UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26483
VaxGen, Inc.
(Exact name of Registrant as Specified in its Charter)
Delaware
(State or other jurisdiction of incorporation or organization)
94-3236309
(I.R.S. Employer Identification Number)
1000 Marina Blvd., Suite 200
Brisbane, California 94005
(Address of Principal Administrative Offices) (Zip Code)
(650) 624-1000
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The issuer has one class of common stock with 14,177,605 shares outstanding as
of July 31, 2001.
VaxGen, Inc.
Form 10-Q
For the Quarter Ended June 30, 2001
Table of Contents
Part I. Financial Information Page
Item 1. Financial Statements:
Condensed Balance Sheets...................................... 1
Condensed Statements of Operations............................ 2
Condensed Statements of Cash Flows............................ 3
Notes to Condensed Financial Statements....................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations:
Overview...................................................... 9
Results of Operations......................................... 11
Liquidity and Capital Resources............................... 13
Risk Factors.................................................. 16
Item 3. Quantitative and Qualitative Disclosure about Market Risk...... 27
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds...................... 28
Item 4. Submission of Matters to a Vote of Security Holders............ 29
Item 6. Exhibits and Reports on Form 8-K............................... 30
Signature...................................................... 31
PART I - FINANCIAL INFORMATION
VaxGen, Inc.
(A Development Stage Enterprise)
BALANCE SHEETS
(Unaudited)
Item 1. Financial Statements
ASSETS
June 30, December 31,
2001 2000
------------- -------------
Current assets:
Cash and cash equivalents $ 13,284,000 $ 5,426,000
Investment securities 43,979,000 43,098,000
Interest receivable 676,000 733,000
Prepaid expenses and other current assets 2,265,000 4,114,000
------------- -------------
Total current assets 60,204,000 53,371,000
Property and equipment, net 2,937,000 3,202,000
Other assets 125,000 224,000
------------- -------------
Total assets $ 63,266,000 $ 56,797,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Payable to Genentech $ 337,000 $ 2,071,000
Accounts payable 149,000 315,000
Accrued liabilities 2,825,000 2,941,000
Dividends payable 127,000 --
Current portion of long-term obligations 31,000 31,000
------------- -------------
Total current liabilities 3,469,000 5,358,000
Long-term obligations 195,000 367,000
Commitments and contingencies
Redeemable convertible preferred stock, $0.01
par value, 20,500 shares authorized:
Series A 6% cumulative convertible stock, $0.01
par value, 20,000 shares issued and outstanding
at June 30, 2001 15,040,000 --
Stockholders' equity:
Preferred stock, $0.01 par value, 20,000,000 shares
authorized; none issued or outstanding -- --
Common stock, $0.01 par value, 40,000,000 shares
authorized; 14,170,105 and 14,045,656 shares issued
and outstanding at June 30, 2001 and
December 31, 2000, respectively 141,000 140,000
Additional paid-in capital 126,150,000 121,717,000
Deferred stock compensation (1,028,000) (1,667,000)
Accumulated other comprehensive income -
unrealized gain on investment securities 556,000 354,000
Deficit accumulated during the development stage (81,257,000) (69,472,000)
------------- -------------
Total stockholders' equity 44,562,000 51,072,000
------------- -------------
Total liabilities and stockholders' equity $ 63,266,000 $ 56,797,000
============= =============
See accompanying notes to condensed financial statements.
1
VaxGen, Inc.
(A Development Stage Enterprise)
STATEMENTS OF OPERATIONS
(Unaudited)
Period from
Three Months Ended Six Months Ended Inception
June 30, June 30, (November 27, 1995)
--------------------------- ---------------------------- through
2001 2000 2001 2000 June 30, 2001
----------- ------------ ------------ ------------ ------------
Revenue:
Contract revenue $ 346,000 $ -- $ 421,000 $ -- $ 696,000
Operating expenses:
Research and development:
Genentech charges 107,000 410,000 502,000 660,000 9,858,000
Other 3,634,000 4,394,000 7,748,000 8,196,000 46,571,000
----------- ------------ ------------ ------------ ------------
Total research and development 3,741,000 4,804,000 8,250,000 8,856,000 56,429,000
General and administrative expenses 3,375,000 1,771,000 5,717,000 3,365,000 35,204,000
----------- ------------ ------------ ------------ ------------
Loss from operations (6,770,000) (6,575,000) (13,546,000) (12,221,000) (90,937,000)
Other income (expense) :
Investment income, net 923,000 1,007,000 1,775,000 2,041,000 9,763,000
Interest expense (7,000) (2,000) (14,000) (6,000) (83,000)
----------- ------------ ------------ ------------ ------------
Total other income, net 916,000 1,005,000 1,761,000 2,035,000 9,680,000
Net loss (5,854,000) (5,570,000) (11,785,000) (10,186,000) (81,257,000)
=========== ============ ============ ============ ============
Charges attributed to convertible preferred stock:
Dividends (127,000) -- (127,000) --
Accretion of redemption value (142,000) (142,000)
Beneficial conversion charge (734,000) -- (734,000) --
----------- ------------ ------------ ------------
Net loss applicable to common shareholders $(6,857,000) $ (5,570,000) $(12,788,000) $(10,186,000)
=========== ============ ============ ============
Net loss per share applicable to common
shareholders, basic and diluted $ (0.49) $ (0.41) $ (0.91) $ (0.75)
Weighted average shares used in computing basic
and diluted loss per share 14,100,000 13,564,000 14,081,000 13,552,000
=========== ============ ============ ============
See accompanying notes to condensed financial statements.
2
VaxGen, Inc.
(A Development Stage Enterprise)
STATEMENTS OF CASH FLOWS
(Unaudited)
Period from
Six Months Ended Inception
June 30, November 27, 1995)
--------------------------- through
2001 2000 June 30, 2001
------------ ------------ -------------
Cash flows from operating activities:
Net loss $(11,785,000) $(10,186,000) $ (81,257,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 452,000 363,000 1,819,000
Amortization of premiums and discounts on investment securities 14,000 143,000 (505,000)
Stock compensation expense 868,000 449,000 14,158,000
Warrants issued to consultants 114,000 -- 114,000
Changes in assets and liabilities:
Interest receivable 57,000 (284,000) (676,000)
Prepaid expenses and other current assets 1,849,000 (145,000) (2,265,000)
Other assets 99,000 1,000 (14,000)
Payable to Genentech (1,734,000) (767,000) 337,000
Accounts payable, accrued liabilities and other long-term obligations (510,000) (223,000) 3,058,000
------------ ------------ -------------
Net cash used in operating activities (10,576,000) (10,649,000) (65,231,000)
------------ ------------ -------------
Cash flows from investing activities:
Purchase of investment securities (16,152,000) (11,512,000) (156,599,000)
Proceeds form sale and maturities of investment securities 15,459,000 24,041,000 113,681,000
Purchase of property and equipment (187,000) (590,000) (4,609,000)
Long-term lease deposits -- -- (120,000)
------------ ------------ -------------
Net cash provided by (used in) investing activities (880,000) 11,939,000 (47,647,000)
------------ ------------ -------------
Cash flows from financing activities:
Payments under capital lease obligations (16,000) (12,000) (68,000)
Proceeds from issuance of preferred stock 18,406,000 -- 18,406,000
Stock issued to Genentech -- -- 1,025,000
Stock issued to other founders -- -- 20,000
Stock issued in private placements -- -- 65,164,000
Stock issued in initial public offering -- -- 46,345,000
Issuance costs of private placements -- -- (4,208,000)
Issuance costs of initial public offering -- -- (4,386,000)
Exercise of employee stock options 924,000 692,000 2,864,000
Loans from Genentech -- -- 1,000,000
------------ ------------ -------------
Net cash provided by financing activities 19,314,000 680,000 126,162,000
------------ ------------ -------------
Increase in cash and cash equivalents 7,858,000 1,970,000 13,284,000
Cash and cash equivalents at beginning of period 5,426,000 16,063,000 --
------------ ------------ -------------
Cash and cash equivalents at end of period $ 13,284,000 $ 18,033,000 $ 13,284,000
============ ============ =============
Supplemental schedule of non cash investing and financing activities:
Dividends payable to redeemable convertible preferred stockholders $ 127,000 $ -- $ 127,000
Accretion of redemption value of redeemable convertible preferred stock 142,000 -- 142,000
Recognition of beneficial conversion feature of redeemable convertible preferred stock 734,000 -- 734,000
Equipment acquired through capital leases -- -- 138,000
Issuance of common stock through conversion of Genentech note payable -- -- 1,000,000
See accompanying notes to condensed financial statements.
