UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

 

Commission file number 333-12570

 

 

STRESSGEN BIOTECHNOLOGIES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

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 ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý No o

 

As of October 27, 2003, the registrant had approximately 61,706,000 shares of Common Stock, no par value, outstanding.

 

 

Stressgen Biotechnologies Corporation and Subsidiaries

 

INDEX

 

			Page
Part I — Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheet September 30, 2003 (Unaudited) and December 31, 2002	1
		Consolidated Statement of Operations and Accumulated Deficit Three and Nine Months Ended September 30, 2003 and 2002 (Unaudited)	2
		Consolidated Statement of Cash Flows Three and Nine Months Ended September 30, 2003 and 2002 (Unaudited)	3
		Notes to Consolidated Financial Statements (Unaudited)	4
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
		Factors That Could Affect Future Performance	17
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22
	Item 4.	Controls and Procedures	23
Part II — Other Information
Items 1 through 6			23
SIGNATURES AND CERTIFICATIONS			24

 

 

CONSOLIDATED BALANCE SHEET

 

Stressgen Biotechnologies Corporation and Subsidiaries
(Canadian dollars in thousands, except share information)

 

		September 30, 2003			December 31, 2002
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	1,706		$	31,202
Short-term investments		36,875			14,811
Accounts receivable, net		1,011			4,279
Inventories		632			838
Other current assets		603			518
Total current assets		40,827			51,648
Capital assets		2,350			2,746
Deferred expenses, net of current portion		270			421
		$	43,447		$	54,815
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued liabilities		$	5,682		$	8,833
Current portion of deferred revenue		953			1,115
Current portion of notes payable		608			318
Total current liabilities		7,243			10,266
Long-term liabilities:
Deferred revenue, net of current portion		2,143			3,344
Notes payable, net of current portion		736			262
Total long-term liabilities		2,879			3,606
Total liabilities		10,122			13,872
Stockholders’ equity:
Common shares and other equity – no par value; unlimited shares authorized, 61,701,789 and  60,209,989 shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively		180,092			175,384
Deferred stock compensation		(235		)	(392		)
Accumulated deficit		(146,532		)	(134,049		)
Total stockholders’ equity		33,325			40,943
		$	43,447		$	54,815

 

See accompanying notes to consolidated financial statements.

 

1

 

CONSOLIDATED STATEMENT OF OPERATIONS AND ACCUMULATED DEFICIT

(Unaudited)

 

Stressgen Biotechnologies Corporation and Subsidiaries
(Canadian dollars in thousands, except per share amounts)

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2002			2003			2002
Revenue:
Collaborative R&D revenue		$	855		$	4,332		$	7,584		$	4,332
Bioreagent sales		1,316			1,494			4,108			4,390
Total revenue		2,171			5,826			11,692			8,722
Operating expenses:
Research and development		6,009			7,447			17,293			26,508
Selling, general and administrative		1,510			1,904			5,666			6,570
Cost of bioreagent sales		296			419			1,049			1,228
		7,815			9,770			24,008			34,306
Operating loss		(5,644		)	(3,944		)	(12,316		)	(25,584		)
Other income (expenses):
Interest and other income, net		41			777			499			1,059
Net foreign exchange (loss) gain		(12		)	902			(638		)	(164		)
Interest expense		(8		)	(15		)	(28		)	(54		)
		21			1,664			(167		)	841
Net loss		(5,623		)	(2,280		)	(12,483		)	(24,743		)
Accumulated deficit, beginning of period		(140,909		)	(127,710		)	(134,049		)	(105,247		)
Accumulated deficit, end of period		$	(146,532	)	$	(129,990	)	$	(146,532	)	$	(129,990	)
Basic and diluted loss per common share		$	(0.09	)	$	(0.04	)	$	(0.20	)	$	(0.42	)
Weighted average shares used to compute basic and diluted loss per common share  (in thousands)		61,692			60,179			61,048			58,573

 

See accompanying notes to consolidated financial statements.

 

2

 

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

Stressgen Biotechnologies Corporation and Subsidiaries
(Canadian dollars in thousands)

 

		Three months ended September 30,						Nine months ended September 30,
		2003			2002			2003			2002
Cash flows from operating activities:
Net loss		$	(5,623	)	$	(2,280	)	$	(12,483	)	$	(24,743	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of capital assets		206			204			550			586
Amortization of deferred stock compensation		50			57			157			173
Unrealized foreign exchange (gain) loss		(15		)	(1,235		)	493			(17		)
Loss (gain) on market value of investments		284			(498		)	336			(113		)
Changes in operating assets and liabilities		1,243			(1,319		)	(974		)	1,052
Net cash used in operating activities		(3,855		)	(5,071		)	(11,921		)	(23,062		)
Cash flows from investing activities:
Purchase of short-term investments		—			(13,975		)	(31,191		)	(57,754		)
Sales and maturities of short-term investments		3,715			24,342			8,577			57,195
Purchase of capital assets		(100		)	(151		)	(154		)	(319		)
Net cash provided by (used in) investing activities		3,615			10,216			(22,768		)	(878		)
Cash flows from financing activities:
Proceeds on issue of common shares		22			1,498			4,720			10,604
Proceeds from term loan		1,004			—			1,004			—
Repayment of borrowings		(78		)	(211		)	(240		)	(458		)
Stock subscription receivable		(12		)	480			(12		)	—
Net cash provided by financing activities		936			1,767			5,472			10,146
Effect of exchange rate changes on cash and cash equivalents		(109		)	345			(279		)	(68		)
Decrease in cash and cash equivalents		587			7,257			(29,496		)	(13,862		)
Cash and cash equivalents, beginning of period		1,119			12,219			31,202			33,338
Cash and cash equivalents, end of period		$	1,706		$	19,476		$	1,706		$	19,476

 

See accompanying notes to consolidated financial statements.

 

3

 

Stressgen Biotechnologies Corporation

Notes to Consolidated Financial Statements

(Canadian dollars)

 

1.                                      THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES

 

The Company

 

Stressgen Biotechnologies Corporation (with its subsidiaries, “Stressgen” or the “Company”) is a biopharmaceutical company focused on the development and commercialization of innovative stress protein-based immunotherapeutics. The Company is developing a broad range of products for the treatment of viral infections and related cancers. Its lead product is HspE7, which targets a broad spectrum of human papillomavirus (“HPV”) related diseases.  The Company has also initiated research studies to evaluate stress protein (also known as heat shock protein) fusions, made through its proprietary CoVal^TM technology, for the treatment of hepatitis B and herpes simplex and is targeting hepatitis C.  Further, Stressgen has an internationally recognized research product supply business with sales to scientists worldwide for the study of cellular stress, apoptosis, oxidative stress and neurobiology.

 

Basis of presentation

 

The consolidated financial statements include the assets, liabilities and operating results of the Company and its wholly-owned subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.

 

Financial statements and estimates

 

The information at September 30, 2003 and for the three and nine month periods ended September 30, 2003 and 2002 has been prepared by the Company and has not been audited.  The financial statements, in the opinion of management, include all adjustments necessary for their fair presentation in conformity with Canadian generally accepted accounting principles (“Canadian GAAP”), and conform in all material respects with accounting principles generally accepted in the United States of America (“U.S. GAAP”), except as discussed in Note 5.  These financial statements should be read in conjunction with the financial statements and notes thereto in the Company’s December 31, 2002 Annual Report on Form 10-K.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with Canadian and U.S. GAAP have been condensed or omitted pursuant to the applicable Canadian regulatory and U.S. Securities and Exchange Commission rules and regulations.  Interim results are not necessarily indicative of results for the full year.

