GENELABS TECHNOLOGIES, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
ANNUAL REPORT ON FORM 10-K
INDEX
PAGE
Report of Ernst & Young LLP, Independent Auditors F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000 F-4
Consolidated Statement of Shareholders' Equity for the Years
Ended December 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000 F-6
Notes to Consolidated Financial Statements F-7 - F-15
All schedules are omitted because they are not required or the required
information is included in the consolidated financial statements or notes
thereto.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Genelabs Technologies, Inc.
We have audited the accompanying consolidated balance sheets of
Genelabs Technologies, Inc. as of December 31, 2002 and 2001, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Genelabs Technologies, Inc. at December 31, 2002 and 2001, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.
The accompanying financial statements have been prepared assuming that
Genelabs Technologies, Inc. will continue as a going concern. As discussed in
Note 1 to the financial statements, the Company has incurred recurring
operating losses and negative cash flows from operations. These conditions
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 1. The financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of this uncertainty.
ERNST & YOUNG LLP
Palo Alto, California
February 5, 2003,
except for Note 1 Paragraph 3 and Note 9, as to which the date is
April 15, 2003
GENELABS TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
DECEMBER 31,
------------------------------
2002 2001
------------- -------------
Current assets:
Cash, cash equivalents and short-term investments:
Cash and cash equivalents $ 3,035 $ 8,626
Short-term investments 3,535 10,374
------------- -------------
Total cash, cash equivalents and short-term investments 6,570 19,000
Net assets of diagnostics subsidiary held for sale 417 287
Other current assets 512 602
------------- -------------
Total current assets 7,499 19,889
Property and equipment, net 1,306 1,251
Long-term investments 960 960
------------- -------------
$9,765 $ 22,100
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accrued liabilities $ 1,853 $ 1,474
Accrued compensation and related expenses 912 1,769
Unearned contract revenue 2,050 3,000
------------- -------------
Total current liabilities 4,815 6,243
Accrued compensation 186 332
Unearned contract revenue 2,050 3,625
------------- -------------
Total liabilities 7,051 10,200
------------- -------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized, none issued or
outstanding at December 31, 2002 or 2001 - -
Common stock, no par value, 75,000 shares authorized, 53,393 and 49,843 shares
issued and outstanding at December 31, 2002
and 2001, respectively 187,264 180,500
Accumulated deficit (184,550) (168,600)
------------- -------------
Total shareholders' equity 2,714 11,900
------------- -------------
$ 9,765 $22,100
============= =============
See accompanying notes.
GENELABS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2002 2001 2000
--------------- --------------- ---------------
Contract revenue $ 3,645 $ 4,769 $ 7,075
--------------- --------------- ---------------
Operating expenses:
Research and development 14,537 13,238 14,671
General and administrative 5,529 6,464 5,626
--------------- --------------- ---------------
Total operating expenses 20,066 19,702 20,297
--------------- --------------- ---------------
Operating loss (16,421) (14,933) (13,222)
Interest income, net 341 1,646 589
Gain on sale of long-term investments - - 351
--------------- --------------- ---------------
Loss from continuing operations (16,080) (13,287) (12,282)
Income from discontinued operations of diagnostics
subsidiary 130 287 -
--------------- --------------- ---------------
Net loss $ (15,950) $ (13,000) $ (12,282)
=============== =============== ===============
Loss per share from continuing operations $ (0.31) $ (0.27) $ (0.28)
=============== =============== ===============
Net loss per share $ (0.31) $ (0.26) $ (0.28)
=============== =============== ===============
Weighted average shares outstanding 51,443 49,584 43,507
=============== =============== ===============
See accompanying notes.
