UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 2001
Commission File Number: 0-23413
INTERLEUKIN GENETICS, INC.
(Exact name of registrant as specified in its Charter)
DELAWARE 94-3123681
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
135 BEAVER STREET
WALTHAM, MA 02452
(Address of principal executive offices) (Zip Code)
(781) 398-0700
Registrant's Telephone Number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Title of Each Class Outstanding at October 31, 2001
------------------- -------------------------------
Common stock, $.001 Par value 21,426,752
INTERLEUKIN GENETICS, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Balance Sheets at
September 30, 2001 (unaudited) and December 31, 2000................... 3
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 2001 and
September 30, 2000 (unaudited)......................................... 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2001 and September 30, 2000
(unaudited) ........................................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements ........ 6
Item 2.
Management's Discussion and Analysis of Financial Condition
And Results of Operations ............................................. 10
Item 3.
Quantitative and Qualitative Disclosure About Market Risk ............. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 17
Item 2. Changes in Securities and Use of Proceeds........................... 17
Item 3. Default Upon Senior Securities...................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................. 17
Item 5. Other Information................................................... 17
Item 6. Exhibits and Reports on Form 8-K.................................... 17
2
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
================================================================================
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,371,327 $ 2,391,561
Marketable securities -- 2,999,040
Accounts receivable, net of allowance for
doubtful accounts of $41,000 and $77,000 at
September 30, 2001 and December 31, 2000,
respectively 13,992 46,870
Prepaid expenses and other current assets 109,325 174,074
------------ ------------
Total current assets 5,494,644 5,611,545
FIXED ASSETS, NET 79,850 68,853
OTHER ASSETS 112,067 14,113
------------ ------------
TOTAL ASSETS $ 5,686,561 $ 5,694,511
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 191,297 $ 297,178
Accrued expenses 745,278 603,072
Deferred revenue 83,948 204,807
Current portion of capital lease obligations 25,217 48,660
------------ ------------
Total current liabilities 1,045,740 1,153,717
CAPITAL LEASE OBLIGATIONS, LESS CURRENT PORTION 23,588 46,989
------------ ------------
Total liabilities 1,069,328 1,200,706
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, no par value - 5,000,000 shares
authorized; none issued or outstanding -- --
Common stock, $0.001 par value - 50,000,000 shares
authorized; 21,451,379 and 19,067,427 shares
issued and 21,426,752 and 19,042,800 outstanding
at September 30, 2001 and December 31, 2000,
respectively 21,451 19,067
Treasury stock - 24,627 shares at cost (250,119) (250,119)
Additional paid-in capital 39,258,987 35,702,628
Accumulated deficit (34,413,086) (30,991,015)
Other comprehensive income -- 13,244
------------ ------------
Total stockholders' equity 4,617,233 4,493,805
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,686,561 $ 5,694,511
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
================================================================================
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------- --------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
REVENUE $ 24,978 $ 38,141 $ 183,923 $ 206,091
COST OF REVENUE 8,443 36,423 43,387 156,848
----------- ----------- ----------- -----------
GROSS PROFIT 16,535 1,718 140,536 49,243
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Research and development 634,719 471,729 2,050,665 1,387,795
Selling, general and administrative 565,110 744,466 1,741,231 2,539,102
----------- ----------- ----------- -----------
Total operating expenses 1,199,829 1,216,195 3,791,896 3,926,897
----------- ----------- ----------- -----------
LOSS FROM OPERATIONS (1,183,294) (1,214,477) (3,651,360) (3,877,654)
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest income, net 47,265 76,896 229,087 204,754
Other income (expense) 149 7,326 202 6,973
----------- ----------- ----------- -----------
Total other income 47,414 84,222 229,289 211,727
----------- ----------- ----------- -----------
NET LOSS $(1,135,880) $(1,130,255) $(3,422,071) $(3,665,927)
----------- ----------- ----------- -----------
BASIC AND DILUTED NET LOSS PER SHARE $ (0.05) $ (0.06) $ (0.16) $ (0.20)
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 21,424,105 18,409,643 20,922,361 18,206,780
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
