1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________.
COMMISSION FILE NUMBER: 0-22788
AXYS PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-2969941
-------- ----------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
180 KIMBALL WAY
SOUTH SAN FRANCISCO, CALIFORNIA 94080
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(650) 829-1000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required 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. [X] Yes [ ] No
The number of outstanding shares of the registrant's Common Stock, $0.001
par value, was 30,138,892 as of July 31, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2
AXYS PHARMACEUTICALS, INC.
INDEX
PAGE
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)*
Condensed Consolidated Balance Sheets -- June 30, 1998 and
December 31, 1997........................................... 3
Condensed Consolidated Statements of Operations -- Three and
six months ended June 30, 1998 and 1997..................... 4
Condensed Consolidated Statements of Cash Flows -- Six
months ended June 30, 1998 and 1997......................... 5
Notes to Condensed Consolidated Financial Statements -- June
30, 1998.................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 3. Quantitative and Qualitative Disclosure About Market Risk... 15
PART II: OTHER INFORMATION
Item 1. Legal Proceedings........................................... 16
Item 2. Changes in Securities....................................... 16
Item 3. Defaults Upon Senior Securities............................. 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
Item 5. Other Information........................................... 16
Item 6. Exhibits and Reports on Form 8-K............................ 17
Signatures............................................................ 18
- ---------------
* The financial information contained herein should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the Securities and Exchange Commission on March 31, 1998.
2
3
AXYS PHARMACEUTICALS, INC.
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
JUNE 30,
1998 DECEMBER 31,
(UNAUDITED) 1997(1)(2)
----------- ------------
(IN THOUSANDS)
Current assets:
Cash and cash equivalents................................. $ 39,075 $22,398
Short-term marketable investments......................... 42,664 30,470
Prepaid expenses and other current assets................. 5,107 4,103
-------- -------
Total current assets................................... 86,846 57,511
Property and equipment, net................................. 20,824 14,454
Investment in joint venture................................. 3,395 --
Note receivable from officer................................ 605 775
Other assets................................................ 4,784 844
-------- -------
TOTAL ASSETS...................................... $116,454 $73,584
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 3,787 $ 1,622
Accrued compensation...................................... 2,552 1,793
Other accrued liabilities................................. 2,858 2,148
Current portion of deferred revenue....................... 7,620 5,410
Current portion of capital lease and debt obligations..... 7,318 3,390
-------- -------
Total current liabilities.............................. 24,135 14,363
Deferred revenue, noncurrent................................ -- 726
Capital lease and debt obligations, net of current
portion................................................... 19,681 14,605
Minority interest in Xyris Corporation...................... 500 --
Stockholders' equity:
Preferred stock........................................... -- --
Common stock.............................................. 289,102 117,786
Note receivable from officer.............................. -- (125)
Accumulated deficit....................................... (216,964) (73,771)
-------- -------
Total stockholders' equity............................. 72,138 43,890
-------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $116,454 $73,584
======== =======
- ---------------
(1) The balance sheet at December 31, 1997 has been derived from the audited
financial statement at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements.
(2) Represents the balances of Arris Pharmaceutical Corporation only.
See accompanying notes to condensed consolidated financial statements.
3
4
AXYS PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ --------------------
1998 1997* 1998 1997*
------- ------- --------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues.......................................... $ 9,097 $ 6,176 $ 17,531 $12,865
Operating expenses:
Research and development........................ 13,887 7,467 29,374 15,314
General and administrative...................... 3,690 1,588 7,122 3,203
Acquired in-process research and development.... -- -- 124,888 --
------- ------- --------- -------
Total operating expenses................ 17,577 9,055 161,384 18,517
------- ------- --------- -------
Operating loss.................................... (8,480) (2,879) (143,853) (5,652)
Interest income................................... 1,288 819 2,669 1,768
Interest expense.................................. (539) (159) (1,107) (381)
Equity interest in loss of joint venture.......... (445) (902)
------- ------- --------- -------
Net loss.......................................... $(8,176) $(2,219) $(143,193) $(4,265)
======= ======= ========= =======
Basic and diluted net loss per share.............. $ (0.27) $ (0.15) $ (4.87) $ (0.29)
======= ======= ========= =======
Shares used in computing basic and diluted net
loss per share.................................. 29,999 14,966 29,390 14,932
======= ======= ========= =======
- ---------------
* Reflects the results of Arris Pharmaceutical Corporation only.
See accompanying notes to condensed consolidated financial statements.