3
VaxGen, Inc.
(A Development Stage Enterprise)
Notes to Condensed Financial Statements
June 30, 2001
(Unaudited)
1. Basis of Presentation
The unaudited condensed financial statements of VaxGen, Inc. (the "Company")
included herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information or
footnote disclosure normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and regulations.
In the opinion of the management of the Company, the accompanying unaudited
condensed financial statements contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial
information included herein. While the Company believes that the disclosures are
adequate to make the information not misleading, it is suggested that these
financial statements should be read in conjunction with the Company's audited
financial statements contained in its Annual Report on Form 10-K for the year
ended December 31, 2000.
2. Non-Cash Compensation
On April 1, 1999, the stockholders of the Company approved an increase in the
number of shares reserved for grant under the Company's 1996 Stock Option Plan
to 1,750,000 shares. This represents the measurement date for stock options
granted to employees earlier in 1999 and in 1998, which were granted subject to
stockholder approval of the plan amendment. As a result, the Company recorded
deferred compensation in the amount of $3,223,000, representing the excess of
fair market value of the common shares on April 1, 1999, $13.00 per share, over
the exercise price of the options on the date stockholder approval was obtained.
The Company has recorded charges to non-cash compensation expense of $379,000
for the portion of the vesting period lapsed for the six months ended June 30,
2001. The balance of deferred compensation is being amortized to expense over
the remaining vesting period of the options. Total non-cash compensation for the
six months ended June 30, 2001 was $868,000 as compared to $449,000 for the
comparable period in 2000.
3. Loss per Share
Basic loss per share is computed as net loss applicable to common stockholders
divided by the weighted average number of common shares outstanding for the
period. Diluted loss per share reflects the potential dilution that could occur
from common shares to be issued through stock options, warrants and other
convertible securities. The potential
4
VaxGen, Inc.
(A Development Stage Enterprise)
Notes to Condensed Financial Statements (continued)
June 30, 2001
(Unaudited)
dilutive effects of 1,758,082 shares of common stock subject to outstanding
stock options, 714,265 shares of common stock subject to outstanding warrants
and 861,383 shares of common stock reserved for conversion of the Series A
Preferred Stock are excluded from the diluted earnings per share calculation for
the period ended June 30, 2001, and 1,467,589 shares of common stock subject to
outstanding stock options and 494,613 shares of common stock subject to
outstanding warrants are excluded from the diluted earnings per share for the
period ended June 30, 2000, because the representative share increments would be
antidilutive.
4. New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS 133
establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts, and for hedging
activities. SFAS 133, as amended by SFAS 138, is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS 133
on January 1, 2001 did not have any impact on the Company's financial
statements.
5. Redeemable Convertible Preferred Stock Financing
The Company entered into a Securities Purchase Agreement dated as of May 23,
2001 with four investors, whereby the Company received approximately $20,000,000
in consideration for the sale of 20,000 shares of the Company's Series A 6%
Cumulative Convertible Preferred Stock ("Preferred Stock") and the issuance of
Common Stock Purchase Warrants described below. Expenses relating to the
transaction were approximately $1,600,000, resulting in net proceeds of
approximately $18,400,000. These proceeds will be used to prepare the Company's
HIV/AIDS vaccine, AIDSVAX(R) ("AIDSVAX"), for commercial-scale manufacturing if
it proves effective, the potential development of new adjuvants and general
corporate purposes.
5
VaxGen, Inc.
(A Development Stage Enterprise)
Notes to Condensed Financial Statements (continued)
June 30, 2001
(Unaudited)
A summary of the significant terms of the Preferred Stock financing is as
follows:
Conversion
Each share of Preferred Stock can be converted at the option of the holder at
any time after issuance according to a conversion ratio, subject to adjustment
for dilution or certain equity adjustments. The initial conversion ratio is
determined by dividing the liquidation value ($1,000 per share plus accrued
dividends) by the original conversion price of $23.2185 then multiplied by the
number of shares to be converted. The Company may also force conversion of the
Preferred Stock into common stock, if, at any time after May 23, 2002, the
weighted average price of the Company's stock for at least 20 out of 30
consecutive trading days equals or exceeds 175% of the conversion price (175% of
$23.2185 or $40.63).
Redemption
In the event that there is no earlier conversion, the Company must redeem the
Preferred Stock for cash on May 23, 2004, at a redemption price equal to $1,000
per share plus all accrued and unpaid dividends. There is also a provision for
an early redemption of the Preferred Stock. An early redemption would occur if
the November 2001 interim analysis results in anything other than (i) permission
to terminate the trial and apply for regulatory approval, or (ii) permission to
proceed to the scheduled endpoint of the trial at the end of 2002, or if the
interim analysis is not completed by December 31, 2001 or the Data and Safety
Monitoring Board's determination is not announced prior to January 31, 2002.
Each holder of the Preferred Stock may require the Company to redeem any or all
of such holder's Preferred Stock as of a date six months after the negative
event at a redemption price per preferred share equal to $1,000 per share plus
all accrued and unpaid dividends. The Company may, within certain limits, pay up
to 50% of such redemption price in shares of the Company's common stock.
The Company accounts for the difference between the carrying amount of
redeemable preferred stock and the redemption amount by increasing the carrying
amount for periodic accretion using the interest method, so that the carrying
amount will equal the redemption amount at the scheduled redemption date.
6
VaxGen, Inc.
(A Development Stage Enterprise)
Notes to Condensed Financial Statements (continued)
June 30, 2001
(Unaudited)
Dividends
Each share of Preferred Stock is entitled to receive a 6% dividend each year,
paid 3% on each June 30 and December 31. If not paid within five days of either
such date, the dividend will accumulate and compound. The first dividend payment
date is December 31, 2001. On that date, each share will be entitled to a
dividend of $37.00 per preferred share. Payment may be made in cash or in shares
of common stock at the Company's option. Net loss applicable to common
shareholders for the second quarter of 2001 includes a non-cash charge of
approximately $127,000 for Preferred Stock dividends.