INTERLEUKIN GENETICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
================================================================================
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
2001 2000
----------- -----------
(Unaudited)
CASH FLOW FROM OPERATING ACTIVITIES
Net loss $(3,422,071) $(3,665,927)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 32,772 129,410
Stock-based compensation expense related to
issuance of stock options 165,331 175,792
Loss on disposal of fixed assets -- 32,167
Unrealized loss on marketable securities (13,244) --
Changes in assets and liabilities:
Accounts receivable, net 32,878 (31,691)
Prepaid expenses and other current assets 64,749 (100,216)
Accounts payable (105,881) (39,063)
Accrued expenses 142,206 103,582
Deferred revenue (120,859) 8,812
----------- -----------
Net cash used in operating activities (3,224,119) (3,387,134)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed assets (43,769) (16,297)
Increase in other assets (97,954) --
Proceeds from investments 2,999,040 (3,930,907)
Purchases of investments -- 1,961,519
----------- -----------
Net cash provided by (used in) investing activities 2,857,317 (1,985,685)
----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES
Net proceeds from sales of common stock 2,911,006 4,733,084
Proceeds from exercises of warrants and stock options 482,406 298,751
Principal payments of capitalized lease obligations (46,844) (53,415)
----------- -----------
Net cash provided by financing activities 3,346,568 4,978,420
----------- -----------
Net increase (decrease) in cash and equivalents 2,979,766 (394,399)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,391,561 668,616
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,371,327 $ 274,217
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 8,165 $ 17,662
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
NOTE 1 - PRESENTATION OF INTERIM INFORMATION
Interleukin Genetics, Inc., a Delaware corporation is a Pharmacogenetics company
focused on personalized medicine. We believe that combining genetic
susceptibility tests with specific therapeutic strategies results in improved
clinical outcomes and more cost-effective disease management. We have a growing
portfolio of patents covering the genetics of many common diseases and
conditions, including cardiovascular diseases, osteoporosis, complications of
diabetes, restenosis, and periodontal disease.
We have prepared the accompanying unaudited condensed consolidated financial
statements in accordance with generally accepted accounting standards for
interim financial reporting and with Securities Exchange Commission rules and
regulations for Form 10-Q. It is recommended that these interim condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes in our Annual Report on Form 10-K for the
year ended December 31, 2000. The interim condensed consolidated financial
statements are unaudited; however, in the opinion of our management, include all
adjustments, consisting only of normal recurring adjustments, necessary to make
the interim financial information not misleading. All significant intercompany
transactions and accounts have been eliminated in consolidation. Results for
interim periods are not necessarily indicative of those to be expected for the
full year.
Since our inception, we have incurred cumulative net losses of approximately
$34.4 million, including a net loss of approximately $3.4 milling during the
nine months ended September 30, 2001. For the nine months ended September 30,
2001, we have incurred negative cash flows from operating activities of
approximately $3.2 million.
During the nine months ended September 30, 2001, we raised net proceeds of
approximately $2.9 million, from a private placement of our common stock and
approximately $480,000 from the exercise of outstanding warrants and stock
options. During the year ended December 31, 2000, we raised approximately $6.7
million from two private placements of our common stock. We believe that our
current cash resources are adequate to fund operations until September 2002;
however, without additional financing, we also believe that these resources will
be depleted by September 2002. We are currently pursuing various sources of
capital and strategic partnerships in order to raise the capital necessary to
continue operations past September 2002. WE CAN GIVE NO ASSURANCE THAT WE WILL
BE ABLE TO RAISE ANY ADDITIONAL CAPITAL, OR IF WE DO RAISE ADDITIONAL CAPITAL,
THAT IT WILL BE ON TERMS ACCEPTABLE TO OUR STOCKHOLDERS OR US. IF ADDITIONAL
AMOUNTS CANNOT BE RAISED, WE WOULD SUFFER MATERIAL ADVERSE CONSEQUENCES TO OUR
BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
NOTE 2 - RESEARCH ARRANGEMENTS
We have had a collaborative relationship with Sheffield University since 1994.
In July 1999, we entered into an arrangement with Sheffield whereby we acquired
the right to develop and commercialize Sheffield's past and future discoveries.