4
5
AXYS PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997*
--------- -------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................... $(143,193) $(4,265)
Adjustments to reconcile net loss to net cash and cash
equivalents used in operating activities:
Depreciation and amortization............................. 4,394 2,112
Equity interest in loss of joint venture.................. 902 --
Forgiveness of note receivable from officer............... 125 --
Acquired in-process research and development.............. 124,888 --
Changes in assets and liabilities:
Prepaid expenses and other current assets.............. 986 (613)
Other assets........................................... (3,357) (63)
Accounts payable, accrued liabilities and deferred
revenue............................................... (8,810) (3,294)
--------- -------
Net cash used in operating activities....................... (24,065) (6,123)
--------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Purchases................................................. (19,301) --
Maturities................................................ 49,019 749
Purchase of held-to-maturity security
Purchases................................................. -- (9,683)
Maturities................................................ -- 28,392
Purchase of restricted cash................................. -- (4,000)
Acquisition of Sequana, net of cash......................... 13,270 --
Investment in joint venture................................. (2,000) --
Purchase of property and equipment.......................... (2,332) (4,295)
--------- -------
Net cash provided by investing activities................... 38,656 11,163
--------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock.................. 1,586 528
Proceeds from notes receivable.............................. 603 --
Proceeds from notes payable and lease financing............. 2,000 4,350
Proceeds from minority interest............................. 500 --
Principal payments on notes payable and capital leases...... (3,143) (1,289)
--------- -------
Net cash provided by financing activities................... 1,546 3,589
--------- -------
Net increase in cash and cash equivalents................... 16,137 8,629
Cash and cash equivalents, beginning of period.............. 22,938 10,822
--------- -------
Cash and cash equivalents, end of period.................... $ 39,075 $19,451
========= =======
- ---------------
* Reflects the results of Arris Pharmaceutical Corporation only.
See accompanying notes to condensed consolidated financial statements.
5
6
AXYS PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Axys Pharmaceuticals, Inc., a Delaware corporation ("Axys" or the
"Company"), formerly known as Arris Pharmaceutical Corporation ("Arris"), is a
leader in the integration of drug discovery technologies from gene
identification through clinical development. Axys has research collaborations
with world-class pharmaceutical companies that are focused on the discovery of
small molecule therapeutics and cover a broad range of therapeutic areas,
including respiratory, cardiovascular, metabolic and infectious diseases, as
well as oncology and central nervous system disorders.
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Arris Protease, Inc., Arris Pharmaceuticals
Canada, Inc., Sequana Therapeutics, Inc. ("Sequana") (see "Acquisition of
Sequana," Note 2) and its wholly owned subsidiary, NemaPharm, Inc., and a
majority ownership in Xyris Corporation (see "Formation of Xyris Corporation,"
Note 4). All significant intercompany accounts and transactions have been
eliminated.
BASIS OF PRESENTATION
The unaudited consolidated financial statements included herein have been
prepared by the Company according to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in complete financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The financial statements reflect, in the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to state fairly the financial position and results of operations as of
and for the periods indicated. The results of operations for the three and six
month periods ended June 30, 1998 are not necessarily indicative of the results
to be expected for subsequent quarters or the full fiscal year.
These financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in the Company's 1997 Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
2. ACQUISITION OF SEQUANA
On January 8, 1998, the Company acquired all of the outstanding capital
stock of Sequana, a genomics company that uses industrial-scale gene discovery
technology and functional genomics to discover and characterize genes that are
believed to cause certain common diseases. The Company issued 14,618,013 shares
of Axys Common Stock in exchange for all the outstanding common stock of
Sequana, on the basis of 1.35 shares of Axys' common stock for one share of
Sequana common stock. The purchase price of $174.1 million consisted of (i) the
issuance of 14,618,013 shares of Company common stock valued at $168.1 million,
in exchange for all outstanding Sequana capital stock, (ii) the issuance of
Company warrants valued at $1.6 million in exchange for all outstanding Sequana
warrants, (iii) severance costs totaling $1.2 million, and (iv) transaction
costs totaling $3.2 million.
6
7
AXYS PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
The allocation of the purchase price was determined as follows:
Net tangible assets acquired........................... $ 45,882,000
Intangible assets acquired:
Workforce............................................ 3,300,000
In-process technology.................................. 124,888,000
------------
Total........................................ $174,070,000
============
The acquisition has been accounted for as a purchase and accordingly, the
original purchase price was allocated to acquired assets and assumed liabilities
based upon their fair value at the date of acquisition. The purchase price has
been allocated to assets acquired and to in-process research and development
which has been charged as an expense in the Axys consolidated financial
statements for the six months ended June 30, 1998. Intangibles acquired in the
acquisition are being amortized on a straight line basis over 36 months. The
operating results of Sequana from January 1, 1998 to June 30, 1998 have been
included in the Company's consolidated results of operations. The operating
results of Sequana from January 1, 1998 to January 8, 1998 (the date of
acquisition) are considered immaterial.
As part of the Company's acquisition of Sequana, the Company also obtained
50% ownership of Genos Biosciences, Inc. ("Genos") (see "Investment in Joint
Venture," Note 3).
