In September 2002, the Company was awarded a $20.9 million cost-plus contract, or 2002 Anthrax Contract, from the National Institute of Allergy and Infectious Diseases, or NIAID, to develop a new anthrax vaccine candidate and to create a feasibility plan for how the Company would manufacture an emergency stockpile of 25 million doses of the vaccine. On September 30, 2003, NIAID awarded the Company a second cost-plus contract valued at $80.3 million for the advanced development of the Company’s anthrax vaccine candidate, or 2003 Anthrax Contract.
In November 2004, the Company was awarded a contract for $877.5 million to provide 75 million doses of its recombinant anthrax vaccine to the U.S. government Strategic National Stockpile, or SNS, for civilian defense, or SNS Contract. In November 2006, VaxGen received a clinical hold notification from the Food and Drug Administration that postponed the initiation of the second Phase 2 trial for its investigational anthrax vaccine, rPA102. On December 19, 2006, HHS terminated for default the SNS Contract. HHS based the decision on its determination that VaxGen “failed to successfully cure the condition endangering performance and failed to” meet a milestone imposed by HHS that required VaxGen to initiate the Phase 2 trial of the vaccine candidate by December 18, 2006.
On April 3, 2007, the Company entered into a settlement agreement with HHS. In accordance with the agreement, the parties terminated the remaining cost-plus contract related to the development of a next-generation anthrax vaccine through a separate contract modification. As part of the settlement agreement, NIAID paid the Company $11.0 million. The settlement agreement also released both parties of all liabilities associated with the Company’s three anthrax government contracts: the 2002 Anthrax Contract, the 2003 Anthrax Contract and the SNS Contract. As part of the settlement agreement, the parties converted the termination of the SNS Contract, which HHS terminated for default on December 19, 2006, to a termination for convenience and also terminated the 2003 Anthrax Contract under a bilateral contract modification for the convenience of the government on a no-cost basis. During the three months ended March 31, 2007, the Company recorded the $11.0 million settlement as a collection of $7.1 million of 2006 receivables and $3.9 million of 2007 receivables. The $3.9 million was recorded as revenue during the three months ended March 31, 2007 primarily for the reimbursement of restructuring costs incurred as a result of the termination of the contracts.
The majority of the January 2007 restructuring costs were recovered from the U.S. government as part of the April 2007 settlement agreement noted above. In May 2007, the Company further reduced its workforce to decrease operating costs. Restructuring costs included employee termination and benefit costs. Estimated costs of the restructuring are $0.6 million. In September 2007, the Company again reduced its workforce to decrease operating costs. Restructuring costs included employee termination and benefit costs. Estimated costs of the restructuring are $1.1 million.
In June 2007, the Company and the Chemo-Sero-Therapeutic Research Institute of Japan, or Kaketsuken, terminated by mutual consent their agreement to co-develop a next-generation, attenuated smallpox vaccine, LC16m8, for use in the United States and elsewhere. Under the terms of the termination agreement, VaxGen transferred to Kaketsuken or its designee all reports, data and materials and all intellectual property rights that relate to conducting non-clinical and clinical development of LC16m8 in the U.S. In return, Kaketsuken has released VaxGen from ongoing development obligations.
This discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006, and our unaudited condensed consolidated financial statements and related notes thereto appearing in Item 1 of this Quarterly Report on Form 10-Q. In addition to the other information contained or incorporated by reference in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors described in Part II – Item 1A herein when evaluating an investment in our common stock. This Quarterly Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, or Exchange Act. All statements other than statements of historical fact are “forward-looking statements” for purposes of these provisions, including any statements of the plans and objectives of management for future operations, any statements regarding future operations, any statements concerning proposed new products or services, any statements regarding pending or future mergers or acquisitions, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “potential” or “continue” or the negative thereof or other comparable terminology.
There can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our forward-looking statements are subject to inherent risks and uncertainties including, but not limited to, the risk factors set forth in this Quarterly Report. Factors that could cause or contribute to such differences include, but are not limited to, our limited cash resources, our ability to finance our research, our significant corporate and Securities and Exchange Commission, or SEC, related expenses and limited revenue to offset these expenses, availability of appropriate prospective acquisitions or investment opportunities, litigation and the risks discussed in our other SEC filings. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results might differ. When used in the report, unless otherwise indicated, “we,” “our” and “us” refers to VaxGen.
OVERVIEW
We are a biopharmaceutical company focused on the development, manufacture and commercialization of biologic products for the prevention and treatment of human infectious disease. We were incorporated in 1995 and formed to complete the development of an investigational recombinant protein vaccine intended to prevent infection by human immunodeficiency virus. In 2002, we broadened our product development portfolio to also include biodefense vaccines.
On August 6, 2004, we announced that we had received notification from Nasdaq that our stock would discontinue trading on Nasdaq effective August 9, 2004. This action followed our appeal to Nasdaq for a listing extension after not meeting the stated time requirements to file Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30, 2004, respectively. We intend to apply for relisting on Nasdaq or listing on another exchange upon filing our remaining, outstanding and delinquent reports. Our common stock is currently quoted on the OTC Pink Sheets under the symbol VXGN.PK.
In September 2002, we were awarded a $20.9 million cost-plus contract, or 2002 Anthrax Contract, from the National Institute of Allergy and Infectious Diseases, or NIAID, to develop a new anthrax vaccine candidate and to create a feasibility plan for how we would manufacture an emergency stockpile of 25 million doses of the vaccine. On September 30, 2003, NIAID awarded us a second cost-plus contract, or 2003 Anthrax Contract, valued at $80.3 million for the advanced development of our anthrax vaccine candidate. These two contracts are collectively referred to as the Anthrax Contracts.
In November 2004, we were awarded a contract for $877.5 million to provide 75 million doses of our recombinant anthrax vaccine to the U.S. government Strategic National Stockpile, or SNS, for civilian defense, or SNS Contract. In November 2006, we received a clinical hold notification from the Food and Drug Administration, or FDA, that postponed the initiation of the second Phase 2 trial for our investigational anthrax vaccine, rPA102. On December 19, 2006, the U.S. Department of Health and Human Services, or HHS, terminated for default the SNS Contract. HHS based the decision on its determination that we “failed to successfully cure the condition endangering performance and failed to” meet a milestone imposed by HHS that required us to initiate a Phase 2 trial of the vaccine candidate by December 18, 2006. Following the HHS decision, we scaled back development of rPA 102 and began pursuing strategic and other alternatives.
As a result of the termination of our SNS Contract, we implemented a reduction in force, or RIF, in January 2007. The cash outflow of the January RIF was $2.8 million and $0.5 million during the three months ended March 31, 2007 and June 30, 2007, respectively, and $0.3 million thereafter. Beginning in April 2007, expected wage savings per month were $0.7 million and $0.2 million, respectively, for Research and Development, or R&D, and General and Administrative, or G&A. In addition, we did not renew an office space lease that expired at the end of May 2007. This lease, coupled with utilities and maintenance, reduced future expenses by $0.2 million per month.
Celltrion
For the three months ended March 31, 2006, our investment in Celltrion, Inc., or Celltrion, a company developing and operating a mammalian cell culture biomanufacturing facility in the Republic of Korea, was accounted for under the equity method. At March 31, 2006, our ownership interest in Celltrion was 22%. During June and December 2006, we received gross proceeds of $130.3 million from the sale of substantially all of our Celltrion common stock. At December 31, 2006 and March 31, 2007, we held a nominal ownership interest in Celltrion.
