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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended August 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER: 0-10824
GENOME THERAPEUTICS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MASSACHUSETTS 04-2297484
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
OR ORGANIZATION)
100 BEAVER STREET, WALTHAM, MASSACHUSETTS 02453
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (781) 398-2300
SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:
COMMON STOCK, $.10 PAR VALUE
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of November 23, 1998 was approximately $58,772,550.
The number of shares outstanding of the registrant's common stock as of
November 23, 1998 was 18,328,702.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for use at its Special Meeting
of Shareholders in lieu of an Annual Meeting to be held on February 22, 1999 are
incorporated by reference into Part III.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Genome Therapeutics Corp. ("GTC" or the "Company") is a leader in the
field of genomics-based drug targets discovery -- the identification and
functional characterization of genes. The Company has over ten years of
experience in positional cloning, having served as one of the primary
researchers under genome programs sponsored by the United States government, and
has developed numerous techniques and tools that are widely used in this field.
GTC's commercial gene discovery strategy capitalizes on its pioneering work in
genomics by applying its high-throughput sequencing technology and positional
cloning, its experience and skills in pathogen functional genomics and its
bioinformatics capabilities. The two areas of focus are: the discovery and
characterization of (i) genes of pathogens that are responsible for many serious
diseases and (ii) human disease genes. The Company believes that its genomic
discoveries may lead to the development of novel therapeutics, vaccines and
diagnostic products by it and its strategic partners. The Company has entered
into several corporate collaborations in connection with its pathogen and human
gene discovery programs.
SCIENTIFIC BACKGROUND
Human disease is caused by a variety of factors, including genetic defects,
pathogens and environmental factors, with many of the most common
life-threatening and chronic diseases believed to have a genetic basis. Genes,
which define the inherited characteristics of an organism, are found in all
living cells (e.g., human, animal and pathogen cells). Each gene codes for a
specific protein that performs a specific function in the body, such as the
production of insulin. In humans, a defect in a gene, or the absence of a
critical gene, may lead to overproduction, underproduction, improper function or
absence of a protein resulting in the onset of disease or an undesirable
physical condition. Genetic defects can be inherited or can accumulate during
the lifetime of an individual. Human diseases caused by pathogens also have a
genetic foundation in that specific genes in the pathogen are required for that
organism to survive and infect its human host.
The genetic content of an organism consists of DNA, a chemically complex
material comprised of four different nucleotides (adenine, guanine, cytosine,
and thymine) which are the building blocks of DNA. The sequence in which these
nucleotides are linked together in a molecule of DNA determines the
informational content of genes. The entire genetic content of an organism,
including humans, is referred to as its genome.
The human genome consists of 23 pairs of chromosomes. These chromosomes
contain approximately 100,000 human genes distributed over approximately three
billion nucleotides. Human genes are found in the chromosomes as coding regions
of DNA ("exons") interrupted by non-coding regions of DNA ("introns"). The
number of exons found in human genes can be quite large as can be the distance
between exons. The function of the majority of human DNA is unknown. The DNA
sequence of a human gene is transcribed into a messenger RNA molecule ("mRNA")
which is processed to contain only the exon sequences. The information in the
mRNA molecule is, in turn, translated into a protein product.
Genomes of pathogens are significantly less complex than the human genome
and generally consist of a single chromosome containing several thousand genes
distributed over millions of nucleotides. The majority of DNA in pathogens
typically is comprised of genes as uninterrupted DNA sequences.
Proteins expressed by genes are the targets of most current drugs. As a
result, the identification of human disease genes and the protein product of
these genes may lead to new therapeutics and diagnostic tests. In the case of
diseases caused by pathogens, the identification of the biologically important
genes of the pathogen may lead to the development of new drugs and vaccines to
combat the pathogen. Moreover, because of the simpler nature of the genomes of
pathogens relative to the human genome, efforts to identify and characterize
pathogen genes may lead to product development candidates more quickly than
human gene discovery efforts. The two principal technologies currently being
used to discover genes are sequencing and positional cloning.
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SEQUENCING
Sequencing is the process of identifying genes through the determination of
the order or sequence of nucleotides in DNA fragments. In recent years,
high-throughput procedures, such as those being employed by the Company, have
been developed which now enable sequencing to be performed on a larger scale and
with greater speed than was previously possible.
There are generally two ways of applying high-throughput sequencing to
discover genes: random discovery and targeted discovery. In random discovery,
high-throughput sequencing is used to identify the genes in a genome without
regard to the function of the genes. In targeted discovery, high-throughput
sequencing is used to identify the genes in a specific chromosomal region or
tissue after the region or the tissue has been implicated in or associated with
a specific disease.
High-throughput sequencing offers a practical way of randomly identifying
all of the genes in a pathogen because the genomes of pathogens consist of
relatively small numbers of uninterrupted gene sequences. In contrast, the human
genome is very large with only small portions of the DNA containing genes which
are present as interrupted DNA sequences. As a result, although high-throughput
sequencing of the DNA in a particular chromosomal region is used in human gene
discovery, sequencing of all of the DNA in the human genome is not a practical
means to identify large numbers of human genes. Although there are now some
commercial ventures proposing to sequence all of the DNA in the human genome by
a random approach, this method still requires proof of principal in its utility.
Publicly funded projects are undertaking sequencing of the human genome using
mapped large insert BAC clones covering the entire genome. In addition, several
groups are randomly discovering large numbers of human genes by sequencing
expressed copies of genes, which contain only exons and are called cDNA, which
they synthesize from mRNA.
Although random discovery permits the rapid identification of pathogen and
human genes, it generally does not provide an understanding of the function of a
gene or of the gene's role in a particular disease. Any determination of
function of randomly discovered genes is dependent on the detection of
structural similarities, or homology, existing between the protein product of
such sequenced genes and genes with a known function or the analysis of the
signaling pathways both upstream and downstream from such sequenced genes.
Targeted gene discovery by high-throughput sequencing of human DNA
typically is applied as part of positional cloning (described below) after a
specific chromosomal region has been identified which is believed to contain a
particular gene. In this targeted gene discovery procedure, the entire
chromosomal region is sequenced in an effort to identify, from all the genes
present in that region, the one gene located in that region which is responsible
for causing the specific disease.
Another type of targeted gene discovery involves the use of high-throughput
sequencing of cDNA to identify genes believed to cause or maintain a particular
disease. In this procedure, which is referred to as "comparative gene
expression," mRNA present in healthy and diseased tissues is converted into cDNA
and then sequenced to identify the genes whose protein product is present in
each. Candidate genes responsible for causing or maintaining the disease are
identified by comparing which genes are expressing or producing their protein
product and at what level this expression is occurring in both the healthy and
diseased tissue.
POSITIONAL CLONING
Positional cloning is the process of analyzing disease inheritance patterns
to identify the genes responsible for causing human disease. The first step in
positional cloning is the identification of individual families or genetically
homogeneous populations in which the occurrence of the disease in individuals
within such families or populations is substantially higher than in the general
population. Blood samples are collected from individuals within the family or
population to provide DNA to be used to identify the region on a particular
chromosome where the disease-causing gene is located. This process is referred
to as "genetic linkage mapping."
In genetic linkage mapping, DNA probes are used to detect genetic markers,
regions of DNA that vary in sequence content from person to person. The position
of these genetic markers on a chromosome, as detected
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by the DNA probes, constitutes a genetic linkage map of the chromosome. The
chromosomal regions which are initially examined are those regions which have
been identified as containing genes that are likely candidates for causing or
predisposing an individual to the disease. Because only a limited number of
human genes have been mapped to date, most genetic mapping is done genome-wide
with a set of DNA probes that span the genome. By following the inheritance
patterns of genetic markers and looking for the coinheritance of the genetic
markers and the disease, the gene responsible for causing or predisposing an
individual to that disease can be located within a specific chromosomal region.
Using additional DNA probes, the chromosomal region containing the targeted
disease gene can be narrowed to a region consisting of approximately 1,000,000
to 3,000,000 nucleotides in size containing between approximately 30 to 100
genes.
Next, libraries comprised of large DNA fragments are examined to find those
fragments which contain pieces of DNA from the relevant chromosomal region. The
aligning of these DNA fragments so that their resulting order represents how
these DNA fragments are related to each other in the relevant chromosomal region
is called physical mapping. The physical map of the relevant chromosomal region
can then be used to identify the genes which are contained within the region.
These genes can be identified in two ways. First, "direct selection" and "exon
trapping" are used, whereby individual exons within this chromosomal region can
be isolated and then used to obtain a complete copy of the gene from a cDNA
library. Alternatively or in combination with the above tools, the DNA of the
chromosomal region can be sequenced using high-throughput procedures and,
through the use of special computer software, the exons which are contained
within the chromosomal region can be predicted. This sequencing information is
then used to search cDNA libraries for DNA fragments which contain these
presumed exons.
Each gene identified through this process is a candidate for causing the
disease. By determining the sequence of these genes in individuals with the
disease and comparing it to the sequence of that gene from healthy individuals,
the gene involved in the disease can be identified. DNA sequence differences,
which are only found in individuals who have inherited the disease, identify the
gene which is believed to be responsible for causing the disease.
TECHNOLOGY PLATFORM
The Company applies its proprietary technologies and know-how in
high-throughput sequencing, positional cloning, bioinformatics, and functional
genomics in its gene discovery programs. In its pathogen programs, the Company
uses its high-throughput sequencing capabilities to sequence the genomes of
pathogens. In its human gene discovery programs, the Company combines its
proprietary positional cloning capabilities, together with its high-throughput
sequencing capabilities, in its efforts to identify human genes associated with
disease. Both the Company's pathogen and human genomics programs utilize
substantial bioinformatics skills to identify genes, tentatively assign them a
likely function, and possibly select genes as targets for drug and vaccine
development. Over the last couple of years, the Company has fully developed
functional genomics and drug discovery skills, including drug discovery target
validation and high-throughput drug discovery assay development.
HIGH-THROUGHPUT SEQUENCING AND FINISHING
GTC has an automated process using DNA sequencers and computers to sequence
and analyze genes in its discovery research programs. Using its technology, the
Company has randomly sequenced the genomes of several pathogens and various
chromosomal regions of the human genome. GTC's current sequencing production
capacity is approximately 6.5 million nucleotides of raw sequence daily.
Improvements in overall throughput and production cost have been implemented
through introduction of proprietary and non-proprietary technologies into the
sequencing process.
Finishing is the "end game" of high-throughput sequencing. It is the
process of producing a complete genome once the majority of the sequence has
been generated by the high-throughput shotgun process. Finishing is necessary
because shotgun sequencing is a random process; the individual clones that are
sequenced contain small randomly selected fragments of the complete genome.
These fragments are assembled using sophisticated computer software which
identifies overlapping regions of sequence and arranges the fragments into large
contiguous sequence regions called "contigs". As more sequence is
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generated, the fragments assemble into larger contigs covering more of the
genome. At an appropriate point in a sequencing project, the process moves from
a random to a directed sequencing approach in order to specifically target and
obtain sequence for the missing regions and, thereby, "finish" the genome
sequence.
The Company has developed a proprietary quality control process to assure a
high-quality sequenced genome. Sequence quality is expressed in terms of the
probability of error at any given base location in the sequence. The integrated
computational and biochemical techniques used in the finishing process, when
coupled with the sequence quality measurements generated by the high-throughput
sequencing process, allow the Company to specify the required quality of the
end-product sequence and then direct the process to achieve the desired quality
level. The Company has developed a proprietary finishing platform that couples
the computational and biochemical techniques utilized in finishing to provide
the highest quality representation of the finished product.
Finishing is also very important in the later stages of human gene
discovery where the identification of disease-associated mutations requires gene
sequences of much higher quality than in the early stages of gene
identification. The quality of the sequence must be such as to allow the
detection of two different nucleotides in a given position. The Company has a
well-established, sequence-based mutation detection program in place essential
for our gene discovery projects.
POSITIONAL CLONING
The Company has over 10 years of experience in various aspects of
positional cloning. GTC was one of the pioneers in the use of genetic linkage
mapping and developed numerous techniques and tools that are widely used in the
positional cloning field. GTC has considerable experience in identifying genetic
markers for specific chromosomal regions. This ability is needed when additional
genetic markers are required to narrow the size of the chromosomal region
believed to contain the disease gene. The Company also has several libraries of
large DNA fragments arranged in a format which facilitates the isolation of DNA
fragments from a specific chromosomal region. These libraries are used to
develop physical maps of chromosomal regions thought to contain disease genes.
In addition, the Company uses specialized tools to identify exons present in
large DNA fragments. These tools are used to identify and isolate genes present
in chromosomal regions believed to contain disease genes.
BIOINFORMATICS
The process of identifying and characterizing genes generates vast amounts
of data that must be organized, managed and analyzed for biological
significance. Such data result from DNA sequencing, genetic linkage analysis,
physical mapping, gene expression studies and other genomic technologies
employed by the Company. The use of computers, software, and databases to track,
process, store, retrieve and analyze data generated by genomic research is
referred to as "bioinformatics," and is a key capability of any participant in
the field. Because of its early work in large-scale genetic linkage analysis,
GTC was one of the first companies to develop significant bioinformatics
capabilities.
The Company's efforts in bioinformatics are focused in four areas:
development and application of genomic data mining and visualization software to
strengthen the gene and drug discovery programs at GTC; integration and
enhancement of laboratory automation systems for high throughput genomic
sequencing and analysis; ongoing development and customer support for the
PathoGenome(TM) database; and support and improvement of the information
infrastructure, including systems, networks and user support. The Company is
continuing to expand its bioinformatics staff and capabilities as it develops
more tools and processes aimed at discovery and validation of drug targets.
FUNCTIONAL GENOMICS (PATHOGEN)
Once the genome of a pathogen has been sequenced, the Company uses its
bioinformatics expertise and the information in its proprietary and public
databases to identify and locate the genes within the genome and assign features
to the genes which help identify their likely function. Relying on the assigned
function and using the criteria for the product to be developed (drug or
vaccine; narrow or broad spectrum), the Company
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examines sequences from the genomes of various pathogens in its proprietary and
public databases and compares these sequences against mammalian sequences to
select pathogen genes as potential targets for drug or vaccine development.
The criteria used for selecting gene targets against which small molecules
(drugs) will be developed include such features as essentiality, uniqueness, and
the ability to be assayed. The gene should be essential for the survival of the
organism. The gene or its protein product should have novel biochemistry or
special characteristics to make it unique to the organism(s) against which the
drug is to be active. In order to reduce possible side effects, such genes
should be absent or have little homology to genes found in humans. The gene or
its protein product should have general features which make it possible to
construct high-throughput screening assays.
If protein or polypeptide vaccines are to be developed, then the criteria
used for selecting gene targets include such features as whether the protein
product is likely to be secreted or found on the cell surface or in the membrane
of the organism or shows homology to a major antigen in other organisms.
For small molecule targets, the transition from bioinformatics to
functional genomics begins by demonstrating that the gene is essential for the
viability or virulence of the organism. That is, the gene must be required for
the survival of the organism on a culture plate (in vitro) or in an animal model
(in vivo). To determine the essentiality of a gene, the Company has developed
high-throughput techniques for either directly or randomly inactivating, i.e.
"knocking-out", specific genes within the genome of a pathogen. After targets
have been validated for their biological relevance, the Company then develops
screening assays for these targets. These assays include conventional
biochemical assays in which the gene target is over-expressed in a recombinant
host and the protein product is purified and used to develop a non-cellular,
high-throughput assay. Assay systems for gene targets of unknown function
include the construction of an over or under-expressing strain for use in
high-throughput bio- or genetic whole cell assays.
For vaccine targets, functional genomics begins with the demonstration that
the gene product is not subject to significant antigenic variation between
strains or under different growth conditions. Gene targets are then
over-expressed in a recombinant host, and the resulting protein product is
purified for testing in an appropriate animal model.
FUNCTIONAL GENOMICS (HUMAN)
In many cases, the protein products of a gene or genes causing a human
disease are pharmaceutically not suitable as drug discovery targets. Therefore,
new targets need to be identified, based on a thorough understanding of the
gene's function, including interaction with other proteins and genes. The
Company has developed and is continuing to improve new technologies to
accelerate the functional analysis of important disease genes, including
high-throughput signaling pathway analyses in mammalian and non-mammalian
systems, gene knock-outs and transgenics and thereby bridging the gap between
gene discovery and drug discovery validated targets. This effort is being
complemented with high-throughput drug discovery assay development skills which
are already implemented in the Company's pathogen functional genomics program.