The following unaudited pro forma financial summary is presented as if the
operations of the Company and Sequana were combined as of December 31, 1996. The
unaudited pro forma combined results are not necessarily indicative of the
actual results that would have occurred had the acquisition been consummated at
that date, or of the future operations of the combined entities. Nonrecurring
charges, such as the acquired in-process research and development charge of
$124.9 million are not reflected in the following pro forma financial summary.
PRO FORMA FINANCIAL SUMMARY FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997
(UNAUDITED)
3 MONTHS ENDED 6 MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1997
-------------- --------------
Contract Revenues.............................. $12,233 $ 21,431
Net Loss....................................... $(5,786) $(14,781)
Basic and diluted net loss per share........... $ (0.19) $ (0.49)
3. INVESTMENT IN JOINT VENTURE
In January 1997, Sequana and Memorial Sloan-Kettering Cancer Center
("MSKCC") formed Genos, a joint venture focused on the research and
identification of genes and related genetic information believed to be of value
in the prognosis, diagnosis and positive treatment of certain common cancers.
Sequana and MSKCC each own 50% of Genos and have committed to make capital
contributions of approximately $5 million each to fund its initial operations.
As of June 30, 1998, Sequana had invested $5.2 million in Genos, meeting its
initial commitment. The investment in Genos is accounted for under the equity
method.
Under the terms of the agreement, Sequana licensed certain of its
technology to Genos and has contracted with Genos to conduct research and
provide certain other services to the joint venture. Payments to date for such
research and services have not been material.
In connection with the formation of Genos, Sequana sold a warrant to MSKCC
to purchase 350,000 shares of the Sequana's common stock. That warrant was
assumed by the Company as part of the
7
8
AXYS PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
acquisition of Sequana on January 8, 1998, and was converted to a warrant to
purchase an aggregate of 472,500 shares at a price of $12.87 per share.
4. FORMATION OF XYRIS CORPORATION
In June 1998, in connection with the formation of Xyris Corporation, a
California corporation and majority-owned subsidiary of the Company ("Xyris"),
the Company and Bay City Capital LLC, a San Francisco based private merchant
bank ("BCC"), each received Series A Preferred Stock of Xyris. Xyris was
established in May 1998 to leverage Axys' existing pharmaceutical technology in
the agricultural market. In exchange for 2,950,000 shares of Xyris' Series A
Preferred Stock, representing 82% of the total outstanding shares of Xyris
capital stock, the Company granted to Xyris the right, for a limited period to
negotiate an exclusive license in the field of agriculture to all Axys
technology, including its genomics, combinatorial chemistry and small molecule
drug discovery technology. BCC purchased Xyris Series A Preferred Stock for
cash. In connection with BCC's purchase, the Company issued an option (the "Put
Option") to BCC, granting BCC the right to require the Company to purchase from
BCC all of the 150,000 shares of Series A Preferred Stock of Xyris (the "Xyris
Stock") held by BCC. If the Put Option is exercised, the Company would purchase
the Xyris Stock with shares of the Company's Common Stock, at its then market
price, with an aggregate market value on the date the Put Option is exercised
equal to $499,500, rounded down to the nearest whole number of shares. The Put
Option will terminate upon the earlier of January 5, 1999 or the occurrence of
certain other events, including the execution of an exclusive license in the
field of agriculture to all Axys technology.
5. NOTE PAYABLE
The Company has two lines of credit, one with Sumitomo Bank, Limited
("Sumitomo") and one with Sumitomo and Silicon Valley Bank jointly, to provide
up to $27 million dollars in debt financing. The loans are subject to certain
financial covenants over the course of the agreements. Interest is computed at
various rates based on a Eurodollar rate and the bank's prime rate, and range
from 7.3% to 7.9%, and 8.5%, respectively, at June 30, 1998. Interest and
principal payments are due monthly on $5.7 million of the balance and interest
only payments are due quarterly on $15.8 million of the balance, until September
30, 1998, at which time principal and interest will be payable in 48 monthly
installments under both lines of credit. The Company was in compliance with all
covenants under both lines of credit at June 30, 1998. The balance outstanding
on these loans at June 30, 1998 was $21.9 million.
6. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Financial Accounting Standards
Board's Statement No. 130, "Reporting Comprehensive Income" (Statement 130).
Statement 130 establishes new rules for the reporting and display of
comprehensive income and its components. Accordingly, the adoption of this
statement had no impact on the Company's net income or stockholders' equity.
Comprehensive income is the same as net income, as there are no adjustments
reported in stockholders' equity which are to be included in the computation.
8
9
AXYS PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 1998
(UNAUDITED)
7. RECENT ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (Statement 131). Statement 131 superseded
Statement No. 14, Financial Reporting for Segments of a Business Enterprise.