Subsequent Events
In December 2006, HHS terminated for default the SNS Contract. In April 2007, we entered into a settlement agreement with HHS, in which HHS modified the SNS Contract from a termination for default to a termination for convenience. As part of the settlement agreement, NIAID paid us $11.0 million. The settlement agreement also released both parties of all liabilities associated with our three government anthrax contracts. We also mutually terminated the 2003 Anthrax Contract for the convenience of the government. The majority of the January 2007 restructuring costs were recovered from the U.S. government as part of the April 2007 settlement agreement.
In May 2007, we reduced our workforce to further lower operating costs. The cash outflow of this RIF was $0.4 million during the three months ended June 30, 2007 and $0.2 million thereafter. This RIF mostly impacted R&D. Beginning in July 2007, additional
12
expected wage savings are $0.1 million per month. The RIFs in January 2007 and May 2007 have reduced our cash disbursements by approximately $1.2 million to $1.4 million per month since June 30, 2007. We do not expect these savings to be materially offset by any anticipated increases in other expenses.
In June 2007, we terminated by mutual consent our agreement with the Chemo-Sero-Therapeutic Research Institute of Japan, or Kaketsuken, to co-develop a next-generation, attenuated smallpox vaccine, LC16m8, for use in the United States and elsewhere. Under the terms of the termination agreement, we transferred to Kaketsuken or its designee all reports, data and materials and all intellectual property rights that relate to conducting non-clinical and clinical development of LC16m8 in the U.S. In return, Kaketsuken has released us from ongoing development obligations.
In September 2007, we further reduced our workforce to decrease operating costs. Restructuring costs included employee termination and benefit costs. Estimated costs of the restructuring are $1.1 million. The cash outflow of this RIF is expected to be $0.7 million during the three months ended September 30, 2007 and $0.2 million and $0.2 million during the three months ended December 31, 2007 and thereafter, respectively. This RIF mostly impacted R&D. Beginning in October 2007, additional expected wage savings are $0.3 million per month. We do not expect these savings to be materially offset by any anticipated increases in other expenses.
See Note 14, Subsequent Events, for more information regarding events occurring after March 31, 2007.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Reference should be made to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, filed with the SEC in August 2007, for a description of our critical accounting policies. There have been no significant changes to our policies since we filed that report other than our adoption of FIN 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, or FIN 48.
Effective January 1, 2007, we adopted FIN 48; see Note 9. We have filed tax returns with positions that may be challenged by the tax authorities. These positions relate to, among others, deductibility of certain expenses, expenses included in our research and development tax credit computations, as well as other matters. Although the outcome of tax audits is uncertain, in management’s opinion, adequate provisions for income taxes have been made for potential liabilities resulting from such matters. We regularly assess the tax positions for such matters and include reserves for those differences in position. The reserves are utilized or reversed once the statute of limitations has expired and/or at the conclusion of the tax examination. We believe that the ultimate outcome of these matters will not have a material impact on our financial position, financial operations or liquidity.
In December 2006, the FASB issued FASB Staff Position EITF 00-19-2, Accounting for Registration Payment Arrangements, or FSP 00-19-2, which provides guidance on accounting for registration payment arrangements. FSP 00-19-2 specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, Accounting for Contingencies. FSP 00-19-2 is required to be applied to reporting periods beginning after December 15, 2006. We adopted FSP 00-19-2 as of January 1, 2007. Our previous accounting for registration payment arrangements in connection with our 5 1/2% Convertible Senior Subordinated Notes, due April 1, 2010, or Notes, as well as shares issued or issuable in private placements of our common stock, or collectively Issuable Shares, was already in compliance with FSP 00-19-2.
We have agreed to file with the SEC a registration statement, or Registration Statement, under the Securities Exchange Act of 1933, as amended, or Securities Act, with respect to the Issuable Shares no later than thirty days following the first date we become current in our reporting requirements under the Securities and Exchange Act of 1934, or Filing Date, and to use our best efforts to cause the Registration Statement to become effective on or before the date that is the earlier of (1) in the event of no review by the SEC no later than 90 days after the Filing Date, (2) in the event of a review by the SEC, no later than 120 days after the Filing Date, the earlier of (1) and (2) is referred to as the Required Effective Date.
In the event of a default, we are required to pay as liquidated damages, for each 30-day period of a default, an amount in cash equal to 1% of the principal amount of the Notes and the purchase price of the private placements until the applicable failure has been cured. We consider the likelihood of becoming obligated for such liquidated damages to be remote and accordingly no provision for their payment has been recorded.
Our obligation to maintain the effectiveness of the registration statement ends upon the earlier to occur of (i) two years from the date of effectiveness of the Registration Statement, (ii) the date when all holders of Issuable Shares are eligible to sell such securities under Rule 144(k) promulgated under the Securities Act, (iii) the date when all securities registered under the Registration Statement have been sold and (iv) the date when all securities registered under the Registration Statement cease to be outstanding. We estimate that the maximum monthly amount of consideration that we could be required to pay as liquidated damages under these registration payment obligations is approximately $1.0 million.
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RESULTS OF OPERATIONS
Comparison of Fiscal Quarters Ended March 31, 2007 and 2006
Revenues
| | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
change
2007/2006 | |
| |
| | |
| | 2007 | | 2006 | | |
| |
| |
| |
| |
| | (in thousands) | | | | |
Revenues | | $ | 4,184 | | $ | 6,304 | | (34 | %) | |
Revenues for the three months ended March 31, 2007 and 2006 were primarily from our Anthrax Contracts principally reflecting work performed in 2006 for NIAID and the 2007 reimbursement of restructuring costs incurred during the three months ended March 31, 2007 as a result of the termination of the Anthrax Contracts in December 2006. In 2007, NIAID-related activities decreased from the comparable period in the prior year as our work on the Anthrax contract ended in December 2006 and revenue in 2007 was primarily related to the restructuring. Services revenues were also earned as part of a consulting services agreement with Celltrion to provide technical assistance related to the design, engineering and start-up of Celltrion’s manufacturing facility. VaxGen recognized $0.3 million and $0.4 million of revenue from Celltrion during the three months ended March 31, 2007 and 2006, respectively. The amounts earned vary with the level of services required.
Revenues earned in one period are not indicative of revenues to be earned in future periods. Following the HHS decision, we ceased actively developing our anthrax vaccine, scaled back our biodefense activities and are actively pursuing strategic and other alternatives; therefore, we expect future 2007 quarters’ revenues to primarily include revenues from Celltrion, which are not expected to be significant.
Research and development expenses
| | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
change
2007/2006 | |
| |
| | |
| | 2007 | | 2006 | | |
| |
| |
| |
| |
| | (in thousands) | | | | |
Research and development expenses | | $ | 7,088 | | $ | 14,176 | | (50 | %) | |
Research expenses include costs associated with research and testing of our product candidates and include the costs of internal personnel, outside contractors, allocated overhead and laboratory supplies. Product development expenses include costs of preclinical development and conducting clinical trials, costs of internal personnel, drug supply costs, research fees charged by outside contractors, allocated overhead and co-development costs.