The Company's integrated approach to gene function and signal pathway
analysis is supported by multiple technology platforms. These include:
RAPID ANALYSIS OF DIFFERENTIAL GENE EXPRESSION PROFILES
GTC has developed a proprietary process to perform rapid analysis of
differential gene expression profiles. Such analysis can be applied to identify
genes differentially expressed in normal vs. disease tissues, or, using cellular
model systems developed by the Company, identify genes differentially expressed
in response to conditional and controlled expression of specific disease genes.
HIGH-THROUGHPUT PROTEIN-PROTEIN INTERACTION SCREENING
GTC is developing a proprietary high-throughput process to identify
critical interactors and regulators of disease gene-encoded protein products and
their downstream signaling mediators. The Company employs various in vitro and
cell-based technologies to identify physiologically relevant and novel
protein-protein
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interactions. These include yeast and mammalian cell-based screening assays. The
Company's high-throughput DNA sequencing, automation, and bioinformatics
capabilities provide critical support to the gene identification process, data
analysis and management, and the development of signal pathway databases.
FUNCTIONAL EXPRESSION CLONING AND ANALYSIS
GTC is developing a high-throughput process to clone and analyze signaling
molecules associated with and regulating specific disease pathways. This
approach employs multiple molecules and cell biological technologies in the
discovery and validation of candidate drug discovery targets.
The identification of novel disease pathway-associated signaling molecules
represents a critical step towards the selection of novel candidate therapeutic
targets. Candidate targets are validated by multiple approaches, including
antisense and gene "knock-out" technologies. High-throughput drug discovery
assay development skills, which are already implemented in the Company's
pathogen programs, will be applied to specific validated targets towards the
identification of novel therapeutic agents.
GTC STRATEGY
Genome Therapeutics' business strategy is to use its genomics and related
technologies to identify and validate gene targets and, together with its
partners, develop novel therapeutic, vaccine and diagnostic products. In order
to achieve its objective, the Company forms exclusive and non-exclusive
strategic collaborations with pharmaceutical and biotechnology companies that
can provide both financial and scientific resources necessary for drug discovery
and clinical development. The Company also packages and markets some of the
outputs of its genetic research, one of which is a non-exclusive genetic
database, PathoGenome(TM) Database, that provides subscribers with genetic
information to identify gene targets which can be used in the development of
novel therapeutics. The Company is currently evaluating other commercial
opportunities outside the life-science industry that lend themselves to the use
of its genomics capabilities.
The Company has served as one of the primary researchers under genomic
programs sponsored by the United States government. These programs have
strengthened the Company's genomics technology base, increased the number and
enhanced the expertise of its scientific personnel. From January 1991 through
August 1998, the United States government awarded the Company grants and
contracts providing for aggregate payments over their terms of approximately $37
million. However, as of the end of fiscal 1998, the Company has substantially
reduced its reliance on government grants and contracts as it implements its
commercial strategy. GTC intends to continue seeking business opportunities with
the National Institute of Health and other government agencies.
DISEASE PROGRAMS
The Company is currently conducting research directed at microbial
infections, fungal infections and human diseases. The factors the Company
considers in determining whether to initiate these programs include the
projected commercial potential, the effectiveness of current therapies, the
likelihood of attracting a pharmaceutical or biotechnology company as a
collaborator, the status of competitive programs and anticipated development
costs.
MICROBIAL AND FUNGAL INFECTIONS
Over the past five years, Genome Therapeutics has devoted a significant
portion of its resources to sequencing the genomes of several disease-causing
pathogens and fungi. The Company plans to continue to identify and characterize
genes of these and other pathogens for which the Company believes new or
improved therapeutic, vaccine or diagnostic products represent a significant
commercial opportunity. In particular, the Company plans to focus its efforts on
pathogens where the incidence of antibiotic resistance or other factors limit
the use or efficacy of currently available therapies, creating a need for novel
antibiotics and vaccines. The Company believes its pathogen gene discovery
programs will lead to product development candidates more quickly than human
gene discovery efforts.
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Antibiotics are the standard therapy for bacterial and fungal infections.
During the past year, approximately 300 million prescriptions for antibiotics
were written in the United States for such infections and approximately $8.5
billion was expended in the United States for oral and injectable antibiotics.
The approximately 100 antibiotics in wide use in the United States today are
primarily variations of a small number of original antibiotic compounds. In the
past decade, a growing number of infections has been caused by pathogens which
are becoming resistant to an increasing number of currently available
antibiotics. This problem of growing resistance to antibiotics is particularly
problematic in the approximately 6,500 acute care hospitals in the United States
in which approximately 2.1 million patients each year develop infections.
Examples of pathogens that have exhibited resistance to a number of current
antibiotics include Staphylococcus aureus, Mycobacterium tuberculosis,
Streptococcus pneumonia, and Enterococcus faecium and faecalis. To date, the
primary response of pharmaceutical companies to the resistance problem has been
to modify existing antibiotics. However, in many cases, the pathogens that are
the targets of these antibiotics have further mutated, often quite rapidly, and
thereby developed resistance to the modified antibiotics. The Company believes
that the development of novel antibiotics and vaccines based on new pathogen
targets identified using genomic information may be less prone to the rapid
development of resistance than antibiotics that are only modified versions of
existing drugs.
HELICOBACTER PYLORI
H. pylori is the pathogen believed responsible for causing 90% of duodenal
peptic ulcers, the most common type of ulcer, and approximately 80% of gastric
peptic ulcers. Peptic ulcer disease is a chronic inflammatory condition of the
stomach and duodenum. Although frequently asymptomatic, all persons infected by
H. pylori have chronic gastric inflammation (gastritis). It is estimated that
approximately 4.5 million people suffer from active peptic ulcers each year, and
approximately 500,000 new cases are diagnosed annually in the United States.
Approximately 600,000 patients are hospitalized each year in the United States
for peptic ulcer disease. Serious complications occur in approximately one-third
of these cases, including intestinal obstruction, upper gastrointestinal
hemorrhage and perforation. Further, each year over 6,000 deaths in the United
States are directly caused by ulcer disease, and peptic ulcers are a
contributing factor in an additional 11,000 deaths. Approximately 10% of the
population in the United States will develop peptic ulcer disease during their
lifetimes. Studies have also linked H. pylori with the development of certain
stomach cancers and coronary heart disease.
The most common medication for treating peptic ulcers are anti-secretory
drugs, such as H2 antagonists (e.g., Tagamet(TM) and Zantac(TM)), and proton
pump inhibitors (e.g., Prilosec(TM)). Although anti-secretory drugs reduce ulcer
symptoms by inhibiting gastric acid secretion, they do not eradicate the H.
pylori which is the primary cause of the disease. In 1997, the market for such
drugs for the treatment of ulcers totaled approximately $10.8 billion worldwide.
An approach being developed to treat recurrent peptic ulcer disease recognizes
the role of H. pylori and involves the administration of antibiotics, often in
combination with bismuth or anti-secretory drugs. The most effective antibiotic
treatments may be complicated by the need to treat for prolonged periods with
multiple drugs, by side effects and problems with patient compliance, by
relapses if treatment is interrupted, and by the development of
antibiotic-resistant strains of the bacteria.
Using its sequencing technology, the Company completed the random
sequencing of the genome of a clinical isolate of H. pylori in December 1994.
Under its agreement with Astra, the Company has identified genes critical to the
survival of H. pylori and proteins on the surface of the bacterium that are
believed to be likely targets for therapeutic products and vaccines,
respectively. (See "Collaborative Agreements -- Pharmaceutical Company
Collaborations.")
STAPHYLOCOCCUS AUREUS
Staph. is the most common cause of skin, wound and blood infections. Staph.
infections are typically treated with antibiotics. The percentage of Staph.
isolates resistant to penicillin and certain other antibiotics increased from
2.4% in 1975 to 29% by 1991 and has continued to increase. Moreover, clinical
isolates of Staph. exist which are resistant to all known antibiotics other than
vancomycin. Vancomycin resistance has appeared in Enterococcus, which has raised
the possibility that such resistance may be transferred to Staph. as
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has been demonstrated to occur in the laboratory. Vancomycin resistance in
Staph. would make such strains untreatable and two such cases have already been
identified, one in Japan and the other in the U.S. Using its high-throughput
sequencing capabilities, the Company has randomly sequenced the genome of a
clinical isolate of methicillin-resistant Staph. Under its agreement with
Schering-Plough, the Company is using the sequence of Staph. aureus to identify
and validate gene targets for the development of new small molecules to treat
pathogens which have become resistant to current antibiotics. (See
"Collaborative Agreements -- Pharmaceutical Company Collaborations.")
FUNGAL INFECTIONS
According to the Centers for Disease Control's National Nosocomial
Surveillance System, between 1980 and 1990, the rate of hospital-associated
fungal infections nearly doubled. Most of this increase was the result of
opportunistic infections in the growing number of people whose immune systems
are compromised. Such infections are mainly seen in patients who are infected
with HIV or have AIDS; are receiving chemotherapy; have undergone transplants;
have debilitating diseases or severe injuries; have been hospitalized long-term
or treated long-term with corticosteroids or antibacterial drugs. Currently,
there are a limited number of anti-fungals available for use in such infections
and the products currently on the market have serious side effects. In addition,
resistance to these agents is increasing. Under its agreement with
Schering-Plough, the Company is employing its experience and use of its
high-throughput capabilities with genomic tools to identify new, validated
fungal targets and to create assays for the development of new small molecules
to treat these fungal pathogens. (See "Collaborative Agreements --
Pharmaceutical Company Collaborations.")
HUMAN GENETIC DISEASES
GTC has initiated a variety of programs to identify human genes that are
responsible for various diseases. In some of these programs, the Company is
using positional cloning strategies, while in others it is employing a
multi-faceted approach incorporating positional cloning and comparative gene
expression. The Company's current human gene discovery programs are directed at
asthma, cancer, osteoporosis, atherosclerosis and a specific class of molecular
targets called G Protein-Coupled Receptors (GPCR's).
In the human disease area, the Company plans to build on its decade of
experience and knowledge in positional cloning, genotyping, sequencing and
bioinformatics capabilities by obtaining exclusive rights to collections of DNA
samples from relevant family resources in order to map, identify and
characterize genes responsible for selected human diseases. The Company actively
seeks collaborations with clinicians and academic researchers to obtain these
rights. The Company believes that access to these family and other resources
will bolster its existing human gene discovery programs and enable it to
initiate additional programs directed at human genes associated with significant
diseases.
ASTHMA
Asthma is a significant health problem that affects approximately 5% of the
U.S. population. Both twin and family studies suggest a strong genetic component
in the etiology of the disease. Despite a clear genetic contribution to the
disease, no consistent mode of inheritance has been observed, suggesting that
multiple genetic factors as well as environmental influences play a role. The
Company, in collaboration with Schering-Plough, has initiated a research program
to use positional cloning strategies to identify genes involved in the etiology
of asthma. The Company believes that newly identified asthma genes will
facilitate the development of superior diagnostics and novel therapeutic agents.
This program is being conducted in collaboration with a leading academic asthma
research center which provides access to appropriate family resources and
clinical insight to asthma pathophysiology. (See "Collaborative
Agreements -- Pharmaceutical Company Collaborations.")
OSTEOPOROSIS
Osteoporosis is a major health problem that affects roughly 50% of
post-menopausal women and nearly 25% of elderly men. In the U.S. alone, there
are in excess of 1.3 million osteoporotic bone fractures per year. As defined by
low bone mineral density, both twin and family studies suggest a strong genetic
component to the disease. The Company has initiated a research program to
identify genes involved in the etiology of
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osteoporosis. Given the complex nature of this disorder, and the lack of
information about biochemical defects involved, the Company is using a
multi-faceted approach including positional cloning and comparative gene
expression strategies to identify osteoporosis genes. The Company expects the
identification of genes regulating bone density and disease progression will
significantly influence the development of diagnostic tests and the discovery of
novel therapeutic agents. This program is being conducted in collaboration with
Creighton University, a leading academic bone research center, which provides
access to appropriate family resources and clinical insight and osteoporosis
pathophysiology.
ATHEROSCLEROSIS
The Company's atherosclerosis program focuses on identifying genes which
regulate high density lipoproteins (HDL) and HDL-mediated athero protection.
Epidemiological studies in man and animal experimentation have established that
HDL is a major risk factor for atherosclerosis. Although there is strong
evidence for genetic determinants, genes responsible for the athero protective
effects of HDL have not yet been identified. In addition, there currently are no
effective drugs for raising HDL levels or mimicking the athero-protective
effects of HDL. Given these opportunities, the company is using positional
cloning to identify genes associated with HDL levels and athero protection for
the purpose of defining new atherosclerotic drug discovery targets. This program
is being conducted in collaboration with Tufts University and Massachusetts
General Hospital, both leading academic research centers.
CANCER PROGRAM
The Company's strategy in cancer is to identify novel signaling molecules
in cellular pathways that control tumor cell survival and are linked to the most
commonly mutated cancer genes known to date, such as the p53 tumor suppressor
gene. Multiple technology platforms are used to paint a comprehensive picture of
such cancer gene signaling pathways. These include tools for the development of
biological model systems, differential gene expression profiling, functional
expression cloning, and protein-protein interaction analysis.
The identification of cancer pathway signaling molecules is expected to
provide an important resource of new therapeutic targets whose inhibition
selectively sensitizes tumor cells to cell death, and, thus, the development of
novel anticancer agents that may be administered either alone or in combination
with currently known chemotherapeutic agents to inhibit tumor growth. To that
end, the Company has signed an exclusive license with Princeton University for
patient rights relating to human mRNA's regulated by the p53 tumor suppressor
protein.
G PROTEIN-COUPLED RECEPTOR (GPCR)
The Company is employing its integrated genomics capabilities to identify
new genes coding for GPCR. GPCRs are recognized to be the largest class of
molecular targets of interest to the pharmaceutical industry, as they are
involved in the majority of basic cell functions. Currently, over 60% of
pharmaceuticals on the market target GPCRs, resulting in annual worldwide sales
of over $85 billion. Experts believe that there are hundreds of GPCRs yet to be
identified that may play a role in disease processes. In a collaboration with
Cadus Pharmaceutical, the Company is identifying novel GPCR, which may be
important drug targets. (See "Collaborative Agreements -- Biotechnology Company
Collaborations.")
COLLABORATIVE AGREEMENTS
An important part of the Company's commercialization strategy is to pursue
research collaborations with pharmaceutical and biotechnology companies for the
development and commercialization of products based on the Company's genomic
discoveries. The Company also plans to continue to seek government grants and
contracts related to the Company's technology and research objectives.
PHARMACEUTICAL COMPANY COLLABORATIONS
The Company continues to seek strategic collaborations with pharmaceutical
and biotechnology companies for the development and commercialization of
products based on the Company's genomic discoveries. This strategy is designed
to provide the Company access to the scientific and product development
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expertise of its partners and permit the Company to benefit from the
commercialization of products based on the Company's gene discoveries without
incurring the substantial costs required for pharmaceutical product development
and commercialization. The Company generally expects to license (either
exclusively or non-exclusively) to its partners most rights to therapeutic
products and vaccines and, depending upon the gene, diagnostic products which
may be developed from the particular genetic information licensed-out by the
Company. In exchange, the Company generally expects to receive a combination of
up-front license fees, research funding, milestone payments and royalty payments
on product sales. Through August 1998, the Company has entered into four
research collaborations, three of which relate to pathogens and one which
relates to asthma genetics. The first pathogen collaboration is with Astra
Hassle AB ("Astra") for the development of therapeutic, diagnostic and vaccine
products effective against gastrointestinal infections and other diseases caused
by H. pylori. The other two collaborations are with Schering Corporation and
Schering-Plough Ltd.(collectively "Schering-Plough") and provide for the use by
Schering-Plough of the genomic sequence of Staph. aureus and two fungal
pathogens, Candida albicans and Aspergillus fumigatus, to identify new gene
targets for the development of antibiotics and vaccines effective against drug
resistant infectious organisms. The Company has a third collaboration with
Schering-Plough to identify genes and associated proteins to be used by
Schering-Plough to develop new pharmaceuticals for asthma.
ASTRA (H. PYLORI)
In August 1995, the Company entered into a collaboration agreement with
Astra to develop pharmaceutical, vaccine and diagnostic products effective
against gastrointestinal infections or any other disease caused by H. pylori.
