================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-K/A (Amendment No. 1) ----------------- (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: December 31, 2001 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ----------------- Commission file number: 0-10824 ----------------- GENOME THERAPEUTICS CORP. (Exact name of registrant as specified in its charter) ----------------- Massachusetts 04-2297484 (State or other jurisdiction (IRS employer of incorporation or organization) identification number) 100 Beaver Street, Waltham, Massachusetts 02453 (Address of principal executive offices) (Zip Code) Registrant's telephone number: (781) 398-2300 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.10 Par Value (Title of Class) ----------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X] The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 18, 2002 was approximately $70,316,000. The number of shares outstanding of the registrant's common stock as of June 18, 2002 was 22,837,573. Documents Incorporated By Reference Portions of the registrant's proxy statement for use at its Annual Meeting to be held on June 25, 2002 are incorporated by reference into Part III. ================================================================================ Introductory Note In 1996 and 1997, the Company accounted for two stock options granted to the Company's former chief executive officer on a fixed plan basis. During the second quarter of 2002, the Company and its auditors determined that it was more appropriate to have accounted for these options on a variable plan basis in 1996 and 1997 in light of a cashless exercise provision contained in these options. As a result of required non cash adjustments to reflect this change in accounting treatment, the Company's net loss for the year ended December 31, 1996 was understated and the Company's net loss for the year ended December 31, 1997 was overstated. As reflected below, these changes have no cash impact to the Company and have no impact on Total Shareholders' Equity. A summary of the cumulative impact of the restatement on the Company's financial statements as of December 31, 2001 and December 31, 2000 is as follows: As previously reported As restated ------------- ------------ December 31, 2001 Accumulated deficit....... $(82,053,635) $(91,758,375) Additional paid in capital 146,509,995 156,214,735 Total shareholders' equity 66,731,938 66,731,938 As previously reported As restated ------------- ------------ December 31, 2000 Accumulated deficit....... $(71,963,333) $(81,668,073) Additional paid in capital 143,018,548 152,723,288 Total shareholders' equity 72,687,452 72,687,452 This Annual Report on Form 10-K/A amends the financial information set forth above contained in Items 6, 7, and 8 of the Company's Annual Report on Form 10-K previously filed for the fiscal year ended December 31, 2001. This Annual Report on Form 10-K/A only reflects the effects of the restatement and does not otherwise reflect events occurring after the filing of the original Annual Report on Form 10-K or otherwise modify or update those disclosures. 1 ITEM 6. Selected Consolidated Financial Data Only those numbers with an asterisk (*) have changed. For the Year Ended December 31, ------------------------------------------------------------------- 1997 1998 1999 2000 2001 ------------ ------------ ----------- ----------- ------------ Revenues: BioPharmaceutical............ $ 11,132,294 $ 18,135,038 $18,162,056 $11,851,091 $ 18,438,286 GenomeVision(TM) Services.... 3,300,881 3,913,376 6,665,529 13,594,143 17,302,239 ------------ ------------ ----------- ----------- ------------ Total revenues............. 14,433,175 22,048,414 24,827,585 25,445,234 35,740,525 Net loss...................... (12,274,795)* (12,967,676) (3,940,075) (5,846,839) (10,090,302) Net loss per common share..... (0.69)* (0.71) (0.21) (0.27) (0.45) Weighted average common shares outstanding................. 17,771,824 18,289,644 18,627,045 21,376,685 22,572,427 As of December 31, ----------------------------------------------------------- Cash and cash equivalents, restricted cash, warrant and long and short- term investments................... $44,492,461 $30,816,859 $26,778,026 $73,009,887 $67,341,249 Working capital...................... 31,298,804 19,749,608 19,447,189 51,601,069 44,156,478 Total assets......................... 61,230,003 48,920,973 45,443,236 90,251,004 82,739,598 Shareholders' equity................. 40,089,689 27,557,237 28,846,957 72,687,452 66,731,938 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Introductory Note: The only number in MD&A that has changed due to the restatement is accumulated deficit as of December 31, 2001, which went from $82.1 million to $91.8 million. Overview We are a biopharmaceutical company focused on the discovery and development of pharmaceutical and diagnostic products. We have eight established product development programs. Our lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). We have six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight projects, we have a portfolio of earlier stage internal drug discovery programs. We also maintain an active service business, GenomeVision/TM/ Services, providing drug discovery services to pharmaceutical and biotechnology companies and to the National Human Genome Research Institute. We receive payments under our bioPharmaceutical business from our product discovery alliances based on license fees, contract research and milestone payments during the term of the alliance. We also receive payments under our GenomeVision Services business from selling, as a contract service business, high quality genomic sequencing information to our customers, including pharmaceutical companies, biotechnology companies, governmental agencies, and academic institutions. In addition, under our GenomeVision Services business, subscribers to our PathoGenome/TM/ Database pay access fees for the information they obtain. We anticipate that our alliances will result in the discovery and commercialization of novel pharmaceutical, vaccine and diagnostic products. In order for a product to be commercialized based on our research, it will be necessary for our product discovery partner to conduct preclinical tests and clinical trials, obtain regulatory clearances, manufacture, sell, and distribute the product. Accordingly, we do not expect to receive royalties based upon product revenues for many years, if at all. 2 Our primary sources of revenue are from alliance agreements with pharmaceutical company partners, subscription agreements to our PathoGenome Database and government research grants and contracts. Currently, we have six product discovery alliances and one joint venture, of which we currently receive contract research funding from three of these alliances. In August 1995, we entered into an alliance with AstraZeneca to develop pharmaceutical, vaccine and diagnostic products effective against gastrointestinal infections or any other disease caused by H. pylori. In August 1999, the contract research under the alliance concluded and the program transitioned into AstraZeneca's pipeline. We are entitled to receive additional milestone payments and royalties based upon the development by AstraZeneca of any products from the research alliance. In December 1995, we entered into an alliance with Schering-Plough. Under this alliance, Schering-Plough can use our Staph. aureus genomic database to identify new gene targets for the development of novel antibiotics. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. In December 1996, we entered into our second research alliance with Schering-Plough to identify genes and associated proteins that Schering-Plough can utilize to develop new pharmaceuticals for treating asthma. In September 1997, we established our third research alliance with Schering-Plough for the development of new pharmaceutical products to treat fungal infections. As of December 31, 2001, we had substantively completed our research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. In September 1999, we entered into a strategic alliance with bioMerieux to develop, manufacture and sell in vitro pathogen diagnostic products for human clinical and industrial applications. As part of the strategic alliance, bioMerieux has purchased a subscription to our PathoGenome Database and has made an equity investment. In December 1999, we entered into a strategic alliance with Wyeth-Ayerst to develop drugs based on our genetic research to treat osteoporosis. In September 2000, we entered into a joint venture with ArQule, Inc. to identify novel anti-infective drug compounds. In May 1997, we introduced our PathoGenome Database and sold our first subscription. Since that date, we have continued to contract with subscribers on a non-exclusive basis, and, as of December 31, 2001, we had seven subscribers. Under our agreements, the subscribers receive non-exclusive access to information relating to microbial organisms in our PathoGenome Database. Subscriptions to the database generate revenue over the term of the subscription with the potential for royalty payments to us from future product sales. We do expect to see a revenue decline in subscription fees over the next two years as subscribers substantially complete data mining of PathoGenome. Since 1989, the United States government has awarded us a number of research grants and contracts related to government genomics programs. The scope of the research covered by grants and contracts encompasses technology development, sequencing production, technology automation, and disease gene identification. These programs strengthen our genomics technology base and enhance the expertise of our scientific personnel. In July 1999, we were named as one of the nationally funded DNA sequencing centers of the international Human Genome Project. We are entitled to receive funding from the National Human Genome Research Institute (NHGRI) of up to $17.4 million through February 2003, of which all funds have been appropriated and $12.0 million had been received through December 31, 2001. In October 1999, the NHGRI named us as a pilot center to the Mouse Genome Sequencing Network. We are entitled to receive $13.4 million in funding over forty-one months with respect to this agreement, of which all funds have been appropriated and $10.4 million had been received through December 31, 2001. In August 2000, we were named one of two primary centers for the Rat Sequencing Program from NHGRI. As part of the agreement, we will use remaining funding under the mouse award, as well as a portion of the remaining funding under the human award, to participate in this rat genome initiative. In October 2001, we acquired an exclusive license in the United States and Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia S.p.A (Biosearch). We will assume responsibility for the product development in the United States of Ramoplanin, currently in Phase III clinical trials. The agreement provides us with exclusive rights to develop and market oral Ramoplanin in the U.S. and Canada. Biosearch will retain all other rights to market and sell Ramoplanin. In addition, we are obligated to purchase bulk material from Biosearch and fund the completion of clinical trials, purchase bulk material, and pay a royalty on product sales. The combined total of bulk product purchases and royalties is expected to be approximately 26% of our net product sales. 3 We have incurred significant operating losses since our inception. As of December 31, 2001, we had an accumulated deficit of approximately $91.8 million. Our losses are primarily from costs associated with prior operating businesses and research and development expenses. These costs have often exceeded our revenues generated by our alliances, subscription agreements and government grants. Our results of operations have fluctuated from period to period and may continue to fluctuate in the future based upon the timing, amount and type of funding. We expect to incur additional operating losses in the future. We are subject to risks common to companies in our industry including unproven technology and business strategy, reliance upon collaborative partners and others, uncertainty of regulatory approval, uncertainty of pharmaceutical pricing, rapid technological change, history of operating losses, need for future capital, competition, patent and proprietary rights, dependence on key personnel, healthcare reform and related matters, availability of, and competition for, unique family resources, and volatility of our stock. New Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible Assets and SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. SFAS No. 142 addresses how intangible assets that are acquired should be accounted for in financial statements upon their acquisition and also how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Beginning on January 1, 2002, with the adoption of SFAS No. 142, goodwill and certain purchased intangibles existing on June 30, 2001, will no longer be subject to amortization over their estimated useful life. Rather, the goodwill and certain purchased intangibles will be subject to an assessment for impairment based on fair value. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 143 establishes accounting standards for the recognition and measurement of legal obligations associated with the retirement of tangible long-lived assets and requires recognition of a liability for an asset retirement obligation in the period in which it is occurred. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adotption of SFAS No. 142 did not have a material impact on the Company's financial position or results of operations. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement supercedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under this Statement, it is required that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and it broadens the presentation of discontinued operations to include more disposal transactions. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this Statement to have a material impact on its financial position or results of operations. Critical Accounting Policies In December 2001, the SEC requested that reporting companies discuss their most "critical accounting policies" in management's discussion and analysis of financial condition and results of operations. The SEC indicated that a "critical accounting policy" is one that is important to the portrayal of a company's financial condition and operating results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. 4 We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of this and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K. The Company's preparation of this Annual Report on Form 10-K requires it to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of its financial statements, and assurance that actual results will not differ from those estimates. Revenue Recognition BioPharmaceutical revenues consist of license fees, contract research and milestone payments from alliances with pharmaceutical companies. GenomeVision Services are revenues from government grants, fees received from custom gene sequencing and analysis services and subscription fees from the PathoGenome Database. Revenues from contract research, government grants, the PathoGenome Database subscription fees, and custom gene sequencing and analysis services are recognized over the respective contract periods as the services are provided. License fees and milestone payments are recognized as earned in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition. Milestone payments will be recognized upon achievements of the milestone as long as the milestone is deemed to be substantive and we have no other performance obligations related to the milestone. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. Clinical Trial Estimates Our clinical development trials related to Ramoplanin are primarily performed by outside parties. It is not unusual at the end of each accounting period to estimate both the total cost of the trials and the percent completed as of that accounting date. We then need to adjust our estimates when final invoices are received. To date, these adjustments have not been material to our financial statements, and we believe that the estimates that we made as of December 31, 2001 are reflective of the actual expenses incurred as of that date. However, readers should be cautioned that the possibility exists that the timing or cost of certain trials might be longer or shorter and cost more or less than we have estimated and that the associated financial adjustments would be reflected in future periods. Results of Operations Years Ended December 31, 2000 and 2001 Revenues Total revenues increased 40% from $25,445,000 in 2000 to $35,741,000 in 2001. BioPharmaceutical revenue increased 56% from $11,851,000 in 2000 to $18,438,000 in 2001 primarily due to increased milestone payments under our product discovery alliances with Wyeth-Ayerst and Schering-Plough. Revenue from GenomeVision Services increased 27% from $13,594,000 in 2000 to $17,302,000 in 2001 due to increased revenue recognized under our commercial sequencing business of approximately $935,000, as well as increased revenue recognized under our government grants with the National Human Genome Research Institute to participate in the Human Genome and Mouse (Rat) Genome sequencing projects of approximately $3,175,000. Costs and Expenses Total costs and expenses increased 45% from $33,780,000 in 2000 to $48,978,000 in 2001. Cost of services increased 39% from $11,715,000 in 2000 to $16,153,000 in 2001 primarily due to increased costs and expenses associated with the increase in GenomeVision Services revenue, as mentioned above. The increase consisted primarily of higher labor and material costs. 5 Research and development expenses include internal research and development, research funded pursuant to arrangements with our strategic alliance partners, as well as clinical development costs and expenses. Research and development expenses increased 58% from $15,191,000 in 2000 to $24,058,000 to 2001. This planned increase was primarily due to the acquisition and clinical development of Ramoplanin of approximately $5,549,000, as well as increased investment in our internal drug discovery programs, specifically in the area of anti-infectives and chronic human diseases of $4,138,000. Selling, general and administrative expenses increased 28% from $6,875,000 in 2000 to $8,767,000 in 2001 reflecting an expansion in the areas of corporate development, sales and marketing and clinical development administrative expenses. The increase consisted of an increase in payroll and related expenses, as well as recruiting and consulting expenses. Interest Income and Expense Interest income increased 15% from $3,331,000 in 2000 to $3,839,000 in 2001 reflecting an increase in funds available for investment as a result of (i) proceeds received from the sale of common stock through a public offering in 2000 and 2001, (ii) proceeds received from the exercise of stock options, and (iii) proceeds received from our employee stock purchase plan. Interest expense decreased 18% from $843,000 in 2000 to $692,000 in 2001. The decrease was due to a decrease in our outstanding balances under long-term obligations from approximately $7.8 million at December 31, 2000 to $5.6 million at December 31, 2001. Years Ended December 31, 1999 and 2000 Revenues Total revenues increased slightly by 2% from $24,828,000 in 1999 to $25,445,000 in 2000. BioPharmaceutical revenue decreased 35% from $18,162,000 in 1999 to $11,851,000 in 2000 primarily due to decreased contract research revenue and milestone payments under our product discovery alliances. Revenue from GenomeVision Services increased 104% from $6,665,000 in 1999 to $13,594,000 in 2000 primarily due to increased revenue recognized under our commercial sequencing business of approximately $691,000, as well as increased revenue recognized under our government grants with the National Human Genome Research Institute to participate in the Human Genome and Mouse (Rat) Genome sequencing projects of approximately $6,779,000. Costs and Expenses Total costs and expenses increased 15% from $29,389,000 in 1999 to $33,780,000 in 2000. Cost of services increased 157% from $4,560,000 in 1999 to $11,715,000 in 2000 primarily due to increased costs and expenses associated with the increase in GenomeVision Services revenue, as mentioned above. The increase consisted primarily of higher labor and material costs. Research and development expenses include internal research and development, research funded pursuant to arrangements with our strategic alliance partners, as well as clinical development costs and expenses. Research and development expenses decreased 25% from $20,376,000 in 1999 to $15,191,000 to 2000. This reduction in research and development expenses was primarily attributable to a decline in our internal drug discovery programs and research funded under our product discovery alliances during 2000. Selling, general and administrative expenses increased 54% from $4,453,000 in 1999 to $6,875,000 in 2000 primarily due to increases in payroll and related expenses, non-cash charges related to the issuance of stock options and restricted stock awards, as well as increased shareholder communication expenses caused by an expanded shareholder base. 6 Interest Income and Expense Interest income increased 124% from $1,488,000 in 1999 to $3,331,000 in 2000 reflecting primarily an increase in funds available for investment as a result of (i) proceeds received from the sale of common stock through a public offering in 2000, (ii) proceeds received from the exercise of stock options, and (iii) proceeds received from our employee stock purchase plan. Interest expense decreased 3% from $867,000 in 1999 to $843,000 in 2000. The decrease was due to a decrease in our outstanding balances under long-term obligations from approximately $8.9 million at December 31, 1999 to $7.8 million at December 31, 2000. Liquidity and Capital Resources Our primary sources of cash have been payments received from product discovery alliances, subscription fees, government grants, borrowings under equipment lending facilities and capital leases and proceeds from sale of equity securities. As of December 31, 2001, we had cash, cash equivalents, restricted cash and short-term and long-term investments of approximately $67,341,000. In 2001, we sold 127,500 shares of common stock in a series of transactions through the Nasdaq National Market, resulting in proceeds received of approximately $1,706,000, net of issuance costs. In 2001, we also issued 352,950 shares of common stock related to the exercise of stock options and our employee stock purchase plan, resulting in proceeds received of approximately $1,204,000. In 2000, we sold 1,500,000 shares of common stock in a series of transactions through the Nasdaq National Market, resulting in proceeds received of approximately $44,723,000, net of issuance costs. In 2000, we issued 1,288,943 shares of common stock related to the exercise of stock options and our employee stock purchase plan, resulting in proceeds received of approximately $3,528,000. In 1999, we also sold 678,610 shares of common stock to bioMerieux, a product discovery partner, resulting in proceeds received of approximately $3,732,000, net of issuance costs. In 1999, we also issued 472,459 shares of common stock related to the exercise of stock options, resulting in proceeds received of approximately $1,235,000. We received payments of approximately $18,087,000, $17,399,000 and $22,866,000 in 2001, 2000 and 1999, respectively, from our product discovery partners consisting of up-front license fees, contract research funding, subscription fee, milestone payments and expense reimbursement. We had various arrangements under which we financed certain office and laboratory equipment and leasehold improvements. We had an aggregate of approximately $5,632,000 outstanding under our borrowing arrangements at December 31, 2001. This amount is repayable over the next 34 months, of which $3,572,000 is repayable over the next 12 months. Under these arrangements, we are required to maintain certain financial ratios, including minimum levels of tangible net worth, total indebtedness to tangible net worth, minimum cash level, debt service coverage and minimum restricted cash balances. We had no additional borrowing capacity under these capital lease agreements at December 31, 2001. In February 2002, we entered into an additional line of credit for $3,500,000, of which $500,000 will be used to refinance a portion of the existing line of credit and the remaining $3,000,0000 to be used to finance office and laboratory equipment. Our operating activities used cash of approximately $3,091,000 in 2001 primarily due to an increase in our net loss and prepaid expenses and other assets, as well as a decrease in deferred revenue. These uses of cash were partially offset by a decrease in interest receivable, accounts receivable and unbilled costs and fees, as well as an increase in accounts payables and accrued liabilities. Our operating activities provided cash of approximately $3,011,000 in 2000 and used cash of approximately $1,616,000 in 1999. 7 Our investing activities provided cash of approximately $20,017,000 in 2001 through the conversion of marketable securities to cash and cash equivalents, partially offset by purchases of marketable securities, equipment and additions to leasehold. Our investing activities used cash of approximately $45,568,000 and $2,467,000 in 2000 and 1999, respectively, to purchase marketable securities, equipment and additions to leasehold, partially offset the conversion of marketable securities to cash and cash equivalents. Capital expenditures totaled $3,706,000 during 2001 consisting of leasehold improvements and purchases of laboratory, computer, and office equipment. We utilized existing capital lease and equipment financing arrangements to finance the majority of these capital expenditures. We currently estimate that we will acquire approximately $5,000,000 in capital equipment in 2002 consisting of primarily computers, laboratory equipment, and additions to leasehold improvement, which we intend to finance the majority of theses purchases under new financing arrangements. Financing activities used cash of approximately $2,217,000 and $205,000 in 2001 and 1999, respectively, primarily for payments of long-term obligations, partially offset by proceeds received from the sale of equity securities, exercise of stock options, and employee stock purchase plan. Financing activities provided cash of approximately $43,636,000 in 2000 primarily from proceeds received from the sale of equity securities, exercise of stock options, and employee stock purchase plan, net of payments of long-term obligations. At December 31, 2001, we had net operating loss and tax credits (investment and research) carryforwards of approximately $93,767,000 and $6,642,000, respectively, available to reduce federal taxable income and federal income taxes, respectively, if any. Net operating loss carryforwards are subject to review and possible adjustment by the Internal Revenue Service and may be limited, in the event of certain cumulative changes in ownership interests of significant shareholders over a three-year period in excess of 50%. Additionally, certain of these losses are expiring due to the limitations of the carryforward period. We believe that our existing capital resources are adequate for approximately two years under our current rate of investment in research and development. There is no assurance, however, that changes in our plans or events affecting our operations will not result in accelerated, or unexpected expenditures. On March 6, 2002, we sold convertible debentures to two institutional investors in a private placement transaction, raising $15 million in gross proceeds. The debentures may be converted into shares of our common stock at the option of the holder, at a price of $8.00 per share, subject to certain adjustments. The maturity date of the debentures is December 31, 2004, provided, that if any time on or after December 31, 2003 the Company maintains a net cash balance (i.e., cash and cash equivalents less obligations for borrowed money bearing interest) of less than $35 million, then the holders of the debentures can require that all or any part of the outstanding principal balance of the notes plus all accrued but unpaid interest be repaid. Interest on the debentures accrues at 6% annually. The investors also received warrants to purchase up to 487,500 shares of common stock at an exercise price of $8.00 per share, subject to certain adjustments. The warrants only become exercisable to the extent the debentures are converted or if certain other redemptions or repayments of the debentures occur. We plan to continue to invest in our internal research and development programs, including our lead candidate, Ramoplanin, currently in Phase III clinical development. We expect to incur $15-20 million in Phase III clinical development expenditures through the end of 2002. We expect to seek additional funding in the future through public or private financing. Additional financing may not be available when needed, or if available, it may not be on terms acceptable to us. To the extent that we raise additional capital by issuing equity or convertible debt securities, ownership dilution to stockholders will result. 