The decrease in research and development expenses in the three months ended March 31, 2007 over the comparable period in 2006 was primarily due to:
| | |
| • | Outside consultant expenses, which decreased by $3.8 million primarily due to reduced activities related to our Anthrax Contracts since March 31, 2006; and |
| | |
| • | Labor and benefits, which decreased by $3.3 million primarily associated with the reductions in force in January 2007 and as a result of overall reductions in activities related to our Anthrax Contracts. |
The process of conducting preclinical studies and clinical trials necessary to obtain FDA approval is costly and time consuming. The probability of success for each product candidate and clinical trial may be affected by a variety of factors, including, among others, the quality of product candidate early clinical data, investment in the program, competition, manufacturing capabilities and commercial viability. As a result of the uncertainties discussed above, the uncertainty associated with clinical trial enrollments and the risks inherent in the development process, we are unable to determine the duration and completion costs of future clinical stages of product candidates. Development timelines, probability of success and development costs vary widely. We anticipate that we will make determinations as to which new programs to pursue and how much funding to direct to each program on an ongoing basis in response to the scientific and clinical success of future product candidates.
We expect quarterly research and development expenses to decrease during the remainder of 2007 because following the HHS decision we scaled back development of our anthrax vaccine and eliminated our other biodefense activities.
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General and administrative expenses
| | | | | | | | | | |
| | Three Months Ended
March 31, | | Percent
change
2007/2006 | |
| |
| | |
| | 2007 | | 2006 | | |
| |
| |
| |
| |
| | (in thousands) | | | | |
General and administrative expenses | | $ | 6,578 | | $ | 6,646 | | (1 | )% | |
The minor decrease in general and administrative expenses in the three months ended March 31, 2007 over the comparable period of 2006 was primarily due to:
| | |
| • | Facility expenses, which decreased by $0.9 million primarily associated with the reductions in force in January 2007 and as a result of overall reductions in activities related to our Anthrax Contracts; |
| | |
| • | Labor and benefits, which decreased by $0.7 million primarily associated with the reductions in force in January 2007 and as a result of overall reductions in activities related to our Anthrax Contracts; |
| | |
| • | Stock-based compensation expenses, which increased by $0.5 million primarily due to stock option awards in February 2007; and |
| | |
| • | Professional services, which increased by $1.1 million principally reflecting services consisting of accounting, consulting and legal fees associated with our efforts to comply with various reporting and regulatory requirements. |
We expect quarterly general and administrative expenses to decrease during the remainder of 2007 because following the HHS decision we scaled back activities and are actively pursuing strategic and other alternatives.
Restructuring expenses
| | | | | | | | | | |
| | Three Months Ended
March 31, | |
| |
| |
| | 2007 | | 2006 | |
| |
| |
| |
| | (in thousands) | |
Restructuring expenses | | $ | 3,717 | | $ | — | |
Restructuring expenses for the three months ended March 31, 2007 reflect a RIF, in January 2007. The restructuring costs include $2.7 million for employee termination benefits and $1.0 million for costs associated with the consolidation of our facilities in California. Refer to Note 6 for further details.
Other income (expense)
| | | | | | | | | | |
| | Three Months Ended
March 31, | | |
| |
| | |
| | 2007 | | 2006 | | |
| |
| |
| | |
| | (in thousands) | | |
Interest expense | | $ | (611 | ) | $ | (630 | ) | |
Interest income and other | | | 1,239 | | | 267 | | |
Valuation adjustments | | | 2,832 | | | 395 | | |
Equity in loss of affiliate | | | — | | | (2,506 | ) | |
Gain on foreign currency transactions | | | — | | | 158 | | |
| |
|
| |
|
| | |
Other income (expense), net | | $ | 3,460 | | $ | (2,316 | ) | |
| |
|
| |
|
| | |
The changes in other income (expense) were primarily due to:
| | |
| • | Interest income and other increased primarily due to the increased cash, cash equivalent and investment balances from financing activities, primarily from the sale of substantially all of our investment in Celltrion during June and December 2006; |
| | |
| • | Expenses for mark-to-market adjustments related to the valuation of our outstanding derivatives on our 5 1/2% Convertible Senior Subordinated Notes, due April 1, 2010, or Notes, changed primarily due to changes in the likelihood of a change in control potentially triggering the redemption option related to the Notes; |
| | |
| • | For the three months ended March 31, 2006, we recognized our share of Celltrion’s losses under the equity method. We sold substantially all of our ownership interest in Celltrion during 2006 and accordingly effective July 1, 2006 no longer account for it under the equity method; and |
| | |
| • | Realized foreign currency gains in 2006 were primarily due to the 2006 collection of the remaining proceeds from the 2005 sale of some of our Celltrion common stock. |
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We anticipate future investment income will fluctuate and will be primarily driven by our future cash, cash equivalent and investment balances. Valuation adjustments will continue to be affected by changes in our common stock price, our volatility and our expectations relative to a change in control. No changes in our debt levels are anticipated and therefore quarterly interest expense is expected to remain at the three months ended March 31, 2007 level throughout 2007.
As noted in Note 13, Segment Information, included in the notes to the unaudited condensed consolidated financial statements in Part I – Item 1 of this report, we have only one segment.
LIQUIDITY AND CAPITAL RESOURCES
| | | | | | | |
| | 2007 | | 2006 | |
| |
| |
| |
| | (in thousands) | |
As of March 31: | | | | | | | |
Cash, cash equivalents and investment securities | | $ | 83,588 | | $ | 19,498 | |
Working capital | | | 83,212 | | | 13,724 | |
| | | | | | | |
Three months ended March 31: | | | | | | | |
Cash provided by (used in): | | | | | | | |
Operating activities | | $ | (11,961 | ) | $ | (22,569 | ) |
Investing activities | | | 7,162 | | | 4,056 | |
Financing activities | | | — | | | 24,162 | |
Our primary financing requirements as of March 31, 2007 were the funding of our remaining operations during the next twelve months because following the HHS decision we scaled back development of rPA102 and eliminated our other biodefense activities. Through March 31, 2007, we financed our operations primarily through sales of our common stock, the issuance of Series A Preferred Stock, the issuance of the Notes, sales of our Celltrion common stock and revenues from research contracts and grants. From time-to-time, as part of our investment strategy, we enter into reverse repurchase agreements to increase our return on investments and improve our liquidity. Reverse repurchase agreements involve a purchase of securities and an agreement to resell the same securities at a later date at an agreed-upon price. The primary risk associated with short-term collateralized borrowings is that the counterparty might be unable to perform under the terms of the contract. Our exposure is limited, however, because we generally invest in overnight agreements.
In April 2005, we raised aggregate net proceeds of $29.7 million through a private placement of $31.5 million of Notes due April 1, 2010. The Notes require us to make semi-annual payments of interest in cash at a rate of 5 1/2%, due April 1 and October 1. If a change in control occurs, as defined in the indenture, on or prior to the stated maturity of the Notes, the holders of the Notes may require under certain circumstances us to repurchase the Notes and pay a make-whole premium to the holders of the Notes. If the stock price on the effective date of redemption is less than $12.30 per share, no make-whole premium will be paid. If the holders request such a repurchase, we or our successor entity, may choose to pay in cash, common stock or a combination of cash and common stock. In addition, in the event of a default, we are required to pay as liquidated damages, for each 30-day period of a default, an amount in cash equal to 1% of the principal amount of the Notes and the purchase price of our private placements until the applicable failure has been cured.
During the year ended December 31, 2006, we received gross proceeds of $130.3 million from the sale of substantially all of our Celltrion common stock. The Company’s basis in the shares sold in 2006 was $19.0 million. The Company incurred $7.3 million in fees and related expenses associated with the sale of this stock, resulting in a gain of $104.0 million. At December 31, 2006 and March 31, 2007, we held a nominal ownership interest in Celltrion.