The Company granted Astra exclusive access to the Company's H. pylori genomic
sequence database and exclusive worldwide rights to make, use and sell products
based on the Company's H. pylori technology. The agreement also provides for a
four-year research collaboration to further develop and annotate the Company's
H. pylori genomic sequence database, identify therapeutic and vaccine targets
and develop appropriate biological assays. This research is being directed by a
Joint Management Committee and a Joint Research Committee, each consisting of
representatives from both parties.
The Company has achieved all the scientific milestones scheduled to date
under this agreement. Several undisclosed novel targets have been identified and
validated by GTC and screening assays have been delivered to Astra for
high-throughput screening for drug candidates.
Under this agreement, Astra agreed to pay an initial license fee, expense
allowance, milestone payments, and fund a research program for a minimum of two
and a half years with an option to extend. On June 4, 1998, Astra exercised its
option to extend the research program for a second time which will carry the
agreement through at least August 1999. Under this agreement as extended, Astra
agreed to pay the Company a minimum of approximately $13.4 million and, subject
to the achievement of certain product development milestones, up to
approximately $23 million (and possibly a greater amount if more than one
product is developed under the agreement) in license fees, expense allowances,
research funding and milestone payments. Of such fees, $500,000 are creditable
against any future royalties payable to GTC by Astra under the agreement. The
Company received approximately $13 million in license fees, expense allowances,
milestone payments and research funding under the Astra agreement through August
31, 1998. For the Company's fiscal years ended August 31, 1996, 1997 and 1998,
revenue recognized by the Company under its agreement with Astra accounted for
approximately 23%, 17% and 9%, respectively, of the Company's total revenue.
The Company will also be entitled to receive royalties on Astra's sale of
any products (i) protected by the claims of patents licensed exclusively to
Astra by the Company pursuant to the agreement, or (ii) the discovery of which
was enabled in a significant manner by the genomic database licensed to Astra by
the Company. GTC has the right under certain circumstances to convert Astra's
license to a nonexclusive license in the event Astra is not actively pursuing
commercialization of the licensed technology.
SCHERING-PLOUGH (STAPH. AUREUS)
In December 1995, the Company entered into a collaboration and license
agreement with Schering-Plough providing for the use by Schering-Plough of the
genomic sequence of Staph. aureus to identify new
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gene targets for development of antibiotics effective against drug-resistant
infectious organisms. As part of this agreement, the Company granted
Schering-Plough exclusive access to the Company's proprietary Staph. genomic
sequence database. The Company also granted Schering-Plough a non-exclusive
license to use the Company's bioinformatics systems for Schering-Plough's
internal use in connection with the genomic databases licensed to
Schering-Plough under the agreement and other genomic databases Schering-Plough
develops or acquires. The Company also agreed to undertake certain research
efforts to identify bacteria-specific genes essential to microbial survival and
to develop biological assays to be used by Schering-Plough in screening natural
product and compound libraries to identify antibiotics with new mechanisms of
action.
The company has achieved all of the scientific milestones scheduled to date
under this agreement. Several undisclosed novel targets have been identified and
validated by GTC and screening assays have been delivered to Schering-Plough for
high-throughput screening for drug candidates.
Under this agreement, Schering-Plough agreed to pay an initial license fee
and fund a research program for a minimum two and a half years with an option to
extend. On March 4, 1998, Schering-Plough elected to extend the research program
to at least April, 2000. Under the agreement as extended, Schering-Plough has
agreed to pay the Company a minimum of $18.5 million in an up-front license fee,
research funding and milestone payments. Subject to the achievement of
additional product development milestones, Schering-Plough has agreed to pay the
Company up to an additional $24 million in milestone payments. The Company has
received approximately $15.2 million in up-front license fee, research funding
and milestone payments through August 31, 1998. For the Company's fiscal years
ended August 31, 1996, 1997 and 1998, revenue recognized by the Company under
this agreement with Schering-Plough accounted for approximately 40%, 20% and
18%, respectively, of the Company's total revenue.
The agreement grants Schering-Plough exclusive worldwide rights to make,
use and sell pharmaceutical and vaccine products based on the genomic sequence
databases licensed to Schering-Plough by the Company and on the technology
developed in the course of the research program. GTC has also granted Schering-
Plough a right of first negotiation if during the term of the research plan GTC
desires to enter into a collaboration with a third party with respect to the
development or sale of any compounds which are targeted against, as their
primary indication, the pathogen that is the principal subject of the Company's
agreement with Schering-Plough. The Company will be entitled to receive
royalties on Schering-Plough's sale of therapeutic products and vaccines
developed using the technology licensed from the Company. Subject to certain
limitations, GTC retained the rights to make, use, and sell diagnostic products
developed based on the Company's genomic database licensed to Schering-Plough or
the technology developed in the course of the research program.
SCHERING-PLOUGH (ASTHMA)
In December 1996, the Company entered into its second research
collaboration and license agreement with Schering-Plough. This agreement calls
for the use of genomics to discover new therapeutics for treating asthma. As
part of the agreement, the Company will employ its high-throughput positional
cloning, bioinformatics, and genomics sequencing capabilities to identify genes
and associated proteins that can be utilized by Schering-Plough to develop new
pharmaceuticals. Under this agreement, the Company has granted Schering-Plough
exclusive access to (i) certain gene sequence databases made available under
this research program, (ii) information made available to the Company under
certain third party research agreements, (iii) an exclusive worldwide right and
license to make, use and sell pharmaceutical and vaccine products based on the
rights to develop and commercialize diagnostic products that may result from
this collaboration.
The Company has achieved all the scientific milestones scheduled to date
under this agreement. In September, 1998, subsequent to the end of the fiscal
year, Schering-Plough authorized an acceleration of the program resulting in a
significant increase in headcount in the coming year.
Under this agreement, Schering-Plough agreed to pay an initial license fee
and an expense allowance to the Company. Schering-Plough is also required to
fund a research program for a minimum number of years with an option to extend.
In addition, upon completion of certain scientific developments, Schering-Plough
will make milestone payments to the Company, as well as pay royalties to the
Company based upon sales of
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therapeutic products developed from this collaboration. If all milestones are
met and the research program continues for its full term, total payments to the
Company will approximate $67 million, excluding royalties. Of the total
potential payments, approximately $22.5 million represents license fees and
research payments, and $44.5 million represents milestone payments based on
achievement of research and product development objectives. The company received
approximately $11.6 million in up-front license fee, research funding and
expense allowances through August 31, 1998. For the Company's fiscal years ended
August 31, 1997 and 1998, revenue recognized under this agreement with
Schering-Plough accounted for approximately 28% and 37%, respectively, of the
Company's total revenue.
SCHERING-PLOUGH (FUNGAL)
On September 24, 1997, the Company entered into its third research
collaboration and license agreement with Schering-Plough to use genomics to
discover and develop new pharmaceutical products to treat fungal infection.
Under the agreement, the Company will employ its bioinformatics, high-throughput
sequencing and functional genomics capabilities to identify and validate genes
and associated proteins as drug discovery targets that can be utilized by
Schering-Plough to develop novel antifungal treatments. Schering-Plough will
receive exclusive access to the genomics information developed in the
collaboration related to two fungal pathogens, Candida albicans and Aspergillus
fumigatus. Schering-Plough will also receive exclusive world-wide right to make,
use and sell products based on the technology developed in the course of the
research program. In return, Schering-Plough has agreed to fund a research
program for a minimum of two and a half years with an option to extend. If all
milestones are met and the research program continues for its full term, total
payments to the Company will approximate $34 million, excluding royalties. As of
the end of fiscal 1998, there was no scientific milestone scheduled. The Company
received approximately $3.6 million in research funding through August 31, 1998.
For the Company's fiscal year ended August 31, 1998, revenue recognized under
this agreement with Schering-Plough accounted for approximately 13% of the
Company's total revenue.
BIOTECHNOLOGY COMPANY COLLABORATIONS
In order to maximize the commercial utilization of novel drug discovery
targets derived from GTC's genomics approach, the Company's alliance strategy
with pharmaceutical companies is being complemented with internal drug discovery
programs. These internal drug discovery efforts are focused in both pathogen and
human genetics. The non-exclusive marketing strategy of the PathoGenome(TM)
database allows GTC to choose its own drug discovery targets from the database.
The Company's internal programs include drug discovery target validation through
gene knock-outs, protein expression and purification, development of high-
throughput assays, and -- via external collaborations -- lead compounds
identification and lead optimization. In human genetics, the Company is using
its genomic tools to identify selected novel molecular targets which can be used
in drug discovery. As of August 1998, the Company has entered into three drug
discovery partnerships, two of which relate to pathogens and the other relates
to human diseases.
VERSICOR, INC.
In March 1997, the Company entered into a collaboration agreement with
Versicor to identify and develop new anti-bacterial compounds. Under the terms
of this agreement, the Company will contribute validated bacterial genomic
targets from its PathoGenome(TM) sequence database together with functional
genomic information. Versicor will supply screening and synthesis of chemical
libraries, high-throughput assay development and lead validation.
Under this agreement, the Company and Versicor will share equally in all
license fees, milestones, and royalties for any products developed and
commercialized as a result of this collaboration. Both companies will split the
research and development investment through preclinical stages of development.
Both companies have the right to maintain a 50/50 stake by investing equally in
additional development if required prior to outlicensing. In addition, Versicor
has retained certain marketing rights and the Company has obtained warrants to
acquire equity in Versicor.
As of the end of the fiscal year, there were no targets in screening under
this collaboration and the research committee is evaluating and refining the
direction of the project.
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ARQULE, INC.
In June 1998, the Company entered into a collaboration agreement with
ArQule to discover novel drugs to combat infectious diseases. ArQule will screen
its proprietary chemical libraries against the Company's unique bacterial
disease targets to identify and optimize small molecule anti-infectives.
Under the agreement, ArQule will use validated targets from the Company's
proprietary PathoGenome(TM) Database to identify compounds with biological
activity from ArQule's Mapping Array(TM) program. Once active leads are
identified, the collaborators intend to use ArQule's Direct Array(TM) program to
rapidly optimize these lead compounds. ArQule and the Company will share
ownership rights to any active lead compounds and will share in any revenues
upon commercialization of those compounds.
As of the end of the fiscal year, there were multiple validated targets in
high-throughput screening under this collaboration.
CADUS PHARMACEUTICAL CORP.
In July 1998, the Company entered into a collaboration agreement with Cadus
to identify and commercially develop novel drug discovery targets. The
collaboration combines the Company's strength in identifying, sequencing and
cloning novel, full-length genes with Cadus' expertise in functional genomics
and drug discovery assay development. The collaboration will also make use of
the Company's gene expression technologies.
Through the agreement, researchers will initially focus on the discovery of
novel G protein-coupled receptors (GPCRs) and may expand their efforts to
include other target class of interest. The two companies would share in the
proceeds from any new alliances that make use of targets identified within the
collaboration.
As of the end of the fiscal year, several novel receptors had been
identified.
DATABASE PRODUCT
In May 1997, the Company introduced to the market a database of genetic
information from over two dozen pathogens and fungi, PathoGenome(TM) Database.
This database is available through multi-year non-exclusive subscriptions to
pharmaceutical and other drug discovery companies. It is one of the most
comprehensive commercial source of microbial genomic information available. It
provides subscribers with an unprecedented volume of highly organized and
functionally annotated sequence information related to some of the most
medically important microbial organisms and fungi. The non-exclusive database is
designed for use at the client site utilizing proprietary bioinformatics
software developed at Genome Therapeutics. It offers a user-friendly graphic
interface and enables researchers to search for new genes among multiple
pathogens and cross-reference genomic information for the development of new
anti-infective products. As of August 31, 1998, the Company had subscribed four
customers to the PathoGenome(TM) Database. Subsequent to the fiscal year end,
the company added one additional subscriber.
BAYER AG
In May, 1997, the Company sold its first subscription to the
PathoGenome(TM) Database to Bayer AG providing them with non-exclusive access to
the genetic information for small molecule therapeutic products. GTC will
receive annual subscription fees and downstream royalties on any products
developed as a result of access to the information provided by the database.
BRISTOL-MYERS SQUIBB
In September, 1997, the Company subscribed Bristol-Myers Squibb to the
PathoGenome(TM) Database granting them non-exclusive access to the genetic
information for small molecule therapeutic products. As consideration, GTC will
receive annual subscription fees, milestone payments and royalties on products
developed from information in the database.
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SCHERING-PLOUGH
In September, 1997, the Company also issued a non-exclusive license to
Schering-Plough granting them access to the PathoGenome(TM) Database for small
molecule therapeutics. The Company, in return, will receive subscription fees
and downstream royalty payments from developed and commercialized products.
SCRIPTGEN PHARMACEUTICALS
In May, 1998, the Company sold its first subscription to a biotech company
giving Scriptgen non-exclusive access to the genetic information in the
PathoGenome(TM) Database for small molecule therapeutics. Scriptgen will pay to
the Company annual subscription fees and, in certain instances, milestone
payments. GTC will also receive downstream royalties on products commercialized
as a result of accessing the genetic information.
HOECHST MARION ROUSSEL
In September, 1998, subsequent to the fiscal year end, GTC subscribed HMR
to the PathoGenome(TM) Database granting them non-exclusive access to the
genetic information for small molecule therapeutics. As consideration, the
Company will receive annual subscription payments and downstream royalties on
products developed and commercialized.
GOVERNMENT GRANTS AND CONTRACTS
Since 1989, the Company has been awarded a number of grants and contracts
by various agencies of the United States government pursuant to the government's
genomics programs. The scope of the research covered by the grants and contracts
encompasses technology development, sequencing production, technology automation
and positional cloning projects.
Under the government grants, the Company has, subject to certain rights of
the government described below, exclusive ownership rights to any commercial
applications of inventions first reduced to practice under the grants, including
all gene discoveries and technology improvements created or discovered. The
Company is strongly encouraged under certain of the government grants to make
data and materials resulting from the research public within 180 days from the
date such data and materials are developed. Under the Company's government
research contracts, the government has ownership rights in the data, clones,
genes and other material derived from the material furnished to the Company by
the government, and the Company has ownership rights in other inventions
developed solely by the Company under the contracts. The government also retains
certain rights, described below under the caption "Patents and Proprietary
Technology", to the inventions first reduced to practice by the Company under
the government grants and contracts.
From January 1991 through August 1998, the United States government awarded
the Company grants and contracts providing for aggregate payments over their
terms of approximately $37 million. These grants and contracts are typically
funded annually and are subject to the appropriation by the United States
Congress of funding in each year. In addition, funding under these grants and
contracts may be discontinued or reduced at any time by the United States
Congress. For the Company's fiscal year ended August 31, 1998, the Company
recognized revenue under its government collaborations of $1.8 million which
accounted for approximately 9% of the Company's total revenue.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company's commercial success will be dependent in part on its ability
to obtain patent protection on genes, or products based on genes, discovered by
it. The current criteria for obtaining patent protection for partially sequenced
genes and for genes whose biological functions have not been characterized are
unclear. The Company's current strategy is to apply for patent protection upon
the identification of a novel gene or novel gene fragment and pursue claims to
these gene sequences as well as equivalent sequences, such as substantially
homologous sequences. Where the biological function of a gene or gene fragment
has not been characterized at the time of filing a patent application, the
Company intends to supplement such patent filing as soon as additional
information with respect to the biological function of such gene or gene
fragment is
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available. However, there can be no assurance that the Company will be able to
obtain patent protection on such genes or gene fragments, and even if such
patents are issued, the scope of the coverage or protection provided by any such
patents is uncertain. In addition, there can be no assurance that any patents,
if issued, will provide protection against any competitors, will provide the
Company with competitive advantages, will provide protection for any
therapeutic, vaccine or diagnostic products based on the Company's gene
discoveries or will not be successfully challenged by others. Furthermore,
others have filed and are likely to file in the future patent applications which
have not yet been published covering genes or protein sequences similar or
identical to the Company's. No assurance can be given that any such patent
application will not have priority over patent applications filed by the Company
or that any patent applications filed by the Company will result in issued
patents.
There have been, and continue to be, intensive discussions on the scope of
patent protection for both gene fragments and full-length genes. In November
1995, the PTO scheduled a hearing and requested public comment on the patenting
of a complete genome of an organism as well as the patenting of human gene
fragments. Although the PTO canceled the hearings and request for comments, they
may be rescheduled at a future date. There can be no assurance that these or
other proposals will not result in changes in, or interpretations of, the patent
laws which will adversely affect the Company's patent position.
