUSE WE ARE SUBJECT TO EXTENSIVE AND UNCERTAIN GOVERNMENT REGULATORY REQUIREMENTS, WE MAY BE UNABLE TO OBTAIN GOVERNMENT APPROVAL OF OUR PRODUCTS IN A TIMELY MANNER.
Our products are subject to the extensive and evolving regulatory approval process of the FDA and comparable agencies in other countries. The regulation of new products is extensive, and the required process of laboratory testing and human studies is lengthy and expensive. We may not obtain FDA approvals in a timely manner, or at all. We and our collaborators may encounter significant delays or excessive costs in our efforts to secure necessary approvals or licenses. Even if we obtain FDA regulatory approvals, the FDA extensively regulates manufacturing, labeling, distributing, marketing, promotion and advertising after product approval. Moreover, several areas in which we or our collaborators may develop products involve relatively new technology and have not been the subject of extensive product testing in humans. The regulatory requirements governing these products and related clinical procedures are still being determined. In addition, these products may be subject to substantial review by foreign governmental regulatory authorities which could prevent or delay approval in those countries. Regulatory requirements imposed on our products could limit our ability to test, manufacture and, ultimately, commercialize our products.
NEGATIVE PUBLIC OPINION AND INCREASED REGULATORY SCRUTINY OF GENE THERAPY AND GENETIC RESEARCH MAY LIMIT OUR ABILITY TO CONDUCT OUR BUSINESS.
Ethical, social and legal concerns about gene therapy, genetic testing and genetic research could result in additional regulations restricting or prohibiting the processes we or our suppliers may use. In recent years, gene therapy studies, including studies of VEGF-2, have come under increasing scrutiny which has delayed ongoing and may delay future clinical trials and regulatory approvals. Federal and state agencies, congressional committees and foreign governments have expressed interest in further regulating biotechnology. More restrictive regulations or claims that our products are hazardous could prevent us from commercializing any products.
BECAUSE WE ARE SUBJECT TO ENVIRONMENTAL, HEALTH AND SAFETY LAWS, WE MAY BE UNABLE TO CONDUCT OUR BUSINESS IN THE MOST ADVANTAGEOUS MANNER.
State and federal laws regarding environmental protection, hazardous substances and human health and safety affect our business. The use of hazardous substances in our operations exposes us to the risk of accidental releases. If our operations result in contamination of the environment or expose individuals to hazardous substances, we could be liable for damages and fines. Future changes to environmental, health and safety laws could cause us to incur additional expense or restrict our operations.
INDUSTRY RISKS
MANY OF OUR COMPETITORS HAVE SUBSTANTIALLY GREATER CAPABILITIES AND RESOURCES AND MAY BE ABLE TO DEVELOP AND COMMERCIALIZE PRODUCTS BEFORE WE DO.
We are in a race to establish uses for and patent as many genes as possible and to bring to market the products we develop. Many of our potential competitors have substantially greater research and product development capabilities and financial, scientific, marketing and human resources. The Human Genome Project and Celera Genomics Corporation have claimed to have mapped the complete human genome, and have made their findings available to the public at no cost. We face competition from other entities using high-speed gene sequencers to discover genes, such as Incyte Genomics, Inc. and Celera Genomics Corporation. We also face competition from entities using more traditional methods to discover genes related to particular diseases, such as Amgen, Inc., Genentech, Inc., Millennium Pharmaceuticals, Inc. and other large biotechnology and pharmaceutical companies. We expect that competition in our field will continue to be intense.
Our competitors include parties conducting research to identify genes and human genome research similar to or competing with our focus on gene discovery, including:
- institutes, such as those sponsored by the U.S. government and the governments of Great Britain, France, Germany and Japan;
- small laboratories associated with universities or other not-for-profit organizations;
- pharmaceutical and biotechnology companies; and
- government-financed programs.
These competitors may:
- succeed in identifying genes or developing products earlier than we do;
- obtain approvals from the FDA or other regulatory agencies for products more rapidly than we do;
- develop treatments or cures that are more effective than those we propose to develop; or
- acquire similar gene sequencing machines and engage in the automated sequencing of genes.
The other risks of competition include the following:
- research and development by others may make our products, or the products we and our collaborators may develop, obsolete or uneconomical;
- consumers may prefer existing or newly developed technologies to any product we develop; and
- other companies use the same gene sequencing machines we use, in some cases for business purposes that compete with our business.
IF WE LOSE OR ARE UNABLE TO ATTRACT KEY MANAGEMENT OR OTHER PERSONNEL, WE MAY EXPERIENCE DELAYS IN PRODUCT DEVELOPMENT.
We depend on our senior executive officers as well as key scientific and other personnel. Only a few of our key personnel are bound by employment agreements, and those with employment agreements are bound only for a limited period of time. Our employment agreement with Dr. William A. Haseltine, our Chairman of the Board and Chief Executive Officer, expires in February 2003. Although Dr. Haseltine's employment agreement automatically extends for additional one year terms, either party can terminate the agreement four months prior to the end of the applicable term. If Dr. Haseltine decides to terminate his employment with us, this termination could delay the commercialization of our products or prevent us from becoming profitable. Further, we have not purchased key-man life insurance on any of our executive officers or key personnel, and therefore may not have adequate funds to find acceptable replacements for them. Competition for qualified employees is intense among pharmaceutical and biotechnology companies, and the loss of qualified employees, or an inability to attract, retain and motivate additional highly skilled employees required for the expansion of our activities, could hinder our ability to complete human studies successfully and develop marketable products.
IF THE HEALTH CARE SYSTEM OR REIMBURSEMENT POLICIES CHANGE, THE PRICES OF OUR POTENTIAL PRODUCTS MAY FALL OR OUR POTENTIAL SALES MAY DECLINE.
In recent years, officials have made numerous proposals to change the health care system in the U.S. These proposals included measures that would limit payments for or prohibit certain medical procedures and treatments or subject the pricing of pharmaceuticals to government control. Government and other third-party payors increasingly attempt to contain health care costs by limiting both coverage and the level of reimbursement of newly approved health care products. In some cases, they may also refuse to provide any coverage of uses of approved products for disease indications other than those for which the FDA has granted marketing approval. Governments may adopt future legislative proposals and federal, state or private payors for health care goods and services may take action to limit their payments for goods and services. In certain foreign countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. Any of these events could limit our ability to commercialize our products successfully.
OTHER RISKS RELATED TO OUR BUSINESS
BECAUSE WE DEPEND ON A SINGLE MANUFACTURER FOR THE RADIOLABELING OF LYMPHORAD(131), WE MAY BE UNABLE TO OBTAIN SUFFICIENT QUANTITIES OF THIS PRODUCT AT COMMERCIALLY ACCEPTABLE RATES.
We are currently dependent upon one manufacturer, MDS Nordion, for the radiolabeling of LymphoRad(131), a product for which we have filed an Investigation New Drug application with the FDA. If we are unable to secure an adequate supply of this product at commercially reasonable rates, our ability to continue with the intended human clinical trials would be adversely affected.
BECAUSE WE CURRENTLY HAVE NO PROVEN MANUFACTURING CAPACITY CAPABLE OF PRODUCING PRODUCTS FOR SALE, WE MAY HAVE TO RELY ON THIRD PARTIES TO MANUFACTURE OUR PRODUCTS, AND WE MAY BE UNABLE TO OBTAIN REQUIRED QUANTITIES ECONOMICALLY.
We currently do not have any manufacturing facilities that have produced materials for commercial sale or any experience in manufacturing materials suitable for commercial sale. If we need others to manufacture our products, we will have to depend on those third parties to comply with current good manufacturing practices, known as cGMPs, and other regulatory requirements and to deliver materials on a timely basis. These third parties may not perform adequately. Any failures by these third parties may delay our development of products or their submission for regulatory approval.
During 1997 and 1998, we designed and MEDCO constructed a process-development and manufacturing facility for the preparation of our proteins for human studies. MEDCO completed an expansion of this facility in 2000. In 2001, we began to design a large-scale manufacturing facility adjacent to the existing process development and manufacturing facility. This 405,000 square foot facility is being designed to enable us to produce commercial quantities of our therapeutic proteins and antibodies. This facility will cost approximately $226.0 million to complete and is expected to open in 2004. The FDA must inspect and license these facilities to determine compliance with cGMP requirements before any commercial production can occur. A delay in the licensing of these facilities could delay or increase the cost of regulatory approval. We may not be able to successfully establish manufacturing capabilities and manufacture our products economically or in compliance with cGMPs and other regulatory requirements.
BECAUSE WE CURRENTLY HAVE NO MARKETING CAPABILITY, WE MAY BE UNABLE TO COMMERCIALIZE OUR PRODUCTS.
We currently do not have any products that are ready to be marketed. We expect that in the future we may rely on collaborators or on third parties to market any products that we may develop. These collaborators or other third parties may not be successful in marketing our products. However, we may also co-promote or retain U.S. marketing rights to our products. If we decide to market products directly, we will incur significant additional expenditures and commit significant additional management resources to develop an external sales force and implement our marketing strategy. We may not be able to establish a successful marketing force.
BECAUSE WE MAY DEPEND ON OTHER THIRD PARTIES TO CONDUCT LABORATORY TESTING AND HUMAN STUDIES, WE MAY ENCOUNTER DELAYS IN OR LOSE SOME CONTROL OVER OUR EFFORTS TO DEVELOP PRODUCTS.
We may be dependent on third-party research organizations to design and conduct our laboratory testing and human studies. If we are unable to obtain any necessary testing services on acceptable terms, we may not complete our product development efforts in a timely manner. If we rely on third parties for laboratory testing and human studies, we may lose some control over these activities and become too dependent upon these parties. These third parties may not complete testing activities on schedule or when we request.
OUR CERTIFICATE OF INCORPORATION, BYLAWS AND RIGHTS PLAN COULD DISCOURAGE ACQUISITION PROPOSALS, DELAY A CHANGE IN CONTROL OR PREVENT TRANSACTIONS THAT ARE IN YOUR BEST INTERESTS.
Provisions of our certificate of incorporation and bylaws, as well as Section 203 of the Delaware General Corporation Law, may discourage, delay or prevent a change in control of our company that you as a stockholder may consider favorable and may be against your best interest. We have also adopted a rights plan, or "poison pill," that may discourage, delay or prevent a change in control. Our certificate of incorporation and bylaws contain
provisions that:
- authorize the issuance of up to 20,000,000 shares of "blank check" preferred stock that could be issued by our board to increase the number of outstanding shares and discourage a takeover attempt;
- classify the directors of our board with staggered, three-year terms, which may lengthen the time required to gain control of our board of directors;
- limit who may call special meetings of stockholders; and
- establish advance notice requirements for nomination of candidates for election to the board or for proposing matters that can be acted upon by stockholders at stockholder meetings.
ITEM 2.
ITEM 2. PROPERTIES
We currently lease and occupy approximately 677,000 square feet of laboratory and office space in ten buildings in Rockville, Maryland. Our leased space includes approximately 415,000 square feet of laboratory space, approximately 203,000 of manufacturing space secured through long-term leases and approximately 59,000 square feet of administrative office space.
In addition, several construction projects are underway that will significantly increase our square footage under lease as follows:
For additional discussion of the financing of these three facilities, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources".
We anticipate that the construction of the laboratory and office campus will enable us to continue to expand our operations in close proximity to one another. We believe that our properties are generally in good condition, well maintained, suitable and adequate to carry on our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Shareholders, held on May 23, 2001, the following proposals were approved.
The following proposals were approved at our Annual Meeting of Shareholders:
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER'S MATTERS
Our common stock has been traded on the NASDAQ National Market System under the symbol HGSI since December 2, 1993. The following table presents the quarterly high and low closing prices as quoted by NASDAQ, restated to reflect two two-for-one stock splits, paid in the form of stock dividends on January 28, 2000 and October 5, 2000.