8 In 2000, we entered into two separate interest-rate-swap agreements with a bank aggregating approximately $1,900,000. Under these agreements, we pay a fixed rate of 8.78% and receives a variable rate tied to the one month LIBOR rate. As of December 31, 2001, the variable rate was 3.83%. These swap agreements meet the required criteria, as defined in SFAS No. 133 to use special hedge accounting, and we have recorded an unrealized loss of $30,830 at December 31, 2001, through other comprehensive income, for the change in the fair value of the swap agreements. At February 28, 2002, this debt had been paid off in its entirety and the interest-rate-swap agreements expired. We generally place our marketable security investments in high quality credit instruments, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer, and type of instrument. We do not expect any material loss from our marketable security investments and therefore believe that our potential interest rate exposure is limited. This Form 10-K and documents we have filed with the Securities and Exchange Commission contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements represent our management's judgment regarding future events. Forward-looking statements typically are identified by use of terms such as "may," "will," "should," "plan," "expect," "intend," "anticipate," "estimate," and similar words, although some forward-looking statements are expressed differently. All forward-looking statements, other than statements of historical fact, included in this report regarding our financial position, business strategy and plans or objectives for future operations are forward-looking statements. We cannot guarantee the accuracy of the forward-looking statements, nor do we plan to update these forward-looking statements. You should be aware that our actual results could differ materially from those contained in the forward looking statements due to a number of risks affecting our business, including our ability and the ability of our alliance partners to (i) successfully develop products based on the Company's genomics information, (ii) obtain the necessary governmental approvals, (iii) effectively commercialize any products developed before our competitors and (iv) obtain and enforce intellectual property rights, as well as the risk factors set forth in this Annual Report on Form 10-K and those set forth in other filings that we may make with the Securities and Exchange commission from time to time. ITEM 8. Financial Statements and Supplementary Data Financial statements and supplementary data required by Item 8 are set forth at the pages indicated in Item 14(a) below. PART IV ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8K (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES (1) AND (2) See "Index to Consolidated Financial Statements and Financial Statement Schedules" appearing on page F-1. (3) Exhibits Exhibit No. Description - ------- ----------- 3 Restated Articles of Organization and By-laws/(1)/ 3.1 Amendment dated January 5, 1982 to Restated Articles of Organization/(2)/ 3.2 Amendment dated January 24, 1983 to Restated Articles of Organization/(3)/ 3.3 Amendment dated January 17, 1984 to Restated Articles of Organization/(4)/ 3.4 Amendment dated October 20, 1987 to the By-laws/(8)/ 3.5 Amendment dated December 9, 1987 to Restated Articles of Organization/(9)/ 3.6 Amendment dated October 16, 1989 to the By-law/(11)/ 9 Exhibit No. Description - ------- ----------- 3.7 Amendment dated January 24, 1994 to Articles Restated Articles of Organization/(14)/ 3.8 Amendment dated August 31, 1994 to Restated Articles of Organizatio /(14)/ 3.9 Amendment dated March 15, 2001 to Restated Articles of Organization/(33)/ 3.10 By-Laws of Genome Therapeutics Corp (as amended through July 24, 2001)/(34)/ 4.2 Form of Note dated March 5, 2002 received by Smithfield Fiduciary LLC and the Tail Wind Fund, Ltd./(35)/ 4.3 Form of Warrant received by Smithfield Fiduciary LLC and The Tail Wind Fund, Ltd./(35)/ 10.4 Incentive Stock Option Plan and Form of Stock Option Certificate/(1)/ 10.6 Genome Therapeutics Corp. (f/k/a Collaborative Research) Incentive Savings Plan/(6)/ 10.7 Amendment dated November 4, 1986 to the Genome Therapeutics Corp. (f/k/a Collaborative Research) Incentive Savings Plan dated March 1, 1985/(7)/ 10.14 1991 Stock Option Plan and Form of Stock Option Certificate/(12)/ 10.15 Lease dated November 17, 1992 relating to certain property in Waltham, Massachusetts/(13)/ 10.16 Lease dated June 3, 1993 relating to certain property in Waltham, Massachusetts/(13)/ 10.19 Employment Agreement with Robert J. Hennessey/(13)/ 10.22 Lease Amendment dated August 1, 1994 relating to certain property in Waltham, MA/(14)/ 10.24 1993 Stock Option Plan and Form of Stock Option Certificate/(14)/ 10.28 Agreement between the Company and AstraZeneca PLC (f/k/a Astra Hassle AB) dated August 31, 1995/(16)/* 10.29 Collaboration and License Agreement between the Company, Schering Corporation and Schering- Plough Ltd., dated as of December 6, 1995/(18)/* 10.30. Form of director Stock Option Agreement and schedule of director options granted/(17)/ 10.37. Lease amendment dated November 15, 1996 to certain property in Waltham, MA/(19)/ 10.38. Collaboration and License Agreement between the Company, Schering Corporation and Schering- Plough Ltd., dated as of December 20, 1996/(20)/* 10.39. Credit agreement between the Company and Fleet National Bank dated February 28, 1997/(21)/ 10.40. Credit agreement between the Company and U S Trust (f/k/a Sumitomo Bank, Limited) dated July 31, 1997/(22)/ 10.41. Collaboration and License Agreement between the Company and Schering Corporation, dated September 22, 1997/(23)/* 10.42. Collaboration and License Agreement between the Company and Schering-Plough Ltd. dated September 22, 1997/(23)/* 10.43. Credit modification agreement between the Company and Fleet National Bank, dated March 9, 1998/(24)/ 10.44. 1997 Directors' Deferred Stock Plan/(25)/ 10.45. 1997 Stock Option Plan/(25)/ 10.46. Amended Employment Agreement with Robert J. Hennessey/(26)/ 10.47. Collaboration and License Agreement between the Company and American Home Products, Inc., acting through its Wyeth-Ayerst Division, dated December 20, 1999/(27)/ 10.49. Collaboration and License Agreement between Genome Therapeutics Corporation and bioMerieux Incorporated dated as of September 30, 1999/(29)/ 10.50. Registration Rights Agreement between the Company and bioMerieux Alliance sa dated September 30, 1999/(30)/ 10.51. Compound Discovery Collaboration Agreement, dated October 17, 2000 between the Company and ArQule, Inc./(31)/* 10.52. 2001 Incentive Plan/(32)/ 10.53. Stock Option Agreements with Steven M. Rauscher/(32)/ 10.55. Employment Letter with Steven M. Rauscher/(34)/ 10.56. Employment Letter with Stephen Cohen/(34)/ 10.57. Employment Letter with Richard Labaudinere PhD/(34)/ 10 Exhibit No. Description - ------- ----------- 10.58. Purchase Agreement dated March 5, 2002 among Smithfield Fiduciary LLC, The Tail Wind Fund, Ltd. and the Company/(35)/ 10.59. Registration Rights Agreement dated March 5, 2002 among Smithfield Fiduciary LLC, The Tail Wind Fund, Ltd. and the Company/(35)/ 10.60. Employment Letter with Robert J. Hennessey/(36)/ 10.61. License and Supply Agreement between the Company and Biosearch Italia, S.P.A., dated October 8, 2001/(36)/* 23.1 Consent of Arthur Andersen LLP Independent Public Accounts/(37)/ 99.1 Risk Factors/(36)/ 99.2 Letter to Commission Pursuant to Temporary Note 3T/(37)/ - -------- /* / Confidential treatment requested with respect to a portion of this Exhibit. /(1)/ Filed as exhibits to the Company's Registration Statement on Form S-1 (No. 2-75230) and incorporated herein by reference. /(2)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 27, 1982 and incorporated herein by reference. /(3)/ Filed as exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended February 26, 1983 and incorporated herein by reference. /(4)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 25, 1984 and incorporated herein by reference. /(6)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1985 and incorporated herein by reference. /(7)/ Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1986 and incorporated herein by reference. /(8)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended August 31, 1987 and incorporated herein by reference. /(9)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 28, 1987 and incorporated herein by reference. /(11)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989 and incorporated herein by reference. /(12)/ Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference. /(13)/ Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference. /(14)/ Filed as exhibits of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1994 and incorporated herein by reference. /(16)/ Filed as an exhibit to the Company's Annual Report on Form 10-K/A3 for the year ended August 31, 1995 and incorporated herein by reference. /(17)/ Filed as an exhibit to the Company Registration Statement on Forms S-8 (File No. 33-61191) and incorporated herein by reference. /(18)/ Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 25, 1995 and incorporated herein by reference. /(19)/ Filed as an exhibit to the Company's 10-K for fiscal year ended August 31, 1996 and incorporated herein by reference. /(20)/ Filed as an exhibit to the Company's 10-Q/A for the quarter ended March 1, 1997 and incorporated herein by reference. /(21)/ Filed as an exhibit to the Company's 10-Q for the quarter ended May 31, 1997 and incorporated herein by reference. /(22)/ Filed as an exhibit to the Company's 10-K for fiscal year ended August 31, 1997 and incorporated herein by reference. 11 /(23)/ Filed as exhibits to the Company's 10-Q for the quarter ended February 28, 1998 and incorporated herein by reference. /(24)/ Filed as an exhibit to the Company's 10-Q for the quarter ended May 30, 1998 and incorporated herein by reference. /(25)/ Filed as exhibits to the Company's Registration Statement on Forms S-8 (333-49069) and incorporated herein by reference. /(26)/ Filed as an exhibit to the Company's 10-K for the fiscal year ended August 31, 1998 and incorporated herein by reference. /(27)/ Filed as an exhibit to the Company's 8-K filed on March 8, 2000 and incorporated herein by reference. /(29)/ Filed as an exhibit to the Company's 10-Q for the quarter ended November 27, 1999 and incorporated herein by reference. /(30)/ Filed as an exhibit to the Company's Registration Statement on Forms S-3 (333-32614) and incorporated herein by reference. /(31)/ Filed as an exhibit to the Company's 10-K for the quarter ended November 25, 2000 and incorporated herein by reference. /(32)/ Filed as an exhibit to the Company's Registration Statement on Form S-8 (333-58274) and incorporated herein by reference. /(33)/ Filed as an exhibit to the Company's 10-Q for the quarter ended February 24, 2001 and incorporated herein by reference. /(34)/ Filed as an exhibit to the Company's 10-Q for the quarter ended September 29, 2001 and incorporated herein by reference. /(35)/ Filed as an exhibit to the Company's 8-K filed on March 6, 2002 and incorporated herein by reference. /(36)/ Filed as an exhibit to the Company's 10-K for the fiscal year ended December 31, 2001 and incorporated herein by reference. /(37)/ Filed herewith. 12 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Genome Therapeutics Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on June 24, 2002. GENOME THERAPEUTICS CORP. /S/ STEPHEN COHEN -------------------------------------- Stephen Cohen Senior Vice President and Chief Financial Officer 13 GENOME THERAPEUTICS CORP. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page ---- Report of Independent Public Accountants.................................................. F-2 Consolidated Balance Sheets as of December 31, 2000 and 2001.............................. F-3 Consolidated Statements of Operations for the Years Ended December 31, 1999, 2000 and 2001 F-4 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 2000 and 2001 F-6 Notes to Consolidated Financial Statements................................................ F-7 Note: The only amounts which changed in these restated financial statements are accumulated deficit and additional paid in capital. See Note 1(m) for a discussion of the changes. F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Genome Therapeutics Corp.: We have audited the accompanying consoldiated balance sheets of Genome Therapeutics Corp. and subsidiary (the Company) as of December 31, 2000 and 2001, and the related consolidated statements of operations, shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's managementment. Our responsibility is to express an opinion on these consoldiated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Genome Therapeutics Corp. and subsidiary as of December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States. /S/ ARTHUR ANDERSEN LLP Boston, Massachusetts February 28, 2002 (except with respect to the matter discussed in Note 1(m) as to which the date is June 18, 2002) F-2 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, ------------------------------ 2000 2001 -------------- -------------- ASSETS (as restated) (as restated) Current Assets: Cash and cash equivalents................................................ $ 10,095,817 $ 24,805,385 Short-term investments (held-to-maturity)................................ 51,743,917 29,961,540 Interest receivable...................................................... 1,466,808 1,074,726 Accounts receivable...................................................... 827,106 513,885 Unbilled costs and fees.................................................. 796,072 164,465 Prepaid expenses and other current assets................................ 900,547 1,583,320 -------------- -------------- Total current assets................................................... 65,830,267 58,103,321 Property and Equipment, at cost: Laboratory and scientific equipment...................................... 18,823,063 20,918,535 Leasehold improvements................................................... 8,302,308 8,798,842 Equipment and furniture.................................................. 1,134,320 1,267,854 -------------- -------------- 28,259,691 30,985,231 Less--Accumulated depreciation........................................... 15,225,148 19,091,703 -------------- -------------- 13,034,543 11,893,528 Restricted Cash (Note 2).................................................. 200,000 200,000 Long-term Investments (held-to-maturity).................................. 10,970,153 11,839,045 Warrant (available-for-sale).............................................. -- 535,279 Other Assets.............................................................. 216,041 168,425 -------------- -------------- $ 90,251,004 $ 82,739,598 LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current maturities of long-term obligations.............................. $ 4,499,696 $ 3,571,578 Accounts payable......................................................... 1,296,511 2,092,593 Accrued expenses......................................................... 3,712,757 4,832,713 Deferred revenue......................................................... 4,720,234 3,449,959 -------------- -------------- Total current liabilities.............................................. 14,229,198 13,946,843 Long-term Obligations, net of current maturities.......................... 3,334,354 2,060,817 Commitments (Note 4) Shareholders' Equity: Common stock, $0.10 par value -- Authorized--50,000,000 shares........................................... Issued and outstanding--22,288,658 and 22,772,170 shares at December 31, 2000 and 2001, respectively............................................ 2,228,866 2,277,217 Additional paid-in capital............................................... 152,723,288 156,214,735 Accumulated deficit...................................................... (81,668,073) (91,758,375) Deferred compensation and note receivable from officer (Note 6(e))....... (596,629) (506,088) Accumulated other comprehensive income................................... -- 504,449 -------------- -------------- Total shareholders' equity............................................. 72,687,452 66,731,938 ============== ============== $ 90,251,004 $ 82,739,598 The accompanying notes are an integral part of these consolidated financial statements. F-3 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, -------------------------------------- 1999 2000 2001 ----------- ----------- ------------ Revenues: BioPharmaceutical......................... $18,162,056 $11,851,091 $ 18,438,286 GenomeVision(TM) services................. 6,665,529 13,594,143 17,302,239 ----------- ----------- ------------ Total revenues.......................... 24,827,585 25,445,234 35,740,525 Costs and Expenses: Cost of services.......................... 4,559,588 11,714,955 16,152,707 Research and development.................. 20,376,271 15,190,531 24,057,760 Selling, general and administrative....... 4,453,252 6,874,579 8,767,229 ----------- ----------- ------------ Total costs and expenses................ 29,389,111 33,780,065 48,977,696 ----------- ----------- ------------ Loss from operations.................. (4,561,526) (8,334,831) (13,237,171) Interest Income (Expense): Interest income........................... 1,488,250 3,330,625 3,839,260 Interest expense.......................... (866,799) (842,633) (692,391) Net interest income..................... 621,451 2,487,992 3,146,869 ----------- ----------- ------------ Net loss.............................. $(3,940,075) $(5,846,839) $(10,090,302) Net Loss per Common Share: Basic and diluted......................... $ (0.21) $ (0.27) $ (0.45) Weighted Average Common Shares Outstanding: Basic and diluted......................... 18,627,045 21,376,685 22,572,427 The accompanying notes are an integral part of these consolidated financial statements. F-4 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME Common Stock --------------------- Additional $0.10 Paid-In Shares Par Value Capital ---------- ---------- ------------ Balance, December 31, 1998 (as restated)............................. 18,348,646 $1,834,865 $ 97,733,824 ---------- ---------- ------------ Sale of common stock, net of issuance costs of $17,885............. 678,610 67,861 3,664,254 Exercise of stock options.......................................... 472,459 47,245 1,187,509 Deferred compensation from grant of stock options.................. -- -- 1,366,574 Amortization of deferred compensation and other stock-based compensation expense.............................................. -- -- -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- -- (119,494) Compensation expense related to grant of stock options............. -- -- 3,464 ---------- ---------- ------------ Net loss.......................................................... -- -- -- Balance, December 31, 1999 (as restated)............................. 19,499,715... 1,949,971... 103,836,131... ---------- ---------- ------------ Sale of common stock, net of issuance costs of $718,066............ 1,500,000 150,000 44,572,729 Exercise of stock options.......................................... 1,280,612 128,062 3,184,327 Issuance of stock under employee stock purchase plan............... 8,331 833 214,723 Deferred compensation from grant of stock options.................. -- -- 1,377,161 Amortization of deferred compensation and other stock-based compensation expense.............................................. -- -- -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- -- (461,783) ---------- ---------- ------------ Net loss.......................................................... -- -- -- Balance, December 31, 2000 (as restated)............................. 22,288,658... 2,228,866... 152,723,288... ---------- ---------- ------------ Sale of common stock, net of issuance costs of $44,622............. 127,500 12,750 1,693,017 Exercise of stock options.......................................... 251,354 25,135 736,584 Issuance of stock under employee stock............................. purchase plan.................................................... 74,596 7,460 434,410 Issuance of restricted common stock and loan to officer (Note 6e).. 24,000 2,400 (2,400) Deferred compensation from grant of stock options.................. -- -- 647,942 Issuance of stock under directors deferred stock plan.............. 6,062 606 (606) Amortization of deferred compensation and other stock-based compensation expense.............................................. -- -- -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- -- (17,500) Unrealized gain on long-term investment (available for sale)....... Unrealized loss on derivative instruments.......................... ---------- ---------- ------------ Net loss.......................................................... -- -- -- Balance, December 31, 2001 (as restated)............................. 22,772,170... $2,277,217... $156,214,735... ---------- ---------- ------------ Deferred Compen- sation & Accumulated Note Other Receivable Compre Accumulated From hensive Deficit Officer Income ------------ ----------- ----------- Balance, December 31, 1998 (as restated)............................. $(71,881,159) $ (130,293) -- ------------ ----------- -------- Sale of common stock, net of issuance costs of $17,885............. -- -- -- Exercise of stock options.......................................... -- -- -- Deferred compensation from grant of stock options.................. -- $(1,366,574) -- Amortization of deferred compensation and other stock-based compensation expense.............................................. -- 259,462 -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- 119,494 -- Compensation expense related to grant of stock options............. -- -- -- ------------ ----------- -------- Net loss.......................................................... (3,940,075) -- -- Balance, December 31, 1999 (as restated)............................. (75,821,234)... (1,117,911) -- ------------ ----------- -------- Sale of common stock, net of issuance costs of $718,066............ -- -- -- Exercise of stock options.......................................... -- -- -- Issuance of stock under employee stock purchase plan............... -- -- -- Deferred compensation from grant of stock options.................. -- (1,377,161) -- Amortization of deferred compensation and other stock-based compensation expense.............................................. -- 1,436,660 -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- 461,783 -- ------------ ----------- -------- Net loss.......................................................... (5,846,839) --. --. Balance, December 31, 2000 (as restated)............................. (81,668,073)... (596,629) -- ------------ ----------- -------- Sale of common stock, net of issuance costs of $44,622............. -- -- -- Exercise of stock options.......................................... -- -- -- Issuance of stock under employee stock............................. purchase plan.................................................... -- -- -- Issuance of restricted common stock and loan to officer (Note 6e).. -- (163,000) -- Deferred compensation from grant of stock options.................. -- (647,942) -- Issuance of stock under directors deferred stock plan.............. -- -- -- Amortization of deferred compensation and other stock-based compensation expense.............................................. -- 883,983 -- Reversal of deferred compensation related to cancellation of stock options........................................................... -- 17,500 -- Unrealized gain on long-term investment (available for sale)....... 535,279 Unrealized loss on derivative instruments.......................... (30,830) ------------ ----------- -------- Net loss.......................................................... (10,090,302) -- -- Balance, December 31, 2001 (as restated)............................. $(91,758,375)... $ (506,088) $504,449) ------------ ----------- -------- Total Share- Compre- holders' hensive Equity Income ------------ ------------ Balance, December 31, 1998 (as restated)............................. $ 27,557,237 ------------ ------------ Sale of common stock, net of issuance costs of $17,885............. 3,732,115 Exercise of stock options.......................................... 1,234,754 Deferred compensation from grant of stock options.................. -- Amortization of deferred compensation and other stock-based compensation expense.............................................. 259,462 Reversal of deferred compensation related to cancellation of stock options........................................................... -- Compensation expense related to grant of stock options............. 3,464 ------------ ------------ Net loss.......................................................... (3,940,075) (3,940,075) Balance, December 31, 1999 (as restated)............................. 28,846,957 (3,940,075) ------------ ------------ Sale of common stock, net of issuance costs of $718,066............ 44,722,729 Exercise of stock options.......................................... 3,312,389 Issuance of stock under employee stock purchase plan............... 215,556 Deferred compensation from grant of stock options.................. -- Amortization of deferred compensation and other stock-based compensation expense.............................................. 