The PTO issued new Utility Guidelines in July 1995 that address the
requirements for demonstrating utility, particularly in inventions relating to
human therapeutics. While the guidelines do not require clinical efficacy data
for issuance of patents for human therapeutics, there can be no assurance that
the PTO's interpretations of such guidelines, and any changes to such
interpretations will not delay or adversely affect the Company's or its
collaborators' ability to obtain patent protection. The biotechnology patent
situation outside the United States is even more uncertain and is currently
undergoing review and revision in many countries.
The Company has filed patent applications and will continue to do so with
respect to a number of full length genes and corresponding proteins and partial
genes resulting from its pathogens program. The Company plans to file foreign
counterparts of these U.S. applications within the appropriate time frames.
These applications seek to protect these full length and partial gene sequences
and corresponding proteins, as well as equivalent sequences, such as
substantially homologous sequences, and products derived therefrom and uses
therefor. These applications also identify possible biological functions for the
genes and gene fragments based in part on a comparison to genes or gene
fragments included in public databases but do not contain any laboratory or
clinical data with respect to such biological functions.
Under the Company's government grants and contracts, the government has a
statutory right to practice or have practiced, and, under certain circumstances
(including inaction on the part of the Company or its licensees to achieve
practical application of the invention or a need to alleviate public health or
safety concerns not reasonably satisfied by the Company or its licensees), to
grant to other parties licenses under any inventions first reduced to practice
under the government grants and contracts. In addition, under the Company's
government research contracts, the government has ownership rights in the data,
clones, genes and other material derived from the material furnished to the
Company by the government, and the Company has ownership rights in other
technology developed solely by the Company under the contracts. Under the
Company's CRADA with the NIH, any inventions or discoveries made in whole or in
part by NIH researchers are the property, either solely or jointly with the
Company, of NIH, and the Company has the right to negotiate with the NIH to
obtain an exclusive license to such inventions and discoveries. The Company is
also strongly encouraged under certain government grants to make data and
materials resulting from the research public within 180 days from the date such
data and materials are developed. If this requirement results in premature
publication of the Company's discoveries and inventions, the Company's ability
to obtain patent protection for such discoveries and inventions may be adversely
affected.
The Company also relies on trade secret protection for its confidential and
proprietary information. There can be no assurance that the Company can maintain
adequate protection for its trade secrets or other proprietary information. In
addition, while the Company has entered into proprietary information agreements
with its employees, consultants and advisors, there can be no assurance that
these agreements will provide
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meaningful protection for the Company's proprietary information in the event of
unauthorized use or disclosure of such information. Moreover, there can be no
assurance that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets or disclose such technology, or that the Company can meaningfully
protect its trade secrets.
COMPETITION
The Company faces intense competition with respect to its human genetics
and pathogen genetics and drug discovery programs. There is a finite number of
genes in the human genome and the Company believes virtually all of such genes
will be identified albeit largely without known function. The Company also
believes that the primary genes that cause or predispose individuals to most
common diseases will eventually be identified and characterized. In addition,
the Company believes that the genomes of many commercially important pathogens
will be sequenced within the next three years.
Competitors of the Company include pharmaceutical and biotechnology
companies both in the United States and abroad. In addition, significant
research to identify and sequence genes is being conducted by universities,
other non-profit research institutions and United States and foreign
government-sponsored entities. A number of commercial, scientific and
governmental entities are attempting to sequence human genes and the genomes of
other organisms. Other entities are utilizing positional cloning to identify and
characterize human disease genes. Certain of the Company's competitors' human
gene programs are more advanced than the Company's and any one of these
companies or other entities may discover and establish a competitive advantage
in one or more pathogen development programs which the Company has commenced.
The Company also faces competition in its human gene discovery programs in
gaining access to family DNA samples for use in positional cloning.
The Company believes that its ability to compete is dependent, in part,
upon its ability to create and maintain advanced technology, the speed with
which it can identify and characterize the genes involved in human diseases, the
Company's ability to rapidly sequence the genomes of selected pathogens, its
collaborators' ability to develop and commercialize therapeutic, vaccine and
diagnostic products based upon the Company's gene discoveries, as well as its
ability to attract and retain qualified personnel, obtain patent protection or
otherwise develop proprietary technology or processes and secure sufficient
capital resources for the expected substantial time period between technological
conception and commercial sales of products based upon the Company's gene
discoveries.
Many of the Company's competitors have greater research and product
development capabilities and financial, scientific, marketing and human
resources than the Company. These competitors may succeed in identifying or
sequencing genes or developing products earlier than the Company or its
collaborators, obtaining authorization from the FDA for such products more
rapidly than the Company or its collaborators or developing products that are
more effective than those proposed to be developed by the Company or its
collaborators. Any potential products based on genes identified by the Company
will face competition both from companies developing gene-based products and
from companies developing other forms of diagnosis or treatment for the
particular diseases targeted by the Company. There can be no assurance that
products developed by others will not render the products which the Company or
its collaborators may seek to develop obsolete or uneconomical or result in
diagnoses, treatments or cures superior to any products developed by the Company
or its collaborators, or that any product developed by the Company or its
strategic collaboration partners will be preferred to any existing or newly
developed technologies.
GOVERNMENT REGULATION
Regulation by governmental entities in the United States and other
countries will be a significant factor in the development, manufacturing and
marketing of any products which may be developed by the Company or its
collaborators. The nature and the extent to which such regulation may apply to
the Company or its collaborators will vary depending on the nature of any such
products. Virtually all of the Company's or its collaborators' developed
pharmaceutical products will require regulatory approval by governmental
agencies prior to commercialization. In particular, human therapeutic and
vaccine products are subject to rigorous preclinical and clinical testing and
other approval procedures by the FDA in the United States and similar
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health authorities in foreign countries. Various federal and, in some cases,
state statutes and regulations also govern or influence the manufacturing,
safety, labeling, storage, record keeping and marketing of such products. The
process of obtaining these approvals and the subsequent compliance with
appropriate federal and foreign statutes and regulations are time consuming and
require the expenditure of substantial resources.
The FDA regulates human therapeutic products in one of three broad
categories: drugs, biologics, or medical devices. Products based on the
Company's technologies could potentially fall into all three categories.
Generally, in order to gain FDA pre-market approval of a new drug or biological
product, a company first must conduct pre-clinical studies in the laboratory and
in animal model systems 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 ("IND"), which the FDA must
review before human clinical trials of a drug or biologic can commence. In order
to commercialize any products, the Company or its collaborators will be required
to sponsor and file an IND and will be responsible for initiating and overseeing
the clinical studies to demonstrate the safety, efficacy and potency that are
necessary to obtain FDA approval of any such products. Clinical trials are
normally done in three phases and are likely to take a number of years to
complete. After completion of clinical trials of a new product, FDA marketing
approval must be obtained. If the product is classified as a new drug, the
Company or its collaborators will be required to file a New Drug Application
("NDA") and receive approval before commercial marketing of the drug. If the
product is classified as a biologic (e.g., a vaccine), the Company or its
collaborator will be required to file a product license application and an
establishment license application ("ELA") and receive approval of both before
commercial marketing of the product can take place. The testing and approval
processes require substantial time and effort and there can be no assurance that
any approvals will be granted on a timely basis, if at all.
Even if FDA regulatory clearances are obtained, a marketed product is
subject to continual review, and later 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. In addition, biologic
products may be subject to batch certification and lot release requirements. To
the extent that any of the Company's products involve recombinant DNA
technology, additional layers of government regulation and review are possible.
For marketing outside the United States, the Company will also be subject to FDA
export regulations and foreign regulatory requirements governing human clinical
trials and marketing approval for pharmaceutical products. The requirements
governing the conduct of clinical trials, product licensing, pricing and
reimbursement vary widely from country to country.
The Company or its collaborators may also develop diagnostic products based
upon the human or pathogen genes that the Company identifies. The Company
believes that the diagnostic products to be developed by the Company or its
collaborators are likely to be regulated by the FDA as devices rather than drugs
or biologics. The nature of the FDA requirements applicable to such diagnostic
devices depends on their classification by the FDA. A diagnostic device
developed by the Company or a collaborator would most likely be classified as a
Class III device, requiring pre-market approval. Obtaining pre-market approval
involves the costly and time-consuming process, comparable to that for new drugs
or biologics, of conducting pre-clinical studies, obtaining an investigational
device exemption to conduct clinical tests, filing a pre-market approval
application, and obtaining FDA approval. Again, there can be no assurance that
any approval will be granted on a timely basis, if at all.
The Company's research and development activities involve the controlled
use of hazardous materials, chemicals and various radioactive materials. The
Company is subject to federal, state and local laws and regulations governing
the use, storage, handling and disposal of such materials and certain waste
products. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state,
federal and local laws and regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any liability could exceed the resources of the Company.
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MANUFACTURING AND MARKETING
The Company does not generally expect to directly manufacture or market
pharmaceutical products in the near term. However, the Company may, in the
future, consider taking such actions if it believes they are appropriate under
the circumstances. The Company has no recent experience in developing
pharmaceutical products or in manufacturing or marketing pharmaceutical
products. The Company may not have the resources to develop or manufacture or
market by itself any products based on genes identified by it. In the event the
Company decides to establish a manufacturing facility, the Company will require
substantial additional funds and will be required to hire and train significant
additional personnel and comply with the extensive "good manufacturing practice"
regulations applicable to such a facility. In addition, if any products produced
at the Company's facilities were regulated as biologics, the Company would be
required to file and obtain approval of an ELA for its facilities.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software applications are
designed to accept only two digit entries in the date code field used to
identify years. These date code fields require modification to recognize
twenty-first century years. As a result, computer systems and software
applications used by many companies may need to be upgraded to comply with the
year 2000 requirements. Significant uncertainty exists concerning the potential
effects of failure to comply with such requirements.
The Company is currently performing an extensive review of its computer
systems, software applications, and genomic database storage and retrieval
systems used both internally and sold to its customers to identify which systems
may be impacted by Year 2000. The Company plans to develop a comprehensive
compliance program, using internal and, if necessary, external resources to
address Year 2000 issues. The program would include an evaluation of its
internally developed operating systems and internally used financial and
administration systems. Externally, the program will include soliciting and
obtaining compliance certificates from third party software vendors as well as
determining the readiness of its major suppliers. At this time, given that the
Company's internal financial and administrative systems have been installed
within the last few years and the internally developed software-based systems
are not generally date sensitive, the Company does not expect the cost of
addressing the Year 2000 Issue to have a material impact on the Company's
business, results of operations or financial condition.
If such modifications, conversions, and/or replacements are not completed
in a timely manner, or if any of the Company's suppliers or customers do not
successfully deal with the Year 2000 Issue, the Year 2000 Issue could have a
material impact on the operations of the Company. The Company's research and
development efforts could be significantly interrupted resulting in delays in
meeting its scientific obligations to existing collaborations, delays in
progress of its internal drug discovery programs and, consequently, delays in
attracting new collaborative partners.
After evaluating its internal compliance efforts as well as the compliance
effort of third parties with which the Company does business, the Company will
develop appropriate contingency plans in fiscal 1999 to address situations in
which various systems of the Company, or of third parties are not yet year 2000
compliant. If there are unidentified dependencies on systems to operate the
business or, if any required modifications are not completed on a timely basis
or are more costly to implement than anticipated, the Company's business,
financial condition or results of operations could be materially affected.
FACTORS THAT MAY AFFECT RESULTS
This Annual Report on Form 10-K contains forward-looking statements. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects,"
"intends," and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the
Company's actual results to differ materially from those indicated by such
forward-looking statements. Those factors include, without limitation, those set
forth throughout this Annual Report on Form 10-K.
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HUMAN RESOURCES
As of August 31, 1998, the Company had 200 full-time equivalent employees,
of whom 182 were engaged in research and development activities, and 18 in
general and administrative functions. Fifty-two of the Company's employees hold
Ph.D. degrees and 62 others hold other advanced degrees.
None of the Company's employees are covered by a collective bargaining
agreement, and the Company considers its relations with its employees to be
good.
FACILITIES
The Company's executive offices and laboratories are located at 100 Beaver
Street, Waltham Massachusetts, where the Company has leased approximately 80,000
square feet of space expiring November 15, 2006 with options to extend for two
consecutive five-year periods. The Company has additional labs at 1365 Main
Street, Waltham, Massachusetts, where the Company has leased approximately
14,000 square feet of space under a lease expiring December 31, 2002. During
fiscal 1998, the Company consolidated its research operations at 100 Beaver
Street leaving the facility at 1365 Main Street unoccupied. The Company plans to
sublease 1365 Main Street for the remaining term of the lease.
During fiscal 1998, the Company incurred aggregate rental costs, excluding
maintenance, taxes and utilities, for all facilities of approximately
$1,085,000. The aggregate rental costs, excluding maintenance, taxes and
utilities, to be paid in fiscal 1999 is expected to be approximately $983,000.
As of August 31, 1998, the Company had completed its renovation project at 100
Beaver Street at a cost of approximately $6,700,000 which consisted of office
and laboratory improvements.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The Company's common stock is traded on the NASDAQ National Market System
(ticker symbol "GENE"). The table below sets forth the range of high and low
quotations for each fiscal quarter of the Company during 1998 and 1997 as
furnished by the National Association of Securities Dealers Quotation System.
1998 1997
---------- -----------
HIGH LOW HIGH LOW
---- --- ---- ---
First Quarter........................................ 9 7/8 7 1/4 10 1/2 7 3/8
Second Quarter....................................... 9 6 12 1/2 8 5/8
Third Quarter........................................ 9 1/2 6 1/2 10 1/8 5 7/8
Fourth Quarter....................................... 6 3/4 2 1/8 8 7/8 6 1/2
As of November 23, 1998, there were approximately 1,241 shareholders of
record of the Company's Common Stock.
The Company has not paid any dividends since its inception and presently
anticipates that all earnings, if any, will be retained for development of the
Company's business and that no dividends on its Common Stock will be declared in
the foreseeable future. Any future dividends will be subject to the discretion
of the Company's Board of Directors and will depend upon, among other things,
future earnings, the operating and financial condition of the Company, its
capital requirements and general business conditions.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
FOR THE YEAR ENDED AUGUST 31, 1994 1995 1996 1997 1998
----------------------------- ----------- ----------- ----------- ------------ ------------
Revenues:
Collaborative research, licenses,
subscription fees and service......... $ 251,529 $ 3,870,620 $12,548,724 $ 11,550,786 $ 17,388,892
Government research..................... 6,077,346 7,014,280 6,795,393 4,454,828 1,807,666
Royalties............................... 148,458 90,541 127,112 647,150 20,574
Total................................... $ 6,477,333 $10,975,441 $19,471,229 $ 16,652,764 $ 19,217,132
Net income (loss)....................... $(1,078,718) $ 585,204 $ 1,920,710 $(11,302,391) $(15,813,383)
Net income (loss) per common share...... $ (0.10) $ 0.05 $ 0.11 $ (0.64) $ (0.87)
Weighted average common and common
equivalent shares..................... 11,097,224 12,961,734 18,129,794 17,617,614 18,212,365
AS OF AUGUST 31,
Cash, cash equivalents, restricted cash
and long and short-term marketable
securities............................ $ 4,217,180 $ 9,011,247 $53,768,562 $ 47,843,597 $ 34,177,269
Working capital......................... 3,244,260 5,498,782 25,904,641 35,708,618 20,823,316
Total assets............................ 5,910,682 11,528,674 63,279,017 60,688,379 51,464,691
Shareholders' equity.................... 4,224,555 7,238,503 54,312,758 43,946,197 29,247,800
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leader in the field of genomics-based drug targets
discovery -- the identification and functional characterization of genes. The
Company has over ten years of experience in the field of genomics, having served
as one of the primary researchers under genome programs sponsored by the United
States government, and has developed numerous techniques and tools that are
widely used in the field. The Company's commercial gene discovery strategy
capitalizes on its pioneering work in genomics by applying its high-throughput
sequencing technology and positional cloning, its experience and skills in
functional genomics and its bioinformatics capabilities. The two areas of focus
are: the discovery and characterization of (i) genes of pathogens that are
responsible for many serious diseases and (ii) human disease genes. The Company
believes that its genomic discoveries may lead to the development of novel
therapeutics, vaccines and diagnostic products by it and its strategic partners.
The Company has entered into numerous corporate collaborations in connection
with its pathogen and human gene discovery programs.
The Company does not anticipate revenues on a sustained basis until such
time that therapeutic, vaccine and diagnostic products based on the Company's
research efforts are commercialized, if at all. The Company's product
development strategy is to form collaborations with pharmaceutical and
biotechnology companies accessing drug discovery and clinical development
capabilities that currently do not exist at the Company. In the pharmaceutical
alliances, the Company generates revenues from licensing fees, sponsored
research and milestone payments during the term of the collaboration. Once a
product resulting from the research collaboration is commercialized, the Company
is entitled to receive royalty payments based upon product revenues.