As of January 31, 2002, there were approximately 774 holders of record of our common stock. We have never declared or paid any cash dividends. We do not anticipate declaring or paying cash dividends for the foreseeable future, in part because existing contractual agreements prohibit such dividends. Instead, we will retain our earnings, if any, for the future operation and expansion of our business.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA, CONTINUED
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(1) For 2001, amounts include non-recurring charges aggregating $26,208 arising from a charge for impaired investment and debt conversion expenses of $22,314, or $0.18 per share, and $3,894, or $0.03 per share, respectively. For 2000, amounts include non-recurring charges aggregating $184,868 arising from purchased in-process research and development and debt conversion expenses of $134,050, or $1.21 per share, and $50,818, or $0.46 per share, respectively.
(2) The cumulative effect of change in accounting principle is a one-time, non-cash charge relating to our implementation of Staff Accounting Bulletin No. 101 ("SAB 101"). SAB 101 was issued by the Securities and Exchange Commission (SEC) in December 1999. SAB 101 provides guidance related to revenue recognition policies based on interpretations and practices followed by the SEC. The impact of our implementation of SAB 101 was to defer revenue recognition for certain portions of the revenue we previously recognized under our collaborative agreements into future accounting periods. For further discussion, see Note B of the notes to our consolidated financial statements included herein.
(3) Restated to reflect two two-for-one stock splits paid in the form of a stock dividend on January 28, 2000 and on October 5, 2000.
(4) The net loss per share amounts prior to fiscal 1998 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. For further discussion of net loss per share, see Note B of the notes to our consolidated financial statements included herein.
(5) Pro forma presentation of the accounting change is not applicable for fiscal year 2001 as the change was implemented in 2000, retroactive to January 1, 2000.
(6) "Cash, cash equivalents, short-term and restricted investments" for 2001, 2000, 1999, 1998 and 1997 includes $144,901, $12,332, $11,637, $6,749 and $6,582, respectively of restricted investments relating to certain operating leases.
(7) "Total assets" for 2001, 2000, 1999, 1998 and 1997 includes $144,901, $12,332, $11,637, $6,749 and $6,582, respectively, of restricted investments relating to certain operating leases. "Total debt and capital lease, less current portion" for 2001 does not include any operating lease obligations under various facility and equipment lease arrangements. See "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a leading genomics and biopharmaceutical company focused on therapeutic product development and functional analysis of genes using our proprietary technology platform. We discover, develop and intend to commercialize novel compounds for treating and diagnosing human disease based on the identification and study of genes. We focus our internal product development efforts on therapeutic proteins, antibodies, peptides and fusion proteins and we use collaborations for the development of gene therapy products and small molecule drugs. We have discovered a large number of genes through our genomics capabilities and have developed a rapidly evolving product pipeline based on our discoveries.
We have seven products, including three therapeutic proteins, one antibody and three albumin fusion products that we have advanced into human clinical trials; two products are awaiting approval from FDA to enter human clinical trials; a tenth product, a gene therapy product based on a gene we discovered, has been licensed to Vascular Genetics, Inc. (VGI) and is in human clinical trials being conducted by VGI; an eleventh product, an enzyme that lowers levels of lipoprotein-associated phospholipase A2 (Lp-PLA2), was discovered by GlaxoSmithKline (GSK) as part of our collaboration with GSK and is also in human clinical trials being conducted by GSK. We have a number of additional products in preclinical development.
We have extensive capabilities in gene discovery, intellectual property protection and preclinical and clinical development and have established a manufacturing capability for the preparation of our proteins, antibodies and fusion proteins for human studies. We intend to add sales and marketing as appropriate and are currently adding additional manufacturing capabilities. We have established strategic partnerships with a number of leading pharmaceutical and biotechnology companies to leverage our capabilities and gain access to complementary technologies and sales and marketing infrastructure. Some of these partnerships provide us with research funding and milestone payments, along with royalty payments as products are developed and commercialized. We are also entitled to certain co-promotion, co-development, revenue sharing and other product rights.
We have not received any product sales revenue or royalties from product sales and do not anticipate revenues from product sales or from royalties on product sales in the next several years. From inception through December 31, 2001, we have received (1) $70.0 million in revenue, $55.0 million in equity payments and $1.0 million in a milestone payment pursuant to our collaboration agreements with GlaxoSmithKline, (2) payments of $87.5 million from additional collaboration partners and (3) an aggregate of $60.8 million from other collaborators, including common stock from Transgene S.A. valued at $25.7 million, $16.0 million from Pioneer Hi-Bred International, Inc., $9.0 million from Pharmacia & Upjohn Company, $5.0 million from Schering-Plough (in addition to certain payments received from Schering-Plough pursuant to our additional collaboration partner agreements), $3.0 million from F. Hoffmann-La Roche, $1.1 million from OraVax Merieux Co. and Merieux OraVax S.N.C., and $1.0 million from MedImmune. To date, we have received all of our revenue from payments made under our collaboration agreements with GlaxoSmithKline and, to a lesser extent, other agreements. The GlaxoSmithKline collaboration agreement and many of our other collaboration agreements expired in 2001 and will only generate additional milestone and royalty payments if our collaborators successfully develop drugs based on our technology. We may not receive any of these payments and may not be able to enter into additional collaboration agreements.
We expect that our revenue sources for at least the next several years may be limited to interest income, payments under various collaboration agreements to the extent milestones are met, payments from the sale of product rights and other payments from other collaborators and licensees under existing or future arrangements, to the extent that we enter into any future arrangements. We expect to continue to incur substantial expenses relating to our research and development efforts, which are expected to increase relative to historical levels as we focus on preclinical and clinical trials required for the development of therapeutic protein, antibody and fusion protein product candidates. As a result, we expect to incur continued and increasing losses over the next several years unless we are able to realize additional revenues under existing or new collaboration agreements. The timing and amounts of such revenues, if any, cannot be predicted with certainty and will likely fluctuate sharply. Results of operations for any period may be unrelated to the results of operations for any other period. In addition, historical results should not be viewed as indicative of future operating results.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our financial statements requiring significant estimates and judgments are as follows:
We carry our cash, cash equivalents, investments, other assets, accounts payable and accrued expenses and other accrued expenses at their respective fair values. Our other assets include deferred financing costs relating to our convertible subordinated notes. We are amortizing these costs over the life of the notes and, in the event the notes are converted to equity, we would reclassify the unamortized deferred financing costs to equity. We periodically monitor these fair values to determine if impairment write-downs are required.
We lease various real properties under operating leases that generally require us to pay taxes, insurance and maintenance. Two of our operating leases are commonly referred to as "synthetic leases". A synthetic lease is a form of off-balance sheet financing under which an unrelated third party funds 100% of the costs for the acquisition and/or construction of the property and leases the asset to the lessee, and at least 3% of the third party funds represent risk equity. Our synthetic leases are treated as operating leases for accounting purposes and financing leases for tax purposes. While we recently entered into these synthetic leases, we will periodically review the fair values of the properties being leased or constructed in order to determine potential accounting ramifications. Changes in the equity participation of the third parties could affect the classification of this lease from operating to financing. In that event, we would include both the cost and debt associated with the properties on our consolidated balance sheet. Additionally, under these leases we also provide a residual value guarantee which guarantees the lessor that the residual value of the leased assets will be at least equal to a specified amount at lease termination.
Revenue from non-refundable upfront license fees where we continue involvement through an obligation to provide access to our technology is recognized ratably over the period of obligation. Deferred revenues related to these obligations are recognized on a straight-line basis over the life of the obligation.
Revenue associated with performance milestones is recognized based on the achievement of the milestones, as defined in the respective agreements.
Research and development expenses include related salaries, contractor fees and allocated facility costs. Such costs are charged to research and development expense as incurred.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001 AND 2000
Revenues. We had revenues of $12.8 million and $22.1 million for the years ended December 31, 2001 and December 31, 2000, respectively. The 2001 revenue consisted of the recognition of $9.2 million in license fees and additional payments from collaborations with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA, the recognition of $2.6 million from the collaboration with Transgene, S.A. and $1.0 million in a milestone payment from GlaxoSmithKline. The 2000 revenue consisted of $18.5 million in license fees and additional payments from collaborations with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA, the recognition of $2.6 million from the collaboration with Transgene, S.A., and $1.0 million in license revenue from MedImmune. In 2000, the Company implemented Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 impacts the Company's revenues pertaining to its collaborative agreements with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA for both 2000 and 2001. See Note B of the Notes to Consolidated Financial Statements for additional discussion.
Expenses. Research and development expenses increased to $146.3 million for the year ended December 31, 2001 from $91.5 million for the year ended December 31, 2000, excluding the $134.1 million charge for Purchased in-process research and development in 2000. We expect to continue to incur substantial expenses relating to our research and development efforts, which expenses are expected to increase relative to historical levels as we focus on preclinical and clinical trials required for the development of our protein, antibody and fusion product candidates.
RESULTS OF OPERATIONS (CONTINUED)
YEARS ENDED DECEMBER 31, 2001 AND 2000 (CONTINUED)
We track our research and development expenditures by type of cost incurred - preclinical, clinical and manufacturing costs.
Our preclinical costs increased to $79.3 million for the year ended December 31, 2001 from $58.3 million for the year ended December 31, 2000. This increase is due primarily to expanded activities, including toxicology studies, needed to support our investigational new drug filings that were made or will be made in the future, along with expanded activities in the area of antibody development, including increased outside collaboration costs and milestone payments.
Our clinical costs increased to $27.8 million for the year ended December 31, 2001 from $11.1 million for the year ended December 31, 2000. This increase is due primarily to the cost of continuing ongoing trials from 2000 along with the cost of filing, initiating and sustaining new trials that began in 2001. We had seven drugs in eleven human clinical trials ongoing as of December 31, 2001 compared to four drugs in six human clinical trials ongoing as of December 31, 2000.
Our manufacturing costs increased to $39.2 million for the year ended December 31, 2001 from $22.1 million for the year ended December 31, 2000. This increase is due to the increased production activities within our process development and manufacturing facilities needed to support our increased clinical activities.
Purchased in-process research and development expense of $134.1 million for the year ended December 31, 2000 relates to the acquisition of Principia Pharmaceutical Corporation on September 8, 2000. This amount represents that portion of the $135.1 million purchase price allocated to in-process research and development. See Note C of the Notes to Consolidated Financial Statements for additional discussion.
General and administrative expenses increased to $38.7 million for the year ended December 31, 2001 from $27.1 million for the year ended December 31, 2000 to support the increase in our activities. The increase also resulted from increased market research costs in connection with our expanding clinical activities and higher legal expenses associated with filing and prosecuting a larger number of patent applications relating to genes and proteins we discovered. Patent expenses will continue to increase as additional applications are filed and existing applications are prosecuted in the United States and internationally.
Interest income was $105.9 million for the year ended December 31, 2001 compared to $62.2 million for the year ended December 31, 2000 due to higher average cash and short-term investment balances. While we had higher average cash balances, the yield on our investments was 6.1% for the year ended December 31, 2001 as compared to 6.7% for the year ended December 31, 2000. Our average cash balance decreased during 2001 as a result of our net loss and capital expenditures in 2001, partially offset by proceeds from the issuance of stock pursuant to our stock option and employee stock purchase plans. Interest expense increased for the year ended December 31, 2001 in comparison to the year ended December 31, 2000 due primarily to a full year of interest expense in 2001 relating to the issuance of $525.0 million of convertible subordinated notes during the first quarter of fiscal 2000 partially offset by a reduction in interest expense associated with previously-issued convertible subordinated notes that were converted to equity during the first quarter of fiscal 2000.
Charge for impaired investment of $22.3 million for the year ended December 31, 2001 relates to the reduction made to the carrying value in our equity investment in Transgene, S.A. We reduced the carrying value of this investment to $3.4 million from $25.7 million due to an impairment that we deemed to be other-than-temporary. See Note D of the Notes to Consolidated Financial Statements for additional discussion.