As a result of the termination of our SNS Contract, we implemented a RIF in January 2007. The cash outflow of the January RIF was $2.8 million and $0.5 million during the three months ended March 31, 2007 and June 30, 2007, respectively, and $0.3 million thereafter. Beginning in April 2007, expected wage savings per month were $0.7 million and $0.2 million, respectively, for R&D and G&A. In addition, we did not renew an office space lease that expired at the end of May 2007. This lease, coupled with utilities and maintenance, reduced future expenses by $0.2 million per month.
In May 2007, we reduced our workforce to further lower operating costs. The cash outflow of this RIF was $0.4 million during the three months ended June 30, 2007 and $0.2 million thereafter. This RIF mostly impacted R&D. Beginning in July 2007, additional expected wage savings are $0.1 million per month. The RIFs in January 2007 and May 2007 have reduced our cash disbursements by approximately $1.2 million to $1.4 million per month since June 30, 2007. We do not expect these savings to be materially offset by any anticipated increases in other expenses.
In September 2007, we further reduced our workforce to decrease operating costs. Restructuring costs included employee termination and benefit costs. Estimated costs of the restructuring are $1.1 million. The cash outflow of this RIF is expected to be $0.7 million during the three months ended September 30, 2007 and $0.2 million and $0.2 million during the three months ended December 31, 2007 and thereafter, respectively. This RIF mostly impacted R&D. Beginning in October 2007, additional expected wage savings are $0.3 million per month. We do not expect these savings to be materially offset by any anticipated increases in other expenses.
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Net cash used in operating activities of $12.0 million and $22.6 million for the three months ended March 31, 2007 and 2006, respectively, was primarily attributable to our operating losses although the effect of non-cash charges upon net cash used in operating activities was significant in both periods and included:
| | |
| • | Stock-based compensation expense of $1.2 million in 2007 and $0.8 million in 2006. The increase from 2006 is primarily the result of stock option awards during the three months ended March 31, 2007; |
| | |
| • | Valuation adjustments of $2.8 million and $0.4 million in 2007 and 2006, respectively, reflecting changes in the fair value of outstanding derivatives. At March 31, 2007 and 2006, we had a derivative liability associated with the Notes; and |
| | |
| • | For the three months ended March 31, 2006, we recognized our share of Celltrion’s losses under the equity method. We sold substantially all of our ownership interest in Celltrion during 2006 and accordingly effective July 1, 2006 no longer account for it under the equity method. |
Cash used in operating activities was also affected by the following:
| | |
| • | Accrued and other current liabilities, which increased by $2.1 million in 2007, decreased by $2.2 million in 2006 primarily due to the timing of payments; |
| | |
| • | Accounts payable, which decreased by $1.8 million in 2007 and by $3.3 million in 2006 primarily due to the timing of payments and the reduced level of operating activities; and |
| | |
| • | Receivables, which increased by $3.1 million in 2007 and by $5.6 million in 2006 primarily due to the timing of payments received from the U.S. government. |
In January and May 2007, we restructured operations to significantly reduce operating cash flows.
Net cash used in investing activities consisted primarily of activities relating to the purchase and sale of investment securities and in 2006 capital expenditures. We expect minimal capital expenditures during the remainder of 2007 because we scaled back development of rPA102 and eliminated our other biodefense activities. Capital expenditures of $0.5 million in the three months ended March 31, 2006 were made in connection with the expansion of the research and development laboratories and leasehold improvements associated with the California manufacturing and office facilities. In addition, during the three months ended March 31, 2006 we purchased $1.0 million of software related to the implementation of a new enterprise resource planning system. During the three months ended March 31, 2007, we paid the final $2.4 million in fees due from the 2006 sale of substantially all of our remaining Celltrion common stock. During the three months ended March 31, 2006, we collected the final $2.4 million in cash due from the 2005 sale of some of our Celltrion common stock.
Net cash provided by our financing activities in the three months ended March 31, 2006 was from net proceeds of $25.2 million through a private placement of 3,500,000 shares of our common stock at $7.70 per share at a discount to the $9.20 per share closing price.
At March 31, 2007, $83.6 million, or 65%, of our assets consisted of cash, cash equivalents and investment securities. Working capital was $83.2 million at March 31, 2007, compared to $13.7 million at March 31, 2006. This increase in working capital is due primarily to the June and December 2006 sale of our Celltrion common stock, partially offset by our operating losses for the twelve months ended March 31, 2007.
We believe that our existing cash, cash equivalents and investment securities will be sufficient to cover our working capital needs, capital expenditures, debt obligations and commitments through at least December 31, 2008. Our future capital requirements will depend upon our ability to identify and exploit business development opportunities including actively pursuing avenues to enhance stockholder value through a strategic transaction.
Off-Balance Sheet Arrangements
As of March 31, 2007, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board, or FASB, issued FAS No. 157, Fair Value Measurement, or FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We are evaluating the impact of adopting FAS 157 on our consolidated financial position, results of operations and cash flows.
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In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115, or FAS 159, which permits all entities to choose to measure eligible items, including many financial instruments, at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. Most of the provisions in FAS 159 are elective; however, the amendment to FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. FAS 159 is effective for fiscal years beginning after November 15, 2007. We are evaluating the impact of adopting FAS 159 on our consolidated financial position, results of operations and cash flows.
In May 2007, the FASB issued FSP No. FIN 48-1, Definition of ‘Settlement’ in FASB Interpretation No. 48, or FIN 48-1.FIN 48-1 provides guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FIN 48-1 will be applied retrospectively to our initial adoption of FIN 48 on January 1, 2007. The adoption of FIN 48-1 is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.
In June 2007, the Emerging Issues Task Force, or EITF, published Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities, or EITF 07-3. The EITF reached a consensus that these payments made by an entity to third parties should be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the related services are performed. Entities should report the effects of applying this Issue as a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. EITF 07-3 is effective beginning on January 1, 2008. Earlier application is not permitted. We do not expect that adoption of this new Standard will have a material effect on our financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We are exposed to market rate changes by debt securities included in our investment portfolio. By policy, we invest in debt instruments of the U.S. government, federal agencies and high-quality corporate issuers, limit the amount of credit exposure to any one issuer, and limit duration by restricting the term. Investments in both fixed rate and floating rate instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may decrease due to changes in interest rates or due to losses we may suffer when securities decline in market value. At March 31, 2007, we held available-for-sale securities in the principal amount of $15.3 million. If market interest rates were to increase immediately and uniformly by 10% from levels at March 31, 2007, the fair value of our portfolio would decline by an immaterial amount, and would not have a significant effect on our operations or cash flows. Our exposure to losses as a result of interest rate changes is managed through investing in a portfolio of securities with a weighted-average maturity of one year or less.
Indebtedness
At March 31, 2007, our outstanding non-current liabilities include $31.5 million of our Notes due April 1, 2010 which we sold in a private placement in April 2005. As the Notes bear interest at a fixed rate, our interest expense under the Notes would not be affected by interest rate changes. As of March 31, 2007, we did not invest in derivative financial instruments, interest rate swaps or other investments that alter interest rate exposure.
