U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO ________________.
Commission file number 0-22170
EPOCH BIOSCIENCES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 91-1311592
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21720 23rd Drive SE, #150, Bothell, WA 98021
(Address of principal executive office, including zip code)
(425) 482-5555
(Issuer's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports to be filed by Section 13 or
15(d) of the Exchange Act during the past 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
----- -----
State the number of shares outstanding of each of the issuer's classes of common
equity as of the latest practicable date.
Class Outstanding at November 12, 2001
----- --------------------------------
Common Stock, $.01 par value 25,641,677
Page 1 of 18
EPOCH BIOSCIENCES, INC.
INDEX TO FORM 10-Q
Part I. Financial Information Page Number
Item 1.Financial Statements........................................................ 3
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 8
Item 3.Quantitative and Qualitative Disclosures About Market Risk.................. 16
Part II. Other Information
Item 1.Legal proceedings........................................................... 17
Item 6.Exhibits and Reports on Form 8-K............................................ 17
Note: Items 2, 3, 4, and 5 are omitted, as they are not applicable.
Signature ............................................................................. 18
2
EPOCH BIOSCIENCES, INC.
BALANCE SHEETS
(unaudited)
ASSETS
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ ------------
Current assets:
Cash and cash equivalents ............................. $ 12,122,461 $ 8,076,726
Restricted cash ....................................... -- 97,369
Accounts receivable ................................... 197,686 350,977
Inventory ............................................. 77,201 203,823
Prepaid expenses and other assets ..................... 340,782 450,367
------------ ------------
Total current assets .............................. 12,738,130 9,179,262
Property and equipment, net ............................... 3,596,652 3,526,934
Intangible assets, net .................................... 3,938,453 4,634,173
Restricted cash ........................................... 629,622 565,929
Other assets .............................................. 31,905 19,265
------------ ------------
Total assets ...................................... $ 20,934,762 $ 17,925,563
============ ============
Current liabilities:
Accounts payable ...................................... $ 1,651,173 $ 287,775
Accrued liabilities ................................... 793,506 960,995
Deferred revenue - current portion .................... 337,611 620,043
Obligations under capital leases - current portion .... 32,889 15,303
------------ ------------
Total current liabilities ......................... 2,815,179 1,884,116
Deferred revenue - less current portion ................... 2,040,578 3,075,038
Deferred rent ............................................. -- 115,414
Obligations under capital leases - less current portion ... 18,602 9,222
Stockholders' equity:
Preferred stock, par value $.01; 10,000,000 shares
authorized; no shares issued and outstanding....... -- --
Common stock, par value $.01; 50,000,000 shares
authorized; shares issued and outstanding:
24,969,118 at December 31, 2000 and 25,641,677
at September 30, 2001 ............................. 249,691 256,417
Additional paid-in capital ............................ 82,302,448 82,683,474
Deferred compensation ................................. (63,922) (27,958)
Accumulated deficit ................................... (66,427,814) (70,070,160)
------------ ------------
Total stockholders' equity ........................ 16,060,403 12,841,773
------------ ------------
Total liabilities and stockholders' equity ........ $ 20,934,762 $ 17,925,563
------------ ------------
See accompanying notes to financial statements.
3
EPOCH BIOSCIENCES, INC.
STATEMENTS OF OPERATIONS
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2000 2001 2000 2001
------------ ------------ ------------ ------------
Revenue:
Product sales ........................... $ 44,560 $ 1,358,523 $ 257,280 $ 3,515,207
License fees and royalty income ......... 18,261 51,444 44,631 213,636
Contract research revenue ............... 120,000 539,098 120,000 1,539,098
------------ ------------ ------------ ------------
Total revenue ......................... 182,821 1,949,065 421,911 5,267,941
Operating expenses:
Cost of product sales ................... 22,551 869,753 51,237 2,496,620
Research and development ................ 772,442 1,079,344 2,403,622 3,405,062
Selling, general and administrative ..... 805,913 1,235,057 2,153,292 3,373,196
------------ ------------ ------------ ------------
Total operating expenses .............. 1,600,906 3,184,154 4,608,151 9,274,878
------------ ------------ ------------ ------------
Operating loss ........................ (1,418,085) (1,235,089) (4,186,240) (4,006,937)
Interest income, net .................... 270,037 88,165 670,860 364,591
------------ ------------ ------------ ------------
Net loss .............................. $ (1,148,048) $ (1,146,924) $ (3,515,380) $ (3,642,346)
============ ============ ============ ============
Net loss per share - basic and diluted .... $ (0.05) $ (0.04) $ (0.15) $ (0.14)
============ ============ ============ ============
Weighted average number of common shares
outstanding - basic and diluted ......... 24,874,593 25,639,873 23,731,138 25,569,810
See accompanying notes to financial statements.
