Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended October 3, 2004

OR

For the transition period from              to             

Commission file number 0-21794

GTC BIOTHERAPEUTICS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code (508) 620-9700

Former Name, Former Address and Former Fiscal Year if Changed Since Last Report

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, including statements regarding GTC’s collaborations and the Company’s future cash requirements. The words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “believes,” “expects”, or similar expressions are intended to identify “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995. Statements that are not historical facts are based on current expectations, beliefs, assumptions, estimates, forecasts and projections for GTC’s business and the industry and markets related to its business. The statements contained in this report are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed in such forward-looking statements. Important factors which may affect future revenues, research and development programs, clinical trials and collaborations and the Company’s future cash requirements include, without limitation, regulatory review of the Company’s ATryn^® product, the ability of the Company to enter into transgenic research and development collaborations in the future and the terms of such collaborations, the results of research and development and preclinical and clinical testing of the Company’s internal product, competitive and technological advances and regulatory requirements.

For a further description of these and other risks and uncertainties, the Company encourages you to read carefully the portion of the Annual Report on Form 10-K for the fiscal year ended December 28, 2003 of the Company under the caption “Factors Affecting Future Operations and Results” in Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations filed with the Securities and Exchange Commission on March 8, 2004.

The forward-looking statements contained in this Quarterly Report on Form 10-Q speak only as of the date of this report. GTC expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained in this Quarterly Report to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any forward-looking statement is based, except as may be required by law.

Table of Contents

GTC BIOTHERAPEUTICS, INC.

TABLE OF CONTENTS

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

GTC BIOTHERAPEUTICS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, dollars in thousands except share amounts)

The accompanying notes are an integral part of these financial statements.

2

Table of Contents

GTC BIOTHERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited, dollars in thousands except per share amounts)

The accompanying notes are an integral part of these financial statements.

3

Table of Contents

GTC BIOTHERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, dollars in thousands)

The accompanying notes are an integral part of these financial statements.

4

Table of Contents

GTC BIOTHERAPEUTICS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

These unaudited consolidated financial statements should be read in conjunction with the Annual Report on Form 10-K of GTC Biotherapeutics, Inc., referred to as GTC or the Company, for the fiscal year ended December 28, 2003 (2003 Form 10-K), which was filed with the Securities and Exchange Commission (SEC) on March 8, 2004 and the financial statements and footnotes included therein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations.

The financial statements for the nine months ended October 3, 2004 and September 28, 2003, are unaudited but include, in the Company’s opinion, all adjustments necessary for a fair presentation of the results for the periods presented. The Company recorded an adjustment of $155,000 to reduce interest income during the first quarter of 2004, which related to activity during 2003.

The Company is subject to risks common to companies in the biotechnology industry, including, but not limited to, the uncertainties of clinical trials and regulatory requirements for approval of therapeutic compounds, the need for additional capital, competitive new technologies, dependence on key personnel, protection of proprietary technology, and compliance with the United States Food and Drug Administration (FDA) and other government regulations. The Company’s consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the continuity of business, realization of assets and the satisfaction of liabilities in the ordinary course of business. The Company has incurred losses from operations since inception and has an accumulated deficit of $172.2 million at October 3, 2004. Based on the current rate of cash utilization, management believes that existing cash resources and potential future cash payments from new partnering and licensing programs will be sufficient to fund operations through 2005. The primary sources of additional capital raised in 2002, 2003 and 2004 have been equity and debt, and management expects that future sources of funds may include new or expanded partnering arrangements, or the sale of equity or debt-related instruments. However, there can be no assurance that the Company will be able to raise needed capital on terms that are acceptable to the Company, or at all. If the Company does not obtain an adequate amount of additional financing, the Company will be required to curtail operating expenses or take other steps that could adversely impact the Company’s ability to grow and commercialize its products.

The accounting policies underlying the quarterly financial statements are those set forth in Note 2 of the financial statements included in the 2003 Form 10-K. There have been no material changes in the accounting policies that are set forth in Note 2 of the financial statements included in the Company’s 2003 Form 10-K.