Debt conversion expenses decreased to $3.9 million for the year ended December 31, 2001 from $50.8 million for the year ended December 31, 2000. The debt conversion expenses of $3.9 million relate primarily to the second quarter of 2001 conversion of $25.0 million aggregate principal of 5% convertible subordinated notes due 2007 into equity. The debt conversion expenses of $50.8 million relate to the first quarter of 2000 conversion costs of $318.3 million aggregate principal amount of convertible subordinated notes into equity. We converted $118.3
RESULTS OF OPERATIONS (CONTINUED)
YEARS ENDED DECEMBER 31, 2001 AND 2000 (CONTINUED)
million of our $125.0 million aggregate principal amount of 5 1/2% notes due 2006 into common stock at a cost of $20.8 million, substantially all of which was paid in the form of common stock. In addition, we converted all of our $200.0 million aggregate principal amount of 5% notes due 2006 into common stock at a cost of $30.0 million, all of which was paid in cash. See Note I of the Notes to Consolidated Financial Statements for additional discussion.
Other income of $5.9 million for the year ended December 31, 2000 relates to the gain realized on the sale of 290,000 ordinary shares of our investment in Cambridge Antibody Technology. See Note D of the Notes to Consolidated Financial Statements for additional discussion.
Cumulative effect of a change in accounting principle of $8.3 million for the year ended December 31, 2000 relates to our implementation of SAB 101.
Net Income (Loss). We recorded a net loss of $117.2 million, or $0.92 per share, for the year ended December 31, 2001 compared to a net loss of $243.8 million, or $2.20 per share, for the year ended December 31, 2000. The decreased loss for 2001 compared to 2000 reflects the absence of Purchased in-process research and development expense of $134.1 million, or $1.21 per share, reduction of debt conversion expenses, an increase in net interest income and the affect of the cumulative effect of a change in accounting principle recognized in 2000, partially offset by the charge for impaired investment, decreased revenue and the increase in manufacturing operations, increased investment in the development of preclinical and clinical drug candidates, and increased general and administrative activities. Excluding the charge for impaired investment incurred in 2001, the charges for debt conversion expenses for both 2001 and 2000, the Purchased in-process research and development and the cumulative effect of a change in accounting principle incurred in 2000, our net loss would have been $90.9 million, or $0.72 per share for the year ended December 31, 2001, compared to $50.7 million, or $0.46 per share for the year ended December 31, 2000.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues. We had revenues of $22.1 million and $24.5 million for the years ended December 31, 2000 and December 31, 1999, respectively. The 2000 revenue consisted of $18.5 million in license fees and additional payments from collaborations with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA, the recognition of $2.6 million from the collaboration with Transgene, S.A., and $1.0 million in license revenue from MedImmune. The 1999 revenue consisted of $18.5 million in license fees and additional payments from collaborations with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA, the recognition of $4.2 million from the collaborations with Transgene, S.A. and Pharmacia, and $1.8 million in other revenue. SAB 101 impacted the Company's revenues pertaining to its collaborative agreements with Schering-Plough, Sanofi-Synthelabo, and Merck KGaA for 2000. See Note B of the Notes to Consolidated Financial Statements for additional discussion.
Expenses. Research and development expenses increased to $91.5 million for the year ended December 31, 2000 from $60.6 million for the year ended December 31, 1999, excluding the $134.1 million charge for Purchased in-process research and development in 2000. We track our research and development expenditures by type of cost incurred - preclinical, clinical and manufacturing costs.
Our preclinical costs increased to $58.3 million for the year ended December 31, 2000 from $41.2 million for the year ended December 31, 1999. This increase is due primarily to expanded activities, including toxicology studies, needed to support our investigational new drug filings that were made or will be made in the future, along with expanded activities in the area of antibody development, including increased outside collaboration costs.
Our clinical costs increased to $11.1 million for the year ended December 31, 2000 from $5.4 million for the year ended December 31, 1999. This increase is due primarily to the cost of expanding our clinical trials in 2000 compared to the prior year. We had four drugs in six human clinical trials ongoing as of December 31, 2000 compared to two drugs in four human clinical trials ongoing as of December 31, 1999.
Our manufacturing costs increased to $22.1 million for the year ended December 31, 2000 from $14.0 million for the year ended December 31, 1999. This increase is due to a full year of operations for our process
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2000 AND 1999
development and manufacturing facility in 2000, compared to 1999, when the facility commenced operations in the second quarter of 1999.
Purchased in-process research and development expense of $134.1 million for the year ended December 31, 2000 relates to the acquisition of Principia Pharmaceutical Corporation on September 8, 2000.
General and administrative expenses increased to $27.1 million for the year ended December 31, 2000 from $14.8 million for the year ended December 31, 1999 to support the increase in our activities. The increase also resulted from higher legal expenses associated with filing and prosecuting a larger number of patent applications relating to genes and proteins we discovered.
Interest income was higher for the year ended December 31, 2000 compared to the year ended December 31, 1999 due to higher average cash balances. In addition, the yield on our investments was 6.7% for the year ended December 31, 2000 as compared to 5.3% for the year ended December 31, 1999. Our average cash balance increased during 2000 as a result of the placement of two convertible subordinated note offerings during 2000, totaling $525.0 million and a public offering of common stock which raised net proceeds of $912.7 million. Interest expense increased for the year ended December 31, 2000 in comparison to the year ended December 31, 1999 due primarily to the issuance of $525.0 million of convertible subordinated notes during the first quarter of fiscal 2000.
We had debt conversion expenses of $50.8 million for the year ended December 31, 2000 but no debt conversion expenses in 1999.
Other income of $5.9 million for the year ended December 31, 2000 relates to the gain realized on the sale of 290,000 ordinary shares of our investment in Cambridge Antibody Technology. See Note D of the Notes to Consolidated Financial Statements for additional discussion.
Cumulative effect of a change in accounting principle of $8.3 million for the year ended December 31, 2000 relates to our implementation of SAB 101. As a result of the implementation of SAB 101, the Company recorded a charge of $8.3 million as a cumulative effect of a change in accounting principle, retroactive to January 1, 2000. See Note B of the Notes to Consolidated Financial Statements for additional discussion.
Net Income (Loss). We recorded a net loss of $243.8 million, or $2.20 per share, for the year ended December 31, 2000 compared to a net loss of $42.2 million, or $0.46 per share, for the year ended December 31, 1999. The difference in results for the years ended December 31, 2000 and 1999 is primarily due to the $134.1 million, or $1.21 per share, charge for purchased in-process research and development, the $50.8 million, or $0.46 per share, of debt conversion expenses, the $8.3 million, or $0.08 per share, charge for the cumulative effect of a change in accounting principle, higher operating expenses, and reduced collaboration partner revenues, offset by higher net interest income. Excluding the impact of the charge for purchased in-process research and development, debt conversion expenses, and the cumulative effect of a change in accounting principle, our net loss would have been $50.7 million, or $0.46 per share, compared to a net loss of $42.2 million, or $0.46 per share, for the year ended December 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
We had working capital of $1.5 billion at December 31, 2001 as compared to $1.7 billion at December 31, 2000. The decrease in working capital is due to our net loss and capital expenditures, along with an increase in our restricted investments, partially offset by proceeds from the issuance of common stock. Our restricted investments totaled approximately $144.9 million and $12.3 million at December 31, 2001 and 2000, respectively. Our restricted investments will increase to approximately $541.0 million by 2004 assuming the full amount of $450.0 million of lease financing is used for construction activities and our other collateral obligations remain in place. We will be required to maintain this collateral in the form of restricted investments until 2008, at which time all or a portion of the collateral may be used to satisfy our residual value guarantees under the leases or to exercise our options to acquire the related properties. As a result, this increase in restricted investments will reduce our working capital.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
We expect to continue to incur substantial expenses relating to our research and development efforts, which expenses are expected to increase relative to historical levels as we focus on preclinical and clinical trials required for the development of an increasing number of therapeutic protein, antibody and fusion protein product candidates. At December 31, 2001, we had outstanding commitments for construction and equipment purchases totaling approximately $16.3 million.
The amounts of expenditures that will be needed to carry out our business plans are subject to numerous uncertainties, which may adversely affect our liquidity and capital resources. We are proceeding with numerous clinical trials, including one multi-year repifermin trial involving over 500 patients. We have several Phase I and Phase II trials underway and expect to initiate additional trials each year. Completion of these trials may extend several years or more, but the length of time generally varies considerably according to the type, complexity, novelty and intended use of the drug candidate. We estimate that the completion periods for our Phase I, Phase II and Phase III trials could span one year, one to two years and two to four years, respectively. The duration and cost of our clinical trials are a function of numerous factors such as the number of patients to be enrolled in the trial, the amount of time it takes to enroll them and the number of clinical sites to be engaged in the trial.
We identify our potential drug candidates by conducting numerous preclinical studies. We may conduct multiple clinical trials to cover a variety of indications for each drug candidate. Based upon the results from our trials, we may elect to discontinue clinical trials for certain indications or certain drugs in order to concentrate our resources on more promising drug candidates. For example, in 2001, we announced that the results from our ulcerative colitis trials showed that our drug candidate, repifermin was safe and well-tolerated, but not shown to be effective. We are continuing to analyze the results to determine how to proceed with this indication.
We are advancing many drug candidates, including therapeutic proteins, antibodies and fusion proteins, in part, to diversify the risks associated with our research and development spending. In addition, our manufacturing plants have been designed to enable multi-product manufacturing capability. Accordingly, we believe our future financial commitments, including preclinical, clinical or manufacturing, are not substantially dependent on any single drug candidate. Should we be unable to sustain a multi-product drug pipeline, our dependence on the success of one or a few drug candidates would increase.
We must receive FDA approval to advance each of our products through each phase of clinical testing. Moreover, we must receive FDA regulatory approval to commercially launch any of our products. In order to receive such approval, the FDA must conclude that our clinical data establish safety and efficacy. We cannot be certain that we will establish sufficient safety and efficacy data to receive regulatory approval for any of our drugs.
In addition, part of our business plan includes collaborating with others. For example, GlaxoSmithKline ("GSK") is conducting human clinical trials of an enzyme discovered by GSK as part of our collaboration with GSK, that lowers levels of lipoprotein-associated phospholipase A2 (Lp-PLA2), as a treatment for cardiovascular disease. We have no control over the progress or completion of these trials. While we received a $1.0 million payment from GSK in connection with a development milestone met by GSK during 2001, we cannot forecast with any degree of certainty the likelihood of receiving future milestone or royalty payments. We also cannot forecast with any degree of certainty whether any of our current or future collaborations will affect our drug development efforts and therefore, our capital and liquidity requirements.
Because of the uncertainties discussed above, the costs to advance our research and development projects are difficult to estimate and may vary significantly. We expect that our existing funds and interest income will be sufficient to fund our operations for the next several years. Our future capital requirements and the adequacy of our available funds will depend on many factors, including scientific progress in our research and development programs (including our preclinical and clinical product development activities), the magnitude of those programs, the ability to establish collaborative and licensing arrangements, the cost involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and competing technological and market developments. There can be no assurance that any additional financing required in the future will be available on acceptable terms, if at all.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our future liquidity and capital resources will be affected by our contractual obligations. These obligations are summarized below:
(1) Certain of our current or future lease payments are based upon currently applicable interest rates. See additional discussion of these facility leases below.
(2) Certain of our operating leases contain residual value guarantees relating to two facility leases described below.
(3) Our unconditional purchase obligations relate primarily to commitments for capital expenditures, consisting primarily of laboratory space build-out and equipment.
(4) Because we cannot forecast with any degree of certainty whether any of our current collaborations will require us to make future milestone or royalty payments, we have excluded these amounts from the above table.
(5) For additional discussion of our debt obligations and lease commitments, see Notes I and J of the Notes to the Consolidated Financial Statements.