Pursuant to this Research and Technology Transfer Agreement, Sheffield agreed to
forego its rights to future royalties and granted us commercialization rights to
future discoveries in exchange for 275,000 shares of our common stock. This
common stock had a market value of $653,000 at the
6
time of issuance and was recorded as an expense in the period of issuance. This
agreement also requires us to issue options on July 1st of each year to
Sheffield to purchase our common stock. Each option issued is exercisable at the
then current market price for a number of shares determined as follows: (i)
25,000 shares if this agreement is in effect and (ii) 10,000 shares for each
patent application related to Sheffield's discoveries that we filed during the
preceding 12 months. This agreement has a term of five years and may be canceled
by us if the principal collaborator at Sheffield, Dr. Gordon Duff, leaves
Sheffield or by either party upon six months' notice. Under the terms of this
agreement we have issued options to acquire 35,000 shares of our common stock in
both 2000 and 2001. In total we have issued options to acquire 70,000 shares of
our common stock. These options were fully vested upon issuance and expire five
years from the dates of issuance.
We also entered into a Research Support Agreement with Sheffield in July 1999
that requires us to pay the costs of all genetic research being conducted at
Sheffield. Sheffield conducts this research according to an Annual Research Plan
that is determined by a Steering Committee made up equally of members from
Sheffield and us. This agreement automatically renews in one-year increments,
but may be canceled by us if Dr. Duff leaves Sheffield or by either party upon
six months' notice. In the event Sheffield terminated the agreement, it is
doubtful we could discover or commercialize new products without incurring
greater expense and increased utilization of our resources. We have made
payments of approximately $154,000 to Sheffield for the nine months ended
September 30, 2001 and approximately $211,000 during the year ended December 31,
2000. We have paid an aggregate amount of $527,000 to Sheffield under the terms
of this agreement through September 30, 2001.
In September 1999, we entered into a five-year Consulting Agreement with
Professor Gordon Duff, Sheffield's key collaborator. In accordance with the
Consulting Agreement, Professor Duff received 200,000 shares of our common stock
for relinquishing interests in previous research agreements, the value of which
was $475,000 and was recorded as research and development expense in the third
quarter of 1999. Under this agreement Dr. Duff will also receive one percent of
the first $4 million of net sales under the PST technology and two percent of
sales above $4 million. In July 2000 in consideration of future services, Dr.
Duff received an option to purchase 25,000 shares of our common stock at the
then current market price. In July 2001 Dr. Duff received an additional option
to purchase 25,000 shares our common stock at the market price as of that date
in consideration of his ongoing consulting for us. These options were fully
vested upon issuance expire five years from the date of issuance. Dr. Duff also
received cash payments of approximately $68,000 for the nine months ended
September 30, 2001 and approximately $93,000 for the year ended December 31,
2000.
NOTE 3 - REVENUE RECOGNITION
Revenue from genetic susceptibility tests is recognized when the tests have been
completed and the results reported to the doctors, provided that collection of
the related receivable is probable. To the extent test kits have been purchased
but not yet submitted for test results, revenue recognition is deferred. Amounts
received prior to meeting the above revenue recognition criteria are presented
as deferred revenue in the accompanying balance sheets. Contract revenues are
recognized ratably as services are provided. In accordance with Staff Accounting
Bulletin No. 101, up front non-refundable license fees are deferred and
recognized ratably over the
7
license term. Provision for anticipated losses on fixed-price contracts is made
in the period losses are identified.
NOTE 4 - USE OF ESTIMATES
The preparation of 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 financial
statements, as well as the reported amounts of revenues and expenses during the
reported periods. Actual results could differ from those estimates.
NOTE 5 - BASIC AND DILUTED NET LOSS PER COMMON SHARE
Statement of Financial Accounting Standards (SFAS) No. 128 (SFAS 128), "Earnings
per Share," outlines methods for computing and presenting earnings per share.
SFAS 128 requires a calculation of basic and diluted earnings per share for all
periods presented. We reported losses for the three and nine months ended
September 30, 2001 and 2000 and accordingly, outstanding options and warrants
have been excluded from the calculation of the diluted weighted average shares
outstanding as they are antidilutive in loss periods. The calculation of diluted
net loss per share excludes 2,626,279 and 1,733,636 stock options outstanding
and 1,345,952 and 1,356,545 warrants to purchase common stock outstanding at
September 30, 2001 and September 30, 2000, respectively.
NOTE 6 - STOCKHOLDERS' EQUITY
In January 2001, we sold in a private placement 1.2 million shares of common
stock for $2.50 per share. The purchasers of the common stock also received
warrants to purchase up to 600,000 shares of common stock exercisable at $3.00
per share. We generated net proceeds of approximately $2.9 million from this
transaction.
In December 2000, we sold in a private placement 542,373 shares of common stock
for $3.69 per share. The purchasers of the common stock also received warrants
to purchase up to 135,593 shares of common stock exercisable at $4.83 per share.