Accounting for Employee Equity Plans

In December 2002, the Financial Accounting Standards Board issued FASB No. 148 (SFAS 148), Accounting for Stock Based Compensation – Transition and Disclosure. SFAS 148, which was effective for fiscal years ending after December 15, 2002, amends Statement of Accounting Standards No. 123 (SFAS 123), Accounting for Stock Based Compensation and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 regardless of the accounting method used to account for stock-based compensation. The Company continues to apply APB Opinion 25 and related interpretations in accounting for its employee equity plans. Accordingly, no compensation cost has been recognized for options granted to employees with exercise prices equal to or greater than the fair market value at the grant date. The Company applies the disclosure only provisions of SFAS 148. If the compensation cost for the Company’s stock-based compensation plans to employees had been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company’s net loss and loss per share for the three and nine months ended October 3, 2004 and September 28, 2003 would have been increased to the pro forma amounts indicated below:

5

Table of Contents

The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: an expected life of five years, expected volatility of 100% for the third quarters of 2004 and 2003 and the nine months ended October 3, 2004 and September 28, 2003, a dividend yield of 0% and a risk-free interest rate of 3.11% for the third quarter of 2004 and the nine months ended October 3, 2004, and 2.96% for the third quarter of 2003 and the nine months ended September 28, 2003. The average fair value per share of those options granted during the third quarters of 2004 and 2003 was $1.34 and $2.73, respectively. The average fair value per share of those options granted during the nine months ended October 3, 2004 and September 28, 2003 was $2.66 and $1.21, respectively.

The fair value of the employees’ purchase rights was estimated using the Black-Scholes model with the following weighted-average assumptions: a dividend yield of 0%, expected volatility of 100% for the third quarters of 2004 and 2003 and the nine months ended October 3, 2004 and September 28, 2003, an expected life of three months for the third quarter of 2004 and 2003 and the nine months ended October 3, 2004 and September 28, 2003 and a risk-free interest rate of 1.39% for the third quarter of 2004 and the nine months ended 2004 and 0.84% for the third quarter of 2003 and the nine months ended 2003. The average fair value of those purchase rights granted during the third quarters of 2004 and 2003 was $0.58 and $1.12, respectively. The average fair value of those purchase rights granted during the nine months ended October 3, 2004 and September 28, 2003 was $0.81 and $0.70, respectively.

Net Loss per Common Share

Per share information is based upon the weighted average number of shares of common stock outstanding during the period. Potential common shares, consisting of warrants and stock options, totaled 5.4 million and 5.5 million at October 3, 2004 and September 28, 2003, respectively. Since the Company was in a net loss position at October 3, 2004 and September 28, 2003, these potential common shares were not used to compute diluted loss per share, as the effect would have been antidilutive.

The Company carries inventory at the lower of cost or market using the first-in, first-out method. The Company capitalizes inventory produced for commercial sale, and the entire inventory on hand at October 3, 2004 and December 28, 2003 was finished goods related to ATryn^®, which has not yet been approved for commercial sale. The Company expects that all of the capitalized inventory will be sold commercially in Europe, provided the Company receives marketing approval. If, at any time, the Company believes that marketing approval of ATryn^® is no longer probable, the Company will charge the inventory to expense. It is possible that the Company could use some of the capitalized inventory for additional clinical trials and, if so, the Company would expense the inventory when it was designated for use in such a clinical trial. The Company determines cost using the first-in, first-out method. The Company analyzes its inventory levels quarterly and will write down inventory that has become obsolete, inventory that has a cost basis in excess of its expected net realizable value, and inventory in excess of expected requirements. Expired inventory will be disposed of and the related costs will be written off. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. In the third quarter of 2004, the Company recorded a charge of approximately $173,000 to research and development to reflect usage of inventory for development purposes.

6

Table of Contents

Accrued liabilities include the following:

In 2003, 22 employees were terminated as a result of a restructuring during the third quarter. In February 2004, the Company completed a further restructuring in which headcount was further reduced by approximately 20% from 159 to 127 full time equivalent employees. The accrued expenses for these restructurings are reflected in “other” in the table above. Approximately $743,000 and $200,000 of the costs associated with the 2004 restructuring are included in selling, general and administrative expense and research and development expenses, respectively. Payments related to the restructuring will be completed in the third quarter of 2005.

Following is a summary of accrued severance:

The Company’s intangible assets as of October 3, 2004 and December 28, 2003 consisted of:

Amortization expense was $259,000 for the three months ended October 3, 2004 and September 28, 2003, and $776,000 for the nine months ended October 3, 2004 and September 28, 2003.

The estimated aggregate amortization expense for the next five fiscal years is $1,035,000 per year from 2004 through 2008 and $5,966,000 for 2009 and thereafter.