During 2001, we entered into two seven-year lease agreements (the "October 2001 lease" and the "November 2001 lease") relating to research, manufacturing, and administrative space either acquired or under construction by two trusts controlled by third parties established solely for that purpose. As part of these agreements, we are required to maintain collateral, in the form of restricted investments, in amounts equal to 100% of the financed project cost for the duration of the leases.
Under these lease agreements, which we have accounted for as operating leases, we have the option to purchase the properties, during and at the end of the lease terms, at an aggregate amount of approximately $526.0 million. Alternatively, we can cause the properties to be sold to third parties. We are contingently liable for the residual value guarantee associated with each property in the event the net sale proceeds are less than the original financed costs of the facilities. The residual value guarantee for the October 2001 lease and the November 2001 lease is approximately $64.6 million and $394.8 million, respectively, assuming the full amount of the financings is used for construction activities.
The October 2001 lease relates to a research and development complex adjacent to our current corporate campus. We are leasing this property for seven years from a trust established solely for this purpose by Allfirst Bank. The trust is leasing the property from the Maryland Economic Development Corporation ("MEDCO"), which is the owner of the property. The cost of the existing property along with a building currently under construction is approximately $76.0 million. We are required to maintain collateral in the form of marketable securities equal to 100% of the financed project cost with the lending institution for the duration of the lease. The rent under this lease is currently based on a floating interest rate, but the trust can lock in a fixed interest rate at any time at our request. To the extent the trust does not lock in a fixed interest rate, if interest rates increase, our rent obligations would also increase. If interest rates decrease, our rent obligations would decrease. As of December 31, 2001, the trust had fixed the interest rate on $56.0 million at approximately 4.5%. The remaining $20.0 million is floating based primarily on the seven-day LIBOR rate, which was approximately 1.98%, as of December 31, 2001.
We have a residual value guarantee of 85% of the total financed cost at lease termination. In the event of our default, we are responsible for 100% of the total financed cost of the project. Although the trust is responsible for servicing and repaying the debt and equity financings to various parties, we have made the residual value guarantee to the trust. This trust was established solely for this one lease. In the event the trust defaults to the lender
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
or in the event the trust is terminated, we have the right to cure the default or exercise our option to acquire the property. At any time during the lease term, we have the option to purchase legal and/or beneficial interest in the project for 100% of the lease balance plus any unpaid indemnity amounts.
The November 2001 lease relates to the construction of our research and development and administrative main campus and a large-scale manufacturing facility. We will lease these properties for approximately five years, following an estimated two-year construction period, from a trust established solely for this purpose by BancBoston Leasing Investment, Inc. and First Union National Bank. The trust has entered into agreements with BancBoston and First Union to provide financing for construction of the properties in the aggregate amount of $450.0 million. We are required to maintain collateral in the form of marketable securities equal to 100% of the financed project cost with the lending institutions for the duration of the lease. The rent under these leases is currently based on a floating interest rate, but the trust can lock in a fixed interest rate at any time at our request. To the extent the trust does not lock in a fixed interest rate, if interest rates increase, our rent obligations would also increase. If interest rates decrease, our rent obligations would decrease. At December 31, 2001, the floating interest rate based primarily on short-term commercial paper was approximately 1.86%.
We have retained ownership of the land for the main campus component of this project. We have entered into a ground lease with the trust for the land at fair market value rates. Thereafter, rent will be reduced to a nominal amount. We will record these lease payments on our balance sheet as deferred rental income over the two-year construction period and then amortize this deferral over the remaining term (approximately five years).
We have a residual value guarantee of 87.74% of the total financed cost at lease termination. In the event of default, we are responsible for 100% of the total financed cost of the project. During the construction period, we have a residual value guarantee of 89.9% of the financed cost incurred. Although the trust is responsible for servicing and repaying the debt and equity financings to various parties, we have made the residual value guarantee to the trust. This trust was established solely for this one lease. In the event the trust defaults to the lender or in the event the trust is terminated, we have the right to cure the default or exercise our option to acquire the property. At any time during the lease term, we have the option to purchase legal and/or beneficial interest in the project for 100% of the lease balance plus any unpaid indemnity amounts.
We understand that the accounting treatment for these leases may be changed by the Financial Accounting Standards Board in 2002. In that event, we may be required to include these leased facilities and the related lease obligations on our balance sheet as assets and liabilities.
Our commitments, and their expiration dates are as follows:
(1) The guarantee of 85.0% included above is based upon the loaned amount of $56.0 million as of December 31, 2001. Our guarantee will increase to approximately $64.6 million when we reach the full $76.0 million financed cost of the project at the end of the construction period.
(2) The construction-period guarantee of 89.9% included above is based upon a financed cost incurred of approximately $16.7 million as of December 31, 2001. Our post-construction guarantee will be 87.74% of financed project costs and will increase to approximately $394.8 million when we reach the full $450.0 million financed cost of the project at the end of the construction period.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
As of December 31, 2001, we had net operating loss carryforwards for federal income tax purposes of approximately $477.6 million, which expire, if unused, by the year 2021. We also have available research and development tax credit and other tax credit carryforwards of approximately $25.0 million, the majority of which will expire, if unused, by the year 2021.
Our funds may be invested in U.S. Treasuries, government agency obligations, high grade debt securities and various money market instruments rated "A" or better. Such investments reflect our policy regarding the investment of liquid assets, which is to seek a reasonable rate of return consistent with an emphasis on safety, liquidity and preservation of capital.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
Certain statements contained in "Item 1. Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are based on our current intent, belief and expectations. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Actual results may differ materially from these forward-looking statements because of our unproven business model, dependence on new technologies, uncertainty and timing of clinical trials, ability to develop and commercialize products, dependence on collaborators for services and revenue, substantial indebtedness, intense competition, uncertainty of patent and intellectual property protection, dependence on key management, uncertainty of regulation of products, dependence on key suppliers, the impact of future alliances or transactions and other risks that may be described in this filing and our other filings with the Securities and Exchange Commission. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today's date. We undertake no obligation to update or revise the information contained in this announcement whether as a result of new information, future events or circumstances or otherwise.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not have operations subject to risks of foreign currency fluctuations, nor do we use derivative financial instruments in our operations or investment portfolio. Our investment portfolio can be comprised of low-risk U.S. Treasuries, government agency obligations, high-grade debt having a rating of at least an "A" rating and various money market instruments. The short-term nature of these securities, which currently have an average term of approximately eighteen months, significantly decreases the risk of a material loss caused by a market change. We believe that a hypothetical 100 basis point adverse move (increase) in interest rates along the entire interest rate yield curve would adversely affect the fair value of our cash, cash equivalents and short-term and restricted investments by approximately $25.3 million, or approximately 1.5% of the aggregate fair value of $1.69 billion, at December 31, 2001. For these reasons, and because these securities are almost always held to maturity, we believe we do not have significant exposure to market risks associated with changes in interest rates related to our debt securities held as of December 31, 2001. We believe that any market change related to our investment securities held as of December 31, 2001 is not material to our consolidated financial statements. However, given the short-term nature of these securities, a general decline in interest rates would adversely affect the interest income from our portfolio as securities mature and are replaced with securities having a lower interest rate.
The facility leases we entered into during the fourth quarter of 2001 require us to maintain minimum levels of restricted investments as collateral for these facilities. By 2004, we expect our restricted investments for these leases to be approximately $526.0 million. We are also required to maintain approximately $15.0 million in restricted investments with respect to our process development and manufacturing facility leases. Although the market value for these investments may rise or fall as a result of changes in interest rates, we will be required to maintain this level of restricted investments in both a rising or declining interest rate environment.
The rent under certain of these facility leases is based on a floating interest rate. We can direct MEDCO or the trusts which own certain of the facilities and lease them to us to lock in a fixed interest rate. As of December 31, 2001, such a fixed rate for seven years would be approximately 5.46% compared to the floating rate as of December 31, 2001 of approximately 2.0%. If interest rates increase, our rent obligations would also increase, which would adversely affect our operating expenses.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
As of December 31, 2001, the carrying values of our equity investments in Transgene, Cambridge Antibody Technology (CAT) and Ciphergen were approximately $3.4 million, $38.7 million and $1.7 million, respectively. Our investments in Transgene and Ciphergen are subject to equity market risk. Our investment in CAT is denominated in pounds sterling and is subject to both foreign currency risk as well as equity market risk.
In 2001, we reduced the carrying value of our equity investment in Transgene to $3.4 million from $25.7 million due to an impairment of the value of the investment that we deemed to be other-than-temporary. See Note D of the Notes to Consolidated Financial Statements for additional discussion.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth on pages -.
ITEM 9.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
We incorporate herein by reference the information concerning directors and executive officers in our Notice of Annual Stockholders' Meeting and Proxy Statement to be filed within 120 days after the end of our fiscal year (the "2002 Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
We incorporate herein by reference the information concerning executive compensation to be contained in the 2002 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
We incorporate herein by reference the information concerning security ownership of certain beneficial owners and management to be contained in the 2002 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We incorporate herein by reference the information concerning certain relationships and related transactions to be contained in the 2002 Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report:
(1) Index to Consolidated Financial Statements
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not required.
(3) Exhibits
- -------------------------------------------------------------------------------
* Incorporated by reference.
(b) Reports on Form 8-K
We filed a Current Report on Form 8-K on July 6, 2001 announcing the expiration of the initial research term of our human gene therapeutic consortium.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HUMAN GENOME SCIENCES, INC.
BY: /S/ William A. Haseltine, Ph.D. -------------------------------- William A. Haseltine, Ph.D. Chairman and Chief Executive Officer
Dated: April 1, 2002
Pursuant to the requirements of 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 the dates indicated:
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders Human Genome Sciences, Inc. Rockville, Maryland
We have audited the accompanying consolidated balance sheets of Human Genome Sciences, Inc. as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these 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 consolidated financial position of Human Genome Sciences, Inc. at December 31, 2001 and 2000, and the consolidated results of its operations and its 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.
As discussed in Note B of Notes to Consolidated Financial Statements, in 2000 the Company changed its method of accounting for revenue recognition in accordance with guidance provided in Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements".
/s/ Ernst & Young LLP
McLean, Virginia February 12, 2002
HUMAN GENOME SCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
The accompanying Notes to Consolidated Financial Statements are an integral part hereof.
HUMAN GENOME SCIENCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying Notes to Consolidated Financial Statements are an integral part hereof.
HUMAN GENOME SCIENCES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARES)
The accompanying Notes to Consolidated Financial Statements are an integral part hereof.
HUMAN GENOME SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES (DOLLARS IN THOUSANDS):
In December 2001, the Company entered into a capital lease for computer equipment with an aggregate value of $763, with thirty-six monthly payments of $23 of principal and interest. No lease payments were made in 2001.
In June 2001, the Company converted $25,000 of 5% Convertible Subordinated Notes Due 2007 into common stock and incurred $3,875 in inducement costs paid in the form of common stock as an inducement to convert. In addition, the Company reclassified $673 of unamortized debt financing costs associated with these notes to stockholders' equity as part of the conversion.
During 2001, the Company converted an aggregate of $3,595 of 5 1/2% Convertible Subordinated Notes Due 2006 into common stock and incurred $19 in inducement costs paid in the form of cash as an inducement to convert. In addition, the Company reclassified $78 of unamortized debt financing costs associated with these notes to stockholders' equity as part of the conversion.
In January 2000, the Company converted $118,285 of 5 1/2% Convertible Subordinated Notes Due 2006 into common stock and incurred $19,433 in inducement costs paid in the form of common stock as an inducement to convert. In addition, the Company reclassified $3,470 of unamortized debt financing costs associated with these notes to stockholders' equity as part of the conversion.
In March 2000, the Company converted $200,000 of 5% Convertible Subordinated Notes Due 2006 into common stock. In connection with this conversion, the Company made a $30,000 cash "make-whole" payment. In addition, the Company reclassified $6,000 of unamortized debt financing costs associated with these notes to stockholders' equity as part of the conversion.