GENELABS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
SERIES A TOTAL
CONVERTIBLE ACCUMULATED SHAREHOLDERS'
PREFERRED STOCK COMMON STOCK DEFICIT EQUITY
---------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 $9,682 $ 139,207 $ (143,318) $ 5,571
Comprehensive loss:
Net loss (12,282) (12,282)
16 shares canceled under the restricted
stock plan (26) (26)
267 shares issued under the employee stock
purchase plan 456 456
811 shares issued under stock options 2,652 2,652
3,333 shares issued upon conversion of
Series A convertible preferred stock (9,682) 9,682 -
1,779 shares issued under financing
agreement 6,925 6,925
3,000 shares and warrant to purchase 500
shares issued to Watson Pharmaceuticals,
Inc. 20,533 20,533
Non-employee equity awards 171 171
---------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 - 179,600 (155,600) 24,000
Comprehensive loss:
Net loss (13,000) (13,000)
336 shares issued under the employee stock
purchase plans 504 504
109 shares issued under stock options 278 278
Non-employee equity awards 118 118
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 180,500 (168,600) 11,900
-
Comprehensive loss:
Net loss (15,950) (15,950)
3,100 shares issued under financing
agreement 6,001 6,001
403 shares issued under the employee stock
purchase plans 617 617
47 shares issued under stock options 122 122
Non-employee equity awards 24 24
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2002 $ - $ 187,264 $ (184,550) $ 2,714
=========================================================================================================
See accompanying notes.
GENELABS TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS)
(IN THOUSANDS)
2002 2001 2000
-------------- --------------- ---------------
Cash flows from operating activities:
Net loss $(15,950) $(13,000) $(12,282)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization expense 1,014 692 665
Income of discontinued diagnostics subsidiary (130) (287) -
Gains on sales of long-term investments - - (351)
Non-employee equity awards 24 118 171
Changes in assets and liabilities:
Other current assets 90 (124) (7)
Accounts payable, accrued liabilities, and accrued compensation
(624) 23 (597)
Unearned contract revenue (2,525) (3,417) 9,073
-------------- --------------- ---------------
Net cash used in operating activities (18,101) (15,995) (3,328)
-------------- --------------- ---------------
Cash flows from investing activities:
Purchases of short-term investments (6,706) (36,215) (29,824)
Proceeds from sales and maturities of short-term investments 13,545 48,866 12,364
Capital expenditures (1,069) (484) (378)
Proceeds from sales of long-term investments - 26 539
Other - - 199
-------------- --------------- ---------------
Net cash provided by/(used in) investing activities 5,770 12,193 (17,100)
-------------- --------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 6,740 782 30,540
Payments on short-term borrowings - - (1,000)
-------------- --------------- ---------------
Net cash provided by financing activities 6,740 782 29,540
-------------- --------------- ---------------
Net (decrease)/increase in cash and cash equivalents (5,591) (3,020) 9,112
Cash and cash equivalents, beginning of the period 8,626 11,646 2,534
-------------- --------------- ---------------
Cash and cash equivalents, end of the period 3,035 8,626 11,646
Short-term investments, end of the period 3,535 10,374 23,025
-------------- --------------- ---------------
Cash, cash equivalents and short-term investments,
end of the period $ 6,570 $ 19,000 $ 34,671
============== =============== ===============
See accompanying notes.
GENELABS TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SIGNIFICANT ACCOUNTING POLICIES
BUSINESS DESCRIPTION
Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a
biopharmaceutical company focused on the discovery and development of novel
pharmaceutical products to improve human health. We have built drug discovery
and clinical development capabilities that can support various research and
development projects. We are currently concentrating our capabilities on three
core programs: developing a late-stage product for lupus, discovering novel
antimicrobial lead compounds, and discovering novel lead compounds that
selectively inhibit replication of the hepatitis C virus.
BASIS OF PRESENTATION
The Company's consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business for the
foreseeable future.