 

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, liabilities, revenue and expenses and related disclosures as of the date of the financial statements.  Significant estimates are used for, but not limited to, reporting revenue recognition, accrual of clinical trial costs, measurement of stock-based compensation, and the allocation of indirect costs.  Actual results could differ from such estimates.

 

Foreign currency translation

 

The Company uses the Canadian dollar as its consolidated functional currency.  Monetary assets and liabilities that are denominated in U.S. dollars are translated into Canadian dollars at the rate of exchange prevailing at the balance sheet date.  Non-monetary assets and liabilities are translated at historical exchange rates.  Revenue and expenses are translated at the average rate of exchange for the period of such transactions.

 

4

 

Revenue recognition

 

Revenue from product sales is recognized upon delivery to customers when persuasive evidence of an arrangement exists, the price is fixed or determinable and collection is reasonably assured.  Revenue also includes amounts charged for shipping and handling costs.

 

Revenue from collaborative research and development (“R&D”) arrangements may include multiple elements within a single contract.  The Company’s accounting policy complies with the revenue determination requirements set forth in EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, relating to the separation of multiple deliverables into individual accounting units with determinable fair values.  Payments received under collaborative arrangements may include the following:  non-refundable fees at inception of contract for technology rights; funding for services performed; milestone payments for specific achievements; and payments based upon resulting sales of products.

 

The Company recognizes collaborative research and development revenues as services are rendered consistent with the performance requirements of the contract.  Revenue from non-refundable contract fees where the Company has continuing involvement through research and development collaborations or other contractual obligations, less the fair market value of any related warrants, is recognized ratably over the development period or the period for which Stressgen continues to have a performance obligation.  The period of development is evaluated on a regular basis.  Revenue from performance milestones is recognized upon the achievement of the milestones as specified in the agreement, provided payment is proportionate to the effort expended.  Payments received in advance of performance or delivery are recorded as deferred revenue.

 

Clinical trial accruals

 

The Company recognizes expenses related to its ongoing clinical trials using a methodology designed to accrue estimated costs in the appropriate accounting periods.  The Company recognizes clinical trial costs in three distinct phases:  the start-up phase, the patient accrual phase, and the close-out phase.  The total estimated trial cost is divided into these three phases based on the tasks involved in conducting the trial.  Based on the design of the trial, the cost of each phase could vary from trial to trial.  Upon start of the trial, the start-up portion of the trial contract is accrued.  As patients enter the trial, the patient accrual cost is ratably recognized.  Once the study is complete and analysis of the patient data has been initiated, the close-out portion of the trial is recognized.

 

Stock-based compensation plan

 

Multiple standards are in use regarding the recognition, measurement and disclosure of stock-based compensation and other stock-based payments. The Company has adopted the recommendations of the CICA Handbook section 3870, Stock-Based Compensation and Other Stock-Based Payments, effective January 1, 2002.  This standard requires that all stock-based awards made to non-employees be measured and recognized using a fair value based method.  The standard encourages the use of a fair value based method for all awards granted to employees, but only requires the use of a fair value based method for direct awards of stock, stock appreciation rights, and awards that call for settlement in cash or other assets.  Awards that a company has the ability to settle in stock are recorded as equity, whereas awards that the entity is required to or has a practice of settling in cash are recorded as liabilities.

 

5

 

The Company’s accounting methods for stock-based compensation plans also materially follow the guidance under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.  The Company has two stock-based compensation plans, which are described in Note 3.  New option grants are made with an exercise price equal to the fair market value of the underlying common stock.  No compensation expense is recognized for options granted at fair market value under the plan when stock options are issued to directors and employees.  Deferred stock compensation charges arise where stock options are granted at exercise prices less than the fair value of the underlying stock and are amortized to expense over the vesting period of the option.  Any consideration paid by directors, employees and others on exercise of stock options is credited to share capital.

 

The following table summarizes the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of the Financial Accounting Standards Board (“FASB”) Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

 

		For the three months ended September 30,						For the nine months ended September 30,
(in thousands, except per share amounts)		2003			2002			2003			2002
		(unaudited)						(unaudited)
Net loss under Canadian GAAP		$	(5,623	)	$	(2,280	)	$	(12,483	)	$	(24,743	)
Net loss under U.S. GAAP (See Note 5 for reconciliation to Canadian GAAP)		$	(5,463	)	$	(3,668	)	$	(11,933	)	$	(24,941	)
Employee stock compensation included in net loss under Canadian and U.S. GAAP		$	50		$	57		$	157		$	173
Stock-based employee compensation expense under the fair value method		(628		)	(907		)	(1,796		)	(2,721		)
Pro forma net loss under Canadian GAAP		$	(6,201	)	$	(3,130	)	$	(14,122	)	$	(27,291	)
Pro forma net loss under U.S. GAAP		$	(6,041	)	$	(4,518	)	$	(13,572	)	$	(27,489	)
Pro forma basic loss per common share under Canadian GAAP		$	(0.10	)	$	(0.05	)	$	(0.23	)	$	(0.47	)
Pro forma basic loss per common share under U.S. GAAP		$	(0.10	)	$	(0.08	)	$	(0.22	)	$	(0.47	)

 

The weighted-average per-share fair values of the individual options granted during the three and nine month periods ended September 30, 2003 were $1.00 and $1.06, respectively, compared to $1.74 and $2.63 for the same periods in 2002.  The fair values of the options were determined using a Black-Scholes option-pricing model with the following assumptions:

 

		For the three months ended September 30,				For the nine months ended September 30,
(unaudited)		2003		2002		2003		2002
Dividend yield		0	%	0	%	0	%	0	%
Volatility		78	%	60	%	80	%	60	%
Risk-free interest rate		2.7	%	5.5	%	2.5	%	5.5	%
Expected life		4 years		4 years		4 years		4 years

 

6

 

New Accounting Pronouncements

 

The FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure in December 2002.  SFAS No. 148 provides alternative transition methods for entities that voluntarily elect to adopt the fair value recognition provisions of the FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.  In addition, SFAS No. 148 requires more prominent pro forma disclosures of the effect on net income and earnings per share if the company had applied these fair value recognition provisions.  The transition and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.  While we have not elected to adopt the provisions in SFAS 123, we have disclosed our pro forma financial results in Note 1 of the accompanying financial statements.

 

2.                                      COLLABORATIVE AGREEMENT

 

In June 2002 the Company entered into a collaboration agreement for the co-development and global commercialization of the Company’s innovative proprietary CoVal^TM fusion product candidate, HspE7, with F. Hoffmann-La Roche and Hoffmann-La Roche Inc. (collectively, “Roche”).  Under the terms of the agreement, Roche has the worldwide exclusive right to manufacture, market and sell the HspE7 product and the Company has the right to co-promote the product in the U.S. to certain physician specialties.  For the three and nine months ended September 30, 2003, the Company recognized collaborative R&D revenue of $855,000 and $7,584,000, respectively, including $2,214,000 related to a development milestone earned in March 2003. Further, in July 2002 and April 2003, Roche made equity investments (see Note 3) in the Company totaling $7,657,000 and $4,594,000, respectively.