The accompanying Notes to Consolidated Financial Statements are an integral part hereof.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE A) - THE COMPANY
Human Genome Sciences, Inc. (the "Company") was incorporated and commenced operations on June 26, 1992. The Company is a leader in the genomics and biopharmaceutical industry focused on therapeutic product development and functional analysis of genes using its proprietary technology platform. The Company discovers, develops and intends to commercialize novel compounds for treating and diagnosing human disease based on the identification and study of genes. The Company focuses its internal product development efforts on therapeutic proteins, antibodies, peptides and fusion proteins and uses collaborations for the development of gene therapy products and small molecule drugs. The Company has discovered a large number of genes through its genomics capabilities and has developed a rapidly evolving product pipeline based on its discoveries. The Company's revenues are currently derived from license fees and research payments under collaboration agreements. The Company does not yet generate any revenues from product sales.
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of Human Genome Sciences, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investment instruments purchased with a maturity of three months or less to be cash equivalents.
The Company classifies its short-term investments into the categories: "held-to-maturity" and "available-for-sale," each of which has different accounting treatment. Investments in securities that are classified as available-for-sale and have readily determinable fair values are measured at fair market value in the balance sheets, and unrealized holding gains and losses for these investments are reported as a separate component of stockholders' equity until realized. Debt securities classified as held-to-maturity securities are carried at amortized cost. See Note D, Investments, for additional information.
Investment Risk
The Company has invested its cash in obligations of the U.S. Government and in high-grade corporate debt securities and various money market instruments. The Company's investment policy limits investments to certain types of instruments issued by institutions with credit ratings of "A" or better, and places restrictions on maturities and concentration by type and issuer.
Investments
Investments in which the Company has the ability to exercise significant influence over the investee, but less than a controlling voting interest, are accounted for under the equity method of accounting. Under the equity method of accounting, the Company's share of the investee's earnings or losses are included in operations, to the extent the
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Investments (continued)
Company has an investment or receivable from the investee company recorded as an asset plus the amount of any continuing commitment to fund the investee.
The Company's investment in Ciphergen Biosystems, Inc. ("Ciphergen") was accounted for under the cost method during the year ended December 31, 1999 and for the three months ended March 31, 2000 and June 30, 2000 because the Company owned a less than a 20% equity interest, did not have significant influence and the market value of the investees' common stock was not readily determinable (i.e., a privately held company). On September 29, 2000, Ciphergen successfully completed an initial public offering of its common stock. As of that date, the Company has accounted for its investment in Ciphergen as an available-for-sale security.
Depreciation and Amortization
Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets as follows:
Laboratory equipment....................... 3 - 10 years Computers and EDP equipment................ 3 years Furniture and office equipment............. 3 - 5 years Leasehold improvements..................... lesser of the lease term or the useful life
Impairment of Long-Lived Assets
Periodically, management determines whether any property and equipment or any other assets have been impaired based on the criteria established in Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of ("SFAS No. 121").
Fair Value of Financial Instruments
The carrying amounts for the Company's cash and cash equivalents, investments, other assets, accounts payable and accrued expenses and other accrued expenses reflected in the consolidated balance sheet at December 31, 2001 approximate their respective fair values.
Stock-Based Compensation
The Company accounts for its stock-based compensation in accordance with the provisions of APB No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and has provided the pro forma disclosures of net loss and net loss per share in accordance with SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123") using the fair value method. Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company's stock and the exercise price of the option and is recognized ratably over the vesting period of the option. The Company accounts for equity instruments issued to nonemployees in accordance with SFAS No. 123 and EITF 96-18, Accounting for Equity Instruments that are issued to other than employees for acquiring, or in conjunction with selling goods or services. See Note K, Stockholders' Equity, for further information.
Revenue Recognition
Collaborative research and development agreements provide for periodic license fees, research payments, additional payments and milestone payments. License fees, research payments, and additional payments are recognized ratably
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition (continued)
over the term of the agreement or as milestones are achieved. Payments received in advance of work performed are recorded as deferred revenue.
The Company previously recognized nonrefundable fees for certain arrangements entered into during 1996 as revenue when payments became due and when all significant contractual obligations of the Company relating to the fees had been fulfilled. Effective January 1, 2000, the Company changed its method of accounting for nonrefundable fees related to these certain arrangements to recognize such fees monthly over the term of the related research collaboration agreement. The Company believes the change in accounting principle is required based on interpretations provided in Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). See Change in Accounting Principle within Note B for additional discussion.
Research and Development
Research and development costs are charged to expense as incurred.
Financing Costs Related to Long-term Debt
Costs associated with obtaining long-term debt are deferred and amortized over the term of the related debt.
Patent Application Costs
Patent application costs are charged to expense as incurred.
Net Income (Loss) Per Share
The Company follows the provisions of SFAS No. 128, Earnings Per Share, which requires the Company to present basic and fully diluted earnings per share. The Company's basic and fully diluted loss per share are calculated by dividing the net loss by the weighted average number of shares of common stock outstanding during all periods presented.
Comprehensive Income (Loss)
SFAS No. 130, Reporting Comprehensive Income, requires unrealized gains or losses on the Company's available-for-sale short-term securities, and on the Company's long-term investments in Transgene S.A., Cambridge Antibody Technology and Ciphergen Biosystems to be included in other comprehensive income.
Comprehensive income (loss) included unrealized gains (losses) on the following:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Comprehensive Income (Loss) (continued)
During the fourth quarter of 2001, the Company recorded an impairment charge relating to its investment in Transgene in the amount of $22,314 and reversed the previously-recorded unrealized loss relating to this investment. As a result, the Company had an adjusted cost of $3,365 as determined by the market value of Transgene's publicly-traded common stock as of December 31, 2001 and no unrealized loss as of this same date. See Note D, Investments, for additional discussion.
Change in Accounting Principle
During the fourth quarter of 2000, the Company implemented SAB 101. SAB 101 provides guidance related to revenue recognition based on interpretations and practices followed by the SEC. SAB 101 requires revenues to be recognized ratably over the life of a contract period whereas previously, the Company generally recognized revenue as non-refundable cash payments were made assuming no significant obligations remained. It requires companies to report any changes in revenue recognition as a cumulative effect of a change in accounting principle at the time of implementation in accordance with APB No. 20, Accounting Changes.
Historically, the Company has recognized non-refundable license fees, research payments, additional payments and milestone payments in connection with collaboration agreements when the revenue is earned in accordance with the applicable performance requirements and/or contractual terms. This revenue recognition policy was applicable to certain multi-year agreements the Company entered into with Schering-Plough, Sanofi-Synthelabo and Merck KGaA during 1996 (the "1996 Agreements"). The Company recognized revenue under these agreements when it had performed all significant obligations and the customer was obligated to pay. The Company generally considered any remaining performance obligation, such as maintaining access to its genomic databases, as insignificant. However, SAB 101 provides guidance that indicates revenue recognition over the collaboration term is generally the required treatment for all fees, regardless of the significance of remaining performance obligations.
As a result of the implementation of SAB 101, the Company recorded a charge of $8,250, or $0.08 per share, as a cumulative effect of a change in accounting principle, retroactive to January 1, 2000. This amount represents that portion of revenue recognized in 1999 for which the contract periods of the 1996 Agreements extended into 2000. The implementation of SAB 101 had no effect on the Company's revenue for the year ended December 31, 2000. Had the change in accounting been adopted as of January 1, 1999, the Company's loss for the year ended December 31, 1999 would have increased by $8,250, or $0.09 per share. As a result of the implementation of SAB 101, the Company had additional deferred revenue as of December 31, 2000 in the amount of $8,250. The Company recorded this amount as revenue ratably over the first two quarters of 2001.
Pro forma financial information presented in the Consolidated Statements of Operations was calculated assuming the accounting change was applied retroactively to the periods presented.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations ("SFAS No. 141") and No. 142, Goodwill and Other Intangible Assets ("SFAS No. 142"), effective for the fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with these pronouncements. Other intangible assets will continue to be amortized over their useful lives. The Company does not expect adoption of SFAS No. 141 or 142 to have a material effect on its financial condition, results of operations or liquidity.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recent Accounting Pronouncements (continued)
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets ("SFAS 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121 and APB No. 30, Reporting the Results of Operations. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect adoption of SFAS No. 144 to have a material effect on its financial condition, results of operations or liquidity.
Sources of Supply
The Company is currently able to obtain its chemicals and equipment from various sources, and therefore, has no dependence upon a single supplier. The Company is currently dependent upon one manufacturer, MDS Nordion of Ottawa, Canada, for the radiolabeling of LymphoRad(131), a product for which the Company has filed an Investigation New Drug application with the FDA. No assurance can be given that the Company will be able to continue to obtain commercial quantities of this product at costs that are not economically prohibitive.
Reclassifications
Certain balances have been reclassified to conform to 2001 presentation.
(NOTE C) - ACQUISITION OF PRINCIPIA PHARMACEUTICAL CORPORATION
On September 8, 2000, the Company acquired all of the outstanding shares of capital stock of Principia Pharmaceutical Corporation ("Principia") from its stockholders. The cost of the acquisition was $135,071, including fees and expenses. The purchase price was paid with 1,582,204 shares of the Company's Common Stock. The Company valued the shares of the Company's common stock at $82.23 per share, which the Company estimates as the fair market value of its common stock on the acquisition date. The consolidated financial statements include the results of operations of Principia since the date of acquisition. In addition, the Company issued 49,364 incentive stock options at a weighted-average exercise price of $0.91 to replace the Principia options that were outstanding as of the date of the acquisition. The options were valued at approximately $4,000 using the Black-Scholes option-pricing model.
The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets and liabilities acquired at their estimated fair values as of the date of acquisition. Of the purchase price, $521 was allocated to Principia's net assets, and the remainder was allocated as follows:
The charge of $134,050 for Purchased In-Process Research & Development was recorded as an expense in the Company's results of operations for the year ended December 31, 2000. The Purchased In-Process Research & Development was analyzed through an independent third-party valuation using the expected cash flow approach to valuation.
The Company's unaudited pro forma consolidated condensed statements of operations information for the year ended December 31, 2000 and 1999, assuming the acquisition of Principia was effected at the beginning of each period, and including the one-time write-off of the Purchased In-Process Research and Development, are summarized as follows:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE C) - ACQUISITION OF PRINCIPIA PHARMACEUTICAL CORPORATION (CONTINUED)
This pro forma information does not purport to be indicative of the results which may have been obtained had the acquisition been consummated at the date assumed.
During the first quarter of 2001, the Company announced its decision to relocate Principia's operations from Norristown, Pennsylvania to the Company's Rockville, Maryland location. As a result, the Company recorded a one-time charge of approximately $1,950 in unit closure costs in the first quarter of 2001. Because most of the Principia employees chose not to relocate, this one-time charge included a write-off of $427, representing the remaining book value of the Assembled Workforce. During 2001, the Company incurred approximately $341 in personnel relocation costs which were charged to the consolidated statement of operations. As of December 31, 2001, the unit closure reserve had a balance of approximately $1,250.
(NOTE D) - INVESTMENTS
Investments, including accrued interest, at December 31, 2001 and 2000 were as follows:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE D) - INVESTMENTS (CONTINUED)
During the fourth quarter of 2001, the Company determined that its investment in Transgene, S.A. had incurred an other-than-temporary impairment, and accordingly, made an adjustment to the carrying value of this asset. As a result, the amortized cost for this investment has been reduced by $22,314 from $25,679 to $3,365, which was the fair market value of the investment as of December 31, 2001. The adjustment of $22,314 has been recorded as a charge in the consolidated statement of operations.
