SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
----------
For the fiscal year ended December 31, 1997 Commission File Number 0-22962
HUMAN GENOME SCIENCES, INC.
(Exact name of registrant)
Delaware 22-3178468
(State of organization) (I.R.S. employer identification number)
9410 Key West Avenue, Rockville, Md. 20850-3338
(address of principal executive offices and zip code )
(301) 309-8504
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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 the 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. [ ]
The number of shares of the registrant's common stock outstanding on February
28, 1998 was 22,361,639.
As of February 28, 1998, the aggregate market value of the common stock held by
non-affiliates of the registrant based on the closing price reported on the
National Association of Securities Dealers Automated Quotations System was
approximately $ 576,000,000.*
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Human Genome Sciences, Inc.'s Notice of Annual Stockholder's Meeting
and Proxy Statement, to be filed within 120 days after the end of the
registrant's fiscal year, are incorporated into Part III of this Annual Report.
*Excludes 8,805,932 shares of common stock deemed to be held by officers and
directors, and stockholders whose ownership exceeds five percent of the shares
outstanding at February 28, 1998. Exclusion of shares held by any person should
not be construed to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of the management or policies of the
registrant, or that such person is controlled by or under common control with
the registrant.
PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains, in addition to historical
information, forward-looking statements that involve risks and uncertainty. The
Company's actual results could differ significantly from the results discussed
in the forward-looking statements. Factors that could cause or contribute to
such differences include those discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations," as well as those
discussed elsewhere in this Annual Report on Form 10-K.
GENERAL
Human Genome Sciences, Inc. (the "Company" or "HGS") is engaged in the
research and development of novel, proprietary pharmaceutical and diagnostic
products based on the discovery and understanding of the medical utility of
genes. Using automated, high-throughput gene sequencing technology, the Company
has generated a very large collection of partial human gene sequences, which the
Company believes correspond to most of the expressed genes in the human body,
and now possesses one of the largest proprietary databases of human and
microbial genes. Based on this genomic database, the Company has created a broad
base of product opportunities. The Company's activities have progressed to
focusing primarily on research and development of therapeutic protein product
candidates. In its efforts to identify the most promising product candidates,
the Company uses its advanced proprietary bioinformatics system to analyze
partial gene sequences and identify the genes corresponding to such partial gene
sequences and the proteins encoded by such genes. As of February 28, 1998, the
Company has isolated and characterized several thousand full-length genes and
expressed and purified more than 200 potential therapeutic proteins. The Company
is currently developing two proteins, MPIF-1 and KGF-2, in phase I clinical
studies and evaluating a number of additional therapeutic protein product
candidates in preclinical studies. In addition, the Company is investigating for
development with its collaborators proprietary product opportunities in
diagnostics and small molecule drugs based on human genes, as well as vaccines,
antibiotics, and diagnostics based on genes of microorganisms.
The Company has a two-pronged commercialization strategy:
Product Development and Commercialization. The Company is using its
internal capabilities to research and develop recombinant therapeutic
proteins, which are proteins that can be produced on a large scale and used
as drugs to treat diseases. The Company generally intends to develop
potential products to a late preclinical or early clinical stage and then
to collaborate with pharmaceutical or biotechnology companies for further
development and commercialization. However, the Company may consider
developing certain potential products on its own.
Corporate Collaborations. The Company increases its resources and
capabilities by establishing collaborations with pharmaceutical companies
for the development and commercialization of new products. The Company
believes that these arrangements will enable the Company to focus its
internal resources on a select number of promising product candidates while
still exploiting the broader product opportunities presented by its genomic
database.
The Company has five collaboration partners in the area of therapeutic and
diagnostic products based on its human gene database. The Company's initial
collaboration was formed with SmithKline Beecham Corporation ("SmithKline
Beecham") in May 1993 (as amended, the "SB Collaboration Agreements"). To date,
the Company has received $125 million in payments from SmithKline Beecham and is
further entitled to product development milestone payments and royalty payments.
In June 1995, the Company and SmithKline Beecham entered into a collaboration
agreement with Takeda Chemical Industries, Ltd. ("Takeda"), whereby Takeda was
granted certain rights to develop and commercialize products based on the
Company's and SmithKline Beecham's human gene technology ("Human Gene
Technology") and an option to develop and commercialize for Japan certain
products developed by the Company. In June 1996 the Company entered into a
significant amendment (the "SB Amendment") to the SB Collaboration Agreements
which, among other things, allows the Company to designate six therapeutic
proteins at any one time for exclusive development and commercialization
(subject to certain restrictions and co-development rights of its collaborators)
and permits the Company and SmithKline Beecham to enter into additional
collaboration agreements in the field covered by the SB Collaboration
Agreements. In July 1997, the Company entered into another amendment to the SB
Collaboration Agreement to streamline the procedures for outlicense of
diagnostic products by SmithKline Beecham and to permit the Company to develop
and market diagnostic tests to support its own therapeutic products.
In June and July 1996, the Company and SmithKline Beecham entered into
collaboration agreements (the "Additional Collaboration Partner Agreements")
with Schering Corporation and Schering Plough, Ltd. (collectively, "Schering
Plough"), Synthelabo S.A. ("Synthelabo") and Merck KGaA (collectively, the
"Additional Collaboration Partners"). Under the terms of the Additional
Collaboration Partner Agreements, $87.5 million of license and research payments
is payable to the Company over five years, of which $34.5 million has been
received to date. In
2
addition, the Additional Collaboration Partner Agreements provide for milestone
and royalty payments with respect to each product developed under these
agreements. In exchange, the Additional Collaboration Partners received certain
rights to research, develop and commercialize therapeutic products based on the
Company's and SmithKline Beecham's Human Gene Technology. Schering Plough and
SmithKline Beecham have been granted the right to develop jointly with the
Company certain of the therapeutic protein product candidates to which the
Company has retained the exclusive development rights.
The Company also has entered into other collaborative agreements in certain
areas where the Company has retained exclusive rights, including: the creation
of bacterial vaccines and immunotherapeutics and antimicrobial agents based on
genes of infectious agents; and corn genomics. Pursuant to the terms of such
collaboration agreements, an aggregate of $29.1 million of license and research
payments is payable to the Company over five years, of which $21.1 million has
been received to date.
The Company also has entered into three gene therapy agreements, one with
Schering Plough as part of the Additional Collaboration Partner Agreements, and
two with early stage gene therapy companies, Vascular Genetics Inc. ("VGI") and
Transgene S.A. ("Transgene"). The Company has received equity in VGI and will
receive equity in Transgene in connection with granting access to certain genes
in its database. In addition, the Company will receive milestone payments and/or
royalties. The Company also has certain co-marketing rights to products
developed under the Transgene agreement.
The Company also formed during its early development a collaboration with
The Institute of Genomic Research ("TIGR"). Under the collaboration agreement,
the Company agreed to provide TIGR with funding totaling $85 million over a
ten-year period ending September 2002. In return, the Company was entitled to
exclusive intellectual property rights to TIGR's research. In June 1997, the
Company and TIGR reached an agreement for the early conclusion of the
collaboration, which relieved the Company of all remaining funding obligations,
totalling approximately $38 million. In exchange, the Company will forego all
intellectual property rights for future work performed at TIGR, but retains all
intellectual property rights for work performed up to June 1997.
The Company vigorously pursues patents to protect its intellectual
property. As of February 28, 1998, the Company has twenty issued U.S. patents
covering full-length genes and has filed U.S. patent applications covering
substantially more than 500 full-length genes and the proteins they encode. The
Company makes patent filings outside the United States as it deems appropriate.
In addition, the Company has filed patent applications on a substantial number
of expressed sequence tags ("ESTs") that represent its large partial gene
sequences, although there is substantial uncertainty as to the patentability of
partial gene sequences.
GENOME SCIENCE
Genome science refers to the characterization of the entire set of genetic
information of any organism, including humans. All cells contain DNA, a complex
material containing all of the genetic information necessary to govern a cell's
biological processes. In humans, approximately 3-5% of DNA consists of segments
called genes. The entire human genome is believed to contain at least 100,000
genes, of which only several thousand were known to have been identified at the
time the Company commenced its operations. Each gene consists of a linear
sequence of nucleotides, the basic structural units of DNA. Sequencing genes
involves determining the order of nucleotides in the gene, which permits
identification of the gene and the protein produced by the gene.
Genes act as the fundamental blueprint for all the physiological attributes
of an individual. Each gene contains the information required to produce
("express") a gene product, generally a protein. Proteins are expressed by a
gene according to a set of genetic instructions encoded in the DNA and are the
principal determinants of an organism's characteristics. A typical cell of
higher animals, such as humans, contains thousands of different proteins
essential to cellular structure, growth and function. The aberrant expression
within a cell by even a single gene can severely alter the cell's normal
function and result in a disease condition.
When a gene is expressed in a cell, the order of different nucleotides in
the gene is copied into RNA in a duplication process called transcription. A
splicing process within the cell then removes the introns, or non-coding gene
segments, from the transcript, thereby creating a messenger RNA ("mRNA"), which
contains only the exons, or coding regions, of the transcribed gene. The mRNA
then directs the production of a protein in a process called translation. The
order of nucleotides in the mRNA determines the protein that is made. By
isolating mRNA from cells, the Company's scientists can analyze primarily the
coding regions of a gene. However, mRNA is unstable and therefore is difficult
to analyze directly. To sequence the mRNA, it is preferable to copy or
transcribe the mRNA back into DNA. This process produces a DNA copy ("cDNA"),
which contains only the exons, or coding regions, of the expressed gene. This
process avoids examination of the majority of human DNA, as approximately 95-97%
of the human genome consists of long stretches of nucleotides which do not code
for protein. By focusing on the mRNA, the Company examines the portion of the
genome which it believes to be the most important, because it is the portion
which makes protein.
Genes play an important role in the development of a variety of
therapeutics, diagnostics and other products and services. Proteins expressed by
genes are the targets of most drugs. As a result, the identification of proteins
can
3
play an important role in the development of drugs and drug screens. Proteins
themselves can also be used as drugs. Two examples of protein drugs on the
market are erythropoietin, which stimulates the production of red blood cells,
and insulin, which regulates sugar metabolism. The identification of genes that
code for proteins that may be missing or defective can enable the development of
therapeutics for genetic diseases. In addition, identification of genes that may
predispose a person to a particular disease may enable the development of
diagnostic tests for the disease.
COMPANY TECHNOLOGY AND RESEARCH
The Human Gene Anatomy Project
The gene discovery activity of the Company has focused on its Human Gene
Anatomy Project. The goal of this project is to identify virtually all human
genes, to catalogue the relative abundance of expressed genes by organ, tissue
and cell of origin and to identify changes in gene expression associated with
the normal processes of development, differentiation and activation, as well as
abnormal changes in gene expression associated with the development of disease.
The Company believes its Human Gene Anatomy Project approach is substantially
different from most others engaged in genomic research, which seek either to
isolate a single copy of each gene, determine the sequence of large regions of
human chromosomes or determine the chromosome location of genes responsible for
inherited genetic diseases. While such approaches will provide information
valuable for the creation of some new gene-based pharmaceutical products, the
Company believes that its Human Gene Anatomy Project provides a much broader
opportunity to discover genes of potential medical use.
The first component of the Human Gene Anatomy Project is the isolation and
preparation of a set of cDNA libraries from most normal human tissues. A library
is comprised of cDNA derived from samples of mRNA expressed in a particular
tissue. The Company's more than 700 libraries reflect the relative abundance of
the various mRNAs expressed in each tissue. The Company isolates and purifies
individual cDNA fragments from each library for sequence analysis to identify
the structure and possible function of genes. The Company sequences a portion of
each cDNA, which the Company believes is often sufficient to identify the
expressed gene and represents the best method for rapid gene discovery.
The Company's gene sequencing efforts now focus principally on comparing
genes expressed in normal, abnormal, and developmental tissues. The Company uses
such information to analyze changes in gene expression associated with
development, differentiation and disease processes, such as tumors of the
prostate, breast, colon and ovary. Additional areas of planned research include
changes in gene expression that occur during the processes of atherosclerosis,
asthma, emphysema, restenosis, osteoporosis, psoriasis, arthritis and a number
of neurological diseases.
Development of Product Opportunities
The Company has created an advanced proprietary bioinformatics system to
facilitate the selection of genes with potential medical utility. Bioinformatics
refers to the use of computers to process, analyze, store and retrieve
biological information. The Company believes it has one of the largest sets of
human gene sequences, and also uses its computer system to access publicly
available gene sequences. The Company's high capacity computer system has been
designed for ease of use by research scientists, who readily access the system
through desktop computers. The Company's data are also available to scientists
at SmithKline Beecham, Takeda, Schering Plough, Synthelabo and Merck KGaA
through bioinformatics systems created by the Company and SmithKline Beecham.
See " -- Collaborative Arrangements."
The Company believes that its proprietary bioinformatics system is an
important asset for the identification and creation of gene-based product
opportunities. The Company's bioinformatics system has several capabilities that
facilitate identification of genes with potential medical utility, including
gene similarity detection, sequence motif identification, sequence assembly and
differential gene expression analysis.
The Company's primary focus has progressed from identification of genes
having potential medical utility to the creation of proprietary product
opportunities. Specifically, the Company is now engaged in the identification
and development of product candidates, including the isolation and
characterization of full-length cDNAs, the purification of proteins encoded by
cDNAs of interest, the creation of cell lines that express specific receptors of
interest, the mapping of genes of interest, the creation of polyclonal and
monoclonal antibodies, the testing of the effects of purified proteins in cell
and tissue-based in vitro assays, the study of the effects of purified proteins
in small laboratory animals, and the initiation of human clinical trials.
As of February 28, 1998, the Company has isolated and fully sequenced
several hundred full-length cDNAs, purified more than 200 potential therapeutic
proteins and mapped more than 250 full-length cDNAs to their chromosomal
locations.
4
RESEARCH AND DEVELOPMENT
The Company's research and development efforts have been organized into the
following divisions:
Gene Discovery Division. The Gene Discovery Division is responsible for
preparing biological samples, extracting and amplifying DNA, performing
sequencing reactions, managing production information and monitoring sequencing
quality. The division manages the operation of 58 automated sequencing machines
along with a variety of laboratory robots and other instruments. The division
has developed technologies that streamline HGS' efforts to fully sequence genes
of interest in a high-throughput fashion.
Molecular Biology Division. The Company's Molecular Biology Division seeks
to identify and evaluate genes that may be useful for the creation of
therapeutic protein drugs, small molecule drugs, gene therapy, antisense
treatments and diagnostic products. The Molecular Biology Division contains the
Protein Therapeutics group and Exploratory Research group.
The Protein Therapeutics group identifies and evaluates genes which encode
proteins which may be useful as therapeutic protein drugs or for gene therapy or
antisense applications. The Protein Therapeutics group also identifies genes
that may be useful for diagnostic purposes. When comparative analysis indicates
that a gene encodes a potential therapeutic protein, this group isolates the
corresponding full-length cDNA, determines its pattern of tissue expression and
its entire coding sequence.
The Company has commenced a program to identify from its database what it
believes to be full-length cDNAs likely to encode potential therapeutic
proteins. To date, the Company has identified what it believes to be several
thousand secreted proteins. The Company is expressing and evaluating these
proteins and assessing their activity using in vitro and in vivo models covering
different therapeutic areas.
In addition to efforts relating to the identification of potential
therapeutic proteins, the Protein Therapeutics group characterizes genes and
proteins that may serve as targets for small molecule drug discovery,
principally to support the work of the Company's collaborators. The group
isolates full-length cDNAs, performs experiments to determine the tissue and
cell type in which the genes are expressed and determines the complete sequence
of the cDNA corresponding to each candidate gene. The group has identified
several hundred genes which encode proteins that may be targets for small
molecule drug screening. Full-length cDNAs corresponding to many of these genes
have been isolated and fully sequenced, and tissue distribution and chromosomal
location of most of these full-length genes have been determined.
The efforts of the Exploratory Research group are focused on development
and implementation of new technologies useful in the identification of
medically-relevant gene candidates. Responsibilities of this group include new
methodologies for cDNA library construction, chromosome mapping, optimization of
full-length gene cloning and development of new methods for gene analysis. This
group is also currently responsible for efforts in microbiology, including
construction and analysis of microbial genome libraries and selection of
candidate genes which may be useful in vaccine and immunotherapeutic programs.
Microbiology Division. The Microbiology Division is responsible for
development of microbial gene sequence information and biological reagents that
support HGS' and collaboration anti-infective efforts. For the Company's
5
microbial gene sequencing projects, the division is responsible for preparation
and analysis of the microbial genome database. These efforts include obtaining
biological samples and preparation of the microbial genome libraries. The group
has been involved in the sequencing of several important microbial pathogens,
including Streptococcus pneumoniae, Staphylococcus aureus and Enterococcus
faecalis. The division also supports internal and collaborative efforts focused
on generation of anti-microbial vaccine and immunotherapeutic products.
Bioinformatics Division. The Company's Bioinformatics Division develops
systems for high-volume data capture and analysis to support HGS' research and
collaborative efforts. The division applies advanced sequence data analysis
techniques to identify candidate genes for biological screening and drug
development. Bioinformatics manages database systems for tracking samples and
reagents during experimental procedures and sample storage. The division
supports collaborative relationships with the delivery of software, databases,
training and support. The division also is implementing systems for clinical
trial data management and analysis, preparation of drug applications and process
control of manufacturing operations.
Protein Development Division. The purpose of the Protein Development
Division is to provide proteins in a form suitable for in vitro and in vivo
testing. The Protein Development Division uses bacterial, insect and mammalian
expression systems that have been engineered to express abundant amounts of
proteins. The Company's therapeutic protein production facilities include 15
bioreactors ranging in capacity from 2 to 100 liters. The Protein Development
Division also purifies potential therapeutic proteins, enzymes that may be
useful in the discovery of small molecule drugs and bacterial proteins that may
be useful as vaccine components. This division also oversees the contract
production of cGMP materials by third parties for preclinical qualification and
Phase I clinical studies and the construction and operation of a pilot scale
production and process development facility, which will be leased from the
Maryland Economic Development Corporation ("MEDCO").
Through February 28, 1998, the Company has produced and purified more than
200 novel human proteins in amounts sufficient to test for activity. In some
cases, the Company also provides highly purified proteins to its collaborators
for further analysis.
Cell Biology Division. The Cell Biology Division determines the activities
of purified therapeutic protein candidates on cells in tissue culture. This
division uses over 75 in vitro assays to evaluate biological activities of
therapeutic protein candidates, many of which are used to determine whether such
candidates have biological activities relevant to serious unmet medical needs.
Examples of such in vitro tests include assays that detect proteins that have an
anti-viral effect, proteins that are capable of prolonging the life of neurons
and of promoting neural cell growth, proteins that have anti-cancer activity and
proteins that affect the growth and differentiation of hematopoietic cells.
High-Throughput Screening Division. The High-Throughput Screening Division
was established in early 1998. This group is responsible for the development and
validation of high-throughput screens to access the activity of the Company's
therapeutic protein candidates. This division is also responsible for generation
of cell-based supernatants that currently represent several thousand individual
genes encoding potential secreted proteins. The High-Throughput Screening group
works closely with the Gene Discovery and Bioinformatics divisions in
development of laboratory information management systems useful for
instrumentation control and analysis of test results.