Voting
Each share of Preferred Stock has voting rights equal to the common stock into
which it is convertible on the record date of the vote.
Liquidation
In the event of liquidation, dissolution or winding up of the Company, either
voluntary or involuntary, each holder of shares of Preferred Stock will be
entitled to receive, out of the assets of the Company available for distribution
to stockholders and prior to any distribution to holders of common stock, $1,000
per preferred share plus accrued dividends.
Common Stock Purchase Warrants
In connection with the Preferred Stock financing, the Company issued Common
Stock Purchase Warrants ("Warrants") for the purchase of 297,177 shares of
common stock to the Preferred Stock investors. The warrants, which expire on May
23, 2006, have an exercise price of $25.2375 per share. However, effective as of
May 23, 2002, the exercise price shall be automatically adjusted to a price
equal to the lesser of (a) the original exercise price of $25.2375 and (b) the
average of the closing bid prices for the Company's common stock on The Nasdaq
Stock Market(R) during the twenty consecutive trading days immediately preceding
May 23, 2002, provided that the exercise price shall not be adjusted to an
amount less than $14.133.
The Company has valued the warrants at $11.80 per share resulting in a total
value of approximately $3,500,000. This amount was accounted for as a reduction
in the carrying value of the Preferred Stock until the scheduled redemption of
the Preferred Stock, and an increase to additional paid-in-capital. The charge
is being amortized over five years,
7
VaxGen, Inc.
(A Development Stage Enterprise)
Notes to Condensed Financial Statements (continued)
June 30, 2001
(Unaudited)
and accordingly net loss to common stockholders for the second quarter of 2001
reflects a non-cash charge of approximately $97,000. The fair value of the
warrants was calculated using the Black-Scholes method.
Effect of Beneficial Conversion Feature
The Company's Preferred Stock was issued with a beneficial conversion feature,
which was valued at $734,000. The beneficial conversion amount has been
accounted for as an increase in additional paid-in capital and as an
in-substance dividend to the preferred stockholders, which increases the net
loss applicable to common stockholders.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis should be read in conjunction with our condensed
financial statements and related notes thereto appearing in Item 1 of this
report. In addition to historical information, this report contains
"forward-looking statements" that are within the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, and that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those projected. The words "believe", "expect", "intend",
"anticipate", and similar expressions are used to identify forward-looking
statements, but their absence does not mean that such statement is not
forward-looking. Factors that might cause such a difference include, but are not
limited to, uncertainties related to the progress, costs and results of the
Company's Phase III clinical trials, the progress of other internal research and
development projects, the establishment of collaborative arrangements with
governmental agencies, the availability of manufacturing capacity, the receipt
of research grants and the timing of certain expenses. Reference should be made
to VaxGen's Annual Report on Form 10-K for the year ended December 31, 2000,
filed with the Securities and Exchange Commission, under the heading "Business,"
and to the heading "Risk Factors" included herein, for a more detailed
description of such factors. These risk factors, among others, could cause
results to differ materially from those presently anticipated by the Company.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this report. The Company
undertakes no obligation to publicly release the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date of this report or to reflect the occurrence of
anticipated events.
Overview
In November 1995, VaxGen was formed to continue development of AIDSVAX. At that
time, Genentech, Inc. ("Genentech") licensed to us the technology necessary for
completing development and commercialization of AIDSVAX. Currently, Genentech
owns approximately 11% of VaxGen common stock.
Since our formation, we have focused on developing and testing AIDSVAX. We have
developed formulations of AIDSVAX that focus on the predominant HIV subtype in
North America, Europe, the Caribbean, and Australia (subtype B) and the
predominant HIV subtype in Southeast Asia and East Asia (subtype E). We have
commenced two Phase III clinical trials, one in North America and Europe and one
in Thailand to determine the efficacy of AIDSVAX. In October 1999, we completed
the enrollment of over 5,400 trial volunteers for the North American/European
Phase III clinical trial, which is being conducted in 59 clinical centers. In
August 2000, we completed the enrollment of over 2,500 volunteers for the Thai
Phase III clinical trial, which is being conducted in 17 clinical centers in
Bangkok.
9
To date, we have generated $696,000 in revenue from grants from the National
Institutes of Health ("NIH") for research and development of HIV vaccines along
with funds received through a collaborative agreement with BBI Biotech, which is
funded by the National Institute of Allergy and Infectious Diseases ("NIAID"),
to obtain and store clinical specimens from our North American/European Phase
III clinical trial. We anticipate only modest revenues from other governmental
agencies or other grants or from collaborations with other entities over the
next three to four years. We have incurred losses since inception as a result of
research and development and general and administrative expenses in support of
our operations. As of June 30, 2001, we had a deficit accumulated during the
development stage of $81,257,000. We anticipate incurring substantial losses
over at least the next three to four years as we complete our clinical trials,
apply for regulatory approvals, continue development of our technology and
expand our operations.
For the North American/European clinical trial, we will have our first
opportunity in November 2001 to find out how well AIDSVAX works. If the results
of the interim analysis demonstrate 30% or greater efficacy, at 97% confidence,
we believe that the Data and Safety Monitoring Board, the independent committee
that oversees our trials, will recommend that we terminate the trial and proceed
with seeking regulatory approval for AIDSVAX. A confidence level of 97% means
that if the clinical trial were repeated, 97 times out of 100 we would see at
least a 30% greater reduction in HIV infections among volunteers who received
AIDSVAX compared with volunteers who received a placebo. To achieve this level
of statistical significance at the interim analysis, the vaccine must have an
actual efficacy rate of over 60%. This higher required efficacy level at the
interim analysis is due to several factors, including the number of volunteers
ultimately retained in the study, the rate of HIV infection in the placebo group
and the length of time associated with the clinical observation period. If the
results of the interim analysis were to demonstrate such efficacy, we would
begin the process of applying for regulatory approval. If the results of the
interim analysis are inconclusive, we will proceed for another 12 months to the
scheduled conclusion of the trial at the end of 2002. During this time, we will
gather additional information that will improve our ability to determine the
vaccine's effectiveness. The confidence interval would drop to 95% at the final
analysis. An interim analysis for the Thai clinical trial is anticipated to take
place during the fourth quarter of 2002.
Our strategy is to develop, test and obtain regulatory approval for various
formulations of AIDSVAX. We intend to use Genentech and/or other third parties
as our partners for manufacturing and distribution. Genentech has exclusive
options to manufacture and market AIDSVAX products. If Genentech does not
exercise its options, we have the right to pursue third party arrangements, with
Genentech obligated to provide the transfer of technology necessary for
manufacturing the vaccine.
10
Results of Operations
Six months ended June 30, 2001 compared to the six months ended June 30, 2000
Contract Revenue
Contract revenue increased to $421,000 for the six months ended June 30, 2001
from $0 for the six months ended June 30, 2000. Contract revenue primarily
consisted of funds received as reimbursements under a collaborative agreement
with BBI Biotech that is funded by NIAID. Research contract revenue earned in
one period is not indicative of research contract revenue to be earned in future
periods.