Derivative Valuation Risk
The terms of our Notes include put features not under our control. These features are considered to be an embedded derivative liability and we determined the fair value of this derivative to be $1.8 million on the date of issuance. Due to the quarterly revaluation of the embedded derivative liability, we recorded in our statements of operations other income of $2.8 million and $0.4 million for the three months ended March 31, 2007 and 2006, respectively. At March 31, 2007, the embedded derivative liability was valued at $5.4 million. We determine the fair value of the derivative liabilities using the Monte Carlo Simulation methodology. This methodology allows flexibility in incorporating various assumptions such as probabilities of certain triggering events. The valuations are based on the information available as of the various valuation dates. Factors affecting the amount of these liabilities include expectations regarding triggering events, the market value of our common stock, the estimated volatility of our common stock, our market capitalization, the risk free interest rate and other assumptions. The inputs for the valuation analysis of the derivatives include the probabilities of certain triggering events, which we believed to be unlikely as of March 31, 2007. A change in this probability and or a change in the market value of our common stock could have a significant impact on the results of our operations; however, there would not be any impact on our cash flows.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, or Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Disclosure controls and procedures are designed to ensure that the information required to be disclosed in our reports which we file or submit under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) as appropriate to allow timely decisions regarding required disclosures, and (ii) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission, or SEC, rules and forms. Based upon the material weaknesses in our internal control over financial reporting as described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
We previously identified the following material weaknesses:
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1) | We did not maintain an effective control environment, specifically, the following material weaknesses were identified within the control environment: |
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| a) | We did not maintain an effective control environment based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Specifically, the financial reporting organization structure was not adequate to support the size, complexity or activities of the Company. In addition, certain finance positions were staffed with individuals who did not possess the level of accounting knowledge, experience and training in the application of generally accepted accounting principles in the United States of America, or GAAP, commensurate with our financial reporting requirements. |
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| b) | We did not maintain effective financial reporting processes, including sufficient formalized and consistent finance and accounting polices and procedures; nor did we prevent or detect instances of non-compliance with certain such policies and procedures that do exist. Specifically, we lacked formalized reporting policies and procedures. |
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| c) | We did not maintain effective monitoring controls and related segregation of duties over automated and manual transactions processes. Specifically, we failed to implement processes to ensure periodic monitoring of our existing internal control activities over financial reporting to identify and assess significant risk that may impact financial statements and related disclosures. Additionally, inadequate segregation of duties led to untimely identification and resolution of accounting and discourse matters and failure to perform timely and effective supervision and reviews. |
The above control deficiencies resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. These control deficiencies affect substantially all financial statement accounts, which could result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected.
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2) | The material weaknesses in our control environment contributed to the existence of the following control deficiencies, each of which is considered to be a material weakness: |
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| a) | We did not maintain effective controls over our process to ensure the complete, accurate and timely preparation and review of our consolidated financial statements in accordance with GAAP. Specifically, we did not have effective controls over the process for identifying, accumulating and reviewing all required supporting information to ensure the completeness, accuracy and timely preparation and review of our consolidated financial statements and disclosures. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of substantially all financial statement accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| b) | We did not maintain effective controls to ensure that journal entries, both recurring and non-recurring, were consistently reviewed and approved in a timely manner to ensure the validity, completeness and accuracy of recorded entries. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of substantially all financial statement accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| c) | We did not maintain effective controls over the procurement process. Specifically, effective controls were not in place to ensure the appropriate controls over the approval of new vendors, authorization of purchase orders, including categorization of appropriate expense line items, the receipt of goods and the approval and authorization of vendor payments. This control deficiency could result in a misstatement of current liabilities and operating expenses that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| d) | We did not maintain effective controls over the completeness and accuracy of certain revenue and expense accruals. Specifically, we failed to identify, analyze and review certain accruals at period end relating to certain accounts receivable, accounts payable, accrued liabilities, revenue and other direct expenses to ensure that they were accurately, completely and properly recorded. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of the aforementioned accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| e) | We did not maintain effective controls over the existence, completeness and valuation of fixed assets and related depreciation expense. Specifically, effective controls were not designed and in place to ensure that fixed asset additions and disposals were recorded, as well as, the periodic physical verification of fixed assets. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of fixed assets and depreciation expense that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| f) | We did not maintain effective controls over spreadsheets. Specifically, we did not maintain effective controls over the completeness, accuracy and validity of spreadsheets used in our financial reporting process to maintain effective version control and ensure that access was restricted to appropriate personnel, and that unauthorized modification of the data or formulas within spreadsheets was prevented. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of substantially all financial statement accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
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| g) | We did not design and maintain effective controls over the completeness, accuracy and valuation of our payroll and payroll expense. Specifically, we did not design and maintain effective controls over the administration of employee data or controls to provide reasonable assurance regarding the proper authorization of non-recurring payroll changes. This control deficiency could result in a misstatement of the aforementioned accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected. |
As described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2006, which we refer to as our 2006 10-K, our management has established a plan for remediation of the material weaknesses in our internal control over financial reporting.
The certifications of our principal executive officer and principal financial officer required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 are attached as exhibits to this Quarterly Report on Form 10-Q. The disclosures set forth in this Item 4 contain information concerning the evaluation of our disclosure controls and procedures and changes in internal control over financial reporting, referred to in the certifications. Those certifications should be read in conjunction with this Item 4 for a complete understanding of the matters covered by the certifications.
Our management undertook and completed reconciliations, analyses, reviews and control procedures in addition to those historically completed to confirm that this Quarterly Report fairly presents in all material aspects our financial position, results of operations and cash flows as of, and for the period presented in accordance with U.S. generally accepted accounting principles.
Changes in Internal Control over Financial Reporting
There has been no change in internal control over financial reporting during the three months ended March 31, 2007, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We are in the process of implementing the remediation plans to address the material weaknesses in our internal control over financial reporting. Our remediation plan is described Item 9A of our 2006 10-K. We expect that the implementation of this plan will extend throughout 2007.
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Elimination of Fiscal 2006 Material Weakness
The following material weakness identified during fiscal 2006 was not applicable during the three months ended March 31, 2007. The cancellation of all our research, grant and revenue contracts has eliminated the material weakness noted below:
We did not design and maintain effective controls over the completeness, accuracy, existence and valuation of our research grant and contract revenue accounts. Specifically, we did not design and maintain effective controls to provide reasonable assurance that indirect and provisional rates used to calculate manufacturing overhead and technical overhead were complete and accurate. This control deficiency resulted in audit adjustments to our fiscal 2006 interim and annual consolidated financial statements. Additionally, this control deficiency could result in a misstatement of the aforementioned accounts that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected.
Inherent Limitations on Effectiveness of Controls
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.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS
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 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 this report, unless otherwise indicated, “we,” “our” and “us” refers to VaxGen. Risk factors which have materially changed since our 2006 10-K are marked with an “*”.
If we fail to cause a registration statement to be declared effective in accordance with the timetable set forth in the Notes, or in accordance with agreements we have made in connection with private placements of our common stock, we will be subject to liquidated damages or liability for breach of contract.
In April 2005, we raised gross proceeds of $31.5 million through a private placement of 5 1/2% Convertible Senior Subordinated Notes, or Notes, due April 1, 2010. We agreed to register under the Securities Act shares of our common stock issuable upon conversion of the Notes, as well as shares issued or issuable in private placements of our common stock. We have agreed to file registration statements for these shares within 30 days following the first date we become current in our reporting requirements under the Exchange Act, and to use our best efforts to cause the registration statements to become effective in no event later than 120 days after the filing of such registration statements. We have also made other customary agreements regarding such registrations, including matters relating to indemnification, maintenance of the registration statements, payment of expenses and compliance with state “blue sky” laws. We may be liable for liquidated damages to each Note holder and purchaser in the private placements (a) if the registration statements are not filed on or prior to 30 days of becoming current in our reporting requirements; (b) if the registration statements are not declared effective by the SEC on or prior to 120 days from filing; or (c) if the registration statements (after being declared effective) cease to be effective in a manner that violates such agreements, or a Registration Default. In the event of a Registration Default, we may be required to pay liquidated damages. Should we become obligated to make payment of these liquidated damages, it could have a material adverse effect on our financial position and our results of operations, particularly if we become obligated to make a payment in full for all liquidated damages potentially due and payable under these agreements.