Additionally, the Company will sell non-exclusive access to its proprietary
PathoGenome(TM) Database. These collaborations are expected to result in the
discovery and commercialization of novel therapeutics, vaccines and diagnostics.
The sale of the genetic database generates subscription revenue over the term of
the subscription and royalty payments to the Company from product sales
downstream. In order for a product to be commercialized based on the Company's
research, it will be necessary for the collaborators to conduct preclinical
tests and clinical trials, obtain regulatory clearances and make manufacturing,
distribution and marketing arrangements. Accordingly, the Company does not
expect to receive royalties based upon product revenues for many years.
The Company's primary sources of revenue are collaborative agreements with
pharmaceutical company partners, subscription agreements to the Company's
proprietary PathoGenome(TM) Database and government research grants and
contracts. As of August 31, 1998, the Company had four collaborative research
agreements and four subscribers to its proprietary PathoGenome(TM)Database. In
September 1998, subsequent to fiscal year end, the Company added one additional
subscriber. The Company entered into corporate collaborations with Astra Hassle
AB ("Astra") relating to H. Pylori in August 1995 and with Schering
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Corporation and Schering-Plough, Ltd. (collectively, "Schering-Plough") in
December 1995 providing for the use by Schering-Plough of the Company's Staph.
aureus genomic database to identify new gene targets for the development of
novel antibiotics. In December 1996, the Company entered into its second
research collaboration with Schering-Plough to identify genes and associated
proteins that can be utilized by Schering-Plough to develop new pharmaceuticals
for treating asthma. In September 1997, the Company entered into its third
research collaboration with Schering-Plough to use genomics to discover and
develop new pharmaceutical products to treat fungal infections.
In May 1997, the Company introduced its proprietary PathoGenome(TM)
Database and sold its first subscription to Bayer AG ("Bayer"). In September
1997, the Company sold subscriptions to Bristol-Myers Squibb and
Schering-Plough. In May 1998, the Company sold a subscription to Scriptgen
Pharmaceuticals, Inc. ("Scriptgen"). In September 1998, subsequent to the fiscal
year end, the Company sold a subscription to Hoechst Marion Roussel ("HMR").
Under these agreements, the subscribers will receive non-exclusive access to the
Company's PathoGenome(TM) database and associated information relating to
microbial organisms.
Since 1989, the Company has been awarded a number of research grants and
contracts by various agencies of the United States government pursuant to the
government genomics programs. The scope of the research covered by grants and
contracts encompasses technology development, sequencing production, technology
automation projects and positional cloning projects. These programs strengthened
the Company's genomics technology base and increased the number and enhanced the
expertise of its scientific personnel. From January 1991 through August 1998,
the United States government awarded the Company grants and contracts providing
for the aggregate payments over their terms of approximately $37 million.
However, over the last two years, the Company has substantially reduced its
reliance on government research grants and contracts as the Company focuses its
resources more toward drug discovery in collaboration with pharmaceutical
partners.
The Company has incurred significant losses, since inception, with an
accumulated deficit of approximately $60,369,000 at August 31, 1998. The
Company's results of operations have fluctuated from period to period and may
continue to fluctuate in the future based upon the timing and composition of
funding under existing and new collaborative agreements and government research
grants and contracts. The Company is subject to risks common to companies in its
industry including unproven technology and business strategy, availability of,
and competition for, family resources, reliance upon collaborative partners and
others, history of operating losses, need for future capital, competition,
patent and proprietary rights, dependence on key personnel, uncertainty of
regulatory approval, uncertainty of pharmaceutical pricing, health care reform
and related matters, product liability exposure, and volatility of the Company's
stock price.
RESULTS OF OPERATIONS
REVENUE
Total revenues increased 15% from $16,653,000 in fiscal 1997 to $19,217,000
in fiscal 1998 and decreased 14% from $19,471,000 in fiscal 1996 to $16,653,000
in fiscal 1997. Collaborative research, licenses and subscription fees increased
51% from $11,551,000 in fiscal 1997 to $17,389,000 in fiscal 1998 due to
increased sponsored research revenue and milestone payments received in fiscal
1998 under the Company's collaborative research agreements with Schering-Plough
as well as increased subscription fees earned in fiscal year 1998 under the
Company's new subscription agreements with Bristol-Myers Squibb,
Schering-Plough, and Scriptgen to access the Company's proprietary
PathoGenome(TM) sequence database. Collaborative research, licenses and
subscription fees decreased 8% from $12,549,000 in fiscal 1996 to $11,551,000 in
fiscal 1997 due to lower license fees and milestone payments received in fiscal
1997 under the Company's collaborative research agreements with Astra and
Schering-Plough.
Government research revenue decreased 59% from $4,455,000 in fiscal 1997 to
$1,808,000 in fiscal 1998 and decreased 34% from $6,795,000 in fiscal 1996 to
$4,455,000 in fiscal 1997. The decrease in government research revenue in both
fiscal 1997 and 1998 is due to the Company focusing its resources toward drug
discovery in collaboration with pharmaceutical partners. Revenue derived from
government research grants
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and contracts is generally based upon direct cost such as labor, laboratory
supplies, as well as an allocation for reimbursement of a portion of overhead
expenses.
The Company had royalty revenue of $127,000, $647,000 and $21,000 in fiscal
1996, 1997 and 1998, respectively. The royalty revenue in fiscal 1996 and 1997
was derived from the Company's rennin patent which was assigned to Pfizer, Inc.
for $671,000 in October 1996. No further royalties will be received under this
patent.
COST AND EXPENSES
Total cost and expenses, excluding noncash charges for stock option grants,
increased 20% from $30,210,000 in fiscal 1997 to $36,138,000 in fiscal 1998 and
increased 80% from $16,801,000 in fiscal 1996 to $30,210,000 in fiscal 1997.
Research and development expense, which includes GTC-sponsored research and
development and research funded pursuant to arrangements with the Company's
corporate collaborators increased 37% from $22,069,000 in fiscal 1997 to
$30,170,000 in fiscal 1998 and increased 179% from $7,924,000 in fiscal 1996 to
$22,069,000 in fiscal 1997. The increase in research and development expenses in
both fiscal 1997 and fiscal 1998 was primarily attributable to increases in both
personnel and laboratory expenses associated with the Company's expansion of its
pathogen, microbial genetic database, human gene discovery and functional
genomics research programs. The increase from fiscal 1996 to fiscal 1997
consisted primarily of increases in payroll and related expenses, laboratory
supplies and overhead expenses.
The cost of government research decreased 59% from $4,455,000 in fiscal
1997 to $1,808,000 in fiscal 1998 and decreased 28% from $6,150,000 in fiscal
1996 to $4,455,000 in fiscal 1997. The decrease in cost of government research
in both fiscal 1996 and fiscal 1997 was due primarily to a decrease in
government research revenue.
Selling, general and administrative expenses increased 13% from $3,686,000
in fiscal 1997 to $4,161,000 in fiscal 1998 and increased 35% from $2,727,000 in
fiscal 1996 to $3,686,000 in fiscal 1997. The increase in selling, general and
administrative expenses in fiscal 1998 was primarily due to increases in payroll
and related expenses. The increase in selling, general and administrative
expenses in fiscal 1997 was primarily due to increases in payroll and related
expenses as well as legal fees. The increase in legal fees in fiscal 1997 was
directly attributable to the Company's new collaborative agreements with
Schering-Plough, Bayer and Bristol-Myers Squibb.
In November and December 1995, the Company's Board of Directors granted
certain employees, officers, and directors options to purchase an aggregate of
440,000 shares of common stock which were subject to shareholder approval. The
options were granted at exercise prices ranging from $7.25 to $9.56 per share,
in each case, the fair market value of the common stock on the date the
Company's Board of Directors granted the option. The Company recorded deferred
compensation of $2,565,000 which represents an amount equal to the difference
between the fair market value of the common stock on February 16, 1996, the date
of shareholder approval, and the per share exercise price of the options. In
March 1997, the Company granted options valued at approximately $51,000 to
certain consultants in lieu of cash for services. In October, 1997, the
Company's Board of Directors granted options valued at $43,000 to an officer of
the Company. Additionally, during fiscal 1998, the Company granted deferred
stock awards valued at $34,000 to certain members of the Board of Directors in
lieu of cash for services. The Company recorded $2,320,000, $79,000 and $131,000
as compensation expense in fiscal 1996, 1997 and 1998, respectively, for these
stock option arrangements.
INTEREST INCOME AND EXPENSE
Interest income decreased 20% from $2,966,000 in fiscal 1997 to $2,387,000
in fiscal 1998 and increased 66% from $1,785,000 in fiscal 1996 to $2,966,000 in
fiscal 1997. The decrease in interest income in fiscal 1998 was due to the
decrease in funds available for investment during fiscal 1998 as a result of
cash being utilized to fund operations. The increase in interest income in
fiscal 1997 as compared to fiscal 1996 was due to the increase in funds
available for investment as a result of (i) proceeds received from the sale of
common stock
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24
through a public offering in February 1996, (ii) the sale of common stock in a
private placement in March 1995 and (iii) payments received under the Company's
collaboration agreements.
Interest expense increased 82% from $631,000 in fiscal 1997 to $1,147,000
in fiscal 1998 and increased 195% from $214,000 in fiscal 1996 to $631,000 in
fiscal 1997. The increase in interest expense for each period was attributable
to increases in the Company's outstanding balance under its capital lease and
debt agreements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash have been revenue from collaborative
research agreements and subscription fees, revenue from government grants and
contract, borrowings under equipment lending facilities and capital leases and
proceeds from sale of equity securities.
In fiscal 1996, the Company received approximately $11,671,000 in
collaborative payments from its collaborative partners consisting of an up-front
license fee, milestone payments and sponsored research funding. In fiscal 1996,
the Company closed a public offering of 3,000,000 shares of its common stock at
$13.00 per share, resulting in proceeds of approximately $36,007,000, net of
issuance costs. The Company also sold an additional 450,000 shares of its common
stock in the underwriter's over-allotment, resulting in proceeds of $5,515,000,
net of issuance costs. Additionally, the Company received proceeds of $1,311,000
from the issuance of 534,831 shares of common stock from the exercise of stock
options and warrants during fiscal 1996.
In fiscal 1997, the Company received payments of $13,496,000 from its
collaborative partners consisting of an up-front license fee, sponsored research
funding, subscription fee, milestone payments and expense allowance included in
research funding. In fiscal 1998, the Company received payments of $19,705,000
from its collaborative partners consisting of sponsored research funding,
subscription fees, milestone payments and expense allowance included in research
funding.
As of August 31, 1998, the Company had cash, cash equivalents, restricted
cash and long and short-term marketable securities of approximately $34,177,000.
The Company has various arrangements under which it can finance certain office
and laboratory equipment and leasehold improvements. Under these arrangements,
the Company is required to maintain certain financial ratios, including minimum
levels of tangible net worth, total indebtedness to tangible net worth, maximum
loss, debt service coverage and minimum restricted cash balances. At August 31,
1998, the Company had approximately $3,647,000 available under these
arrangements for future borrowings. The Company has an aggregate of
approximately $14,090,000 outstanding under its borrowing arrangement at August
31, 1998, which is repayable over the four year period ending December 2002.
The Company's operating activities used cash of approximately $9,279,000
and $4,757,000 in fiscal 1998 and 1997, respectively, and provided cash of
approximately $2,976,000 in fiscal 1996. The Company primarily used cash in
fiscal 1998 and 1997 to fund the Company's operating loss which was partially
offset by increases in deferred revenue, accrued liabilities as well as
decreases in receivables. Net cash provided in fiscal 1996 was comprised
primarily of deferred revenue, accounts payable and operating income.
The Company's investing activities provided cash of approximately
$10,898,000 and $2,257,000 in fiscal 1998 and 1997, respectively, and used cash
of approximately $40,258,000 in fiscal 1996. The Company's investing activities
in fiscal 1998 and 1997 provided cash through the sale of its marketable
securities offset by the purchase of equipment and leasehold improvements. The
Company used cash in fiscal 1996 primarily for purchases of marketable
securities and to a lesser extent the purchase of equipment and leasehold
improvements. In addition, the Company financed $3,573,000, $5,843,000 and
$4,724,000 of property and equipment in fiscal 1998, 1997 and 1996,
respectively, under equipment financing arrangements.
Capital expenditures totaled $8,735,000 during fiscal 1998 consisting of
capital improvements and purchases of laboratory, computer and office equipment.
The Company consolidated its operations at its Beaver Street facility during
fiscal 1998 at a total cost of approximately $6,700,000 of which approximately
$847,000 and $5,853,000 was incurred in fiscal 1997 and 1998, respectively. The
Company utilized existing
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capital lease and equipment financing arrangements to finance substantially all
of these capital expenditures. The Company currently estimates that it will
acquire approximately $2,000,000 in capital equipment in fiscal 1999 consisting
of primarily computer and laboratory equipment which it intends to finance under
existing equipment financing arrangements.
Financing activities provided cash of approximately $756,000, $422,000 and
$42,075,000 in fiscal 1998, 1997 and 1996, respectively, primarily from the sale
of equity securities, exercise of stock options and warrants, net of payments of
capital obligations.
At August 31, 1998, the Company had net operating loss and tax credit
carryforwards of approximately $62,908,000 and $1,658,000, respectively. Certain
of these net operating losses will expire in the next few years. (See Note 3 of
"Notes to Consolidated Financial Statements.") These net operating losses and
tax credits are available to reduce federal taxable income and federal income
taxes, respectively, in future years, if any, are subject to review and possible
adjustment by the Internal Revenue Service and may be limited in the event of
certain cumulative changes in ownership interests of significant shareholders
over a three-year period in excess of 50%. The Company does not believe it has
experienced a cumulative ownership change in excess of 50%. However, there can
be no assurance that ownership changes will not occur in future periods which
will limit the Company's ability to utilize the losses and tax credits.
The Company believes that its existing capital resources are adequate to
meet its cash requirements for at least two years under its current rate of
investment in research and development. There is no assurance, however, that
changes in the Company's plans or events affecting the Company's operations will
not result in accelerated or unexpected expenditures.
The Company may seek additional funding through public or private financing
and expects additional funding through collaborative or other arrangements with
corporate partners. There can be no assurance, however, that additional
financing will be available from any of these sources or will be available on
terms acceptable to the Company.
The Company does not use derivative financial instruments in its investment
portfolio. The Company places its investments in instruments that meet high
credit quality standards, as specified in the Company's investment policy
guidelines; the policy also limits the amount of credit exposure to any one
issue, issuer, and type of instrument. The Company does not expect any material
loss with respect to its investment portfolio. (See Note 2 to "Consolidated
Financial Statements.")
Many currently installed computer systems and software applications are
designed to accept only two digit entries in the date code field used to
identify years. These date code fields require modification to recognize
twenty-first century years. As a result, computer systems and software
applications used by many companies may need to be upgraded to comply with the
year 2000 requirements. Significant uncertainty exists concerning the potential
effects of failure to comply with such requirements.
The Company is currently performing an extensive review of its computer
systems, software applications, and genomic database storage and retrieval
systems used both internally and sold to its customers to identify which systems
may be impacted by Year 2000. The Company plans to develop a comprehensive
compliance program, using internal and, if necessary , external resources to
address Year 2000 issues. The program would include an evaluation of its
internally developed operating systems and internally used financial and
administration systems. Externally, the program will include soliciting and
obtaining compliance certificates from third party software vendors as well as
determining the readiness of its major suppliers. At this time, given that the
Company's internal financial and administrative systems have been installed
within the last few years and the internally developed software-based systems
are not generally date sensitive, the Company does not expect the cost of
addressing the Year 2000 Issue to have a material impact on the Company's
business, results of operations or financial condition.
If such modifications, conversions, and/or replacements are not completed
in a timely manner, or if any of the Company's suppliers or customers do not
successfully deal with the Year 2000 Issue, the Year 2000 Issue could have a
material impact on the operations of the Company. The Company's research and
development efforts could be significantly interrupted resulting in delays in
meeting its scientific obligations to
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26
existing collaborations, delays in progress of its internal drug discovery
programs and, consequently, delays in attracting new collaborative partners.