In May 2004, the Company entered into a four year loan agreement with General Electric Capital Corporation, or GE Capital, in the amount of $10 million with a 9.94% interest rate and monthly payments of approximately $253,000, which was used to refinance the Company’s outstanding loan with Silicon Valley Bank, or SVB. Collateral for the loan includes all existing and future acquired assets of the Company, excluding intellectual property. As a result of this refinancing, the Company was no longer required to maintain $18.2 million as unrestricted cash and marketable securities before it would be required to provide cash collateral for the loan. In connection with the refinancing, the Company was required to provide $450,000 of cash collateral for its two outstanding stand-by letters of credit which appears as restricted cash on the balance sheet.

7

Table of Contents

In March 2004, the Company sold 6,395,298 shares of its common stock at $2.35 per share in a registered direct offering to institutional investors. These shares were issued under the Company’s shelf registration statement previously filed with the SEC. SG Cowen Securities, lead agent, and Rodman & Renshaw, LLC acted as placement agents for the offering and the Company paid a placement agent fee for their services. Proceeds to the Company, net of offering costs of approximately $1.2 million, were approximately $13.9 million.

The Company defers direct costs incurred under a binding purchase order in excess of revenues recognized to date if the costs incurred are recoverable and the pending contract is not a loss contract. The deferred costs include direct labor, direct materials and overhead. Deferred costs are limited to the non-refundable cash received under the contract plus amounts receivable for work performed or milestones achieved as of the balance sheet date. As of October 3, 2004, the Company had $992,000 of capitalized costs which are classified as deferred contract costs on the balance sheet. The deferred contract costs are related to one pending contract for which ongoing work is being performed under terms and conditions that have not been finalized by a formal arrangement and for which the Company has not recognized any revenue.

On November 13, 2001, two employees of one of the Company’s former subsidiaries filed an action in the Court of Common Pleas for Philadelphia County in Pennsylvania against the Company seeking damages, declaratory relief and certification of a class action relating primarily to their Company stock options. The claims arise as a result of the Company’s sale of Primedica Corporation to Charles River Laboratories International, Inc. in February 2001, which the Company believes resulted in the termination of Primedica employees’ status as employees of the Company or its affiliates and termination of their options. The plaintiffs contend that the sale of Primedica to Charles River did not constitute a termination of their employment with the Company or its affiliates for purposes of the Company’s equity incentive plan and, therefore, that the Company breached its contractual obligations to them and other Primedica employees who had not exercised their stock options. The complaint demands damages in excess of $5 million, plus interest. GTC has filed an answer denying all material allegations in the complaint, and is vigorously defending the case and objecting to certification of the claims as a class action. The Company believes that it has meritorious defenses and that, although the ultimate outcome of the matter cannot be predicted with certainty, the disposition of the matter should not have a material adverse effect on the financial position, results of operations or cash flows of the Company.

In July 2004, the Company entered into a three year lease agreement with GE Capital, which allows the Company to finance up to $1.4 million of laboratory, office and computer equipment. During the third quarter of 2004, the Company utilized $226,000 through a sale lease-back transaction which is being accounted for as an operating lease. The Company has $1.2 million available to finance future equipment purchases.

8

Table of Contents

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview

GTC Biotherapeutics, Inc., referred to as GTC or the Company, is a leader in the development, production, and commercialization of human therapeutic proteins in the milk of animals, principally goats and cattle. Using a technology known as transgenics, GTC inserts protein-specific DNA into the animal to enable it to produce that specific human protein in its milk. The protein is then purified from the milk under pharmaceutical manufacturing conditions to obtain the therapeutic product, which is typically administered by injection or infusion. A significant focus of the Company’s product development pipeline is on commercializing recombinant forms of therapeutic human plasma proteins, including the lead program, ATryn^®. GTC’s technology enables recombinant forms of human plasma proteins that are otherwise difficult to express at practical levels in traditional production technologies.

GTC is dependent upon funding from collaborations and proceeds from equity financings and short and long-term debt to finance operations. The Company enters into licensing and development agreements with collaborative partners for the development, production and purification of therapeutic recombinant proteins produced transgenically. The terms of the agreements typically include non-refundable license fees, funding of research and development, payments based upon the achievement of certain milestones and, in some cases, royalties on future product sales.