We generated net proceeds of approximately $2.0 million from this transaction.
Under the terms of this private placement we are required to adjust downward the
price per share paid in the offering, by issuing additional shares, to match any
lower price per share paid in subsequent offerings during the 24 months
following the date of the private placement. Following the January 2001 private
placement, described above, we issued an additional 257,627 shares of common
stock to the purchasers in the December 2000 private placement, and new warrants
to purchase 264,407 shares of Common Stock exercisable at a price of $3.13 per
share to replace the previously issued warrants to purchase 135,593 shares of
Common Stock at a price of $4.83 per share.
None of the warrants discussed in this section have been exercised.
NOTE 7 - SEGMENT INFORMATION
We follow the provisions of SFAS No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information." SFAS 131 establishes
8
standards for reporting information about operating segments in annual and
interim financial statements, requiring that public business enterprises report
financial and descriptive information about reportable segments based on a
management approach. SFAS 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. In applying
the requirements of this statement, we continue to have one reportable segment,
which is the development of genetic susceptibility tests and therapeutic targets
for common diseases.
During 2000, we closed our foreign operations. Therefore, we no longer have any
assets outside of the United States. Since September 30, 2000 substantially all
of our assets have been located in the United States. For the nine-month periods
ended September 31, 2000 and 2001 all revenue was primarily generated in the
United States.
NOTE 8 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141),
which applies to all business combinations initiated after June 30, 2001. This
statement requires that all business combinations be accounted for by the
purchase method and defines the criteria used to identify intangible assets to
be recognized apart from goodwill.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142), which is effective for fiscal years beginning after December 15,
2001, except goodwill and intangible assets acquired after June 30, 2001 which
are subject immediately to the non-amortization and amortization provisions of
this Statement. Under the new rules, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statement. Other intangible assets will
continue to be amortized over their useful lives.
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143 "Accounting for Asset Retirement
Obligations", effective for fiscal years beginning after June 15, 2002. This
statement addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the retirement
costs.
In October 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144 "Accounting for the Impairment or
Disposal of Long-lived Assets", effective for fiscal years beginning after
December 15, 2001. This statement addresses financial accounting and reporting
for the impairment or disposal of long-lived assets.
The Company does not expect the effect of complying to these new accounting
pronouncements to be material to its financial position or its results of
operations.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q contain certain forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Securities Exchange Act. Statements contained in this report that are not
statements of historical fact may be deemed to be forward-looking statements.
Words or phrases such as "will likely result", "expect", "will continue",
"anticipate", "estimate", "intend", "plan", "project", "outlook", or similar
expressions are intended to identify forward-looking statements. Forward-looking
statements address or may address the following subjects:
- - The sufficiency of our current cash resources to fund operations until
September 2002;
- - Our expectation of the benefits that will result from the ongoing clinical
trial that Brigham and Women's Hospital is conducting on our behalf to
investigate the genetic control of inflammation;
- - Our expectation of the benefits that will result from the ongoing research
we are funding at Sheffield University;
- - Our expectation that total research and development costs, including
clinical costs, will be approximately $2.8 million for the year ended
December 31, 2001; and
- - Our expectation that we will continue to experience losses until our
genetic testing revenues grow substantially from current levels.
Actual results may vary materially from those expressed in forward-looking
statements. Factors that could cause actual results to differ from expectations
include but are not limited to; risks related to market acceptance of genetic
risk assessment tests in general and the Company's products in particular, risk
related to technology and product obsolescence, delays in development of
products, dependence on third parties, our ability to obtain adequate capital,
competitive risks and those risks set forth within the Company's Report on Form
8-K we filed with the SEC on May 31, 2001 (File No. 0-23413) and within the
section titled "Risk Factors" within the Company's Registration Statement of
Form S-3, as amended, filed on March 5, 2001 (File No. 333-56558). We cannot be
certain that our results will not be adversely affected by one or more of those
factors or by other factors not currently anticipated. All information set forth
in this Form 10-Q is as of the date of this Form 10-Q. Unless required by law we
accept no responsibility to update this information.
GENERAL OVERVIEW
We develop and sell genetic susceptibility tests, tests that identify which
individuals will respond to specific drug therapies and medical research tools.
