Management believes that, through implementation of the measures noted above, we have begun to address the conditions identified above as material weaknesses. We are monitoring the effectiveness of these measures, and of our internal control over financial reporting on an ongoing basis. We will take further action, as appropriate, to strengthen our internal control over financial reporting to the greatest extent reasonable and possible.
Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
On March 17, 2003, a civil complaint for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 was filed in the United States District Court for the Northern District of California, entitled Janice Whitkens v. VaxGen, Inc., et al., Civil Action No. C03-1129 JSW. Named, as defendants are VaxGen, Inc., Chief Executive Officer Lance K. Gordon and former President Donald P. Francis. The plaintiff seeks to represent a class of persons who purchased our securities between August 6, 2002 and February 26, 2003, and alleges that the defendants misled investors about the progress of certain clinical trials and our future manufacturing and marketing plans. Following the filing of the Whitkens complaint, several additional class action complaints were filed in the same court, each making identical or similar allegations against the same defendants. See Subsequent Events in Note 16 to the unaudited condensed financial statements.
On or about March 21, 2003, two separate but virtually identical shareholder derivative actions were filed in California Superior Court for San Mateo County entitled Rhodes v. Allen, et al. civil action No. CIV 430087, and MacDonald v. Allen, et al., civil action No. CIV 430088. A consolidated complaint was filed in June 2003. Named as defendants in the action are VaxGen directors Lance K. Gordon, Randall L-W. Caudill, and William D. Young, and former VaxGen directors Donald P. Francis, Phillip W. Berman, David W. Beier, and Stephen C. Francis (“Company Directors”). Also named as defendants are Paul Allen and Vulcan Ventures, Inc. (“Vulcan Defendants”). The allegations of the consolidated complaint (“Derivative Lawsuit”) are similar to those contained in the class action, although unlike the class action, in the Derivative Lawsuit the plaintiff purports to seek recovery on behalf of VaxGen, rather than from VaxGen. Plaintiffs allege as well that the Vulcan Defendants sold shares of our stock while in possession of material non-public information about the Company. Plaintiffs, purportedly suing on behalf of VaxGen, assert claims against all defendants for breach of fiduciary duty, mismanagement, waste and unjust enrichment and against the Vulcan Defendants for breach of fiduciary duty and insider trading. As of September 30, 2004, we have provided $0.5 million for the settlement of these derivative actions. See Subsequent Events in Note 16 to the unaudited condensed financial statements.
ITEM 1A. RISK FACTORS
For the nine months ended September 30, 2004, there has been no significant change to the identified risk factors filed in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on September 26, 2006, other than the addition of risk factors associated with our newly consolidated VIE, Celltrion, and the removal of “Risks Related to the Issuance of Series A 6% Cumulative Redeemable Convertible Preferred Stock (Series A Preferred Stock) and Warrants” because the Series A Preferred Stock and associated warrants are no longer outstanding as of September 30, 2004.
You should carefully consider the following risk factors as well as other information in our filings under the Exchange Act before making any investment decisions regarding our common stock.The risks and uncertainties described herein are not the only ones we face. Additional risks and uncertainties that we do not presently know or that we currently deem immaterial may also impair our business, financial condition, operating results and prospects. If events corresponding to any of these risks actually occur, they could materially adversely affect our business, financial condition, operating results or prospects. In that case, the trading price of our common stock could decline. When used in the report, unless otherwise indicated, “we,” “our” and “us” refers to VaxGen.
Risks Relating to Our Business
We do not have current financial statements and therefore you are not able to evaluate our current financial condition or operating history and results.
We are in the process of restating certain historical financial statements and engaged our new independent registered public accounting firm to reaudit those financial statements. In July 2004, we announced that we were reauditing and restating our financial statements for the fiscal years ended December 31, 2003 and 2002, because we determined that we should recognize revenue from certain government contracts as costs are incurred, instead of after completing contract milestones. In October 2004, we announced that we would also be reauditing and restating our financial statements for the fiscal year ended December 31, 2001. In connection with the restatement of our financial statements for the fiscal year ended December 31, 2001, we also made adjustments to our balance sheet as of December 31, 2000.
Effective January 1, 2004, we are required to consolidate Celltrion’s financial statements into our own. Celltrion maintains its records in accordance with Korean accounting principles; however, we require financial statements that are prepared in accordance with GAAP and which have been audited in conformity with U.S. Auditing Standards. Celltrion’s internal controls over financial reporting may not be sufficient to enable them to report their interim GAAP financial results to us on a timely basis. In addition, their independent registered public accounting firm could conclude that Celltrion’s internal controls over financial reporting are not sufficient to enable the registered public accounting firm to complete their required annual audit of Celltrion’s GAAP financial statements in a timely fashion, if at all.
If we do not receive adequate timely financial reporting from Celltrion, we could be delinquent in our filings required under Section 13 of the Exchange Act and we might not be able to maintain or file registration statements relating to shares of our common stock. If we are relisted and are unable to timely file periodic reports, we could again be delisted from Nasdaq. In addition, Celltrion’s failure to achieve and maintain an effective internal control environment for GAAP periodic financial reporting may also cause our investors to lose confidence in our filed financial statements, which could have a material adverse effect on the market price of our common stock.
We are not currently listed on a national exchange or on the Nasdaq National Market or Nasdaq SmallCap Market, and cannot assure you we will ever be listed.
As a result of our failure to have current financial statements for the fiscal years ended December 31, 2003, 2002 and 2001, we have been delisted from the Nasdaq, and our common stock is not currently listed on any national stock exchange or on Nasdaq or the Nasdaq SmallCap Market. Until we complete all necessary filings with the SEC pursuant to Sections 13 and 15(d) of the Exchange Act, we will not be able to apply for our common stock to be re-listed on Nasdaq or for our common stock to be listed on a national exchange or the Nasdaq SmallCap Market. We do not know when, if ever, this will be completed, and thus, whether our common stock will ever be listed. In addition, we cannot be certain that Nasdaq will approve our stock for relisting. In order to be eligible for relisting we must meet Nasdaq’s initial listing criteria, and we believe we will need to be in compliance with Sections 13 and 15(d) of the Exchange Act. Our common stock is currently traded on the Pink Sheets, LLC.