During 2001, the Company entered into two seven-year lease agreements (the "October 2001 lease" and the "November 2001 lease") relating to research, manufacturing, and administrative space either acquired or under construction by two trusts established solely for that purpose. The total financed cost of the facilities covered under the October 2001 lease and the November 2001 lease is approximately $76,000 and $450,000, respectively. By the conclusion of the construction period, the Company will be required to restrict investments equal to the full amount of the financed project costs, approximately $526,000 as collateral for the duration of the leases, assuming the full amount of the leases is used for construction purposes. In addition, the Company's restricted investments as collateral for the existing process development and manufacturing facility are $12,787 as of December 31, 2001 and with accrued interest, increase to $15,000, bringing the total collateral requirements of the Company to $541,000. At December 31, 2001, the Company had pledged $144,901 in connection with these leases, which is classified as restricted investments on the consolidated balance sheet.
The following table summarizes maturities of our investment securities at December 31, 2001:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE D) - INVESTMENTS (CONTINUED)
The Company's short-term investments include mortgage-backed securities with an aggregate cost of $174,610 and an aggregate fair value of $177,679 at December 31, 2001. The Company's restricted investments include mortgage-backed securities with an aggregate cost of $13,464 and an aggregate fair value of $13,796 at December 31, 2001. These securities have no single maturity date and accordingly, have been allocated on a pro rata basis to each maturity range based on each maturity range's percentage of the total value.
The Company's gross proceeds, realized gains and realized losses from its investments are as follows:
In 2001, the realized gains and losses relate to the Company's short-term investments and are included in interest income in the consolidated statement of operations. In 2000, the realized gain relates to the Company's sale of 290,000 ordinary shares of Cambridge Antibody Technology in November 2000 and is included in other income in the consolidated statement of operations. These ordinary shares were included in the Company's April 2000 purchase of 1,670,000 ordinary shares of CAT for the sterling equivalent of approximately $54,744, which gave the Company an equity stake of approximately six percent in CAT. In November 2000, the Company sold 290,000 ordinary shares for approximately $15,368, realizing a gain of approximately $5,861. As of December 31, 2001, the Company adjusted the investment of the remaining 1,380,000 ordinary shares to the current market value of $38,739 with an offsetting debit of $6,498 to accumulated other comprehensive income within the Company's stockholders' equity section of the balance sheet. Gross proceeds and realized gains and losses on all other sales of investments for 2000 and 1999 were immaterial. The cost of securities sold is based on the specific identification method.
(NOTE E) - COLLABORATION AGREEMENTS
Agreements with SmithKline Beecham Corporation (now GlaxoSmithKline Corporation)
In May 1993, the Company entered into a collaboration agreement as amended ("SB Collaboration Agreement"), providing SmithKline Beecham Corporation ("SB"), now GlaxoSmithKline Corporation ("GSK"), a first right to develop and market products in human and animal healthcare ("SB Products"), based upon human genes identified by the Company. In return, GSK has paid $126,000 to the Company since 1993. Approximately $55,000 was allocated to the purchase price of 5,406,952 shares of common stock with the balance of $71,000 recognized from license fees, option rights and milestone payments. In addition, the Company is entitled to (1) royalties on the net sales of SB Products, (2) product development progress payments and (3) the option to co-promote up to 20% of any product developed by SB under the collaboration agreement.
In June 1996, the SB Collaboration Agreements were substantially amended (the "SB Amendment") to allow the Company and SB together to enter into collaboration agreements with additional pharmaceutical companies ("Collaboration Partners") in certain pre-specified areas ("the SB Field"). The SB Amendment restricted the Company from entering into further collaborations in the SB Field during the initial research term, which expired in June 2001.
The SB Amendment provides that GSK and the Company share equally in any license fee payments paid by the Collaboration Partners and that the Company will receive all royalties and research payments paid by the Collaboration Partners.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE E) - COLLABORATION AGREEMENTS (CONTINUED)
Agreements with SmithKline Beecham Corporation (now GlaxoSmithKline Corporation) (continued)
In 2001, the Company received a $1,000 payment from GSK in connection with a development milestone met by GSK during the year.
Other Collaboration Agreements in the SB Field
In June 1995, the Company entered into an Option and License Agreement with Takeda Chemical Industries, Ltd. ("Takeda") pursuant to which Takeda was granted an exclusive option to license rights under the Company's patents and technology in the field of human healthcare (other than gene therapy, antisense and diagnostics) to make and sell a limited number (equal to the number of collaboration partners other than SB and Takeda with which the Company enters into collaboration agreements in the SB Field) of products in Japan. In consideration of the grant of the option, Takeda paid the Company $5,000, which was recognized as revenue by the Company in 1995, and agreed to pay to the Company royalties based on the sale of Takeda products covered by the Option and License Agreement and certain milestone payments.
In June 1996, the Company and SB entered into collaboration agreements ("Additional Collaboration Partner Agreements") with Schering Corporation and Schering-Plough Ltd. ("Schering-Plough"), Sanofi-Synthelabo S.A., and Merck KGaA ("Merck"), (collectively "Additional Collaboration Partners"). The Additional Collaboration Partner Agreements provide the Additional Collaboration Partners the rights and licenses to access the Company's human gene technology, as well as biological information developed by the Company and SB prior to, and in the case of the Company, after the effective date of such Agreement, to discover, develop and commercialize products based upon or derived from such Company technology in the SB Field (other than diagnostics and animal healthcare). The Additional Collaboration Partners are obligated to pay license fees, research payments, milestone payments and royalties in connection with the agreements. The initial research term expired in June 2001. The Company received aggregate license fees and research payments due under the Additional Collaboration Partner Agreements in the amount of $87,500, paid in equal installments over a five-year period, beginning in 1996. The Company has recognized revenue of $9,250, $17,500 and $17,500 in license fees and additional payments during 2001, 2000 and 1999, respectively, related to the Additional Collaboration Partner Agreements. In 2000, the Company implemented SAB 101. SAB 101 impacted the Company's revenues pertaining to these agreements for 2001 and 2000. See Note B, Summary of Significant Accounting Policies, for additional discussion.
Post-Initial Research Term
The initial research term under the collaboration agreements with GlaxoSmithKline and the other four collaboration partners expired on June 30, 2001. As of June 30, 2001, the Company's partners were pursuing approximately 430 research programs involving approximately 280 different genes for the creation of small molecule and antibody drugs. They also were developing approximately 30 therapeutic protein drugs. The Company cannot provide any assurance that any of these programs will be continued or result in any approved drugs.
Collaborative Agreements Outside of the SB Field
During 1996, the Company entered into several collaborative agreements with an initial aggregate research value of $33,000. These collaboration partners included Pioneer Hi-Bred International, Inc., Pharmacia & Upjohn Company, Schering-Plough Ltd. and F. Hoffman-La Roche, Ltd. The Company received no payments and did not recognize any revenues in 2001 pursuant to these agreements. For fiscal years 2000 and 1999, respectively, the Company received payments of $1,000 from these collaborators in each year and recognized revenue of $1,000 and $2,600 pursuant to these agreements. In addition, the Company received $1,000 in revenue in 2000 from MedImmune, Inc. pursuant to a 1995 license and royalty agreement.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE E) - COLLABORATION AGREEMENTS (CONTINUED)
Collaborative Agreements Outside of the SB Field (continued)
In March 1998, the Company entered into a gene therapy collaboration agreement with Transgene, S.A. ("Transgene"), of Strasbourg, France. Under this agreement, the Company received a 10% equity interest in Transgene valued at $25,679 based on Transgene's initial public offering ("IPO") share price in exchange for giving Transgene the right to develop and co-market gene therapy products from 10 genes selected by Transgene from the Company's database. The Company initially recorded its investment in Transgene at the IPO price with an offsetting entry to deferred revenue. The Company is recognizing the $25,679 of revenue from this transaction over the shorter of the ten-year term of the agreement or prorated upon the selection of genes by Transgene. The Company recognized $2,568 as revenue in fiscal years 2001, 2000 and 1999.
In August 1999, the Company entered into a collaborative agreement with Cambridge Antibody Technology Ltd. ("CAT") of Melbourn, United Kingdom to jointly pursue the development of fully human monoclonal antibody therapeutics. Under the agreement, CAT will conduct research to identify fully human, monoclonal antibodies specific for the Company's proprietary proteins. CAT will receive milestone payments from the Company in connection with the development of any such antibodies as well as royalty payments on the Company's net sales of such licensed product following regulatory approval. During 2000 and 1999, the Company paid CAT a total of $62 and $313, respectively, towards the achievement of the first contractual milestone. In addition, during 2000, the Company paid $375 based on the achievement of the first milestone pursuant to this agreement. The agreement provides for additional payments to CAT for each product relating to the achievement of milestones corresponding to the regulatory approval process. In the event of the achievement of other milestones or successful product launch, the Company would be obligated to pay CAT additional compensation and royalties. Subject to early termination under certain circumstances, this agreement will expire on the later of the expiration date of certain CAT patents or ten years after the date of first commercial sale of a product licensed by the Company.
In December 1999, the Company entered into a collaborative agreement, which was amended in 2001, with Abgenix, Inc. ("ABX"), of Fremont, California to exchange technology to identify novel human antibody drug candidates for development and commercialization. The Company has the right to use ABX's proprietary technology to generate fully human antibody drug candidates. In addition, ABX has a future option to develop and commercialize products derived from the Company's pool of novel human antibody drug candidates. Under this reciprocal agreement, depending upon which party's product moves through the regulatory approval process, the Company or ABX would be obligated to the other for milestone payments for each therapeutic product or each diagnostic product along with royalties in the event of a successful product launch. Subject to early termination under certain circumstances, this agreement will expire on the last of each party's royalty obligations.
In February 2000, the Company entered into a second agreement with Cambridge Antibody Technology. The ten-year agreement provides the Company with rights to use CAT technology to develop and sell an unlimited number of fully human antibodies for therapeutic and diagnostic purposes. The Company also has rights to use CAT antibody technology for the use and sale of research tools, for which the Company will pay CAT a share of revenues received. The Company will also pay CAT clinical development milestones and royalties based on product sales. The Company and CAT also plan to combine resources to develop and sell therapeutic antibody products. CAT has the right to select up to twenty-four of the Company's proprietary antigens for laboratory development. The Company has the option to share clinical development costs and to share the profits equally with CAT on up to eighteen such products. CAT has rights to develop six such products on its own. The Company is entitled to clinical development milestones and royalty payments on the products developed by CAT. In December 2001, the Company exercised an option to enter into an exclusive development partnership with CAT relating to a fully human monoclonal antibody and paid $1,000 to CAT in accordance with the terms of this agreement.
In March 2000, the Company paid $12,000 in licensing fees to CAT, which includes research support at CAT for ten years to help CAT develop the Company's human antibody products. The Company has capitalized this cost and is
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE E) - COLLABORATION AGREEMENTS (CONTINUED)
Collaborative Agreements Outside of the SB Field (continued)
amortizing it on a straight-line basis of ten years. The unamortized amount of this research support was $9,800 and $11,000 as of December 31, 2001 and 2000, respectively.
In March 2000, the Company entered into a multi-year agreement with Dyax Corporation ("Dyax"), which was amended in July 2001. The agreement, as amended, provides the Company with rights to use Dyax's technology for ten years to develop an unlimited number of therapeutic and diagnostic products which the Company may elect to market itself or to out-license. The amended agreement also modifies the existing collaborative terms and now requires the Company to make minimum quarterly payments of $250 to Dyax in exchange for research services to be provided to the Company through the first quarter of 2003. The Company will also pay Dyax clinical development milestones and royalties based on product sales. In 2000, the Company paid $6,000 to Dyax for the technology license, which the Company has capitalized and is amortizing on a straight-line basis over five years, which is the term of the collaboration agreement. The unamortized amount of this license fee was $3,900 and $5,100 as of December 31, 2001 and 2000, respectively. The Company paid $2,623 and $2,075 in support payments during 2001 and 2000, respectively.