We focus our efforts on discovering genetic factors that predict the
susceptibility of individuals to various diseases or determine which individuals
will respond to a specific drug therapy. We market PST(R) in the United States
and Europe. PST is our first genetic test and predicts the risk of periodontal
disease. Products currently under development include tests
10
that predict the risk of osteoporosis, coronary artery disease and complications
from diabetes and a test that predicts which drug treatment will be most
effective for patients with advanced Rheumatoid Arthritis.
Every living organism has a unique "genome," a master blueprint of all the
cellular structures and activities necessary to build and support life. A genome
is a map of the organism's DNA, which is in part comprised of segments called
"genes." Genes contain the specific sequences of information responsible for
particular physiological traits and processes. Each gene contains a sequence of
nucleotides, which provide precise genetic instructions to create, or "express"
a protein. Proteins are the primary building blocks of an organism's
physiological characteristics. A typical human cell contains thousands of
different proteins essential to its structure, growth and function. If even one
gene or single nucleotide is abnormal, it can severely alter the cell's function
and result in a disease condition. Throughout the past decade, researchers have
focused on discovering genes and sequencing the human genome to determine the
order of nucleotides in a specific gene, permitting identification of the gene
and the protein it produces using a variety of techniques. For example,
scientists have used cDNA libraries, which contain copies of DNA with only the
expressed portion of the gene, in conjunction with computer software to identify
locations of genes within the genome. Recent advances have allowed these
technologies to operate in a high-throughput manner, causing the discovery of
genes to become much more efficient and allowing researchers to focus on the
functional aspects of genes. Understanding the functional aspects of genes
permits the researchers to correlate those genes to medically relevant
conditions. The efforts to discover and understand these functional aspects of
the genes in the human genome are commonly referred to as "functional genomics."
Identifying genes that may predispose a person to a particular disease may allow
researchers to develop diagnostic tests for the disease permitting early
diagnosis and more successful treatment. We believe that combining genetic
susceptibility tests with specific therapeutic strategies results in improved
clinical outcomes and more cost-effective disease management.
We also develop and license our medical research tools to pharmaceutical and
biotech companies. For instance, BioFusion(R) is our proprietary computer
modeling system that simulates complex diseases and allows researchers to
identify useful information from the rapidly increasing genetic information
databases that companies and academic centers worldwide generate.
We have had a collaborative relationship with Sheffield University since 1994.
In July 1999, we entered into an arrangement with Sheffield whereby we acquired
the right to develop and commercialize Sheffield's past and future discoveries.
Pursuant to this Research and Technology Transfer Agreement, Sheffield agreed to
forego its rights to future royalties and granted us commercialization rights to
future discoveries in exchange for 275,000 shares of our common stock. This
common stock had a market value of $653,000 at the time of issuance. This
agreement also requires us to issue options on July 1st of each year to
Sheffield to purchase our common stock. Each option issued is exercisable at the
then current market price for a number of shares determined as follows: (i)
25,000 shares if this agreement is in effect and (ii) 10,000 shares for each
patent application related to Sheffield's discoveries that we filed during the
preceding 12 months. This agreement has a term of five years and may be canceled
by us if the principal collaborator at Sheffield, Dr. Gordon Duff, leaves
Sheffield or by either party upon six months' notice. Under the terms of this
agreement we have issued options to
11
acquire 35,000 shares of our common stock in both 2000 and 2001. In total we
have issued options to acquire 70,000 shares of our common stock. These options
were fully vested upon issuance and expire five years from the dates of
issuance.
We also entered into a Research Support Agreement with Sheffield in July 1999
that requires us to pay the costs of genetic research being conducted at
Sheffield on our behalf. Sheffield conducts this research according to an Annual
Research Plan that is determined by a Steering Committee made up equally with
members from Sheffield and us. This agreement automatically renews in one-year
increments, but may be canceled by us if Dr. Duff leaves Sheffield or by either
party upon six months' notice. In the event Sheffield terminated the agreement,
it is doubtful we could discover or commercialize new products without incurring
greater expense and increased utilization of our resources. We have made
payments of approximately $154,000 to Sheffield for the nine months ended
September 30, 2001 and approximately $211,000 during the year ended December 31,
2000. We have paid an aggregate amount of $527,000 to Sheffield under the terms
of this agreement through September 30, 2001.