The Company has incurred recurring operating losses and negative cash flows
from operations. The Company incurred a net loss of $15,950 for the year ended
December 31, 2002, and has working capital of $2,684 and an accumulated deficit
of $184,550 at December 31, 2002. The ability of the Company to continue as a
going concern is dependent upon its ability to achieve profitable operations
and to obtain additional capital. These factors raise substantial doubt about
the Company's ability to continue as a going concern. The Company is
aggressively seeking funding in order to satisfy its projected cash needs for
at least the next twelve months. The Company is pursuing the close of the sale
of its diagnostics operation and also renegotiating the terms of a key
collaboration, which, if completed, the company expects would provide
additional cash resources to the Company. The Company may be unable to complete
either of these transactions as currently contemplated or at all. While these
are in process, our board of directors has approved, and we are implementing a
plan to furlough a majority of our employees in order to preserve short-term
resources. Under the furlough program, Genelabs expects that it will have
sufficient resources to meet its operational needs through the end of May 2003.
The Company will continue to rely on outside sources of financing to meet its
capital needs. The outcome of these matters cannot be predicted at this time.
Further, there can be no assurance, assuming the Company successfully raises
additional funds, that the Company will achieve positive cash flow. If the
Company is not able to secure additional funding, in addition to the furlough
program, the Company will be required to scale back its research and
development programs, preclinical studies and clinical trials, and selling,
general, and administrative activities and may not be able to continue in
business. These consolidated financial statements do not include any
adjustments to the specific amounts and classifications of assets and
liabilities, which might be necessary should the Company be unable to continue
in business.
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, Accelerated Clinical Research Organization,
Inc., Genelabs Diagnostic, Inc. and Genelabs Europe B.V. All intercompany
accounts and transactions have been eliminated. Genelabs operates in one
business segment, the discovery and development of pharmaceutical products. See
Note 4 for discussion of the Company's diagnostics subsidiary.
Certain reclassifications of prior year amounts have been made to conform to
the current year presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. It is possible that actual amounts will differ from those estimates.
REVENUE RECOGNITION
Contract revenue for research and development, or R&D, is recorded as earned
based on the performance requirements of the contract. Non-refundable contract
fees for which no further performance obligations exist, and there is no
continuing involvement by Genelabs, are recognized on the earlier of when the
payments are received or when collection is assured.
Revenue from non-refundable upfront license fees where we continue involvement
through development, a collaboration, or an obligation to supply product is
recognized ratably over the development period when, at the execution of the
agreement, the development period involves significant risk due to the
incomplete stage of the product's development.
Revenue associated with development milestones, if any, is recognized based
upon the achievement of the milestones, as defined in the respective
agreements. Revenue associated with royalty payments based on third party
sales, if any, is recognized as earned in accordance with contract terms, when
third-party results are reliably measured and collectibility is reasonably
assured.
Revenue under R&D cost reimbursement contracts is recognized as the related
costs are incurred.
Advance payments received in excess of amounts earned are classified as
deferred revenue.
In November 2000, Genelabs entered into an agreement with Watson
Pharmaceuticals, Inc. providing Watson with an exclusive license to the
marketing rights for Prestara (formerly Aslera) in North America. Under the
agreement, Genelabs received a $10,000 non-refundable up-front license fee in
2000, of which $2,525, $3,000 and $400 was recognized as revenue in 2002, 2001
and 2000, respectively. The non-refundable license fee has been deferred and is
being recognized on a straight-line basis over the term Genelabs management
believes it has significant ongoing obligations to Watson, currently estimated
to be the completion of a confirmatory clinical trial, submission of a complete
response to the U.S. Food and Drug Administration's approvable letter for
Prestara and the FDA reaching a final decision on approval of Prestara.
Deferred revenue at December 31, 2002 of approximately $4,100 consists entirely
of the remaining portion of the up-front fee received from Watson in 2000.
During 2002, beginning in the third quarter, Genelabs extended the amortization
period of the upfront payment received from Watson from a period ended March
31, 2004 to a period ending December 31, 2004. The estimated period for
amortization has a noteworthy impact on the revenue recognized and the net loss
reported in Genelabs' financial statements. This change in accounting estimate
had the effect of decreasing revenue earned in the third and fourth quarters of
2002 by an aggregate amount of $425 with a resulting increase of $0.01 in loss
per share.The collaboration and license agreement with Watson also provides
Genelabs with significant royalties on product sales and a milestone payment of
up to $45,000 if the FDA approves the marketing of Aslera for the treatment of
systemic lupus erythematosus. Also see Note 6 regarding sale of common stock
and warrants to Watson in 2000.