4
EPOCH BIOSCIENCES, INC.
STATEMENTS OF CASH FLOWS
(unaudited)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
2000 2001
------------ ------------
Cash flows from operating activities:
Net loss ................................................... $ (3,515,380) $ (3,642,346)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization:
Property and equipment ................................. 108,210 472,882
Intangible assets ...................................... 12,226 276,773
Deferred stock compensation ............................ 35,964 35,964
Stock compensation charge .............................. 387,461 --
License rights ......................................... 12,225 27,507
Issuance of common stock warrants for services ........... -- 7,483
Interest accrued on restricted cash ...................... (25,504) (33,676)
Deferred revenue ......................................... 455,367 1,316,892
Deferred rent ............................................ -- 115,414
Changes in operating assets and liabilities, net
of acquisition:
Accounts receivable .................................... (46,983) (153,291)
Inventory .............................................. -- (126,622)
Prepaid expenses and other assets ...................... (70,923) (96,945)
Accounts payable ....................................... 136,777 7,294
Accrued liabilities .................................... 127,871 167,489
------------ ------------
Net cash used in operating activities ................ (2,382,689) (1,625,182)
------------ ------------
Cash flows from investing activities:
Security deposit on new facilities ....................... (592,893) --
Investment in license rights ............................. (250,000) (1,000,000)
Investment in leasehold improvements on new facilities ... (1,384,043) --
Acquisition of property and equipment .................... (346,835) (1,416,164)
Acquisition of Synthetic Genetics ........................ -- (357,692)
------------ ------------
Net cash used in investing activities ................ (2,573,771) (2,773,856)
------------ ------------
Cash flows from financing activities:
Repayment of capital leases .............................. (26,966)
Proceeds from sale of common stock ....................... 10,000,039 --
Proceeds from exercise of warrants ....................... 9,580,030 332,376
Proceeds from exercise of stock options .................. 58,032 47,893
------------ ------------
Net cash provided by financing activities ............ 19,638,101 353,303
------------ ------------
Net increase (decrease) in cash and cash equivalents ....... 14,681,641 (4,045,735)
Cash and cash equivalents at beginning of period ........... 1,772,274 12,122,461
------------ ------------
Cash and cash equivalents at end of period ................. $ 16,453,915 $ 8,076,726
============ ============
Supplemental disclosure of cash flow information -
Issuance of common stock in exchange for license rights .. $ 306,250 $ --
Interest payments ........................................ $ 153 $ 7,725
============ ============
See accompanying notes to financial statements.
5
EPOCH BIOSCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) NATURE OF BUSINESS
Epoch Biosciences, Inc. is developing and commercializing proprietary
technologies to enhance the study of genes. Our scientists are applying their
expertise in nucleic acid chemistry to develop products that improve current
methods of studying the genetic sequence, or genomes, of humans, animals and
plants. Our technology is based on our expertise in DNA chemistry, which allows
us to design, synthesize and modify synthetic DNA strands, or probes, that
selectively bind to the gene being studied. Using our DNA technology, we are
developing molecular tools and chemical compounds for improved genetic analysis.
We also manufacture and distribute specialty oligonucleotides through our San
Diego facility, including the recently launched Eclipse(TM) Probe System which
incorporates the performance advantages of some of our technologies.
We have adapted our chemical compounds and techniques to genetic
analysis systems developed by Applied Biosystems and Third Wave Technologies.
Our technology has broad potential in the developing field of genomics, or the
study of genes. Applications include the detection of infectious diseases,
diagnosis of inheritable diseases through prenatal testing, screening
populations to identify genetic markers that correlate with disease risk or drug
response, as well as any other genetic analysis based on DNA sequence
determination.
Our technologies are compatible with many of the genetic analysis
systems currently in use or in development. Just as microprocessors are found in
essentially all electronic appliances, our chemistries and technologies have the
potential to be incorporated in all genetic analysis systems.
(b) BASIS OF PRESENTATION
The unaudited financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes required
to be presented for complete financial statements. The accompanying financial
statements include all adjustments (consisting only of normal recurring
adjustments), which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. Certain 2000
balances have been reclassified to conform with the 2001 presentation.
The financial statements and related disclosures have been prepared with
the presumption that users of the interim financial information have read or
have access to the audited financial statements for the preceding fiscal year.
Accordingly, these financial statements should be read in conjunction with the
audited financial statements and the related notes included in Epoch's 2000
Annual Report on Form 10-KSB as filed with the Securities and Exchange
Commission.