 

Upon receiving the upfront license fee payment from Roche in 2002, the Company recorded a $634,320 payable due to MIT/Whitehead and a related deferred expense.  The payment was made in January 2003.  The Company recognizes the related deferred expense over the development period.  At September 30, 2003 and December 31, 2002, the Company had a total of $390,116 and $561,778, respectively, of deferred expense related to this payment.  Upon receiving the $2,214,000 milestone payment in April 2003 (see Note 2), the Company recorded an additional $221,000 payable due to MIT/Whitehead and a related deferred expense.  At September 30, 2003 all payments due to MIT/Whitehead have been made.

 

3.                                      BALANCE SHEET DETAILS

 

In September 2003, the Company entered into a 36 month term loan agreement collateralized by equipment owned by the Company.  At September 30, 2003, there was $1,004,000 outstanding on the loan.  Under the terms of the agreement, the Company must issue a letter of credit for the outstanding loan balance if combined cash, cash equivalents, and short-term investments fall below $6,000,000.

 

The following tables provide details of selected balance sheet items:

 

7

 

(In thousands)		September 30, 2003			December 31, 2002
		(unaudited)
Accounts receivable:
Trade accounts receivable		$	614		$	527
Collaborative receivable		435			3,790
Less:  allowance for doubtful accounts		(38		)	(38		)
		$	1,011		$	4,279
Inventories:
Raw materials, net		$	226		$	417
Work in progress, net		105			145
Finished goods, net		301			276
		$	632		$	838
Accounts payable and accrued liabilities:
Clinical trial accruals		$	2,932		$	3,133
Trade accounts payable		1,633			3,607
Accrued compensation and benefits		1,007			1,274
Royalty payable		—			634
Other accrued liabilities		110			185
		$	5,682		$	8,833

 

		September 30, 2003 (unaudited)									December 31, 2002
(In thousands)		Cost			Accumulated Depreciation			Net Book Value			Net Book Value
Capital Assets:
Laboratory equipment		$	4,395		$	2,678		$	1,717		$	1,932
Computer equipment		1,025			702			323			393
Furniture and fixtures		561			375			186			240
Leasehold improvements		716			592			124			181
		$	6,697		$	4,347		$	2,350		$	2,746

 

Stockholders’ equity

 

In June 2002 the Company issued 2,036,436 common shares for $7,657,000 pursuant to the collaboration agreement with Roche (see Note 2).  The equity was issued at a per share price determined by the weighted average price of common shares of the Company during the ten business days prior to the Roche transaction.   The Company also issued two warrants to acquire between 2,036,435 and 2,356,000 additional common shares.  The Company allocated $1,264,000 as the fair value of the warrants, as determined by an independent valuation expert.  In April 2003 the Company provided notice for Roche to exercise one of the warrants; Roche subsequently purchased 1,413,600 common shares at $3.25, resulting in net proceeds of $4,594,000 to the Company.  An exercise of the second warrant would result in the future issuance of between 814,574 and 942,400 additional common shares, at an exercise price ranging from $3.76 to $3.25 per share, depending upon whether the Company calls the warrant and upon the price of the Company’s common stock.  Roche may exercise the second warrant until June 28, 2007.

 

8

 

Stockholders’ equity at September 30, 2003 and December 31, 2002 includes $2,174,000 and $2,179,000, respectively of contributed surplus.  At September 30, 2003 and December 31, 2002, there were 66,088,170 and 68,541,541 fully diluted (exercisable) common shares, respectively.

 

Employee share option plan

 

In 2001, the Company issued out-of-plan stock options prior to stockholder approval of the 2001 Equity Incentive Plan (the “2001 Plan”).  Between the date of grant and stockholder approval, the market price of the Company’s common stock increased, resulting in deferred compensation of $807,000 associated with these options.  The deferred compensation is amortized as an expense over the vesting period of the granted options.  The stockholders subsequently approved adoption of the 2001 Plan, reserving an additional 3,500,000 new common shares for issuance pursuant to the grant of stock options.  Once the 2001 Plan was approved, the 2001 grants ceased to be considered out-of plan.   In addition, the Company stopped granting options under its pre-existing 1996 Share Incentive Plan.  At September 30, 2003, there were 329,423 options available for future grant under the 2001 Plan.

 

The following table summarizes information related to all stock options outstanding and exercisable as of September 30, 2003.

 

		Options Outstanding							Options Exercisable
Range of Exercise Prices		Number Outstanding		Weighted Average Remaining Contractual Life (in years)		Weighted Average Exercise Price			Number Exercisable		Weighted Average Exercise Price
$ 1.22 - $1.99		1,521,464		7.54		$	1.70		853,677		$	1.74
$ 2.00 - $3.99		625,333		8.91		$	3.25		285,933		$	3.50
$ 4.00 - $5.99		1,489,100		7.67		$	4.87		1,015,932		$	4.86
$ 6.00 - $8.00		1,544,600		6.69		$	6.19		1,416,265		$	6.19
		5,180,497							3,571,807

 

At October 27, 2003 there were approximately 5,177,000 options outstanding.

 

9

 

4.                                      SEGMENT INFORMATION

 

The Company manages its operations in two reportable segments, Biotechnology and Bioreagents.  Revenues are allocated to countries based on customer locations.  The Company does not allocate interest and other income, foreign exchange losses or interest on capital lease obligations to each segment.

 

		Three months ended September 30,						Nine months ended September 30,
(in thousands)		2003			2002			2003			2002
		(unaudited)						(unaudited)
Biotechnology
Collaborative R&D revenue		$	855		$	4,332		$	7,584		$	4,332
Expenses:
Research and development		5,569			7,159			16,099			25,651
Selling, general and administrative		1,151			1,536			4,394			5,432
		6,720			8,695			20,493			31,083
Operating loss		$	(5,865	)	$	(4,363	)	$	(12,909	)	$	(26,751	)
Bioreagents
Revenue:
U.S.		$	908		$	1,030		$	2,763		$	2,913
Canada		66			75			192			220
Other		342			389			1,153			1,257
		1,316			1,494			4,108			4,390
Expenses:
Research and development		440			288			1,194			857
Selling, general and administrative		359			368			1,272			1,138
Cost of bioreagent sales		296			419			1,049			1,228
		1,095			1,075			3,515			3,223
Operating income		$	221		$	419		$	593		$	1,167
Totals
Revenue:
Collaborative R&D revenue		$	855		$	4,332		$	7,584		$	4,332
Bioreagent sales		1,316			1,494			4,108			4,390
Total revenue		2,171			5,826			11,692			8,722
Expenses:
Research and development		6,009			7,447			17,293			26,508
Selling, general and administrative		1,510			1,904			5,666			6,570
Cost of bioreagent sales		296			419			1,049			1,228
		7,815			9,770			24,008			34,306
Operating loss		$	(5,644	)	$	(3,944	)	$	(12,316	)	$	(25,584	)

 

10

 

5.                                      THE EFFECT OF APPLYING ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE U.S.

 

These financial statements have been prepared in accordance with Canadian GAAP which, except as set out below, conform in all material respects to U.S. GAAP.

 

Effect on the consolidated financial statements:

 

Balance Sheet

 

For all periods presented there are no significant balance sheet differences under Canadian and U.S. GAAP.