After evaluating its internal compliance efforts as well as the compliance
effort of third parties with which the Company does business, the Company will
develop appropriate contingency plans in fiscal 1999 to address situations in
which various systems of the Company, or of third parties are not yet year 2000
compliant. If there are unidentified dependencies on systems to operate the
business or, if any required modifications are not completed on a timely basis
or are more costly to implement than anticipated, the Company's business,
financial condition or results of operations could be materially affected.
Statements in this Form 10K that are not strictly historical are "forward
looking" statements as defined in the Private Securities Litigation Reform Act
of 1995. The actual results may differ from those projected in the forward
looking statement due to risks and uncertainties that exist in the Company's
operations and business environment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data required by Item 8 are set
forth at the pages indicated in Item 14(a) below.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Pursuant to General Instruction G(3) to Form 10-K, the information required
for Part III (Items 10, 11, 12, and 13) is incorporated herein by reference from
the Company's proxy statement for the Special Meeting of Shareholders in Lieu of
an Annual Meeting to be held on February 22, 1999.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) AND (2) See
"Index to Consolidated Financial Statements and Financial Statement Schedules"
appearing on page F-1.
(3) Exhibits
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3 Restated Articles of Organization and By-laws(1)
3.1 Amendment dated January 5, 1982 to Restated Articles of
Organization(2)
3.2 Amendment dated January 24, 1983 to Restated Articles of
Organization(3)
3.3 Amendment dated January 17, 1984 to Restated Articles of
Organization(4)
3.4 Amendment dated October 20, 1987 to the By-laws(8)
3.5 Amendment dated December 9, 1987 to Restated Articles of
Organization(9)
3.6 Amendment dated October 16, 1989 to the By-laws(11)
3.7 Amendment dated January 24, 1994 to Restated Articles of
Organization(15)
3.8 Amendment dated August 31, 1994 to Restated Articles of
Organization(15)
4 Series B Restricted Stock Purchase Plan(3)
10.1 Research Agreement with The Dow Chemical Company dated May
21, 1980(1)
26
27
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.2 Research Agreement with The Dow Chemical Company dated
August 19, 1981(1)
10.3 1981 Amended Stock Option Plan and Form of Stock Option
Certificate(1)
10.4 Incentive Stock Option Plan and Form of Stock Option
Certificate(1)
10.5 1984 Stock Option Plan and Form of Stock Option
Certificate(5)
10.6 Collaborative Research Incentive Savings Plan(6)
10.7 Amendment dated November 4, 1986 to the Collaborative
Research Incentive Savings Plan dated March 1, 1985(7)
10.8 Stock Option Agreement with Mr. Lawrence Levy(8)
10.9 Form of Amendment to the 1981 Incentive Stock Option Plan(8)
10.11 1988 Stock Option Plan and Form of Stock Option
Certificate(10)
10.14 1991 Stock Option Plan and Form of Stock Option
Certificate(13)
10.15 Lease dated November 17, 1992 relating to certain property
in Waltham, Massachusetts(14)
10.16 Lease dated June 3, 1993 relating to certain property in
Waltham, Massachusetts(14)
10.19 Employment Agreement with Robert J. Hennessey(14)
10.22 Lease Amendment dated August 1, 1994 relating to certain
property in Waltham, MA (15)
10.23 Consulting Agreement with Dr. Philip Leder(15)
10.24 1993 Stock Option Plan and Form of Stock Option
Certificate(15)
10.25 Stock and Warrant Purchase Agreement among the Company and
certain purchasers named therein dated March 20, 1995(16)
10.26 Registration Rights Agreement among the Company and certain
purchasers named therein dated March 20, 1995(16)
10.27 Form of Warrant Certificate issued pursuant to the Stock and
Warrant Purchase Agreement(16)
10.28 Agreement between the Company and Astra Hassle AB dated
August 31, 1995.(17)*
10.29 Collaboration and License Agreement between the Company,
Schering Corporation and Schering-Plough Ltd., dated as of
December 6, 1995.(20)*
10.30 Form of director Stock Option Agreement and schedule of
director options granted(18)
10.36 Credit Agreement between the Company and Silicon Valley Bank
dated June 1, 1995, as amended.(17)
10.37 Lease amendment dated November 15, 1996 to certain property
in Waltham, MA.(21)
10.38 Collaboration and License Agreement between the Company,
Schering Corporation and Schering-Plough Ltd., dated as of
December 20, 1996.(22)*
10.39 Credit agreement between the Company and Fleet National Bank
dated February 28, 1997.(23)
10.40 Credit agreement between the Company and Sumitomo Bank,
Limited dated July 31, 1997.(24)
10.41 Collaboration and License Agreement between the Company and
Schering Corporation, dated September 22, 1997.(25)*
10.42 Collaboration and License Agreement between the Company and
Schering-Plough Ltd. dated September 22, 1997.(25)*
10.43 Credit modification agreement between the Company and Fleet
National Bank, dated March 9, 1998.(26)
10.44 1997 Directors' Deferred Stock Plan.(27)
10.45 1997 Stock Option Plan.(27)
27
28
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.46 Amended Employment Agreement with Robert J. Hennessey.(28)
23. Consent of Arthur Andersen LLP Independent Public
Accounts.(28)
27. Financial Data Schedule.(28)
- ---------------
* Confidential treatment requested with respect to a portion of this Exhibit.
FOOTNOTES
(1) Filed as exhibits to the Company's Registration Statement on Form S-1 (No.
2-75230) and incorporated herein by reference.
(2) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 27, 1982 and incorporated herein by reference.
(3) Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 26, 1983 and incorporated herein by reference.
(4) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended February 25, 1984 and incorporated herein by reference.
(5) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1984 and incorporated herein by reference.
(6) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1985 and incorporated herein by reference.
(7) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1986 and incorporated herein by reference.
(8) Filed as exhibits to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1987 and incorporated herein by reference.
(9) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended November 28, 1987 and incorporated herein by reference.
(10) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1988 and incorporated herein by reference.
(11) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1989 and incorporated herein by reference.
(13) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1992 and incorporated herein by reference.
(14) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1993 and incorporated herein by reference.
(15) Filed as an Exhibit of the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1994 and incorporated herein by reference.
(16) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
fiscal year ended August 31, 1995 and incorporated herein by reference.
(17) Filed as an Exhibit to the Company's Annual Report on Form 10-K/A3 for the
year ended August 31, 1995 and incorporated herein by reference.
(18) Filed as an Exhibit to the Company Registration Statement on Forms S-8
(File No. 33-61191) and incorporated herein by reference.
28
29
(20) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended November 25, 1995 and incorporated herein by reference.
(21) Filed as an Exhibit to the Company's 10-K for fiscal year ended August 31,
1996.
(22) Filed as an Exhibit to the Company's 10-Q/A for the quarter ended March 1,
1997.
(23) Filed as an Exhibit to the Company's 10-Q for the quarter ended May 31,
1997.
(24) Filed as an Exhibit to the Company's 10-K for fiscal year ended August 31,
1997.
(25) Filed as an Exhibit to the Company's 10-Q for the quarter ended February
28, 1998.
(26) Filed as an Exhibit to the Company's 10-Q for the quarter ended May 30,
1998.
(27) Filed as an Exhibit to the Company's Registration Statement on Forms S-8
(333-49069).
(28) Filed herewith.
29
30
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets as of August 31, 1997 and
1998...................................................... F-3
Consolidated Statements of Operations for the Years Ended
August 31, 1996, 1997 and 1998............................ F-4
Consolidated Statements of Shareholders' Equity for the
Years Ended August 31, 1996, 1997 and 1998................ F-5
Consolidated Statements of Cash Flows for the Years Ended
August 31, 1996, 1997 and 1998............................ F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
31
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Genome Therapeutics Corp.:
We have audited the accompanying consolidated balance sheets of Genome
Therapeutics Corp. and subsidiaries (a Massachusetts corporation) as of August
31, 1997 and 1998, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended August 31, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Genome Therapeutics Corp.
and subsidiaries as of August 31, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
August 31, 1998, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN, LLP
Boston, Massachusetts
October 9, 1998
F-2
32
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AUGUST 31,
-------------------------
1997 1998
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 8,602,698 $10,978,176
Marketable securities..................................... 34,814,601 21,969,524
Interest receivable....................................... 1,280,611 742,411
Unbilled costs and fees................................... 140,320 150,299
Prepaid expenses and other current assets................. 463,382 721,239
----------- -----------
Total current assets.............................. 45,301,612 34,561,649
----------- -----------
Equipment and Leasehold Improvements, at cost:
Laboratory and scientific equipment....................... 11,855,630 14,434,808
Leasehold improvements.................................... 1,964,981 7,872,336
Equipment and furniture................................... 792,342 1,334,268
Construction-in-progress.................................. 1,111,526 41,234
----------- -----------
15,724,479 23,682,646
Less--Accumulated depreciation............................ 5,352,999 8,579,440
----------- -----------
10,371,480 15,103,206
Restricted Cash............................................. 301,500 200,000
Long-Term Marketable Securities............................. 4,124,798 1,029,569
Note Receivable from Officer................................ 160,000 160,000
Other Assets................................................ 428,989 410,267
----------- -----------
$60,688,379 $51,464,691
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 1,288,391 $ 977,610
Accrued expenses.......................................... 2,373,788 2,450,400
Deferred revenue.......................................... 2,335,695 4,699,137
Current maturities of long-term obligations............... 3,595,120 5,611,186
----------- -----------
Total current liabilities......................... 9,592,994 13,738,333
----------- -----------
Long-Term Obligations, net of current maturities............ 7,149,188 8,478,558
----------- -----------
Commitments and Contingencies (Note 4)
Shareholders' Equity:
Common stock, $.10 par value-
Authorized--34,375,000 shares
Issued and outstanding--17,782,929 and 18,312,589
shares at August 31, 1997 and 1998, respectively...... 1,778,293 1,831,259
Series B restricted stock, $.10 par value-
Authorized--625,000 shares
Issued and outstanding--none......................... -- --
Additional paid-in capital................................ 86,942,034 87,964,523
Accumulated deficit....................................... (44,555,906) (60,369,289)
Deferred compensation..................................... (218,224) (178,693)
----------- -----------
Total shareholders' equity........................ 43,946,197 29,247,800
----------- -----------
$60,688,379 $51,464,691
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
33
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED AUGUST 31,
-------------------------------------------
1996 1997 1998
----------- ------------ ------------
Revenues:
Collaborative research, licenses and
subscription fees............................ $12,548,724 $ 11,550,786 $ 17,388,892
Government research............................. 6,795,393 4,454,828 1,807,666
Royalties....................................... 127,112 647,150 20,574
----------- ------------ ------------
Total revenues.......................... 19,471,229 16,652,764 19,217,132
----------- ------------ ------------
Costs and Expenses:
Research and development........................ 7,924,113 22,068,996 30,169,715
Cost of government research..................... 6,150,234 4,454,828 1,807,666
Selling, general and administrative............. 2,726,855 3,686,385 4,161,066
Noncash charge for stock option grants.......... 2,320,217 79,370 131,405
----------- ------------ ------------
Total costs and expenses................ 19,121,419 30,289,579 36,269,852
----------- ------------ ------------
Interest income................................. 1,785,164 2,965,866 2,386,523
Interest expense................................ (214,264) (631,442) (1,147,186)
----------- ------------ ------------
Net interest income..................... 1,570,900 2,334,424 1,239,337
----------- ------------ ------------
Net income (loss)....................... $ 1,920,710 $(11,302,391) $(15,813,383)
=========== ============ ============
Net Income (Loss) per Common Share:
Basic........................................... $ .12 $ (.64) $ (.87)
=========== ============ ============
Diluted......................................... $ .11 $ (.64) $ (.87)
=========== ============ ============
Weighted Average Number of Common and Common
Equivalent Shares Outstanding:
Basic........................................... 15,530,639 17,617,614 18,212,365
=========== ============ ============
Diluted......................................... 18,129,794 17,617,614 18,212,365
=========== ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
34
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN ACCUMULATED DEFERRED SHAREHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT COMPENSATION EQUITY
---------- ---------- ----------- ------------ ------------ -------------
BALANCE, AUGUST 31, 1995........... 13,476,135 $1,347,613 $41,066,932 $(35,174,225) $ (1,817) $ 7,238,503
Exercise of stock options,
including tax effects.......... 496,756 49,676 1,151,079 -- -- 1,200,755
Exercise of warrants............. 38,075 3,808 106,643 -- -- 110,451
Deferred compensation from grant
of stock options............... -- -- 2,565,400 -- (2,565,400) --
Amortization of deferred
compensation................... -- -- -- -- 2,320,217 2,320,217
Sale of common stock............. 3,450,000 345,000 41,177,122 -- -- 41,522,122
Net income....................... -- -- -- 1,920,710 -- 1,920,710
---------- ---------- ----------- ------------ ----------- ------------
BALANCE, AUGUST 31, 1996........... 17,460,966 1,746,097 86,067,176 (33,253,515) (247,000) 54,312,758
Exercise of stock options........ 321,963 32,196 824,264 -- -- 856,460
Deferred compensation from grant
of stock options............... -- -- 50,594 -- (50,594) --
Amortization of deferred
compensation................... -- -- -- -- 79,370 79,370
Net loss......................... -- -- -- (11,302,391) -- (11,302,391)
---------- ---------- ----------- ------------ ----------- ------------
BALANCE, AUGUST 31, 1997........... 17,782,929 1,778,293 86,942,034 (44,555,906) (218,224) 43,946,197
Exercise of stock options........ 529,660 52,966 930,615 -- -- 983,581
Deferred compensation from grant
of stock options............... -- -- 91,874 -- (91,874) --
Amortization of deferred
compensation................... -- -- -- -- 131,405 131,405
Net loss......................... -- -- -- (15,813,383) -- (15,813,383)
---------- ---------- ----------- ------------ ----------- ------------
BALANCE, AUGUST 31, 1998........... 18,312,589 $1,831,259 $87,964,523 $(60,369,289) $ (178,693) $ 29,247,800
========== ========== =========== ============ =========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
35
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED AUGUST 31,
------------------------------------------
1996 1997 1998
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................... $ 1,920,710 $(11,302,391) $(15,813,383)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities --
Depreciation and amortization.................... 887,907 2,382,286 3,714,383
Loss on disposal of fixed assets................. -- 227,864 288,979
Deferred compensation............................ 2,320,217 79,370 131,405
Changes in assets and liabilities-
Accounts receivable............................ (1,057,514) 1,283,276 29,460
Interest receivable............................ (1,216,768) 16,046 538,200
Unbilled costs and fees........................ (86,768) 205,453 (9,979)
Prepaid expenses and other current assets...... (502,763) 144,663 (287,317)
Loan to officer................................ -- (160,000) --
Accounts payable............................... 454,997 424,112 (310,781)
Accrued expenses............................... (5,349) 642,568 76,612
Deferred revenue............................... 261,456 1,300,191 2,363,442
------------ ------------ ------------
Total adjustments........................... 1,055,415 6,545,829 6,534,404
------------ ------------ ------------
Net cash provided by (used in) operating
activities................................ 2,976,125 (4,756,562) (9,278,979)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities.................. (49,553,183) (20,575,625) (30,820,944)
Proceeds from sale of marketable securities......... 9,000,000 24,530,000 46,761,250
Purchases of equipment and leasehold improvements... (164,211) (1,370,028) (5,162,311)
(Increase) decrease in restricted cash.............. 588,971 (106,000) 101,500
(Increase) decrease in other assets................. (129,233) (220,850) 18,722
------------ ------------ ------------
Net cash (used in) provided by investing
activities................................ (40,257,656) 2,257,497 10,898,217
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options, including
tax benefits..................................... 1,200,755 856,460 983,581
Proceeds from exercise of warrants.................. 110,451 -- --
Proceeds from sale of common stock.................. 41,522,122 -- --
Proceeds from long-term obligations................. -- 2,500,000 4,011,000
Payments on long-term obligations................... (758,694) (2,933,984) (4,238,341)
------------ ------------ ------------
Net cash provided by financing activities... 42,074,634 422,476 756,240
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS......................................... 4,793,103 (2,076,589) 2,375,478
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR.......... 5,886,184 10,679,287 8,602,698
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR................ $ 10,679,287 $ 8,602,698 $ 10,978,176
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the year....................... $ 214,264 $ 631,442 $ 1,147,186
============ ============ ============
Income taxes paid during the year................... $ 43,240 $ 36,612 $ 24,700
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Equipment acquired under capital leases............. $ 4,723,678 $ 5,843,037 $ 3,572,777
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
36
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Genome Therapeutics Corp. (GTC or the Company) is a leader in the field of
genomics-based drug discovery--the identification and functional
characterization of genes. The Company has over 10 years of experience in
positional cloning, having served as one of the primary researchers under genome
programs sponsored by the United States government, and has developed numerous
techniques and tools that are widely used in this field. GTC's commercial gene
discovery strategy capitalizes on its pioneering work in genomics by applying
its high-throughput sequencing technology and positional cloning, its experience
and skills in pathogen functional genomics and its bioinformatics capabilities.