This discussion and analysis of our financial condition should be read in connection with the Company’s consolidated financial statements and accompanying notes thereto in the Company’s 2003 Form 10-K, including without limitation the information set forth under the heading “Critical Accounting Policies and Estimates.” The key value drivers for the Company remain substantially the same as those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth in the Company’s 2003 Form 10-K.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements requires that the Company make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s accounting policies are summarized in Note 2 in the Notes to Consolidated Financial Statements included in Item 15 of the Company’s 2003 Form 10-K. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, investments, intangible and long-lived assets, income taxes, accrued expenses, financing operations, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes in the critical accounting policies that are set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of the Company’s 2003 Form 10-K.

Results of Operations

As a Company that has not yet launched a commercial product, the key components to the Company’s losses are costs of revenue, research and development expenses, and selling, general and administrative expenses. In September 2003, the Company implemented an initial restructuring plan followed by a further restructuring in February 2004. As part of these actions, headcount was reduced by approximately 30% and the Company also renegotiated certain research agreements with outside contractors. These restructurings resulted in a $1.7 million reduction of expense in the third quarter of 2004 as compared with the same quarter of 2003, including reductions of $600,000 in cost of revenue, $331,000 in research and development and $815,000 in selling, general and administrative expenses.

9

Table of Contents

Three months ended October 3, 2004 and September 28, 2003

Revenue. During the third quarter of 2004, $848,000 of the revenue was derived from external development programs, primarily the programs with Merrimack Pharmaceuticals and Nexia Biotechnologies, and $76,000 of the revenue was derived from the malaria program which is funded by the National Institute of Allergy and Infectious Diseases, or NIAID, a part of the National Institutes of Health, or NIH. The decrease in revenue derived from the malaria program is primarily a result of the timing of activities on the program. During the third quarter of 2003, $1.6 million of the revenue was derived from external programs while $565,000 of the revenue was derived from the malaria program. The 2003 revenue from external programs was primarily derived from the achievement of milestones in connection with the Merrimack program. Due to the nature and timing of the Company’s milestone-based research and development revenue, the Company expects to see variation in reported revenue on a quarter to quarter basis. Deferred contract revenue, which is not included in the statement of operations but is reflected on the balance sheet, has increased by $1 million in the quarter to $2.1 million representing revenue deferred to future accounting periods on existing contracts in process.

Cost of revenue. The decrease in cost of revenue is primarily the result of a decrease in revenue due to the stage of development on external programs for which revenue is being recognized as well as the cost reductions from the restructurings. In addition, deferred contract costs, which are recorded on the balance sheet, have increased by $505,000 in the quarter to $992,000 representing work done on one pending contract for which no revenue has been recognized to date. The level of expenses on the Company’s external programs will continue to fluctuate depending upon the stage of development of these individual contracts.

Research and development expense. Of the third quarter 2004 expenses, approximately $3 million were incurred to support the regulatory filing for approval to market ATryn^® in Europe to treat hereditary antithrombin deficiency, compared with $2.2 million in the third quarter of 2003. The Company incurred expenses of $500,000 in both the third quarters of 2004 and 2003 in the development of the recombinant human albumin, or rhA, program. Additionally, in the third quarters of 2004 and 2003, the Company incurred expenses of $100,000 and $700,000, respectively, in the development of the malaria program, and $1 million and $1.4 million, respectively, in the development of other internal programs. Research and development expenses going forward are expected to fluctuate based on a number of factors, including the timing and status of clinical development activities for ATryn^® and other programs. During the fourth quarter of 2004, the Company plans to submit an amendment to its Investigational New Drug (IND) application to the Food and Drug Administration (FDA) to define the clinical protocol for ATryn^® in the United States in the HD indication. The results of this clinical study, in conjunction with the data provided to the European Medicines Agency (EMEA), are anticipated to form the basis for a filing for market approval in the U.S.

Selling, General and Administrative Expense. Expenses for the third quarter of 2004 decreased compared with the third quarter of 2003 due to lower headcount which resulted from the 2003 and 2004 restructurings.

Nine months ended October 3, 2004 and September 28, 2003

Revenue. During the first nine months of 2004, $2.5 million of the revenue was derived from external development programs, primarily the programs with Merrimack and Centocor, and $868,000 of the revenue was derived from the malaria program which is funded by the NIAID. During the first nine months of 2003, $5.6 million of the revenue was derived from external programs while $2.4 million of the revenue was derived from the malaria program. The decrease in revenue derived from the malaria program is primarily a result of the timing of activities on the program. The 2003 revenue from external programs was

10

Table of Contents

primarily derived from the achievement of milestones in connection with the Merrimack, Elan and Bristol-Myers Squibb programs. Due to the nature and timing of the Company’s milestone-based research and development revenue, the Company expects to see variation in reported revenue on a quarter- to-quarter basis. Deferred contract revenue, which is not included in the statement of operations but is reflected on the balance sheet, has increased by $1.7 million in the first nine months of 2004 to $2.1 million, representing revenue deferred to future accounting periods on existing contracts in process.