We are currently not eligible to register securities with the SEC, and may never regain compliance.
Until we have filed current financial statements and made all the necessary filings with the SEC pursuant to Sections 13 and 15(d) of the Exchange Act, we will not be able to register any securities for re-sale. Until we are able to register securities with the SEC for resale, any purchasers who purchase our common stock or other securities directly from us, will have to rely on an exemption from the federal and state securities laws in order to resell their securities. We cannot estimate when, if ever, we will have, completed the restatement of our 2001 through 2003 financial statements, filed amended and outstanding reports and regained compliance with Sections 13 and 15(d) of the Exchange Act.
Our internal controls may not be sufficient to ensure timely and reliable financial information.
In response to a letter the Audit Committee of the Board of Directors received from our independent auditors regarding material weaknesses in the effectiveness of our internal controls, we believe we need to correct deficiencies in our internal controls and procedures for financial reporting. These deficiencies include insufficient staffing, inadequate controls and procedures relating to revenue recognition for government contracts, account reconciliations, segregation of duties, journal entries and depth of accounting knowledge.
Failure to address these deficiencies in a timely manner might increase the risk of future financial reporting misstatements and may prevent us from being able to meet our filing deadlines. Under the supervision of our Audit Committee, we are continuing the process of identifying and implementing corrective actions where required to improve the design and effectiveness of our internal controls, including the enhancement of systems and procedures. Significant additional resources will be required to establish and maintain appropriate controls and procedures and to prepare the required financial and other information during this process.
Even after corrective actions are implemented, the effectiveness of our controls and procedures may be limited by a variety of risks including:
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| • | faulty human judgment and simple errors, omissions or mistakes; |
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| • | collusion of two or more people; |
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| • | inappropriate management override of procedures; and |
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| • | risk that enhanced controls and procedures may still not be adequate to assure timely and reliable financial information. |
If we fail to have effective internal controls and procedures for financial reporting in place, we could be unable to provide timely and reliable financial information. Additionally, if we fail to have effective internal controls and procedures for financial reporting in place, it could adversely affect our financial reporting requirements under our government contracts.
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We will need to raise additional capital, and any inability to raise required funds could harm our business.
We will require additional funds to continue operations and may attempt to raise these funds through equity or debt financings, collaborative arrangements with corporate partners or from other sources. Any equity financings will be dilutive to existing stockholders, and any debt financings will likely involve covenants restricting our business activities. We cannot guarantee you that additional funds will be available on acceptable terms, or at all. If we are unable to raise additional capital when necessary, we may be required to relinquish our rights to certain key technologies, drug candidates or marketing territories under the terms of certain of our collaborative agreements.
We may fail to obtain contracts to supply the Strategic National Stockpiles of anthrax and smallpox vaccines to the U.S. government, and we may be unable to commercialize our vaccine candidates.
The U.S. government has undertaken commitments to help secure improved countermeasures against bioterrorism, including the stockpiling of vaccines for anthrax and smallpox. On September 30, 2003, VaxGen and Avecia were awarded cost-reimbursement plus fixed fee contracts to advance development of their respective anthrax vaccines and to each supply an inventory of three million doses of their anthrax vaccines to the U.S. government. These contracts have estimated values of $80.3 million and $71.3 million, respectively. Under the then current version of Project BioShield, the U.S. government expected to purchase a total of 60 million doses of an rPA anthrax vaccine over a 10-year period. On March 11, 2004, the government issued a request for proposal, which increased the size of the intended stockpile from 60 million doses to 75 million doses. The process of obtaining government contracts is lengthy and uncertain and we must compete for each contract. Moreover, the award of one government contract does not necessarily secure the award of future contracts covering the same vaccine. Accordingly, we cannot be certain that we will be awarded any future contracts to supply a government stockpile of anthrax vaccine. It is possible that future awards to provide the U.S. government with emergency stockpiles of anthrax vaccine will be granted solely to Avecia or another supplier. If the U.S. government makes significant future contract awards for the supply of its emergency stockpile to our competitors, such as Avecia, our business will be harmed and it is unlikely that we will be able to ultimately commercialize that particular vaccine.
In addition, the determination of when and whether a product is ready for large scale purchase and potential use will be made by the government through consultation with a number of governmental agencies, including the FDA, the NIH, the CDC and the Department of Homeland Security. President Bush has proposed, and Congress is considering, measures to accelerate the development of biodefense products through NIH funding, the review process by the FDA and the final government procurement contracting authority. While this may help speed the approval of our vaccine candidates, it may also encourage competitors to develop their own vaccine candidates. In its March 11, 2004 RFP regarding procurement of a 75 million-dose stockpile, the government identified the OSPHEP within HHS as the procurement authority. If competitive vaccine candidates gain approval, we could face severe competition, which could harm our business. Furthermore, while Project BioShield was passed by the House of Representatives, we cannot be certain that this legislation will be enacted into law or, if it is enacted into law, predict the timing of its enactment, nor can we predict the decisions that will be made in the future by various government agencies.
If the U.S. government fails to continue funding our anthrax vaccine candidate development efforts or fails to purchase sufficient quantities of any future biodefense vaccine candidate, we may be unable to generate sufficient revenues to continue operations.