Research and Development Expenses
Research and development expenses decreased 7%, from $8,856,000 for the six
months ended June 30, 2000 to $8,250,000 for the six months ended June 30, 2001.
The decrease is due to a reduction in expenses related to the ongoing North
American/European and Thai clinical trials offset by an increase in expenses
associated with development of additional AIDSVAX vaccines (see further
discussion in "Liquidity and Capital Resources"). The reduction in clinical
trial expenses was due to fewer scheduled volunteer visits consistent with the
clinical trial protocol. Research and development expenses for the six months
ended June 30, 2001 included costs for additional personnel along with operating
our research laboratory facility.
General and Administrative Expenses
General and administrative expenses increased 70%, from $3,365,000 for the six
months ended June 30, 2000 to $5,717,000 for the six months ended June 30, 2001.
The increase was primarily due to additional personnel hired to support our
growing infrastructure, non-cash compensation expense related to an employment
matter and an increase in outside professional service fees.
Other Income, Net
Other income, net, consisting primarily of investment income, decreased by 13%
from $2,035,000 for the six months ended June 30, 2000 to $1,761,000 for the six
months ended June 30, 2001. This was primarily due to lower average balances of
cash, cash equivalents and investment securities.
11
Three months ended June 30, 2001 compared to the three months ended June 30,
2000
Contract Revenue
Contract revenue increased to $346,000 for the three months ended June 30, 2001
from $0 for the three months ended June 30, 2000. Contract revenue consisted of
funds received as reimbursements under a collaborative agreement with BBI
Biotech that is funded by NIAID. Research contract revenue earned in one period
is not indicative of research contract revenue to be earned in future periods.
Research and Development Expenses
Research and development expenses decreased 22%, from $4,804,000 for the three
months ended June 30, 2000 to $3,741,000 for the three months ended June 30,
2001. The decrease is due to a reduction in expenses related to the ongoing
North American/European and Thai clinical trials offset by an increase in
expenses associated with development of additional AIDSVAX vaccines (see further
discussion in "Liquidity and Capital Resources"). The reduction in clinical
trial expenses was due to fewer scheduled volunteer visits consistent with the
clinical trial protocol. Research and development expenses for the three months
ended June 30, 2001 included costs for additional personnel along with operating
our research laboratory facility.
General and Administrative Expenses
General and administrative expenses increased 91%, from $1,771,000 for the three
months ended June 30, 2000 to $3,375,000 for the three months ended June 30,
2001. The increase was primarily due to additional personnel hired to support
our growing infrastructure, non-cash compensation expense related to an
employment matter and an increase in outside professional service fees.
Other Income, Net
Other income, net, consisting primarily of investment income, decreased by 9%
from $1,005,000 for the three months ended June 30, 2000 to $916,000 for the
three months ended June 30, 2001. This was primarily due to lower average
balances of cash, cash equivalents and investment securities.
12
Liquidity and Capital Resources
Cash, cash equivalents and investment securities were $57,263,000 at June 30,
2001. We have financed our operations since inception through private placements
of common stock and preferred stock, our initial public offering ("IPO") and
capital provided by Genentech. Genentech last funded VaxGen in 1997 and has no
obligation to provide future funding to the Company.
We completed our IPO in July 1999, in which we issued and sold 3,565,000 shares
of common stock for aggregate proceeds to us in the amount of $46,400,000. Of
the aggregate proceeds received in the IPO, approximately $4,400,000 was used to
pay costs and expenses related to the IPO, resulting in net proceeds of
approximately $42,000,000.
In December 1999, we completed a private placement of common stock to Vulcan
Ventures, Inc., the investment organization of Paul G. Allen. The funds from the
private placement will support our ongoing operations along with our current
clinical trials. This private placement has also enabled us to commence
development of a formulation of AIDSVAX, that focuses on the predominant HIV
type found in Sub-Saharan Africa, China, India and South America (subtype C).
Currently, we have developed formulations of AIDSVAX that focus on the
predominant HIV type in North America, Europe, the Caribbean and Australia
(subtype B) and the predominant HIV subtype in Southeast Asia and East Asia
(subtype E). The private placement consisted of approximately 2,174,000 shares
of common stock, which resulted in proceeds, net of expenses, to us of
approximately $24,000,000.
On May 23, 2001 we completed a preferred stock financing through which four
investors paid us an aggregate of approximately $20,000,000 in consideration for
20,000 shares of our Series A Cumulative Convertible Preferred Stock ("Preferred
Stock") at a price of $1,000 per share, convertible into shares of our common
stock, at an initial conversion price of $23.2185 per share. In the event that
there is no earlier conversion, we must redeem the Preferred Stock for cash on
May 23, 2004, at a redemption price equal to $1,000 per share plus all accrued
and unpaid dividends. Expenses relating to the transaction were approximately
$1,600,000, resulting in net proceeds of $18,400,000. These proceeds from the
preferred stock financing will be used to prepare our HIV/AIDS vaccine, AIDSVAX,
for commercial-scale manufacturing if it proves effective, the potential
development of new adjuvants and general corporate purposes.
In connection with the preferred stock financing, we issued warrants for the
purchase of 297,177 shares of our common stock to our Preferred Stock investors.
The warrants, which expire on May 23, 2006, have an exercise price of $25.2375
per share, subject to a
13
one-time possible downward adjustment on May 23, 2002, but not below $14.133 per
share.
Since our inception, investing activities, other than purchases and sales of
investment securities, have consisted entirely of equipment acquisitions and
leasehold improvements. From inception through June 30, 2001, our gross
investment in equipment and leasehold improvements was $4,609,000. The increase
in equipment and leasehold improvements has been primarily due to the
development of our research and development laboratory and the establishment of
larger office facilities. Net cash used in operating activities for the six
months ended June 30, 2001 was $10,576,000, representing expenditures for
research and development costs and general and administrative expenses.
In October 1999, we entered into a collaboration with the federal Centers for
Disease Control and Prevention ("CDC") to support research at six of the 54
clinics in the United States currently conducting Phase III clinical trials of
our AIDSVAX vaccine. The CDC selected the six sites in the fourth quarter of
1999. Contractual arrangements between the CDC and the clinics were completed in
the second quarter of 2000. The participating sites will continue to implement
our Phase III protocol, as well as conduct epidemiological, social and
behavioral research, which will be shared by the Company and the CDC. The sites
will be compensated directly by the CDC for the clinical costs, which would have
been incurred by the Company, and for conducting the additional research. The
CDC has agreed to contribute approximately $8,000,000 to the participating sites
over a four-year period.
On March 23, 2001, we finalized a collaborative agreement with BBI Biotech
Research Laboratories, Inc. ("BBI Biotech"), which is being funded by the
National Institute of Allergy and Infectious Diseases ("NIAID"), an agency
within the National Institutes of Health, to obtain and store clinical specimens
from our North American/European Phase III clinical trial. The project is being
funded under a contract, which NIAID awarded to BBI Biotech for seven years.
Under a subcontract with BBI Biotech, we will receive approximately $489,000 to
support the collection of human tissue and cell samples. We received $346,000 in
the second quarter ended June 30, 2001. If AIDSVAX proves successful in our
Phase III clinical trials, the samples will be used to determine if the vaccine
induced a cellular immune response in the volunteers who received the active
vaccine.