The two areas of focus are the discovery and characterization of (i) genes of
pathogens that are responsible for many serious diseases and (ii) human disease
genes.
The accompanying consolidated financial statements reflect the application
of certain accounting policies described in this note and elsewhere in the
accompanying notes to the consolidated financial statements.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
(b) Revenue Recognition
Research revenues are derived from collaborative agreements with
pharmaceutical companies as well as government grants and contract arrangements.
Research revenues are recognized as earned under government grants, which
consist of cost-plus fixed-fee contracts and fixed-price contracts. Revenues are
recognized under collaborative agreements as earned. Milestone payments from
collaborative research and development arrangements are recognized when they are
achieved. Subscription fee revenue from the PathGenome(TM) database is
recognized ratably over the life of the subscription. License fees and royalties
from collaborative agreements are recognized as earned. Unbilled costs and fees
represent revenue recognized prior to billing. Deferred revenue represents
amounts received prior to revenue recognition.
(c) Equipment and Leasehold Improvements
Equipment and leasehold improvements are depreciated over their estimated
useful lives using the straight-line method. The estimated useful life for
leasehold improvements is the lesser of the term of the lease or the estimated
useful life of the assets. Equipment and all other depreciable assets' useful
lives vary from three to seven years. The majority of the Company's equipment
and leaseholds are financed through capital leases. Construction-in-progress
primarily consisted of renovations and expansions of the Company's headquarters.
(d) Net Income (Loss) per Common Share
In March 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per Share.
This statement established standards for computing and presenting earnings per
share and applies to entities with publicly held common stock or potential
common stock. The Company has applied SFAS No. 128 beginning in the year ended
August 31, 1998. Earnings per share information for the years ended August 31,
1996 and 1997 has been restated to reflect the adoption of SFAS No. 128.
Basic earnings per share was determined by dividing net income (loss) by
the weighted average common shares outstanding during the period. Diluted
earnings per share was determined by dividing net income (loss) by diluted
weighted average shares outstanding. Diluted weighted average shares reflects
the dilutive effect, if any, of potential common stock, which include common
stock options and warrants, based on the
F-7
37
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
treasury stock method. Diluted loss per share is the same as basic loss per
share for the years ended August 31, 1997 and 1998 as the effect of the
potential common stock is antidilutive.
The calculations of basic and diluted weighted average shares outstanding
are as follows:
YEAR ENDED AUGUST 31,
-------------------------
1996 1997 1998
------ ------ ------
(IN THOUSANDS)
Basic weighted average common shares outstanding.... 15,531 17,618 18,212
Weighted average potential common stock............. 2,599 -- --
------ ------ ------
Diluted weighted average shares outstanding......... 18,130 17,618 18,212
====== ====== ======
Diluted weighted average shares outstanding do not include, 1,973,309,
4,869,938, and 4,089,226 common equivalent shares at August 31, 1996, 1997 and
1998, respectively as their effect would be anti-dilutive.
(e) Concentration of Credit Risk
SFAS No. 105, Disclosure of Information About Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. The Company has no significant off-balance-sheet or
concentrations of credit risk such as foreign exchange contracts, options
contracts or other foreign hedging arrangements. The Company maintains its cash
and cash equivalents and marketable securities balances with several
nonaffiliated institutions.
The Company had revenues from the following significant customers:
PERCENTAGE OF
NUMBER TOTAL
OF REVENUES
SIGNIFICANT ---------------
CUSTOMERS A B C
----------- --- --- ---
Year Ended August 31, 1996............................ 3 23% 35% 40%
1997................................................ 3 17 27 48
1998................................................ 3 9 9 71
(f) Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles 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.
(g) Financial Instruments
The estimated fair value of the Company's financial instruments, which
include cash equivalents, marketable securities, accounts receivable, accounts
payable and long-term debt, approximates carrying value.
(h) Reclassifications
The Company has reclassified certain prior year information to conform with
the current year's presentation.
F-8
38
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires disclosure of all components of comprehensive income on an
annual and interim basis. Comprehensive income is defined as the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. Comprehensive income (loss) is
the same as net income (loss) for all periods presented.
In July 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 131 requires certain financial
and supplementary information to be disclosed on an annual and interim basis for
each reportable segment of an enterprise. SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997. Unless impracticable, companies would
be required to disclose similar prior period information upon adoption.
Accordingly, the Company will adopt this standard for its fiscal year ending
August 1999.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires
computer software costs associated with internal use software to be charged to
operations as incurred until certain capitalization criteria are met. SOP 98-1
is effective beginning January 1, 1999. The Company does not expect adoption of
this statement to have a material effect on its consolidated financial position
or results of operations.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 is effective for fiscal
years beginning December 15, 1999. The Company does not expect adoption of this
statement to have a material impact on its consolidated financial position or
results of operations.
(2) CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company applies SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities. At August 31, 1998, the Company's cash equivalents
and marketable securities are classified as held-to-maturity, as the Company has
the positive intent and ability to hold these securities to maturity. Cash
equivalents are short-term, highly liquid investments with original maturities
of less than three months. Marketable securities are investment securities with
original maturities of greater than three months. Cash equivalents are carried
at cost, which approximates market value, and consist of money market funds,
repurchase agreements and debt securities. Marketable securities are recorded at
amortized cost, which approximates market value. The Company has not recorded
any realized gains or losses on its marketable securities. Marketable securities
consist of commercial paper and U.S. government debt securities.
F-9
39
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The aggregate fair values and costs of the investments at August 31, 1997
and 1998 were as follows:
1997 1998
------------------------- -------------------------
AMORTIZED MARKET AMORTIZED
MATURITY COST VALUE COST
----------- ----------- ----------- -----------
Less than one year-
Corporate and other debt
securities..................... $34,814,601 $34,806,434 $21,969,524 $21,958,963
=========== =========== =========== ===========
Greater than one year-
U.S. government and agency
securities..................... $ 654,529 $ 657,406 $ -- $ --
Corporate and other debt
securities (average maturity of
1.5 and 1 year in 1997 and
1998, respectively)............ 3,470,269 3,462,547 1,029,569 1,029,687
----------- ----------- ----------- -----------
$ 4,124,798 $ 4,119,953 $ 1,029,569 $ 1,029,687
=========== =========== =========== ===========
The Company has $301,500 and $200,000 in restricted cash at August 31, 1997
and 1998, respectively, in connection with certain capital lease obligations
(see Note 5).
(3) INCOME TAXES
The Company applies SFAS No. 109, Accounting for Income Taxes, which
requires the Company to recognize deferred tax assets and liabilities for
expected future tax consequences of events that have been recognized in the
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using the enacted tax rates in
effect for the year in which the differences are expected to reverse. SFAS No.
109 requires deferred tax assets and liabilities to be adjusted when the tax
rates or other provisions of the income tax laws change.
At August 31, 1998, the Company had net operating loss and tax credit
carryforwards of approximately $62,908,000 and $1,658,000, respectively,
available to reduce federal taxable income and federal income taxes,
respectively, if any. Net operating loss carryforwards and credits are subject
to review and possible adjustment by the Internal Revenue Service and may be
limited in the event of certain cumulative changes in the ownership interest of
significant shareholders over a three-year period in excess of 50%. In the year
ended August 31, 1996, the Company utilized approximately $4,398,000 of net
operating loss carryforwards to offset taxable income. In the years ended August
31, 1997 and 1998, the Company did not utilize any loss carryforwards.
The net operating loss carryforwards and tax credits expire approximately
as follows:
NET OPERATING RESEARCH INVESTMENT
LOSS TAX CREDIT TAX CREDIT
EXPIRATION DATE CARRYFORWARDS CARRYFORWARDS CARRYFORWARDS
--------------- ------------- ------------- -------------
1999............................................ $ 6,886,000 $208,000 $ 90,000
2000............................................ 5,039,000 273,000 143,000
2001............................................ 3,829,000 84,000 75,000
2002............................................ 4,812,000 24,000 3,000
2003............................................ 2,254,000 -- --
2004-2014....................................... 40,088,000 721,000 37,000
F-10
40
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the deferred tax assets at the respective dates are as
follows:
AUGUST 31,
-------------------------
1997 1998
----------- -----------
Net operating loss carryforwards............................ $17,743,000 $23,154,000
Research and development credits............................ 677,000 1,310,000
Investment tax credits...................................... 451,000 347,000
Other, net.................................................. 1,856,000 1,856,000
----------- -----------
20,727,000 26,667,000
Valuation allowance......................................... (20,727,000) (26,667,000)
----------- -----------
$ -- $ --
=========== ===========
The valuation allowance has been provided due to the uncertainty
surrounding the realization of the deferred tax assets.
(4) COMMITMENTS
(a) Lease Commitments
At August 31, 1998, the Company has operating leases for office and
laboratory facilities, the last of which expires on November 15, 2006. Minimum
lease payments and facilities charges under the leases at August 31, 1998 are as
follows:
Year Ending August 31,
1999................................................... $1,114,659
2000................................................... 1,118,938
2001................................................... 1,124,938
2002................................................... 1,179,393
2003................................................... 1,138,797
Thereafter............................................. 3,574,180
----------
$9,250,905
==========
Rental expense was approximately $472,000, $949,000 and $1,085,000 in the
years ended August 31, 1996, 1997 and 1998, respectively. Rental expense for
fiscal 1997 and 1998 includes the expansion of laboratory and office space at
the Company's primary facility.
(b) Research and Development Commitments
The Company has entered into three academic research collaborations. These
collaborations provide for the funding of research activities by the Company to
the academic institutions and the possibility of royalties and, in some cases,
license fees. At August 31, 1998, the Company's obligations under these
arrangements totaled $711,484, of which $606,839 and $104,645 was payable for
the fiscal years ending August 31, 1999 and 2000, respectively.
(c) Employment Agreement
The Company has an employment agreement with an executive officer which
provides for bonuses, as defined, and severance benefits upon termination of
employment, as defined.
(d) Loan to Officer
On December 6, 1996, the Company loaned $160,000 to an officer of the
Company. The loan bears interest at prime plus 1% and is due October 9, 1999.
F-11
41
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(5) LONG-TERM OBLIGATIONS
On February 28, 1997, the Company entered into an equipment lease line of
credit with a certain financial institution under which it financed $6,000,000
of laboratory, computer and office equipment. The lease is payable in 48 monthly
installments from the point of takedown, at a variable interest rate of prime
(8.5% as of August 31, 1998) plus 1/4 of 1%. At any time during the term of this
agreement, the Company may elect to convert to a fixed rate loan at the
prevailing interest rate. On March 9, 1998, the Company increased the equipment
lease line of credit by $4,300,000 to $10,300,000. The additional borrowings
under the equipment lease line of credit have been and will continue to be
utilized to finance laboratory, computer and office equipment. Borrowings under
the new credit line are payable in 16 quarterly installments commencing March
31, 1999. The Company is required to maintain certain restricted cash balances,
as defined (see Note 2). In addition, the Company is required to maintain
certain financial ratios pertaining to minimum cash balances, tangible net worth
and debt service coverage. The Company had approximately $3,647,000 available
under the modified line of credit at August 31, 1998.
On July 31, 1997, the Company entered into a financing arrangement with
another financial institution under which it financed $6,000,000 of laboratory
and office renovations at its Beaver Street facility. The principal amount of
the loan will be repaid over 48 consecutive months commencing on July 1, 1998 at
the prevailing 12-month Eurodollar rate (12-month Eurodollar rate was 5.5% as of
August 31, 1998) plus 1 1/2%. The Company is required to maintain certain
financial ratios pertaining to minimum cash balances, debt to net worth and
tangible net worth. The Company has no additional availability under this
financing arrangement at August 31, 1998.
The Company has entered into other capital lease line arrangements under
which it financed approximately $9,725,000 of certain laboratory, computer and
office equipment. These leases are payable in 36 monthly installments. The
interest rates range from 7.52% to 10.29%. The Company is required to maintain
certain restricted cash balances, as defined (see Note 2). In addition, the
Company is required to maintain certain financial ratios pertaining to minimum
cash balances, tangible net worth, debt to tangible net worth and debt service
coverage. The Company has no additional borrowing capacity under these capital
lease agreements at August 31, 1998.
Additionally, in connection with its facilities lease, the Company issued a
$100,000 note payable in September 1994 to its lessor to finance leasehold
improvements. The note bore interest at 9% and was payable in 60 monthly
payments of $2,076. The Company had no outstanding balance on this note payable
at August 31, 1998.
Payments under capital lease obligations at August 31, 1998 are as follows:
Year Ending August 31,
1999...................................................... $6,555,434
2000...................................................... 4,151,078
2001...................................................... 3,553,180
2002...................................................... 1,706,065
----------
Total minimum lease payments...................... 15,965,757
Less -- Amount representing interest...................... 1,876,013
----------
Present value of total minimum lease payments.......... 14,089,744
Less -- Current portion................................... 5,611,186
----------
$8,478,558
==========
F-12
42
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) SHAREHOLDERS' EQUITY
(a) Public Offering
In February 1996, the Company closed a public offering of 3,000,000 shares
of its common stock at $13.00 per share, resulting in proceeds of approximately
$36,007,000, net of issuance costs. In March 1996, the Company sold an
additional 450,000 shares of its common stock in the underwriter's
overallotment, resulting in proceeds of approximately $5,515,000, net of
issuance costs.
(b) Stock Options
The Company has granted stock options to key employees and consultants
under its 1988, 1991, 1993 and 1995 Stock Option Plans. In January 1998, the
Company's stockholders approved the 1997 Stock Option Plan covering options to
purchase 850,000 shares of common stock. The purchase price and vesting schedule
applicable to each option grant are determined by the stock option and
compensation committee of the Board of Directors. In addition, under separate
agreements not covered by any plan, the Company has granted certain key
employees and certain directors of the Company, options to purchase common
stock.
During fiscal 1997, the Board of Directors of the Company granted
nonqualified stock options outside of the above plans for the purchase of an
aggregate 65,000 shares of common stock to a director of the Company and two
consultants. The options were granted with an exercise price equal to the fair
market price at the date of grant and vest over a four-year period. In
accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the
Company computed the fair value of the options granted to the consultants at
$50,594 using the Black-Scholes option pricing model. Of this amount, $5,270 and
$12,648 was charged to operations for the years ended August 31, 1997 and 1998
respectively. The remaining amount will be amortized over the vesting periods of
the options.
The Company records deferred compensation when stock options are granted at
an exercise price per share that is less than the fair market value on the date
of the grant. Deferred compensation is recorded in an amount equal to the excess
of the fair market value per share over the exercise price times the number of
options granted. In 1996, 1997 and 1998, the Company recorded $2,565,400,
$50,594 and $91,874, respectively, of deferred compensation. Deferred
compensation is being recognized as an expense over the estimated vesting period
of the underlying options. Compensation expense included in the statements of
operations was approximately $2,320,000, $79,000 and $131,000 for the years
ended August 31, 1996, 1997 and 1998, respectively. The compensation expense in
the year ended August 31, 1996, related to non-qualified stock options granted
to purchase an aggregate of 380,000 shares of common stock to four members of
the Board of Directors and the Company's Chief Executive Officer.