We have received funding from the U.S. government for the development of our anthrax vaccine candidate. Changes in government budgets and agendas may result in future funding being decreased and de-prioritized, and government contracts typically contain provisions that permit cancellation in the event that funds are unavailable to the governmental agency. Furthermore, we cannot be certain of the timing of any future funding, and substantial delays or cancellations of funding could result from protests or challenges from third parties. If the U.S. government fails to continue to adequately fund our research and development programs, we may be unable to generate sufficient revenues to continue operations. Similarly, if we develop an anthrax vaccine candidate that is approved by the FDA, but the U.S. government does not place sufficient orders for this product, our future business will be harmed.
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U.S. government agencies have special contracting requirements, which create additional risks.
We have entered into contracts with NIAID and a license agreement with USAMRIID, which are U.S. government agencies. Substantially all of our revenue is derived from government contracts and grants. In contracting with government agencies, we are subject to various U.S. government agency contract requirements. Future sales to U.S. government agencies will depend, in part, on our ability to meet U.S. government agency contract requirements, certain of which we may not be able to satisfy.
U.S. government contracts typically contain unfavorable termination provisions and are subject to audit and modification by the government at its sole discretion, which subjects us to additional risks. These risks include the ability of the U.S. government to unilaterally:
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| • | suspend or prevent us for a set period of time from receiving new contracts or extending existing contracts based on violations or suspected violations of laws or regulations; |
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| • | terminate our existing contracts; |
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| • | reduce the scope and value of our existing contracts; |
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| • | audit and object to our contract-related costs and fees, including allocated indirect costs; |
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| • | control and potentially prohibit the export of our products; and |
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| • | change certain terms and conditions in our contracts. |
The U.S. government may terminate any of its contracts with us either for its convenience or if we default by failing to perform in accordance with the contract schedule and terms. Termination for convenience provisions generally enable us to recover only our costs incurred or committed, and settlement expenses and profit on the work completed prior to termination. Termination for default provisions do not permit these recoveries and make us liable for excess costs incurred by the U.S. government in procuring undelivered items from another source.
As a U.S. government contractor, we are required to comply with applicable laws, regulations and standards relating to our accounting practices and are subject to periodic audits and reviews. As part of any such audit or review, the U.S. government may review the adequacy of, and our compliance with, our internal control systems and policies, including those relating to our purchasing, property, estimating, compensation and management information systems. Based on the results of its audits, the U.S. government may adjust our contract-related costs and fees, including allocated indirect costs. In addition, if an audit or review uncovers any improper or illegal activity, we may be subject to civil and criminal penalties and administrative sanctions, including termination of our contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government. We could also suffer serious harm to our reputation if allegations of impropriety were made against us. Although adjustments arising from government audits and reviews have not seriously harmed our business in the past, future audits and reviews could cause adverse effects. In addition, under U.S. government purchasing regulations, some of our costs, including most financing costs, amortization of intangible assets, portions of our research and development costs, and some marketing expenses, may not be reimbursable or allowed under our contracts. Further, as a U.S. government contractor, we are subject to an increased risk of investigations, criminal prosecution, civil fraud, whistleblower lawsuits and other legal actions and liabilities to which purely private sector companies are not.
In addition, the license agreement provides that USAMRIID reserves the right to require us and our affiliates to grant a nonexclusive, partially exclusive, or exclusive sublicense in any field of use to a responsible applicant, upon terms that are reasonable under the circumstances and under applicable law, to fulfill public health or safety needs.
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We license our vaccine candidates from third parties. If we fail to perform our obligations under these license agreements, we could lose our ability to develop and commercialize our vaccine candidates.
We license our anthrax vaccine candidate from USAMRIID and we license our smallpox vaccine candidate from Kaketsuken. Each of these license agreements requires that we perform certain obligations. If we fail to comply with our obligations under these agreements in a timely fashion, our licensors could terminate our rights to develop and commercialize our anthrax and smallpox vaccine candidates, which would adversely affect our business and prospects.
Our license agreement with Kaketsuken for our smallpox vaccine candidate may restrict our ability to develop and commercialize other smallpox vaccine products.
For a period of five years after the termination of the LC16m8 Agreement, we may not, without Kaketsuken’s prior written consent, file for or obtain regulatory approval, sell and or otherwise deal in any product potentially in competition with LC16m8. During the term of the LC16m8 Agreement, we may not, without the prior written consent of Kaketsuken, develop, sell, commercialize and/or otherwise deal in any products which may compete with LC16m8. These restrictions will be waived if the LC16m8 Agreement is terminated due to Kaketsuken’s uncured material breach of the LC16m8 Agreement or the FDA determines that LC16m8 is not approvable in the United States. These restrictions may adversely affect our ability to pursue attractive business opportunities.
Our suppliers may fail to provide, or may be delayed in providing, us with the necessary materials to produce our vaccine candidates.
We rely on suppliers to provide us with the necessary materials to produce our vaccine candidates. Any significant delays in obtaining any of these materials from our suppliers could cause us to fail to perform under our contracts, which may cause us to be in breach under those contracts and cause those contracts to be terminated. We cannot assure you that we will not face shortages from one or more of these subcontractors in the future.
We have only a limited operating history and we expect to continue to generate losses.
To date, we have engaged primarily in research, development and clinical testing. Since our inception in 1995, we have not been profitable, and we cannot be certain that we will ever achieve or sustain profitability. Developing our product candidates will require significant additional research and development, including non-clinical testing and clinical trials, as well as regulatory approval. We expect these activities, together with our general and administrative expenses, to result in operating losses for the foreseeable future. Our ability to achieve profitability will depend, in part, on our ability to procure future contracts to supply the anthrax and smallpox vaccines to the U.S. government, to successfully complete development of our proposed products, to obtain required regulatory approvals and to manufacture and market our products directly or through business partners. We cannot assure you that we will be able to accomplish any of these objectives.
We may encounter difficulties managing the change and growth of our operations, which could adversely affect our business.