The Company's other ongoing technology collaborations as of December 31, 2001 are as follows:
During 2001, the Company paid an aggregate of $942 in research services to certain of the above collaborators. No payments for research services were paid to these collaborators in 2000 or 1999. While future license or royalty payments may occur in the future in connection with these collaborations, no license or royalty payments were made or received during 2001, 2000 or 1999.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE F) - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost and are summarized as follows:
The Company entered into a capital lease for computer equipment in 2001. The capital lease is included in the Computer and EDP equipment amount above, at a cost of $763 and accumulated amortization of $21 as of December 31, 2001. Amortization expense for this equipment is included in depreciation and amortization within the consolidated statements of cash flows.
(NOTE G) - OTHER ASSETS
Other assets are comprised of the following:
Deferred financing costs were incurred in connection with the Company's four convertible subordinated debt offerings during fiscal 2000 and 1999. During the first quarter of 2000, the Company completed the private placement of $225,000 of 5% Convertible Subordinated Notes due 2007 and $300,000 of 3 3/4% Convertible Subordinated Notes due 2007. Debt issuance costs for the total $525,000 of Notes amounted to approximately $16,305, representing primarily underwriting fees of approximately 3% of the gross amount of notes, and are being amortized on a straight-line basis which approximates an effective interest method over the life of the Notes.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE G) - OTHER ASSETS (CONTINUED)
During 1999, in connection with the private placement of $125,000 of 5 1/2% Convertible Subordinated Notes due 2006 and $200,000 of 5% Convertible Subordinated Notes due 2006, the Company incurred financing costs of approximately $10,174, representing primarily underwriting fees of 3% of the gross amount of notes issued. These costs were being amortized on a straight-line basis over the life of the Notes. However, in January 2000, the Company completed a tender offer to substantially all of the holders of the 5 1/2% Convertible Subordinated Notes due 2006, which resulted in a reclassification of $3,470 of unamortized deferred financing costs associated with these Notes to stockholders' equity. In March 2000, the Company announced and completed the call of its $200,000 5% Convertible Subordinated Notes due 2006. As a result, the Company reclassified $6,000 of remaining unamortized debt financing costs to stockholders' equity as part of the conversion.
During 2001, the Company converted an aggregate of $28,595 of convertible subordinated notes to common stock. In addition, the Company reclassified $751 of unamortized debt financing costs associated with these notes to stockholders' equity as part of the conversion. See Note I, Long-Term Debt, for additional discussion.
See Note E, Collaboration Agreements, for discussion of prepaid research services and license fees relating to Cambridge Antibody Technology and Dyax Corporation, respectively. Prepaid research services also includes $500 paid to MDS Nordion that will be amortized over an eighteen-month period beginning in 2002 in connection with future services to be provided to the Company.
The Company holds a note receivable from an officer of $891 that is due on demand and does not bear interest. The note is collateralized by shares of the Company's common stock owned by the officer that have a market value of at least 200% of the outstanding balance of the note.
See Note C, Acquisition of Principia Pharmaceutical Corporation, for discussion of Principia Assembled Workforce and the write-off of this asset in 2001.
(NOTE H) - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are comprised of the following:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE I) - LONG-TERM DEBT
The components of long-term debt are as follows:
Annual maturities of all long term debt are as follows:
2002 $ 444 2003 448 2004 -- 2005 -- 2006 3,120 2007 and thereafter 499,900 -------- $503,912 ========
In December 1994, the Company entered into a loan agreement with Maryland Industrial Development Financing Authority ("MIDFA"). Major leasehold improvements were financed with the proceeds of a $4,000 taxable variable rate bond issue (the "Bonds") from MIDFA. The Company is required to make annual payments of $444 commencing December 1995 plus interest at a variable rate of interest (1.84% at December 31, 2001 and 6.57% at December 31, 2000), to the trustee on behalf of the bondholders which is equal to the interest and principal requirements on the bonds. The variable rate is equal to 50 basis points plus the higher of the yield equivalent of the average 30-day or 90-day commercial paper rate. Under certain circumstances, the rate may be adjusted either upward or downward but in no event in excess of 10 basis points above or below the rate determined above. MIDFA has entered into an indenture with the Trustee whereby the Trustee has obtained an irrevocable letter of credit on behalf of the bondholders.
Required monthly principal payments of $37 plus interest are deposited into a bond fund. The interest is disbursed monthly to the bondholders. Principal is repaid to the bondholders at the rate of $444 annually with a final payment of $448 on December 1, 2003. The Company deposited $502, $559 and $561 of principal and interest into the bond fund during the years ended December 31, 2001, 2000 and 1999, respectively.
In connection with the loan agreement, the Company entered into an irrevocable Letter of Credit Agreement with a bank for the account of the Company and in favor of the trustee in the initial amount of $4,067, which expires on December 15, 2003. Concurrently, the Company entered into a Collateral Pledge Agreement with the bank. The Company is required to maintain 43% of the outstanding principal amount of the Bonds (50% is required under certain circumstances) with the bank as Collateral for the Letter of Credit. Pursuant to the Collateral Pledge Agreement at December 31, 2001 and 2000, the Company had $1,164 and $1,123, respectively, on deposit with the bank, which is included in Restricted Investments in the consolidated balance sheets. The pledge collateral will be released upon the payment and performance in full of the Company's Letter of Credit obligations. The agreement
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE I) - LONG-TERM DEBT (CONTINUED)
contains covenants with respect to tangible net worth, cash and cash equivalents and investment securities, as well as other covenants, and prohibits the payment of cash dividends.
During the second quarter of 1999, the Company completed the private placement of $125,000 of 5 1/2% Convertible Subordinated Notes due June 2006 convertible into common stock at $13.05 per share. In January 2000, the Company concluded an offer to the holders of its $125,000 aggregate principal amount of 5 1/2% Notes to convert their notes into common stock. As an inducement to convert, the Company offered its 5 1/2% Note holders an additional one hundred and eighty dollars per thousand dollars of principal amount of the 5 1/2% Notes, payable in the Company's common stock. This inducement was in addition to the 76.6284 shares issuable for each thousand dollars of principal amount of 5 1/2% Notes convertible at $13.05 per share. As a result of the conversions, the Company converted $118,285 of 5 1/2% Notes to common stock and issued a total of 9,572,208 shares of common stock, including a total of 508,244 shares of common stock issued as an inducement to convert. In the first quarter of fiscal 2000, the Company recorded a one-time charge of $20,818, including $19,433 in inducement costs associated with this conversion. In addition, the Company reclassified $3,470 of unamortized debt financing costs to stockholders' equity as part of the conversion. During 2001, holders of $3,595 of these 5 1/2% Notes voluntarily converted their Notes into 275,477 shares of common stock. In addition, the Company reclassified $78 of unamortized debt financing costs to stockholders' equity as part of the conversions. Total remaining debt issuance costs were approximately $111 and $213, of which $40 and $46 had been amortized as of December 31, 2001 and 2000, respectively.
During the fourth quarter of 1999, the Company completed the private placement $200,000 of 5% Convertible Subordinated Notes due December 2006, convertible into common stock at $35.8125 per share. In March 2000, the Company announced and completed the call of its $200,000 aggregate principal amount of 5% Convertible Subordinated Notes due 2006. All of the holders of the notes converted their notes into common stock at a price of $35.8125 per share, which is equivalent to 27.9232 shares of common stock per one thousand dollars of principal amount of notes. As a result of the conversion, the Company issued 5,584,584 shares of common stock to the holders of these Notes. In addition, the Company made a "make-whole" payment of one hundred and fifty dollars per one thousand dollars of principal amount of notes, which resulted in a one-time charge to earnings of $30,000. In addition, the Company reclassified $6,000 of unamortized debt financing costs to stockholders' equity as part of the conversion.
During the first quarter of 2000, the Company completed the private placement of $225,000 of 5% Convertible Subordinated Notes due 2007 ("5% Notes") and $300,000 of 3 3/4% Convertible Subordinated Notes due 2007 ("3 3/4% Notes"). The 5% Notes and the 3 3/4% Notes are convertible into common stock at $56.25 and $109.50 per share, respectively. Debt issuance costs for the total $525,000 of Notes amounted to approximately $16,305, including accrued expenses, of which $2,035 had been amortized as of December 31, 2000. During 2000, holders of $100 of these 5% Notes voluntarily converted their Notes into 1,776 shares of common stock. During 2001, holders of $25,000 of these 5% Notes voluntarily converted their Notes into 506,690 shares of common stock. In addition, the Company reclassified $673 of unamortized debt financing costs to stockholders' equity as part of the conversions. Total remaining debt issuance costs were approximately $15,468 and $16,299, of which $4,135 and $2,035 had been amortized as of December 31, 2001 and 2000, respectively
In connection with the Company's acquisition of Principia Pharmaceutical Corporation ("Principia") in the third quarter of 2000, the Company acquired equipment debt to GE Capital Corporation. As of the date of Principia's acquisition, the unpaid debt was approximately $1,000. Because this debt carried an interest rate of 12.6%, the Company repaid the remaining amount of this debt during 2001.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE J) - COMMITMENTS AND OTHER MATTERS
Leases
The Company leases office and laboratory premises and equipment pursuant to operating leases expiring at various dates through 2021. The leases contain various renewal options. Minimum annual rentals are as follows:
Operating Capital Year Ending December 31, Leases Lease ---------------------------------- --------------- ---------
2002 $ 16,057 $ 241 2003 15,730 255 2004 21,635 247 2005 21,297 - 2006 20,395 - 2007 and thereafter 96,533 - ------ ----- $ 191,647 743 ======= Current portion under capital lease 241 ----- Long-term obligation under capital lease $ 502 =====
During 1997 and 1999, the Company entered into two long-term leases expiring January 1, 2019 for a process development and manufacturing facility aggregating 127,000 square feet and built to the Company's specifications. Annual base rent under the leases is $3,765. Pursuant to the terms of these leases, the Company had security deposits of $12,787 and $12,332 as of December 31, 2001 and 2000, respectively, on deposit with the financing bank which is included in Restricted Investments in the consolidated balance sheets. The security deposit will accrue interest up to a total security deposit of $15,000. Any amounts over $15,000 will be released to the Company. The security deposit will be released at the end of the lease term. The lease agreements contain covenants with respect to tangible net worth, cash and cash equivalents and investment securities, as well as other covenants. The leases require additional security deposit if the Company does not meet its covenants. The Company has an option, but not an obligation, to purchase these facilities during the lease term at various prices or at the end of the lease term for an aggregate price of approximately $19,400.
During 2001, the Company entered into two seven-year lease agreements (the "October 2001 lease" and the "November 2001 lease") relating to research, manufacturing, and administrative space the Company either acquired or has under construction by two trusts established solely for that purpose. The total financed cost of the facilities anticipated to be covered under the October 2001 lease and the November 2001 lease is approximately $76,000 and $450,000, respectively. Rent obligations for the October 2001 lease began in 2001, while rent obligations for the November 2001 lease do not begin until the end of the construction period, which is currently anticipated as 2004. The Company's rent obligations will approximate the lessor's debt service costs. With respect to the Company's rent for October 2001 lease, as of December 31, 2001, the trust had fixed the interest rate on $56,000 at approximately 4.5%. The remaining $20,000 is floating based primarily on the seven-day LIBOR rate, which was approximately 1.98%, as of December 31, 2001.
The Company's operating lease commitments include minimum annual rentals for these leases and have been computed using either the locked-in interest rate or the applicable floating interest rate as of December 31, 2001. Over the life of these leases, an aggregate rent obligation of approximately $65,816 has been included in the Company's total operating lease commitment.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE J) - COMMITMENTS AND OTHER MATTERS (CONTINUED)
Leases (continued)
With respect to the November 2001 lease, the Company has retained ownership of the land for the main campus component of this project. The Company has entered into a ground lease with the trust for the land at fair market value rates. Thereafter, rent will be reduced to a nominal amount. The Company will record these lease payments on its balance sheet as deferred rental income over the two-year construction period and then amortize this deferral over the remaining term (approximately five years).