(c) LOSS PER SHARE
Basic loss per share is computed based on weighted average shares
outstanding during the reporting period and excludes any potential dilution.
Diluted loss per share reflects potential dilution from the exercise or
conversion of securities into common stock or from other contracts to issue
common stock. Our capital structure includes the following common stock options
and common stock warrants, all of which have been excluded from net loss per
share calculations as they are antidilutive:
6
AT SEPTEMBER 30,
---------------------
2000 2001
--------- ---------
Outstanding options 1,419,756 2,296,134
Outstanding warrants 7,798,875 383,333
(d) REVENUE RECOGNITION
We earn product revenues through sales of chemical products and reagents
to manufacturers for incorporation into their products, from the sale of
specialty oligonucleotides to end users in the research fields of genomics and
molecular diagnostics, from license fees for the use of our proprietary
technology and know-how, and by providing services to third parties for
performing research and development on their behalf. We also have product
royalty agreements that result in royalties to us upon ultimate sales of
products by our partners.
Revenues from product sales that require no ongoing obligations are
recognized when shipped to the customer and title has passed.
Up front license fees are recognized over the term of the agreement to
which the license fees correspond, which may extend to the expiration of the
underlying patents, and based on the terms and future performance obligations in
the underlying agreements. Deferred revenue principally represents license fees
received in advance.
Contract research revenues are recognized as the research and
development activities are performed under the terms of commercial collaboration
and supply agreements and government grants. Direct costs related to these
contracts and grants are reported as research and development expenses.
Royalty revenues are recognized when earned under the terms of the
related agreements, which is generally upon our partner's sale of products
containing our technologies.
(e) CONCENTRATION OF CREDIT RISK
Credit is extended based on an evaluation of a customer's financial
condition and collateral is generally not required. The majority of revenues are
derived from private and public companies and public enterprises in the research
market in the United States.
One customer accounted for approximately 53% of revenues in the current
quarter and 54% of revenues in the current year to date. Revenues from this
customer were 100% of total revenues in the comparable quarter of the prior year
and 99% of revenues in the first nine months of 2000. Accounts receivable from
this customer amounted to $50,000 at September 30, 2001, and $37,000 at December
31, 2000.
Another customer accounted for approximately 21% of revenues in the
current quarter and 19% of revenues in the current year to date. Revenues from
this customer were not material in the prior year.
7
(f) INCYTE ALLIANCE
In September 2001 Epoch entered into an alliance with Incyte Genomics,
Inc. (Incyte). The alliance consists of three elements: Incyte granted a license
to Epoch for access to Incyte's LifeSeq(R) Gold and ZooSeq(R) databases to allow
Epoch to develop oligonucleotide probes based upon Incyte's unique gene content;
Epoch will be identified as Incyte's preferred third party provider of unique,
custom oligonucleotide probes and other proprietary hybridization probes to
Incyte's database users; and Epoch will supply Epoch Eclipse(TM) Probe Systems
to Incyte for Incyte's internal development purposes.
The cost of the license rights is included in intangible assets, on the
accompanying balance sheet. Amounts advanced to Epoch by Incyte as prepayments
for the supply of Eclipse probes are included in deferred revenue on the
accompanying balance sheet.
2. SYNTHETIC GENETICS ACQUISITION
We acquired the assets of Synthetic Genetics, a provider of specialty
oligonucleotides in San Diego California, on November 15, 2000 in a transaction
accounted for as a purchase business combination. Accordingly, the assets and
liabilities of Synthetic Genetics were recorded at their estimated fair values
at the acquisition date, and the results of Synthetic Genetics operations have
been included in our results from the acquisition date. The purchase price
amounted to $3,788,194.
The following summary, prepared on a pro forma basis, presents the
combined results of operations for the three and nine month periods ended
September 30, 2000, as if the acquisition had been consummated as of January 1,
2000, after including the impact of certain adjustments such as depreciation and
amortization on assets acquired.
Three Months ended Nine Months ended
September 30, 2000 September 30, 2000
------------------ ------------------
Revenues $ 561,137 $ 1,564,198
Net loss (1,308,834) (4,044,982)
Net loss per share $ (0.05) $ (0.17)
The pro forma results are not necessarily indicative of what actually
might have occurred if the acquisition had been completed as of the beginning of
the period presented. In addition, they are not intended to be a projection of
future results of operations and do not reflect any of the synergies that might
be achieved from combined operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. That
Act provides a "safe harbor" for forward-looking statements to encourage
companies to provide prospective information about themselves so long as they
identify these statements as forward-looking and provide meaningful, cautionary
statements identifying important factors that could cause actual results to
differ from the projected results.