We have experienced a period of rapid change in our business as a result of increased emphasis on biodefense opportunities. In addition, we expect to experience growth in manufacturing, clinical and regulatory functions associated with our biodefense business. This change and growth in our business has strained and may continue to strain our administrative, financial and operational functions. We will need to expand our staff and improve our systems and procedures to manage our expected growth and to maintain an adequate system of internal controls. If we are unable to manage the change and growth of our business effectively, we may be unable to obtain future government contracts and our results of operations and financial condition will be adversely affected.
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Vaccine development is a long, expensive and uncertain process, and delay or failure can occur at any stage of our clinical trials.
To develop vaccine candidates, we must provide the FDA and foreign regulatory authorities with clinical data that demonstrate adequate safety and immune response. Because humans are not normally exposed to anthrax or smallpox, statistically significant effectiveness of our biodefense product candidates cannot be demonstrated in humans, but instead must be demonstrated, in part, by utilizing animal models before they can be approved for commercial sale. Vaccine development to show adequate evidence of effectiveness in animal models and safety and immune response in humans is a long, expensive and uncertain process, and delay or failure can occur at any stage of our animal studies or clinical trials. Any delay or significant adverse clinical events arising during any of our clinical trials could force us to abandon a vaccine candidate altogether or to conduct additional clinical trials in order to obtain approval from the FDA or foreign regulatory bodies. These development efforts and clinical trials are lengthy and expensive, and the outcome is uncertain. If we are unable to successfully develop our vaccine candidates, our revenues will suffer, and our stock price is likely to decline.
Delays in successfully completing our clinical trials could jeopardize our ability to obtain regulatory approval or market our vaccine candidates on a timely basis.
Our business prospects will depend on our ability to complete patient enrollment in clinical trials, to obtain satisfactory results, to obtain required regulatory approvals and to successfully commercialize our vaccine candidates. Completion of our clinical trials, announcement of results of the trials and our ability to obtain regulatory approvals could be delayed for a variety of reasons, including:
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| • | slower-than-anticipated enrollment of volunteers in the trials; |
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| • | lower-than-anticipated recruitment or retention rate of volunteers in the trials; |
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| • | serious adverse events related to the vaccine candidates; |
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| • | unsatisfactory results of any clinical trial; |
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| • | the failure of our principal third-party investigators to perform our clinical trials on our anticipated schedules; or |
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| • | different interpretations of our pre-clinical and clinical data, which could initially lead to inconclusive results. |
Our development costs will increase if we have material delays in any clinical trial or if we need to perform more or larger clinical trials than planned. If the delays are significant, or if any of our vaccine candidates do not prove to be safe or effective or do not receive required regulatory approvals, our financial results and the commercial prospects for our product candidates will be harmed. Furthermore, our inability to complete our clinical trials in a timely manner could jeopardize our ability to obtain regulatory approval.
The independent clinical investigators that we rely upon to conduct our clinical trials may not be diligent, careful or timely, and may make mistakes, in the conduct of our clinical trials.
We depend on independent clinical investigators to conduct our clinical trials. The investigators are not our employees, and we cannot control the amount or timing of resources that they devote to our vaccine development programs. If independent investigators fail to devote sufficient time and resources to our vaccine development programs, or if their performance is substandard, it may delay FDA approval of our vaccine candidates. These independent investigators may also have relationships with other commercial entities, some of which may compete with us. If these independent investigators assist our competitors at our expense, it could harm our competitive position.
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The approval requirements for vaccines used to fight bioterrorism are still evolving, and we cannot be certain that any vaccines we develop, if effective, would meet these requirements.
We are developing product candidates based upon current governmental policies regulating these vaccines. For instance, we intend to pursue FDA approval of our anthrax and smallpox vaccine candidates under requirements published by the FDA in 2002 that allow the FDA to approve certain vaccines used to reduce or prevent the toxicity of chemical, biological, radiological or nuclear substances based on human clinical data to demonstrate safety and immune response, and evidence of effectiveness derived from appropriate animal studies and any additional supporting data. Our business is subject to substantial risk because these policies may change suddenly and unpredictably and in ways that could impair our ability to obtain regulatory approval of these products, and we cannot guarantee that the FDA will approve our anthrax and smallpox vaccines.
If we fail to comply with extensive regulations enforced by domestic and foreign regulatory authorities, the commercialization of our product candidates could be prevented or delayed.
Vaccine candidates are subject to extensive government regulations related to development, testing, manufacturing and commercialization in the United States and other countries. Our vaccine candidates are in the pre-clinical and clinical stages of development and have not received required regulatory approval from the FDA to be commercially marketed and sold. With the exception of LC16m8, which was licensed and sold in Japan, our vaccine candidates have not received required regulatory approval from foreign regulatory agencies to be commercially marketed and sold. The process of obtaining and complying with FDA, other governmental and foreign regulatory approvals and regulations is costly, time consuming, uncertain and subject to unanticipated delays. Despite the time and expense exerted, regulatory approval is never guaranteed.