We believe that our existing cash and cash equivalents and investment
securities, together with investment income along with funds from other
potential collaborative arrangements, will enable us to meet our forecasted
expenditures through the anticipated completion of our North American/European
Phase III clinical trial. However, we may need to raise additional funds to
complete the Thai Phase III clinical trial and we would need to raise additional
funds to support the necessary manufacturing and development programs if we
apply for regulatory approval of the vaccine.
14
We will also need to raise additional capital if the Phase III clinical trials
are delayed or more costly than currently anticipated, or to continue operations
if the Phase III clinical trials are not successful, or if commercialization is
delayed for any other reason. Our future capital requirements are also dependent
on several other factors, including:
o the progress of other internal research and development projects;
o the need for leasehold improvements to facilities and the purchase of
additional capital equipment;
o the ability to attract and negotiate business development
opportunities; and
o the timing of revenue, if any, from AIDSVAX.
We cannot assure you that we will be able to raise funds when needed, or that
such funds will be available on satisfactory terms, or at all. We expect that
our ability to raise additional capital will be affected by whether AIDSVAX
achieves clinical success at either the interim or final analysis. However, if
clinical success is achieved at either point of analysis, we do not expect
difficulty in raising additional capital.
15
Risk Factors
Risks Relating to Our Business
If we are unable to commercialize our sole product candidate, AIDSVAX, we will
not have revenues to continue operations.
AIDSVAX is our only product candidate. We do not know whether the current or
planned formulations of AIDSVAX will be effective in preventing HIV infection.
The overall scientific knowledge of HIV is limited. Although our research has
indicated that AIDSVAX contains a protein that is critical in the infection
process, other proteins and elements may be necessary to develop an effective
vaccine.
Our success will depend entirely on the success of AIDSVAX. In particular, we
must be able to:
o establish the safety, purity, potency and efficacy of AIDSVAX in
humans;
o obtain regulatory approvals for AIDSVAX, including a preapproval
inspection of a manufacturing facility; and
o successfully commercialize AIDSVAX through collaborative
relationships.
If we are unable to commercialize AIDSVAX, we do not have other products from
which to derive revenue.
We may not be able to obtain regulatory approval to market AIDSVAX in the United
States or abroad on a timely basis, or at all.
Clinical testing is a long, expensive and uncertain process. We cannot assure
you that the data collected from our clinical trials will be sufficient to
support approval of AIDSVAX by the FDA or any foreign regulatory authorities,
that the clinical trials will be completed on schedule or, even if the clinical
trials are successfully completed and on schedule, that the FDA or any foreign
regulatory authorities will ultimately approve AIDSVAX for commercial sale.
To gain regulatory approval for the sale of AIDSVAX in the United States, we
believe, based on discussions with the FDA and the vote of its Vaccine and
Related Biological Products Advisory Committee, that the requirement for
regulatory approval will be a 30% greater reduction in HIV infections, at
statistical significance, among volunteers who received AIDSVAX compared with
volunteers who received a placebo. These discussions and the vote of the Vaccine
and Related Biological Products Advisory Committee, however, are not binding on
the FDA. In the context of our North
16
American/European clinical trial, which represents a small sampling from the
entire population, this means that to establish 30% efficacy at a statistically
significant level there must be an actual efficacy rate of over 60% at the
interim analysis, meaning that the trial results would need to demonstrate at
least a 60% greater reduction in HIV infections among volunteers receiving
AIDSVAX compared with the placebo group. We anticipate that the efficacy
required to obtain regulatory approval to market AIDSVAX in foreign countries
will vary from one country to another and may differ significantly from that
required by the FDA. We cannot assure you that the data collected from our North
American/European or Thai clinical studies will demonstrate the required level
of efficacy to permit the commercialization of AIDSVAX in the Unites States, in
Thailand or in any other foreign country.
Delay in completing our clinical trials could jeopardize our ability to obtain
regulatory approval to market AIDSVAX in the United States or abroad on a timely
basis.
Our clinical trials could be delayed for a variety of reasons, including:
o lower-than-anticipated retention rate of volunteers in the trial;
o serious adverse events related to the vaccine; or
o different interpretations of our preclinical and clinical data, which
can lead initially to inconclusive results.
Our inability to complete our clinical trials in a timely manner could
jeopardize our ability to obtain domestic or foreign regulatory approval.
If we fail to comply with extensive regulations enforced by domestic and foreign
regulatory authorities, the commercialization of AIDSVAX could be prevented or
delayed.
AIDSVAX is subject to extensive government regulations related to development,
clinical trials, manufacturing and commercialization. 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. It also subjects us to the following risks and obligations, among
others.
o The FDA or foreign regulators may refuse to approve an application if
they believe that applicable regulatory criteria are not satisfied.
o The FDA or foreign regulators may require additional testing for
safety and efficacy.
17
o If regulatory approval of a product is granted, the approval may be
limited to specific indications or limited with respect to its
distribution; for example, the FDA may approve the licenses for only
high-risk populations.
o The FDA or foreign regulators may not approve the AIDSVAX
manufacturing processes or manufacturing facilities, or may require
additional clinical studies to establish the safety, purity and
potency of AIDSVAX.
o Even if United States regulatory approval for AIDSVAX is obtained, the
license will be subject to continual review, and newly discovered or
developed safety or efficacy data may result in revocation of the
marketing license.
o If regulatory approval of the vaccine is granted, the marketing of
AIDSVAX would be subject to adverse event reporting requirements and
the FDA's general prohibition against promoting products for
unapproved or "off-label" uses.
o We will be subject to continual regulatory review and periodic
inspection and approval of manufacturing modifications, including
compliance with the FDA's Good Manufacturing Practices regulations.
In addition, the FDA stringently applies regulatory standards for manufacturing.
Failure to comply with any of these post-approval requirements can, among other
things, have resulted in warning letters, product seizures, recalls, fines,
injunctions, suspensions or revocations of marketing licenses, operating
restrictions and criminal prosecutions.
There can be no assurance that we will avoid incurring significant costs to
comply with such laws and regulations in the future, or that such laws or
regulations will not have a material adverse effect on us.
We have only a limited operating history and we expect to continue to generate
losses.
To date, we have engaged primarily in research, development and clinical
testing. At June 30, 2001, we had an accumulated deficit of approximately $81.3
million. We sustained net losses of approximately $2.1 million in 1996, $3.1
million in 1997, $9.2 million in 1998, $23.3 million in 1999, $31.8 million in
2000 and $11.8 million for the six months ended June 30, 2001. We expect to
incur substantial losses for at least an additional three to four years.
If we need additional funds, and are unable to raise them, we would have to
curtail or cease operations.
We cannot be certain that our existing capital resources, together with the
funding from the Centers for Disease Control and Prevention and the funding from
the National Institute of Allergy and Infectious Diseases, will be sufficient to
support our current and planned operations through commercialization of AIDSVAX.
We do not expect
18
AIDSVAX to be commercially available until at least the fourth quarter of 2004.
If taken to completion, the North American/European Phase III clinical trial is
anticipated to be completed in the fourth quarter of 2002. Once the trial is
completed, we will need to analyze the data and, if favorable, prepare our
Biologics License Application for submission to the FDA, which typically takes
between six and 12 months to be accomplished. The FDA review process could take
at least an additional six months. We anticipate that it would take at least six
months after obtaining regulatory approval for Genentech or another third party
to begin commercialization of AIDSVAX.