In September 1999, we entered into a five-year Consulting Agreement with
Professor Gordon Duff, Sheffield's key collaborator. In accordance with the
Consulting Agreement, Professor Duff received 200,000 shares of our common stock
for relinquishing interests in previous research agreements, the value of which
was $475,000 and was recorded as research and development expense in the third
quarter of 1999. Dr. Duff will also receive one percent of the first $4 million
of net sales under the PST technology and two percent for sales above $4
million. In July 2000 in consideration of future services, Dr. Duff received an
option to purchase 25,000 shares of our common stock at the then current market
price. In July 2001 Dr. Duff received an additional option to purchase 25,000
shares our common stock at the market price as of that date in consideration of
his ongoing consulting for us. These options were fully vested upon issuance and
expire five years from the date of issuance. Dr. Duff also received cash
payments of approximately $68,000 for the nine months ended September 30, 2001
and approximately $93,000 for the year ended December 31, 2000.
We distribute PST through third party distributors. The Straumann Company and
Kimball Genetics market PST in the United States and Puerto Rico. Straumann is a
leading supplier of dental implants, and Kimball has expertise in processing
genetic tests and analyzing their results. Hain Diagnostika/ADA GmbH distributes
PST in all countries outside of North America and Japan. Hain has extensive
experience in commercializing genetic tests in several fields, as well as a
specific commitment to marketing products directly to dentists. Sales of PST
have generated minimal revenues to date, and we do not know if or when PST will
achieve commercial acceptance.
We collaborate with the University of Washington School of Dentistry in
a study sponsored by Washington Dental Service. This study involved
administering 1,150 PSTs, and we believe it will provide scientific and
financial data regarding the use of PST as a treatment-planning tool to assess
risk before actual periodontal damage occurs. The data from the study are
currently being analyzed.
Commercial success of genetic susceptibility tests will depend upon their
acceptance as medically useful and cost-effective by patients, physicians,
12
dentists, other members of the medical and dental community, and third-party
payers. We are not certain whether we will be successful in developing and
bringing to market our current or future tests based on the genetic discoveries
made by our collaborators and us.
Our ability to successfully commercialize genetic susceptibility tests depends
partly on obtaining adequate reimbursement for such products and related
treatment from government and private health care insurers and other third-party
payers. Doctors' decisions to recommend genetic susceptibility tests may be
influenced by the scope and reimbursement for such tests by third-party payers.
If both third-party payers and individuals are unwilling to pay for the test,
then the number of tests performed will significantly decrease, therefore
resulting in a reduction of revenues.
Research in the field of disease predisposing genes and genetic markers is
intense and highly competitive. We have many competitors in the United States
and abroad that have considerably greater financial, technical, marketing, and
other resources available. If we do not discover disease predisposing genes or
genetic markers and develop susceptibility tests and launch such services or
products before our competitors, then revenues may be reduced or eliminated.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2001 TO THREE MONTHS ENDED
SEPTEMBER 30, 2000
Revenue for the three months ended September 30, 2001 was $24,978 compared to
$38,141 for the three months ended September 30, 2000, a decrease of 35%. In the
three months ended September 30, 2001, the Company recorded revenue from 577 PST
tests compared to 304 tests in the same period in 2000. Cost of revenue was
$8,443 for the three months ended September 30, 2001 compared to $36,423 for
2000. Gross profit margin was 66% in the three months ended September 30, 2001
compared to 5% for the same period in 2000.
The decrease in revenue and the improved gross margin are the result of the
change in strategy in how we market, distribute and process PST. We no longer
market, distribute or process PST ourselves. We now use third parties to perform
these activities on our behalf and we earn a royalty on end-user sales.
For the three months ended September 30, 2001, the Company had research and
development expenses of $634,719 as compared to $471,729 for the same quarter of
2000, an increase of 35%. The increase was primarily the result of increases in
personnel costs and increases in expenses for outside research projects. The
2001 expense includes approximately $133,000 for outside research projects
compared to approximately $36,000 for outside research projects during the same
period of 2000.
We have recently completed a research project with Genome Therapeutics, Inc. to
provide us with DNA sequencing information, including identifying SNP (Single
Nucleotide Polymorphism) variations in the region of the IL-1 genes. The program
is focusing on those key genes in this very specific chromosomal region that we
and others have shown to be associated with risk for inflammatory diseases,
including Alzheimer's disease, asthma, cardiovascular disease, diabetes, gastric
cancer and osteoporosis.