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We are not currently listed on a national exchange and cannot assure you we will ever be listed.
As a result of our failure to make timely filings of financial statements, we were delisted from Nasdaq, and our common stock is not currently listed on another national stock exchange. 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 listed on a national exchange. 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 or that any other exchange will approve our stock for listing. In order to be eligible for relisting or listing, we must meet Nasdaq’s or another exchange’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 quoted on the Pink Sheets, LLC.
Our business to date has been largely dependent on the success of rPA 102, which was the subject the SNS Contract that was terminated in December 2006. Although we scaled back development of rPA102 and have reduced our workforce, we may be unable to successfully manage our remaining resources, including available cash, while we seek to identify and complete a strategic transaction.
We scaled back clinical development of rPA102 after HHS terminated our SNS Contract. In addition, in June 2007 we terminated our contract with Kaketsuken to develop a smallpox vaccine. We had previously devoted substantially all of our research, development and clinical efforts and financial resources toward the development of rPA, and we have no other product candidates in clinical or preclinical development. In connection with the suspension of our clinical development of rPA102, we announced restructuring activities, including significant workforce reductions. In 2007, we incurred non-recurring charges associated with our restructuring activities of approximately $5.4 million, which includes employee severance costs of $4.4 million and facilities-related and other expenses of $1.0 million. As a result of the termination of our SNS Contract, we are evaluating strategic alternatives and have retained Lazard Ltd. to act as our advisor in this process. We cannot predict whether we will be able to identify an appropriate strategic alternative which will either provide us with a pipeline and/or return value to our shareholders on a timely basis or at all. We also cannot predict whether any such transaction would be consummated on favorable terms, and anticipate that such transaction may require us to incur significant additional costs.
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 rebuild our product candidate pipeline.
Our current 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 may expand our product pipeline and capabilities through company or product acquisitions, mergers or in-licensing.
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 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.
We are currently ineligible to register securities with the SEC, and we 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 resale. Until we are able to register securities with the SEC for resale, any purchasers of 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 filed outstanding periodic reports and regained compliance with Sections 13 and 15(d) of the Exchange Act.
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Our internal controls may be insufficient to ensure timely and reliable financial information.
We believe we need to correct deficiencies in our internal controls and procedures for financial reporting. Because of the material weaknesses described in Item 4 of this report, management has concluded that we did not maintain effective internal control over financial reporting as of March 31, 2007, based on the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Failure to address the identified 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 with the SEC. 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 control over financial reporting, 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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| • | the 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 in place for financial reporting, 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 future government contracts.
We may need to raise additional capital to support our operations in order to continue as a going concern if we successfully complete a strategic transaction.
Absent a strategic transaction, we believe that our existing cash, cash equivalents and securities available-for-sale as of March 31, 2007 along with the proceeds of our April 2007 settlement with the U.S. government over the termination of the SNS Contract will be sufficient to meet our projected operating requirements through at least December 31, 2008. In addition to our workforce reductions and the scaling back of our rPA102 development activities and the termination of our smallpox development activities, we have announced that we are exploring strategic alternatives. We may not successfully identify or implement any of these alternatives, and even if we determine to pursue one or more of these alternatives, we may be unable to do so on acceptable financial terms. Our restructuring measures implemented to date and any proposed strategic alternatives may disappoint investors and further depress the price of our common stock and the value of an investment in our common stock thereby limiting our ability to raise additional funds.
We will require substantial funds to conduct development activities if we acquire additional products or companies or consummate certain strategic transactions. Our ability to conduct the required development activities related to any new product candidates will be significantly limited if we are unable to obtain the necessary capital. We may seek to raise additional funds through the sale of equity or debt to meet our working capital and capital expenditure needs. We do not know, however, whether additional financing will be available when needed, or whether it will be available on favorable terms or at all. Failure to obtain adequate financing also may adversely affect our ability to operate as a going concern.
As a result of the reduction in our workforce that we announced in January, May and September 2007, we may not be successful in retaining key employees and in attracting qualified new employees as required in the future. If we are unable to retain our management, scientific staff and scientific advisors or to attract additional qualified personnel, our ability to rebuild our business will be seriously jeopardized.
In January 2007, we implemented a restructuring resulting in the reduction of our workforce by approximately 51%. In May 2007, we scaled back any further development activities with respect to rPA102 and announced a corporate restructuring plan that included a reduction in our workforce to fewer than 70 employees. In September 2007, we announced a corporate restructuring plan that included a reduction in our workforce to fewer than 30 employees. Competition among biotechnology companies for qualified employees is intense, and the ability to retain and attract qualified individuals is critical to our success. We may experience further reductions in force due to voluntary employee resignations and a diminished ability to recruit new employees. We may be unable to attract or retain key personnel on acceptable terms, if at all.
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If we fail to meet our obligations under the Notes, our payment obligations may be accelerated.
The Notes have the following features:
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| • | require semi-annual payment of interest in cash at a rate of 5 1/2%; |
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| • | convert, at the option of the holder, into shares of our common stock at an initial conversion price of approximately $14.76 per share, subject to adjustment; |
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| • | will be provisionally redeemable at our option in cash upon the occurrence of certain circumstances, including among others, that the closing price of VaxGen common stock exceeds $22.14 per share, subject to adjustment, for at least 20 trading days within a period of 30 consecutive trading days; |
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| • | if a change in control, as defined in the indenture, occurs on or prior to the stated maturity of the Notes, the holders of the Notes may require us to repurchase the Notes and pay a make-whole premium to the holders of the Notes. If the holders request such a repurchase, we or the successor entity may choose to pay in cash, common stock or a combination of cash and common stock; and |
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| • | constitute senior subordinated obligations. |
Under the terms of the Notes, if certain events occur, including, without limitation, our failure to pay any installment of principal or interest due under the Notes, then the holders may, among other things, elect to accelerate our obligations under the Notes and declare the outstanding principal balance of the Notes and accrued but unpaid interest thereon immediately due and payable. In the event that the holders declare the Notes immediately due and payable or seek to foreclose on any of our assets, it would have a material adverse effect on our financial position and we may not have sufficient cash to satisfy our obligations.
Our indebtedness could adversely affect our financial health, limit our cash flow available to invest in the ongoing requirements of our business and adversely affect the price of our common stock.
Our existing indebtedness consists of $31.5 million in Notes. This indebtedness, and any future indebtedness we may incur, could have important consequences, including:
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| • | making it more difficult for us to satisfy our financial and payment obligations, or to refinance maturing indebtedness; |
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| • | making us more vulnerable to a downturn in the economy or our business; |
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| • | limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions and other general corporate purposes; |
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| • | requiring application of a significant portion of our cash flow from operations to the payment of debt service costs, which would reduce the funds available to us for our operations; |
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| • | limiting our flexibility in planning for, or reacting to, changes in our industry, business and markets; and |
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| • | placing us at a competitive disadvantage to the extent we are more highly leveraged than some of our competitors. |
We may incur significant additional indebtedness in the future to fund our continued operations or future acquisitions. To the extent new debt is added to our current debt levels, the substantial leverage risks described above would increase. We may be required to repurchase the Notes if certain change in control events occur.