Pharmacology Division. The Pharmacology Division tests for in vitro and in
vivo activity of therapeutic protein candidates and is also responsible for
safety studies. The division is responsible for preclinical animal testing of
the Company's therapeutic protein product candidates and employs a number of
standard assays for determining biological function. The division has also
developed several specialized assays to test biological function of specific
therapeutic proteins. The Company has recently expanded this division to
increase its efforts to develop therapeutic protein product candidates, and the
Company expects to continue to expand the division as necessary to support
preclinical and clinical development. The Company intends to establish a
clinical management team to manage and oversee clinical trials. The Company
intends to utilize contract research organizations to conduct toxicology,
pathology and clinical trials on the Company's lead therapeutic protein product
candidates.
Medical and Regulatory Affairs Divisions. The Medical and Regulatory
Affairs Divisions manage all activities necessary for the preparation and
submission of regulatory documentation including Investigational New Drug
Applications (INDs), Biologics License Applications, and New Drug Applications.
The divisions are responsible for developing and implementing clinical and
regulatory strategies that will ensure submissions meet U.S. and international
regulatory requirements to initiate clinical trials and obtain marketing
approvals for products developed by the Company.
The Quality Assurance (QA) staff, within Regulatory Affairs, is supporting
the establishment of current good manufacturing practices (GMPs) for HGS' leased
pilot product manufacturing facility. The QA staff provides guidance and assists
in creation and implementation of standard operating procedures (SOPs), assures
GMP training for facility employees, and maintains documentation of these
activities. QA participates in GMP audits of contract vendors.
6
INDs are currently active for two therapeutic protein product candidates --
MPIF-1 and KGF-2. Leading physicians and investigators have been identified and
consulted for possible new drug indications and for optimizing clinical trial
designs related to investigating prevention of chemotherapy-induced damage to
myeloid precursors, treatment of surgical and dermal wounds, and mucositis.
Clinical investigators have been selected from this group to conduct the
clinical trials sponsored by HGS. The data from these studies will be entered
into an electronic database and analyzed by HGS medical, regulatory, and
statistical staffs. Formal reports of clinical and non-clinical data then will
be submitted to the FDA. If the safety and efficacy of the investigational drug
for the specified indication are demonstrated by clinical trial data, the
Company intends to submit a biologics license or new drug application to the FDA
for marketing approval.
AREAS OF PRODUCT DEVELOPMENT
The Company believes that the genes it identifies have the potential to be
valuable for the development of a wide range of healthcare products in some or
all of the following areas:
Therapeutic Proteins. Therapeutic proteins are recombinant human proteins
that in native or modified form exert medically useful physiologic or
pharmacologic activity. By discovering and isolating genes, the Company may be
able to cause the genes that code for therapeutic proteins to express those
proteins. Therapeutic proteins may be useful for the treatment of diseases,
including inflammatory and autoimmune diseases, neurodegenerative diseases,
cardio-pulmonary diseases and other diseases caused by insufficient or defective
proteins resulting from a missing or defective gene. Therapeutic proteins
currently in clinical use include interferon, insulin, human growth hormone,
DNAse, G-CSF, GM-CSF and erythropoietin.
Currently, the Company is conducting pre-clinical and clinical development
studies on a number of potential therapeutic proteins, including Myeloid
Progenitor Inhibitory Factor-1 (MPIF-1), Keratinocyte Growth Factor-2 (KGF-2),
and Vascular Endothelial Growth Factor -2 (VEGF-2).
MPIF-1. MPIF-1 is a member of the chemokine family. The Company has shown
that MPIF-1 in in vitro and in vivo studies inhibits the differentiation and
growth of bone marrow cells (myeloid progenitor cells) responsible for
maintenance of red and white blood cells. Myeloid progenitor cells are destroyed
by many forms of cancer chemotherapy resulting in severe leukopenia,
thrombocytopenia and anemia. By preventing the growth of myeloid progenitor
cells during aggressive cancer chemotherapy, it may be possible to reduce the
destruction of these cells allowing the more rapid repopulation of red and white
blood cells in the circulation. This, in turn, may reduce the incidence of
serious infection, anemia and coagulation disorders associated with cancer
chemotherapy. An Investigational New Drug application for MPIF-1 was submitted
to the FDA during November of 1997. Clinical trials were initiated in the first
quarter of 1998.
KGF-2. KGF-2 is a member of the Fibroblast Growth Factor superfamily. The
Company has shown in in vivo tests that KGF-2 stimulates the growth of
epithelial cells. The protein has potential for use in the treatment of topical
(skin) ulcers, surgical and other wounds and burns and possibly other conditions
affecting epithelial cells. In addition, KGF-2 may be useful in the treatment of
mucositis (frequently a toxicity of cancer chemotherapy) and/or acute renal
failure. An Investigational New Drug application for KGF-2 was submitted to the
FDA during December of 1997. Clinical trials were initiated in the first quarter
of 1998.
VEGF-2. VEGF-2 is a member of the vascular endothelial/platelet-derived
growth factor superfamily. The Company has shown in in vitro studies that VEGF-2
promotes the growth of certain subsets of vascular endothelial cells. In in vivo
animal models performed in collaboration with Dr. Jeffrey Isner at the St.
Elizabeth's Medical School, VEGF-2 protein and DNA encoding the VEGF-2 gene had
been shown to reduce the severity of ischemia in a rabbit hind limb ischemia
model.
As a result of the SB Amendment, in June 1996, the Company obtained the
right to designate a limited number of therapeutic protein candidates at any one
time for exclusive development and commercialization by the Company, with the
right to add additional proteins as products enter clinical trials, are
outlicensed or dropped. Schering Plough and SmithKline Beecham have certain
co-development rights with respect to these product candidates. Subject to
certain limitations, the Company has the right to substitute new proteins for
proteins (i) that have been licensed to third parties under procedures set forth
in the SB Amendment, (ii) that are the subject of clinical trials or (iii) the
rights to which have been surrendered by the Company. See " -- Collaborative
Arrangements."
All of the Company's therapeutic protein product candidates are in the
early stages of preclinical and clinical testing. Accordingly, the results of
testing to date may not be indicative of results that will be obtained in
further preclinical trials or in clinical trials, as applicable. As further
results of tests are received, the Company may abandon particular projects which
it might otherwise have considered promising. Additionally, there can be no
assurance that clinical trials as to any particular product candidate, if
commenced, will be successful, or that any product can be successfully
commercialized.
7
Small Molecule Drugs. The Company believes that knowledge of a more
complete set of genes and the proteins they express will enable pharmaceutical
companies to design and screen pharmaceutical products in a more efficient
fashion by providing logical specific targets for discovering drugs. The
discovery of new drugs often involves screening a large family of synthetic and
natural products to determine their impact on proteins expressed by genes.
Increasingly, automated biochemical assays that test the ability of proteins to
bind to and modify the activity of purified proteins are used to test the
efficacy and selectivity (i.e., the ability to affect only the desired protein
targets and not other proteins expressed in the human body) of new drugs. The
undesired binding of a drug to other proteins not detected by a screening assay
can result in toxicity or other undesirable side effects. The Company believes
that the genes it discovers may contribute to screening assays by permitting
more complete sets of target proteins to be assembled for an assay. SmithKline
Beecham is currently using proteins expressed by genes identified by the Company
in a number of screening assays used to identify new drugs.
Diagnostics. The Company also believes that the genetic data obtained by it
could lead to the development of diagnostic tests for diseases. Such diagnostics
would likely be focused on four different applications. First, the comparative
analysis of genes expressed during the progression of tissues from normal to
fully diseased states may permit more accurate staging of diseases, thereby
facilitating the diagnosis and treatment of the disease. Proteins expressed by
"marker" genes associated with a specific disease can be a starting point in the
synthesis of antibodies, the principal components in many diagnostic systems.
Second, the Company's genetic data may enable the development of methods to
determine individual predisposition to disease. Third, tests could be designed
to detect inherited diseases in fetal cells. Fourth, the Company believes that
the genetic data obtained from the sequencing of disease-causing microorganisms
may allow for the rapid determination of the presence and activity of a
particular microorganism in an infected person. The development of diagnostics
based on genes identified by the Company is part of SmithKline Beecham's field
under the SB Diagnostic Amendment.
Antimicrobial Agents and Vaccines. The Company has retained exclusive
rights to utilize its information and technology to develop antimicrobial agents
and vaccines and, accordingly, is identifying and characterizing genes of
microorganisms, including bacteria, viruses, fungi and multicellular parasites.
The Company anticipates using its automated sequencing techniques to identify
genes expressed by microorganisms and parasites during resting, vegetative and
pathogenic states of infection. The Company believes that genes expressed during
the pathogenic phase of a microorganism may be found to be required for disease.
Each such gene (called a virulence gene) might be a candidate target for a new
antibiotic or vaccine. The Company also believes that knowledge of genes and
proteins expressed by pathogenic organisms may facilitate the development of
gene-based and antibody-based diagnostic assays for infectious diseases.
Analysis of the total genome of a microorganism should provide a complete
picture of all genes encoded by the microorganism. With this information, the
Company believes it may be possible to choose protein candidates that may be
useful as vaccine components or antigens required for the development of
immunotherapeutics. The Company also believes that a high-throughput approach of
gene identification may identify new genes capable of producing antibiotics and
other useful secondary metabolites.
The Company, either alone or in collaboration with TIGR, has completed
sequencing pathogenicity islands of Escherichia coli and the majority of the DNA
comprising the genome of the bacteria of the Staphylococcus aureus,
Streptococcus pneumoniae, Enterococcus faecalis, Helicobacter pylori, Borrelia
burgdorferi, Haemophilus influenzae, Mycoplasma genitalium and Methanococcus
jannaschii. The Company has entered into agreements with MedImmune, Inc.
("MedImmune"), Hoffmann-La Roche Inc. ("Roche") and Pharmacia & Upjohn Company
("Pharmacia") to create vaccines, immunotherapeutic products, and new
anti-infectives and antibiotics based on the genomes of many of these organisms.
See "-- Collaborative Arrangements." Patent applications have been filed by the
Company on these genomes.
Gene Therapy. The Company believes that its gene discovery technology may
identify new genes that can be introduced into the body through the use of gene
therapy techniques. Many diseases result when specific proteins are produced in
inappropriate quantities, in a defective manner, or not at all. Gene therapy is
a novel approach to the treatment of disease in which genes are inserted into a
patient's cells for the purpose of inducing these cells to produce therapeutic
proteins or to replace defective or missing genes. In other applications, the
Company believes that gene therapy may induce cells to secrete proteins that
enhance the immune system's ability to recognize and attack a specific disease.
Gene therapy might also allow localized delivery of proteins that cannot reach
the appropriate site through conventional methods of administration. There are
currently no gene therapy products on the market, although a number are
undergoing clinical trials. The Company has entered into agreements with
Schering Plough, Vascular Genetics Inc., and Transgene S.A., granting them the
right to use of the Company's technologies for gene therapy. See "--
Collaborative Arrangements."
Antisense Drugs. The Company believes that the knowledge of the structure
of genes developed through the use of its sequencing technology may facilitate
the development of antisense drugs. Antisense technology involves the use of
short oligonucleotide sequences, complementary to the gene, that, after binding
to the mRNA encoded by the gene, inhibit the synthesis of the protein encoded by
the gene. If, for example, the target gene expressed a protein involved in rapid
cell growth leading to a particular cancer, then use of the antisense drug could
have the potential of inhibiting the synthesis of the target protein encoded by
the particular gene and lead to restoration of normal growth. Antisense drugs
8
could also be of potential benefit in diseases where production of excess
protein leads to the disease state. There are currently no antisense drugs
approved for treatment.
COLLABORATIVE ARRANGEMENTS
Agreements with SmithKline Beecham. In May 1993, the Company entered into
the SB Collaboration Agreements pursuant to which SmithKline Beecham was granted
certain exclusive rights to develop and commercialize therapeutic and diagnostic
products within the "SB Field" (as defined below) based on human genes
discovered by the Company. Pursuant to the SB Collaboration Agreements,
SmithKline Beecham has paid to the Company an aggregate of $125 million,
including $55 million which was allocated to the purchase of an aggregate of
1,351,738 shares of common stock.
In June 1996, the SB Collaboration Agreements were substantially amended
(the "SB Amendment"). The SB Amendment allowed the Company and SmithKline
Beecham together to enter into collaboration agreements with additional
pharmaceutical companies ("Additional Collaboration Partners") in the SB Field
(other than diagnostics and animal healthcare in which SmithKline Beecham has
generally retained exclusive rights). The "SB Field" is the field of human and
animal healthcare, other than gene therapy (excluding gene therapy vaccines),
antisense products and the use of genes for synthesizing drugs that were known
at the time the SB Collaboration Agreements were executed. In addition, the SB
Amendment provides that each of the Company and SmithKline Beecham can
independently designate potential therapeutic proteins for its exclusive
development and commercialization (e.g., marketing or outlicensing) provided
that the designating entity is the first among the Company, SmithKline Beecham
and the Additional Collaboration Partners to select the protein and certain
research requirements are met prior to such designation. Under the SB Amendment,
the Company can designate six therapeutic protein candidates for its exclusive
development and commercialization at any one time. Subject to certain
limitations, the Company may substitute additional proteins for any of the six
proteins designated by the Company (i) which have been licensed by the Company
to third parties in accordance with the SB Amendment, (ii) which are the subject
of clinical studies by the Company or (iii) the rights to which have been
surrendered by the Company. SmithKline Beecham's right to select therapeutic
protein candidates during the initial research term of the SB Collaboration
Agreements is not limited. In addition, the SB Amendment provides that each of
the Company and SmithKline Beecham may independently (i) research, develop and
commercialize antibody products directed against antigens derived from the human
genome database created by the Company and (ii) identify and use novel molecular
targets derived from the human genome database created by the Company to
discover and develop small molecule pharmaceutical products, provided that the
Company will not initiate screening of such targets for three years from the
effective date of the SB Amendment and will not use certain targets subject to
agreements with third parties, subject to certain other restrictions. The SB
Amendment restricts the Company from entering into collaborations with third
parties (other than Additional Collaboration Partners and Takeda) in the SB
Field (i) during the initial research term, except with respect to products for
which the Company has exclusive development rights and (ii) during the initial
research term and for a period thereafter with respect to certain products which
are the subject of research plans submitted by SmithKline Beecham or an
Additional Collaboration Partner or Takeda prior to the expiration of the
initial research term.
The SB Amendment provides that SmithKline Beecham and the Company will
share equally in any license fees and product development milestone payments
paid under Additional Collaboration Partner Agreements, and that the Company
will receive all royalties and research support payments under such Additional
Collaboration Partner Agreements. The SB Collaboration Agreements provide for
payments to the Company of royalties on net sales of products based on the
Company's patents or technologies within the SB Field ("SB Products") sold by
SmithKline Beecham (or its licensees) and milestone payments in connection with
the development of SB Products. The Company has an option to co-promote SB
Products sold by SmithKline Beecham, on a country-by-country basis, in the
United States, Canada, Mexico and Europe (subject to certain limitations as to
rights granted to Takeda and other parties). If the Company develops and markets
or outlicenses a product in the SB Field pursuant to its rights under the
agreements with SmithKline Beecham, SmithKline Beecham will generally be
entitled to royalties or to share in milestone payments and license fees
received by the Company from licensees with respect to such products. The
Additional Collaboration Partner Agreement with Schering Plough includes an
option for Schering Plough to co-develop and co-commercialize up to two products
in the SB Field to which the Company has exclusive development and
commercialization rights under the SB Collaboration Agreements. The SB
Collaboration Agreements include an option for SmithKline Beecham to co-develop
and co-commercialize products in the SB Field to which the Company has exclusive
development and commercialization rights under the SB Collaboration Agreements
and for which Schering Plough has not exercised its option to co-develop and
co-commercialize. SmithKline Beecham will also be entitled to royalties on, and
an option to co-promote, products outside the SB Field sold by the Company which
are based on or incorporate patents or information developed by SmithKline
Beecham based on the Human Gene Technology of the Company.
The initial research term under the SB Collaboration Agreements continues
through June 2001. After expiration of the initial research term, the Company
will have all rights to the Company's Human Gene Technology, except that
SmithKline Beecham will retain rights to the Company's Human Gene Technology
pursuant to research plans meeting certain specified criteria submitted prior to
9
expiration of the initial term, Takeda will retain rights granted to it under a
license agreement prior to expiration of the initial research term and
Additional Collaboration Partners will retain rights granted to them under
Additional Collaboration Partner Agreements. See "-- Other Collaborations in the
SB Field." SmithKline Beecham has the right to extend the research term for up
to five additional years by making certain payments, which would extend the time
for submitting research plans as to therapeutic products other than antibody
products and therapeutic protein products.
The Company has agreed that it will make available 35 gene sequencers and
related personnel and reagents to sequence genes at the direction of a research
committee comprised of representatives of SmithKline Beecham and the Company.
In July 1997, the SB Collaboration Agreements were further amended with
respect to the field of human diagnostic products (the "SB Diagnostic
Amendment"). The SB Diagnostic Amendment streamlined the procedures for
outlicense by SmithKline Beecham of diagnostic products based on HGS technology
and specified a royalty on diagnostic products sold by SmithKline Beecham or its
licensees. The agreement also permits HGS to develop and market diagnostic tests
that support its own therapeutic products, if SmithKline Beecham is not already
developing and marketing such a diagnostic test. The agreement provides for an
initial research term that continues through June 2001, and may be extended by
SmithKline Beecham for up to five additional years by making certain payments
and provided that the SB Amendment agreement is also extended for a commensurate
period of time.
Other Collaboration Agreements in the SB Field. In June and July 1996, the
Company and SmithKline Beecham entered into the Additional Collaboration Partner
Agreements with Schering Plough, Synthelabo, and Merck KGaA. Each of the
Additional Collaboration Partner Agreements provides the Additional
Collaboration Partner the rights and licenses to access and use the Company's
Human Gene Technology, as well as biological information developed by the
Company and SmithKline Beecham prior to, and in the case of the Company, after
the effective date of such Agreement, to discover, develop and commercialize
products based upon or derived from such Human Gene Technology in the SB Field
(other than diagnostics and animal healthcare). Each Additional Collaboration
Partner may also designate, and receive exclusive license rights under the
Company and SmithKline Beecham patents and technology to, potential therapeutic
protein products for its exclusive development and commercialization, subject,
in certain cases, to certain restrictions as to the number of therapeutic
protein candidates that can be claimed, and subject to achievement of certain
research requirements prior to such designation. Each of the Additional
Collaboration Partners is obligated to pay license fees, research payments, and
milestone payments in connection with development of products under the
agreement and royalties. Each of the Additional Collaboration Partner Agreements
is for an initial research term expiring in June 2001. Each Additional
Collaboration Partner has the right to extend the term for up to five additional
years by making certain payments. The Company cannot enter into additional
agreements similar to the Additional Collaboration Partner Agreements without
the consent of SmithKline Beecham, Takeda and certain of the Additional
Collaboration Partners.
The Company will be entitled to one-half of all license fees and milestone
payments and to all royalties due from each Additional Collaboration Partner. In
addition, each Additional Collaboration Partner will make research payments
directly to the Company for the duration of the initial research term which
continues through June 2001. Aggregate license fees and research payments due
under the New Collaborative Partner Agreements are $140 million during the
initial research term, of which the Company will be entitled to $87.5 million,
payable in equal installments over a five-year period. $34.5 million has been
received by the Company as of February 28, 1998.