Statement 131 established standards for the way that public business enterprises
report information about operation segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. Statement 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The adoption of Statement 131 did not affect the results of
operations or financial position of the Company, but may affect the disclosure
of the segment information at December 31, 1998.
In March 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits" ("SFAS132"). SFAS 132 does not change the
recognition or measurement of pension or postretirement benefit plans, but
revises and standardizes disclosure requirements for pensions and other
postretirement benefits. The adoption of SFAS 132 has no impact on the Company's
results of operations or financial condition.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Financial
Instruments and for Hedging Activities" ("SFAS 133") which provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. SFAS 133 is effective for years beginning
after June 15, 1999 and is not anticipated to have an impact on the Company's
results of operations or financial condition when adopted.
9
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains, in addition to historical
information, forward-looking statements that involve risks and uncertainties.
The Company expressly disclaims any obligation to update this information or
publicly release any revisions or reflect events or circumstances after the date
of this report. The Company's actual results could differ significantly from the
results discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
below under "Certain Business Risks," as well as elsewhere herein, together with
those discussed in "Item 1. Business" and "Additional Risk Factors" in the
Company's report on Form 10-K for the fiscal year ended December 31, 1997, filed
with the Securities and Exchange Commission on March 31, 1998.
OVERVIEW
Since its inception in April 1989, the Company has devoted substantially
all of its resources to its research and development programs. To date, the
Company's only source of revenue has been its corporate collaborations with
Pharmacia & Upjohn, Inc. and its predecessors ("PNU"), Amgen, Inc. ("Amgen"),
Bayer AG ("Bayer"), SmithKline Beecham Corporation ("SB"), Merck & Co.
("Merck"), Abbott Laboratories ("Abbott"), and Bristol-Myers Squibb ("BMS"). In
addition, through its acquisition of Sequana on January 8, 1998, the following
corporate collaborations are included with the revenue sources listed above,
Boehringer Ingelheim International GmbH ("BI"), Corange International Ltd.
("Corange"), Parke-Davis ("PD"), and Glaxo-Wellcome ("Glaxo"). These
collaborations have taken a variety of forms including, in each case, certain of
the following elements: payments to the Company of an up-front commitment fee
and license fees, purchase of the Company's common stock, research funding
payments, purchase of compounds produced, reimbursement of patient collection
costs, milestone payments when milestones are achieved, and royalties upon the
sale of any resulting products. Where appropriate, the up-front commitment fees
have been recorded as deferred revenue until earned.
In May 1998, the Company and Glaxo announced that following a review of
their relationship, the companies will discontinue their collaboration to
discover genes associated with type 2 diabetes mellitus and obesity. Under the
terms of the dissolution agreement, Axys was granted exclusive rights to all
obesity family samples and data and non-exclusive rights to certain type 2
diabetes samples and data.
In June 1998, in connection with the formation of Xyris Corporation, a
California corporation and majority-owned subsidiary of the Company ("Xyris"),
the Company and Bay City Capital LLC, a San Francisco based private merchant
bank ("BCC"), each received Series A Preferred Stock of Xyris. Xyris was
established in May 1998 to leverage Axys' existing pharmaceutical technology in
the agricultural market. In exchange for 2,950,000 shares of Xyris' Series A
Preferred Stock, representing 82% of the total outstanding shares of Xyris'
capital stock, the Company granted to Xyris the right, for a limited period to
negotiate an exclusive license in the field of agriculture to all Axys
technology, including its genomics, combinatorial chemistry and small molecule
drug discovery technology. BCC purchased Xyris' Series A Preferred Stock for
cash. Also in June 1998, in connection with BCC's purchase of Xyris' Series A
Preferred Stock, the Company issued an option (the "Put Option") granting BCC
the right to require the Company to purchase from BCC all of the 150,000 shares
of Series A Preferred Stock of Xyris (the "Xyris Stock") held by BCC. If the Put
Option is exercised, the Company would purchase the Xyris Stock with shares of
the Company's Common Stock, at its then market price, with an aggregate market
value on the date the Put Option is exercised equal to $499,500, rounded down to
the nearest whole number of shares. The Put Option will terminate upon the
earlier of January 5, 1999 or the occurrence of certain other events, including
the execution of an exclusive license in the field of agriculture to all Axys
technology.
In June 1998, the Company announced an alliance with Roche Bioscience
("RBS") in the area of functional genomics. The alliance will focus on
evaluating the function of genes provided by RBS that
10
11
may serve as drug targets in the development of therapies for pain and other
conditions involving peripheral nervous system disorders. The alliance provides
for an upfront fee plus research support.