 

Statement of Operations

 

		Three months ended September 30,						Nine months ended September 30,
(In thousands except per share amounts)		2003			2002			2003			2002
		(unaudited)						(unaudited)
Net loss under Canadian GAAP		$	(5,623	)	$	(2,280	)	$	(12,483	)	$	(24,743	)
Reversal of unrealized foreign exchange (gain) loss on available-for-sale securities (*)		(124		)	(890		)	214			(85		)
Reversal of write-down (up) of short-term investments (*)		284			(498		)	336			(113		)
		160			(1,388		)	550			(198		)
Net loss under U.S. GAAP		$	(5,463	)	$	(3,668	)	$	(11,933	)	$	(24,941	)
Basic loss per common share under Canadian GAAP		$	(0.09	)	$	(0.04	)	$	(0.20	)	$	(0.42	)
Basic loss per common share under U.S. GAAP		$	(0.09	)	$	(0.06	)	$	(0.20	)	$	(0.43	)
Common shares used to compute basic loss per share under Canadian and U.S. GAAP		61,692			60,179			61,048			58,573

 

Statement of Cash Flows

 

For all periods presented there are no significant differences under Canadian and U.S. GAAP in net cash (used in) provided by operating, investing and financing activities.

 

Differences

 

As disclosed in Note 11 to the financial statements in the Company’s December 31, 2002 Annual Report on Form 10-K, differences exist for the Company between Canadian and U.S. GAAP.

 

The following outlines the differences that affect the Company for the three and nine month periods ended September 30, 2003 and 2002.

 

(*)                                 Under U.S. GAAP Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, the Company has classified certain of its short-term securities as available-for-sale and, accordingly, has included the changes in net unrealized holding gains or losses on these securities as a component of stockholders’ equity rather than in operations.

 

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SFAS No. 130, Reporting Comprehensive Income, establishes standards for the reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements.  Comprehensive income is as follows:

 

		Three months ended September 30,						Nine months ended September 30,
(In thousands except per share amounts)		2003			2002			2003			2002
		(unaudited)						(unaudited)
Net loss under U.S. GAAP		$	(5,463	)	$	(3,668	)	$	(11,933	)	$	(24,941	)
Other comprehensive income
Adjustment to unrealized foreign exchange and market gains (losses) on available-for-sale investments		(160		)	1,388			(550		)	198
Comprehensive net loss under U.S. GAAP		$	(5,623	)	$	(2,280	)	$	(12,483	)	$	(24,743	)
Comprehensive loss per share under U.S. GAAP		$	(0.09	)	$	(0.04	)	$	(0.20	)	$	(0.42	)

 

6.                                      SUPPLEMENTAL CASH FLOW INFORMATION

 

The changes in operating assets and liabilities are as follows:

 

		Three months ended September 30,						Nine months ended September 30,
(In thousands)		2003			2002			2003			2002
		(unaudited)						(unaudited)
Collaborative receivable		$	645		$	(3,673	)	$	3,355		$	(3,673	)
Trade receivables		71			24			(87		)	(82		)
Inventories		65			(15		)	206			(44		)
Other current assets		(269		)	(121		)	(85		)	(347		)
Deferred expenses, net of current portion		31			(459		)	151			(459		)
Accounts payable and accrued liabilities		950			(1,830		)	(3,151		)	902
Deferred revenue		(250		)	4,755			(1,363		)	4,755
		$	1,243		$	(1,319	)	$	(974	)	$	1,052
Supplemental disclosures of cash flows:
Interest paid		$	8		$	15		$	28		$	54
Supplemental disclosures of non-cash transactions
Reversal of deferred compensation related to terminated employees		$	4		$	—		$	4		$	28

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties.  The predictions described in these statements may not materialize if management’s current expectations regarding our future performance prove incorrect. Our results could also be affected by factors including, but not limited to, our reliance on collaborative partners and other risks described below under “Factors That Could Affect Future Performance.”  The forward-looking statements are based on currently available information; we disclaim any obligation to update them.

 

The following information should be read in conjunction with our September 30, 2003 consolidated financial statements and related notes therein, which are prepared in accordance with Canadian generally accepted accounting principles or Canadian GAAP.  These principles differ in certain respects from accounting principles generally accepted in the United States or U.S. GAAP.  The differences, as they affect our consolidated financial statements, are described in Note 5 to our September 30, 2003 consolidated financial statements.  All amounts following are expressed in Canadian dollars unless otherwise indicated.

 

Overview

 

Our activities are focused primarily on the research and development of a unique class of proteins, called stress proteins or heat shock proteins, to regulate the body’s own immune response to combat infectious diseases and cancer.  We believe that the use of stress proteins, genetically combined with various antigens derived from disease-causing organisms or cancer cells, can yield novel therapeutic products.

 

In June 2002 we entered into a strategic collaboration with F. Hoffmann-La Roche and Hoffmann-La Roche Inc. (collectively, “Roche”) for the development of our product for the treatment of human papilloma virus, known as HspE7.   This partnership and future partnerships could enable us to develop our product candidates and exploit new applications for our technology, resulting in additional product opportunities.

 

We have incurred significant losses since our inception and expect to incur substantial losses for the foreseeable future as we invest in our research and product development programs, including manufacturing, pre-clinical studies and clinical trials, and regulatory activities.  At September 30, 2003 our accumulated deficit was $146,532,000.  Historically, we have depended principally on equity financings to fund our business activities.  We intend to pursue additional equity financings to fund our business activities, markets permitting.

 

Liquidity and Capital Resources

 

Since inception we have relied principally on equity financings, coupled with cash flows generated from our bioreagents business, to fund our research and development programs, operations and capital expenditures.  Through September 30, 2003 we have raised net equity proceeds of $180,092,000, principally through our public issuances of stock, the exercise of warrants and stock options issued since 1996 and, more recently, the issuance of stock and warrants to Roche in connection with the collaboration agreement.  We employ a financial performance measurement system designed to ensure our revenues and expenses are consistent with management’s operational objectives and budgetary constraints.  The variability of anticipated cash utilization is dependent upon several factors, including the timing and extent of clinical development of HspE7.  We believe that our current capital resources are sufficient to fund operations into 2005.  This belief is based on our evolving research and development plans, the current regulatory environment, our historical industry experience in the development of therapeutics and general economic conditions.  Under our collaborative agreement, Roche is obligated to fund process development and manufacture HspE7 for clinical development and commercialization.  At this time, we do not have

 

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internal manufacturing capabilities to supply clinical trials or commercial quantities of HspE7.  If we are required or choose to manufacture HspE7 for clinical trials or on a commercial scale, we will need significant additional funds.  If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate the development of HspE7 or other research or development programs.

 

At September 30, 2003 we had cash, cash equivalents and short-term investments of $38,581,000, a decrease of $7,432,000 from December 31, 2002.  Approximately 23% of cash, cash equivalents and short-term investments were held in U.S. dollars as of September 30, 2003, compared to approximately 13% as of December 31, 2002.

 

During the three and nine months ended September 30, 2003, capital expenditures totaled $100,000 and $154,000 respectively compared with $151,000 and $319,000 for the same periods in 2002.  Capital purchases in 2003 are consistent with management’s investment policy limiting purchases to those required to preserve our current level of manufacturing and research capabilities.

 

We have a credit facility for $2,000,000 with a Canadian chartered bank.  At September 30, 2003 and December 31, 2002, $328,000 and $541,000, respectively were used and outstanding under this facility in the form of fixed rate capital leases.   In September 2003 we entered into a term loan agreement with Oxford Finance Corporation, collateralized by equipment owned by the Company.  At September 30, 2003 there was $1,004,000 outstanding on the loan.  Under the terms of the agreement, the Company must issue a letter of credit for the outstanding loan balance if combined cash, cash equivalents, and short-term investments fall below $6,000,000.