1,436,660 Reversal of deferred compensation related to cancellation of stock options........................................................... -- ------------ ------------ Net loss.......................................................... (5,846,839) (5,846,839) Balance, December 31, 2000 (as restated)............................. 72,687,452 (5,846,839) ------------ ------------ Sale of common stock, net of issuance costs of $44,622............. 1,705,767 Exercise of stock options.......................................... 761,719 Issuance of stock under employee stock............................. purchase plan.................................................... 441,870 Issuance of restricted common stock and loan to officer (Note 6e).. (163,000) Deferred compensation from grant of stock options.................. -- Issuance of stock under directors deferred stock plan.............. -- Amortization of deferred compensation and other stock-based compensation expense.............................................. 883,983 Reversal of deferred compensation related to cancellation of stock options........................................................... -- Unrealized gain on long-term investment (available for sale)....... 535,279 535,279 Unrealized loss on derivative instruments.......................... (30,830) (30,830) ------------ ------------ Net loss.......................................................... (10,090,302) $(10,090,302) Balance, December 31, 2001 (as restated)............................. $ 66,731,938 $ (9,585,853) ------------ ------------ The accompanying notes are an integral part of these consolidated financial statements. F-5 GENOME THERAPEUTICS CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, ---------------------------------------- 1999 2000 2001 ------------ ------------ ------------ Cash Flows from Operating Activities: Net loss.................................................. $ (3,940,075) $ (5,846,839) $(10,090,302) Adjustments to reconcile net loss to net cash (used in) provided by operating activities- Depreciation and amortization............................. 3,973,001 4,471,722 4,807,379 Loss on disposal of equipment and leasehold improvements.. 362,534 665,207 39,355 Amortization of deferred compensation..................... 262,926 1,436,660 883,983 Changes in assets and liabilities- Interest receivable..................................... (274,095) (612,005) 392,082 Accounts receivable..................................... (806,527) (10,787) 313,221 Unbilled costs and fees................................. (317,216) 1,220,195 631,607 Prepaid expenses and other current assets............... (34,174) (323,730) (682,773) Accounts payable........................................ 210,409 305,954 796,082 Accrued expenses........................................ (46,230) 1,049,809 1,089,126 Deferred revenue........................................ (1,006,212) 654,545 (1,270,275) Net cash (used in) provided by operating activities... (1,615,659) 3,010,731 (3,090,515) Cash Flows from Investing Activities: Purchases of investments.................................. (23,129,394) (69,013,466) (47,526,465) Proceeds from sale of investments......................... 22,880,646 23,860,411 68,439,950 Purchases of property and equipment....................... (2,514,394) (460,835) (944,278) Decrease in other assets.................................. 296,372 46,167 47,616 Net cash (used in) provided by investing activities... (2,466,770) (45,567,723) 20,016,823 Cash Flows from Financing Activities: Proceeds from sale of common stock........................ 3,732,115 44,722,729 1,705,767 Proceeds from exercise of stock options................... 1,234,754 3,312,389 761,719 Proceeds from issuance of stock under the employee stock purchase plan........................................... -- 215,556 441,870 Note receivable from officer.............................. (120,000) 120,000 (163,000) Payments on long-term obligations......................... (5,052,021) (4,734,876) (4,963,096) Net cash (used in) provided by financing activities... (205,152) 43,635,798 (2,216,740) Net (Decrease) Increase in Cash and Cash Equivalents....... (4,287,581) 1,078,806 14,709,568 Cash and Cash Equivalents, beginning of year............... 13,304,592 9,017,011 10,095,817 Cash and Cash Equivalents, end of year..................... $ 9,017,011 $ 10,095,817 $ 24,805,385 Supplemental Disclosure of Cash Flow Information: Interest paid during the year............................. $ 866,800 $ 842,633 $ 692,391 Income taxes paid during the year......................... $ 31,800 $ 8,231 $ 60,000 Supplemental Disclosure of Noncash Investing and Financing Activities: Equipment acquired under capital leases................... $ 1,126,597 $ 3,691,840 $ 2,761,441 Unrealized gain on warrant................................ -- -- $ 535,279 Unrealized loss on derivative instruments................. -- -- (30,830) The accompanying notes are an integral part of these consolidated financial statements. F-6 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Genome Therapeutics Corp. and subsidiary (the Company) is a biopharmaceutical company focused on the discovery and development of pharmaceutical and diagnostic products. The Company has eight established product development programs. The Company's lead product candidate, Ramoplanin, is in Phase III clinical trials for the prevention of bloodstream infections caused by vancomycin-resistant enterococci (VRE). The Company has six alliances with pharmaceutical companies including Schering-Plough, AstraZeneca, Wyeth-Ayerst and bioMerieux, and a joint venture with ArQule. In addition to these eight projects, the Company has a portfolio of earlier stage internal drug discovery programs. The Company also maintains an active service business, GenomeVision(TM) Services, providing drug discovery services to pharmaceutical and biotechnology companies and to the National Human Genome Research Institute. The accompanying consolidated financial statements reflect the application of certain accounting policies, as described in this note and elsewhere in the accompanying notes to the consolidated financial statements. (a) Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Collaborative Securities Corp. (a Massachusetts Securities Corporation). All intercompany accounts and transactions have been eliminated in consolidation. (b) Revenue Recognition BioPharmaceutical revenues consist of license fees, contract research and milestone payments from alliances with pharmaceutical companies. GenomeVision Services are revenues from government grants, fees received from custom gene sequencing and analysis services and subscription fees from the PathoGenome(TM) Database. Revenues from contract research, government grants, the PathoGenome Database subscription fees, and custom gene sequencing and analysis services are recognized over the respective contract periods as the services are provided. License fees and milestone payments are recognized as earned in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition. Milestone payments will be recognized upon achievements of the milestone as long as the milestone is deemed to be substantive and the Company has no other performance obligations related to the milestone. Unbilled costs and fees represent revenue recognized prior to billing. Deferred revenue represents amounts received prior to revenue recognition. (c) Property and Equipment Property and equipment, including leasehold improvements, are depreciated over their estimated useful lives using the straight-line method. The estimated useful life for leasehold improvements is the lesser of the term of the lease or the estimated useful life of the assets. The majority of the Company's equipment and leasehold improvements are financed through bank lines of credit. Estimated Useful Life --------------------- Laboratory Equipment......... 5 Years Computer Equipment & Licenses 3 Years Office Equipment............. 5 Years Furniture & Fixtures......... 5 Years (d) Net Loss Per Share Basic and diluted earnings per share were determined by dividing net loss by the weighted average shares outstanding during the period. Diluted loss per share is the same as basic loss per share for all periods presented, F-7 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) as the effect of the potential common stock is antidilutive. Antidilutive securities which consist of stock options, directors' deferred stock and unvested restricted stock that are not included in diluted net loss per share were 3,762,856, 3,320,113 and 3,773,990 shares at December 31, 1999, 2000 and 2001, respectively. (e) Concentration of Credit Risk SFAS No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, requires disclosure of any significant off-balance-sheet and credit risk concentrations. At December 31, 2001, the Company had entered into two interest- rate-swap agreements with a bank. The Company has no other off-balance-sheet or concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. The Company maintains its cash and cash equivalents and investment balances with several nonaffiliated institutions. The Company maintains reserves for the potential write-off of accounts receivable. To date, the Company has not written off any significant accounts. The following table summarizes the number of customers that individually comprise greater than 10% of total revenues and their aggregate percentage of the Company's total revenues: Percentage of Number of Total Revenues Significant ------------- Year ended December 31, Customers A B C ----------------------- ----------- -- -- -- 1999.......... 1 71% 9% -- 2000.......... 2 35% 36% -- 2001.......... 3 31% 36% 18% The following table summarizes the number of customers that individually comprise greater than 10% of total accounts receivable and their aggregate percentage of the Company's total accounts receivable: Percentage of Total Accounts Receivable -------------------------------------- At December 31, B D E F G H I --------------- -- -- -- -- -- -- -- 1999...... -- 11% 31% -- -- 35% 18% 2000...... 87% -- -- -- -- -- -- 2001...... -- -- -- 37% 29% -- -- (f) Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (g) Financial Instruments The estimated fair value of the Company's financial instruments, which includes cash and cash equivalents, short-term and long-term investments, accounts receivable, accounts payable and long-term debt, approximates the carrying values of these instruments. (h) Derivative Instruments and Hedging Activities The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, in 2001. SFAS No. 133 establishes standards for accounting and reporting derivative instruments, F-8 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) including certain derivative instruments embedded in other contracts, and for hedging activities. To manage the Company's exposure to movements in interest rates on its variable rate debt, the Company entered into two interest-rate-swap agreements. See Note 5 for further discussion. (i) Reclassifications The Company has reclassified certain prior-year information to conform with the current year's presentation. (j) Comprehensive Income (Loss) The Company has adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of all components of comprehensive income (loss) on an annual and interim basis. Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. At December 31, 2001, the Company recorded approximately $535,000 to comprehensive income related to the value of a warrant and ($35,000) to comprehensive loss related to two interest-rate-swap agreements. See Notes 2 and 5 for further discussion. (k) Segment Reporting The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions as to how to allocate resources and assess performance. The Company's chief decision makers, as defined under SFAS No. 131, are the chief executive officer and chief financial officer. To date, the Company has viewed its operations and manages its business as principally two operating segments: GenomeVision Services and BioPharmaceutical. As a result, the financial information disclosed herein represents all of the material financial information related to the Company's two operating segments. All of the Company's revenues are generated in the United States and all assets are located in the United States. GenomeVision(TM) Services BioPharmaceutical Total ---------------- ----------------- ----------- 1999 Revenues............................. $ 6,665,529 $18,162,056 $24,827,585 Gross profit......................... 2,105,941 7,083,332 9,189,273 Company-funded research & development -- 9,297,547 9,297,547 2000 Revenues............................. $13,594,143 $11,851,091 $25,445,234 Gross profit......................... 1,879,188 3,715,045 5,594,233 Company-funded research & development -- 7,054,485 7,054,485 2001 Revenues............................. $17,302,239 $18,438,286 $35,740,525 Gross profit......................... 1,149,532 11,122,807 12,272,339 Company-funded research & development -- 16,742,281 16,742,281 The Company does not allocate assets by its operating segments. F-9 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (l) Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combination, SFAS No. 142, Goodwill and Other Intangible Assets and SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. SFAS No. 142 addresses how intangible assets that are acquired should be accounted for in financial statements upon their acquisition and also how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Beginning on January 1, 2002, with the adoption of SFAS No. 142, goodwill and certain purchased intangibles existing on June 30, 2001, will no longer be subject to amortization over their estimated useful life. Rather, the goodwill and certain purchased intangibles will be subject to an assessment for impairment based on fair value. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 143 establishes accounting standards for the recognition and measurement of legal obligations associated with the retirement of tangible long-lived assets and requires recognition of a liability for an asset retirement obligation in the period in which it is occurred. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 142 did not have a material impact on the Company's financial position or results of operations. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This Statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. Under this Statement, it is required that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and it broadens the presentation of discontinued operations to include more disposal transactions. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this Statement to have a material impact on its financial position or results of operations. (m) Restatement During the second quarter of 2002, the Company and its auditors determined that an error had inadvertently been made in the accounting during 1996 and 1997 for two stock options granted to the Company's former Chief Executive Officer. Due to this error the accounting treatment did not properly reflect that these options contained a cashless exercise provision. As a result of required non-cash adjustments, the Company's net loss for the year ended December 31, 1996 was understated and the Company's net loss for the year ended December 31, 1997 was overstated. As reflected below, these corrections have no cash impact to the Company and have no impact on Total Shareholders' Equity. F-10 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A summary of the cumulative impact of the restatement on the Company's financial statements as of December 31, 2001 and December 31, 2000 is as follows: As previously reported As restated ------------- ------------ December 31, 2001 Accumulated deficit....... $(82,053,635) $(91,758,375) Additional paid in capital 146,509,995 156,214,735 Total shareholders' equity 66,731,938 66,731,938 As previously reported As restated ------------- ------------ December 31, 2000 Accumulated deficit....... $(71,963,333) $(81,668,073) Additional paid in capital 143,018,548 152,723,288 Total shareholders' equity 72,687,452 72,687,452 (2) CASH EQUIVALENTS AND INVESTMENTS The Company applies the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. At December 31, 2000 and 2001, the Company's investments include short-term and long-term investments which are classified as held-to-maturity, as the Company has the positive intent and ability to hold these securities to maturity. Cash equivalents are short-term, highly liquid investments with original maturities of 90 days or less. The Company's short-term and long-term investments include marketable securities with original maturities of greater than 90 days. Cash equivalents are carried at cost, which approximates market value, and consist of debt securities. Short-term and long-term investments are recorded at amortized cost, which approximates market value and consist of commercial paper and U.S. government debt securities. The average maturity of the Company's investments is approximately 7.5 months at December 31, 2001. At December 31, 2001, the Company had an unrealized gain of approximately $442,000, which is the difference between the amortized cost and the market value of the held to maturity investments. The Company's investment also include a warrant to purchase 45,000 shares of common stock from Versicor, Inc. which was received in connection with its collaboration agreement with Veriscor, Inc. dated March 10, 1997. The warrant was immediately vested and is exercisable through March 10, 2002. The Company is accounting for the warrant in accordance with SFAS No. 115 as an "available for sale security" and as a result, the warrant is record at fair value. Upon exercise, the shares received will be restricted and as a result the Company will not be able to liquidate its position in the shares for at least one year. At December 31, 2001, the Company had recorded an unrealized gain of $535,000 in other comprehensive income in its consolidated statements of shareholders' equity related to the appreciation in value of the warrant. F-11 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) At December 31, 2000 and 2001, the Company's cash and cash equivalents and investments consisted of the following: 2000 2001 ----------- ----------- Cash and Cash Equivalents: Cash.............................. $ 9,245,817 $21,801,201 Debt securities................... 850,000 3,004,184 ----------- ----------- Total cash and cash equivalents. $10,095,817 $24,805,385 =========== =========== Investments: Short-term investments............ $51,743,917 $29,961,540 Long-term investments............. $10,970,153 $11,839,045 -- 535,279 ----------- ----------- Warrant: Total investments............... $62,714,070 $42,335,864 =========== =========== The Company also has $200,000 in restricted cash at December 31, 2000 and 2001 in connection with certain capital lease obligations (see Note 5). (3) INCOME TAXES The Company applies SFAS No. 109, Accounting for Income Taxes, which requires the Company to recognize deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS No. 109 requires deferred tax assets and liabilities to be adjusted when the tax rates or other provisions of the income tax laws change. At December 31, 2001, the Company had net operating loss and tax credit carryforwards of approximately $93,767,000 and $6,642,000, respectively, available to reduce federal taxable income and federal income taxes, respectively, if any. Net operating loss and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and may be limited in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50%. The net operating loss and tax credit carryforwards expire approximately as follows: Net Operating Research Tax Investment Loss Credit Tax Credit Expiration Date Carryforwards Carryforwards Carryforwards --------------- ------------- ------------- ------------- 2002........ $ 2,254,000 $ -- $ -- 2003........ 697,000 -- -- 2004........ 2,702,000 -- -- 2005........ 1,456,000 80,000 -- 2006-2021... 86,658,000 6,525,000 37,000 ----------- ---------- ------- $93,767,000 $6,605,000 $37,000 =========== ========== ======= F-12 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The components of the Company's net deferred tax asset at the respective dates are as follows: December 31, -------------------------- 2000 2001 ------------ ------------ Net operating loss carryforwards $ 36,538,000 $ 37,265,000 Research and development credits 5,816,000 6,605,000 Investment tax credits.......... 37,000 37,000 Other, net...................... 4,018,000 4,233,000 ------------ ------------ 46,409,000 48,140,000 Valuation allowance............. (46,409,000) (48,140,000) ------------ ------------ $ -- $ -- ============ ============ The valuation allowance has been provided due to the uncertainty surrounding the realization of the deferred tax assets. (4) COMMITMENTS (a) Lease Commitments At December 31, 2001, the Company has operating leases for office and laboratory facilities, the last of which expires on November 15, 2006. Approximate minimum lease payments and facilities charges under the operating leases at December 31, 2001 are as follows: Year ending December 31, ------------------------ 2002.......... $1,028,000 2003.......... 946,000 2004.......... 1,100,000 2005.......... 1,107,000 2006.......... 1,073,000 ---------- $5,254,000 ========== Rental expense under these operating leases was approximately $1,009,000, $927,000 and $1,007,000 for the years ended December 31, 1999, 2000 and 2001, respectively. (b) Employment Agreements The Company has employment agreements with its executive officers, which provide for bonuses, as defined, and severance benefits upon termination of employment, as defined. (5) LONG-TERM OBLIGATIONS In February 2000, the Company entered into an equipment line of credit under which it may finance up to $4,000,000 of laboratory, computer and office equipment. In December 2000, the Company increased the line of credit by $2,712,000 to $6,712,000. The Company, at its discretion, can enter into either operating or capital leases. The borrowings under operating leases are payable in 24 monthly installments and capital leases are payable in 36 monthly installments. As of December 31, 2001, the Company had entered into $256,000 in operating leases and $6,456,000 in capital leases. The interest rates under the capital leases range from 7.55% to 10.37%. The Company had no additional borrowing capacity under this line of credit at December 31, 2001. There are no covenants related to this agreement. F-13 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Over the last five years, the Company had entered into other lines of credit or capital lease arrangements under which it financed approximately $15,060,000 of laboratory, computer and office equipment, as well as facility renovations. The borrowings under these arrangements are payable in 36 to 48 monthly installments from the date of initiation. Interest rates range from 7.63% to 10.28%. The Company is required to maintain certain restricted cash balances, as defined. In addition, the Company is required to maintain certain financial ratios pertaining to minimum cash balances, tangible net worth and debt service coverage. As of December 31, 2001, the Company was in compliance with all covenants. The Company had no additional borrowing capacity under these other lines of credit or capital lease agreements at December 31, 2001. In February 2002, the Company entered into an additional line of credit for $3,500,000, of which $500,000 will be used to refinance a portion of an existing line of credit. This line of credit is payable in twelve consecutive quarterly payments at the prevailing LIBOR rate (2.08% at February 28, 2002) plus 1 1/2 %. The Company is required to maintain certain financial ratios pertaining to minimum cash balances. As of December 31, 2001, the Company was in compliance with all covenants. During 2000, the Company entered into two interest-rate-swap agreements to manage its exposure to movements in the interest rates on its variable rate debt. The swap agreements are cash flow hedges and are used to manage exposure to interest rate movement by effectively converting the variable rate to a fixed rate. Such instruments are matched with the underlying borrowings. SFAS No. 133 eliminates special hedge accounting if a swap agreement does not meet certain criteria, thus requiring the Company to reflect all changes in the fair value of the swap agreement in earnings in the period of change. The Company entered into two separate interest-rate-swap agreements with a bank aggregating approximately $1,900,000. Under these agreements, the Company pays a fixed rate of 8.78% and receives a variable rate tied to the one month LIBOR rate. As of December 31, 2001, the variable rate was 3.83%. These swap agreements meet the required criteria, as defined in SFAS No. 133 to use special hedge accounting, and the Company has recorded an unrealized loss of $30,830 at December 31, 2001, through other comprehensive income, for the change in the fair value of the swap agreements. At February 28, 2002, this debt had been paid off in its entirety and the interest-rate-swap agreements expired. Finance payments under long-term obligations at December 31, 2001 are as follows: Year ending December 31, ------------------------ 2002............................................. $3,881,339 2003............................................. 1,727,572 2004............................................. 432,459 Total minimum lease payments.................. 6,041,370 Less--Amount representing interest............... 408,975 Present value of total minimum lease payments. 5,632,395 Less--Current portion............................ 3,571,578 ---------- $2,060,817 ========== (6) SHAREHOLDERS' EQUITY (a) Stock Options The Company has granted stock options to key employees and consultants under its 1991, 1993, 1995 and 1997 Stock Option Plans, as well as the 2001 Incentive Plan. The Stock Option and Compensation Committee of F-14 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) the Board of Directors determines the purchase price and vesting schedule applicable to each option grant. In addition, under separate agreements not covered by any plan, the Company has granted certain key employees and directors of the Company, options to purchase common stock. The Company granted nonqualified stock options for the purchase of 65,000 and 10,000 shares of common stock to consultants during fiscal years 1997 and 1999, respectively. The options were granted with an exercise price equal to the fair market value price at the date of grant and vest ratably over the contract period, as defined. In accordance with Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services, the Company will measure the fair value of the options as they vest using the Black-Scholes option pricing model. The Company has charged $29,750, $281,636 and $3,160 to operations for the years ended December 31, 1999, 2000 and 2001, respectively, related to the grant of these options. During 2000, the Company granted to certain employees the right to receive 154,616 shares of common stock. The employees received the common stock in two equal installments on the anniversary of the grant date. The Company recorded deferred compensation of $647,942 related to the grant of these rights to receive the common stock, which will be amortized to expense over the period the shares are earned. Since the inception of this program, employees who resigned from the Company forfeited 62,915 shares of the restricted stock. The Company records deferred compensation when stock options, restricted stock and other stock-based awards are granted at an exercise price per share that is less than the fair market value on the date of the grant. Deferred compensation is recorded in an amount equal to the excess of the fair market value per share over the exercise price times the number of options or shares granted. Deferred compensation is being recognized as an expense over the vesting period of the underlying options. During the years ended 1999, 2000 and 2001, the Company recorded $1,366,574, $1,377,161 and $647,942, respectively, of deferred compensation. The Company recorded compensation expense of approximately $262,926, $1,436,660 and $883,983 for the years ended December 31, 1999, 2000 and 2001, respectively. During 1999, 2000 and 2001, in connection with the termination of several employees, the Company reversed $119,494, $461,783 and $17,500, respectively, of unamortized deferred compensation due to the cancellation of options. There were 2,734,903 common shares available for future grant at December 31, 2001. The following is a summary of all stock option activity: Number Exercise Weighted of Shares Price Range Average Price ---------- ----------- ------------- Outstanding, December 31, 1998 3,622,570 $0.20-14.50 $ 3.63 Granted...................... 