Revenue recognized from certain of Company's grants and collaborations
represents 10% or more of total contract revenue. In 2002, there were two
significant sources of revenue accounting for 73% and 11% of total contract
revenue. In each of 2001 and 2000, there was one significant source of revenue
accounting for 63% and 70% of total contract revenue, respectively.
EARNINGS PER SHARE
Net loss per share has been computed using the weighted average number of
shares of common stock outstanding during the period. Diluted net loss per
share has not been presented, as, due to the Company's net loss position, it is
antidilutive. Had the Company been in a net income position, diluted earnings
per share for 2002, 2001 and 2000 would have included an additional 201, 529
and 1,373 shares, respectively, related to the Company's outstanding stock
options, respectively, and in 2000, 1,667 shares related to the Series A
Convertible Preferred Stock.
STOCK-BASED COMPENSATION
The Company grants employee stock options at an exercise price equal to the
fair market value of the shares at the date of grant. The Company accounts for
employee stock-based compensation using the intrinsic value method and,
accordingly, recognizes no compensation expense for stock options granted to
employees. Option valuation models have been developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. These models require highly subjective assumptions
regarding expected stock price volatility. Because the Company's stock options
have characteristics significantly different from those of traded options and
changes in the volatility assumptions can materially affect the fair value
estimate, the Company's management believes that these models do not provide a
representative measure of the fair value of options actually granted to
employees under the Company's stock-based compensation plans. Using one of
these models, the following table presents information showing what the effects
to the reported net loss and net loss per share would be if the company had
accounted for employee stock-based compensation using the fair-value method:
2002 2001 2000
-------------- -------------- ---------------
Net loss as reported $ (15,950) $ (13,000) $ (12,282)
Stock-based employee compensation cost:
Included in net loss as reported - - -
Amount that would have been included in
net loss if we had accounted for all stock-
based employee compensation at its
theoretical (Black-Scholes) fair value (2,813) (3,695) (2,430)
-------------- -------------- ---------------
Pro forma net loss as if the fair value method
had been applied to all awards $ (18,763) $ (16,695) $ (14,712)
============== ============== ===============
Net loss per share as reported $ (0.31) $ (0.26) $ (0.28)
Stock-based employee compensation cost:
Included in net loss per share as reported - - -
Amount that would have been included in
net loss per share if we had accounted for
all stock-based employee compensation at
its theoretical (Black-Scholes) fair value (0.05) (0.08) (0.06)
-------------- -------------- ---------------
Pro forma net loss per share as if the fair
value method had been applied to all
awards $ (0.36) $ (0.34) $ (0.34)
============== ============== ===============
Compensation expense for options or warrants granted to non-employees is
recorded at fair value of the consideration received or fair value of the
equity instruments issued, whichever is more reliably measured. The fair value
of options granted to non-employees is remeasured and adjusted over the vesting
term of the underlying options.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash, cash equivalents and short-term investments are held primarily in demand
deposit, money market and custodial accounts with United States banks. Cash
equivalents consist of financial investments with maturities of 90 days or less
at acquisition that are readily convertible into cash and have insignificant
interest rate risk.
The Company invests funds that are not required for immediate operating needs
principally in a diversified portfolio of debt securities. Management
determines the appropriate classification of these marketable debt securities
at the time of purchase and reevaluates such designation as of each balance
sheet date. As of December 31, 2002 and 2001, all marketable securities are
classified as available-for-sale as we do not intend to hold them to maturity.
These securities are stated at estimated fair value based upon market quotes.