 

We will require additional capital to fund future research and product development activities.  We expect to seek additional funds from various sources, including corporate partners that enter into research and development collaborations with us, and public and private equity financings.  We cannot assure you that additional financing will be available when needed or on satisfactory terms.  If we raise additional funds by issuing equity securities, substantial dilution to our existing shareholders may result.  We may need to obtain funds through collaborative arrangements with others that are on unfavorable terms.  We may also have to relinquish rights to certain of our technologies, product candidates or products that we would otherwise seek to develop ourselves.

 

Results of Operations

 

For the three and nine months ended September 30, 2003, our net loss was $5,623,000 and $12,483,000 or $0.09 and $0.20 per common share.  This compares with a net loss of $2,280,000 and $24,743,000 or $0.04 and $0.42 per common share for the same periods in 2002.  Our increased net loss during the current quarter compared to the same quarter in 2002 is due, in part, to the timing of research and development (“R&D”) activities, including the current quarter’s completion of phase III AIN and phase II RRP clinical studies, together with a reduction in collaboration revenue generated by R&D activities reimbursable by Roche.  The aggregate improvement during the nine month period in 2003 over 2002 is also attributed to the extent of collaboration revenue and timing of HspE7 clinical trials.

 

Collaborative R&D revenue

 

Collaborative R&D revenue was $855,000 and $7,584,000 for the three and nine months ended September 30, 2003, compared with $4,332,000 for the same periods in 2002.  Collaborative R&D revenue for the nine months ended September 30, 2003 includes $4,615,000 for development activities in support of Roche, a time-based development payment of $2,214,000, and $755,000 from the amortization of up-front license fees in accordance with SAB No. 101, Revenue Recognition in Financial Statements. Collaborative R&D revenue declined in the current three month period due to fewer research activities being performed by the Company compared to the period immediately after the consummation of the collaboration agreement.

 

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Bioreagent sales

 

The production and sale of bioreagents supports our business strategy by building our market presence in stress proteins and strengthening our strategic relationships with companies, academic institutions and stress response researchers. Our products are sold directly to end-users and through third party distributors.  The overall economic slowdown in North America caused industry-wide demand for bioreagents to slow; consequently, our bioreagent sales have declined to $1,316,000 and $4,108,000 for the three and nine months ended September 30, 2003, respectively, compared with $1,494,000 and $4,390,000, for the same periods in 2002.  Foreign exchange fluctuations between the U.S. and Canadian dollar also had an unfavorable effect on our reported sales results, totaling approximately $168,000 and $393,000 during the three and nine month periods ended September 30, 2003 compared to last year’s foreign currency exchange during the same periods.  These impacts were partially offset by the introduction of several higher priced kit-based research products.

 

Research and development

 

Research and development, or R&D, includes costs associated with clinical studies, product development, and ongoing exploratory research.  In order to optimize our financial flexibility, we employ clinical research organizations to conduct our clinical trials and engage contract manufacturers to assist us with our product development and manufacturing.

 

R&D spending decreased by approximately 19% and 35% to $6,009,000 and $17,293,000, respectively, for the three and nine months ended September 30, 2003, compared with $7,447,000 and $26,508,000 for the same periods in 2002.  The decrease for the nine month period in 2003 reflects the cost shift of HspE7 manufacturing scale-up costs and other product development efforts to Roche, partially offset by the timing of HspE7 clinical trials.  Approximately 65% of our R&D spending related to efforts developing HspE7 during the nine months ended September 30, 2003, while most of the remaining spending related to exploratory research, including our follow-on CoVal^TM fusion product candidates.

 

Selling, general and administrative expenses

 

Selling, general and administrative expense, or SG&A, includes executive management, business development, investor relations, legal support and general administrative activities.

 

SG&A spending decreased by approximately 21% and 14% to $1,510,000 and $5,666,000, respectively, for the three and nine months ended September 30, 2003, compared with $1,904,000 and $6,570,000 for the same periods in 2002.  The decline in spending is attributed to significant business development costs incurred in 2002 to consummate the Roche collaboration agreement.

 

Cost of bioreagent sales

 

The aggregate cost of bioreagent sales as a percentage of bioreagent sales was approximately 22% and 26% for the three and nine months ended September 30, 2003, resulting in gross margins of 78% and 74% compared with 72% for the same periods in 2002.    The improvement compared to the prior period is due principally to improved efficiency in the manufacturing process and related allocated overhead.

 

Interest and other income, net

 

Interest and other income, net decreased to $41,000 and $499,000 for the three and nine months ended September 30, 2003 compared to $777,000 and $1,059,000 in the same periods in the prior year.  The reduction in interest and other income in the current three month period compared to the same period last year is principally due to a temporary loss on the market value of investments, which is expected to reverse during the fourth quarter of 2003.  Further, lower market interest rates applied to a lower investment portfolio balance contributed to the decline.

 

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Net realized foreign exchange loss

 

During the three and nine months ended September 30, 2003 and 2002, the US dollar weakened against the Canadian dollar.  Our loss due to foreign exchange rate fluctuation during the three and nine months ended September 30, 2003, was $12,000 and $638,000 respectively, compared to a foreign exchange gain of $902,000 and a loss of $164,000, respectively, in 2002.  During the past several quarters, the U.S. and Canadian dollar exchange rate has fluctuated dramatically, causing gains and losses from quarter to quarter.  We have attempted to minimize this foreign exchange volatility by ensuring that the majority of our investments are denominated in Canadian dollars.

 

Basic and diluted loss per share

 

The 147% increase and 50% decrease in net loss to $5,623,000 and $12,483,000 for the three and nine months ended September 30, 2003, respectively, compared to $2,280,000 and $24,743,000 in 2002, was diluted by a 3% and 4% increase in the weighted average number of common shares outstanding for the three and nine months ended September 30, 2003, respectively.   This improvement resulted in a basic and diluted loss per share of $0.09 and $0.20 for the three and nine month periods ended September 30, 2003, as compared with $0.04 and $0.42 for the same periods in 2002.

 

Differences between Canadian and U.S. generally accepted accounting principles

 

Our consolidated financial statements include adjustments necessary for their fair presentation in accordance with Canadian GAAP.  Certain adjustments would be required if these statements were to be prepared in all material respects in accordance with U.S. GAAP.

 

To conform to U.S. GAAP, our net loss would decrease by $160,000 and $550,000 for the three and nine months ended September 30, 2003.  The principal differences under U.S. GAAP as opposed to Canadian GAAP for the three and nine month periods in 2003, respectively, were the reversal of an unrealized foreign exchange gain on available-for-sale securities of $124,000 and a loss of $214,000, coupled with a $284,000 and $336,000 reversal of a write-down of short-term investments.  Under U.S. GAAP, adjustments to the market value of our investment portfolio would be recorded as a component of stockholders’ equity.  Under Canadian GAAP, unfavorable market value adjustments are recorded as a component of retained earnings.

 

Similarly, to conform to U.S. GAAP for the three and nine months ended September 30, 2002, our net loss would increase by $1,388,000 and $198,000, respectively.  The principal differences under U.S. GAAP compared to Canadian GAAP were the reversal of unrealized foreign exchange gains on available-for-sale securities of $890,000 and $85,000 for the same periods in 2002, coupled with a $498,000 and $113,000 reversal of a write-up of short-term investments in those same periods.

 

Basic net loss per common share under U.S. GAAP would have been $0.09 and $0.20 in the three and nine months ended September 30, 2003, compared to $0.06 and $0.43 during the same periods in the prior year.  Our current assets and stockholders’ equity at September 30, 2003 are the same under U.S. GAAP and Canadian GAAP: $40,827,000 and $33,325,000, respectively.