We may need to raise additional funds if:
o AIDSVAX is not sufficiently safe, pure and potent to commercialize in
its current formulation;
o our Phase III clinical trials are delayed, are not successful or are
more costly than currently estimated;
o commercialization of AIDSVAX is delayed for any other reason,
including the need to locate a third-party manufacturer other than
Genentech;
o we need to manufacture AIDSVAX ourselves using our own facilities; or
o additional trials are required.
We cannot assure you that we will be able to raise sufficient funds in the
future. If we fail to raise sufficient funds, we would have to curtail or cease
operations. We believe that our existing cash and cash equivalents and
investment securities, together with investment income and funds from
collaborative arrangements, will enable us to meet our forecasted expenditures
through the anticipated completion of our North American/European Phase III
clinical trial. However, we may need to raise additional funds to complete the
Thai Phase III clinical trial, and we may need to raise additional funds to
support the necessary manufacturing and development programs required to obtain
regulatory approval.
We face competition from several companies with greater financial, personnel and
research and development resources than ours.
The goal of developing an HIV vaccine is an area of interest to competitors, and
several companies with substantially greater financial, personnel and research
and development resources than ours have announced that they are trying to
develop an HIV vaccine and are planning, conducting or have completed Phase I or
Phase II clinical trials. Although our research has indicated that AIDSVAX
contains a protein that is critical in the infection process, other proteins and
elements may be necessary to develop an effective vaccine, and several of our
competitors are working to develop vaccines that activate a different arm of the
immune system. In addition, several of these companies are developing new "drug
cocktails" and other treatments that may mitigate the impact of the
19
disease. Even if we complete our Phase III clinical trials, obtain FDA and other
required regulatory approvals and commercialize AIDSVAX, our competitors may
develop vaccines or treatments that are as or more effective, or less complex or
less expensive to produce, than AIDSVAX.
Adverse publicity regarding the safety or side effects of AIDSVAX could harm our
business and cause our stock price to fall.
Despite the favorable safety tests that have been completed with respect to
AIDSVAX and our clinical trials, there still may be potential side effects or
safety concerns that have not yet come to light. If our studies or other
researchers' studies were to raise or substantiate concerns over the safety or
side effects of AIDSVAX or vaccine development efforts generally, our reputation
and public support for our clinical trials could be harmed, which would harm our
business and could cause our stock price to fall.
Failure to hire and retain key management employees could adversely affect our
ability to obtain financing, develop AIDSVAX, conduct clinical trials or execute
our business strategy.
We are highly dependent on our senior management and scientific staff,
particularly Donald Francis, M.D., D.Sc., our President, and Phillip Berman,
Ph.D., our Senior Vice President, Research & Development. These individuals have
played a critical role in raising financing, developing the vaccine and
conducting clinical trials. Dr. Francis is currently serving as our interim
chief executive officer while we conduct a search for a permanent chief
executive officer. The loss of the services of any of these key members of
senior management and scientific staff or our inability to hire a permanent
chief executive officer, may prevent us from achieving our business objectives.
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 the intellectual property rights of others, we may be prevented from
developing or marketing AIDSVAX.
We rely on patent and other intellectual property protection to prevent our
competitors from manufacturing and marketing AIDSVAX. Our technology, including
technology licensed from Genentech, 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. As a result, our success depends on our
ability, and Genentech's ability, to:
o obtain patents;
o protect trade secrets;
o operate without infringing upon the proprietary rights of others; and
o prevent others from infringing on our proprietary rights.
20
We cannot be certain that our patents or patents that we license from Genentech
will be enforceable and afford protection against competitors. We cannot assure
you that our operations or technology will not infringe intellectual property
rights of others. If we infringe the intellectual property of others, there can
be no assurance that we would be able to obtain licenses to use the technology
on commercially reasonable terms or at all.
We may become subject to product liability claims, which could reduce demand for
AIDSVAX or result in damages that exceed our insurance limitation.
We face an inherent risk of exposure to product liability suits in connection
with AIDSVAX vaccines being tested in human clinical trials and products that
may be sold commercially. We may become subject to a product liability suit if
AIDSVAX causes injury, or if vaccinated individuals subsequently become infected
with HIV. Regardless of merit or eventual outcome, product liability claims may
result in decreased demand for a vaccine, injury to our reputation, withdrawal
of clinical trial volunteers and loss of revenues.
Political or social factors may delay or reduce revenues by delaying or
impairing our ability to market AIDSVAX.
Products developed for use in addressing the HIV/AIDS epidemic have been, and
will continue to be, subject to competing and changing political and social
pressures. The political and social response to the HIV/AIDS epidemic has been
highly charged and unpredictable. Political or social pressures may delay or
cause resistance to bringing our product to market or limit pricing of our
product.
Risks Relating to Our Relationship with Genentech
We rely on Genentech for the manufacture of AIDSVAX. Our inability to
manufacture AIDSVAX, and our dependence on Genentech, may delay or impair our
ability to generate revenues, or adversely affect our profitability.
We have no manufacturing facilities. We are entirely dependent on third parties
to produce AIDSVAX. To date, we have relied on Genentech for this purpose.
Genentech currently has an exclusive option to manufacture AIDSVAX. Our license
agreement with Genentech does not specify the price we will be required to pay
Genentech to manufacture AIDSVAX. Genentech is not able to assure us that it
will have adequate manufacturing capacity to produce AIDSVAX for us on a
commercial scale.
We are working with Genentech to investigate alternative means of addressing our
potential future manufacturing needs. Our efforts to identify alternative
manufacturing solutions will require us to address the following risks.
o We may be unable to locate another manufacturer because the
availability and capacity of manufacturing facilities capable of
producing biological drug products
21
using mammalian cell culture fermentation in large scale is in short
supply and high demand on a worldwide basis.
o Any third-party manufacturer would have to prove to us, Genentech and
the FDA, and to other regulatory authorities, that its manufacturing
processes, facilities, procedures, and personnel comply with
government regulations and that it could consistently produce AIDSVAX
in accordance with regulatory standards.
o If we use a third-party manufacturer, or if we alter the formulation
of AIDSVAX, we may have to conduct additional clinical trials to show
the therapeutic equivalence of the product made by the other company
to the Genentech product.
o We may be unable to enter into a manufacturing agreement with a
third-party on reasonable terms, if at all.
o We have no way to determine the price we would be charged by a
third-party to manufacture AIDSVAX.
o If we are unable to locate a suitable third-party manufacturer, we may
need to manufacture AIDSVAX ourselves or through a joint venture,
which, if even possible, could require significant capital investment.
The cost and time to establish or locate manufacturing facilities to produce
AIDSVAX, other than through Genentech would be substantial and could delay
bringing AIDSVAX to market. This delay could require us to raise additional
funds, may delay or impair our ability to generate revenues or adversely affect
our profitability.
We intend to rely on Genentech and/or other third parties for the sale,
marketing and commercialization of AIDSVAX. Our lack of sales and marketing
personnel and distribution relationships may impair our ability to generate
revenues.