Unrealized gains and losses, when material, are included in accumulated other
comprehensive income. Amortization of premiums and discounts and realized gains
and losses are included in interest income. The cost of securities sold is
based on the specific identification method. The Company has not experienced
any significant losses on its investments.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation on equipment is
calculated on a straight-line basis over the estimated useful lives of the
assets, generally three to five years. Leasehold improvements are amortized
over the shorter of the lease term or the estimated useful lives of the
improvements.
LONG-TERM INVESTMENTS
The Company uses the cost method of accounting for its equity investment in a
private company. The Company holds less than 20% of the voting shares of this
entity and management periodically monitors the liquidity and financing
activities of this entity to determine if an impairment write-down is required.
RESEARCH AND DEVELOPMENT EXPENSES
Our research and development costs are expensed as incurred. Research and
development expenses include, but are not limited to, payroll and personnel
expense, lab supplies, consulting costs, clinical trial costs and allocations
of corporate costs.
RECENT ACCOUNTING PRONOUNCEMENTS
We adopted Statement of Financial Accounting Standards No. 144 (FAS 144),
Accounting for the Impairment or Disposal of Long-Lived Assets, on January 1,
2002. FAS 144 superseded Financial Accounting Standards No. 121 (FAS 121),
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of, and certain accounting and reporting provisions of Accounting
Principles Board Opinion No. 30, Reporting the Results of Operations (APB 30).
The primary objectives of FAS 144 are to develop one accounting model based on
the framework established in FAS 121 for long-lived assets to be disposed of by
sale, and to address significant implementation issues. FAS 144's held for sale
criteria apply to the accounting treatment of our diagnostics subsidiary,
Genelabs Diagnostics Pte. Ltd., or GLD, which we plan to divest and continue to
account for as a discontinued operation under APB 30. As of December 31, 2002
the held for sale criteria of FAS 144 were met for our diagnostics subsidiary.
In June 2002, the Financial Accounting Standards Board (or FASB) issued
Statement of Financial Accounting Standards No. 146 (FAS 146), Accounting for
Costs Associated with Exit or Disposal Activities, which addresses accounting
for restructuring, discontinued operation, plant closing, or other exit or
disposal activities. FAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. FAS 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The adoption of FAS 146 is not expected to have a significant impact on our
financial position and results of operations.
In November 2002, the FASB issued Interpretation No. 45 (or FIN 45),
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the
existing disclosure requirements for most guarantees. It also clarifies that at
the time a company issues a guarantee, the company must recognize an initial
liability for the fair value of the obligation it assumes under that guarantee
and must disclose that information in its financial statements. While the
initial recognition and measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002, the disclosure
requirements are effective for financial statements for periods ending after
December 15, 2002. Our adoption of FIN 45 did not have a material impact on our
results of operations and financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148 (FAS 148), Accounting for Stock-Based Compensation - Transition and
Disclosure. FAS 148 amends an earlier standard on accounting for stock-based
compensation, FAS 123, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, FAS 148 amends the disclosure requirements
of FAS 123 to require more prominent disclosure about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. The additional disclosure requirements of FAS 148 are
effective for fiscal years ending after December 15, 2002. We have elected to
continue to follow the intrinsic value method of accounting as prescribed by
Accounting Principles Board Opinion No. 25 (or APB 25), "Accounting for Stock
Issued to Employees," to account for employee stock options, and have provided
the additional disclosures of FAS 148 in these financial statements.
2. AVAILABLE-FOR-SALE SECURITIES
The following table summarizes estimated fair value and cost of
available-for-sale securities at December 31:
2002 2001
------------- -------------
Description:
U.S. Treasury securities and obligations of U.S.