The Additional Collaboration Partner Agreement with Schering Plough
includes an option for Schering Plough to co-develop and co-commercialize up to
two of the Company's products in the SB Field to which the Company has exclusive
development and commercialization rights under the SB Collaborative Agreements.
SmithKline Beecham and Takeda entered into a License Agreement (the "Takeda
License Agreement") relating to the development and sale of products in the SB
Field based upon rights licensed from the Company. The Company will be entitled
to all royalty payments and one-half of the milestone payments due from Takeda
to SmithKline Beecham under the Takeda License Agreement on sales of products
developed by Takeda under the agreement. In addition, at the same time that
SmithKline Beecham and Takeda entered into the Takeda License Agreement, Takeda
and the Company entered into an Option and License Agreement pursuant to which
Takeda was granted an exclusive option to license rights under the Company's
patents and technology in the field of human healthcare (other than gene
therapy, antisense and diagnostics) to make and sell a limited number (equal to
the number of collaboration partners other than SmithKline Beecham and Takeda
with which the Company enters into collaboration agreements in the SB Field) of
products in Japan. In consideration of the grant of the option, Takeda paid the
Company $5 million and agreed to pay to the Company royalties based on the sale
of Takeda products covered by the Option and License Agreement and certain
milestone payments. The option period terminates three years following
expiration of the initial research term under the SB Collaboration Agreements.
Collaboration Agreements Outside of the SB Field. The Company has entered
into collaboration agreements with respect to the development of products based
on the Company's gene discovery research outside of the SB Field. These
collaboration agreements, which generally provide for milestone payments and
royalties and in most cases up front license fees and/or research payments,
include the following:
10
A Collaboration and License Agreement with MedImmune, entered into in July
1995 and amended in March and December 1997, with respect to the
development of drugs based upon certain infectious agents sequenced by the
Company or TIGR or as to which the Company has licensed the rights.
Programs under the agreement with MedImmune include the creation of
vaccines and immunotherapeutics for non-encapsulated Haemophilus
influenzae, Streptococcus pneumoniae, Escherichia coli, Helicobacter pylori
and Borrelia burgdorferi;
A Research Collaboration Agreement with Pioneer Hi-Bred International, Inc.
("Pioneer"), entered into in January 1996 under which Pioneer was granted
certain rights in the field of corn genomics;
A License Agreement with Roche, entered into in March 1996, under which the
Company is responsible for sequencing and assembling the genome of
Streptococcus pneumoniae, a bacterial pathogen responsible for severe
respiratory and other infections and under which Roche received a
non-exclusive license to use this information to identify potential new
anti-infectives and antibiotics; a similar agreement was entered into in
1997 with respect to the genome of Enterococcus faecalis, a bacterial
pathogen which is a major component of hospital-acquired infections;
A Collaboration and License Agreement with Schering Plough relating to the
field of human gene therapy (including gene therapy vaccines to the extent
the Company has the right to do so), under which Schering Plough was
granted (i) a non-exclusive license to use the Company's Human Gene
Technology to conduct research and (ii) an option to obtain an exclusive
license to specific genes in the field of gene therapy;
An agreement entered into in October 1996 with Pharmacia whereby the
Company granted to Pharmacia (i) a nonexclusive license to conduct research
and to make, use and sell products based on genes of Staphylococcus aureus
and the pathogenicity islands of Escherichia coli sequenced by the Company,
(ii) the right to obtain an exclusive license to certain products and (iii)
the right to negotiate to obtain an exclusive license as to certain
microbial genomes as to which the Company desires to grant an exclusive
license;
An agreement entered into in November 1996 with OraVax Merieux Co.
("OraVax"), with respect to an exclusive license granted by MedImmune and
the Company with respect to use of the Company's and MedImmune's technology
for a Helicobacter pylori vaccine;
An agreement entered into in November 1997 with a newly formed company,
Vascular Genetics Inc., whereby the Company granted to Vascular Genetics
(i) an exclusive license in the field of gene therapy for the Company's
vascular endothelial growth factor 2 (VEGF-2) gene, and (ii) an option for
up to two additional genes for use as gene therapy drugs to treat vascular
disease; in return the Company received 19.9 percent of Vascular Genetics'
equity and warrants for the purchase of an additional 5.1 percent interest;
other initial investors included St. Elizabeth's Medical Center of Boston,
Inc., CATO Holding Company, and Jeffrey M. Isner, M.D.; and
A Collaboration and License Agreement with Transgene S.A., entered into in
February 1998, relating to the field of human gene therapy (including gene
therapy vaccines to the extent the Company has the right to do so), under
which Transgene was granted the right to license exclusively up to 10
genes; the Company obtained a 10 percent interest in Transgene's equity and
certain co-development and co-marketing rights; the agreement is
conditional on Transgene's completion of an initial public offering of a
specified size and value.
As of February 28, 1998, the Company had entered into approximately 276
material transfer agreements with 135 academic institutions covering
approximately 1,354 gene sequences, cDNAs and proteins. The Company is
continuing to negotiate additional material transfer and license agreements. The
purpose of these agreements is to expand research and development relating to
the Company's gene information by providing academic researchers with
proprietary gene sequence information and related materials which enable them to
explore the biological activity and potential medical utility of newly
discovered human genes. Most of these material transfer agreements grant to the
Company a license, with established royalty rates, to any invention resulting
from the use of gene sequence information or related materials provided by the
Company. A relatively small number of the material transfer agreements signed by
the Company provide for an option to license any invention resulting from the
use of the Company's gene sequencing information. The Company has not signed a
material transfer agreement with an academic institution which does not provide
for a license or option to exclusive rights for inventions resulting from use of
the Company's information. In addition, TIGR, SmithKline Beecham and Takeda have
also entered into material transfer agreements with academic institutions. The
Company is also entitled to rights with respect to inventions resulting from use
of sequence information and related materials under such arrangements.
Agreements with TIGR. In October 1992 the Company entered into a Research
Services Agreement and an Intellectual Property Agreement with TIGR, a
not-for-profit research institute. TIGR initially performed most of the gene
sequencing and made the sequences available to the Company. The Company
subsequently developed its own gene sequencing capability.
Pursuant to these agreements, a Lease Funding Agreement entered into in
March 1993 and a subsequent agreement entered into in April 1993, the Company
had committed to provide an aggregate of approximately $85 million to TIGR over
a ten-year period, ending September 2002, of which $70 million consists of a
research grant and equipment funding for TIGR's scientific research relating to
determining human genes and their functions and uses. Through December 31, 1997,
11
the Company had paid approximately $48 million pursuant to these agreements. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Under the Research Services Agreement and the Intellectual Property
Agreement, TIGR was obligated to disclose to the Company all significant
developments relating to information or inventions discovered at TIGR, and the
Company owned (on a royalty-free basis) all of TIGR's interest in inventions and
patent rights arising out of TIGR's research during the term of the agreement
(including rights arising from research funded by third parties, except for
research funded by certain governmental and not-for-profit organizations as to
which the Company has been granted a royalty-bearing, worldwide, perpetual,
exclusive license, subject to a non-exclusive royalty-free license retained by
such organization).
In June 1997, the Company and TIGR agreed to an early conclusion of the
relationship between the two companies. Accordingly, the parties terminated the
prior agreements and entered into a new agreement whereby HGS ceased all future
payments to TIGR in return for relinquishing rights to future work done by TIGR.
The Company retained rights to inventions and patents arising out of TIGR's
research prior to June 1997. TIGR agreed not to enter into commercial agreements
for four years on selected therapeutic proteins and associated diagnostic tests
in development by HGS, and further agreed to share with HGS any proceeds from
all commercial arrangements relating to other human therapeutic proteins
completed prior to June 1999. In exchange for this limited non-compete
agreement, HGS granted to TIGR and its non-commercial collaborators a research
license for its prior work. The new agreement also eliminated certain
restrictions that prevented TIGR from publishing sequence information. This
agreement relieved HGS of a funding obligation of more than $38 million over the
remaining life of the original agreement.
The Company currently has a sequencing and analysis capacity greater than
that of TIGR. The Company believes that, while it benefited from the initial
TIGR agreement, termination of the agreement with TIGR will have no material
impact on its capacity to sequence and analyze human genes.
The Human cDNA Database Agreement. In July 1994, the Company, TIGR and
SmithKline Beecham reached an agreement to contribute a number of partial cDNA
sequences to a database (the "Human cDNA Database") that is accessible to
academic scientists and researchers at non-profit institutions that sign access
agreements. To date, approximately 160,000 human cDNAs resulting from the
collaboration between the Company and TIGR have been contributed to the Human
cDNA Database, including 50,000 cDNAs sequenced by the Company. The Human cDNA
Database Agreement provides that the Human cDNA Database is not available to
persons or entities engaged in commercial activities. In October 1996, TIGR
notified SmithKline Beecham and the Company of its decision to terminate the
Human cDNA Database Agreement according to its terms, such termination to be
effective in April 1997. Upon termination in April 1997, all Company sequences
were removed from the database and the remaining TIGR sequences were made
publicly available without restriction.
PATENTS AND PROPRIETARY RIGHTS
The Company's commercial success is dependent in part on its ability to
obtain patent protection on genes discovered by it. The Company applies for
patent protection for genes identified by partial sequencing and, subsequently,
for those genes which it fully sequences. However, there is substantial
uncertainty as to the patentability of genes based on partial sequences. Even if
patent protection is afforded for such sequences, it may not provide effective
marketing exclusivity. The Company's business might be enhanced by obtaining
patent protection based on partial gene sequences, but the Company does not
believe that its commercial success will be materially dependent on its ability
to do so. The Company has isolated and obtained full-length sequence information
for many of the genes that the Company or its collaborators intend to develop
further and has filed, and continues to file, for patent protection based on
such full-length sequences. However, the Company does not expect to isolate and
fully sequence a significant portion of the partial gene sequences it discovers.
See "-- Company Technology and Research."
The patent positions of biotechnology firms generally are highly uncertain
and involve complex legal and factual questions. There is a substantial backlog
of biotechnology patent applications at the PTO, and no clear policy has emerged
regarding the breadth of claims covered in biotechnology patents. There have
been, and continue to be, intensive discussions on the scope of patent
protection for both gene fragments and full-length genes. There have also been
proposals for review of the appropriateness of patents on genes and gene
fragments. There can be no assurance that these or other proposals will not
result in changes in, or interpretations of, the patent laws which will
adversely affect the Company's patent position. The biotechnology patent
situation outside the United States is even more uncertain and is currently
undergoing review and revision in many countries.
As of February 28, 1998, the Company had filed United States patent
applications with respect to substantially more than 500 full-length human genes
and their corresponding proteins. The Company has also filed U.S. patent
applications with respect to all or portions of the genomes of eight infectious
microorganisms and one non-infectious microorganism. As of February 28, 1998,
the Company has twenty issued U.S. patents covering full-length human genes.
There can be no assurance that the remaining applications covering full-length
genes and their corresponding proteins will result in the issuance of any
12
patents. For example, the disclosures in these applications may not be
sufficient to meet the statutory requirements for patentability in all cases.
Additionally, in view of the substantial number of genes that may be covered by
the Company's patent applications, the Company cannot predict what issues may
arise in connection with the Company's patent applications or the timing of the
grant of patents with respect to genes covered by such patent applications.
Moreover, in certain instances, the Company will be dependent upon its
collaborators to file and prosecute patent applications.
The Company also has filed United States patent applications claiming more
than 200,000 partial human gene sequences. These applications seek to protect
partial human and non-human gene sequences, the full-length gene sequences that
include the partial sequences, as well as products derived therefrom and uses
therefor. These applications identify possible biological functions for some of
the genes based in part on a comparison to genes included in public databases,
but do not contain any laboratory or clinical data with respect to such
biological functions. There are certain court decisions indicating that
disclosure of a partial sequence may not be sufficient to support the
patentability of a full length sequence. In view of these court decisions, as
well as the uncertain position of the PTO, the Company believes that there is
significant risk that patents will not issue based on patent disclosures limited
to partial gene sequences. Finally, even if patents issue on the basis of
partial gene sequences, there is uncertainty as to the commercial meaningfulness
of the protection that might be provided by any such patents.
Publication of information concerning genes prior to the time the Company
applies for patent protection based on the full-length gene could adversely
affect the Company's ability to obtain patent protection with respect to genes
identified by it. Washington University has identified genes through partial
sequencing pursuant to funding provided by Merck & Co., and has deposited the
partial sequences identified in a public database. In January 1997, TIGR, in
collaboration with the National Center for Biological Information (NCBI),
disclosed full-length DNA sequences (which are reportedly in excess of 35,000
sequences) assembled from partial gene sequences (ESTs) available in publicly
accessible databases or sequenced at TIGR. Such disclosures might limit the
scope of claims or make unpatentable subsequent patent applications filed by the
Company on full-length genes. Moreover, the termination of the Human cDNA
Database Agreement in April 1997 and the termination of the prior agreements
between the Company and TIGR in June 1997 eliminated limitations on the
publication of TIGR sequences as of those dates. While the Company believes that
the previous limitations on publication of sequences have generally been
sufficient to permit the Company to apply for patent protection on genes in
which it is interested in pursuing further research, there can be no assurance
that such publication has not and will not affect the Company's ability to
obtain patent protection for some genes in which it may have an interest, which,
in the case of genes of commercial significance, could have a material adverse
effect on the Company. See "-- Collaborative Agreements -- Agreements with TIGR
and -- The Human cDNA Database Agreement."
In addition, others have filed and are likely to file in the future patent
applications which have not yet been published covering genes or protein
sequences similar or identical to those of the Company. Moreover, the number of
patent applications covering genes and proteins expressed by genes has been
increasing, and is expected to continue to increase, as a result of the increase
in the number of entities conducting genomic research. See "-- Competition." The
Company has been notified that there may be patent applications filed by others
which cover genes for which the Company has filed patent applications. The
priority of competing patent claims would be decided in an interference
proceeding before the PTO. No assurance can be given that any such patent
application of third parties will not have priority over patent applications
filed by the Company or that any patent applications filed by the Company will
result in issued patents.
Accordingly, there can be no assurance that patents issued and any
additional patents, if issued, will provide commercially meaningful protection
against competitors. There can also be no assurance that any patent issued to
the Company will provide it with competitive advantages, or will not be
challenged by others. Furthermore, there can be no assurance that others will
not independently develop similar products which could result in an interference
proceeding in the PTO. Others may be able to design around issued patents or
develop products providing similar effect to products being developed by the
Company based on genes or proteins expressed by genes which are not covered by
patents issued to the Company. In addition, others may discover uses for genes
or proteins other than those uses covered in the Company's patent applications,
and these other uses may be separately patentable. In such case, the holder of a
use patent covering an invention as to which the Company has a composition of
matter patent claim could exclude the Company from selling a product for a use
covered by such use patent.
The Company's potential products may conflict with patents that have been
or may be granted to competitors, universities or others. As the biotechnology
industry expands and more patents are issued and other companies engage in the
business of discovering genes through the use of high speed sequencers, the risk
increases that the Company's potential products may give rise to claims that
they infringe the patents of others. Such other persons could bring legal
actions against the Company claiming damages and seeking to enjoin clinical
testing, manufacturing and marketing of the affected products. If any such
actions are successful, in addition to any potential liability for damages, the
Company could be required to obtain a license in order to continue to
manufacture or market the affected products. There can be no assurance that the
Company would prevail in any such action or that any license required under any
such patent would be made available on acceptable terms. The Company believes
that there will continue to be significant litigation in the industry regarding
patent and other intellectual property rights. If the Company becomes involved
13
in such litigation, it could consume a substantial portion of the Company's
resources.
In addition, a small percentage of sequences covered by the Company's
patent filings were identified pursuant to research funded by grants from the
United States Department of Energy ("DOE"). The DOE has a statutory right under
certain circumstances (including inaction on the part of the holder of the
patent rights to achieve practical application of the invention or a need to
alleviate public health or safety concerns not reasonably satisfied by the
holder of the patent rights) to grant to other parties licenses under the
patents which may be granted based on research funded by the DOE.
The enactment of the legislation implementing the General Agreement on
Trade and Tariffs has resulted in certain changes to United States patent laws
that became effective on June 8, 1995. Most notably, the term of patent
protection for patent applications filed on or after June 8, 1995 is no longer a
period of seventeen years from the date of grant. The new term of United States
patents will commence on the date of issuance and terminate twenty years from
the earliest effective filing date of the application. Because the time from
filing to issuance of patent applications is often more than three years, a
twenty-year period from the effective date of filing may result in a
substantially shortened term of patent protection, which may adversely impact
the Company's patent position.
The Company also relies on trade secret protection for its confidential and
proprietary information. The Company believes it has developed proprietary
procedures for making cDNA libraries and sequencing and analyzing genes. The
Company has not sought patent protection for these procedures. Additionally, the
Company has developed a substantial database concerning genes identified by it.
The Company has taken security measures to protect its data and continues to
explore ways to further enhance the security for its data. However, trade
secrets are difficult to protect. While the Company has entered into
confidentiality agreements with employees and academic collaborators who are
provided data or materials under material transfer agreements, there can be no
assurance that such data or material will not be disclosed, that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets or disclose
such technology, or that the Company can meaningfully protect its trade secrets.
In addition, certain trade secrets important to the Company's business have been
developed by, or are in the possession of, TIGR, including information
concerning sequencing procedures. Although TIGR also enters into confidentiality
agreements with its employees, there is an additional risk that such trade
secrets cannot be meaningfully protected.
COMPETITION
There is a finite number of genes in the human genome, and the Company
believes that the great majority of such genes have been identified by the
Company or others conducting genomic research and that virtually all will be
identified within several years. While the Company's goal has been to identify,
establish the utility of and ultimately patent as many genes as rapidly as
possible, the Company continues to face substantial competition in these efforts
both from entities using high-throughput gene sequencers to discover genes, as
well as from entities using more traditional methods to discover genes related
to particular diseases. Research to identify genes is also being conducted by
various institutes and United States and foreign government-financed entities,
including British, French, German and Japanese efforts, as well as numerous
smaller laboratories associated with universities or other not-for-profit
entities. In addition, a number of pharmaceutical and biotechnology companies
and government-financed programs are engaged or have announced the intention to
engage in areas of human genome research similar to or competitive with the
Company's focus on gene discovery, and other companies are likely to enter the
field.
The gene sequencing machines used by the Company are commercially available
and are currently being utilized by many other companies, in some cases for
business purposes competitive with those of the Company. In addition, a number
of other companies have announced plans to engage in gene discovery and could
acquire similar machines and develop procedures for automated sequencing of
genes. Although the Company believes that its large scale, automated processes
and lead time provide it with a competitive advantage, any one of these
companies or other entities may discover and establish a patent position in one
or more genes that the Company has identified and might have designated or
considered designating as a product candidate. Any potential products based on
genes identified by the Company will face competition both from companies
developing gene-based products and from companies developing other forms of
treatment for diseases that may be caused by, or related to, genes identified by
the Company.