We have no sales, marketing or commercialization capability. Genentech currently
has an exclusive option to market and distribute AIDSVAX. We may rely on
Genentech to provide an established distribution system and sales force to
market AIDSVAX. If Genentech does not elect to exercise its option to market and
distribute the product, we will need to identify and engage another partner to
market and commercialize AIDSVAX. We cannot assure you that we would be able to
establish marketing or commercialization arrangements with third parties in a
timely manner or on favorable terms, or at all.
If Genentech were to terminate our license agreement, we would not be able to
develop or market AIDSVAX.
Our license agreement with Genentech permits Genentech to terminate the
agreement, or terminate the exclusivity of our license, if we:
22
o fail to use due diligence in developing, seeking regulatory approval
for, marketing or commercializing products covered by the Genentech
license agreement;
o fail to file the first market approval application for AIDSVAX with
the FDA prior to May 2002, subject to potential extension for up to
two years in certain circumstances, with any other extension being at
Genentech's sole decision;
o breach the license agreement and fail to cure the breach within the
time period provided in the agreement; and
o fail to maintain a tangible net worth of at least $1 million.
Risks Related to the Issuance of Series A Preferred Stock and Warrants
We may be obligated to redeem the Series A Preferred Stock, the common stock
issued on exercise of the warrants and/or the warrants at a premium to the
purchase or exercise price.
On May 23, 2001 we completed a private placement in which we issued 20,000
shares of our Series A 6% Cumulative Convertible Preferred Stock and common
stock purchase warrants for aggregate proceeds of $20.0 million. The terms of
our Series A preferred stock, and the warrants, give the selling stockholders
the right to require us to redeem all of the Series A preferred stock, common
stock issued on exercise of the warrants, and/or the warrants, under certain
circumstances, including:
o on May 23, 2004, with respect to the Series A preferred stock;
o upon a change of control, at a 15% premium to the purchase price, plus
accrued dividends, with respect to the Series A preferred stock;
o if (i) the November 2001 interim analysis of the North
American/European Phase III clinical trial does not result in a
recommendation by the Data and Safety Monitoring Board, which is
overseeing our North American/European clinical trial, either to
terminate the trial early so that we can seek FDA approval, or to
continue the trial to the scheduled conclusion, (ii) the interim
analysis is not completed by December 31, 2001, or (iii) the results
of the interim analysis are not announced by January 31, 2002, in each
case with respect to the Series A preferred stock;
o a 20% premium, if:
|X| the selling stockholders are unable to sell common stock under
the registration statement after the expiration of the time
periods described in the registration rights agreement;
23
|X| our stock is delisted or not quoted on an approved stock exchange
or on the Nasdaq National Market or Small Cap Market for 5
consecutive trading days;
|X| we do not have a sufficient number of shares of common stock
authorized to satisfy our obligations in connection with the
conversion of the Series A preferred stock or exercise of the
warrants;
|X| we commit a material breach under, or otherwise materially
violate the terms of, the transaction documents entered into in
connection with the issuance of the Series A preferred stock and
the warrants; or
|X| we are insolvent or take other actions, or allow actions to be
taken, as part of a bankruptcy proceeding.
Our redemption of the Series A preferred stock, common stock issued on
conversion of the Series A preferred stock or on exercise of the warrants,
and/or the warrants, would require the expenditure of a significant amount of
cash that would substantially exceed the proceeds that we received in the
private placement and could exceed our ability to make such payment or raise
additional capital.
We cannot issue common stock to a selling stockholder, whether as a dividend or
in redemption of securities, if after such issuance such selling stockholder
would be deemed the beneficial owner of more than 9.9% of our common stock.
Under the terms of the agreements between us and the selling stockholders, we
are, under limited circumstances, permitted to satisfy dividend and redemption
obligations through the issuance of common stock rather than the payment of
cash. We are not permitted to issue common stock to a selling stockholder if
after such issuance such selling stockholder would be deemed the beneficial
owner of more than 9.9% of our common stock. If we are unable to issue common
stock to satisfy our dividend and redemption obligations, we would be required
to use cash to satisfy our obligations, which could adversely affect our
business and operating results.
Our stockholders could experience substantial dilution as result of the terms of
our Series A preferred stock and warrants issued in the private placement to the
selling stockholders or our ability to issue additional preferred stock.
The 20,000 outstanding shares of Series A preferred stock are initially
convertible into approximately 861,383 shares of common stock, obtained by
dividing $20 million by $23.2185, which represents a 15% premium to the closing
price of $20.19, calculated for purposes of the private placement that closed on
May 23, 2001. The outstanding warrants are initially exercisable for 297,177
shares of common stock. The number of
24
shares of common stock issuable by us upon conversion of the Series A preferred
stock and exercise of the warrants can increase substantially in certain events,
including our issuance of common stock at prices less than the conversion price
of the Series A preferred stock or the exercise price of the warrants. For
example, the exercise price of the warrants initially is $25.2375 per share, but
the exercise price is subject to downward adjustment on May 23, 2002 if the
average of the closing bid prices for our common stock during the 20 trading
days prior to May 23, 2002 is less than $25.2375, to such average price, but not
below $14.133 per share. If the exercise price of the warrants adjusts to a
price below the conversion price of the Series A preferred stock, which is
currently $23.2185 per share, and if a warrant is exercised, then the conversion
price of the Series A preferred stock will automatically be reduced to the
exercise price of the warrants, but not to a price less than $14.133 per share.
Any such exercise or conversion price adjustment could result in the issuance of
up to approximately 790,000 additional shares, assuming exercise and conversion
prices of $14.133 per share.
In addition, we are permitted under limited circumstances to satisfy dividend
and redemption obligations on the preferred stock through the issuance of common
stock rather than through the expenditure of cash. Any increase in the number of
shares of common stock issuable pursuant to the terms of the Series A preferred
stock and the warrants, or our issuance of common stock to the selling
stockholders to satisfy our dividend and redemption obligations, may result in a
decrease in the value of the outstanding shares of our common stock.
Our board of directors has the authority to establish the designation of
19,979,500 additional shares of preferred stock that are convertible into common
stock without any action by our stockholders, and to fix the rights,
preferences, privileges and restrictions, including voting rights, of such
shares. The issuance and conversion of any such preferred stock would further
dilute the percentage ownership of our stockholders.
The perceived risk of dilution or any actual dilution occasioned by Series A
preferred stock, the warrant or additional preferred stock may cause our
stockholders to sell their shares, which would contribute to the downward
movement in stock price of the common stock. In addition, the significant
downward pressure on the trading price of the common stock could encourage
investors to engage in short sales, which would further contribute to a downward
pricing of the common stock.
If the holders of the Series A preferred stock and the warrants elect to have
the Series A preferred stock and the warrants assumed by a potential acquirer of
VaxGen, or redeemed by VaxGen, the acquirer could be deterred from completing
the acquisition.
The Series A preferred stock and the warrants permit the holders to elect to
have their shares of Series A preferred stock and the warrants remain
outstanding after an acquisition of VaxGen, and to have the acquirer assume all
of our obligations to the holder. The Series A preferred stock also permits the
holders of Series A preferred stock to require us to repurchase the Series A
preferred stock, at a premium, in connection with
25
an acquisition. The ability to force an acquirer to assume the Series A
preferred stock and the warrants, and the ability to force us to repurchase the
Series A preferred stock at a premium, in the event of a merger could deter a
potential acquirer from completing an acquisition of VaxGen.