We have only a limited operating history and we expect to continue to generate operating losses.
To date, we have engaged primarily in research, development and clinical testing. Since our inception in 1995, our operations have not been profitable, and we cannot be certain that we will ever achieve or sustain operating profitability. At March 31, 2007, we had an accumulated deficit of $220 million. Developing any future 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.
Biopharmaceutical product development is a long, expensive and uncertain process and the approval requirements for many products, including vaccines used to fight bioterrorism, are still evolving. If we are unable to successfully develop and test product candidates in accordance with such requirements, our business will suffer.
We are subject to rigorous and extensive regulation by the FDA and comparable foreign regulatory authorities. In the United States, our product candidates are regulated by the FDA as biological drug products, known as Biologics. In order to obtain approval from the FDA to market our product candidates, we will be required to submit to the FDA a Biologics License Application, or BLA, which must include both preclinical and clinical trial data as prescribed by the FDA’s current regulatory criteria, as well as extensive data regarding the manufacturing procedures and processes for the product candidates. Ordinarily, the FDA requires a sponsor to support a
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BLA application with substantial evidence of the product’s safety and effectiveness in treating the targeted indication based on data derived from adequate and well-controlled clinical trials, including Phase 3 efficacy trials conducted in patients with the disease or condition being targeted.
We cannot predict whether we will obtain regulatory approval for any of our product candidates pursuant to these provisions, or at all. We may fail to obtain approval from the FDA or foreign regulatory authorities, or experience delays in obtaining such approvals, due to varying interpretations of data or failure to satisfy current safety, efficacy, and quality control requirements. Further, our business is subject to substantial risk because the FDA’s current policies may change suddenly and unpredictably and in ways that could impair our ability to obtain regulatory approval of our product candidates. We cannot guarantee that the FDA will approve our product candidates on a timely basis or at all.
Delays in successfully completing our clinical trials could jeopardize our ability to obtain regulatory approval or market our product candidates on a timely basis.
Our business prospects may 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 product candidates. Product development is a long, expensive and uncertain process, and delay or failure can occur at any stage of our non-clinical studies or clinical trials. Any delay or significant adverse clinical events arising during any of our clinical trials could force us to abandon a product candidate altogether or to conduct additional clinical trials in order to obtain approval from the FDA or other regulatory body. These development efforts and clinical trials are lengthy and expensive, and the outcome is uncertain. 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 product 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 preclinical 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 product 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.
If we resume clinical trials, the independent clinical investigators that we rely upon to conduct these studies 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 product development programs. If independent investigators fail to devote sufficient time and resources to our product development programs, or if their performance is substandard or fails to comply with the protocol and applicable laws and regulatory standards, FDA approval of our product candidates may be delayed or prevented. 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.
If we fail to comply with extensive regulations enforced by domestic and foreign regulatory authorities both before and after we obtain approval of our product candidates, the commercialization of our product candidates could be prevented, delayed or suspended.
Product candidates are subject to extensive government regulations related to development, testing, manufacturing and commercialization in the United States and other countries. Our product candidates have not received required regulatory approval from the FDA to be commercially marketed and sold in the United States. Our product 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 regulatory 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 non-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; and |
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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. |
Failure to comply with the 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, including any products that we manufacture; |
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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. |
We may be subject to ongoing regulatory review and periodic inspection and approval of manufacturing procedures and operations, including compliance with cGMP regulations.
The manufacturing methods, equipment and processes used by us and any future subcontractors must comply with the FDA’s current Good Manufacturing Practices, or cGMP, regulations. The cGMP requirements govern, among other things, recordkeeping, production processes and controls, personnel and quality control. The FDA must approve the facilities used to manufacture our products before they can be used to commercially manufacture our vaccine products and these facilities are subject to ongoing and periodic inspections. If we or our subcontractors fail to comply with cGMP requirements, or fail to pass a pre-approval inspection of our manufacturing facility, we may not receive regulatory approval. In addition, preparing a manufacturing facility for commercial manufacturing may involve unanticipated delays and the costs of complying with the cGMP regulations may be significant. Any material changes we make to our manufacturing processes after we obtain approval of a product may require approval by the FDA, state or foreign regulatory authorities.
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 acquire, develop and obtain regulatory approval to market new biopharmaceutical products. Development of a product requires substantial technical, financial and human resources. 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:
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| • | the lack of adequate quality or sufficient prevention benefit, or unacceptable safety during preclinical studies or clinical trials; |
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| • | their failure to receive necessary regulatory approvals; |
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| • | the existence of proprietary rights of third parties; or |
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| • | the inability to develop manufacturing methods that are efficient, cost-effective and capable of meeting stringent regulatory standards. |
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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. Given the rights retained and licenses granted to the U.S. government with regard to our anthrax vaccine candidate, to the extent that the U.S. government or foreign governments or organizations procuring vaccines through treaties or agreements with the U.S. government constitute the primary market for any of our products, the licenses granted by the U.S. government may not provide us with a competitive advantage.
In addition, under our U.S. government contracts, we have a duty to disclose each invention that we conceive or reduce to practice in performing the agreement, and if we wish to retain title to such invention, we must affirmatively elect to do so. If we fail to strictly follow these disclosure requirements, the U.S. government could take title to such inventions and preclude us from using them. For each invention to which we retain title, the U.S. government has both a worldwide, irrevocable, royalty-free license to practice or have practiced such invention on behalf of the U.S. government, and certain “march-in” rights pursuant to which the U.S. government could require us to license the invention that we own to third parties, including our competitors.
Technology that we may acquire or 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 and exclusively licensed to us. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. 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, even in such instances in which the outcome is favorable to us.
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 Kaketsuken or 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; or |
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| • | we will develop additional proprietary technologies that are patentable; or 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 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 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.
Moreover, we could lose the USAMRIID license if the U.S. government terminates the license if we or any of our sublicensees:
| | |
| • | fail to diligently develop a vaccine product in accordance with the development plan described in the agreement; |
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| • | materially breach the agreement; |
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| • | make a materially false statement (or fail to provide required information) in a plan or report required under the agreement; |
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| • | fail to make payments required under the agreement; or |
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| • | file for bankruptcy. |
In addition, we cannot assure you that our operations or technology will not infringe intellectual property rights of others. The United States Patent and Trademark Office keeps United States patent applications confidential while the applications are pending. As a result, we cannot determine which inventions third parties claim in pending patent applications that they have filed. We may need to engage in litigation to defend or enforce our patent and license rights or to determine the scope and validity of the proprietary 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. Failure to obtain licenses could force us to cease development or sale of a product candidate.
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We face competition from several companies with greater financial, personnel and research and development resources than ours.
Our competitors are developing product candidates which could compete with those we develop in the future. 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 more adaptable to various modes of dosing; |
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| • | are easier to store or transport; |
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| • | are easier to administer; or |
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| • | are less expensive than the product candidates we develop. |
Even if we are successful in developing effective 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, making our products obsolete, or that are marketed before any products we develop are marketed.
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. Many of the organizations competing with us 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.
Our corporate and manufacturing facilities are primarily located in California. Our facilities in California are 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 we maintain 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.
Our use of hazardous materials and chemicals require us to comply with regulatory requirements and exposes us to potential liabilities.