Other than statements of historical fact, all statements in this
Quarterly Report on Form 10-Q and, in particular, any projections of or
statements as to our expectations or beliefs concerning our future financial
performance or financial position or as to future trends in our business or in
our markets, are forward-looking statements. Forward-looking statements reflect
our current expectations and are inherently uncertain and our actual results in
future periods may differ materially from our expectations concerning our
projections of those results or of future business trends described in this
Quarterly Report
8
on Form 10-Q. The sections below entitled "Certain Factors that May Affect Our
Business and Future Results" under Item 2, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," describe some, but not all,
of the factors, risks and uncertainties that could cause these differences,
including but not limited to the possibility that potential products utilizing
Epoch's technology may be ineffective or, although effective, may be
uneconomical to market; that third parties hold proprietary rights that preclude
Epoch or its licensees from marketing its products; or that third parties may
market superior products. Readers of this Quarterly Report on Form 10-Q are
urged to read those sections in their entirety. In light of the significant
uncertainties inherent in the forward-looking information included in this
document, the inclusion of information should not be regarded as a
representation by us or any other person that our objectives or plans will be
achieved. The forward-looking statements contained in this Quarterly Report on
Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q and
Epoch undertakes no obligation to update or revise the forward-looking
statements, whether as a result of new information, future events or otherwise.
The following discussion of Epoch's financial condition and results of
operations should be read in conjunction with the financial statements and the
related notes thereto included elsewhere in this Quarterly Report on Form 10-Q
and other documents Epoch files from time to time with the Securities and
Exchange Commission, including subsequent Current Reports on Form 8-K, Quarterly
Reports on Form 10-Q and Annual Reports on Form 10-K.
RESULTS OF OPERATIONS
OVERVIEW
Epoch develops proprietary products with commercial applications in the
fields of genomics and molecular diagnostics, including specialty chemistries,
probes and other genomic detection systems. We sell some of our products to end
users, and also provide chemical intermediate products that are utilized by our
collaborative partners and other parties in the manufacture of end-user products
by those parties. The sale of chemical intermediates began in December 1999, and
grew steadily throughout calendar 2000 as our technologies became more known and
validated, and as we executed collaborative agreements with Applied Biosystems
and Third Wave Technologies, among others. In November 2000, we acquired the
assets of Synthetic Genetics, a provider of specialty probes. The transaction
was accounted for using the purchase method of accounting.
We report revenues in three categories:
- Product Sales, which include revenues from sales of probes and
related genetic detection systems, and chemical intermediates;
- License fees and royalty income, which reflects amortization of
license fees received for the transfer of technology and know-how to
our partners, plus contractual royalty payments received for the
sale by third parties of products that include our technologies; and
- Contract research revenue, representing payments for research and
development performed under various collaborative agreements and
grants.
9
REVENUES
Product Sales. Product sales increased to $1,359,000 in the quarter
ended September 30, 2001 from $45,000 in the comparable quarter of the prior
year as a result of increased sales of specialty probes and genetic detection
chemistries to end users, including MGB TaqMan(R) probes to Applied Biosystems,
and higher levels of chemical intermediate sales to our collaborative partners.
Included in this quarter's revenues is $305,000 representing payments for a
contractual minimum level of product purchases. Product sales similarly
increased to $3,515,000 for the nine month period ended September 30, 2001 from
$257,000 in the prior year period as a result of the same higher level of sales
activity.
License Fees and Royalty Income. License fees and royalty income
increased to $51,000 in the quarter ended September 30, 2001 from $18,000 in the
comparable quarter of the prior year and increased to $214,000 for the nine
month period compared to $45,000 in the prior year period primarily as a result
of product royalties received from Applied Biosystems.
Contract Research Revenue. Contract research revenue increased to
$539,000 in the quarter and $1,539,000 for the nine month period ended September
30, 2001 from $120,000 in both periods of the prior year primarily as the result
of research and development activities under our agreements with Applied
Biosystems that began in August 2000 and with Third Wave Technologies that began
in January 2001.
OPERATING EXPENSES
Cost of Product Sales. Cost of product sales increased to $870,000 in
the quarter and $2,497,000 for the nine month period ended September 30, 2001,
from $23,000 in the comparable quarter and $51,000 in the comparable nine month
period of the prior year as a result of the increase in product sales. Costs as
a percentage of product sales, including contractual minimum payments in 2001,
rose from 51% in the quarter and from 20% for the nine month period of 2000 to
64% in the current quarter and 71% for the nine month period of 2001 for a
number of reasons, including a significantly different product mix due in part
to inclusion of Synthetic Genetics' specialty probe business, the impact of
building manufacturing capacity through investments in capital equipment and
personnel that is not yet being fully utilized, and the existence of contractual
product pricing levels for certain chemical intermediate products.