government agencies $2,678 $12,205
Corporate debt securities 244 2,065
Asset-backed securities 613 2,304
Money-market mutual funds 2,035 1,409
------------- -------------
$5,570 $17,983
============= =============
Balance Sheet Classification:
Included in cash and cash equivalents $ 2,035 $ 7,609
Included in short-term investments 3,535 10,374
------------- -------------
$5,570 $17,983
============= =============
Maturity:
Due within one year $4,021 $14,927
Due after one year through two years 1,549 3,056
------------- -------------
$5,570 $17,983
============= =============
3. PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
2002 2001
------------- -------------
Laboratory equipment $ 4,990 $ 4,479
Leasehold improvements 4,639 4,421
Office and other equipment 2,566 2,226
------------- -------------
12,195 11,126
Less accumulated depreciation and amortization (10,889) (9,875)
------------- -------------
$ 1,306 $ 1,251
============= =============
4. DISCONTINUED OPERATION - DIAGNOSTICS SUBSIDIARY
At December 31, 2002, the Company owned 100% of the common stock of Genelabs
Diagnostics Pte. Ltd. ("GLD") through a series of separate domestic and foreign
corporations. In 1998, Genelabs adopted a plan to divest this subsidiary and
began accounting for GLD as a discontinued operation. Shortly thereafter,
Institut Pasteur and Pasteur Sanofi Diagnostics filed a lawsuit in Singapore,
alleging that GLD infringed an HIV-2 patent owned by Institut Pasteur and
exclusively licensed to Pasteur Sanofi Diagnostics. Subsequent to the filing of
the lawsuit, Pasteur Sanofi Diagnostics was sold to Bio-Rad Laboratories, Inc.
("Bio-Rad").
On February 4, 2000, a Singapore court found that GLD infringed the patent and
assessed an interim royalty to be paid by GLD on sales of products that
infringed the patent. Damages were not determined at that time because
Singapore law requires a separate damages hearing. To estimate potential
damages, the interim royalty rate determined by the court was applied to the
period of infringement, and the damages calculated exceeded the net assets of
GLD. Based on the Singapore court's findings, Genelabs believed that GLD's
value had been impaired and that there was reasonable basis for estimating the
amount of the loss. Therefore, Genelabs wrote down its investment in GLD as of
December 31, 1999.
On October 24, 2001, Bio-Rad and GLD announced a global settlement of claims
regarding alleged infringement of HIV-2 patents. In consideration of the
settlement an HIV-2 license was granted to GLD for the products at issue in the
lawsuit, and GLD is required to make certain payments to Bio-Rad.
Summarized financial information for GLD for the years ended and as of
December 31, is as follows:
STATEMENTS OF OPERATIONS
2002 2001 2000
-------------- -------------- ---------------
Product sales $ 4,520 $ 6,676 $7,925
Cost of sales 2,544 3,467 4,108
-------------- -------------- ---------------
Gross profit 1,976 3,209 3,817
Operating expenses 1,846 2,792 2,960
-------------- -------------- ---------------
Income prior to loss of patent litigation 130 417 857
Charge accrued in consolidation for loss of HIV-2
patent litigation - 130 857
-------------- -------------- ---------------
Income from discontinued operations $ 130 $ 287 $ -
============== ============== ===============
BALANCE SHEETS
2002 2001
--------------- ---------------
Cash, cash equivalents and short-term investments $ 714 $1,713
Accounts receivable 545 1,047
Inventories 432 463
--------------- ---------------
Total assets $1,691 $3,223
=============== ===============
Liabilities, principally current $1,274 $2,936
Net equity of Genelabs Diagnostics Pte. Ltd. 417 287
--------------- ---------------
Total liabilities and net equity $1,691 $3,223
=============== ===============
5. COMMITMENTS AND CONTINGENCIES
The Company leases its primary office and laboratory facilities under a
non-cancelable operating lease that has a term expiring November 2006. The
Company is required to pay certain maintenance expenses in addition to monthly
rent. There are no other material lease obligations. At December 31, 2002,
future minimum lease payments under all operating leases with original terms
greater than one year are $1,233, $1,269, $1,308 and $1,231 for 2003, 2004,
2005, and 2006, respectively, for a total of $5,041, excluding sublease
rentals. Total lease expense, net of sublease income, was $879, $883 and $1,043
for 2002, 2001 and 2000, respectively.