We also are subject to the following risks and obligations, among others:
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| • | The FDA or foreign regulators may refuse to approve an application if they believe that applicable regulatory criteria are not satisfied. |
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| • | The FDA or foreign regulators may require additional testing for safety and effectiveness. |
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| • | The FDA or foreign regulators may interpret data from pre-clinical testing and clinical trials in different ways than we interpret them. |
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| • | If regulatory approval of a product is granted, the approval may be limited to specific indications or limited with respect to its distribution. In addition, many foreign countries control pricing and coverage under their respective national social security systems. |
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| • | The FDA or foreign regulators may not approve our manufacturing processes or manufacturing facilities. |
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| • | The FDA or foreign regulators may change their approval policies or adopt new regulations. |
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| • | Even if regulatory approval for any product is obtained, the marketing license will be subject to continual review, and newly discovered or developed safety or effectiveness data may result in suspension or revocation of the marketing license. |
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| • | If regulatory approval of the vaccine candidate is granted, the marketing of that vaccine would be subject to adverse event reporting requirements and a general prohibition against promoting products for unapproved or “off-label” uses. |
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| • | In some foreign countries, we may be subject to official release requirements that require each batch of the vaccine we produce to be officially released by regulatory authorities prior to its distribution by us. |
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| • | We will be subject to continual regulatory review and periodic inspection and approval of manufacturing modifications, including compliance with cGMP regulations. |
Failure to comply with these or other regulatory requirements of the FDA and other applicable foreign regulatory bodies may subject us to administrative or judicially imposed sanctions, including:
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| • | warning letters; |
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| • | civil penalties; |
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| • | criminal penalties; |
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| • | injunctions; |
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| • | product seizure or detention; |
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| • | product recalls; |
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| • | total or partial suspension of production; and |
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| • | suspension or revocation of the marketing license. |
Our product development efforts may not yield marketable products due to results of studies or trials, failure to achieve regulatory approvals or market acceptance, proprietary rights of others or manufacturing issues.
Our success depends on our ability to successfully develop and obtain regulatory approval to market new biopharmaceutical products. We expect that a significant portion of the research that we will conduct will involve new and unproven technologies. Development of a product requires substantial technical, financial and human resources even if the product is not successfully completed.
Our potential products may appear to be promising at various stages of development yet fail to reach the market for a number of reasons, including the:
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| • | lack of adequate quality or sufficient prevention benefit, or unacceptable safety during pre-clinical studies or clinical trials; |
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| • | failure to receive necessary regulatory approvals; |
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| • | existence of proprietary rights of third parties; or |
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| • | inability to develop manufacturing methods that are efficient, cost-effective and capable of meeting stringent regulatory standards. |
Political or social factors may delay or impair our ability to market our vaccine products.
Products developed to treat diseases caused by or to combat the threat of bioterrorism will be subject to changing political and social environments. The political and social responses to bioterrorism have been highly charged and unpredictable. Political or social pressures may delay or cause resistance to bringing our products to market or limit pricing of our products, which would harm our business.
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We may fail to protect our intellectual property or may infringe on the intellectual property rights of others, either of which could harm our business.
If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology in competitive products. If we infringe on the intellectual property rights of others, we may be prevented from developing or marketing our product candidates. We rely on patent and other intellectual property protection to prevent our competitors from manufacturing and marketing our product candidates. Our technology, including technology licensed from Genentech and USAMRIID, or that we may license in the future, if any, will be protected from unauthorized use by others only to the extent that it is covered by valid and enforceable patents or effectively maintained as trade secrets. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date. Accordingly, we cannot predict the scope and breadth of patent claims that may be afforded to other companies’ patents. In addition, we could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties, or if we initiate these suits.
The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:
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| • | others will not independently develop similar or alternative technologies or duplicate any of our technologies; |
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| • | any patents issued to us or licensed from Genentech, USAMRIID or other parties, or that we may license in the future, if any, will provide a basis for commercially viable products or will provide us with any competitive advantages or will not be challenged by third parties; |
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| • | we or any of our current or future licensors will adequately protect trade secrets; |
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| • | we will develop additional proprietary technologies that are patentable; or |
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| • | the patents of others will not have a material adverse effect on our business. |
We cannot be certain that patents issued to us in the future, if any, or patents that we have licensed from Genentech, Kaketsuken and USAMRIID, or that we may license in the future, if any, will be enforceable and afford protection against competitors. In this regard, the U.S. government has the right to use, for or on behalf of the U.S. government, any technologies developed by us under our U.S. government contracts and we cannot prohibit third parties, including our competitors, from using those technologies in providing products and services to the U.S. government. Accordingly, under our license agreement with USAMRIID granting us an exclusive license to commercialize the anthrax vaccine, the U.S. government retains a license for any federal government agency to practice and have practiced USAMRIID’s anthrax-related inventions, by or on behalf of the government, thereby allowing the use of the inventions in support of government contracts with other parties, including our competitors. In addition, we cannot assure you that our operations or technology will not infringe intellectual property rights of others. If we infringe the intellectual property of others, there can be no assurance that we would be able to obtain licenses to use the technology on commercially reasonable terms or at all.
Our South Korean manufacturing joint venture may not be successful.
Celltrion has not yet completed its full capitalization and we have not completed the transfer of our technology to Celltrion. Two of the existing investors in Celltrion have failed to meet a total of $6.3 million in funding obligations. Celltrion will be unable to validate and operate the manufacturing facility in the Republic of Korea if Celltrion is unable to secure or raise the necessary funding or does not receive the necessary technology for the manufacture of mammalian cell culture or other biopharmaceutical products.
Even if Celltrion successfully completes the construction of its South Korean manufacturing facility, we cannot be certain that the facility will pass domestic or foreign regulatory approvals or be able to manufacture mammalian cell culture products in commercial quantities on a cost-effective basis or at all. In addition, as of September 30, 2004, Celltrion has not secured any agreements under which products would be produced at this facility, and it is uncertain
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whether there will be sufficient demand for mammalian cell culture biomanufacturing to make this facility profitable.
In addition, the political, social and economic situation in the Republic of Korea, and the stability of the Korean peninsula as a whole, may not provide an environment in which Celltrion would be able to manufacture products cost-efficiently or at all. The Korean government may impose regulations or restrictions that would make it difficult, impractical or impossible, whether economically, legally or otherwise, for Celltrion to conduct its business there. Celltrion’s manufacturing operations may expose our business to numerous risks inherent in international operations including:
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| • | foreign currency controls; |
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| • | currency fluctuations; |
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| • | trade restrictions or changes in tariffs; |
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| • | the difficulties associated with staffing and managing international operations; |
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| • | generally longer receivables collection periods; |
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| • | potentially limited protection for intellectual property rights; |
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| • | potentially adverse taxes; and |
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| • | international conflict and war. |
If Celltrion is unable to manufacture mammalian cell culture products, or if it becomes commercially impractical for Celltrion to manufacture such products, we may not gain financial or other benefit from the joint venture.