Research and Development. Research and development expenses increased to
$1,079,000 in the quarter ended September 30, 2001 from $772,000 in the
comparable quarter in the prior year and similarly increased to $3,405,000 for
the nine month period ended September 30, 2001 from $2,404,000 in the comparable
period of the prior year. The primary reasons for the increases include:
- Increased personnel costs of $144,000 in the quarter, and $643,000
for the nine month period, primarily as a result of incentive
compensation costs and increased headcount;
- Increased facilities and equipment expenses of $176,000 in the
quarter, and $509,000 for the nine month period, related to the new
Bothell headquarters facility occupied in late 2000;
- An increase in chemical reagents and operating supplies expense of
$151,000 in the quarter, and $384,000 for the nine month period,
resulting from increased headcount and activity; and
- Increased research and development costs of $223,000 in the quarter,
and $673,000 for the nine month period, included in cost of product
sales for personnel and other costs related to product
manufacturing. This amount will fluctuate quarterly depending on the
time and availability of personnel to conduct research and
development activities.
10
Selling, General, and Administrative. Selling, general, and
administrative expenses increased to $1,235,000 in the quarter ended September
30, 2001 from $806,000 in the comparable quarter in the prior year and similarly
increased to $3,373,000 for the nine month period ended September 30, 2001 from
$2,153,000 in the comparable period of the prior year. The primary reasons for
the increase include:
- Increased facilities related expenses over the prior year period of
$30,000 for the quarter, and $132,000 for the nine month period,
related to the new Bothell headquarters facility occupied in late
2000;
- Intangible asset amortization charges of $92,000 for the quarter,
and $277,000 for the nine month period, resulting from the
acquisition of Synthetic Genetics;
- Recruiting, relocation, and compensation expenses of $152,000 for
the quarter and $494,000 for the nine month period, related to the
addition of two vice presidents late in the 2001 first quarter;
- Increased travel expenses of $40,000 for the quarter, and $114,000
for the nine month period, resulting from increased corporate
development activities; and
- Increased sales, marketing, and administrative expenses of $371,000
for the quarter, or $826,000 for the nine month period, from the
Synthetic Genetics division acquired in late 2000.
These increased costs were partially offset by reduced costs in 2001
over 2000 which were primarily:
- In the first quarter of 2000 we paid $150,000 in expenses associated
with a warrant call and private placement;
- In the second quarter of 2000 we issued a warrant valued at $94,000
in exchange for public relations services;
- In the second quarter of 2000 we paid $94,000 in fees to The Nasdaq
National Market associated with our being relisted on the exchange;
- In the third quarter of 2000 we issued a warrant in exchange for
services in conjunction with our warrant call. We recognized
$293,000 in expense in conjunction with the issuance of this
warrant; and
- Increased costs of $44,000 in the quarter, and $128,000 for the nine
month period included in cost of product sales for personnel and
other costs related to product manufacturing. This amount will
fluctuate quarterly depending on the time and availability of
personnel to conduct research and development activities.
Interest Income, net. Interest income, net, decreased to $88,000 in the
third quarter of 2001 compared to $270,000 in the third quarter of 2000 and
similarly decreased to $365,000 in the nine month period ended September 30,
2001 from $671,000 in the comparable period of 2000 as a result of lower average
cash balances available for investment and lower realized interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Operating cash and cash equivalents amounted to $8,077,000 at September
30, 2001, a $4,046,000 decrease from December 31, 2000 balances. In addition, at
September 30, 2001 we have one short term certificate of deposit in the amount
of $97,000 and several long term certificates of deposit amounting to $566,000
pledged under a security agreement for an operating lease. Such amounts are
classified as restricted cash on the accompanying balance sheets, and are not
considered part of cash and cash equivalents.
11
Cash used in operations during the nine months ended September 30, 2001
amounted to $1,625,000 as a result of our net loss of $3,642,000 adjusted for
certain non-cash reconciling items and fluctuations in working capital accounts,
including:
- An increase in accounts receivable of $153,000 as a result of
increased product sales;
- An increase in inventory of $127,000 as a result of stocking higher
levels of chemical intermediates and other materials to support
higher product sales; and
- An increase in deferred revenue as the result of additional license
and other payments received from existing and new collaborations.
Cash used in investing activities amounted to $2,774,000 in the nine
months ended September 30, 2001. We paid $1,000,000 to Incyte Genomics, Inc. in
September 2001 for a license to use Incyte's LifeSeq(R) and ZooSeq(R) databases
to develop oligonucleotide probes based upon Incyte's unique gene content.