 

Critical Accounting Policies

 

Our significant accounting policies are disclosed in Note 1 to our consolidated financial statements.  Certain of our policies require the application of management judgment in making estimates and assumptions that affect the amounts reported in the consolidated financial statements and disclosures made in the accompanying notes.  Those estimates and assumptions are based on historical experience and various other factors deemed applicable and reasonable under the circumstances.  The use of judgment in determining such estimates and assumptions is, by nature, subject to a degree of uncertainty.  Accordingly, actual results could differ from the estimates made.  Our critical accounting policies include:

 

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Revenue recognition

 

Revenue from collaborative R&D arrangements may include multiple elements within a single contract.  Our accounting policy complies with the revenue determination requirements set forth in EITF 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables,” relating to the separation of multiple deliverables into individual accounting units with determinable fair values.  Under the guidance of EIT 00-21, we have estimated the fair value of deliverables in the Roche agreement using standard industry techniques.  Changes in the determination of fair values or performance periods relating to certain deliverables, and associated milestones, could impact the timing of future revenue streams.

 

Clinical trial accruals

 

Clinical trial costs constitute a significant portion of R&D expense.  The Company recognizes expenses related to its ongoing clinical trials using a methodology designed to accrue estimated costs in the appropriate accounting periods.  Clinical trials can span multiple accounting periods.  The Company recognizes clinical trial costs in three distinct phases:  start-up phase, patient accrual phase, and close-out phase.  Our expenses related to clinical trials vary based on patient availability, additional statistical analysis requirements, and decisions to extend the patient evaluation period.  Using our current trial accrual methodology, our liability for clinical trials as of September 30,2003 is $2,932,000, including the effect of any work in process terminated at the end of the reporting period.  Alternately, if we utilized a percentage of completion approach and used an operational estimate of the actual work completed as of September 30, 2003 compared to the total contract value, our clinical trial liability would decrease by approximately $1,100,000.

 

FACTORS THAT COULD AFFECT FUTURE PERFORMANCE

 

Before investing in our common stock you should carefully consider the following risk factors, the other information included herein and the information included in our other reports and filings.  Our business, financial condition, and the trading price of our common stock could be adversely affected by these and other risks.

 

We Are At an Early Stage of Development

 

Our biotechnology business is still at an early stage of development.  Significant additional research and development and clinical trials must be completed before our technology can be commercialized.  We have not completed the development of any therapeutic products and, therefore, have not begun to market or generate revenues from the commercialization of any therapeutic products.  We have undertaken only limited human clinical trials for some of our product candidates and we cannot assure you that the results obtained from laboratory or research studies will be replicated in human studies or that such human studies will not identify undesirable side effects.  We cannot assure you that any of our products will meet applicable health regulatory standards, obtain required regulatory approvals or clearances, be produced in commercial quantities at reasonable costs, be successfully marketed or be profitable enough that we will recoup the investment made in such product candidates.  None of our therapeutic product candidates are expected to be commercially available for several years.  There is no precedent for the successful commercialization of products based on our CoVal^TM fusion technology.  It is possible that we will not successfully develop any therapeutic products.

 

We Have a History of Operating Losses and We May Never Become Profitable

 

We have not recorded any revenues from the sale of therapeutic products and have accumulated substantial net losses.  We expect to incur continued losses for at least the next several years as we continue research and development, and clinical trials.  To become profitable we, either alone or with one or more partners, must develop, manufacture and successfully market our product candidates.

 

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We Must Obtain Additional Financing to Execute Our Business Plan

 

Our revenues from the production and sale of bioreagents and the projected revenues and expense reimbursements from our HspE7 collaboration are not adequate to support the therapeutic product development programs.  We will need substantial additional funds to pursue further research and development; carry out clinical trials; obtain regulatory approvals; file, prosecute, defend and enforce our intellectual property rights and market our products.  We will seek additional funds through public or private equity or debt financing, strategic transactions and/or from other sources.  We could enter into collaborative arrangements for the development of particular products that would lead to our relinquishing some or all of our rights to the related technology or products.

 

Although we expect to seek additional funding when there are market opportunities, future funding may not be available on favorable terms or at all.   If additional funding were not obtained, we would reduce, defer or cancel development programs, planned initiatives or overhead expenditures, to the extent necessary.  The failure to fund our capital requirements would have a material adverse effect on its business, financial condition and results of operations.

 

Our Success Depends On Collaborative Partners, Licensees and Other Third Parties Over Whom We Have Limited Control

 

Due to the complexity of the process of developing therapeutics, our core business depends on our arrangements with pharmaceutical companies, corporate and academic collaborators, licensors, licensees and others for the research, development, clinical testing, manufacturing, marketing and commercialization of our products. We have various research collaborations and outsource many other business functions, including clinical trials and manufacturing.  We may not be able to establish or maintain collaborations that are important to our business on favorable terms, if at all.  The Roche partnership currently requires further information concerning the mechanism of action of the HspE7 product.  We are working with Roche to address these questions.

 

A number of risks arise from our dependence on collaborative agreements with third parties.  Our product development and commercialization efforts could be adversely affected if any collaborative partner, including Roche, terminates or suspends its agreement with us, causes delays, fails to timely develop or manufacture in adequate quantities a substance we need in order to conduct clinical trials, fails to adequately perform clinical trials, determines not to develop, manufacture or commercialize a product to which it has or we have rights, or otherwise fails to meet its contractual obligations.  Our collaborative partners could pursue other technologies or develop alternative products that could compete with our future products.

 

We license technologies and materials from third parties for our therapeutic and our bioreagent businesses.  We plan to acquire additional licenses from other companies and academic institutions.  Pursuant to the terms of our license agreements, we could be obligated to diligently bring potential products to market, make milestone payments that, in some instances, could be substantial, and incur the costs of filing and prosecuting patent applications.  We cannot assure you that these licenses will not terminate or that they will be renewed.  In addition, we cannot assure you that these licenses will remain in good standing.   Our licensors may attempt to terminate our licenses for their own business reasons.

 

The Profitability of Our Products Will Depend On Our Ability to Protect Our Proprietary Rights and Operate Without Infringing the Proprietary Rights of Others

 

The profitability of our products will depend in part on our ability to obtain and maintain patents and licenses and preserve trade secrets, and the period our intellectual property remains exclusive.  We must also operate without infringing the proprietary rights of third parties and without third parties circumventing our rights. We have received U.S. and European patents and have filed and are actively pursuing applications for additional patents.  The patent positions of pharmaceutical and biotechnology enterprises, including ours, are uncertain and involve complex legal and factual questions for which

 

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important legal principles are largely unresolved.  For example, no consistent policy has emerged regarding the breadth of biotechnology patent claims that are granted by the U.S. Patent and Trademark Office or enforced by the U.S. federal courts.  In addition, the scope of the originally claimed subject matter in a patent application can be significantly reduced before a patent is issued.  The biotechnology patent situation outside the U.S. is even more uncertain, is currently undergoing review and revision in many countries, and may not protect our intellectual property rights to the same extent as the laws of the U.S.  Because patent applications are maintained in secrecy in some cases, we cannot be certain that we or our licensors are the first creators of inventions described in our pending patent applications or patents or the first to file patent applications for such inventions.