We face competition from several companies with greater financial, personnel and research and development resources than ours.
Our competitors are developing vaccine candidates for anthrax and smallpox, which could compete with the vaccine candidates we are developing. Our commercial opportunities will be reduced or eliminated if our competitors develop and market products for any of the diseases that we target that:
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| • | are more effective; |
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| • | have fewer or less severe adverse side effects; |
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| • | are better tolerated; |
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| • | are more adaptable to various modes of dosing; |
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| • | are easier to administer; or |
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| • | are less expensive than the products or product candidates we are developing. |
Even if we are successful in developing effective vaccine products, and obtain FDA and other regulatory approvals necessary for commercializing them, our products may not compete effectively with other successful products. Researchers are continually learning more about diseases, which may lead to new technologies for treatment. Our competitors may succeed in developing and marketing products either that are more effective than those that we may develop, alone or with our collaborators, or that are marketed before any products we develop are marketed.
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Our competitors include fully integrated pharmaceutical companies and biotechnology companies that currently have drug and target discovery efforts, as well as universities and public and private research institutions. For instance, Avecia, in collaboration with Baxter Healthcare Corp. and the United Kingdom’s Defense Science and Technology Laboratory, was recently awarded a $71.3 million cost reimbursement plus fixed fee contract by NIAID to make three million doses of an anthrax vaccine for the U.S. government. Many of the organizations competing with us, including Avecia, may have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals, and greater marketing capabilities than we do.
Natural disasters, including earthquakes, may damage our facilities.
VaxGen’s corporate and manufacturing facilities are primarily located in the San Francisco Bay area. In addition to office and research facilities, through our ownership position in both Celltrion and VCI, we have a significant investment in VCI’s biomanufacturing facilities in California, which contain sensitive and expensive bioreactor equipment. The San Francisco Bay area is in close proximity to known earthquake fault zones. As a result, our corporate, research and manufacturing facilities are susceptible to damage from earthquakes and other natural disasters, such as fires, floods and similar events. Although VaxGen maintains general business insurance against fires and some general business interruptions, there can be no assurance that the amount of coverage will be adequate in any particular case.
Celltrion’s manufacturing facilities are located in the Republic of Korea. These facilities are susceptible to damage from earthquakes and other natural disasters, such as fires, floods and similar events.Although Celltrion maintains general business insurance against fires and some general business interruptions, there can be no assurance that the scope or amount of coverage will be adequate in any particular case.
If we fail to manage successfully any company or product acquisitions, joint ventures or in-licensed product candidates, we may be limited in our ability to develop our product candidates and to continue to expand our product candidate pipeline.
Our current vaccine product development programs were initiated through in-licensing or collaborative arrangements. These collaborations include licensing proprietary technology from, and other relationships with, biotechnology companies and government research institutes and organizations. As part of our business strategy, we intend to continue to expand our product pipeline and capabilities through company or product acquisitions, in-licensing or joint venture arrangements.
Any such activities will be accompanied by certain risks including:
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| • | exposure to unknown liabilities of acquired companies; |
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| • | higher than anticipated acquisition costs and expenses; |
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| • | the difficulty and expense of integrating operations and personnel of acquired companies; |
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| • | disruption of our ongoing business; |
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| • | diversion of management’s time and attention; and |
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| • | possible dilution to stockholders. |
If our competitors successfully enter into partnering or license agreements with these groups, or we are unable to reach agreement on license or partnering agreements on terms acceptable to us, we may then be precluded from pursuing those specific opportunities. Since each of these opportunities is unique, we may not be able to find a substitute. In addition, if we are unable to manage successfully any acquisitions, joint ventures and other collaboration opportunities, we may be limited in our ability to develop new products and therefore to continue to expand our product pipeline.
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Our use of hazardous materials, chemicals and viruses require us to comply with regulatory requirements and exposes us to potential liabilities.
Our research and development involves the controlled use of hazardous materials, chemicals and viruses. We are subject to federal, state, local and foreign laws governing the use, manufacture, storage, handling and disposal of such materials. Although we believe that our safety procedures for the use, manufacture, storage, handling and disposal of such materials comply with the standards prescribed by federal, state, local and foreign regulations, we cannot eliminate the risk of accidental contamination or injury from these materials. In the event of such an accident, we could be held liable for significant damages or fines. These damages could exceed our resources and any applicable insurance coverage. In addition, we may be required to incur significant costs to comply with regulatory requirements in the future.
We may become subject to product liability claims, which could reduce demand for our product candidates or result in damages that exceed our insurance coverage.
We face an inherent risk of exposure to product liability suits in connection with vaccines being tested in human clinical trials or sold commercially. We may become subject to a product liability suit if any vaccine we develop causes injury, or if vaccinated individuals subsequently become infected or otherwise suffer adverse effects from our vaccines or products. Regardless of merit or eventual outcome, product liability claims may result in decreased demand for a vaccine or product, injury to our reputation, withdrawal of clinical trial volunteers and loss of revenues. If a product liability claim is brought against us, the cost of defending the claim would be significant and any adverse determination may result in liabilities in excess of our insurance coverage. We currently have product liability insurance in the amount of $25.0 million for our anthrax program including the supply of three million doses of anthrax vaccine to NIAID, as well as separate product liability coverage in the amount of $25.0 million for our smallpox and AIDSVAX programs. However, we cannot be certain that our current insurance can be maintained, or that additional insurance coverage could be obtained, on acceptable terms, if at all.