Acquisition of property and equipment totaled $1,416,000, including $1,013,000
in payments for capital expenditures made during the fourth quarter 2000 for
leasehold improvements and capital equipment for our new facilities. We also
paid $358,000 in acquisition related costs in 2001 for our November 2000
purchase of Synthetic Genetics.
Cash provided by financing activities amounted to $353,000 for the nine
months ended September 30, 2001, including the receipt of $332,000 from the
exercise of common stock warrants.
We believe that our existing cash and cash equivalents, together with
cash that we expect to generate from our operations, will be sufficient to meet
our capital needs for at least the next twelve months. However, it is possible
that we may need to raise additional funds to fund our activities beyond the
next year or to consummate acquisitions of other businesses, products or
technologies. We may be able to raise such funds by selling more stock to the
public or to selected investors, or by borrowing money. In addition, even though
we may not need additional funds, we may still elect to sell additional equity
securities or obtain credit facilities for other reasons. We may not be able to
obtain additional funds on terms that would be favorable to our shareholders and
us, or at all. If we raise additional funds by issuing additional equity or
convertible debt securities, the ownership percentages of existing shareholders
would be reduced. In addition, the equity or debt securities that we issue may
have rights, preferences or privileges senior to those of the holders of our
common stock.
During 2000 and the first half of 2001 we spent approximately $925,000
on capital equipment to expand our San Diego manufacturing operations. We expect
that we will continue to make capital equipment and other investments in that
business prospectively as our operations expand. We may finance these purchases
from our cash and cash equivalents on hand, cash generated from our operations,
borrowings, equity offerings, or a combination thereof.
CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS AND FUTURE RESULTS
We have never been profitable and anticipate future losses
We have never been profitable. Since our formation in 1985, we have
generated limited revenues. As of September 30, 2001, we had an accumulated
deficit of approximately $70 million. We expect to incur additional losses as we
expand our research and development and related product commercialization
efforts. There is no assurance that we will ever become profitable or that we
will sustain profitability if we do become profitable. Should we experience
continued or unforeseen operating losses, our capital requirements would
increase and our stock price would likely decline.
There is a risk that our technology may not be effective or might not work
12
The science and technology of synthetic DNA-based products is rapidly
evolving. While we are beginning to produce and supply products to customers for
commercial use, the majority of our products and proposed products are in the
discovery or early development stage. The proposed products will require
significant further research, development, and testing. We face the risk that
any or all of our products and proposed products could prove to be ineffective
or unsafe, or be an inferior product to products marketed by others because our
products are based on new and unproven innovative technologies. Some of our
current research and development activities may not result in any commercially
viable products. If we do not have commercially viable products, we will not be
able to generate funds internally to support operations.
We have limited manufacturing experience
While we have experience in researching and developing unique,
proprietary technologies to enhance the study of genes, and in manufacturing
oligonucleotides, our experience in manufacturing other chemical reagent
products is relatively limited. While we are beginning to produce and supply
products to customers for commercial use, we do not currently have the capacity
for high-volume production of our reagents. We will need to expand our reagent
manufacturing capacity in connection with our continued development and
commercialization of our products. Any delay or inability to expand our reagent
manufacturing capacity could materially adversely affect our reagent
manufacturing ability.
There is a risk that we do not own exclusive rights to our technology and our
competition may have access to our technology, which may prevent us from selling
our products
We attempt to protect our proprietary technology by relying on several
methods including United States patents. We also have international patent
applications that correspond to many of the U.S. patents and patent
applications. The issued patents and pending patent applications cover
inventions relating to the components of our core technologies. The expiration
dates of these patents range from January 2010 to June 2015. We make no
guarantee that any issued patents will provide us with significant proprietary
protection, that pending patents will be issued, or that products incorporating
the technology from our issued patents or pending applications will be free from
challenges by competitors. Further, third parties may hold proprietary rights,
which precede our claims and, therefore, could prohibit us from marketing the
proposed products.
Some of our technology might infringe on the rights of others, which may prevent
us from selling our products
There is a great deal of litigation regarding patents and other
intellectual property rights in the biomedical industry. We were defendants in
one action of this kind, which we settled prior to 1997. Although patent and
intellectual property disputes in the biomedical area are sometimes settled
through licensing or similar arrangements, this kind of solution can be
expensive, if a license can be obtained at all. An adverse determination in a
judicial or administrative proceeding or our failure to obtain necessary
licenses could prevent us from manufacturing and selling our products. This
would substantially hurt our business.