In June 1998, the Company announced an agreement between the Company's
Advanced Technologies Division and Parke-Davis ("PD"), the Pharmaceutical
Research Division of Warner-Lambert, to provide PD with a generic compound
screening library consisting of multiple small molecule synthetic organic
compound libraries created using the Company's combinatorial chemistry
technologies. The agreement consists of the delivery to PD by the Company of
compounds over three years and also calls for Axys to provide PD with the
enabling technologies and protocols for recreating the library and making
directed libraries, as well as other compounds.
In July 1998, the Company announced a collaboration with Signal
Pharmaceuticals, Inc. ("Signal"), for the accelerated discovery of compounds
that interact with specific cell signaling pathways. Signal has developed
proprietary assays for these signaling pathways which Signal will use to screen
small molecules derived from Axys' Advanced Technologies Division's compound
libraries. The agreement provides that Axys will receive an upfront fee, as well
as other payments upon the achievement of certain research and development
milestones.
In July 1998, the Company announced an agreement with Wyeth-Ayerst
Laboratories ("WA"), a division of American Home Products, to conduct a clinical
trial to study the role played by an Axys proprietary gene variant, or
polymorphism, in drug metabolism. The trial is designed to evaluate the effect
of the polymorphism on the metabolism of two classes of marketed drugs to
determine if patients who have the gene variant metabolize the drugs
differently. Under the terms of the agreement, WA will conduct the clinical
study and Axys will provide patient genotyping and certain intellectual
property.
In August 1998, the Company received written notification from Corange
that, due to a change in research priorities following the Roche Group's
acquisition of Corange, Corange was exercising, effective as of mid-February
1999, its contractual right to bring to a conclusion its osteoporosis
collaboration with the Company, including its related research support. Through
mid-February 1999, Corange remains contractually obligated to continue its
research funding and to make milestone-related payments if any milestones are
achieved. After the collaboration is concluded in mid-February 1999, the Company
expects to have the right to use the jointly-developed research results and to
have the right to pursue this osteoporosis research. The Company is currently
considering whether, after mid-February 1999, to continue this research by
itself, to continue this research with a new partner, or to suspend this
research and reallocate the resources currently devoted to it to other research
efforts.
The Company has not been profitable since inception and expects to incur
substantial losses for at least the next several years, primarily due to the
cost of its research and development programs, including preclinical studies and
human clinical trials. The Company expects that losses will fluctuate from
quarter to quarter, that such fluctuations may be substantial, and that results
from prior quarters may not be indicative of future operating results. As of
June 30, 1998, the Company's accumulated deficit was approximately $217 million.
Included in the Company's accumulated deficit at June 30, 1998 was approximately
$147 million of acquired in-process research and development from the
acquisition of Khepri Pharmaceuticals, Inc. in 1995 and the acquisition of
Sequana in January 1998.
11
12
RESULTS OF OPERATIONS
The following discussion of results of operations compares the combined pro
forma operating results for the three-and six-months ended June 30, 1997 (see
table below) of the Company and Sequana as if the acquisition had been effective
as of December 31, 1996 and the Company's consolidated operating results for the
three- and six- month periods ended June 30, 1998.
PRO FORMA OPERATING RESULTS FOR THE THREE AND SIX MONTHS ENDED JUNE 30,
1997 (UNAUDITED):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1997
------------------ ----------------
(IN THOUSANDS)
Revenues.................................. $12,233 $ 21,431
Operating expenses:
Research and development................ 15,126 30,486
General and administrative.............. 2,893 5,726
------- --------
Total operating expenses.................. 18,019 36,212
------- --------
Operating Loss............................ $(5,786) $(14,781)
======= ========
REVENUES
The Company's revenues on a pro forma basis decreased to $9.1 million and
$17.5 million for the three and six-month periods ended June 30, 1998,
respectively, compared to $12.2 million and $21.4 million, respectively, for the
comparable periods in 1997. All of the Company's revenues presently are
attributable to the Company's collaborations. Although revenues for the three-
and six-months ended June 30, 1998 were lower than for the same periods in 1997,
revenues for the three- and six-month periods ended June 30, 1998 were
positively affected, primarily due to: (i) the inclusion of the full effects of
the research funding for the collaboration with PD to develop novel therapeutic
products for the treatment of schizophrenia and bipolar disorder; and (ii) the
inclusion of the full effects of the research funding for the collaboration with
BMS to develop small molecule inhibitors of proteases involved in hepatitis C
virus infection. These revenue increases were more than offset by (i) the ending
of the research funded portion of a tryptase inhibitor collaboration with Bayer
during the fourth quarter of 1997; (ii) a planned reduction in research support
with Merck to develop small molecule inhibitors of proteases involved in
osteoporosis; and (iii) an overall reduction (despite record second quarter 1998
revenues) for the six-month period ended June 30, 1998 from the shipments of
small molecule synthetic organic compounds under two of the Company's
combinatorial chemistry collaborations with PNU and PD. The Company started
shipping under the combinatorial collaboration with PD in June 1998. Under the
existing collaboration with PNU, the Company has shipped approximately 109,000
compounds to date (250,000 total compounds are due under the three-year
agreement).