The Company faces significant competition in its product development and
commercialization efforts, including competition from pharmaceutical and
biotechnology firms, including the Company's collaborators, many of which have
substantially greater research and product development capabilities and
financial, scientific, marketing and human resources than the Company. In
particular, although the Company believes that there are significant product
development opportunities for both it and its collaborators based on the
Company's gene database, competition exists among the Company and its
collaborators to develop and commercialize products. In addition, the Company's
competitors may succeed in developing products earlier than the Company,
obtaining approvals from the United States Food & Drug Administration (the
"FDA") or other regulatory agencies for such products more rapidly than the
14
Company, or developing products that are more effective than those proposed to
be developed by the Company. Similarly, while the Company through royalties and
co-payment arrangements will share any success of its collaborators in
identifying and commercializing products, they face similar competition from
other competitors who may succeed in developing products more quickly, or
developing products that are more effective, than those developed by such
collaborators. Certain of these competitors may be further advanced than the
Company in developing potential products that may compete with potential
products of the Company. There can be no assurance that research and development
by others will not render the products that the Company or its collaborators may
seek to develop obsolete or uneconomical or result in treatments, cures or
diagnostics superior to any therapy or diagnostic developed by the Company or
its collaborators, or that any therapy or diagnostic developed by the Company or
its collaborators will be preferred to any existing or newly developed
technologies.The Company expects that competition in this field will intensify.
GOVERNMENT REGULATION
Regulation of Pharmaceutical Products. New drugs are subject to regulation
under the Federal Food, Drug, and Cosmetic Act, and biological products, in
addition to being subject to certain provisions of that Act, are regulated under
the Public Health Service Act. The Company believes that the pharmaceutical
products developed by it or its collaborators will be regulated either as
biological products or as new drugs. Both statutes and the regulations
promulgated thereunder govern, among other things, the testing, manufacturing,
distribution, safety, efficacy, labeling, storage, record keeping, advertising
and other promotional practices involving biologics or new drugs, as the case
may be. FDA approval or other clearances must be obtained before clinical
testing, and before manufacturing and marketing, of biologics and drugs. At the
FDA, the Center for Biological Evaluation and Research ("CBER") is responsible
for the regulation of biologics, and the Center for Drug Evaluation and Research
("CDER") is responsible for the regulation of new drugs.
In addition, any gene therapy products (which is one of the areas in which
the Company may develop products) developed by the Company will require
regulatory approvals prior to clinical trials and additional regulatory
approvals prior to commercialization. New human gene therapy products are
subject to extensive regulation by the FDA (CBER) and comparable agencies in
other countries. Currently, each clinical protocol is reviewed by the FDA and,
in some instances, the NIH, on a case-by-case basis. The FDA and the NIH have
published a "Points to Consider" guidance documents, with respect to the
development and submission of gene therapy protocols.
Obtaining FDA approval has historically been a costly and time consuming
process. Generally, in order to gain FDA pre-market approval, a developer first
must conduct preclinical studies in the laboratory and in animal model systems
to gain preliminary information on an agent's efficacy and to identify any
safety problems. The results of these studies are submitted as a part of an
investigational new drug ("IND") application, which the FDA must review before
human clinical trials of an investigational drug can start. The IND application
includes a detailed description of the initial clinical investigation to be
undertaken.
Preclinical studies can take several years to complete, and there is no
assurance that an IND based on such studies will ever become effective so as to
permit clinical testing to begin. A 30-day waiting period after the receipt of
each IND is required by the FDA prior to the commencement of initial clinical
testing. If the FDA has not commented on or questioned the IND within this
30-day period, initial clinical studies may begin, although companies often
obtain affirmative FDA approval before beginning such studies. If the FDA has
comments or questions, it places the studies on clinical hold and the questions
must be answered to the satisfaction of the FDA before the initial clinical
testing may begin.
In order to commercialize pharmaceutical products, the Company or its
collaborator must sponsor and file an IND and will be responsible for initiating
and overseeing the clinical studies to demonstrate the safety and efficacy and,
for a biologic product, the potency, which are necessary to obtain FDA approval
of any such products. For Company or collaborator-sponsored INDs, the Company or
its collaborator will be required to select qualified investigators (usually
physicians within medical institutions) to supervise the administration of the
products, and ensure that the investigations are conducted and monitored in
accordance with FDA regulations and the general investigational plan and
protocols contained in the IND. Clinical trials are normally done in three
phases, although the phases may overlap. Phase I trials are concerned primarily
with the safety and preliminary effectiveness of the drug, involve fewer than
100 subjects, and may take from six months to over a year. Phase II trials
normally involve a few hundred patients and are designed primarily to
demonstrate effectiveness in treating or diagnosing the disease or condition for
which the drug is intended, although short-term side effects and risks in people
whose health is impaired may also be examined. Phase III trials are expanded
clinical trials with larger numbers of patients which are intended to gather the
additional information for proper dosage and labeling of the drug and
demonstrate its safety and effectiveness. Clinical trials generally take two to
five years, but may take longer, to complete. Recent regulations promulgated by
the FDA may shorten the time periods and reduce the number of patients required
to be tested in the case of certain life-threatening diseases which lack
available alternative treatments.
The FDA receives reports on the progress of each phase of clinical testing,
and it may require the modification, suspension, or termination of clinical
trials if an unwarranted risk is presented to patients. If the FDA imposes a
15
clinical hold, clinical trials may not recommence without prior FDA
authorization and then only under terms authorized by the FDA. The IND process
can thus result in substantial delay and expense. Human gene therapy products
(which is one of the areas in which the Company is seeking to develop products)
are a new category of therapeutics. Because this is a relatively new and
expanding area of novel therapeutic interventions, there can be no assurance as
to the length of the clinical trial period, the number of patients the FDA will
require to be enrolled in the clinical trials in order to establish the safety,
efficacy and potency of human gene therapy products, or that the clinical data
generated in these studies will be acceptable to the FDA to support marketing
approval.
After completion of clinical trials of a new drug or biologic product, FDA
marketing approval must be obtained. If the product is regulated as a biologic,
CBER will require the submission and approval, depending on the type of
biologic, of either a Biologic License Application or, in some cases, a Product
License Application and an Establishment License Application before commercial
marketing of the biologic. If the product is classified as a new drug, the
Company must file a New Drug Application ("NDA") with CDER and receive approval
before commercial marketing of the drug. The NDA or BLA must include results of
product development, preclinical studies and clinical trials. The testing and
approval processes require substantial time and effort and there can be no
assurance that the FDA will accept the NDA or BLA for filing and, even if filed,
that any approval will be granted on a timely basis, if at all. In the past,
NDAs and BLAs submitted to the FDA have taken, on average, two to five years to
receive approval. If questions arise during the FDA review process, approval can
take more than five years. Notwithstanding the submission of relevant data, the
FDA may ultimately decide that the NDA or BLA does not satisfy its regulatory
criteria for approval and require additional clinical studies. Even if FDA
regulatory approvals are obtained, a marketed product is subject to continual
review, and later discovery of previously unknown problems or failure to comply
with the applicable regulatory requirements may result in restrictions on the
marketing of a product or withdrawal of the product from the market as well as
possible civil or criminal sanctions. In addition, the FDA may condition
marketing approval on the conduct of specific post-marketing studies to further
evaluate safety and effectiveness.
If a developer obtains designation by the FDA of a biologic or drug as an
"orphan" drug for a particular use, the developer may request small grants from
the federal government to help defray the costs of qualified testing expenses in
connection with the development of such drug. Orphan drug designation may be
granted to drugs for rare diseases (generally, a disease or condition that
affects populations of fewer than 200,000 individuals in the United States),
including many genetic diseases. The first applicant who has obtained
designation of a drug for a particular use as an orphan drug and then obtains
approval of a marketing application for such drug for the particular use is
entitled to marketing exclusivity for a period of seven years, subject to
certain limitations. Essentially, this means that no other company can market
the same orphan drug for the use approved by the FDA for seven years after the
approval.
Orphan drug designation does not convey any advantage in, or shorten the
duration of, the regulatory approval process. Although obtaining FDA approval to
market a product with an orphan drug designation can be advantageous, there can
be no assurance that the scope of protection or the level of marketing
exclusivity that is currently afforded by orphan drug designation and marketing
approval will remain in effect in the future.
Rigorous and extensive FDA regulation of pharmaceutical products continues
after approval, particularly with respect to manufacturing, which must be done
in compliance with cGMP, reporting of adverse effects, and advertising,
promotion, and marketing.
The Company currently is conducting clinical development activities with
respect to MPIF-1 and KGF-2. The Company is conducting preclinical trials with
respect to other proteins and expects to continue to conduct preclinical and
clinical studies with respect to additional potential products, as permitted
under its collaboration agreements. Accordingly, the Company is beginning to
incur significant expenses with respect to its preclinical and clinical
development activities. There can be no assurance that the preclinical or
clinical trials will lead to the successful development of any products for the
Company, and as further studies are conducted, the Company may choose to abandon
particular projects which it might have previously considered promising.
Regulation of Diagnostics. Some of the diagnostic products developed by the
Company or its collaborators are likely to be regulated by the FDA as medical
devices rather than drugs. The nature of the FDA requirements applicable to such
diagnostic devices depends on their classification by the FDA. A diagnostic
device developed by the Company or its collaborators would be automatically
classified as a Class III device, requiring premarket approval, and would remain
in Class III and require premarket approval unless the device were reclassified
into Class II or Class I by the FDA or the sponsor could demonstrate to the FDA,
in the required pre-market notification procedure, that the device was
substantially equivalent to a legally marketed existing device that has been
classified in Class I or Class II or to a legally marketed Class III device for
which premarket approval is not required. Following submission of a premarket
notification, a company may not market the device for clinical use until an
order is issued by the FDA finding the device to be substantially equivalent.
The FDA has no specific time limit by which it must respond to a premarket
notification. If the Company or its collaborators were unable to demonstrate
such substantial equivalence to the FDA's satisfaction, it would be required to
undertake the costly and time-consuming process, comparable to that for new
drugs, of conducting preclinical studies and conducting clinical tests, filing a
pre-market approval ("PMA") application, and obtaining FDA approval.
16
If the Company or its collaborators can demonstrate substantial equivalence
to a Class I product, the "general controls" of the Food, Drug, and Cosmetic Act
- -- chiefly adulteration, misbranding, and "good manufacturing practice"
requirements -- will apply. If substantial equivalence to a Class II device can
be shown, the general controls plus "special controls" -- such as performance
standards, guidelines for safety and effective, and post-market surveillance --
will apply. If substantial equivalence to a Class III device (for which
premarket approval is not required) can be shown, the general controls plus any
applicable special controls will apply, and the product will require premarket
approval once the FDA requires such approval for the device to which substantial
equivalence was shown and other devices of the same generic type. While
demonstrating substantial equivalence to a Class I, Class II or Class III
product (for which premarket approval is not required) is not ordinarily as
costly or time-consuming as the premarket approval process for Class III
devices, it can in some cases also involve conducting clinical tests to
demonstrate that any differences between the new device and devices already on
the market do not affect safety or effectiveness.
In January 1997, the NIH-Department of Energy Task Force on Genetic Testing
issued proposed recommendations including increased monitoring of genetic
disorders, and tracking of people with positive and negative test results, by
CDC; establishment (under the Clinical Laboratory Improvement Amendments of
1988) of national program for the accreditation of laboratories performing
genetic testing, based on quality assurance, proficiency testing, and on-site
inspections; and additional regulation by the FDA. The Task Force's proposed
recommendations, if adopted and implemented, would significantly increase
federal regulation of genetic tests, whether provided as a product or service,
beginning with their manufacture and continuing through their marketing and use.
Marketed devices are subject to pervasive and continuing regulatory
oversight by the FDA, including record-keeping requirements and reporting of
adverse experiences with the use of the device. The Federal Food, Drug and
Cosmetic Act requires that medical devices be manufactured in accordance with
the FDA's cGMP regulation. This regulation requires, among other things, that
(i) the manufacturing process be regulated, controlled and documented by the use
of written procedures, and (ii) the ability to produce devices which meet the
manufacturer's specifications be validated by extensive and detailed testing of
every aspect of the process. The regulation also requires investigation of any
deficiencies in the manufacturing process or in the products produced and
detailed record keeping. Manufacturing facilities are subject to FDA inspection
on a periodic basis to monitor compliance with GMP requirements. If violations
of the applicable regulations are noted during FDA inspections of manufacturing
facilities, the FDA can prohibit further manufacturing, distribution and sale of
the devices until the violations are cured. On October 7, 1996, the FDA
published a revision of its GMP requirements, incorporating them into a new
regulation called the quality system ("QS") regulation. The QS regulation
requires, among other things, pre-production design controls, purchasing
controls, and maintenance of service records. The QS regulation is effective
June 1, 1997, except that the FDA has stated that as long as manufacturers are
taking reasonable steps to come into compliance with the design control
requirements, the FDA will not initiate action (including enforcement cases)
based on a failure to comply with these requirements before June 1, 1998. Once
in effect, the QS regulation is expected to increase the cost of complying with
the cGMP requirements and related requirements. Other applicable requirements
include the FDA's medical device (manufacturer) reporting regulation, which
requires that the device manufacturer provide information to the FDA on deaths
or serious injuries alleged to have been associated with the use of its marketed
devices, as well as product malfunctions that would likely cause or contribute
to a death or serious injury if the malfunction were to recur.
Labeling, advertising and promotional activities for investigational and
marketed devices are subject to scrutiny by the FDA and, in certain instances,
by the Federal Trade Commission. The FDA enforces statutory prohibitions against
promoting or marketing products for unapproved uses.
Other. In addition to the foregoing, the Company's business is and will be
subject to regulation under various state and federal environmental laws,
including the Occupational Safety and Health Act, the Resource Conservation and
Recovery Act and the Toxic Substances Control Act. These and other laws govern
the Company's use, handling and disposal of various biological, chemical and
radioactive substances used in and wastes generated by its operations. The
Company believes that it is in material compliance with applicable environmental
laws and that its continued compliance therewith will not have a material
adverse effect on its business. The Company cannot predict, however, whether new
regulatory restrictions on the production, handling and marketing of
biotechnology products will be imposed by state or federal regulators and
agencies or whether existing laws and regulations will not adversely affect it
in the future.
SOURCES OF SUPPLY
The Company currently relies on a single supplier, Applied Biosystems, a
division of Perkin-Elmer Corporation, to provide all of its gene sequencing
machines and certain reagents required in connection with the gene sequencing
process. The Company has not experienced problems in obtaining either gene
sequencing machines or reagents in a timely manner. While other gene sequencing
machines are available, the Company does not believe that such other machines
are as efficient as the machines currently used by the Company. The Company has
17
entered into certain agreements with Perkin-Elmer Corporation that (i) provide
for an established pricing structure with respect to the Company's purchases of
selected reagents, although such pricing is subject to change if the Company
does not meet certain minimum purchase requirements, and (ii) in the case of one
enzyme, provide that the Company will purchase and Perkin-Elmer Corporation will
sell a stated quantity at a fixed price. The Company orders these reagents by
submitting purchase orders at the time of purchase. No assurance can be given
that either the gene sequencing machines or the reagents will remain available
in commercial quantities at costs that are not economically prohibitive. Should
the Company be unable to obtain additional machines or an adequate supply of
reagents or other ingredients at commercially reasonable rates, its ability to
continue to identify genes through gene sequencing in accordance with its
current business plan would be adversely affected.
The Company has contracted for the manufacture of therapeutic proteins for
preclinical testing and clinical development from a single supplier. The Company
will be dependent on this company for its supply of therapeutic proteins until
it is able to produce therapeutic proteins at its own facility currently under
construction (see Item 2: Properties). Any failure or delay in supplying
therapeutic proteins could affect the timing of preclinical tests and clinical
trials and could delay submission of products for regulatory approval.
MANUFACTURING AND MARKETING
The Company has developed in-house capabilities for the production and
purification of recombinant proteins for use in its research activities, but
does not currently have any manufacturing facilities capable of supplying
materials suitable for clinical trials or for commercial sale or any experience
in manufacturing materials suitable for clinical trials or for commercial sale.
Currently, the Company relies on a third party for production of certain of its
therapeutic proteins for use in pre-clinical and early clinical development. The
Company will depend on such third party to comply with current good
manufacturing practices ("cGMPs") and other regulatory requirements and to
deliver materials on a timely basis, however there can be no assurance that such
party will perform. Any failures by the third party may delay clinical trial
development or the submission of products for regulatory approval, or otherwise
impair the Company's competitive position, which could have a materially adverse
effect on the Company's business.
During 1997, the Company designed and the Maryland Economic Development
Corporation ("MEDCO") began construction of a process development and production
facility for the preparation of clinical trial quantities of its therapeutic
proteins in compliance with cGMP requirements. The facility will comprise
approximately 80,000 square feet and is located in the Johns Hopkins Belward
Research Campus near the Company's offices and research laboratories.
Construction is expected to be completed in December 1998. After construction,
the facility must be validated and inspected by the FDA to determine compliance
with cGMP requirements. The facility has been designed to allow for the
production and purification of multiple recombinant proteins. The Company
intends to use the facility for production of preclinical and clinical supplies
of its therapeutic proteins and for process development and scale-up. A delay in
completion and/or validation of the facility could adversely affect the cost and
timing of clinical trials and could delay submission of products for regulatory
approval. The Company has entered into a long term lease arrangement with MEDCO
for the facility. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity."
The Company's long range plan is to establish additional manufacturing
capabilities to allow it to meet its full commercial manufacturing requirements.
However, the Company may contract with third party manufacturers or may develop
products with partners and take advantage of the partner's manufacturing
capabilities. There can be no assurance that the Company will be able to
successfully establish manufacturing capabilities and manufacture its products
economically or in compliance with cGMPs and other regulatory requirements.
The Company generally expects to rely on its collaborators or on third
parties with whom the Company may contract to market any products. In either
case, the Company will be dependent on such third parties for marketing.
However, in the future, the Company may co-promote or retain U.S. marketing
rights to certain of its products. Significant additional expenditures and
management resources will be required to develop an external sales force and
implement its marketing strategy if the Company decides to market products
directly. There can be no assurance that the Company's collaborators or other
third parties will be successful in marketing products, or that the Company will
be able to establish a successful marketing force.
EMPLOYEES
As of February 28, 1998, the Company had 353 full-time employees, of whom
301 were in research and development, including 63 scientists holding doctorate
degrees. The Company anticipates hiring approximately 100 additional employees
during the next twelve months. The additional staff is expected to include
additional research and development staff, pilot plant personnel, and medical
and regulatory affairs staff. None of the Company's employees is covered by
collective bargaining agreements and management considers its relations with its
employees to be good.
18
ITEM 2. PROPERTIES
The Company currently leases approximately 169,000 square feet of
laboratory and office space in six buildings in Rockville, Maryland. This
includes approximately 120,000 square feet of laboratory space and approximately
49,000 square feet of administrative office space. In addition, the Company has
entered into a long term lease for a process development and manufacturing
facility. Construction recently began on the 80,000 square foot facility which
is being built to the Company's specifications on a site near the Company's
headquarters and research and development laboratories. When completed, the
facility will be used to produce clinical trial quantities of its lead product
candidates.
The Company considers that its properties are generally in good condition,
are well maintained and are generally suitable and adequate to carry on the
Company's business.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER'S MATTERS
The Company's common stock is traded on the NASDAQ National Market System
under the symbol HGSI. The Company's common stock began trading on December 2,
1993. The following table presents the quarterly high and low sales price as
quoted by NASDAQ.