13
Another ongoing research project is a clinical trial Brigham and Women's
Hospital ("BWH") is conducting on our behalf to investigate the genetic control
of inflammation. The proprietary screening platform being used in the BWH study,
the Inflammation Response Induction System ("IRIS"), allows the rapid evaluation
of inflammatory responses in humans with specific IL-1 genetic variations. We
believe the BWH studies will improve understanding of how IL-1 genetic
variations affect their risk for several chronic diseases and will help identify
preventive and therapeutic compounds for patients who are at increased risk.
We are also funding research at Sheffield University in support of several
research projects including the following: A study to determine the haplotypes,
or sets of genetic variations that are inherited together, that exist within the
IL-1 gene cluster; A study to discover novel drug targets for inflammatory
diseases by discovering genes involved in the responses of cells after they have
been activated by IL-1; the development of a system that measures the net IL-1
biologic activity of blood or any tissue fluid and the discovery of the genetic
variations that control patient to patient differences in inflammatory
mechanisms. We believe that the completion of these studies will greatly enhance
our understanding of the IL-1 gene cluster and the relationship of this gene
cluster to inflammatory responses and disease risk.
During the month of October 2001 we substantially completed the physical
construction on our new research laboratory located at our corporate offices at
135 Beaver Street in Waltham, Massachusetts. We expect the lab to be operational
before the end of the year. We plan to undertake the following research
activities within the laboratory:
- - Identification of functional SNPs: A project to determine which of the SNPs
within the IL-1 gene cluster leads to an alteration in the expression of
the IL-1 genes.
- - Create IL-1 genotype and haplotype specific cell models that can be used
for studying drug responses. These models will be critical proprietary
reagents for the analyses of genotype related drug response for use in
future partnerships and collaborative projects for the development of new
drugs.
- - Investigate IL-1 genotype and haplotype influences on the expression of
inflammatory response genes derived from tissues of individuals with
diseases that we are studying clinically.
We expect total research and development costs, including clinical costs, to be
approximately $2.8 million for the calendar year 2001. Actual costs may vary
from this estimate as a result of changes in technology, the success of current
and future research projects, the success or failure of our current or future
strategic alliances and collaborations, the identification of new business
opportunities and our ability to raise additional new capital.
We have not made an attempt to finalize an estimate of our research and
development expenses for 2002 or beyond due to the factors listed above.
Selling, general and administrative expenses were $565,110 during the three
months ended September 30, 2001 compared to $744,466 during the same quarter
last year, a decrease of 24%. The decrease was primarily the result of a
14
reduction in administrative, sales and marketing expense related to the sale and
distribution of PST. As mentioned above, we no longer market, sell, distribute
or process PST directly. We now use third parties to perform these activities on
our behalf. This has significantly reduced our operating expenses as they relate
to PST.
Interest income in the third quarter of 2001 was $49,661 compared to $80,853 in
the third quarter of 2000. This decrease is due entirely to the lower average
cash, cash equivalent and marketable securities and lower interest rates in 2001
in comparison to the same period in 2000. Interest expense of $2,396 was
incurred during the quarter ended September 30, 2001, compared to $3,957 in the
same period in 2000.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2001 TO NINE MONTHS ENDED
SEPTEMBER 30, 2000
Revenue for the nine months ended September 30, 2001 was $183,923 compared to
$206,091 for the nine months ended September 30, 2000, a decrease of 11%. In the
nine months ended September 30, 2001, the Company recorded revenue based on
3,035 PST tests processed compared to 1,340 tests in the same period in 2000.
Cost of revenue was $43,387 for the nine months ended September 30, 2001
compared to $156,848 for 2000. Gross profit margin was 76% in the nine months
ended September 30, 2001 compared to 24% for the year earlier period.
The decrease in revenue and cost of revenue and the improvement in gross margin
was the result of a change in our strategy for marketing, distributing and
processing PST. We no longer market, distribute or process PST ourselves. We now
use third parties to perform these functions on our behalf and we earn a royalty
on end-user sales. The decrease in revenue was partially offset by revenue
produced by a study of PST being conducted by Washington Dental University. The
number of processed tests in the six months ended June 2001 associated with this
study was 1,150. This study ended in July and revenue from this source has not
continued after that time.
For the nine months ended September 30, 2001, the Company had research and
development expenses of $2,050,665 as compared to $1,387,795 for the same period
in 2000. The increase was due to increases in personnel costs and increases in
the cost of outside research projects. The 2001 expense includes approximately
$581,000 for outside research projects compared to approximately $148,000 for
outside research projects during the same period of 2000.