RESEARCH AND DEVELOPMENT
Research and development expenses decreased to $13.9 million and $29.4
million for the three and six-month periods ended June 30, 1998, respectively,
from $15.1 and $30.5 million in the comparable periods in 1997. The expense
reduction for the three- and six-month periods ended June 30, 1998 was primarily
due to reduced chemical consumption used in the production of small molecule
synthetic organic compounds (since fewer compounds were produced in the three-
and six-months ended June 30, 1998 compared to the same period in 1997), as well
as lower outside consulting fees associated with clinical trials in 1997
(calculated on a pro forma basis) as compared to 1998. Research and development
expenses as a percentage of total expenses, without the consideration of
acquired in-process research and development expenses of $124.9 million, has
decreased to approximately 79% of total expenses for the three- and six-months
ended June 30, 1998, compared to 83% for the comparable periods in 1997. The
Company expects that its research and development costs will increase for the
remainder of 1998 in absolute dollars when compared to pro forma amounts in
1997, primarily as a
12
13
result of further expansion of its proprietary research programs, and the
conduct of preclinical studies and clinical trials.
GENERAL AND ADMINISTRATIVE
The Company's general and administrative expenses increased to $3.7 million
and $7.1 million, respectively, for the three- and six-month periods ended June
30, 1998, from $2.9 and $5.7 million in the comparable periods in 1997. The
increase in expenses was primarily due to transition costs resulting from the
acquisition of Sequana (see "Acquired in-process research and development"
below), and administrative costs of closing down the Cambridge, Massachusetts
operation of Sequana's NemaPharm, Inc. subsidiary and relocating the activities
to South San Francisco, California, as well as an increase in headcount and
facilities required to support additional research programs. Some of the
reoccurring administrative costs common to both companies were eliminated by
combining the two companies. General and administrative expenses as a percentage
of total expenses, without the consideration of acquired in-process research and
development expenses of $124.9 million, represented approximately 21% for the
three- and six-month periods ended June 30, 1998, compared to 16% for the
comparable periods in 1997. The Company expects its general and administrative
costs will increase for the remainder of 1998 in absolute dollars when compared
to pro forma amounts in 1997, in order to provide corporate support for
expanding research and development efforts.
EQUITY INTEREST IN LOSS OF JOINT VENTURE
The equity interest in loss of joint venture at June 30, 1998 represents
the Company's portion of the losses for the three- and six-months ended June 30,
1998 of Genos Biosciences, Inc. ("Genos"). The Company holds a 50% interest in
Genos. Genos expects to incur increased operating losses in future periods as it
expands its research and development activities. Such losses will result in
corresponding changes in the Company's equity in net loss of joint venture.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
On January 8, 1998, the Company acquired Sequana, a genomics company based
in La Jolla, California. The acquisition was a tax-free reorganization accounted
for as a purchase. The Company issued approximately 14,620,000 shares of its
common stock in exchange for all the outstanding common stock of Sequana, on the
basis of 1.35 shares of the Company's common stock for one share of Sequana
common stock. The direct transaction costs associated with the acquisition were
approximately $3.2 million. The total purchase price of approximately $174
million was allocated to the assets acquired and liabilities assumed based upon
the fair value on the date of the acquisition. Approximately $125 million of the
purchase price was allocated to in-process research and development and charged
to expense at March 31, 1998.
INTEREST INCOME AND EXPENSE
Interest income increased to $1.3 million and $2.7 million, respectively,
for the three- and six-months period, ended June 30, 1998, compared to $819,000
and $1.8 million, respectively, for the comparable periods in 1997. The
increases were primarily due to the average cash balances between the periods,
resulting from the combination of the Company's cash and Sequana's cash. In
addition, the receipt of proceeds from research funding, collection of revenues
from the shipment of compounds under the collaborations with PNU and PD, and
reimbursement of patient collection fees by the Company's collaborators have
helped to sustain the cash levels. Interest expense increased to $538,000 and
$1.1 million, respectively, for the three- and six-month periods ended June 30,
1998, from $159,000 and $381,000, respectively, for the comparable periods in
1997. The interest expense increases were primarily due to higher debt balances
from the combination of the Company's and Sequana's debt financing. The Company
has primarily drawn down its lines of credit to purchase equipment and make
leasehold improvements. The Company expects interest expense to fluctuate as
financing needs change for future expansion of the Company's facilities and
acquisition of laboratory equipment.
13
14
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception primarily through
private and public offerings of its capital stock and through corporate
collaborations. As of June 30, 1998, the Company had realized approximately $95
million in net proceeds from offerings of its capital stock. In addition, the
Company had realized $91.7 million since inception from its corporate
collaborations.