1997 HIGH LOW
-------------- -------- ---------
First Quarter $ 48 $ 32 1/2
Second Quarter 39 1/4 30 3/4
Third Quarter 43 1/2 30 1/2
Fourth Quarter 45 1/4 38 1/8
1996 HIGH LOW
-------------- -------- ---------
First Quarter 49 3/4 31 1/2
Second Quarter 48 1/4 32 1/2
Third Quarter 39 1/2 24 3/4
Fourth Quarter 43 1/4 34 3/4
As of February 28, 1998, there were approximately 502 holders of record of the
Company's common stock. No cash dividends have been paid on the common stock to
date.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company for the years
ended December 31, 1997, 1996 and 1995, and as of December 31, 1997 and 1996
have been derived from the audited financial statements included elsewhere
herein and should be read in conjunction with such financial statements and the
accompanying notes. The following selected financial data of the Company for the
years ended December 31, 1994 and 1993, and as of December 31, 1995, 1994 and
1993 have been derived from audited financial statements not included herein.
The results of operations of prior periods are not necessarily indicative of
results that may be expected for any other period. See "ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" and
"ITEM 1. BUSINESS."
20
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
------------------------------ ---------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenue-research and
development collaborative
contracts.................... $25,605 $ 36,460 $ 5,000 $41,065 $22,000
Costs and expenses:
Research and development:
Direct expenditures....... 39,893 30,409 22,904 17,636 7,611
Payments under research
services agreement...... 6,247 10,063 10,075 9,662 8,989
-------- -------- -------- ------- -------
Total research and
development............. 46,140 40,472 32,979 27,298 16,600
General and administrative... 11,113 9,639 8,745 6,840 3,998
------- -------- -------- ------- -------
Total cost and expenses........ 57,253 50,111 41,724 34,138 20,598
------- -------- -------- ------- -------
Income (Loss) from operations (31,648) (13,651) (36,724) 6,927 1,402
Net interest income 10,500 6,092 4,005 2,813 390
------- --------- -------- ------- -------
Income (loss) before taxes..... (21,148) (7,559) (32,719) 9,740 1,792
Provision for (benefit) from
income taxes................. 245 208 (1,651) 2,436 (2)
------- -------- -------- ------- --------
Net income (loss).............. $(21,393) $ (7,767) $(31,068) $ 7,304 $ 1,794
======== ======== ======== ======= =======
Net income (loss) per share.... $ (0.99)(1) $ (0.42)(1) $ (1.98)(1) $ 0.47(1) $ 0.15(1)
======== ======== ======== ======= =======
Net income (loss) per share
assuming dilution............ $(0.99)(1) $ (0.42)(1) $ (1.98)(1) $ 0.47(1) $ 0.14(1)
========== ======== ======== ======= =======
AS OF DECEMBER 31,
---------------------------------------------------------
1997 1996 1995 1994 1993
-------- ---------- ---------- ---------- -------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and
investments................ $205,212 $ 116,116 $ 105,462 $ 76,002 $ 69,478
Total assets................. 236,232 140,117 126,963 95,543 82,450
Total debt and capital leases,
less current portions...... 2,224 2,954 4,332 5,346 1,338
Retained earnings (deficit).. (55,522) (34,129) (26,362) 4,706 (2,598)
Total stockholders' equity... 223,254 128,521 115,606 83,785 75,929
- --------------------------------------------------------------------------------
(1) The net loss per share amounts prior to fiscal 1998 have been restated as
required to comply with Statement of Financial Accounting Standards No. 128,
Earnings Per Share. For further discussion of net loss per share and the impact
of Statement No. 128, see Notes B and O of the notes to the Company's financial
statements included herein.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company initially focused its efforts on developing proprietary
processes for automating the gene discovery process, establishing collaborative
arrangements, and establishing and expanding its pre-clinical research and
development capabilities. The Company's activities are currently focused on
research and development of novel, proprietary pharmaceutical and diagnostic
products based on the discovery and understanding of the medical utility of
genes.
The Company has not received any product sales revenue or royalties from
product sales and does not anticipate revenues from product sales or from
royalties on product sales in the next several years. Through December 31, 1997,
the Company had received (i) $70 million in revenue and $55 million in equity
payments pursuant to the SB Collaboration Agreements, (ii) payments from the
Additional Collaboration Partners of $34.0 million and (iii) an aggregate of
$23.1 million from other collaborators, including $11.0 million from Pioneer
Hi-Bred International, Inc. ("Pioneer"), $3.0 million from F. Hoffmann-La Roche
("Roche"), $6.0 million from Pharmacia & Upjohn Company ("Pharmacia"), $1.1
million from OraVax Merieux Co. and Merieux OraVax S.N.C. (collectively,
"OraVax") and $2.0 million from Schering Plough (in addition to certain payments
received from Schering Plough pursuant to the Additional Collaboration Partner
Agreements). Pursuant to the terms of such collaboration agreements, the Company
expects to receive license fees and research payments of $63.5 million in the
aggregate over the next three years. See "Business -- Collaborative
Arrangements."
The Company expects that its revenue sources for at least the next several
years may be limited to interest income, payments under various collaboration
agreements, payments from the sale of rights and other payments from other
collaborators and licensees under existing or future arrangements, to the extent
that the Company enters into any such further arrangements. The Company expects
to continue to incur substantial expenses relating to its research and
development efforts, which are expected to increase relative to historical
levels as the Company focuses on preclinical and clinical trials required for
the development of therapeutic protein product candidates. As a result, the
Company expects to incur continued and increasing losses over the next several
years unless it is able to realize additional revenues under existing or new
collaboration agreements. The timing and amounts of such revenues, if any,
cannot be predicted with certainty and will likely fluctuate sharply. Results of
operations for any period may be unrelated to the results of operations for any
other period. In addition, historical results should not be viewed as indicative
of future operating results.
On March 2, 1998, the Company signed a ten year agreement with Transgene
S.A. ("Transgene"), based in Strasbourg, France, to develop gene therapy
products. Under the terms and conditions of the agreement, Transgene will have
the right to exclusively license, and sublicense, up to 10 genes and to develop,
manufacture and commercialize any resulting gene therapy products worldwide. The
two companies may also choose to co-develop and co-market the identified new
gene therapy products, and, in such case, commercialization rights will be held
by the Company for North America and by Transgene for Europe and will be shared
equally for the rest of the world's markets. Transgene will pay an initial
licensing fee and research funding in an amount equal to the proceeds to
Transgene from the Company's purchase of a 10% interest in Transgene. The value
of the 10% interest based on the anticipated close of Transgene's Initial Public
Offering (currently in process) would be approximately $25 million. Additional
payments to the Company are dependent upon the number of genes which Transgene
licenses and the accomplishment of certain milestones. Royalties on future
product sales and partnering revenues will be paid by Transgene to the Company.
On co-marketed products, the Company and Transgene will pay reciprocal
royalties.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996
Revenues. The Company had revenues of $25.6 million and $36.5 million for
the years ended December 31, 1997 and December 31, 1996, respectively. The 1997
revenue consisted of $4.1 million in license fees and research payments from
collaborations with Pioneer and Roche, $12.0 million in annual license fees and
additional payments from collaborations with Schering Plough and Synthelabo,
$5.5 million in annual license fees and additional payments pursuant to a
collaboration agreement with Merck, and $4.0 million in license fees from
collaborations with Pharmacia, MedImmune and OraVax. The 1996 revenue consisted
of $6.9 million for the achievement of the third milestone ("Milestone III")
under the SB Collaboration Agreements, $10.0 million in license fees and
research payments from collaborations with Pioneer and Roche, $12.0 million in
annual license fees and additional payments from collaborations with Schering
Plough and Synthelabo, $5.5 million in annual license fees and additional
payments pursuant to a collaboration agreement with Merck, and $2.1 million in
license fees from collaborations with Pharmacia, MedImmune and OraVax.
22
Expenses. Research and development expenses increased to $46.1 million for
the year ended December 31, 1997 from $40.5 million for the year ended December
31, 1996. The increase resulted primarily from significant expansions in the
Company's cell biology, protein expression and pharmacology departments, the
production of clinical trial quantities of the Company's first two therapeutic
product candidates and the formation of a medical affairs department to manage
clinical trials. Expenses will continue to increase in support of research and
development of potential products by the Company and in support of the new
collaborations.
General and administrative expenses increased to $11.1 million for the year
ended December 31, 1997 from $9.6 million for the year ended December 31, 1996.
The increase resulted primarily from significantly higher legal expenses
associated with filing and prosecuting a larger number of patent applications
relating to genes and proteins discovered by the Company. Patent expenses will
continue to increase significantly as additional applications are filed and
existing applications are prosecuted in the United States and internationally.
Interest income was significantly higher for the year ended December 31, 1997
compared to the year ended December 31, 1996 due to higher cash balances.
Net Income (Loss). The Company recorded a net loss of $21.4 million, or
$0.99 per share, for the year ended December 31, 1997 compared to a net loss of
$7.8 million, or $0.42 per share, for the year ended December 31, 1996. The
difference in results for the year ended December 31, 1997 and 1996 is primarily
due to the lower collaboration partner payments during the year ended December
31, 1997 and higher expenses, which were partially offset by higher interest
income.
YEARS ENDED DECEMBER 31, 1996 AND 1995
Revenues. The Company had revenues of $36.5 million and $5.0 million for
the years ended December 31, 1996 and December 31, 1995, respectively. The 1996
revenue consisted of $6.9 million for the achievement of Milestone III under the
SB Collaboration Agreements, $10.0 million in license fees and research payments
from collaborations with Pioneer and Roche entered into in the first quarter of
1996, $12.0 million in annual license fees and additional payments from
collaborations with Schering Plough and Synthelabo entered into in the second
quarter of 1996, $5.5 million in annual license fees and additional payments
pursuant to a collaboration agreement entered into with Merck in July 1996, and
$2.1 million in license fees from collaborations with Pharmacia, MedImmune and
OraVax entered into in the fourth quarter of 1996. The 1995 revenue consisted of
$5.0 million from Takeda for an option and license agreement to commercialize
certain future products of the Company in Japan.
Expenses. Research and development expenses increased to $40.5 million for
the year ended December 31, 1996 from $33.0 million for the year ended December
31, 1995. The increase resulted primarily from significant expansions in the
Company's cell biology, protein expression and pharmacology departments and
reflect the Company's increasing emphasis on determining the biological
functions and possible medical utilities of genes and proteins discovered as a
result of the Company's gene discovery efforts.
General and administrative expenses increased to $9.6 million for the year
ended December 31, 1996 from $8.7 million for the year ended December 31, 1995.
The increase resulted primarily from significantly higher legal expenses
associated with filing and prosecuting a larger number of patent applications
relating to genes and proteins discovered by the Company. Interest income was
significantly higher for the year ended December 31, 1996 compared to the year
ended December 31, 1995 due to higher cash balances and interest rates.
Net Income (Loss). The Company recorded a net loss of $7.8 million, or
$0.42 per share, for the year ended December 31, 1996 compared to a net loss of
$31.1 million, or $1.98 per share, for the year ended December 31, 1995. The
difference in results for the year ended December 31, 1996 and 1995 is primarily
due to the receipt of $36.5 million in license fees and research payments during
the year ended December 31, 1996, which was partially offset by higher expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $196.9 million at December 31, 1997 as
compared to $110.8 million at December 31, 1996. The increase resulted from the
sale in March 1997 of 3,192,750 shares of common stock at a public offering
price of $37.00 per share for which the Company received net proceeds of $112.0
million, which was partially offset by the net loss generated during the year,
capital expenditures, and payments on capitalized leases.
The Company expects to continue to incur substantial expenses relating to
its research and development efforts, which expenses are expected to increase
relative to historical levels as the Company focuses on preclinical and clinical
trials required for the development of therapeutic protein product candidates.
At December 31, 1997, the Company had outstanding commitments for construction
and equipment purchases totaling approximately $353,000.
23
The Company expects that its existing funds, interest income, and committed
license fees and research payments from the Additional Collaboration Partners
and under existing collaboration agreements will be sufficient to fund the
Company's operations for the foreseeable future. The Company's future capital
requirements and the adequacy of its available funds will depend on many
factors, including scientific progress in its research and development programs
(including its preclinical and clinical product development activities), paper,
the magnitude of those programs, the ability of the Company to establish
collaborative and licensing arrangements, the cost involved in preparing,
filing, prosecuting, maintaining and enforcing patent claims and competing
technological and market developments.
The Company entered into a 20 year lease for a process development and
production facility being built to the Company's specifications. Annual base
rent in the amount of $2.2 million is expected to begin January 1, 1999, the
anticipated completion date of the facility.
As of December 31, 1997, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $51 million which expire, if
unused, by the year 2012. The Company also has available research and
development tax credit carryforwards of approximately $6.8 million, the majority
of which will expire, if unused, by the year 2012.
The Company's funds are currently invested in U.S. Treasury and government
agency obligations and high grade corporate debt securities and commercial paper
investment-grade commercial paper and interest-bearing securities. Such
investments reflect the Company's policy regarding the investment of liquid
assets, which is to seek a reasonable rate of return consistent with the
emphasis on safety, liquidity and preservation of capital.
Recently, national attention has focused on the potential problems and
costs resulting from computer programs being written using two digits rather
than four to define the applicable year. Any computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, or engage in similar normal business
activities. While the Company believes that its internal software applications
are Year 2000 compliant, there can be no assurance until the year 2000 that all
systems will function adequately. Further, if the software applications of
others on whose services the Company depends are not Year 2000 compliant, such
noncompliance could have a material adverse effect on the Company.
RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), "Comprehensive Income,"
which is required to be adopted in the year ended December 31, 1998 consolidated
financial statements. SFAS 130 requires that an enterprise (a) classify items of
comprehensive income by their nature in the financial statements and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the Statement of Stockholders'
Equity. The Company does not expect the adoption of SFAS 130 to be material to
its financial condition and results of operations.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounts Standards No. 131 ("SFAS 13l"), "Disclosures about Segments
of an Enterprise and Related Information," which is required to be adopted in
the year ended December 31, 1998 consolidated financial statements. SFAS changes
the way public companies report segment information in annual financial
statements and also requires those companies to report selected segment
information in interim financial reports to stockholders. The disclosures for
segment information in the consolidated financial statements is not expected to
be material to its financial condition and results of operations.
24
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements contained in "Item 1. Business" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations," including statements concerning future collaboration agreements,
royalties and other payments under collaboration agreements, and product
development and sales and other statements are forward looking statements, as
defined in the Private Securities Litigation Reform Act of 1995. Actual results
may differ materially from those projected in the forward looking statements as
a result of risks and uncertainties, including but not limited to, the
following: the scientific progress of the Company in its research and
development programs; the magnitude of these programs; the ability of the
Company to establish additional collaborative and licensing arrangements; the
extent to which the Company engages in clinical development of any products on
its own; the scope and results of pre-clinical testing and clinical trials; the
time and costs involved in obtaining regulatory approvals; the costs involved in
preparing, filing, prosecuting, maintaining and enforcing patent claims;
competing technological and market developments; and whether conditions to
milestone payments are met and the timing of such payments, and other risks and
uncertainties detailed elsewhere herein and from to time in the Company's
filings with the Securities and Exchange Commission.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item are set forth here in on pages F-1 -
F-20.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company incorporates herein by reference the information concerning
directors and executive officers in its Notice of Annual Stockholder's Meeting
and Proxy Statement to be filed within 120 days after the end of the Company's
fiscal year (the "1998 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The Company incorporates herein by reference the information concerning
executive compensation contained in the 1998 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company incorporates herein by reference the information concerning
security ownership of certain beneficial owners and management contained in the
1998 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company incorporates herein by reference the information concerning
certain relationships and related transactions contained in the 1998 Proxy
Statement.
26
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report:
(1) Index to Financial Statements
PAGE
NUMBER
------
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Balance Sheets at December 31, 1997 and 1996............................. F-3
Statements of Operations for the years ended December 31, 1997, 1996 and
1995................................................................. F-4
Statements of Stockholders' Equity for the years ended December 31,
1997, 1996 and 1995.................................................. F-5
Statements of Cash Flows for the years ended December 31, 1997, 1996 and
1995................................................................. F-6
Notes to Financial Statements............................................ F-7
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not required.
(3) Exhibits
Exhibit No.
- -----------
3.1* Restated Certificate of Incorporation (Fifth) of the Registrant (Filed
as Exhibit 3.1 to the Registrant's Form 10-K for the fiscal year ended
December 31, 1993 and incorporated herein by reference).
3.2* By-laws of the Registrant (Filed as Exhibit 3.2 to the Registrant's
Form 10-K for the fiscal year ended December 31, 1993 and incorporated
herein by reference).
3.3 Certificate of Amendment of the Certificate of Incorporation of
Registrant
4.1* Form of Common Stock certificate.
10.1*+ Collaboration Agreement, dated May 19, 1993, between the Registrant and
SmithKline Beecham Corporation ("SmithKline Beecham"), as amended on
May 19, 1993 and August 19, 1993 (Filed as Exhibit 10.1 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.2* Second Amendment to HGS-SB Collaboration Agreement, effective September
1, 1993, between the Registrant and SmithKline Beecham (Filed as
exhibit 10.2 to the Registrant's Form 10-K for the fiscal year ended
December 31, 1993 and incorporated herein by reference).
10.3* Amendment to HGS-SB Collaboration Agreement, effective March 17, 1994,
between the Registrant and SmithKline Beecham (Filed as Exhibit 10.3 to
the Registrant's Form 10-K for the fiscal year ended December 31, 1993
and incorporated herein by reference).
10.4*+ License Agreement between the Registrant and SmithKline Beecham
Corporation dated September 15, 1994 (Filed as Exhibit 10.8 to the
Registrant's Form 10-Q filed November 14, 1994 and incorporated herein
by reference).
10.5*+ Amendment to HGS-SB Collaboration Agreement (Therapeutic Protein
Amendment), effective December 23, 1994, between the Registrant and
SmithKline Beecham (Filed as Exhibit 10.4 to the Registrant's Form 10-
K for the fiscal year ended December 31, 1994 and incorporated herein
by reference).
27
10.6*+ Amendment to HGS-SB Collaboration Agreement (Milestone III Amendment),
effective December 29, 1994, between the Registrant and SmithKline
Beecham (Filed as Exhibit 10.5 to the Registrant's Form 10-K for the
fiscal year ended December 31, 1994 and incorporated herein by
reference).
10.7* Amendment to the Series B Convertible Preferred Stock Purchase
Agreement between the Registrant and SmithKline Beecham Corporation,
dated December 29, 1994. (Filed as Exhibit 10.96 to the Registrant's
form S-3 Registration Statement, as amended (Commission File No.
33-96206) originally filed August 25, 1995 and incorporated herein by
reference).
10.8*+ Amendment to HGS-SB Collaboration Agreement, effective April 24, 1995,
between the Registrant and SmithKline Beecham Corporation. (Filed as
Exhibit 10.6 to the Registrant's form S-3 Registration Statement, as
amended (Commission File No. 33-96206), originally filed August 25,
1995 and incorporated herein by reference).
10.9*+ Amendment to HGS-SB Collaboration Agreement, effective May 31, 1995,
between the Registrant and SmithKline Beecham. (Filed as Exhibit 10.1
to the Registrant's Form 10-Q filed August 14, 1995 and incorporated
herein by reference).
10.10*+ Amendment and Restated License Agreement between the Registrant and
SmithKline Beecham effective May 31, 1995 (Filed as Exhibit 10.1 to the
Registrant's Form 10-Q filed August 14, 1995 and incorporated herein by
reference).