Cost of revenue and operating expenses. The expenses for the first nine months of 2004 included a $943,000 charge associated with the corporate restructuring that was implemented in February 2004, of which approximately $743,000 and $200,000, respectively, are included in selling, general and administrative expense and research and development expense. The first nine months of 2004 also include an additional week of expenses due to the fact that the first quarter was a 14 week fiscal quarter. The impact of the additional week of operating expenses in the first nine months of 2004 was approximately $600,000 as compared with the first nine months of 2003.

Cost of revenue. The decrease in cost of revenue is primarily the result of a decrease in revenue due to the stage of development on external programs for which revenue is being recognized as well as the reduction from the restructurings. In addition, deferred contract costs, which are recorded on the balance sheet, have increased to $992,000 in the first nine months of 2004, representing work done on one pending contract for which no revenue has been recognized to date. The level of expenses on the Company’s external programs will continue to fluctuate depending upon the stage of development of these individual contracts.

Research and development expense. The increase in research and development is primarily a result of the increase in expenses incurred to support the regulatory filing for approval to market ATryn^® in Europe to treat hereditary antithrombin deficiency to $7.3 million in the first nine months of 2004 as compared with $5.4 million in the first nine months of 2003. In the first nine months of 2003, $3 million was capitalized in connection with the FDA and EMEA approval process for the manufacturing equipment to be used for the bulk production of ATryn^®.

Additionally, in the first nine months of 2004 and 2003, the Company incurred expenses of $1.4 million and $1.5 million, respectively, in the development of the rhA program, $800,000 and $1.6 million, respectively, in the development of the malaria program and $4.1 million and $3.6 million, respectively, in the development of other internal programs. Research and development expenses going forward are expected to fluctuate based on a number of factors, including the timing and status of clinical development activities for ATryn^® and other programs. During the fourth quarter of 2004, the Company plans to submit an amendment to its IND application to the FDA to define the clinical protocol for ATryn^® in the United States in the HD indication. The results of this clinical study, in conjunction with the data provided to the EMEA, are anticipated to form the basis for a filing for market approval in the U.S.

Selling, General and Administrative Expense. The decrease in selling, general and administrative expenses in the first nine months of 2004, of approximately $1.2 million, reflects lower expenses throughout all areas of selling, general and administrative, primarily a result of the restructurings. This is offset by $743,000 of costs associated with the 2004 restructuring.

Interest Income. The decrease in interest income is primarily the result of an adjustment of $155,000 recorded in the first quarter of 2004 related to interest income on the Company’s investments during 2003, as well as lower average cash and marketable securities balances in 2004.

Liquidity and Capital Resources

The Company’s objective is to finance its business appropriately through a mix of equity financings, collaboration and grant revenue, debt financings and interest income earned on its cash and cash equivalents. The Company’s ability to raise future funds will be affected by the progress of clinical trials and the regulatory review of ATryn^®, the ability of the Company to enter into new or expanded transgenic research and development collaborations, the terms of such collaborations, the results of research and development and preclinical testing of the Company’s other internal product candidates, competitive and technological advances.

The Company uses its cash for a mix of activities focused on enhancing product development and program execution and development and expansion of operational capabilities, which consist primarily of salaries and wages, facility and facility-related costs for office and laboratory space and other outside direct costs. The Company anticipates utilizing approximately $20 million of cash in 2005 which includes supporting the launch of ATryn^® in Europe and the HD clinical trial in the U.S. After a successful launch of this product in mid-2005, and on the basis of a supportive ATryn^® partnering agreement, the Company may manufacture additional product to supply clinical studies for larger markets. This additional manufacturing may increase the Company’s total net cash utilization in 2005 to $25 million.

11

Table of Contents

The Company had cash, cash equivalents and marketable securities of approximately $29.8 million at October 3, 2004. This amount includes cash and cash equivalents of $9.2 million. The Company had working capital of $16.1 million at October 3, 2004 compared to $24.2 million at December 28, 2003.