Selling, general and administrative expenses were $1,741,231 during the nine
months ended September 30, 2001 compared to $2,539,102 during the same period
last year, a decrease of 31%. The decrease was partially the result of a
reduction in administrative, sales and marketing expense related to the sale and
distribution of PST. As mentioned above, we no longer market, sell or distribute
PST directly. This has significantly reduced our operating expenses as they
relate to PST. In addition, during the nine month period ended September 30,
2000 we incurred $180,000 expense associated with our relocation to our current
facility in Waltham Massachusetts and $98,000 in connection with the
cancellation of a distribution agreement.
Interest income during the nine months ended September 30 2001 was $237,252
compared to $222,416 during the same period of 2000. Interest expense of
15
$8,165 was incurred during the nine month period ended September 30, 2001,
compared to $17,662 in the same period in 2000.
LIQUIDITY AND CAPITAL RESOURCES
To date, we have funded our operations primarily through public and private
sales of equity. During the nine months ended September 30, 2001, we raised net
proceeds of approximately $2.9 million, net of expenses, from a private
placement of common stock and approximately $480,000 from the exercise of stock
options and warrants. During 2000, we raised approximately $6.7 million from two
private placements of common stock.
Since inception, we have incurred cumulative net losses of approximately $34.4
million, including losses of approximately $3.4 million during the nine months
ended September 30, 2001. Net cash used in operating activities was $3.2 million
during the nine months ended September 30, 2001 and $3.4 million during the same
period last year.
We anticipate that we will continue to experience losses until our genetic
testing revenues grow substantially from current levels. In addition, if we are
successful in reaching agreements with strategic partners, milestone payments,
if any, from these strategic partners will help cover our research and
development expense and could also reduce our net loss. We cannot give any
assurances that we will be able to increase our revenues, either from genetic
tests or licensing revenue, or that we will be able to reach collaborative
partnering agreements.
We currently do not have any commitments for material capital expenditures. The
Company's obligation at September 30, 2001 for capitalized lease obligations
totaled approximately $49,000, of which $24,000 is classified as long-term and
$25,000 is classified as current.
As of both September 30, 2001 and December 31, 2000 we had cash, cash
equivalents and marketable securities of approximately $5.4 million. We
anticipate that existing cash and cash equivalents will be sufficient to conduct
operations through September 2002. However, future capital requirements are
anticipated to be substantial, and we do not have commitments for additional
capital at this time. Capital requirements are expected to arise from the
commercial launch of additional genetic tests, continued research and
development efforts, the protection of intellectual property rights (including
preparing and filing of patent applications), as well as operational,
administrative, legal and accounting expenses. We are currently pursuing sources
of capital and strategic partnerships in order to raise the capital necessary to
continue operations past September 2002. However, we can not assure that we will
be successful in these efforts. WE CAN GIVE NO ASSURANCE THAT WE WILL BE ABLE TO
RAISE ANY ADDITIONAL CAPITAL, OR IF WE DO RAISE ADDITIONAL CAPITAL, THAT IT WILL
BE ON TERMS ACCEPTABLE TO OUR STOCKHOLDERS OR US. IF ADDITIONAL AMOUNTS CANNOT
BE RAISED, WE WOULD SUFFER MATERIAL ADVERSE CONSEQUENCES TO OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As of September 30, 2001, the only financial instruments we carried were cash
and cash equivalents. We believe the market risk arising from holding these
financial instruments is not material.
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Some of our sales occur outside the United States and are transacted in foreign
currencies. Accordingly, we are subject to exposure from adverse movements in
foreign currency exchange rates. At this time we do not believe this risk is
material and we do not currently use derivative financial instruments to manage
foreign currency fluctuation risk. However, if foreign sales increase and the
risk of foreign currency exchange rate fluctuation increases, we may in the
future consider utilizing derivative instruments to mitigate these risks.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to, nor is its property the subject of, any pending
legal proceeding.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
(c) Not applicable
(d) Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTERLEUKIN GENETICS, INC.
Date: November 12, 2001 By: /s/ Philip R. Reilly
----------------------------------
Philip R. Reilly
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Fenel M. Eloi
---------------------------------
Fenel M. Eloi
Chief Financial Officer,
Secretary & Treasurer
(Principal Financial and
Accounting Officer)
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