10.11*+ Amendment to SmithKline Beecham and Human Genome Sciences, Inc.
Collaboration Agreement and License Agreement and Amended and Restated
License Agreement dated June 28, 1996. (Filed as Exhibit 10.1 to the
Registrants 10-Q filed August 14, 1996 and incorporated herein by
reference).
10.12*+ SmithKline Beecham and Human Genome Sciences, Inc. License Agreement
Dated June 28, 1996. ( Filed as Exhibit 10.2 to the Registrants 10 -Q
filed August 14, 1996 and incorporated herein by reference).
10.13*+ Therapeutic Collaboration and License Agreement by and among Human
Genome Sciences, Inc., Schering Corporation, Schering Plough Ltd., and
SmithKline Beecham Corporation dated June 28, 1996. (Filed as Exhibit
10.3 to the Registrants 10-Q filed August 14, 1996 and incorporated
herein by reference).
10.14*+ Gene Therapy Collaboration and License Agreement by and among Human
Genome Sciences, Inc., Schering Corporation, and Schering Plough Ltd.,
June 28, 1996. ( Filed as Exhibit 10.4 to the Registrants 10-Q filed
August 14, 1996 and incorporated herein reference).
10.15*+ Collaboration and License Agreement by and among Human Genome Sciences,
Inc. SmithKline Beecham Corporation and Synthelabo dated June 30, 1996.
(Filed as Exhibit 10.5 to the Registrants 10-Q filed August 14, 1996
and incorporated herein by reference).
10.16*+ Collaboration and License Agreement between SmithKline Beecham
Corporation, Human Genome Sciences, Inc. and Merck KGaA effective July
10, 1996. ( Filed as Exhibit 10.6 to the Registrants 10-Q filed
November 14, 1996 and incorporated herein by reference).
10.17*+ Research Collaboration Agreement between the Registrant and Genetic
Therapy, Inc. dated September 13, 1994 (Filed as Exhibit 10.7 to the
Registrant's Form 10-Q filed November 14, 1994 and incorporated herein
by reference).
10.18*+ Option and License Agreement between the Company and Takeda Chemical
Industries, Ltd. dated June 12, 1995 (Filed as Exhibit 10.3 to the
Registrant's Form 10-Q filed August 14, 1995 and incorporated herein by
reference).
10.19*+ Collaboration and License Agreement between the Registrant and
MedImmune, Inc. dated July 27, 1995 (Filed as Exhibit 10.5 to the
Registrant's Form 10-Q filed August 14, 1995 and incorporated herein by
reference).
10.20*+ Research Collaboration Agreement, dated January 19, 1996, between
Registrant and Pioneer Hi-Bred International, Inc. ("Pioneer"). (Filed
as Exhibit 10.15 to the Registrants Form 10-K filed March 31,1996 and
incorporated herein by reference).
28
10.21*+ License Agreement between Registrant and F. Hoffmann-La Roche, Ltd.
("Roche"). (Filed as Exhibit 10.16 to the Registrants Form 10-K filed
March 31,1996 and incorporated herein by reference).
10.22*+ Research Services Agreement, dated October 1, 1992, between the
Registrant and The Institute for Genomic Research ("TIGR") (Filed as
Exhibit 10.4 to the Registrant's Form S-1 Registration Statement, as
amended (Commission File No. 33-69850), originally filed October 1,
1993 and incorporated herein by reference).
10.23*+ Intellectual Property Agreement, dated October 2, 1992, between the
Registrant and TIGR (Filed as Exhibit 10.5 to the Registrant's Form S-1
Registration Statement, as amended (Commission File No. 33-69850),
originally filed October 1, 1993 and incorporated herein by reference).
10.24* Lease Funding Agreement and Assignment, dated March 2, 1993, between
the Registrant and TIGR (Filed as Exhibit 10.6 to the Registrant's Form
S-1 Registration Statement, as amended (Commission File No. 33-69850),
originally filed October 1, 1993 and incorporated herein by reference).
10.25* Letter Agreement, dated March 31, 1993, between the Registrant and TIGR
(Filed as Exhibit 10.7 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.26*+ Letter Agreement, dated April 19, 1993, between the Registrant and TIGR
(Filed as Exhibit 10.8 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.27* Stock Purchase, Restriction and Repurchase Agreement, dated April 26,
1993, between the Registrant and TIGR (Filed as Exhibit 10.47 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.28* Letter Agreement, dated May 7, 1993, between the Registrant and TIGR
(Filed as Exhibit 10.9 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.29*+ Human cDNA Database Agreement among the Registrant, SmithKline Beecham
Corporation, and The Institute for Genomic Research dated July 7, 1994
(Filed as Exhibit 10.5 to the Registrant's Form 10-Q filed November 14,
1994 and incorporated herein by reference).
10.30*+ Amendment to the Human cDNA Database Agreement between the Registrant
and SmithKline Beecham Corporation and the Institute for Genomic
Research dated October 26, 1994 (Filed as Exhibit 10.6 to the
Registrant's Form 10-Q filed November 14, 1994 and incorporated herein
by reference).
10.31*+ Second Amendment to the Human cDNA Database Agreement between the
Registrant and SmithKline Beecham Corporation and the Institute for
Genomic Research dated as of April 14, 1995 (Filed as Exhibit 10.87 to
the Registrant's Form 10-K for the fiscal year ended December 31, 1994
and incorporated herein by reference).
10.32* Common Stock Purchase Warrant, dated June 8, 1993, granted to HCV III
(Filed as Exhibit 10.33 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.33* Common Stock Purchase Warrant, dated June 8, 1993, granted to HCV IV
(Filed as Exhibit 10.34 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.34* Common Stock Purchase Warrant, dated June 8, 1993, granted to Everest
(Filed as Exhibit 10.36 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
29
10.35* Master Lease Agreement, dated January 31, 1993, between the Registrant
and MMC/GATX Partnership No. I (Filed as Exhibit 10.25 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.36* Warrant Agreement, dated January 31, 1993, between the Registrant and
MMC/GATX Partnership No. I (Filed as Exhibit 10.26 to the Registrant's
Form S-1 Registration Statement, as amended (Commission File No. 33-
69850), originally filed October 1, 1993 and incorporated herein by
reference).
10.37* Master Lease Agreement, dated as of January 31, 1993, between the
Registrant and Dominion Ventures, Inc. (Filed as Exhibit 10.27 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.38* Master Lease Agreement, dated January 31, 1993, between the Registrant
and Comdisco, Inc. (Filed as Exhibit 10.29 to the Registrant's Form S-
1 Registration Statement, as amended (Commission File No. 33-69850),
originally filed October 1, 1993 and incorporated herein by reference).
10.39* Master Lease Agreement (Equipment) between the Registrant and Comdisco,
Inc., dated June 30, 1994 (Filed as Exhibit 10.12 to the Registrant's
Form 10-Q filed August 12, 1994 and incorporated herein by reference).
10.40* Lease of Premises at 9620 Medical Center Drive, Rockville, Maryland
(Filed as Exhibit 10.42 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.41* Lease of Premises at 9430 Key West Avenue, Rockville, Maryland (Filed
as Exhibit 10.44 to the Registrant's Form S-1 Registration Statement,
as amended (Commission File No. 33-69850), originally filed October 1,
1993 and incorporated herein by reference).
10.42* Office Lease between the Registrant and Key West IV Limited
Partnership, dated June 14, 1994 (Filed as Exhibit 10.11 to the
Registrant's Form 10-Q filed August 12, 1994 and incorporated herein by
reference).
10.43* Stock Purchase and Restriction Agreement, dated December 31, 1992,
between the Registrant and William A. Haseltine, Ph.D. (Filed as
Exhibit 10.15 to the Registrant's Form S-1 Registration Statement, as
amended (Commission File No. 33-69850), originally filed October 1,
1993 and incorporated herein by reference).
10.44* Employment Agreement, dated February 25, 1997, with William A.
Haseltine, Ph.D. (Filed as Exhibit 10.44 to the Registrant's Form 10 K
for the fiscal year ended December 31, 1996 and incorporated herein by
reference).
10.45* Restricted Stock Purchase Agreement, dated May 18, 1993, between the
Registrant and William A. Haseltine, Ph.D. (Filed as Exhibit 10.24 to
the Registrant's Form S-1 Registration Statement, as amended
(Commission File No. 33-69850), originally filed October 1, 1993 and
incorporated herein by reference).
10.46* Promissory Note, dated March 4, 1994, given by William A. Haseltine,
Ph.D. to the Registrant (Filed as Exhibit 10.58 to the Registrant's
Form 10-K for the fiscal year ended December 31, 1993 and incorporated
herein by reference).
10.47* First Allonge to Promissory Note, dated December 16, 1994, given by
William A. Haseltine, Ph.D. to the Registrant (Filed as Exhibit 10.65
to the Registrant's Form 10-K for the fiscal year ended December 31,
1994 and incorporated herein by reference).
10.48* Pledge Agreement, dated March 4, 1994, between William A. Haseltine,
Ph.D. and Registrant (Filed as Exhibit 10.59 to the Registrant's Form
10-K for the fiscal year ended December 31, 1993 and incorporated
herein by reference).
30
10.49* First Amendment to Pledge Agreement, dated December 16, 1994, between
William A. Haseltine, Ph.D. and Registrant (Filed as Exhibit 10.67 to
the Registrant's Form 10-K for the fiscal year ended December 31, 1994
and incorporated herein by reference).
10.50* Employment Agreement, dated October 1992, with Craig A. Rosen, Ph.D.
(Filed as Exhibit 10.17 to the Registrant's Form S-1 Registration
Statement, as amended (Commission File No. 33-69850), originally filed
October 1, 1993 and incorporated herein by reference).
10.51* Restricted Stock Purchase Agreement, dated April 21, 1993, between the
Registrant and Craig A. Rosen, Ph.D. (Filed as Exhibit 10.22 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.52* Employment Agreement, dated March 14, 1994, with Bradley G. Lorimier
(Filed as Exhibit 10.22 to the Registrant's Form 10-K for the Fiscal
year ended December 31, 1993 and incorporated herein by reference).
10.53* Promissory Note dated September 12, 1994, given by Bradley G. Lorimier
to the Registrant (Filed as Exhibit 10.9 to the Registrant's Form 10-Q
filed November 14, 1994 and incorporated herein by reference).
10.54* Employment Agreement, dated January 23, 1995 with Robert H. Benson
(Filed as Exhibit 10.27 to the Registrant's From 10-K for the Fiscal
year ended December 31, 1994 and incorporated herein by reference).
10.55* Employment Agreement between the Company and Melvin D. Booth dated June
19, 1995 (Filed as Exhibit 10.4 to the Registrant's Form 10-Q filed
August 14, 1995 and incorporated herein by reference).
10.56* Restricted Stock Purchase Agreement, dated April 21, 1993, between the
Registrant and Catherine G. Blair (Filed as Exhibit 10.19 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.57* Restricted Stock Purchase Agreement, dated April 21, 1993, between the
Registrant and James W. Church (Filed as Exhibit 10.20 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.58* Restricted Stock Purchase Agreement, dated April 21, 1993, between the
Registrant and Donald D. Johnston (Filed as Exhibit 10.21 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.59* 1993 Stock Option Plan (Filed as Exhibit 10.45 to the Registrant's Form
S-1 Registration Statement, as amended (Commission File No. 33- 69850),
originally filed October 1, 1993 and incorporated herein by reference).
10.60* 1994 Stock Option Plan (Filed as Exhibit 4 to the Registrant's
Registration Statement on Form S-8, File No. 33-79020, filed May 17,
1994 and incorporated herein by reference).
10.61* Form of Stock Option Agreement (Filed as Exhibit 10.46 to the
Registrant's Form S-1 Registration Statement, as amended (Commission
File No. 33-69850), originally filed October 1, 1993 and incorporated
herein by reference).
10.62*+ Agreements between the Registrant and Perkin-Elmer Corporation (Filed
as Exhibit 10.48 to the Registrant's Form S-1 Registration Statement,
as amended (Commission File No. 33-69850), originally filed October 1,
1993 and incorporated herein by reference).
10.63* $4,000,000 Maryland Industrial Development Financing Authority Taxable
Variable Rate Demand Economic Development Revenue Bonds dated December
21, 1994 (Filed as Exhibit 10.90 to the Registrant's Form 10-K for the
fiscal year ended December 31, 1994 and incorporated herein by
reference).
31
10.64*+ HGS/TIGR Agreement dated June 20, 1997 (Filed as Exhibit 10.1 to the
Registrant's Form 10-Q filed August 14, 1997 and incorporated herein by
reference).
10.65*+ Amendment to SmithKline Beecham Corporation and SmithKline Beecham
p.l.c. and Human Genome Sciences, Inc. Collaboration Agreement dated
July 24, 1997 (Filed as Exhibit 10.2 to the Registrant's 10-Q filed
August 14, 1997 and incorporated herein by reference).
10.66++ Gene Therapy Collaboration and License Agreement between Human Genome
Sciences, Inc. and Transgene S.A., dated February 25, 1998.
10.67 Lease Agreement between Maryland Economic Development Corporation and
Human Genome Sciences, Inc., dated December 1, 1997.
23.1 Consents of Ernst & Young LLP, Independent Auditors.
27 Financial Data Schedule.
- -------------------------------------------------------------------------------
* Incorporated by reference.
+ Confidentiality treatment has been granted by the Commission. The copy filed
as an exhibit omits the information subject to the confidentiality request.
++ Confidentiality treatment has been requested. The copy filed as an exhibit
omits the information subject to the confidentiality request.
32
b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the fourth
quarter of 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
HUMAN GENOME SCIENCES, INC.
BY: /S/William A. Haseltine, Ph.D.
---------------------------------------
William A. Haseltine, Ph.D.
Chairman and Chief Executive Officer
Dated: March 31, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and the dates indicated:
Signature Title Date
- --------- ----- ----
/S/William A. Haseltine Ph.D. Chairman of the Board and Chief March 31, 1998
- -------------------------------------- Executive Officer (principal executive
William A. Haseltine, Ph.D. officer)
/S/Melvin D. Booth President, Chief Operating Officer March 31, 1998
- ----------------------------------------------- Director
Melvin D. Booth
/S/Craig A. Rosen, Ph.D. Senior Vice President, Research and March 31, 1998
- ----------------------------------------------- Development and Director
Craig A. Rosen, Ph.D.
/S/Steven C. Mayer Senior Vice President and March 31, 1998
- ----------------------------------------------- Chief Financial Officer(principal
Steven C. Mayer financial and accounting officer)
/S/Robert A. Armitage Director March 31, 1998
- -----------------------------------------------
Robert A. Armitage
/S/James Cavanaugh, Ph.D. Director March 31, 1998
- -----------------------------------------------
James Cavanaugh, Ph.D.
/S/Jurgen Drews, M.D. Director March 31, 1998
- -----------------------------------------------
Jurgen Drews, M.D.
/S/Beverly Sills-Greenough Director March 31, 1998
- -----------------------------------------------
Beverly Sills-Greenough
33
/S/Robert Hormats Director March 31, 1998
- -----------------------------------------------
Robert Hormats
/S/Donald D. Johnston Director March 31, 1998
- -----------------------------------------------
Donald D. Johnston
/S/Max Link, Ph.D. Director March 31, 1998
- -----------------------------------------------
Max Link, Ph.D.
/S/Alan G. Spoon Director March 31, 1998
- -----------------------------------------------
Alan G. Spoon
/S/James Barnes Wyngaarden, M.D. Director March 31, 1998
- -----------------------------------------------
James Barnes Wyngaarden, M.D.
34
INDEX TO FINANCIAL STATEMENTS
Page
Number
------
Report of Ernst & Young LLP, Independent Auditors........................ F-2
Balance Sheets at December 31, 1997 and 1996............................. F-3
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995........................................ F-4
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995......................................... F-5
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995........................................ F-6
Notes to Financial Statements............................................ F-7
F-1
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders
Human Genome Sciences, Inc.
Rockville, Maryland
We have audited the accompanying balance sheets of Human Genome Sciences, Inc.
as of December 31, 1997 and 1996 and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. 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 generally accepted auditing
standards. 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 financial position of Human Genome Sciences, Inc. at
December 31, 1997 and 1996 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ Ernst & Young LLP
Vienna, Virginia
February 23, 1998
F-2
HUMAN GENOME SCIENCES, INC.
BALANCE SHEETS
December 31,
---------------------------
1997 1996
------------ --------------
ASSETS (dollars in thousands, except
- ------ for share and per share amounts)
Current assets:
Cash and cash equivalents..................................................... $ 44,346 $ 27,341
Short-term investments........................................................ 160,866 88,775
Prepaid expenses and other current assets..................................... 2,120 2,935
------------ --------------
Total current assets...................................................... 207,332 119,051
Property, plant and equipment (net of accumulated depreciation and amortization)... 20,647 18,031
Restricted investments............................................................. 6,582 1,705
Other assets....................................................................... 1,671 1,330
------------ --------------
TOTAL..................................................................... $236,232 $140,117
============ ==============
LIABILITIES
- -----------
Current liabilities:
Current portion of long-term debt............................................. $ 444 $ 444
Accounts payable and accrued expenses......................................... 4,656 3,361
Accrued payroll and related taxes............................................. 2,077 1,120
Current obligation under capital leases....................................... 223 811
Deferred revenues............................................................. 3,020 2,537
------------ --------------
Total current liabilities................................................. 10,420 8,273
Long-term debt, net of current portion............................................. 2,224 2,668
Obligations under capital leases, net of current portion........................... 0 286
Other liabilities.................................................................. 334 369
------------ --------------
TOTAL..................................................................... 12,978 11,596
Commitments and other matters...................................................... - -
STOCKHOLDERS' EQUITY
- ---------------------
Common stock - $.01 par value; shares authorized - 50,000,000; shares issued -
22,313,504 and 18,784,382 at December 31, 1997 and 1996, respectively......... 223 188
Additional paid-in capital......................................................... 278,626 162,583
Unearned portion of compensatory stock............................................. (121) -
Unrealized gain (loss) on investments available for sale........................... 48 (121)
Retained deficit................................................................... (55,522) (34,129)
------------ --------------
Total stockholders' equity................................................ 223,254 128,521
------------ --------------
TOTAL..................................................................... $236,232 $140,117
============ ==============
The accompanying notes to financial statements are an integral part hereof.
F-3
HUMAN GENOME SCIENCES, INC.
STATEMENTS OF OPERATIONS
Year Ended December 31,
-------------------------------------------------
1997 1996 1995
--------------- -------------- ------------------
(dollars in thousands, except for share
and per share amounts)
Revenue - research and development collaborative contracts..... $ 25,605 $ 36,460 $ 5,000
Costs and expenses:
Research and development:
Direct expenditures................................... 39,893 30,409 22,904
Payments under research services agreement............ 6,247 10,063 10,075
--------------- -------------- -----------------
Total research and development..................... 46,140 40,472 32,979
General and administrative..................................... 11,113 9,639 8,745
--------------- -------------- -----------------
Total costs and expenses.............................. 57,253 50,111 41,724
--------------- -------------- -----------------
Income (loss) from operations.................................. (31,648) (13,651) (36,724)
Interest income................................................ 10,889 6,462 4,555
Interest expense............................................... (389) (370) (550)
--------------- -------------- -----------------
Income (loss) before taxes..................................... (21,148) (7,559) (32,719)
Provision for (benefit) from income taxes:
Current................................................... 245 208 (1,651)
--------------- -------------- -----------------
Net Income (Loss).............................................. $ (21,393) $ (7,767) $ (31,068)
=============== ============== =================
Basic and diluted net income (loss) per share.................. $ (0.99) $ (0.42) $ (1.98)
=============== ============== =================
Weighted average shares outstanding basic and diluted.......... 21,525,283 18,630,986 15,723,144
=============== ============== =================
The accompanying notes to financial statements are an integral part hereof.