 

Other companies may independently develop similar products and design around any patented products we develop.  We cannot assure you that any of our patent applications will result in the issuance of patents, that we will develop additional patentable products, that the patents we have been issued will provide us with any competitive advantages, that the patents of others will not impede our ability to do business or that third parties will not be able to circumvent our patents.  On October 22, 2002 Antigenics Inc. announced that it had filed an opposition in the European Patent Office to a European patent and requests for re-examination in the U.S. Patent Office of two U.S. patents we have licensed.  Until we receive final results from the opposition and re-examination processes, we will not be able to assure you of the success of our planned vigorous defense of the patents.

 

A number of pharmaceutical, biotechnology, research and academic companies and institutions have developed technologies, filed patent applications or received patents on technologies that may relate to our business.  If these technologies, applications or patents conflict with ours, the scope of our current or future patents could be limited or our patent applications could be denied.  Our business may be adversely affected if competitors independently develop competing technologies, especially if we do not obtain, or only obtain narrow, patent protection.  If patents that cover our activities are issued to other companies, we may not be able to obtain licenses at a reasonable cost, or at all, or develop alternative technology.  If we are blocked from using our current technologies we may not be able to introduce, manufacture or sell our planned products.

 

Patent litigation is becoming widespread in the biotechnology industry.  Such litigation may affect our efforts to form collaborations, to conduct research or development, to conduct clinical testing or to manufacture or market any products under development.  We cannot assure you that our patents would be held valid or enforceable by a court or that competitor’s technology or product would be found to infringe our patents.  Our business could be materially affected by an adverse outcome to such litigation.  Similarly, we may participate in interference proceedings declared by the U.S. Patent and Trademark Office or equivalent international authorities to determine priority of invention.  We could incur substantial costs and devote significant management resources to defend our patent position or seek a declaration that the patents of others are invalid.

 

Much of our know-how and technology may not be patentable, though it may constitute trade secrets. We cannot assure you that we will be able to meaningfully protect our trade secrets.  We cannot assure you that any of the existing confidentiality agreements with our employees, consultants, advisors or collaborators will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure.  Collaborators, advisors or consultants may dispute the ownership of proprietary rights to our technology, for example by asserting that they developed it independently.

 

We May Encounter Difficulties in Developing Manufacturing Capabilities and Facilities or Entering into Contracts for Manufacturing with Third Parties

 

Our manufacturing experience in bioreagents is not directly applicable to the manufacture of therapeutic products.  We have not yet introduced any therapeutic products and have no manufacturing experience with immunotherapeutics.  Before our products can be profitable they must be produced in commercial quantities in a cost-effective manufacturing process that complies with regulatory requirements.  Because we do not have facilities for the production of the products we are developing, we

 

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will depend on the manufacturing capabilities of collaborators.  If we cannot arrange for or maintain commercial-scale manufacturing on acceptable terms, or if there are delays or difficulties in manufacturing, we may not be able to conduct clinical trials, obtain regulatory approval or meet demand for our products.

 

Production of our products could require raw materials which are scarce or which can be obtained from a limited number of sources.  If our manufacturers were unable to obtain adequate supplies of such raw materials, the development, regulatory approval and marketing of our products would be delayed.

 

We Could Need to Conduct More Clinical Trials or Take More Time to Complete Our Clinical Trials Than We Originally Plan

 

Clinical trials vary in design by factors including their dosage, end points, length, controls, and numbers and types of patients enrolled.  We may need to conduct a series of trials to demonstrate the safety and efficacy of our products.  In addition, we may be required to determine whether our products delay or prevent disease recurrence.  Clinical trials to show that a disease does not recur take longer to complete than clinical trials that end when patients stop having specific symptoms.  The actual schedules for our clinical trials could vary dramatically from the forecasted schedules due to factors including conflicts with the schedules of participating clinicians and clinical institutions, delayed patient accrual and changes affecting supplies for clinical trials.  For example, on June 10, 2003, we announced that we would delay the start of a pivotal Phase III study of pediatric recurrent respiratory papillomatosis until we can use pilot final commercial grade material in the study.

 

We have limited experience in conducting clinical trials.  We rely on corporate collaborators such as Roche, academic institutions and clinical research organizations to conduct, supervise, monitor and design some or all aspects of clinical trials involving our products.  In addition, the NCI is sponsoring some HspE7 clinical trials.  Since these trials depend on governmental participation and funding, we have less control over their timing and design.  Delays in or failure to commence or complete any planned clinical trials could delay the ultimate timelines for product release.  Such delays could reduce investors’ confidence in our ability to develop products, likely causing our stock price to decrease.

 

We May Not Be Able to Obtain the Regulatory Approvals or Clearances That Are Necessary to Commercialize Our Products

 

The U.S., Canada and other countries impose significant statutory and regulatory obligations upon the manufacture and sale of human therapeutic products.  In order for our products to obtain marketing approval and clearance for each indication, our preclinical and clinical data and manufacturing facilities will need to meet complex criteria establishing the safety and efficacy of the ultimate products.

 

Our product candidates, some of which are currently in the early stages of development, will require significant additional development and pre-clinical and clinical testing prior to their commercialization. These steps and the process of obtaining required approvals and clearances can be costly and time-consuming.  If our potential products are not successfully developed, cannot be proven to be safe and effective through our clinical trials, or do not receive applicable regulatory approvals and clearances, or if there are delays in the process:

 

•                  the successful commercialization of our products could be adversely affected;

 

•                  our competitive advantages could be diminished; and

 

•                  revenues or collaborative milestones from our products could be reduced or delayed.

 

Governmental and regulatory authorities may approve a product candidate for fewer indications or narrower circumstances than we request or may condition approval on the performance of post-marketing studies for a product candidate.  Even if we receive regulatory approval and clearance, our product candidates may later exhibit adverse side effects that limit or prevent their widespread use or that force us

 

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to withdraw those product candidates from the market.  In addition, any marketed product and its manufacturer will continue to be subject to strict regulation after approval.  Any unforeseen problems with an approved product or any violation of regulations could result in restrictions on the product, including its withdrawal from the market.

 

The manufacturers of our products will be required to comply with applicable good manufacturing practices regulations, which include requirements relating to quality control and quality assurance as well as the corresponding maintenance records and documentation.  If the manufacturers cannot comply with regulatory requirements including applicable good manufacturing practice requirements, we may not be allowed to develop or market our product candidates.  If we or our manufacturers fail to comply with applicable regulatory requirements at any stage during the regulatory process, we may be subject to sanctions, including fines, product recalls or seizures, injunctions, refusal of regulatory agencies to review pending market approval applications or supplements to approval applications, total or partial suspension of production, civil penalties, withdrawals of previously approved marketing applications and criminal prosecution.

 

Competitors May Develop and Market Drugs That Are Less Expensive, More Effective or Safer, Making Our Products Obsolete or Uncompetitive

 

Many of our competitors and potential competitors have substantially greater product development capabilities and financial, scientific, marketing and human resources than ours.  Technological competition from pharmaceutical companies and biotechnology companies is intense and is expected to increase.  Other companies have developed technologies that could be the basis for competitive products.  Some of these products have an entirely different approach or means of accomplishing the desired therapeutic effect than products being developed by us.  Alternative products may be developed that are more effective and less costly than the products developed by us.  Competitors may succeed in developing products earlier than us, obtaining approvals and clearances for such products more rapidly than us, or developing products that are more effective than ours.  In addition, other forms of medical treatment may be competitive with our products. Our technology or products may become obsolete or uncompetitive.

 

Our Products May Not Gain Market Acceptance

 

Our products may not gain market acceptance among physicians, patients, healthcare payors and the medical community.  The degree of market acceptance of any product that we may develop will depend on a number of factors, including establishment and demonstration of clinical efficacy and safety, cost-effectiveness, clinical advantages over alternative products, and marketing and distribution support for the products.