In connection with the Active Pharmaceutical Ingredient and Finished Product
Supply Agreement with Watson, as of December 31, 2002, the Company had
outstanding orders with third party suppliers totaling $263.
The Company is subject to legal proceedings and claims that arise in the
ordinary course of business. Management currently believes that the ultimate
amount of liability, if any, with respect to any pending actions, either
individually or in the aggregate, will not materially affect Genelabs'
financial position or results of operations. However, the ultimate outcome of
any litigation is uncertain. If an unfavorable outcome were to occur, the
impact could be material. Furthermore, any litigation, regardless of the
outcome, can have an adverse impact on the Company's results of operations as a
result of defense costs, diversion of management resources, and other factors.
6. SHAREHOLDERS' EQUITY
COMMON STOCK
At December 31, 2002, the Company had 9,639 shares reserved for future
issuance.
The Company has entered into a series of agreements with Watson for the
licensing of marketing rights to Prestara in North America. In connection with
these agreements the Company issued 3,000 shares of common stock and a warrant
to purchase 500 shares of common stock to Watson for $20,550 in November 2000.
The warrant is immediately exercisable at $6.85 per share and expires no later
than November 2005.
7. STOCK-BASED COMPENSATION
EMPLOYEE STOCK PURCHASE PLAN ("STOCK PURCHASE PLAN"). Employees who meet
certain minimum requirements are eligible to participate in the Company's Stock
Purchase Plan, for which 2,000 shares of Common Stock have been reserved.
Eligible employees are entitled to purchase stock at 85% of the market value at
the beginning or ending of six-month purchase periods, whichever is lower, and
stock may be purchased at the same price for up to four periods. Purchases are
limited to a maximum of $25 per year and employees can contribute up to 15% of
total compensation. Through December 31, 2002 and 2001, a cumulative total of
1,864 and 1,461 shares, respectively, had been issued under the Stock Purchase
Plan and a similar predecessor plan, with 1,451 shares remaining for future
purchases.
STOCK AWARD PLANS. The Company has a stock award plan that provides for the
issuance of shares of common stock to employees who are not officers or
directors. There are 400 shares of Common Stock reserved for issuance under
this plan and through December 31, 2002, no shares had been issued. During
2002, an additional plan that also allowed issuance of shares of common stock
to employees and independent contractors who are not officers or directors
expired, and at the time of expiration a cumulative total of 204 shares had
been issued.
STOCK OPTION PLAN. The Company's stock option plan provides for the issuance of
incentive stock options and nonqualified stock options to employees, officers,
directors and independent contractors. The number of stock options granted is
determined by the Board of Directors or a committee designated by the Board of
Directors, except for grants to directors, who receive options based on a
formula. Stock options generally may not be granted at prices lower than fair
market value on the date of grant and vest over periods ranging from two to
four years, with expiration no later than ten years from the date of grant. At
December 31, 2002, 1,709 shares were available for future grants.
Stock option transactions from 2000 through 2002 are summarized as follows:
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------------ -----------------
Outstanding at December 31, 1999 3,825 $3.34
Granted 1,018 5.29
Exercised (811) 3.30
Canceled (604) 3.53
------------ ----------------
Outstanding at December 31, 2000 3,428 3.85
Granted 1,392 4.22
Exercised (109) 2.50
Canceled (524) 4.63
------------ ----------------
Outstanding at December 31, 2001 4,187 3.91
Granted 1,808 1.81
Exercised (47) 2.62
Canceled (518) 3.62
------------ ----------------
Outstanding at December 31, 2002 5,430 $3.25
============ ================
The exercise price ranges and average remaining terms of options outstanding
and exercisable at December 31, 2002 were:
NUMBER OF NUMBER OF
OPTIONS WEIGHTED OPTIONS WEIGHTED
RANGE OF EXERCISE OUTSTANDING AT WEIGHTED AVERAGE AVERAGE EXERCISABLE AT AVERAGE
PRICES 12/31/02 REMAINING TERM EXERCISE PRICE 12/31/02 EXERCISE PRICE
- ------------------- ---------------- ---------------- -------------- --------------- ---------------
$0.71-$1.99 1,394 8.5 years $1.35 566 $1.67
$2.05-$4.00 2,443 6.3 years $2.50 1,630 $2.62
$4.02-$12.78 1,593 6.0 years $6.06 1,224 $6.01
---------------- ---------------
$0.71-$12.78 5,430 6.8 years $3.25 3,420 $3.68
================ ===============
There were options for 2,726 and 2,067 shares exercisable at December 31, 2001
and 2000, respectively.