F-4
HUMAN GENOME SCIENCES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT FOR SHARES)
Unrealized
Common Stock Unearned Gain (Loss)
---------------------- Portion of on
Number Additional Compensatory Investments Retained
Of Paid-In Stock and Available Earnings
Shares Amount Capital Warrants for Sale (Deficit) Total
- -------------------------------------------- ----------- ---------- --------------- ------------- ----------- -----------
Balance - December 31, 1994 14,846,009 $ 148 $ 80,729 $ (1,584) $ (214) $ 4,706 $ 83,785
Exercise of options 113,691 1 932 - - - 933
Warrants exercised by lessor 216,330 2 (2) - - - -
Warrants exercised 7,499 - 1 - - - 1
Issuance of common stock
pursuant to public offering
(net of expenses) 3,048,402 31 60,964 - - - 60,995
Compensatory stock and warrants
earned - - - 699 - - 699
Net loss - - - - - (31,068) (31,068)
Unrealized gain on investments - - - - 261 - 261
----------- ----------- ---------- --------------- ------------- ----------- -----------
Balance - December 31, 1995 18,231,931 182 142,624 (885) 47 (26,362) 115,606
Exercise of options 193,752 3 1,897 - - - 1,900
Warrants exercised by lessor 17,431 - - - - - -
Warrants exercised 2,203 - - - - - -
Issuance of common stock in
connection with SB Milestone
III 339,065 3 18,062 - - - 18,065
Compensatory stock and warrants
earned - - - 885 - - 885
Net loss - - - - - (7,767) (7,767)
Unrealized (loss) on investments - - - - (168) - (168)
----------- ----------- ---------- --------------- ------------- ----------- -----------
Balance - December 31, 1996 18,784,382 188 162,583 - (121) (34,129) 128,521
Exercise of options 280,340 3 4,173 - - - 4,176
Warrants exercised by lessor 5,161 - - - - - -
Warrants exercised 50,871 - 10 - - - 10
Issuance of common stock
pursuant to public
offering (net of expenses) 3,192,750 32 111,713 - - - 111,745
Compensatory stock options
issued - - 147 (147) - - -
Compensatory stock and warrants
earned - - - 26 - - 26
Net loss - - - - - (21,393) (21,393)
Unrealized gain on investments - - - - 169 - 169
----------- ----------- ---------- --------------- ------------- ----------- -----------
Balance - December 31, 1997 22,313,504 $ 223 $278,626 $ (121) $ 48 $(55,522) $223,254
=========== =========== ========== =============== ============= =========== ===========
The accompanying notes to financial statements are an integral part hereof.
F-5
HUMAN GENOME SCIENCES, INC.
STATEMENTS OF CASH FLOWS
Year Ended December 31,
1997 1996 1995
---------------------------------
(dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................................................... $ (21,393) $ (7,767) $(31,068)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Accrued interest on U.S. Treasury bills and commercial paper........... (1,109) (857) (251)
Depreciation and amortization.......................................... 6,359 5,858 4,395
Loss due to disposal and write-down of property, plant and equipment... 50 66 665
Compensation expense related to stock options and warrants............. 26 885 699
Changes in operating assets and liabilities:
Prepaid expenses and other current assets........................... 738 (718) (699)
Funds available - facility fund..................................... - - (52)
Other assets........................................................ (341) 3 12
Accounts payable and accrued expenses............................... 988 1,376 305
Accrued payroll and related taxes................................... 957 428 143
Deferred income..................................................... 483 537 2,000
Income taxes payable................................................ - - (2,134)
Other liabilities................................................... (35) (5) (26)
---------- ----------- ----------
Net cash provided by (used in) operating activities................. (13,277) (194) (26,011)
---------- ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures - property, plant and equipment....................... (8,717) (8,306) (7,697)
Purchase of investments and marketable securities.......................... (205,572) (182,030) (98,717)
Proceeds from sale and maturities of investments
and marketable securities................................................ 134,833 159,499 73,552
---------- ----------- ----------
Net cash provided by (used in) investing activities................. (79,456) (30,837) (32,862)
---------- ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt............................................... - - 2,353
Repayment of long-term debt................................................ (444) (444) (444)
Restricted cash............................................................ (4,877) 295 -
Payments on capital lease obligations...................................... (874) (1,297) (1,139)
Proceeds from issuance of common stock (net of expenses)................... 115,933 19,965 61,929
---------- ----------- ----------
Net cash provided by (used in) financing activities................. 109,738 18,519 62,699
---------- ----------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......................... 17,005 (12,512) 3,826
Cash and cash equivalents - beginning of year.................................. 27,341 39,853 36,027
---------- ----------- ----------
CASH AND CASH EQUIVALENTS - END OF YEAR........................................ $ 44,346 $ 27,341 $ 39,853
========== ========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest............................................................... $ 240 $ 199 $ 233
Income taxes........................................................... 245 208 508
See Note G for noncash exercise of warrants.
The accompanying notes to financial statements are an integral part hereof.
F-6
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE A) - THE COMPANY
Human Genome Sciences, Inc. (the "Company") was incorporated and commenced
operations on June 26, 1992. The Company is engaged in the research and
development of novel, proprietary pharmaceutical and diagnostic products based
on the discovery and understanding of the medical utility of genes. The
Company's revenues are currently derived from license fees and research payments
under collaboration agreements. The Company does not yet generate any revenues
from product sales.
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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 and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash equivalents and Short-Term Investments
The Company considers all highly liquid investment instruments purchased with a
maturity of three months or less to be cash equivalents. On December 31, 1997
and 1996, the Company had purchased $15,171,000 and $6,840,054, respectively, of
U.S. Government securities under agreements to resell on January 1, 1998 and
1997, respectively. Due to the short-term nature of the agreements, the Company
did not take possession of the securities which were held by the Company's asset
managers. The market value of the securities approximated the carrying amount.
The Company classifies its short-term investments into the categories:
"held-to-maturity" and "available-for-sale," each of which have different
accounting treatment. Investments in securities that are classified as
available-for-sale and have readily determinable fair values are measured at
fair market value in the balance sheet, and unrealized holding gains and losses
for these investments are reported as a separate component of stockholders'
equity until realized. Debt securities classified as held-to-maturity securities
will be carried at amortized cost.
During 1997, the Company instructed its cash portfolio managers to hold all
securities as available-for-sale to be available for current operations. For
comparative purposes, the Company has reclassed long-term investments to
short-term investments.
Investment Risk
The Company has invested its cash in obligations of the U.S. Government and in
high grade corporate debt securities and commercial paper. The Company's
investment policy limits investments to certain types of instruments issued by
institutions with investment grade credit ratings, and places restrictions on
maturities and concentration by type and issuer.
Investments
All investments in which the Company has the ability to exercise significant
influence over the investee, but less than a controlling voting interest, are
accounted for under the equity method of accounting. Under the equity method of
accounting, the Company's share of the investee's earnings or losses are
included in operations, to the extent the Company has an investment recorded as
an asset plus the amount of any continuing commitment to fund the investee.
F-7
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Depreciation and amortization
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the assets as follows:
Laboratory equipment................................. 3 - 10 years
Computers and EDP equipment.......................... 3 years
Furniture and office equipment....................... 3 - 5 years
Leasehold improvements............................... over the lease term
Equipment acquired under capital lease agreements is amortized over the terms of
the leases ranging from three to four years.
Impairment of Long-Lived Assets
Periodically, management determines whether any property and equipment or any
other assets have been impaired based on the criteria established in Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to be Disposed Of" ("SFAS No. 121"). The
Company made no adjustments to the carrying values of the assets during the
years ended December 31, 1997, 1996, and 1995.
Stock-Based Compensation
During 1996, the Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). The provisions
of SFAS No. 123 allow companies to either expense the estimated fair value of
stock options or to continue to follow the intrinsic value method set forth in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), but disclose the pro forma effects on net income
(loss) had the fair value of the options been expensed. The Company has elected
to continue to apply APB No. 25 in accounting for its stock option incentive
plans. See Note L to the financial statements for further information.
Revenue recognition
Nonrefundable license fees, research payments, additional payments and milestone
payments in connection with collaboration agreements are recognized when they
are earned in accordance with the applicable performance requirements and / or
contractual terms.
Research and development
Research and development costs are charged to expense as incurred.
Patent costs
Patent application costs are charged to expense as incurred.
Net income (loss) per share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share" ("SFAS No. 128"). SFAS No. 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All net income (loss) earnings per share amounts for all
periods have been presented, and where appropriate, restated to conform to the
SFAS No. 128 requirements.
F-8
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE B) - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Sources of supply
The Company currently relies on a single supplier, Applied Biosystems, a
division of Perkin-Elmer Corporation, to provide all of its gene sequencing
machines and certain reagents required in connection with the gene sequencing
process. The Company has not experienced problems in obtaining either gene
sequencing machines or reagents in a timely manner. While other gene sequencing
machines are available, the Company does not believe that such other machines
are as efficient as the machines currently used by the Company. No assurance can
be given that either the gene sequencing machines or the reagents will remain
available in commercial quantities at costs that are not economically
prohibitive.
Reclassification
Certain reclassifications have been made to the 1996 financial statements
to conform with the 1997 presentations.
Recent Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS
No. 130"), which is required to be adopted for the Company's December 31, 1998
financial statements. SFAS No. 130 establishes new rules for the reporting and
display of comprehensive income and its components in a full set of general
purpose financial statements. Comprehensive income is the total of net loss and
all other nonowner changes in equity. The impact of SFAS No. 130 on the
Company's December 31, 1998 financial condition and results of operations is not
expected to be material.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"), which is required to be
adopted for the Company's December 31, 1998 financial statements. SFAS No. 131
establishes annual and interim reporting standards for a company's operating
segments and related disclosures about its products, services, geographic areas
and major customers. The impact of SFAS No. 131 on the Company's December 31,
1998 financial condition and results of operations is not expected to be
material.
(NOTE C) - INVESTMENTS
Investments, including accrued interest, at December 31, 1997 and 1996 were as
follows:
December 31, 1997
-----------------
Amortized Unrealized
Available-for-Sale Cost Fair Value Gain/(Loss)
------------------ -------------- ---------- -----------
U.S. Treasury and agencies $ 16,838,000 $ 16,836,000 $ (2,000)
Corporate debt securities 143,980,000 144,030,000 50,000
-------------- --------------- -------------
$160,818,000 $160,866,000 $ 48,000
============== =============== =============
December 31, 1996
-----------------
Held-to-Maturity
----------------
Corporate debt securities $58,282,000 $58,247,000 $ (35,000)
============== =============== =============
Available-for-Sale
------------------
U.S. Treasury and agencies $15,262,000 $15,194,000 $ (68,000)
Corporate debt securities 15,352,000 15,299,000 (53,000)
-------------- --------------- -------------
$30,614,000 $30,493,000 $(121,000)
============== =============== =============
F-9
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE D) - AGREEMENT WITH THE INSTITUTE FOR GENOMIC RESEARCH ("TIGR")
In June 1997, the Company and TIGR reached an agreement to terminate the
Research Services Agreement (the "Services Agreement") dated October 1, 1992,
the Intellectual Property Agreement dated October 2, 1992, the Lease Funding
Agreement and Assignment dated March 2, 1993, the Agreement of April 19, 1993
related to human cDNA sequencing, and all other agreements entered into any time
prior to the Termination Date between the Company and TIGR. Pursuant to the
Termination Agreement, the Company retains rights in intellectual property
arising out of TIGR's research prior to June 2, 1997, but will have no rights to
intellectual property resulting from future research by TIGR. The Company is
relieved of its obligation to provide future funding (including all research
funding) to TIGR, which would have amounted to approximately $38 million.
Certain limitations on TIGR's publication of intellectual property and
restrictions on TIGR entering into commercial agreements contained in the prior
agreements were also terminated. However, pursuant to the Termination Agreement,
TIGR has agreed not to enter into commercial agreements for the next four years
with respect to selected therapeutic proteins and associated diagnostic tests
currently in development by the Company. In addition, the Company will be
entitled to be paid a percentage of certain payments received by TIGR from
commercial agreements relating to human therapeutic proteins in which TIGR
grants or agrees to grant rights within two years.
(NOTE E) - COLLABORATION AGREEMENTS
Agreements with SmithKline Beecham Corporation
In May 1993, the Company entered into a collaboration agreement, as amended ("SB
Collaboration Agreements"), providing SmithKline Beecham Corporation ("SB") a
first right to develop and market products in human and animal healthcare ("SB
Products"), based upon human genes identified by the Company. In return, SB has
paid $125 million to the Company since 1993. Approximately $55 million was
allocated to the purchase price of 1,351,738 shares of common stock with the
balance of $70 million recognized from license fees, option rights and milestone
payments. Of the $70 million recognized since 1993, $6.9 million was recognized
during the year ended December 31, 1996.
The 1996 payment by SB of $25 million was made pursuant to the Company's
achievement of Milestone III. Pursuant to the SB Collaboration Agreements, the
payment was allocated as follows. The Company sold 339,065 shares of common
stock to SB at $58.28 per share, which was calculated pursuant to the contract
as 125% of the average market price of the Company's common stock for the five
trading days preceding payment, for total proceeds of approximately $18.1
million. The remainder of the payment was allocated to the deliverables and
other data being transferred to SB and recorded by the Company as revenue.
In addition, the Company is entitled to (i) royalties on the net sales of SB
Products, (ii) product development progress payments and (iii) the option to
co-promote up to 20% of any product development by SB under the collaboration
agreement.
In June 1996, the SB Collaboration Agreements were substantially amended (the
"SB Amendment") to allow the Company and SB together to enter into collaboration
agreements with additional pharmaceutical companies ("Collaboration Partners")
in the SB Field (other than diagnostics and animal healthcare in which SB has
generally retained exclusive rights). The SB Amendment restricts the Company
from entering into further collaborations in the SB Field during the initial
research term (through June 2001). The restriction also applies to certain
products which are subject to research plans submitted by SB prior to the
expiration of the initial research term and for a period thereafter. SB has the
right to extend the research term for up to five additional years by making
certain payments, which would extend the time for submitting research plans as
to therapeutic products.
The SB Amendment provides that SB and the Company will share equally in any
license fee payments paid by the Collaboration Partners and that the Company
will receive all royalties and research payments paid by the Collaboration
Partners. The SB Collaboration Agreements provide for payments to the Company by
SB of royalties on net sales of SB Products based on the Company's patents or
technologies made by SB and milestone payments in connection with the
development of SB Products.
In July 1997, the Collaboration Agreement with SB was amended with respect to
human diagnostic products based on the Company's human gene technology. The
amended agreement simplified procedures for outlicense by SB of diagnostic
products based on the Company's human gene technology. In addition, the new
agreement permits the Company to develop and market diagnostic tests that
correspond to therapeutic products developed by the Company pursuant to its
collaboration agreement with SB and to outlicense diagnostic tests corresponding
to therapeutic products outlicensed by the Company. Under the new agreement, SB
has agreed to pay a royalty to the Company
F-10
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE E) - COLLABORATION AGREEMENTS (Continued)
Agreement with Smithkline & Beecham (Continued)
which is at a rate that is competitive in the diagnostic field on diagnostic
products based on the Company's human gene technology sold or outlicensed by SB.
Except for the modifications relating to human diagnostic products, this amended
agreement has no effect on the existing collaboration between the Company and
SB, nor does it have any effect on collaboration agreements with the Company's
and SB's collaboration partners.
Other Collaboration Agreements in the SB Field
In June 1995, the Company entered into an Option and License Agreement with
Takeda Chemical Industries, Ltd. ("Takeda") pursuant to which Takeda was granted
an exclusive option to license rights under the Company's patents and technology
in the field of human healthcare (other than gene therapy, antisense and
diagnostics) to make and sell a limited number (equal to the number of
collaboration partners other than SB and Takeda with which the Company enters
into collaboration agreements in the SB field) of products in Japan. In
consideration of the grant of the option, Takeda paid the Company $5 million,
which was recognized as revenue by the Company in 1995, and agreed to pay to the
Company royalties based on the sale of Takeda products covered by the Option and
License Agreement and certain milestone payments.
In June 1996, the Company and SB entered into collaboration agreements
("Additional Collaboration Partner Agreements") with Schering Corporation and
Schering Plough Ltd. ("Schering Plough"), Synthelabo S.A., and Merck KGaA
("Merck"), (collectively "Additional Collaboration Partners"). The Additional
Collaboration Partner Agreements provide the Additional Collaboration Partners
the rights and licenses to access the Company's Human Gene Technology, as well
as biological information developed by the Company and SB prior to, and in the
case of the Company, after the effective date of such Agreement, to discover,
develop and commercialize products based upon or derived from such Company
technology in the SB Field (other than diagnostics and animal healthcare). The
Additional Collaboration Partners are obligated to pay license fees, research
payments, milestone payments and royalties in connection with the agreements.
The initial research term expires in June 2001. The Additional Collaboration
Partners have the right to extend the term for up to five additional years by
making certain additional payments. Aggregate license fees and research payments
due under the Additional Collaborative Partner Agreements to which the Company
is entitled is $87.5 million, payable in equal installments over a five-year
period. The Company has recognized revenue of $16.5 million and $16.5 million in
license fees and additional payments during 1997 and 1996, respectively, related
to the Additional Collaboration Partner Agreements.
Collaborative Agreements Outside of the SB Field
In January 1996, the Company entered into a comprehensive Research Collaboration
Agreement in the field of corn genomics with Pioneer Hi-Bred International, Inc.
("Pioneer"). Under the terms of the agreement, the Company will receive $16
million from Pioneer over three years for work performed under the
collaboration. The relationship is exclusive for five years. Pioneer will own
all sequence information and intellectual property developed as a result of this
collaboration. The Company retains commercial rights to use any gene sequence in
human health and for certain specialty and industrial enzyme applications. In
January 1997, the Company received $3 million pursuant to this agreement that
the Company recognized as revenue in 1997. During 1996, pursuant to this
agreement, the Company received and recorded as revenue $8 million from Pioneer
related to license fees and research payments.
In March 1996 the Company entered into a License Agreement with F. Hoffmann-La
Roche, Ltd. ("Roche") to sequence and assemble the genome of Streptococcus
pneumoniae, a major bacterial pathogen responsible for severe respiratory and
other infections. Roche has received a license to use this information to
identify potential new anti-infectives and antibiotics. During 1997, the Company
received and recorded as revenue $1 million from Roche related to an additional
research payment. The Company received $2 million from Roche in 1995, which was
recorded as revenue in 1996. The Company will receive additional research
payments and potential future royalties.