Our research and development may involve the controlled use of hazardous materials and chemicals. We are subject to federal, state, local and foreign laws governing the use, manufacture, storage, handling and disposal of such materials. 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 result in damages that exceed our insurance coverage.
We face an inherent risk of exposure to product liability suits in connection with product candidates tested in human clinical trials or sold commercially. We may become subject to a product liability suit if any product candidate we develop causes injury, or if individuals subsequently become infected or otherwise suffer adverse effects from our product candidates. If a product liability claim is brought against us, the cost of defending the claim could be significant and any adverse determination could result in liabilities in excess of our insurance coverage. We maintained product liability insurance, including clinical trial liability, in the amount of $10.0 million for our programs up until March 2007, when the programs were suspended. We have an extended reporting period for claims that may arise under this coverage. We cannot be certain that additional insurance coverage, if required, could be obtained on acceptable terms, if at all.
We may be subject to claims that our employees or we 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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Our stockholders could experience substantial dilution as a result of the issuance of additional shares of common or preferred stock.
Our Board of Directors has the authority to establish the designation of almost 20,000,000 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. In February 2006, we raised net proceeds of $25.2 million through a private placement of 3.5 million shares of common stock at $7.70 per share to a group of accredited institutional investors. We also issued to the investors five-year warrants initially exercisable to purchase 699,996 shares of common stock at an exercise price of $9.24 per share. Because we did not file all of our delinquent periodic reports with the SEC by January 31, 2007, the warrants became exercisable for an additional 700,000 shares of common stock, at a price of $9.24 per share. We may raise additional funds through public or private offerings of our preferred stock or our common stock, or through issuance of debt securities that are convertible into shares of our common stock. The issuance of additional shares of our common stock, or conversion of preferred stock or debt securities into shares of common stock, would further dilute the percentage ownership of our stockholders.
Shares of our common stock eligible for future sale may adversely affect the market for our common stock.
After we have filed all of our outstanding periodic reports with the SEC, if at all, from time to time, certain of our stockholders may be eligible to sell all or some of their shares of our common stock by means of effective resale registration statements. We agreed to register for resale under the Securities Act the shares of our common stock issuable upon conversion of the Notes and the shares of our common stock issued in private placements of our common stock in November 2004 and February 2006. We have agreed to file registration statements for these shares within 30 days following the first date we become current in our reporting requirements under the Exchange Act and to use our best efforts to cause the registration statements to become effective in no event later than 120 days after the filing of these registration statements. In addition, pursuant to Rule 144, generally, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one year holding period may, under certain circumstances, sell within any three month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitation, by our stockholders that are non-affiliates that have satisfied a two year holding period, such as certain of those stockholders who purchased shares of our common stock in our November 2004 private placement. Any substantial sale of our common stock under effective resale registration statements or pursuant to Rule 144 or pursuant to any resale prospectus may have a material adverse effect on the market price of our securities.
Our stock price is likely to be volatile.
Currently, our common stock is traded OTC and is quoted on the OTC Pink Sheets LLC. Stocks traded OTC typically are subject to greater volatility than stocks traded on stock exchanges, such as the Nasdaq Global Market or the Nasdaq Capital Market, due to the fact that OTC trading volumes are generally significantly less than on stock exchanges. This lower volume may allow a relatively few number of stock trades to greatly affect the stock price. As such, the trading price of our common stock has been and is likely to continue to be extremely volatile. For example, between August 9, 2004 and March 31, 2007, the closing price of our common stock, as quoted on the Pink Sheets, has ranged from a high of $18.55 per share to a low of $1.24 per share.
Our stock price could continue to be subject to wide fluctuations in response to a variety of factors, including:
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| • | timing and consistency of filing financial statements; |
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| • | failure to win future government contracts and government activities relating to prior contracts; |
| | |
| • | adverse results or delays in clinical trials; |
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| • | delays in our product development efforts; |
| | |
| • | real or perceived safety issues with any of our product candidates; |
| | |
| • | failure to obtain or maintain required regulatory approvals; |
| | |
| • | changes in financial estimates by securities analysts and our failure to meet or exceed such estimates; |
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| • | rumors about our business prospects, product development efforts or the progress, timing and completion of our clinical trials; |
| | |
| • | new products or services offered by us or our competitors or announcements relating to product developments by our competitors; |
| | |
| • | issuances of debt or equity securities; |
| | |
| • | issuances of securities or the expectation of the issuance of securities as part of a merger or other strategic transaction; |
| | |
| • | actual or expected 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 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. If we face securities litigation in the future, even if it is without merit or unsuccessful, it would result in substantial costs and a diversion of management attention and resources, which could have a material adverse effect on our business.
We have no history of paying dividends on our common stock.
We have never paid cash dividends on our common stock and do not anticipate paying any cash dividends on our common stock in the foreseeable future. We plan to retain any future earnings to finance our growth. If we decide to pay dividends to the holders of our common stock, such dividends may not be paid on a timely basis.
Our charter documents and Delaware law may discourage an acquisition of VaxGen.
Provisions of our certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. We may issue shares of preferred stock in the future without stockholder approval and upon such terms as our board of directors may determine. Our issuance of this preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of our outstanding stock. Our charter and by-laws also provide that special stockholders meetings may be called only by our Chairman of the board of directors, by our Secretary at the written request of the chairman or by our board of directors, with the result that any third-party takeover not supported by the board of directors could be subject to significant delays and difficulties.
We are not compliant with Section 404 under the Sarbanes-Oxley Act of 2002.
Section 404 under the Sarbanes-Oxley Act of 2002 requires that we perform an assessment of our internal control over financial reporting, and engage our independent registered public accounting firm to perform an audit of our internal control over financial reporting. We were required to complete the assessment as to the adequacy of our internal control reporting as of December 31, 2006, 2005 and 2004.
Although we completed our assessments in 2006 and 2005, given our focus on completing and filing our financial statements for those years, we did not have sufficient time nor did we provide sufficient time to our independent registered public accounting firm to complete our and their 2004 respective responsibilities before December 31, 2004. Our independent registered public accounting firm concluded that we failed to complete the required 2004 assessment as to the effectiveness of our internal control over financial reporting, and they were unable to complete their required audit of internal control over financial reporting. Accordingly, they disclaimed an opinion as to the effectiveness of our internal control over financial reporting for 2004.
We do not believe that the SEC has provided guidance as to the effect of such a disclaimer. Having received such a disclaimer, our Annual Report on Form 10-K for the year ended December 31, 2004, may be deemed to be deficient by the SEC. If our 2004 10-K were deemed to be deficient, the SEC may conclude that we are in violation of Sections 13 and 15(d) of the Exchange Act.
Our operating results may be adversely impacted by recently adopted changes in accounting for stock options.
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, or FAS 123R, in December 2004. FAS123R, which we implemented effective January 1, 2006, requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. The future impact of FAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. We use the Black-Scholes option pricing model as allowed under FAS 123R to determine the fair value.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None
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ITEM 6. EXHIBITS
(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.)
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.
| | |
| VaxGen, Inc. |
| | |
Dated: September 20, 2007 | By: | /s/ James P. Panek |
| | |
|
|
| | |
| James P. Panek |
| Chief Executive Officer |
| (Principal Executive Officer) |
| | |
Dated: September 20, 2007 | By: | /s/ Matthew J. Pfeffer |
| | |
|
|
| | |
| Matthew J. Pfeffer |
| Chief Financial Officer |
| (Principal Financial Officer) |
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