Legislation limiting or restricting liability for medical products used to fight bioterrorism is evolving, and we cannot be certain that any such protections will apply to our vaccines or products.
Legislation relating to medical products used to fight bioterrorism is evolving, and may enable the U.S. government to release and use certain medical products prior to such products obtaining FDA or other regulatory approval. According to the terms of one proposed bill, upon a declaration of emergency, the U.S. government may authorize the introduction and use of a qualified medical product prior to such medical product obtaining FDA regulatory approval. Further, such proposed legislation provides that the United States government may elect to purchase and stockpile quantities of vaccines or products prior to receipt of regulatory approval to fight bioterrorism. Legislation limiting or restricting liability for the use of such vaccines is evolving, and we cannot be certain that any such protections will apply to the vaccines or products developed by us. If the legislation does not provide sufficient protection, and we are not able to obtain these protections by contract, we may become subject to product liability suits and other third party claims if vaccines or products developed by us cause injury, or if vaccinated individuals subsequently become infected or otherwise suffer adverse effects from such vaccines or products.
We may be subject to claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.
As is commonplace in the biotechnology industry, we employ individuals who were previously employed at other biotechnology or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.
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Failure to hire and retain key management employees could adversely affect our ability to obtain financing, develop our products, conduct clinical trials or execute our business strategy.
We are highly dependent on our senior management and scientific staff. These individuals have played a critical role in raising capital, negotiating business development opportunities, developing the vaccine candidates, conducting clinical trials and manufacturing products. If we lose the services of any key members of senior management or scientific staff and we are unable to recruit qualified replacements where we deem it necessary, we may be unable to achieve our business objectives.
We currently do not have an internal marketing and sales force and may rely on third parties for the sales or marketing of some or all of our vaccines if they are successfully developed. Our dependence on third parties may delay or impair our ability to generate revenues, or adversely affect our profitability.
We lack any sales or marketing history, and as of present do not have plans on developing internally such capability, other than for sales directly to the U.S. government and certain foreign governments. We intend to rely on third parties for the sales and marketing of our products to entities other than the U.S. and foreign governments. Our lack of sales and marketing personnel and distribution relationships may impair our ability to generate revenues.
We license AIDSVAX from Genentech and our license agreement may be terminated under certain circumstances.
From inception through mid-2003, VaxGen was focused on research and development of a vaccine for HIV infection (AIDSVAX), which we licensed from Genentech. This license agreement, as amended effective as of May 1, 2002, permits Genentech to terminate the agreement, or terminate the exclusivity of our license, if we:
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| • | fail to use due diligence in developing, seeking regulatory approval for, marketing or commercializing products covered by the agreement; |
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| • | fail to file a BLA for AIDSVAX with the FDA prior to May 1, 2006; or |
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| • | breach the license agreement and fail to cure the breach within the time period provided in the agreement. |
If Genentech were to terminate our license agreement, we would not be able to develop or market AIDSVAX.
Under the Genentech license agreement, Genentech has retained title to the licensed patents and patent applications and other licensed technology previously owned by Genentech, while we will retain title to any improvements developed by us.
Other Risks
We are involved in litigation concerning the results of our AIDSVAX Phase III clinical trial.
Since the announcement of the results of the North American/European Phase III clinical trial for AIDSVAX, we have been named in several securities class action lawsuits and a shareholder derivative lawsuit relating to how those results were disclosed. We are engaged in defending against these class actions, which, if decided against us, could adversely affect our financial position. The derivative action is purportedly being brought on our behalf, but we are subject to certain obligations to indemnify the individual defendants in connection with their defense of the claims asserted against them. Furthermore, these actions are not likely to be resolved in less than a year. The costs incurred in connection with these lawsuits could be significant and may not be covered by our insurance policies. These lawsuits could also result in continued diversion of our time and attention away from business operations, which could harm our business.
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Our stockholders could experience substantial dilution as result of the issuance of additional preferred stock.
Our board of directors has the authority to establish the designation of 19,979,500 additional shares of preferred stock that are convertible into common stock without any action by our stockholders, and to fix the rights, preferences, privileges and restrictions, including voting rights, of such shares. The issuance and conversion of any such preferred stock would further dilute the percentage ownership of our stockholders.
Our stock price may be volatile, and an investment in our stock could decline in value.
The trading price of our common stock has been and is likely to continue to be extremely volatile. Our stock price could be subject to wide fluctuations in response to a variety of factors, including the following:
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| • | failure to win future government contracts for anthrax or smallpox vaccines; |
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| • | adverse results or delays in clinical trials; |
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| • | delays in our product development efforts; |
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| • | real or perceived safety issues with any of our vaccine candidates; |
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| • | failure to obtain or maintain required regulatory approvals; |
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| • | delays in completion and/or validation of our manufacturing facilities in South Korea; |
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| • | changes in financial estimates by securities analysts; |
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| • | rumors about our business prospects, product development efforts or clinical trials; |
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| • | if our stock is delisted or not quoted on an approved stock exchange or the Nasdaq National Market or Small Cap Market for five consecutive days; or |
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| • | new products or services offered by us or our competitors or announcements relating to product developments by our competitors; |
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| • | issuances of debt or equity securities; |
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| • | sales by our stockholders of substantial amounts of our common stock, including shares issued upon exercise of outstanding options and warrants; and |
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| • | other events or factors, many of which are beyond our control. |
In addition, the stock market in general, and the Nasdaq National Market and biotechnology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against companies.
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Fluctuations in foreign exchange rates may adversely affect our financial position and results of operations.