The Company's principal sources of liquidity are its cash and marketable
investments, which totaled $81.7 million as of June 30, 1998. The Company has
two lines of credit totaling $27 million in borrowing capacity. As of June 30,
1998, the Company had borrowed a total of $21.7 million and had $4.2 million
remaining available under the agreements. Under the terms of the loan agreement,
the time available to draw down on one of the lines of credit has expired.
Net cash used in operating activities during the six-month period ended
June 30, 1998 was $24.1 million, compared to $6.1 million in the same period in
1997. The increase was primarily due to the increase in net loss for the six
months ended June 30, 1998 and the timing of cash received under the Company's
collaboration agreements. Cash used in operating activities is expected to
fluctuate from quarter to quarter depending, in part, upon the timing and
amounts, if any, of cash received from existing and any new collaboration
agreements.
The Company also spent approximately $2.3 million for the purchase of
property, plant and equipment during the six months ended June 30, 1998.
Additional equipment is expected to be needed as the Company increases its
research and development activities.
The Company's revenues presently are attributable to collaborations with
PNU, Merck, BMS, BI, Corange, PD, Glaxo, and RBS. The research support for the
Factor Xa program with PNU is currently under revision with an effort being made
to repartner this program. The osteoporosis program with Merck extends through
the fourth quarter of 1998. As discussed above, the research support from
Corange for the osteoporosis collaboration with Corange will continue through
mid-February 1999, at which time it will end. The combinatorial chemistry
collaborations with PNU and PD, and all other collaborations, extend beyond the
next 12 months. If the Company is unable to renew or replace any of these
collaborations, such events may have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company expects that its existing capital resources, including research
and development revenues from existing collaborations, will enable the Company
to maintain current and planned operations for at least three years. The Company
will need to raise substantial additional capital to fund its operations beyond
the end of such period. The Company expects that it will seek such additional
funding through new collaborations, through the extension of existing
collaborations or through public or private equity or debt financing.
There can be no assurance that the Company will be able to enter into new
collaborations on acceptable terms, or at all, or that additional financing will
be available to the Company on acceptable terms, or at all. Any additional funds
raised by issuing equity securities may result in further dilution to
stockholders. If adequate funds are not available, the Company may be required
to delay, to reduce the scope of, or to eliminate one or more of its research or
development programs or to obtain funds through arrangements with collaborative
partners or others that may require the Company to relinquish rights to certain
of its technologies or products that the Company would otherwise seek to develop
or commercialize itself.
CERTAIN BUSINESS RISKS
The Company is at an early stage of development. The Company's technologies
are, in many cases, new and all are still under development. All of the
Company's proposed products are in research or development and will require
significant additional research and development efforts prior to any commercial
use, including extensive preclinical and clinical testing, as well as lengthy
regulatory approval. There can be no assurance that the Company's research and
development efforts will be
14
15
successful, that any of its proposed products will prove to be safe and
efficacious in clinical trials or that any commercially successful products will
ultimately be developed by the Company. In addition, many of the Company's
currently proposed products are subject to development and licensing
arrangements with the Company's collaborators. Therefore, the Company is
dependent on the research and development efforts of these collaborators.
Moreover, the Company is entitled only to a portion of the revenues, if any,
realized from the commercial sale of any of the proposed products covered by the
collaborations. The Company has experienced significant operating losses since
its inception and expects to incur significant operating losses over at least
the next several years. The development of the Company's technology and proposed
products will require a commitment of substantial funds to conduct these costly
and time consuming activities. All of the Company's revenues to date have been
received pursuant to the Company's collaborations. Should the Company or its
collaborators fail to perform in accordance with the terms of their agreements,
any consequent loss of revenue under the agreements could have a material
adverse effect on the Company's business, financial condition and results of
operations. The proposed products under development by the Company have never
been manufactured on a commercial scale and there can be no assurance that such
products can be manufactured at a cost or in quantities necessary to make them
commercially viable. The Company has no sales, marketing or distribution
capability. If any of its proposed products subject to collaborative agreements
are successfully developed, the Company must rely on its collaborators to market
such products.
If the Company develops any products which are not subject to collaborative
agreements, it must either rely on other pharmaceutical companies to market such
products or must develop a marketing and sales force with technical expertise
and supporting distribution capability in order to market such products
directly.
The foregoing risks reflect the Company's early stage of development and
the nature of the Company's industry and products. Also inherent in the
Company's stage of development is a range of additional risks, including
competition, uncertainties regarding protection of patents and proprietary
rights, government regulation and uncertainties related to clinical trials and
regarding health care reform. These risks and uncertainties are discussed
further in "Item 1. -- Business -- Additional Risk Factors" on the Company's
report on Form 10-K for the year ended December 31, 1997, filed by the Company
on March 31, 1998.