Among our obligations that an acquirer might be forced to assume which would act
as a deterrent are:
o the price adjustment provisions, which could have an adverse effect on
the market value of the acquirer's outstanding securities;
o the obligation to register the resale of the common stock issuable
upon conversion of the Series A preferred stock and the warrants,
which could result in the sale of a substantial number of shares in
the market;
o the obligation to pay dividends on the Series A preferred stock;
o the obligation to redeem the Series A preferred stock, including
redemption at a premium to the purchase price, on the occurrence of
certain events or on May 23, 2004;
o the obligation to pay the holders of Series A preferred stock the
amount invested plus accrued dividends before any other stockholder
receives any payment if we are liquidated; and
o the obligation to seek the consent of the holders of the Series A
preferred stock before we can take certain actions, including the
issuance of securities that have senior or equal rights as the Series
A preferred stock or incurring unsecured indebtedness for borrowed
money, or take other actions with respect to the Series A preferred
stock or securities that have fewer rights than the Series A preferred
stock.
We may be required to obtain the consent of the holders of Series A preferred
stock before taking corporate actions, which could harm our business.
Our certificate of incorporation requires us to obtain the consent of the
holders of the Series A preferred stock before we may issue securities that have
senior or equal rights as the Series A preferred stock or incur unsecured
indebtedness for borrowed money, or take other actions with respect to the
Series A preferred stock or securities that have fewer rights than the Series A
preferred stock. We are also required to obtain the consent of the holders of
the Series A preferred stock before we amend or modify our certificate of
incorporation or bylaws to change any of the rights of the Series A preferred
stockholders. While these obligations may deter a potential acquirer from
completing a transaction with us, they may also prevent us from taking corporate
actions that would be beneficial to us and our stockholders.
26
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our exposure to market rate changes is related primarily to our debt securities
included in our investment portfolio. We do not hold any derivative financial
instruments. 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, limit duration by restricting the term, and hold
investments to maturity except under rare circumstances. Investments in both
fixed rate and floating rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted 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 June 30, 2001, we held government debt instruments and
corporate obligations in the principal amount of $43,200,000. If market interest
rates were to increase immediately and uniformly by 10% from levels at June 30,
2001, the fair value of our portfolio would decline by an immaterial amount. Our
exposure to losses as a result of interest rate changes is managed through
investing primarily in securities that mature in a period of one year or less
and holding them until maturity.
We have exposure to foreign exchange rate risk primarily related to our
conducting clinical trials in Thailand. Thailand is currently considered an
emerging economy. A material increase in the value of Thailand's currency
against the U.S. Dollar could cause an increase in our expenses. The majority of
our contracts associated with conducting clinical trials in Thailand are priced
in Baht. At the time these contracts were written, the Thailand exchange rate
was 37.5 Baht per one U. S. Dollar. As of June 30, 2001, we have incurred $2,000
in foreign exchange losses.
27
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds
The Company's Registration Statement under the Securities Act of 1933 (File No.
333-78065) was declared effective June 29, 1999. Offering proceeds, net of
aggregate expenses of approximately $4,400,000, were approximately $42,000,000.
All of the expenses related to the offering were direct or indirect payments to
others and not payments to our directors or officers (or their associates) or to
our affiliates or 10% shareholders. As of June 30, 2001, the Company has
utilized approximately $29,700,000 of net proceeds of the offering ($28,700,000
for working capital and $1,000,000 for leasehold improvements and equipment).
The Company has invested the remainder of the net proceeds from the offering in
short-term investments such as high-quality corporate issues and government
obligations.
Please see the description of our sale of redeemable convertible preferred stock
and warrants to Halifax Fund, L.P., Societe Generale, Velocity Investment
Partners, Ltd. and SDS Merchant Fund, L.P. in May 2001 provided above in Part I,
Item 1 - Financial Statements, under Notes to Condensed Financial
Statements--Redeemable Convertible Preferred Stock Financing, and in Part I,
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources, which descriptions are
incorporated herein by this reference. These sales were made in a private
transaction pursuant to the exemption from registration provided by Section 4(2)
of the Securities Act of 1933, as amended, and Rule 506 of Regulation D
promulgated thereunder. On July 20, 2001, a registration statement on Form S-3
that registered for resale certain shares of common stock issuable on conversion
of such shares of redeemable convertible preferred stock, and upon exercise of
such warrants, was declared effective by the Securities and Exchange Commission.
28
Item 4. Submission of Matters to a Vote of Security Holders
At our Annual Meeting of Stockholders, held on May 30, 2001, four matters were
voted upon. A description of each matter and tabulation of votes follows:
1. Election of Directors
Votes
--------------------------------------
Nominee For Withheld
- ------------------------------- ----------------- ---------------
Donald P. Francis 12,370,683 89,880
Phillip W. Berman 12,435,931 24,632
Randall L-W. Caudill 12,444,731 15,832
Stephen C. Francis 12,396,009 64,554
Ruth B. Kunath 12,443,665 16,898
William D. Young 12,445,081 15,482
There were no abstentions or broker non-votes.
2. Ratification of KPMG LLP as our independent auditors for the 2001
fiscal year ending December 31, 2001:
Votes
- --------------------------------------------------------------------------------
For Against Abstain
- --------------------------- -------------------- -------------------------
12,385,796 56,351 18,416
There were no broker non-votes.
3. To approve the Company's 2001 Employee Stock Option Plan:
Votes
- --------------------------------------------------------------------------------
For Against Abstain
- --------------------------- -------------------- -------------------------
12,210,112 214,088 36,363
There were no broker non-votes.
4. To approve the increase in the number of authorized shares of Common Stock
by 20,000,000 shares:
Votes
- --------------------------------------------------------------------------------
For Against Abstain
- --------------------------- -------------------- -------------------------
12,124,058 286,823 49,682
There were no broker non-votes.
29
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 and Regulation S-K:
The following exhibits are filed as part of this report:
- -------------- ------------------------------------------------------ ------------------------------------------------
Incorporated by Reference
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
Filing Exhibit
Exhibit No. Exhibit Form File No. Date No.
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
3.1 Certificate of Designations, Rights and Preferences 8-K 000-26483 5-24-01 3.1
of Series A 6% Cumulative Convertible Preferred Stock
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
10.1 Securities Purchase Agreement by and among the 8-K 000-26483 5-24-01 10.1
Company and Certain Stockholders
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
10.2 Registration Rights Agreement by and among the 8-K 000-26483 5-24-01 10.2
Company and Certain Stockholders
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
4.1 Form of Common Stock Purchase Warrant 8-K 000-26483 5-24-01 4.1
- -------------- ------------------------------------------------------ --------- -------------- ----------- -----------
(b) Reports on Form 8-K:
A current report on Form 8-K, dated May 24, 2001, was filed with the
Securities and Exchange Commission, reporting under Item 5 that the Company
raised $20 million through a private placement of convertible preferred
stock.
30
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: August 13, 2001 By:/s/ Carter A. Lee
---------------------------------
Carter A. Lee
Senior Vice President
Finance & Administration
(Principal Financial Officer)