The operations of Celltrion expose us to currency fluctuations and exchange rate risks. Celltrion, which is incorporated in the Republic of Korea, records its transactions in Korean Won. Celltrion’s results, however, are reflected in our consolidated financial statements in U.S. dollars. Therefore, our reported results are exposed to fluctuations in the exchange rates between the U.S. dollar and the Korean Won. During a period in which the U.S. dollar weakens against the Korean Won, our reported consolidated net losses will increase because our share of Celltrion’s net losses in Korean Won will translate into relatively more U.S. dollars. In addition, Celltrion’s purchases of engineering and construction services in Swiss francs are translated into Korean Won at the time of payment.
The assets and liabilities of Celltrion that are denominated in foreign currencies are reflected in their balance sheet in Korean Won and translated at the spot rate at the balance sheet date. The operating expenses of Celltrion that are denominated in foreign currencies are reflected in their statement of operations in Korean Won and translated at the average exchange rates for the reporting period. The resulting foreign currency translation adjustments are recorded in our stockholders’ equity as accumulated other comprehensive income or loss.
We have, in the past, not protected ourselves from the potential negative effects of exchange rate fluctuations resulting from Celltrion’s operations. We do not expect to enter into such hedging transactions or other forms of currency protection in the form of forward exchange contracts, options or similar agreements. Accordingly, changes in exchange rates will cause fluctuations in our net loss and stockholders’ equity. These factors could increase our net losses and could have a material adverse effect on our financial condition and results of operations.
On an ongoing basis, we are required to have current GAAP financial statements for Celltrion and until we receive this information, we may not be able to evaluate our financial condition or operating results on a timely basis.
Effective January 1, 2004, we are required to consolidate Celltrion’s financial statements into our own. Celltrion maintains its records in accordance with Korean accounting principles; however, we require financial statements that are prepared in accordance with GAAP and which have been audited in conformity with U.S. Auditing Standards. Celltrion’s internal controls over financial reporting may not be sufficient to enable them to report their interim GAAP financial results to us on a timely basis. In addition, their independent auditors could conclude that Celltrion’s internal controls over financial reporting are not sufficient to enable the auditors to complete their required annual audit of Celltrion’s GAAP financial statements in a timely fashion, if at all.
If we do not receive adequate timely financial reporting from Celltrion, we could be delinquent in our filings required under Section 13 of the Exchange Act and we might not be able to maintain or file registration statements relating to shares of our common stock. If we are relisted and are unable to timely file periodic reports on account of Celltrion, we could again be delisted from Nasdaq. In addition, Celltrion’s failure to achieve and maintain an effective internal control environment for GAAP periodic financial reporting may also cause our investors to lose confidence in our filed financial statements, which could have a material adverse effect on the market price of our common stock.
Celltrion subcontractors may fail to perform, or may be delayed in performing, certain tasks related to the construction of the Incheon manufacturing facility.
Celltrion relies on subcontractors to perform certain tasks related to the construction of their manufacturing facility.Any significant delays in performing these tasks by subcontractors, or a failure to perform them in compliance with applicable governmental regulations, could cause Celltrion to fail to complete their facility in a timely manner, if at all, which may cause them to be in breach under their customer contracts and cause those contracts to be terminated.We cannot assure you that one or more of these subcontractors will not be delayed in performing, or fail to perform their obligations under these contracts in compliance with applicable legal requirements.
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Celltrion’s suppliers may fail to provide, or may be delayed in providing, Celltrion with the necessary materials to produce their products.
When Celltrion begins production at their manufacturing facility, they will be relying on suppliers to provide them with the necessary materials to produce their products. Any significant delays in obtaining any of these materials from suppliers or other failure by suppliers to perform as agreed may cause Celltrion to fail to perform under their contracts, which may cause Celltrion to be in breach under those contracts and cause those contracts to be terminated.We cannot assure you that Celltrion will not face shortages from one or more of these suppliers in the future. We cannot ensure that if a shortage of materials occurs, that Celltrion will be able to obtain suppliers that will agree to provide them to us at terms favorable to us or at all.
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ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
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None. |
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ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
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None. |
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ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
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None. |
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ITEM 5. | OTHER INFORMATION |
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None. |
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ITEM 6. | EXHIBITS |
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(a) | Exhibits required by Item 601 of Regulation S-K: |
The following exhibits are filed as part of this report:
(Note: Management contracts and compensatory plans or arrangements are identified with a “+” in the following list.)
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| | | Incorporated by Reference |
Exhibit No. | | Exhibit | | Form | | File No. | | Filing Date | | Exhibit No. | | Filed Herewith |
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10.58 | | Amendment, dated July 14, 2004, to Joint Venture Agreement between VaxGen and certain investors, dated February 25, 2002. | | | | | | | | | | X |
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10.59 | | Warrant Exchange Agreement, by and between VaxGen and CD Investment Partners, Ltd, dated September 21, 2004. | | 8-K | | 000-26483 | | 9-24-04 | | 10.52 | | |
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10.60 | | Warrant Exchange Agreement by and between VaxGen and Societe Generale, Kepler Capital, LLC, Cheyenne LLC and Prism Capital 5, L.P., dated September 21, 2004. | | 8-K | | 000-26483 | | 9-24-04 | | 10.53 | | |
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10.61 | | Employment Agreement between VaxGen and Dr. Kathrin Jansen, dated September 30, 2004. + | | 8-K | | 000-26483 | | 10-21-04 | | 10.56 | | |
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31.1 | | Certification of Chief Executive Officer | | | | | | | | | | X |
| | | | | | | | | | | | |
31.2 | | Certification of Chief Financial Officer | | | | | | | | | | X |
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32.1 | | Section 1350 Certification | | | | | | | | | | X |
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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.
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| | VaxGen, Inc.
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Dated:February 6, 2007 | | By: /s/ James P. Panek |
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| | James P. Panek |
| | Chief Executive Officer
(Principal Executive Officer) |
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Dated:February 6, 2007 | | By: /s/ Matthew J. Pfeffer |
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|
| | Matthew J. Pfeffer |
| | Chief Financial Officer
(Principal Financial Officer) |
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