DISCLOSURE OF FAIR VALUE OF STOCK OPTIONS. As disclosed in Note 1, Genelabs
accounts for employee stock options using their intrinsic value at the time of
grant. However, generally accepted accounting principles require companies that
account for stock options under the intrinsic value method to also disclose the
pro forma impact as if they had accounted for stock options using a fair value
approach. Accordingly, for disclosure purposes, the fair value of stock options
was estimated at the date of grant using a Black-Scholes option valuation
model. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. This model requires highly subjective assumptions
regarding expected stock price volatility. Because the Company's stock options
have characteristics significantly different from those of traded options and
changes in the volatility assumptions can materially affect the fair value
estimate, the Company's management believes that this model does not provide a
representative measure of the fair value of the options actually granted under
the Company's stock-based compensation plans. To determine the pro forma
disclosure, the Company used the following weighted average assumptions for
2002, 2001 and 2000, respectively: dividend yields of zero, risk-free interest
rates of 3.0%, 4.0% and 6.0%, volatility factors of 1.0 and a one-year expected
life of the options after vesting. Based on these assumptions, the
weighted-average fair value of options granted during 2002, 2001 and 2000 was
$1.41, $3.53 and $4.28 per share, respectively. For purposes of pro forma
disclosures, the estimated fair value of the options is expensed ratably over
the options' vesting period. If the Company elected to record the fair value
estimate of stock options in its financial statements, the net loss for 2002,
2001 and 2000, respectively, would have been $18,763, $16,695 and $14,712 and
the net loss per share would have been $0.36, $0.34 and $0.34 per share.
8. INCOME TAXES
There is no provision for income taxes because the Company has incurred
operating losses.
Deferred tax assets and liabilities reflect the net tax effects of net
operating loss and tax credit carryovers and temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets as of December 31 are as follows:
2002 2001
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 53,900 $ 47,400
Research credits 3,300 3,100
Capitalized research expenditures 1,800 1,300
Deferred revenue 1,600 2,700
Other individually immaterial items, net 1,600 2,000
------------ ------------
Total deferred tax assets 62,200 56,500
Valuation allowance for deferred tax assets (62,200) (56,500)
------------ ------------
Net deferred tax assets $ - $ -
============ ============
Realization of deferred tax assets is dependent upon future earnings, if any,
the timing and amount of which are uncertain. Accordingly, the net deferred tax
assets have been fully offset by a valuation allowance. For 2002, 2001 and
2000, the valuation allowance increased by $5,700, $4,800 and $6,500,
respectively. Deferred tax assets at December 31, 2002 include approximately
$2,700 associated with stock option activity for which any subsequently
recognized tax benefits will be credited directly to shareholder's equity.
At December 31, 2002, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $154,000 which expire in the years
2003 through 2022 and federal research and development tax credits of
approximately $2,300 which expire in the years 2003 through 2022. In addition
the Company had net operating loss carryforwards for state income tax purposes
of approximately $27,000 which expire in the years 2004 through 2013 and state
research and development tax credits of approximately $1,500 which do not
expire. Utilization of the Company's net operating loss and tax credit
carryforwards may be subject to substantial annual limitation due to the
ownership change limitations provided by the Internal Revenue Code and similar
state provisions. Such an annual limitation could result in the expiration of
the net operating loss and tax credits before utilization.
9. SUBSEQUENT EVENT
In February 2003, Genelabs entered into an agreement for the sale of GLD,
subject to closing conditions.