IMPACT OF THE YEAR 2000
The Company has initiated modification of its information technology
systems to recognize the year 2000 and has begun converting critical hardware
and data processing systems. The Company expects the project to be substantially
complete by early 1999. The Company does not expect this project to have a
significant effect on operations, and the costs of modification are expected to
be insignificant. The Company is in the process of replacing its finance
information system which will be year 2000 compliant. In addition, the Company
is evaluating significant vendors and other third parties which could have an
effect on the Company's operations to ensure Year 2000 compliance by such
vendors and third parties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable.
15
16
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
In June 1998, the Company issued an option (the "Put Option") to Bay City
Capital Fund I ("BCC"), granting BCC the right to require the Company to
purchase from BCC all of the 150,000 shares of Series A Preferred Stock of Xyris
Corporation (the "Xyris Stock") held by BCC. If the Put Option is exercised, the
Company would purchase the Xyris Stock with shares of the Company's Common
Stock, at its then market price, with an aggregate market value on the date the
Put Option is exercised equal to $499,500.00, rounded down to the nearest whole
number of shares. The Put Option was granted in connection with a Series A
Preferred Stock Purchase Agreement between BCC, Xyris Corporation and the
Company, whereby BCC purchased Series A Preferred Stock of Xyris Corporation in
connection with the initial funding of Xyris Corporation as a majority owned
agricultural subsidiary of the Company. The Put Option will terminate upon the
earlier of January 5, 1999 or the occurrence of certain other events, including
the execution of an exclusive license in the field of agriculture to all Axys
Technology.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 1998 Annual Meeting of Stockholders was held on May 27, 1998.
Stockholders were asked (i) to elect directors to serve for the ensuing year and
until their successors are elected; and (ii) to ratify the selection of Ernst &
Young LLP as independent auditors of the Company for its fiscal year ending
December 31, 1998.
All of the matters were approved by the stockholders of the Company. The
number of shares voted for, against and withheld for each matter were:
ELECTION OF DIRECTORS: IN FAVOR WITHHELD
---------------------- ---------- --------
John P. Walker........................................ 22,538,577 152,764
Ann M. Arvin, M.D. ................................... 22,590,203 101,138
Brook H. Byers........................................ 22,521,027 170,314
Anthony B. Evnin, Ph.D. .............................. 22,518,127 173,214
Vaughn M. Kailian..................................... 22,592,672 98,669
Donald Kennedy, Ph.D. ................................ 22,534,922 156,419
Irvin Lerner.......................................... 22,537,643 153,698
J. Leighton Read, M.D. ............................... 22,578,958 112,383
BROKER
FOR AGAINST ABSTAIN NON-VOTES
---------- ------- ------- ---------
Selection of Ernst & Young LLP: 22,614,346 58,538 18,457 7,306,844
ITEM 5. OTHER INFORMATION
Pursuant to the Company's bylaws, stockholders who wish to bring matters or
propose nominees for director at the Company's 1999 annual meeting of
stockholders must provide specified information to the Company between February
26, 1999 and March 28, 1999 (unless such matters are included in the Company's
proxy statement pursuant to Rule 14a-8 under the Securities Exchange Act of
1934, as amended).
16
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENTS
------- ------------------------
10.4* 1997 Equity Incentive Plan
10.87** Termination of Collaborative Research Agreement between
Sequana and Glaxo Wellcome, Inc., effective February 1,
1998.
10.88** Combinatorial Chemistry Agreement between the Company and
Warner-Lambert Company, dated May 15, 1998.
10.89** Collaboration Agreement by and among the Company and its
subsidiaries, NemaPharm, Inc. and Sequana, and Roche
Bioscience, dated June 1, 1998.
27 Financial Data Schedule
- ---------------
* Compensatory Benefit Plan.
** Confidential treatment has been requested with respect to certain portions of
this exhibit.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the period covered
by this report.
17
18
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.
AXYS PHARMACEUTICALS, INC.
Date: August 13, 1998 By: /s/ FREDERICK J. RUEGSEGGER
------------------------------------
Frederick J. Ruegsegger
Senior Vice President Finance and
Corporate Development and
Chief Financial Officer
(Principal Financial and Accounting
Officer and Authorized Officer)
18
19
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENTS
------- ------------------------
10.4* 1997 Equity Incentive Plan
10.87** Termination of Collaborative Research Agreement between
Sequana and Glaxo Wellcome, Inc., effective February 1,
1998.
10.88** Combinatorial Chemistry Agreement between the Company and
Warner-Lambert Company, dated May 15, 1998.
10.89** Collaboration Agreement by and among the Company and its
subsidiaries, NemaPharm, Inc. and Sequana, and Roche
Bioscience, dated June 1, 1998.
27 Financial Data Schedule
- ---------------
* Compensatory Benefit Plan.
** Confidential treatment has been requested with respect to certain portions of
this exhibit.