F-13
43
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
There were 805,482 common shares available for future grant at August 31,
1998. The following is a summary of all stock option activity:
NUMBER OF EXERCISE WEIGHTED
SHARES PRICE RANGE AVERAGE PRICE
--------- ------------------ -------------
Outstanding, August 31, 1995............... 3,540,187 $ .20 - 8.00 $2.01
Granted.................................. 1,361,775 1.56 - 14.50 7.96
Exercised................................ (496,756) .20 - 8.00 2.16
Canceled................................. (56,992) 1.56 - 7.25 2.25
--------- ------------------ -------------
Outstanding, August 31, 1996............... 4,348,214 .20 - 14.50 3.85
Granted.................................. 797,950 6.19 - 9.69 8.58
Exercised................................ (321,963) .88 - 7.25 2.66
Canceled................................. (178,513) 1.56 - 14.50 6.86
--------- ------------------ -------------
Outstanding, August 31, 1997............... 4,645,688 .20 - 14.50 4.63
Granted.................................. 468,900 4.88 - 9.50 6.30
Exercised................................ (529,660) 1.31 - 8.31 1.86
Canceled................................. (719,952) 2.03 - 14.50 7.77
--------- ------------------ -------------
Outstanding, August 31, 1998............... 3,864,976 $ .20 - 14.50 $4.63
========= ================== =============
Exercisable................................ 2,674,323 $ .20 - 14.50 $3.43
========= ================== =============
The range of exercise prices for options outstanding and options
exercisable at August 31, 1998 are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED AVERAGE --------------------------- ---------------------------
REMAINING WEIGHTED WEIGHTED
RANGE OF CONTRACTUAL LIFE AVERAGE AVERAGE
EXERCISE PRICE (IN YEARS) NUMBER EXERCISE PRICE NUMBER EXERCISE PRICE
- -------------- ----------------- --------- --------------- --------- ---------------
$0.20 3.04 29,000 $0.20 29,000 $0.20
$1.31-2.04 4.44 1,587,984 1.65 1,567,512 1.65
$2.12-3.41 5.56 401,000 2.32 364,000 2.32
$4.25-6.94 9.30 428,600 5.64 39,396 5.36
$7.08-9.69 8.01 1,404,892 8.33 665,411 8.09
$14.50 7.46 13,500 14.50 9,004 14.50
--------- ----- --------- -----
Total 3,864,976 $4.63 2,674,323 $3.43
========= ===== ========= =====
F-14
44
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) Pro Forma Disclosure of Stock-Based Compensation
The Company applies SFAS No. 123, Accounting for Stock-Based Compensation,
which requires the measurement of the fair value of stock options or warrants
granted to employees to be included in the consolidated statement of operations
or, alternatively, disclosed in the notes to consolidated financial statements.
The Company has determined that it will continue to account for stock-based
compensation for employees and nonemployee directors under Accounting Principles
Board Opinion No. 25 and elect the disclosure-only alternative under SFAS No.
123. As previously discussed, the Company records the fair market value of stock
options and warrants granted to nonemployees in the consolidated statement of
operations. The Company has computed the pro forma disclosures required under
SFAS No. 123 for stock options granted in 1996, 1997 and 1998 using the
Black-Scholes option pricing model. The weighted average assumptions used for
1996, 1997 and 1998 are as follows:
1996 1997 1998
----------- ----------- -----------
Risk-free interest rate............... 6.13%-6.52% 6.20%-6.73% 5.36%-6.20%
Expected dividend yield............... -- -- --
Expected life......................... 7 years 7 years 7 years
Expected volatility................... 65% 65% 65%
Weighted average fair market value at
grant date.......................... $ 6.04 $ 4.93 $ 3.61
The total value of the options granted to employees during 1996, 1997 and
1998 was computed as $5,691,880, $3,857,026 and $1,635,318, respectively. Of
these amounts, $811,018, $2,951,660 and $652,668 would be charged to operations
for the years ended August 31, 1996, 1997 and 1998, respectively. The remaining
amount, approximately $2,325,000, would be amortized over the remaining vesting
periods. The pro forma effect of these option grants for the years ended August
31, 1996, 1997 and 1998 is as follows:
1996 1997 1998
------------------------ --------------------------- ---------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- ---------- ------------ ------------ ------------ ------------
Net income (loss)...... $1,920,710 $1,109,692 $(11,302,391) $(14,254,051) $(15,813,383) $(16,466,051)
========== ========== ============ ============ ============ ============
Net income (loss) per
share................ $ 0.11 $ 0.06 $ (0.64) $ (0.81) $ (0.87) $ (0.90)
========== ========== ============ ============ ============ ============
The resulting pro forma compensation expense may not be representative of
the amount to be expected in future years, as the pro forma expense may vary
based on the number of options granted. The Black-Scholes option pricing model
was developed for use in estimating the fair value of traded options that have
no vesting restrictions and are fully transferable. In addition, option pricing
models require the input of highly subjective assumptions, including expected
stock price volatility. Because the Company's employee stock options have
characteristics significantly different from those of traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
(d) 1997 Directors Deferred Stock Plan
In January 1998, the Company's stockholders approved the 1997 Directors
Deferred Stock Plan (the 1997 Directors Plan) covering 150,000 shares of common
stock. Stocks will be issued under the 1997 Directors Plan based upon the value
of the services provided by the Directors divided by the current fair market
value of the stock. At August 31, 1998, 5,132 shares have been granted under the
plan.
(e) Warrants
In connection with the Company's public offering described in Note 6(a),
the Company issued three-year warrants to its underwriters for the purchase of
224,250 shares of common stock at $15.60 per share. These warrants are
outstanding and exercisable as of August 31, 1998.
F-15
45
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) INCENTIVE SAVINGS PLAN 401(K)
The Company maintains an incentive savings plan (the Plan) for the benefit
of all employees. On October 1, 1996, the Company changed its matching
contribution from 50% of the first 2% of salary and 25% of the next 4% of
salary, limited to the first $50,000 of annual salary to 100% of the first 2% of
salary and 50% of the next 2% of salary, limited to the first $100,000 of annual
salary. The Company contributed $58,354, $165,778 and $229,460 to the Plan for
the years ended August 31, 1996, 1997 and 1998, respectively.
(8) COLLABORATION AGREEMENTS
(a) Astra Hassle AB
In August 1995, the Company entered into a collaboration agreement with
Astra Hassle AB (Astra) to develop pharmaceutical, vaccine and diagnostic
products effective against gastrointestinal infection or any other disease
caused by H. pylori. The Company granted Astra exclusive access to the Company's
H. pylori genomic sequence database and exclusive worldwide rights to make, use
and sell products based on the Company's H. pylori technology. The agreement
also provides for a four-year research collaboration to further develop and
annotate the Company's H. pylori genomic sequence database, identify therapeutic
and vaccine targets and develop appropriate biological assays. This research is
being directed by a Joint Management Committee and a Joint Research Committee,
each consisting of representatives from both parties.
Under this agreement, Astra agreed to pay an initial license fee, expense
allowance, milestone payments, and fund a research program for a minimum of two
and a half years with an option to extend. On June 4, 1998, Astra exercised its
option to extend the research program for a second time which will carry the
agreement through at least August 1999. Under this agreement as extended, Astra
agreed to pay the Company a minimum of approximately $13.4 million and, subject
to the achievement of certain product development milestones, up to
approximately $23 million (and possibly a greater amount if more than one
product is developed under the agreement) in license fees, expense allowances,
research funding and milestone payments. Of such fees, $500,000 are creditable
against any future royalties payable to the Company by Astra under the
agreement.
The Company will also be entitled to receive royalties on Astra's sale of
products (i) protected by the claims of patents licensed exclusively to Astra by
the Company pursuant to the agreement, or (ii) the discovery of which was
enabled in a significant manner by the genomic database licensed to Astra by the
Company. The Company has the right, under certain circumstances, to convert
Astra's license to a nonexclusive license in the event Astra is not actively
pursuing commercialization of the technology.
The Company has recognized $4,539,496, $2,859,262 and $1,653,623 in revenue
under the agreement in the years ended August 31, 1996, 1997 and 1998,
respectively, which consisted of milestone payments and collaborative research
revenues.
(b) Schering-Plough
In December 1995, the Company entered into a collaboration and license
agreement with Schering Corporation and Schering-Plough Ltd. (collectively
Schering-Plough) providing for the use by Schering-Plough of the genomic
sequence of Staph. aureus. The Company is identifying new gene targets for
development of antibiotics effective against drug-resistant infectious
organisms. As part of this agreement, the Company granted Schering-Plough
exclusive access to certain of the Company's genomic sequence databases. The
Company also granted Schering-Plough a nonexclusive license to use the Company's
bioinformatics systems for Schering-Plough's internal use in connection with the
genomic databases licensed to Schering-Plough under the agreement and other
genomic databases Schering-Plough develops or acquires. The Company also agreed
to undertake certain research efforts to identify bacteria-specific genes
essential to microbial survival and to develop biological assays to be used by
Schering-Plough in screening natural product and compound libraries to identify
antibiotics with new mechanisms of action.
F-16
46
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under this agreement, Schering-Plough agreed to pay an initial license fee
and fund a research program for a minimum number of years with an option to
extend. On March 4, 1998, Schering-Plough elected to extend the research program
to the full term of the agreement which expires on March 31, 2000. Under the
agreement as extended, Schering-Plough has agreed to pay the Company a minimum
of $18.5 million in an up-front license fee, research funding and milestone
payments. Subject to the achievement of additional product development
milestones, Schering-Plough has agreed to pay the Company up to an additional
$24 million in milestone payments. The Company received approximately $15.2
million in an up-front license fee, research funding and milestone payments
through August 31, 1998.
The agreement grants Schering-Plough exclusive worldwide rights to make,
use and sell pharmaceutical and vaccine products based on the genomic sequence
databases licensed to Schering-Plough by the Company and on the technology
developed in the course of the research program. The Company has also granted
Schering-Plough a right of first negotiation if during the term of the research
plan the Company desires to enter into a collaboration with a third party with
respect to the development or sale of any compounds that are targeted against,
as their primary indication, the pathogen that is the principal subject of the
Company's agreement with Schering-Plough. The Company will be entitled to
receive royalties on Schering-Plough's sale of therapeutic products and vaccines
developed using the technology licensed from the Company. Subject to certain
limitations, the Company retained the rights to make, use and sell diagnostic
products developed based on the Company's genomic database licensed to
Schering-Plough or the technology developed in the course of the research
program.
Under the December 1995 agreement, the Company has recognized $7,867,579,
$3,364,810 and $3,435,807 in revenue in the years ended August 31, 1996, 1997
and 1998, respectively, under this collaborative agreement, which consisted of a
license fee, collaborative research revenue and milestone payments.
In December 1996, the Company entered into its second research
collaboration and license agreement with Schering-Plough. This agreement calls
for the use of genomics to discover new therapeutics for treating asthma. As
part of the agreement, the Company will employ its high-throughput positional
cloning, bioinformatics, and genomics sequencing capabilities to identify genes
and associated proteins that can be utilized by Schering-Plough to develop new
pharmaceuticals. Under this agreement, the Company has granted Schering-Plough
exclusive access to (i) certain gene sequence databases made available under
this research program, (ii) information made available to the Company under
certain third-party research agreements, (iii) an exclusive worldwide right and
license to make, use and sell pharmaceutical and vaccine products based on the
rights to develop and commercialize diagnostic products that may result from
this collaboration.
Under this agreement, Schering-Plough agreed to pay an initial license fee
and an expense allowance to the Company. Schering-Plough is also required to
fund a research program for a minimum number of years with an option to extend.
In July 1998, Schering-Plough amended the original agreement in order to
accelerate the research effort being undertaken. In addition, upon completion of
certain scientific developments, Schering-Plough will make milestone payments to
the Company, as well as pay royalties to the Company based on sales of
therapeutics products developed from this collaboration. If all milestones are
met and the research program continues for its full term, total payments to the
Company will approximate $67 million, excluding royalties. Of the total
potential payments, approximately $22.5 million represents license fees and
research payments, and $44.5 million represents milestone payments based on
achievement of research and product development milestones.
Under this second agreement, the Company has recognized $4,603,805 and
$7,099,911 in revenue in the years ended August 31, 1997 and 1998, respectively,
which consisted of a license fee, expense allowance and collaborative research
revenues.
F-17
47
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On September 24, 1997, the Company entered into a third research
collaboration and license agreement with Schering-Plough to use genomics to
discover and develop new pharmaceutical products to treat fungal infection.
Under the agreement, the Company will employ its bioinformatics,
high-throughput sequencing and functional genomics capabilities to identify and
validate genes and associated proteins as drug discovery targets that can be
utilized by Schering-Plough to develop novel antifungal treatments.
Schering-Plough will receive exclusive access to the genomic information
developed in the collaboration related to two fungal pathogens, Candida albicans
and Aspergillus fumigatus. Schering-Plough will also receive exclusive worldwide
right to make, use and sell products based on the technology developed in the
course of the research program. In return, Schering-Plough has agreed to fund a
research program for a minimum number of years with an option to extend. If all
milestones are met and the research program continues for its full term, total
payments to the Company will approximate $34 million, excluding royalties. Of
the total potential payments, approximately $11 million represents research
payments and $23 million represents milestone payments based on achievement of
research and product development milestones. Additionally, the Company entered
into a subscription agreement with Schering-Plough to provide Schering-Plough
with nonexclusive access to the Company's proprietary PathoGenome(TM) database
and associated information relating to microbial organisms (see Note 9).
Under the third agreement, the Company has recognized $2,432,005 in revenue
for the year ended August 31, 1998, which consisted of research funding.
(9) DATABASE SUBSCRIPTIONS
The Company has entered into PathoGenome(TM) database subscriptions with
Bayer AG, Bristol-Meyers Squibbs, Scriptgen Pharmaceuticals, Inc. and
Schering-Plough (see Note 8). The database subscription provides nonexclusive
access to the Company's proprietary PathoGenome(TM) database and associated
information relating to microbial organisms. The subscription agreement calls
for the Company to provide periodic data updates, analysis tools and software
support. Under the subscription agreements, the customer has agreed to pay an
annual subscription fee and royalties on any molecules developed as a result of
access to the information provided by PathoGenome(TM) database. The Company
retains all rights associated with protein therapeutic, diagnostic and vaccine
use of bacterial genes or gene products.
The Company has recognized $666,667 and $2,766,671 in revenue under these
subscription agreements in the years ended August 31, 1997 and 1998,
respectively.
(10) HARVARD LICENSE AGREEMENT
On November 12, 1993, the Company entered into an agreement with Harvard
College for an exclusive worldwide license for commercial applications of their
patented multiplex sequencing technology. The Company must pay minimum royalties
ranging from $5,000 in 1995 to $35,000 in 1998 and beyond. The Company may
terminate this agreement upon 90 days' notice. The Company recorded $135,000,
$20,000 and $25,000 of expense under this agreement in the years ended August
31, 1996, 1997 and 1998, respectively, primarily relating to the Astra and
Schering-Plough collaborative agreements. In 1997, the Company discontinued use
of its multiplex sequencing operation however, the Company will continue to
incur royalty expense for future sales of its proprietary information derived
from multiplex sequencing technology.
F-18
48
GENOME THERAPEUTICS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) ACCRUED EXPENSES
Accrued expenses consist of the following:
AUGUST 31,
------------------------
1997 1998
---------- ----------
Payroll and related expenses................................ $1,130,296 $1,109,626
Professional fees........................................... 321,626 285,058
Facilities.................................................. 157,228 469,932
Employee relocation......................................... 106,764 162,519
License and other fees...................................... 355,434 185,434
All other................................................... 302,440 237,831
---------- ----------
$2,373,788 $2,450,400
========== ==========
(12) SUBSEQUENT EVENTS
On September 28, 1998, the Company entered into a license agreement with
Hoechst Marion Roussel to provide nonexclusive access to the Company's
proprietary PathoGenome(TM) database and associated information relating to
microbial organisms. The subscription agreement calls for the Company to provide
Hoechst Marion Roussel with periodic data updates, analysis tools and software
support. Under the agreement, Hoechst Marion Roussel has agreed to pay annual
subscription fees and royalties on any molecules developed as a result of access
to the information provided by PathoGenome(TM). The Company retains rights
associated with therapeutic, diagnostic and vaccine use of bacterial genes or
gene products.
F-19
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, Genome Therapeutics Corp. has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on
November 24, 1998.
GENOME THERAPEUTICS CORP.
/s/ ROBERT J. HENNESSEY
--------------------------------------
Robert J. Hennessey
Chief Executive Officer
SIGNATURES
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 indicated as of November 24, 1998.
SIGNATURE TITLE
--------- -----
/s/ ROBERT J. HENNESSEY Chairman, President,
- ----------------------------------------------------- Chief Executive Officer
Robert J. Hennessey
/s/ PHILIP LEDER Director
- -----------------------------------------------------
Philip Leder
/s/ LAWRENCE LEVY Director
- -----------------------------------------------------
Lawrence Levy
/s/ STEVEN M. RAUSCHER Director
- -----------------------------------------------------
Steven M. Rauscher
/s/ FENEL M. ELOI Sr. Vice President, Treasurer
- ----------------------------------------------------- Chief Financial Officer
Fenel M. Eloi (Principal Financial and Accounting Officer)
50
EXHIBIT INDEX
10.46 Amended Employment Agreement with Robert J. Hennessey.
23. Consent of Arthur Andersen LLP Independent Public Accounts.
27. Financial Data Schedule.