1,121,479 0.00- 9.25 3.60 Exercised.................... (472,459) 0.20- 8.31 2.61 Cancelled.................... (632,232) 0.00-14.50 5.35 Outstanding, December 31, 1999 3,639,358 0.00-14.50 3.45 Granted...................... 1,198,004 0.00-66.00 14.89 Exercised.................... (1,280,612) 0.00-14.72 2.59 Cancelled.................... (381,769) 0.00-66.00 4.44 Outstanding, December 31, 2000 3,174,981 0.00-66.00 7.99 Granted...................... 865,640 1.80-16.08 7.87 Exercised.................... (251,354) 0.00-14.72 3.03 Cancelled.................... (143,403) 0.00-39.38 11.74 Outstanding, December 31, 2001 3,645,864 $0.00-66.00 $ 8.15 Exercisable, December 31, 2001 1,951,126 $0.10-66.00 $ 5.73 Exercisable, December 31, 2000 1,607,085 $0.00-14.72 $ 4.10 Exercisable, December 31, 1999 2,091,258 $1.56-14.50 $ 2.87 F-15 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The range of exercise prices for options outstanding and options exercisable at December 31, 2001 are as follows: Options Outstanding Options Exercisable -------------------------- -------------------------- Weighted Average Remaining Contractual Life of Options Range of Outstanding Weighted Average Weighted Average Exercise Prices (In Years) Number Exercise Price Number Exercise Price - --------------- ---------------- --------- ---------------- --------- ---------------- $ 0.00-3.38... 2.98 994,202 $ 1.95 841,161 $ 1.81 3.52-4.88... 7.34 464,290 4.35 430,184 4.34 5.05-7.50... 8.82 400,754 6.73 71,027 7.03 7.56-9.50... 6.02 495,956 8.65 321,133 8.88 9.80-14.72.. 8.96 1,186,349 13.77 261,052 14.49 15.97-66.00.. 8.56 104,313 23.20 26,569 24.15 Total...... 6.69 3,645,864 $ 8.15 1,951,126 $ 5.73 (b) Sale of Common Stock In September 1999, the Company sold 678,610 shares of its common stock to bioMerieux as part of a strategic alliance agreement (see Note 8 (c)). The Company received $3,732,115 in proceeds from the sale of common stock, net of issuance costs of $17,885. In June and July of 2000, the Company sold 1,500,000 shares of its common stock in a series of transactions through the Nasdaq National Market at an average price of $31.01 per share resulting in proceeds of $44,722,729, net of issuance costs of $718,066. In June and July of 2001, the Company sold 127,500 shares of its common stock in a series of transactions through the Nasdaq National Market at an average price of $13.73 per share resulting in proceeds of $1,705,767, net of issuance costs of $44,622. (c) Pro Forma Disclosure of Stock-based Compensation SFAS No. 123, Accounting for Stock-Based Compensation requires the measurement of the fair value of stock options or warrants granted to employees to be included in the consolidated statement of operations or, alternatively, disclosed in the notes to consolidated financial statements. The Company has determined that it will continue to account for stock-based compensation for employees and nonemployee directors under APB Opinion No. 25 and elect the disclosure-only alternative under SFAS No. 123. The Company has computed the pro forma disclosures required under SFAS No. 123 for stock options granted in 1999, 2000 and 2001 using the Black-Scholes option-pricing model. The weighted average assumptions used for 1999, 2000 and 2001 and certain weighted average data are as follows: 1999 2000 2001 ----------- ----------- ----------- Risk-free interest rate.............. 5.10%-6.38% 5.36%-6.71% 4.31%-5.24% Expected dividend yield.............. -- -- -- Expected life........................ 5 years 5 years 5 years Expected volatility.................. 72% 87% 87% Weighted average fair market value at grant date......................... $3.28 $11.45 $6.25 F-16 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The pro forma effect of these option grants for the years ended December 31, 1999, 2000 and 2001 is as follows: As Reported Pro Forma ------------ ------------ 1999 ---- Net loss.......... $ (3,940,075) $ (4,498,680) Net loss per share $ (0.21) $ (0.24) 2000 ---- Net loss.......... $ (5,846,839) $ (7,175,564) Net loss per share $ (0.27) $ (0.34) 2001 ---- Net loss.......... $(10,090,302) $(16,700,952) Net loss per share $ (0.45) $ (0.74) The resulting pro forma compensation expense may not be representative of the amount to be expected in future years, as the pro forma expense may vary based on the number of options granted. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. (d) 1997 Directors' Deferred Stock Plan In January 1998, the Company's stockholders approved the 1997 Directors' Deferred Stock Plan (the 1997 Directors' Plan) covering 150,000 shares of common stock. The shares will be granted as services are performed by members of the Company's Board of Directors. As of December 31, 2001, the Company granted 39,012 shares of restricted common stock under the 1997 Directors' Plan. These shares are issued at the end of the three-year period or earlier if the individual ceases to serve as a member of the Company's Board of Directors. As of December 31, 2001, 6,862 shares of restricted common stock were vested under the 1997 Directors' Plan. (e) Note Receivable from Officer On March 28, 2001, the Company loaned $163,000 to an officer of the Company to allow him to pay income tax liabilities associated with a restricted stock grant of 24,000 shares. The loan bears interest at 4% and is payable in full on December 31, 2004 and may be extended by either party to December 31, 2006. The loan may also be extended beyond December 31, 2006 upon mutual consent. The principal amount of the note is non-recourse as it is secured only by the 24,000 shares of restricted stock. The interest portion of the loan is full-recourse as it is secured by the officer's assets. The Company issued these shares to the officer for no consideration and as a result recorded deferred compensation of approximately $347,000, which will be amortized over the vesting period of the award, which is forty-eight months. (f) Employee Stock Purchase Plan On February 28, 2000, the Company adopted an Employee Stock Purchase Plan under which eligible employees may contribute up to 15% of their earnings toward the semi-annual purchase of the Company's common stock. The employees' purchase price will be 85% of the fair market value of the common stock at the time of grant of option or the time at which the option is deemed exercised, whichever is less. No compensation expense will be recorded in connection with the plan. As of December 31, 2001, the Company has issued 82,927 shares under this plan. F-17 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (7) INCENTIVE SAVINGS 401(K) PLAN The Company maintains an incentive savings 401(k) plan (the Plan) for the benefit of all employees. In February 2002, the Company changed its match to 50% of the first 6% of salary from 100% of the first 2% of salary and 50% of the next 2% of salary, limited to the first $100,000 of annual salary. The Company contributed $229,732, $201,759 and $251,157 to the Plan for the years ended December 31, 1999, 2000 and 2001, respectively. (8) ALLIANCES--BIOPHARMACEUTICAL (a) ASTRAZENECA In August 1995, the Company entered into a strategic alliance with AstraZeneca (Astra), formerly Astra Hassle AB, to develop drugs, vaccines and diagnostic products effective against peptic ulcers or any other disease caused by H. pylori. The Company granted Astra exclusive access to the Company's H. pylori genomic sequence database and exclusive worldwide rights to make, use and sell products based on the Company's H. pylori technology. The agreement provided for a four-year research alliance (which ended in August 1999) to further develop and annotate the Company's H. pylori genomic sequence database, identify therapeutic and vaccine targets and develop appropriate biological assays. Under this agreement, Astra agreed to pay the Company, subject to the achievement of certain product development milestones, up to $23.3 million (and possibly a greater amount if more than one product is developed under the agreement) in license fees, expense allowances, research funding and milestone payments. The Company has received a total of $13.5 million in license fees, expense allowances, milestone payments and research funding under the Astra agreement through December 31, 2001. The Company will also be entitled to receive royalties on Astra's sale of products protected by the claims of patents licensed exclusively to Astra by the Company pursuant to the agreement or the discovery of which was enabled in a significant manner by the genomic database licensed to Astra by the Company. The Company has the right, under certain circumstances, to convert Astra's license to a nonexclusive license in the event that Astra is not actively pursuing commercialization of the technology. The Company recognized approximately $620,000, $6,000 and $0 in revenue under the agreement during the years ended December 31, 1999, 2000 and 2001, respectively. (b) SCHERING-PLOUGH In December 1995, the Company entered into a strategic alliance and license agreement (the December 1995 agreement) with Schering Corporation and Schering-Plough Ltd. (collectively, Schering-Plough) providing for the use by Schering-Plough of the genomic sequence of Staph. aureus to identify and validate new gene targets for development of drugs to target Staph. aureus and other pathogens that have become resistant to current antibiotics. As part of this agreement, the Company granted Schering-Plough exclusive access to the Company's proprietary Staph. aureus genomic sequence database. The Company agreed to undertake certain research efforts to identify bacteria-specific genes essential to microbial survival and to develop biological assays to be used by Schering-Plough in screening natural product and compound libraries to identify antibiotics with new mechanisms of action. Under this agreement, Schering-Plough paid an initial license fee and agreed to fund the research program through March 31, 2002. Under this agreement, Schering-Plough agreed to pay the Company a minimum of $21.4 million in an up-front license fee, research funding and milestone payments. Subject to the achievement of additional product development milestones, Schering-Plough agreed to pay the Company up to an additional $24 million in milestone payments. F-18 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The agreement grants Schering-Plough exclusive worldwide rights to make, use and sell pharmaceutical and vaccine products based on the genomic sequence databases licensed to Schering-Plough and on the technology developed in the course of the research program. The Company will be entitled to receive royalties on Schering-Plough's sale of therapeutic products and vaccines developed using the technology licensed. As of December 31, 2001, the Company had substantively completed its research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. A total of $21.4 million has been received through December 31, 2001. Under the December 1995 agreement, the Company recognized approximately $2,344,000, $1,887,000 and $1,570,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively. In December 1996, the Company entered into its second strategic alliance and license agreement (the December 1996 agreement) with Schering-Plough. This agreement calls for the use of genomics to discover new pharmaceutical products for treating asthma. As part of the agreement, the Company will employ its high-throughput disease gene identification, bioinformatics, and genomics sequencing capabilities to identify genes and associated proteins that can be utilized by Schering-Plough to develop pharmaceuticals and vaccines for treating asthma. Under this agreement, the Company has granted Schering-Plough exclusive access to (i) certain gene sequence databases made available under this research program, (ii) information made available to the Company under certain third-party research agreements, and (iii) an exclusive worldwide right and license to make, use and sell pharmaceutical and vaccine products based on the rights to develop and commercialize diagnostic products that may result from this alliance. Under this agreement (and subsequent extensions), Schering-Plough paid an initial license fee and an expense allowance to the Company and agreed to fund the research program through at least December 2002. In addition, upon completion of certain scientific developments, Schering-Plough has made or will make milestone payments, as well as pay royalties based upon sales of therapeutics products developed from this collaboration. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $81.0 million, excluding royalties. Of the total potential payments, approximately $36.5 million represents license fees and research payments, and $44.5 million represent milestone payments based on achievement of research and product development milestones. A total of $38.5 million has been received through December 31, 2001. Under the December 1996 agreement, the Company recognized approximately $9,280,000, $4,711,000 and $8,084,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively. In September 1997, the Company entered into a third strategic alliance and license agreement (the September 1997 agreement) with Schering-Plough to use genomics to discover and develop new pharmaceutical products to treat fungal infections. Under this agreement, the Company will employ its bioinformatics, high-throughput sequencing and functional genomics capabilities to identify and validate genes and associated proteins as drug discovery targets that can be utilized by Schering-Plough to develop novel antifungal treatments. Schering-Plough will receive exclusive access to the genomic information developed in the alliance related to two fungal pathogens, Candida albicans and Aspergillus fumigatus. Schering-Plough will also receive exclusive worldwide rights to make, use and sell products based on the technology developed during the course of the research program. In return, Schering-Plough agreed to fund a research program through March 31, 2002. If all milestones are met and the research program continues for its full term, total payments to the Company will approximate $33.2 million, excluding royalties. Of the total potential payments, approximately $10.2 million represents contract research F-19 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) payments and $23.0 million represents milestone payments based on achievement of research and product development milestones. As of December 31, 2001, the Company had substantively completed its research obligations under this alliance and had turned over validated drug targets and assays to Schering-Plough for high-throughput screening. A total of $12.2 million has been received through December 31, 2001. Under the September 1997 agreement, the Company recognized approximately $5,261,000, $1,912,000 and $1,137,000 in revenue for the years ended December 31, 1999, 2000 and 2001, respectively. Under certain circumstances, the Company may have an obligation to give Schering-Plough a right of first negotiation to develop with the Company certain of its asthma and infectious disease related discoveries if it decides to seek a third party collaborator to develop such discovery. (c) BIOMERIEUX ALLIANCE In September 1999, the Company entered into a strategic alliance with bioMerieux to develop, manufacture and sell in vitro diagnostic products for human clinical and industrial applications. As part of the alliance, bioMerieux purchased a subscription to the Company's PathoGenome Database (see Note 9), paid an up-front license fee, agreed to fund a research program for at least four years and pay royalties on future products. In addition, bioMerieux purchased $3.75 million of the Company's common stock. The total amount of research and development funding, excluding subscription fees, approximates $5.2 million for the four-year term of this agreement. The research and development funding will be recognized as the research services are performed over the four-year term of the agreement. Approximately $3.4 million has been received through December 31, 2001. The Company recognized approximately $232,000, $1,469,000 and $1,173,000 in revenue during the years ended December 31, 1999, 2000 and 2001, respectively, which consisted of alliance research revenue and amortization of the up-front license fees. (d) WYETH-AYERST LABORATORIES In December 1999, the Company entered into a strategic alliance with Wyeth-Ayerst Laboratories to develop novel therapeutics for the prevention and treatment of osteoporosis. The alliance will focus on developing therapeutics, utilizing targets based on the characterization of a gene associated with a unique high bone mass trait. The agreement provides for the Company to employ its established capabilities in positional cloning, bioinformatics and functional genomics in conjunction with Wyeth-Ayerst's drug discovery capabilities and its expertise in bone biology and the osteoporotic disease process to develop new pharmaceuticals. Under the terms of the agreement, Wyeth-Ayerst paid the Company an up-front license fee, and funded a multi-year research program, which includes milestone payments and royalties on sales of therapeutics products developed from this alliance. If the research program continues for its full term and substantially all of the milestone payments are met, total payments to the Company, excluding royalties, would exceed $118 million. Approximately $8.1 million has been received through December 31, 2001. The Company recognized approximately $1,640,000 and $6,485,000 in revenue during the years ended December 31, 2000 and 2001, respectively, which consisted of alliance research revenue milestone payments and amortization of the up-front license fees. (9) GENOMEVISION(TM) SERVICES GenomeVision(TM) services are revenues from government grants, fees received from custom gene sequencing and analysis and subscription fees from PathoGenome(TM) Database. F-20 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (a) DATABASE SUBSCRIPTIONS The Company has entered into a number of PathoGenome Database subscriptions. The database subscriptions provide nonexclusive access to the Company's proprietary genome sequence database, PathoGenome Database, and associated information relating to microbial organisms. These agreements call for the Company to provide periodic data updates, analysis tools and software support. Under the subscription agreements, the customer pays an annual subscription fee and will pay royalties on any molecules developed as a result of access to the information provided by the PathoGenome Database. The Company retains all rights associated with protein therapeutic, diagnostic and vaccine use of bacterial genes or gene products. (b) NATIONAL HUMAN GENOME RESEARCH INSTITUTE In July 1999, the Company was named as one of the nationally funded DNA sequencing centers of the international Human Genome Project. The Company is entitled to receive funding from the National Human Genome Research Institute (NHGRI) of up to $17.4 million through February 2003, of which all funds have been appropriated. In October 1999, the NHGRI named the Company as a pilot center to the Mouse Genome Sequencing Network. The Company is entitled to receive $13.4 million in funding through February 2003 with respect to this agreement, of which all funds have been appropriated. In August 2000, the Company was named one of two primary centers for the Rat Sequencing Program from NHGRI. As part of the agreement, we will use remaining funding under the mouse award, as well as a portion of the remaining funding under the human award, to participate in this rat genome initiative. Funding under our government grants and research contracts is subject to appropriation each year by the U.S. Congress and can be discontinued or reduced at any time. In addition, we cannot be certain that we will receive additional grants or contracts in the future. (10) PRODUCT DEVELOPMENT In October 2001, the Company acquired an exclusive license in the United States and Canada for a novel antibiotic, Ramoplanin, from Biosearch Italia S.p.A (Biosearch Italia). The Company will assume responsibility for the product development in the United States of Ramoplanin, currently in Phase III clinical trials. The agreement provides the Company with exclusive rights to develop and market oral Ramoplanin in the U.S. and Canada. Biosearch Italia will provide the bulk material for manufacture of the product and will retain all other rights to market and sell Ramoplanin. Under the terms of this agreement, the Company paid Biosearch Italia an initial license fee of $2 million and is obligated to make payments of up to $8 million in a combination of cash and notes convertible into Company stock upon the achievement of specified milestones. In addition, the Company is obligated to purchase bulk material from Biosearch Italia and fund the completion of clinical trials and pay a royalty on product sales. The Company expended approximately $5,549,000 and made cash payments of approximately $4,263,000 under this agreement during the year ended December 31, 2001, which consisted of the initial license fee and clinical development expenses. F-21 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (11) QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly statement of operations data for each of the eight quarters in the period ended December 31, 2001. In the opinion of management, this information has been prepared on the same basis as the audited financial statements appearing elsewhere in this Form 10-K, and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the unaudited quarterly results of operations. Quarter Quarter Quarter Quarter One Two Three Four Year ----------- ----------- ----------- ----------- ------------ 2000 - ---- Revenues: BioPharmaceutical................... $ 3,341,373 $ 2,872,424 $ 2,783,478 $ 2,853,816 $ 11,851,091 GenomeVision(TM) Services........... 3,668,813 3,301,520 3,141,373 3,482,437 13,594,143 Total revenues.................... 7,010,186 6,173,944 5,924,851 6,336,253 25,445,234 Costs and Expenses: Cost of services.................... 2,937,332 2,671,538 2,750,809 3,355,276 11,714,955 Research and development............ 3,638,769 3,522,553 3,754,546 4,274,663 15,190,531 Selling, general and administrative. 1,835,662 1,198,426 1,711,451 2,129,040 6,874,579 Total costs and expenses.......... 8,411,763 7,392,517 8,216,806 9,758,979 33,780,065 Loss from operations.............. (1,401,577) (1,218,573) (2,291,955) (3,422,726) (8,334,831) Interest Income (Expense): Interest income..................... 463,209 456,593 1,180,363 1,230,460 3,330,625 Interest expense.................... (198,607) (217,749) (210,751) (215,526) (842,633) Net interest income............... 264,602 238,844 969,612 1,014,934 2,487,992 Net loss.......................... $(1,136,975) $ (979,729) $(1,322,343) $(2,407,792) $ (5,846,839) Net Loss per Common Share: Basic and diluted................... $ (0.06) $ (0.05) $ (0.06) $ (0.11) $ (0.27) Weighted Average Common Shares Outstanding: Basic and diluted................... 20,309,912 20,696,487 22,215,971 22,284,371 21,376,685 2001 - ---- Revenues: BioPharmaceutical................... $ 3,557,570 $ 7,459,478 $ 2,917,389 $ 4,503,849 $ 18,438,286 Genome Vision(TM) Services.......... 4,532,678 3,930,400 4,460,646 4,378,514 17,302,239 Total revenues.................... 8,090,248 11,389,879 7,378,035 8,882,363 35,740,525 Costs and Expenses: Cost of services.................... 3,680,816 3,430,803 4,633,058 4,408,030 16,152,707 Research and development............ 3,822,329 4,438,822 5,247,912 10,548,697 24,057,760 Selling, general and administrative. 1,634,922 2,190,432 2,559,004 2,382,871 8,767,229 Total costs and expenses.......... 9,138,067 10,060,057 12,439,974 17,339,598 48,977,696 Loss from operations.............. (1,047,819) 1,329,822 (5,061,939) (8,457,235) (13,237,171) Interest Income (Expense): Interest income..................... 1,143,795 986,723 1,055,631 653,111 3,839,260 Interest expense.................... (169,342) (212,123) (174,269) (136,657) (692,391) Net interest income............... 974,453 774,600 881,362 516,454 3,146,869 Net loss.......................... $ (73,366) $ 2,104,422 $(4,180,577) $(7,940,781) $(10,090,302) Net Loss per Common Share: Basic and diluted................... $ (0.00) $ 0.09 $ (0.18) $ (0.35) $ (0.45) Weighted Average Common Shares Outstanding: Basic and diluted................... 22,409,501 22,451,753 22,685,660 22,742,794 22,572,427 F-22 GENOME THERAPEUTICS CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (12) ACCRUED EXPENSES Accrued expenses consist of the following: December 31, --------------------- 2000 2001 ---------- ---------- Payroll and related expenses $1,717,108 $1,990,394 Facilities.................. 466,678 463,279 Professional fees........... 242,273 108,375 License and other fees...... 435,434 183,724 Employee relocation......... 146,936 224,543 Clinical development........ -- 1,286,324 704,328 576,074 ---------- ---------- $3,712,757 $4,832,713 ========== ========== (13) SUBSEQUENT EVENT (UNAUDITED) On March 6, 2002, the Company sold convertible debentures to two institutional investors in a private placement transaction, which resulted in $15 million in gross proceeds. The debentures may be converted into shares of the Company's common stock at the option of the holder, at a price of $8.00 per share, subject to certain adjustments. The maturity date of the debentures is December 31, 2004; provided, that if any time on or after December 31, 2003 the Company maintains a net cash balance (i.e., cash and cash equivalents less obligations for borrowed money bearing interest) of less than $35 million, then the holders of the notes can require that all or any part of the outstanding principal balance of the notes plus all accrued but unpaid interest be repaid. Interest on the debentures accrues at 6% annually. The investors also received warrants to purchase up to 487,500 shares of common stock at an exercise price of $8.00 per share, subject to certain adjustments. The warrants only become exercisable to the extent the debentures are converted or if certain other redemptions or repayments of the debentures occur. The warrant was valued using the Black-Scholes Option Pricing Model and recorded as a discount to the debt in accordance with EITF 00-27. The discount will be amortized as interest expense over the term of the debt. F-23