The Company has incurred losses from operations since inception and has an accumulated deficit of $172.2 million at October 3, 2004. Based on the current rate of cash utilization, management believes that existing cash resources and potential future cash payments from new partnering and licensing programs will be sufficient to fund operations through 2005. The primary sources of additional capital raised in 2002, 2003 and 2004 have been equity and debt, and management expects that future sources of funds may include new or expanded partnering arrangements, or the sale of equity or debt-related instruments. However, there can be no assurance that the Company will be able to raise needed capital on terms that are acceptable to the Company, or at all. If the Company does not obtain an adequate amount of additional financing, the Company will be required to curtail operating expenses or take other steps that could adversely impact the Company’s ability to grow and commercialize products. Any future sales of common stock will proportionally reduce the ownership interest of the Company’s current shareholders and may have an adverse impact on the price of the Company’s common stock.

2004 Financing Activities

In March 2004, the Company sold 6,395,298 shares of its common stock at $2.35 per share in a registered direct offering to institutional investors. These shares were issued under the Company’s shelf registration statement previously filed with the SEC. SG Cowen Securities, lead agent, and Rodman & Renshaw, LLC acted as placement agents for the offering and the Company paid a placement agent fee for their services. Proceeds to the Company, net of offering costs of approximately $1.2 million, were approximately $13.9 million.

Credit Facility

Of the Company’s $14.6 million of outstanding long-term debt at October 3, 2004, approximately $4.8 million is classified as current. Approximately $9.4 million was related to a term loan from GE Capital, with monthly payments through 2008, approximately $443,000 was related to capital leases with monthly payments through 2006 and approximately $4.8 million was related to a promissory note payable to Genzyme with two equal payments of $2.4 million each due April 3, 2005 and April 3, 2006.

In May 2004, the Company entered into a four year loan agreement with GE Capital, in the amount of $10 million with a 9.94% interest rate and monthly payments of approximately $253,000, which was used to refinance the Company’s outstanding loan with SVB. Collateral for the loan includes all existing and future acquired assets of the Company, excluding intellectual property. As a result of this refinancing, the Company is no longer required to maintain $18.2 million as unrestricted cash and marketable securities before it would be required to provide cash collateral for the loan. In connection with the refinancing, the Company was required to provide $450,000 of cash collateral for its two outstanding stand-by letters of credit, which appears as restricted cash on the balance sheet

Other Sources of Funds

Other sources of funds during the first nine months of 2004 included $2.4 million in net redemptions of marketable securities in the Company’s portfolio, approximately $1 million in new proceeds from refinancing the SVB debt, and $410,000 from the issuance of common stock under various employee stock plans.

Other Uses of Funds

Uses of funds during the period (in which the Company recognized a net loss of $22 million) included $12.7 million used in operations.

Other uses of funds during the period included:

12

Table of Contents

The Company has entered into transactions with related parties in the normal course of business. The terms of these transactions are considered to be at arms-length.

COMMITMENTS AND CONTINGENCIES

The Company’s commitments and contingencies are disclosed in Note 9 of this Form 10-Q as well as in the Company’s 2003 Form 10-K in the notes to the consolidated financial statements. The Company has reviewed the commitments and contingencies at October 3, 2004 and noted that there were no material changes or additions.

The Company is a party to license agreements for certain technologies. Certain of these agreements contain provisions for future royalties to be paid on commercial sales of products developed from the licensed technologies. Currently the amounts payable under these agreements and any resulting commitments on the Company’s behalf are unknown and are not able to be estimated since the level of future sales, if any, is uncertain.

13

Table of Contents

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the Company’s market risk since December 28, 2003. The Company’s market risk disclosures are discussed in its Annual Report on Form 10-K under the heading Item 7A, Quantitative and Qualitative Disclosures About Market Risk.

ITEM 4 - CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of its principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, the “Exchange Act”) as of the end of the period covered by this quarterly report. Based on this evaluation, the principal executive officer and the principal financial officer concluded that the Company’s disclosure controls and procedures were effective and designed to ensure that the information required to be disclosed in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods.

(b) Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in connection with the evaluation of the Company’s internal control that occurred during its last fiscal quarter that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

14

Table of Contents

PART II - OTHER INFORMATION

ITEM 6 – EXHIBITS

15

Table of Contents

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 hereunto duly authorized.

16

Table of Contents

EXHIBIT INDEX