 

Our sales experience is limited to the sale of our bioreagents.  To directly market and distribute any pharmaceutical products we may develop, we or our collaborators will need a marketing and sales force with appropriate technical expertise and supporting distribution capabilities.  We may not be able to establish sales, marketing and distribution capabilities of our own or enter into arrangements with third parties on terms that are acceptable to us.  If we or our partners cannot successfully market and sell our products, our ability to generate revenue will be limited.

 

Our Operations Involve Risks Which Could Subject Us to Damages Resulting from Accidental Contamination or Injury

 

The human clinical trials we conduct, including trials in children, may have unforeseen long-term health implications.  We have only limited amounts of product liability insurance for our clinical trials.  We may not correctly anticipate or be able to maintain on acceptable terms the level of insurance coverage that would adequately cover potential liabilities from proposed clinical trials.  Product liability insurance is expensive, difficult to obtain and may not be available in the future.  If we cannot obtain sufficient insurance coverage or other protection against potential product liability claims, we may not be able to commercialize our products.  If any liabilities from a claim exceed the limit of our insurance coverage, we may not have the resources to pay them.

 

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Our research and development processes involve the controlled use of hazardous and radioactive materials.  We are subject to federal, provincial and local laws and regulations governing the use, manufacture, storage, handling and disposal of such materials and certain waste products.  The risk of accidental contamination or injury from handling and disposing of such materials cannot be completely eliminated. In the event of or an accident involving hazardous or radioactive materials, we could be held liable for any damages that result. We are not insured with respect to this liability. Such liability could exceed our resources.  In the future we may be required to incur significant costs to comply with environmental laws and regulations.

 

Our Success Depends On Our Ability to Attract and Retain Qualified Personnel

 

We depend on a core management and scientific team.  The loss of any of these individuals may prevent us from achieving our business objective of commercializing our product candidates.  Our future success will also depend in large part on our continued ability to attract and retain other highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical testing and government regulation.  We face competition for personnel from other companies, universities, public and private research institutions, government entities and other organizations.  If we are unsuccessful in our recruitment and retention efforts, our business operations will suffer.

 

We Will Depend Upon the Availability of Reimbursement from Third-Party Payors Who Are Increasingly Challenging the Price and Examining the Cost Effectiveness of Medical Products and Services

 

Sales of our products will depend in part upon the availability of reimbursement from third-party payors, including government health administration authorities, managed care providers, private health insurers and other organizations.  These third-party payors increasingly attempt to contain costs by challenging the price of products and services and limiting the coverage and level of reimbursement for pharmaceutical products.  Third-party reimbursement for our products may be inadequate to enable us to maintain prices that provide a return on our product development investment.  Governments continue to propose and pass legislation designed to reduce healthcare costs.  This legislation could further limit reimbursement.  If government and third-party payors do not adequately reimburse patients for our products, there may not be a market for the products.

 

Our Share Price Has Been and Is Likely to Continue to Be Highly Volatile

 

As is typical for biotechnology companies without an approved product on the market, our share price has been highly volatile in the past and is likely to continue to be volatile. The price of our shares could be materially affected by factors including the announcement of technological innovations, the release of publications, the announcement of clinical trials results by us or our competitors, the development of new commercial products, changes affecting patents or exclusive licenses, changes in regulations, the release of financial results, public concerns over risks relating to biotechnology, future issuances of shares by us, sales of shares by our shareholders and changes in analyst recommendations.

 

The volatility of our stock may be heightened while it is traded primarily on the Toronto Stock Exchange, which attracts primarily Canadian shareholders.  Because some institutional investors invest in Toronto Stock Exchange companies in proportion to their weight on that index, changes within the S&P/TSX Composite Index may also increase volatility in our share price.  We continue to explore a cross-listing on the Nasdaq or a U.S. exchange, but can provide no assurances regarding the timing or ultimate results of such a transaction.

 

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to foreign currency fluctuations through our operations in the U.S. because a substantial amount of our contract research and development spending is transacted in U.S. dollars.

 

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However, since approximately 95% of our bioreagent product sales are in U.S. dollars, there is partial matching of U.S. currency expenses and revenues.  We use the Canadian dollar as our measurement and functional currency.  As a result, we translate monetary assets and liabilities into Canadian dollars at the rate of exchange prevailing at our balance sheet date and include resulting exchange gains and losses in the other income line item.  We do not currently engage in hedging or other activities to reduce foreign currency risk, beyond matching investments proportionately with anticipated spending, but may do so in the future under certain conditions. A substantial amount of our receivables and payables are denominated in U.S. dollars. We record resulting exchange gains and losses in our statement of operations.

 

Our sales and contract research and development expenses are denominated in U.S. dollars.  Because our financial statements are stated in Canadian dollars, we are exposed to fluctuations of the U.S. exchange rate.  We do not believe this currency risk will have a material impact on our results of operations in the foreseeable future.

 

We maintain cash equivalent and short-term investment portfolio holdings of various issuers, types, and maturity dates with large banks and investment banking institutions.  Typically, 75% of our investments are in government bonds rated AAA. We occasionally hold short-term investments beyond 120 days, and the market value of these investments during the investment term varies as a result of market interest rate fluctuations.

 

We maintain a non-trading investment portfolio.  Our market risk exposure is limited to interest rate risk and foreign exchange rate risk.  We computed a hypothetical change in interest rates by applying a 10% change to our average rate of return, resulting in a $82,000 impact.  If interest rates were to increase by 10%, our net loss would decrease by $82,000.  Further, if interest rates were to decrease by 10%, our net loss would increase by $82,000.  In addition, we computed a hypothetical change in foreign exchange rates by applying a 10% change to our year-end foreign exchange rate and then applied that rate to our average level of U.S. investments during the year, resulting in a $542,000 impact.  If the value of the Canadian dollar relative to the U.S. dollar were to increase by 10%, our net loss would decrease by $542,000.  Further, if the value of the Canadian dollar relative to the U.S. dollar were to decrease by 10%, our net loss would increase by $542,000. We have not used derivative financial instruments in our investment portfolio.  We classify our investments as available-for-sale or held-to-maturity at the time of purchase and re-evaluate this designation as of each balance sheet date. We had $38,581,000 in cash, cash equivalents and short-term investments as of September 30, 2003.

 

Item 4.  CONTROLS AND PROCEDURES

 

Our chief financial officer and chief executive officer concluded as of September 30, 2003 that our disclosure controls and procedures (as defined in Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended) are effective and designed to alert them to material information relating to Stressgen and its consolidated subsidiaries, based on the evaluation of these controls and procedures as required by paragraph (b) of Rule 15d-15.

 

PART II—OTHER INFORMATION

 

Item 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                              Exhibits: For a list of exhibits filed with this report, refer to the Index to Exhibits set forth after the signature page hereto.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Stressgen Biotechnologies Corporation
Date: October 27, 2003	/s/ Donald D. Tartre
	Donald D. Tartre
	Vice President and Chief Financial Officer
	(Principal Financial and Accounting Officer duly authorized to sign this report on behalf of the registrant)

 

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INDEX OF EXHBITS

 

Exhibit No.		Description
3.9*		Articles of Continuance of the Company
3.10*		By-Laws of the Company
4.4*		Form of Stock Certificate
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
32		Section 1350 Certification

 

* Incorporated by reference to the Company’s Form 10-Q for the quarter ended June 30, 2001, as filed with the Commission on August 2, 2001