Under these lease agreements, which the Company has accounted for as operating leases, the Company has the option to purchase the properties, during or at the end of the lease terms, at an aggregate amount of approximately $526,000. Alternatively, the Company can cause the properties to be sold to third parties. The Company is contingently liable for the residual value guarantee associated with each property up to an aggregate amount of $459,430, assuming the full amount of the leases is used for construction activities.
With respect to the October 2001 lease, the Company has a residual value guarantee of 85% of the total financed cost at lease termination. In the event of the Company's default, the Company is responsible for 100% of the total financed cost of the project. Although the trust is responsible for servicing and repaying the debt and equity financings to various parties, the Company has made the residual value guarantee to the trust. In the event the trust defaults to the lender or in the event the trust is terminated, the Company has the right to cure the default or exercise its option to acquire the property. At any time during the lease term, the Company has the option to purchase legal and/or beneficial interest in the project for 100% of the lease balance plus any unpaid indemnity amounts.
With respect to the November 2001 lease, the Company has a residual value guarantee of 87.74% of the total financed cost at lease termination. In the event of default, the Company is responsible for 100% of the total financed cost of the project. During the construction period, the Company has a residual value guarantee of 89.9% of the financed cost incurred. Although the trust is responsible for servicing and repaying the debt and equity financings to various parties, the Company has made the residual value guarantee to the trust. In the event the trust defaults to the lender or in the event the trust is terminated, the Company has the right to cure the default or exercise its option to acquire the property. At any time during the lease term, the Company has the option to purchase legal and/or beneficial interest in the project for 100% of the lease balance plus any unpaid indemnity amounts.
In connection with the October 2001 lease, the Company must maintain minimum levels of unrestricted cash, cash equivalents and marketable securities. In connection with the November 2001 lease, the Company must maintain minimum levels of unrestricted cash, cash equivalents and marketable securities and certain debt ratios.
The Company has entered into leases for office and laboratory space which provide for certain rent abatement and rent escalations on each anniversary of the lease commencement date. For financial reporting purposes, rent expense is charged to operations on a straight-line basis over the term of the lease, resulting in a liability for deferred rent of $2,439 and $2,705 at December 31, 2001 and 2000, respectively.
Certain other leases provide for escalation for increases in real estate taxes and certain operating expenses, as well as various renewal terms.
Rent expense aggregated $14,713, $8,352 and $7,210 for the years ended December 31, 2001, 2000 and 1999, respectively.
Capital Expenditures
At December 31, 2001 and 2000, the Company had commitments for capital expenditures, consisting primarily of laboratory space and equipment, of approximately $16,300 and $3,637, respectively.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE J) - COMMITMENTS AND OTHER MATTERS (CONTINUED)
401(k) Plan
The Company has adopted a 401(k) pension plan available to eligible full-time employees. The Company made contributions of $857, $600 and $446 to the plan for the years ended December 31, 2001, 2000 and 1999, respectively.
(NOTE K) - STOCKHOLDERS' EQUITY
Common Stock and Preferred Stock
On May 23, 2001, the Company's stockholders approved an amendment to the Company's Restated Certificate of Incorporation (Fifth) which increased the Company's authorized common stock to 400,000,000 from 250,000,000 shares. In addition, the Company's stockholders approved an amendment to the 2000 Stock Incentive Plan which established a limit on the number of shares of common stock that may be issued with respect to awards granted each year. For 2001, 2002 and 2003, this limit will be equal to five percent of the outstanding common stock as of the end of the preceding fiscal year. Shares that are available for a given year but not subject to awards granted in that year will be carried forward ("Carryover Shares") to the following year. After 2003, only the carried forward shares and the shares that are returned to the pool of available shares due to award forfeitures, will be available for issuance. Following stockholder approval on May 23, 2001, five percent of the outstanding common stock as of December 31, 2000, or 6,259,627 shares, were reserved for issuance under the 2000 Plan.
On January 5, 2000, the Company's Board of Directors approved a two-for-one stock split to be effected in the form of a stock dividend payable to stockholders of record as of January 14, 2000. On January 28, 2000, the Company effected the two-for-one stock split.
On September 12, 2000, the Company's Board of Directors approved a two-for-one stock split to be effected in the form of a stock dividend payable to stockholders of record as of September 28, 2000. On October 5, 2000, the Company effected the two-for-one stock split.
On November 1, 2000, the Company completed a public offering of its common stock by issuing 12,650,000 shares at an aggregate value of $948,750, or $75.00 per share. Stock issuance costs for the offering amounted to approximately $36,092. The Company received net proceeds of $912,658.
All share, per share and common stock amounts presented in the financial statements and related footnotes for all periods presented have been restated to reflect the two two-for-one stock splits effected during 2000.
Stock Option Plans
The Company has stock option plans under which options to purchase shares of the Company's common stock may be granted to employees, consultants and directors at a price no less that the fair market value on the date of grant. At December 31, 2001, the total authorized number of shares under all plans was 40,372,299. The vesting period of the options is determined by the Board of Directors and is generally four years. All options expire after ten years from the date of grant.
The Company issued 10,000, 2,600 and 48,000 options to non-employees during the years ended December 31, 2001, 2000 and 1999, respectively. The fair value of these options is being amortized to expense over the service period.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE K) - STOCKHOLDERS' EQUITY (CONTINUED)
Common Stock and Preferred Stock (continued)
Option transactions during 2001, 2000 and 1999 are summarized as follows:
The following table summarizes information about stock options outstanding at December 31, 2001:
Employee Stock Purchase Plan
During 2000, the Company's stockholders approved the establishment of an Employee Stock Purchase Plan that qualifies under Section 423 of the Internal Revenue Code and permits substantially all employees to purchase shares of common stock. Participating employees may purchase common stock through payroll deductions at the end of each participation period at a purchase price equal to 85% of the lower of the fair market value of the common stock at the beginning or the end of the participation period. Common stock reserved for future employee purchases under the plan aggregated 481,056 and 500,000 shares as of December 31, 2001 and 2000, respectively. Common stock
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE K) - STOCKHOLDERS' EQUITY (CONTINUED)
Stock Option Plans (continued)
issued under this plan totaled 18,944 in 2001. Under the plan, eligible employees may purchase shares of common stock on certain dates and at certain prices as set forth in the plan.
The Company applies APB No. 25 in accounting for its stock option plans and, accordingly, recognizes compensation expense for the difference between the fair value of the underlying common stock and the grant price of the option at the date of grant. Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date for awards under the plans consistent with the methodology prescribed under SFAS No. 123, the Company's net loss in 2001, 2000 and 1999 would have been approximately $242,615, $300,569 and $78,202, respectively, or $1.91, $2.71 and $0.85 per share, respectively. The weighted-average fair value of the stock options granted during 2001, 2000 and 1999 is estimated as $31.26, $57.08 and $15.65 per share, respectively. The weighted-average fair value of the employee stock purchase plan rights granted during 2001 is estimated as $23.71 per share. These weighted average fair values were determined based on the Black-Scholes option-pricing model with the following assumptions:
The effect of applying SFAS No. 123 on 2001, 2000 and 1999 pro forma net loss and net loss per share as stated above is not necessarily representative of the effects on reported net loss for future years due to, among other things, (1) the vesting period of the stock options and the (2) fair value of additional stock options in future years.
Options available for future grant were 4,691,650 at December 31, 2001.
(NOTE L) - PREFERRED SHARE PURCHASE RIGHTS
On May 20, 1998, the Company adopted a Shareholder Rights Plan which provided for the issuance of rights to purchase shares of Junior Participating Preferred Stock, par value $0.01 per share (the "Preferred Shares"), of the Company. Under the Shareholder Rights Plan, the Company distributed one preferred share purchase right (a "Right") for each outstanding share of common stock, par value $0.01 (the "Common Shares"), of the Company. The Rights were distributed on June 26, 1998 to stockholders of record on May 27, 1998.
Each Right entitles the holder to purchase from the Company one four-thousandth of a Preferred Share at a price of $250 per one four-thousandth of a Preferred Share, subject to adjustment. The rights become exercisable ten business days after any party acquires or announces an offer to acquire beneficial ownership of 15% or more of the Company's Common Shares. In the event that any party acquires 15% or more of the Company's Common Stock, the Company enters into a merger or other business combination, or if a substantial amount of the Company's assets are sold after the time that the Rights become exercisable, the Rights provide that the holder will receive, upon exercise, shares of the common stock of the surviving or acquiring company, as applicable, having a market value of twice the exercise price of the Right.
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE L) - PREFERRED SHARE PURCHASE RIGHTS (CONTINUED)
The Rights expire May 20, 2008, and are redeemable by the Company at a price of $0.00025 per Right at any time prior to the time that any party acquires 15% or more of the Company's Common Shares. Until the earlier of the time that the Rights become exercisable, are redeemed or expire, the Company will issue one Right with each new Common Share issued.
(NOTE M) - INCOME TAXES
The Company provides for income taxes using the liability method. The difference between the tax provision and the amount that would be computed by applying the statutory Federal income tax rate to income before taxes is attributable to the following:
Temporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities are as follows:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE M) - INCOME TAXES (CONTINUED)
The Company recognized a valuation allowance to the full extent of its deferred tax assets since the likelihood of realization of the benefit cannot be determined. Not included in the above schedule of deferred tax assets and liabilities is a deferred tax liability associated with unrealized gains on investments of $12,385 and $10,887 at December 31, 2001 and 2000, respectively. This liability is currently shown as a component in the consolidated statements of stockholders' equity.
Provision for income taxes is comprised of the following:
The Company has available tax credit carryforwards of approximately $25,000, which expire, if unused, from the year 2008 through the year 2021. The Company has net operating loss carryforwards for federal income tax purposes of approximately $477,600 which expire, if unused, from the year 2010 through the year 2021. The Company's ability to utilize these NOLs may be limited under Internal Revenue Code Section 382. The tax benefit of approximately $232,500 of net operating losses related to stock options will be credited to equity when the benefit is realized through utilization of the net operating loss carryforwards.
(NOTE N) - INVESTMENT IN VASCULAR GENETICS, INC.
In November 1997, the Company entered into an agreement with three other parties to form Vascular Genetics, Inc. ("VGI"), to pursue the development and commercialization of gene therapy products for the treatment of vascular diseases. As a result of the November 1997 agreement and other transactions since that time, as of December 31, 2001, the Company holds a significant minority equity interest in VGI of 27%. The Company also holds certain preemptive rights that will permit retention of the Company's ownership position under some circumstances in the event of a future financing by VGI. In addition, the Company has the option to purchase 100% of VGI's common stock at fair market value upon receiving the approval of two-thirds of the shareholders. The Company will earn
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE N) - INVESTMENT IN VASCULAR GENETICS INC. (CONTINUED)
royalties on net sales from products developed and commercialized by VGI or by a party granted a sublicense by VGI. Royalty rates are competitive and increase as specified sales targets are reached. In 1998, the Company loaned $600 to VGI of which the Company forgave $100 in 1998. The Company has appointed two directors to the Board of Directors of VGI.
During 1999, the Company provided manufacturing services and product to VGI in connection with a manufacturing agreement. At December 31, 2000, the Company's receivable balance due from VGI was $1,532. Based upon VGI's uncertain financial condition, the Company decided to fully reserve the receivable balance from VGI as of December 31, 2000. During 2001, the Company provided no manufacturing or research services to VGI nor did the Company receive any payments from VGI. The Company has no carrying value for its investment in VGI at December 31, 2001.
(NOTE O) - NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net loss per share:
HUMAN GENOME SCIENCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands, except share and per share data)
(NOTE P) - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for fiscal 2001 and 2000 is presented in the following tables:
(1) The Company's results for the fourth quarter of 2001 include a non-recurring charge of $22,314, or $0.17 per share, relating to an impairment charge recognized in connection with the Company's investment in Transgene, S.A.
(2) The Company's results for the first and third quarters of 2000 include non-recurring charges relating to debt conversion expenses of $50,818, or $0.49 per share, and purchased in-process research and development of $134,050, or $1.21 per share, respectively.