We face numerous competitors and changing technologies which could make our
products obsolete
Many companies do research and development and market products designed
to diagnose conditions based on a number of technologies and are developing
additional products using gene-based technologies. Many of these companies have
substantially greater capital resources, larger research and development and
marketing staffs and facilities and greater experience in developing products
than we have. Furthermore, our specific field in which we operate is subject to
significant and rapid technological change. Even if we successfully introduce
our products or proposed products, our
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technologies could be replaced by new technologies or our products or proposed
products might be obsolete or non-competitive.
We will be dependent upon our Agreement with Applied Biosystems for a
significant portion of our revenues for 2001 and 2002, and a reduction of sales
under or early termination of this Agreement would seriously harm our revenues
and operating results and would likely cause our stock price to decline
In January 1999, Epoch and Applied Biosystems entered into a License and
Supply Agreement pursuant to which we licensed some of our technology to Applied
Biosystems for use in its TaqMan(R) 5'-nuclease real-time PCR assays, or tests
(TaqMan(R) is a registered trademarK of Roche Molecular Systems, Inc.). In July
1999, we licensed our proprietary software, which speeds the design of chemical
tools used in the study of genes, to Applied Biosystems. In August 2000, the
agreement was amended to include Epoch manufacturing product for Applied
Biosystems. We will depend upon product sales to Applied Biosystems under this
agreement, and royalties from Applied Biosystems' sales of its TaqMan(R) assays,
for a significant portion of our revenues for 2001 and future periods. In
addition, we have incurred significant expenditures to date to equip our
facilities for the development of the assays we are developing under this
agreement.
Either party may terminate the agreement upon 180 days written notice.
In the event that this agreement is terminated, our revenues would be adversely
affected. We would also have a major investment in facilities and equipment that
we might be unable to redeploy for new projects. These events would seriously
harm our business, financial condition and operating results and would likely
cause our stock price to decline.
The loss of key personnel could adversely affect operations by impairing our
research and our efforts to commercialize and license our products
Our performance is greatly dependent upon our key management including
our Chief Executive Officer, Dr. William Gerber, and technical personnel and
consultants. Our future success will depend in part upon our ability to retain
these people and to recruit additional qualified personnel. We must compete with
other companies, universities, research entities and other organizations in
order to attract and retain highly qualified personnel. Although we have entered
into agreements with our key executive officers, we make no guarantee that we
will retain these highly qualified personnel or hire additional qualified
personnel. We currently maintain no key man life insurance on any of our
management or technical personnel.
The value of our common stock could change significantly in a very short time
The market price of our common stock may fluctuate significantly. For
example, our stock traded as high as $11.50 and as low as $1.28 over the 52
weeks ended October 23, 2001. The rapid price changes Epoch has experienced
recently, and throughout our history, place your investment in our common stock
at risk of total loss over a short period of time. We are in the biotechnology
industry and the market price of securities of biotechnology companies have
fluctuated significantly and these fluctuations have often been unrelated to the
companies' operating performance. Announcements by us or our competitors
concerning technological innovations, new products, proposed governmental
regulations or actions, developments or disputes relating to patents or
proprietary rights, and other factors that affect the market generally could
significantly impact our business and the market price of our securities.
Public opinion regarding ethical issues surrounding the use of genetic
information may adversely affect demand for our products
Public opinion regarding ethical issues related to the confidentiality
and appropriate use of
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genetic testing results may influence governmental authorities to call for
limits on, or regulation of the use of, genetic testing. In addition, these
authorities could prohibit testing for genetic predisposition to certain
conditions, particularly for those that have no known cure. Furthermore, adverse
publicity of public opinion relating to genetic research and testing, even in
the absence of any governmental regulation, could harm our business. Any of
these scenarios could reduce the potential markets for our products and
technologies, which could materially and adversely affect our revenues.
Government regulation of genetic research or testing may adversely affect the
demand for our products and impair our business and operations
Federal, state and local governments may adopt regulations relating to
the conduct of genetic research and genetic testing. These regulations could
limit or restrict genetic research activities as well as genetic testing for
research or clinical purposes. In addition, if state and local regulations are
adopted, these regulations may be inconsistent with, or in conflict with,
regulations adopted by other state or local governments. Regulations relating to
genetic research activities could adversely affect our ability to conduct our
research and development activities. Regulations restricting genetic testing
could adversely affect our ability to market and sell our products and our
technologies. Accordingly, any regulations of this nature could harm our
business.
Energy shortages may adversely impact operations
California and Washington states, among other areas, are currently
experiencing shortages of electrical power and other energy sources. In
California, this condition has periodically resulted in rolling blackouts, or
the temporary and generally unannounced loss of the primary electrical power
source. The computer and manufacturing equipment and other systems in our
operating locations in San Diego, California and Bothell, Washington are powered
by electricity. Currently, we do not have secondary electrical power sources to
mitigate the impacts of temporary or longer-term electrical outages. It is not
anticipated that the power shortages will abate soon, and therefore, our
operating facilities may experience brown-outs, black-outs, or other
consequences of the shortage, and may be subject to usage restrictions or other
energy consumption regulations that could adversely impact or disrupt our
commercial manufacturing and other activities. We are evaluating the cost
effectiveness of secondary power systems that would reduce our dependency on our
primary power sources. The cost of such systems is not currently known.
Health care cost containment initiatives could limit the adoption of genetic
testing as a clinical tool, which would harm our revenues and prospects
In recent years, health care payers as well as federal and state
governments have focused on containing or reducing health care costs. We cannot
predict the effect that any of these initiatives may have on our business, and
it is possible that they will adversely affect our business. In particular,
gene-based therapeutics, if successfully developed and commercialized, are
likely to be costly compared to currently available drug therapies. Health care
cost containment initiatives focused either on gene-based therapeutics or on
genetic testing could cause the growth in the clinical market for genetic
testing to be curtailed or slowed. In addition, health care cost containment
initiatives could also cause pharmaceutical companies to reduce research and
development spending. In either case, our business and our operating results
would be harmed.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. Statement 141 also
specifies the
15
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be accounted for
separately. Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of.
Epoch is required to adopt the provisions of Statement 141 immediately
and Statement 142 effective January 1, 2002. Furthermore, any goodwill and any
intangible asset determined to have an indefinite useful life that are acquired
in a purchase business combination completed after June 30, 2001 will not be
amortized, but will continue to be evaluated for impairment in accordance with
the appropriate pre-Statement 142 accounting literature. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
As of the date of adoption, Epoch expects to have unamortized goodwill
in the amount of $2,152,000 and unamortized identifiable intangible assets in
the amount of $2,366,000 all of which will be subject to the transition
provisions of Statements 141 and 142. Amortization expense related to goodwill
was $15,000 and $116,000 for the year ended December 31, 2000 and the nine
months ended September 30, 2001, respectively. Because of the extensive effort
needed to comply with adopting Statements 141 and 142, it is not practicable to
reasonably estimate the impact of adopting these Statements on Epoch's financial
statements at the date of this report, including whether any transitional
impairment losses will be required to be recognized as the cumulative effect of
a change in accounting principle.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Epoch's financial instruments include cash and short-term investment
grade debt securities. At September 30, 2001 the carrying values of Epoch's
financial instruments approximated their fair values based on current market
prices and rates. It is Epoch's policy not to enter into derivative financial
instruments. Epoch does not currently have material foreign currency exposure as
the majority of its international transactions are denominated in U.S. currency.
Accordingly, Epoch does not have a significant currency exposure at September
30, 2001.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Mordecai Jofen, as Trustee of the Harbor Trust, f/k/a The Edward
Blech Trust v. Epoch Biosciences, Inc., United States District
Court for the Southern District of New York, Case No. 01 CV 4129
The Harbor Trust ("Trust") (formerly the Edward Blech Trust)
filed a complaint against Epoch on May 16, 2001, alleging the
breach of a March 29, 1996 letter agreement ("Agreement") between
Epoch and David Blech. Pursuant to the Agreement, upon payment of
a pre-existing debt owed to Epoch by Blech (the "Ribonetics
Debt"), Epoch was to release to Blech from escrow warrants to
purchase 500,000 shares of Epoch common stock. Blech assigned all
of his rights under the Agreement to the Trust. The Trust's claim
is based on Epoch's alleged failure to timely register the common
stock underlying the warrants, allegedly resulting in damages to
Blech and/or the Trust of $10 million, based on the peak trading
value of Epoch's common stock. Epoch has filed and is awaiting a
decision on a motion to dismiss the complaint based on, among
other things, the positions that: (1) Blech and the Trust have
never had rights to receive or exercise the warrants because
Blech failed to perform a condition precedent, i.e., payment of
the Ribonetics Debt; and (2) Epoch had no obligation to register
the common stock unless and until Blech was entitled to the
warrants. Further, the warrants expired pursuant to the Agreement
in June 2000.
No trial has been scheduled in the case. While Epoch believes it
has a strong position, it is not possible at this time to state
the likelihood of an unfavorable outcome because of the inherent
uncertainties of litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(a) EXHIBITS
None
(b) REPORTS ON FORM 8K
None
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Epoch Biosciences, Inc.
Date: November 13, 2001 By: /s/ Bert W. Hogue
------------------------------------------
Bert W. Hogue
Vice President and Chief Financial Officer
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