In June 1996, the Company entered into a Collaboration and License Agreement
with Schering Plough relating to the field of human gene therapy (including gene
therapy vaccines to a limited extent). Under this agreement, the Company has
granted Schering Plough a non-exclusive license to use the Company's Human Gene
Technology to conduct research, and an option to obtain an exclusive license to
specific genes in the field of gene therapy. The agreement provides that
Schering Plough will pay the Company a $5 million license fee (payable over five
years) for
F-11
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE E) - COLLABORATION AGREEMENTS (CONTINUED)
Collaborative Agreements Outside of the SB Field (continued)
a non-exclusive research license, an option exercise fee and development
milestone payments for each gene for which it exercises its option to obtain an
exclusive license and royalties on net sales of gene therapy products resulting
from research under the agreement. The agreement is for an initial term expiring
June 2001, subject to extension until 2006 on payment of certain amounts. The
Company has received $1 million for the license fee each in 1997 and 1996, which
the Company recorded as revenue.
In October 1996, the Company entered into a License and Research Agreement with
Pharmacia & Upjohn Company to sequence a certain genome. Pharmacia & Upjohn
Company has received license rights to use this information to develop products
for the human pharmaceutical and veterinary fields. The Company received $3
million from Pharmacia & Upjohn Company in 1997 related to license fees and
research payments of which $2 million has been recorded as revenue during 1997
with the remaining $1 million recorded as deferred revenues. The Company
received $3 million from Pharmacia & Upjohn Company in 1996 of which $1.5
million was recorded as deferred revenue at December 31, 1996, and recognized as
revenue in 1997.
(NOTE F) - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including equipment under capital leases, are
stated at cost and are summarized as follows:
December 31,
------------
1997 1996
---- ----
Laboratory equipment.................................... $18,854,000 $16,692,000
Computers and EDP equipment............................. 6,073,000 5,363,000
Furniture and office equipment.......................... 1,113,000 1,010,000
Leasehold improvements.................................. 8,551,000 7,777,000
Construction in Progress................................ 2,787,000 -
-------------- -----------
37,378,000 30,842,000
Less accumulated depreciation and amortization.......... 16,731,000 12,811,000
------------- -----------
$20,647,000 $18,031,000
============== ===========
(NOTE G) - EQUIPMENT LEASE OBLIGATIONS
Prior to 1995, the Company entered into sale and leaseback agreements in
connection with certain computer and laboratory equipment having a net book
value of $2,132,000 and $1,302,000, respectively. The Company sold the equipment
for $2,198,000 and $1,575,000, respectively, and entered into three master lease
agreements pursuant to which it leased back the above equipment for initial
terms of 48 months. All of the equipment leased under these agreements has been
accounted for as capital leases. In addition, the Company entered into other
capital lease agreements for certain equipment for initial terms of 36 months.
The recording of capital leases is considered a non-cash transaction, and
therefore is excluded from the Statements of Cash Flows. Amortization expense
related to equipment under capital leases is included in depreciation and
amortization on the statements of cash flows.
The net book value of the equipment held under capital leases was $81,000 and
$719,000 at December 31, 1997 and 1996, respectively.
As of December 31, 1997, the Company had future capital lease payments for
fiscal 1998 of $223,000.
F-12
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE G) - EQUIPMENT LEASE OBLIGATIONS (CONTINUED)
In conjunction with the master lease agreements, the Company granted warrants to
the lessors to purchase 594,000 shares of the Company's common stock, which the
Company valued at $.27 per warrant. The warrants may be exercised at a purchase
price of $1.33 per share or by receiving shares equal to the value (as
determined by a formula) of the warrants by surrender of the warrants. The
warrants contain registration and certain antidilution rights and are
exercisable through November 1998.
In 1997, a lessor exercised warrants for the purchase of 5,350 shares by
electing to receive 5,161 shares. In 1996, a lessor exercised warrants for the
purchase of 18,000 shares by electing to receive 17,431 shares. In 1995, the
lessors exercised warrants for the purchase of 230,000 shares by electing to
receive 216,330 shares.
(NOTE H) - OTHER ASSETS
Other assets at December 31, 1997 and 1996, include a note receivable from an
officer of $891,000. The note is due on demand and does not bear interest. The
note is collateralized by shares of the Company's common stock owned by the
officer that have a market value of at least 200% of the outstanding balance of
the note.
(NOTE I) - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses are comprised of the following:
December 31,
------------
1997 1996
---- ----
Equipment purchases..................................... $ 868,000 $ 561,000
Professional fees....................................... 1,223,000 489,000
Other accrued expenses.................................. 2,565,000 2,311,000
------------- -------------
$4,656,000 $ 3,361,000
============= =============
(NOTE J) - LONG-TERM DEBT
In December 1994, the Company entered into a loan agreement with Maryland
Industrial Development Financing Authority ("MIDFA"). Major leasehold
improvements were financed with the proceeds of a $4,000,000 taxable variable
rate bond issue (the "Bonds") from MIDFA. The Company is required to make annual
payments of $444,000 commencing December 1995 plus interest at a variable rate
of interest (6.06% at December 31, 1997 and 5.64% at December 31, 1996), to the
trustee on behalf of the bondholders which is equal to the interest and
principal requirements on the bonds. The variable rate is equal to 50 basis
points plus the higher of the yield equivalent of the average 30-day or 90-day
commercial paper rate. Under certain circumstances, the rate may be adjusted
either upward or downward but in no event in excess of 10 basis points above or
below the rate determined above. MIDFA has entered into an indenture with the
Trustee whereby the Trustee has obtained an irrevocable letter of credit on
behalf of the bondholders.
The following fund was created under the terms of the trust indenture:
Bond fund
Required monthly principal payments of $37,000 plus interest are deposited into
this fund beginning January 1, 1995. The interest is disbursed monthly to the
bondholders. Principal is to be repaid from this fund to the bondholders at the
rate of $444,000 annually commencing on December 1, 1995 with a final payment of
$448,000 on December 1, 2003. The Company deposited $797,850 and $632,000 of
principal and interest into this fund during the years ended December 31, 1997
and 1996, respectively.
In connection with the Loan Agreement, the Company entered into an irrevocable
Letter of Credit Agreement with a bank for the account of the Company and in
favor of the Trustee in the initial amount of $4,066,667 which expires on
December 15, 2003. Concurrently, the Company entered into a Collateral Pledge
Agreement with the bank.
F-13
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE J) - LONG-TERM DEBT (CONTINUED)
The Company is required to maintain 43% of the outstanding principal amount of
the Bonds (50% is required under certain circumstances) with the bank as
Collateral for the Letter of Credit. Pursuant to the Collateral Pledge Agreement
at December 31, 1997 and 1996, the Company had $1,452,000 and $1,705,000,
respectively, on deposit with the bank that is invested in a U.S. Government
agency security, which is included in Restricted Investments in the Balance
Sheets. The pledge collateral will be released upon the payment and performance
in full of the Company's Letter of Credit obligations. The agreement contains
covenants with respect to tangible net worth, cash and cash equivalents and
investment securities, as well as other covenants and prohibits the payment of
cash dividends. During 1994, the Company incurred costs of $136,000 in
connection with this loan which are being amortized over the term of the loan.
(NOTE K) - COMMITMENTS AND OTHER MATTERS
Operating leases
The Company leases office and laboratory premises and equipment pursuant to
operating leases expiring at various dates through 2017. The leases contain
various renewal options. Minimum annual rentals are as follows:
Years Ending December 31,
------------------------------
1998............................$..2,304,000
1999...............................3,876,000
2000...............................3,765,000
2001...............................3,762,000
2002...............................3,767,000
Thereafter........................36,608,000
--------------
$54,082,000
==============
The Company has entered into leases for office and laboratory space which
provide for certain rent abatement and rent escalations on each anniversary of
the lease commencement date. For financial reporting purposes, rent expense is
charged to operations on a straight-line basis over the term of the lease,
resulting in a liability for deferred rent of $300,000 and $262,000 included in
other liabilities at December 31, 1997 and 1996, respectively.
Certain other leases provide for escalation for increases in real estate taxes
and certain operating expenses, as well as various renewal terms.
The Company entered into a 20 year lease for a process development and
production facility being built to the Company's specifications. Annual base
rent of $2.2 million is expected to begin January 1, 1999, the anticipated
completion date of the facility.
Rent expense aggregated $2,384,000, $1,988,000, and $1,866,000 for the years
ended December 31, 1997, 1996 and 1995, respectively.
Capital expenditures
At December 31, 1997 and 1996, the Company had commitments for capital
expenditures, consisting primarily of laboratory equipment, of $353,000 and
$700,000, respectively.
401(k) Plan
Effective January 15, 1993, the Company adopted a 401(k) pension plan available
to eligible full-time employees. The Company made discretionary contributions of
$235,000, $168,000, and $97,000 to the plan for the years ended December 31,
1997, 1996, and 1995, respectively.
F-14
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE L) - STOCKHOLDERS' EQUITY
Preferred Stock
In November 1993, the shareholders authorized a new series of preferred stock of
1,000,000 shares, $.01 par value, none of which was issued and outstanding at
December 31, 1997 and 1996.
Common Stock
The Company has the right of first refusal on the sale of certain common stock
issued in connection with restricted stock purchase agreements. The price to be
paid by the Company is $1.13 and $.19 per share less than the price of any
proposed sale for 561,160 and 246,052 shares, respectively.
Stock option plan
The 1993 Employee Incentive and Non-qualified Stock Option Plan (the "1993
Plan") provides for the granting of options to purchase up to 565,827 shares of
the Company's common stock, at a price, for the incentive options, of not less
than the fair market value of the common stock on the date of grant. The vesting
period of the options is determined by the Board of Directors and is generally
five years. Outstanding options expire after ten years.
Additional information with respect to 1993 Stock Option activity is summarized
as follows:
Years Ended December 31,
--------------------------------------------------------------------------------------------
1997 1996 1995
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------- ------------- ------------- ------------- ------------- -------------
Outstanding at beginning of
year 293,618 $11.21 399,111 $ 9.16 428,592 $ 4.40
Options granted - - - - 78,455 27.50
Options exercised (105,748) 8.68 (96,128) 2.07 (73,449) 2.98
Options canceled or expired (20,911) 14.41 (9,365) 17.90 (34,487) 4.89
------------- ------------- -------------
Outstanding at end of year 166,959 12.41 293,618 11.21 399,111 9.16
============= ============= =============
Options exercisable at end
of year 128,979 11.53 148,900 9.25 118,724 3.27
============= ============= =============
The following table summarizes information about stock options outstanding at
December 31, 1997:
Options Outstanding Options Exercisable
------------------------------------------------------ ------------------------------
Weighted- Weighted- Weighted-
Average Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Price Outstanding Life (In Years) Price Exercisable Price
--------------- ----------------- ------------ ------------- ------------
$.20 to $6.00 92,806 5.4 $ 2.66 78,331 2.23
$9.00 to $27.50 74,153 7.5 24.60 50,648 25.91
--------------- ----------------- ------------ ------------- ------------
166,959 6.3 $12.41 128,979 11.53
=============== ================= ============ ============= ============
F-15
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE L) - STOCKHOLDERS' EQUITY (CONTINUED)
Stock option plan (continued)
On March 14, 1994, the Company adopted a 1994 Employee Incentive and
Nonqualified Stock Option Plan (the "1994 Plan") for the granting of options to
purchase up to 950,000 shares of common stock to officers, employees, directors,
consultants and non-employee directors. The exercise price of options granted
under the plan may not be less than the market price on the date of grant. In
May 1996 an amendment was approved to increase the number of shares available
for issuance from 950,000 options to 2,450,000 options. In February 1997, an
amendment was approved to increase the number of shares available for issuance
from 2,450,000 options to 3,450,000 options. The vesting period of the options
is determined by the Board of Directors and is generally five years. Outstanding
options expire after ten years.
Additional information with respect to 1994 Stock Option activity is summarized
as follows:
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- ----------------------------- ------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------- ------------- ------------- ------------- ------------- -------------
Outstanding at beginning of
year 1,528,779 $25.29 884,214 $18.01 655,958 $18.01
Options granted 1,644,351 48.57 790,616 32.18 348,263 17.86
Options exercised (174,592) 18.66 (97,624) 17.42 (40,242) 17.75
Options canceled or expired (122,588) 28.41 (48,427) 20.58 (79,765) 17.54
------------- ------------- -------------
Outstanding at end of year 2,875,950 38.87 1,528,779 25.29 884,214 18.01
============= ============= =============
Options exercisable at end
of year 597,305 26.00 348,533 $20.05 190,861 $17.52
============= ============= =============
The following table summarizes information about stock options outstanding at
December 31, 1997:
Options Outstanding Options Exercisable
------------------------------------------------------ ------------------------------
Weighted-Average Weighted- Weighted-
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Price Outstanding Life (In Years) Price Exercisable Price
--------------- ----------------- ------------ ------------- ------------
$12.75 to $22.00 457,074 6.77 $16.71 267,114 17.11
$23.50 to $34.50 634,150 8.34 28.62 136,450 25.87
$36.25 to $39.00 739,375 9.15 37.37 108,925 37.31
$39.25 to $42.56 695,351 9.63 40.09 84,816 39.66
$70.00 to $100.00 350,000 9.06 87.14 -0- -0-
--------------- ----------------- ------------ ------------- ------------
2,875,950 8.70 $38.87 597,305 26.00
=============== ================= ============ ============= ============
The Company applies APB No. 25 in accounting for its stock option incentive plan
and, accordingly, recognizes compensation expense for the difference between the
fair value of the underlying common stock and the grant price of the option at
the date of grant. The effect of applying SFAS No. 123 on 1997, 1996 and 1995
pro forma net loss and net loss per share as stated above is not necessarily
representative of the effects on reported net loss for future years due to,
among other things, (1) the vesting period of the stock options and the (2) fair
value of additional stock
F-16
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE L) - STOCKHOLDERS' EQUITY (CONTINUED)
Stock option plan (continued)
options in future years. Had compensation cost for the Company's stock option
plans been determined based upon the fair value at the grant date for awards
under the plans consistent with the methodology prescribed under SFAS No. 123,
the Company's net loss in 1997, 1996, and 1995 would have been approximately
$32.5 million, $12.9 million, and $32.8 million, respectively, or $1.51 per
share, $0.69 per share, and $2.08 per share, respectively. The fair value of the
options granted during 1997 and 1996 are estimated as $18.26 and $23.73 per
share, respectively, on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: dividend yield 0%, volatility of 46.03%
for 1997 and 63.61% for 1996, risk-free interest rate of 5.75% for 1997 and
6.28% for 1996, and expected life of 6 years.
At December 31, 1997, options for 79,375 and 261,592 were available for future
grant under the 1993 Plan and 1994 Plan, respectively. At December 31, 1996,
options for 58,464 and 783,355 were available for future grant under the 1993
Plan and 1994 Plan, respectively.
Reserved for issuance:
The Company has also reserved shares of common stock for issuance upon exercise
of warrants and options as follows:
(i) Warrants issued in conjunction with leasing agreements (Note G)........... 75,650
(ii) Warrants issued to certain stockholders (a).............................. 14,415
(iii)Stock option plan - 1993 plan.....,....................................... 246,334
(iv) Stock option plan - 1994 plan............................................. 3,137,542
(a) These warrants were issued in connection with a commitment made by
certain stockholders in 1993; they are exercisable at $.20 per
share and expire in December 1998.
(NOTE M) - INCOME TAXES
The Company provides for income taxes using the liability method. The difference
between the tax provision and the amount that would be computed by applying the
statutory Federal income tax rate to income before taxes is attributable to the
following:
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Federal income tax provision at 34%................... $(7,181,000) $(2,570,000) $ (11,124,000)
State taxes, net of federal effect.................... - - (1,511,000)
Expenses for which no tax benefit is available........ 31,000 112,000 96,000
Expenses for which no book benefit is available....... (1,550,000) - -
Utilization of NOL carryforward....................... - - -
Increase in valuation allowance on deferred tax
assets......................................... 12,465,000 3,262,000 12,484,000
State taxes and valuation allowance change............ (1,286,000) (391,000) -
Foreign taxes paid.................................... 245,000 225,000 500,000
Tax credits generated and not used.................... (2,436,000) (403,000) (2,305,000)
Other................................................. (43,000) (27,000) 209,000
--------------- ---------------- ----------------
$ 245,000 $ 208,000 $ (1,651,000)
=============== ================ ================
F-17
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE M) - INCOME TAXES (CONTINUED)
Temporary differences and carryforwards which give rise to a significant portion
of deferred tax assets and liabilities are as follows:
CURRENT LONG-TERM
ASSET/(LIABILITY) ASSET/(LIABILITY)
---------------- ----------------
December 31, 1997
Net operating loss carryforward...................................... $ - $ 19,359,000
Research and development tax credit carryforward..................... - 7,186,000
Depreciation......................................................... - 744,000
Other................................................................ 267,000 118,000
---------------- ----------------
267,000 27,407,000
Less valuation allowance............................................. (267,000) (27,407,000)
================ ================
$ - $ -
================ ================
December 31, 1996
Net operating loss carryforward...................................... $ - $ 11,808,000
Research and development tax credit carryforward..................... - 4,750,000
Deferred start-up costs.............................................. 41,000 -
Other................................................................ 218,000 262,000
---------------- ----------------
259,000 16,820,000
Less valuation allowance............................................. (259,000) (16,820,000)
================ ================
$ - $ -
================ ================
The Company recognized a valuation allowance to the full extent of its deferred
tax assets since the likelihood of realization of the benefit cannot be
determined.
Provision for income taxes is comprised of the following:
Years Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Current:
Federal............................................. $ - $ - $(1,643,000)
State............................................... (17,000) (508,000)
Foreign taxes....................................... 245,000 225,000 500,000
Deferred................................................ - - -
------------- --------------- --------------
$245,000 $ 208,000 $(1,651,000)
============= =============== ==============
The Company has available tax credit carryforwards expiring as follows:
2000............................................................... $ 500,000
2001............................................................... 225,000
2002............................................................... 245,000
2008............................................................... 745,000
2009............................................................... 1,297,000
2010............................................................... 534,000
2011............................................................... 846,000
2012............................................................... 2,191,000
No expiration...................................................... 238,000
==============
$ 6,821,000
==============
F-18
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE M) - INCOME TAXES (CONTINUED)
The Company has net operating loss carryforwards for federal income tax purposes
of approximately $51.0 million which expire, if unused, from the year 2010
through the year 2012. According to APB 25, the tax benefit of approximately
$4.6 million of net operating losses related to stock options will be credited
to equity when the benefit is realized through utilization of the net operating
loss carryforwards.
(NOTE N) - INVESTMENT IN VASCULAR GENETICS INC.
In November 1997, the Company entered into an agreement with three other parties
to form a new privately held company, Vascular Genetics Inc. ("Vascular
Genetics"), to pursue the development and commercialization of gene therapy
products for the treatment of vascular diseases. The Company will hold a 19.9%
equity interest in Vascular Genetics' common stock in exchange for technology.
Under the terms of the agreement, the Company will receive warrants for the
purchase of an additional 5.1% equity interest in Vascular Genetics which can be
exercised at any time while Vascular Genetics is privately held. The Company
also holds preemptive rights that will permit retention of the Company's
ownership position in the event of a future financing. In addition, the Company
has the option to purchase 100% of Vascular Genetics' common stock at fair
market value upon receiving the approval from one of the other parties and the
board of directors of Vascular Genetics. The Company will earn royalties on net
sales from products developed and commercialized by Vascular Genetics or by a
party granted a sublicense by Vascular Genetics. Royalty rates are competitive
and increase as specified sales targets are reached. In addition, the Company
has the option to manufacture certain products developed by Vascular Genetics
Inc. and receive a manufacturing fee. The Company has committed to lend Vascular
Genetics up to $600,000 at an interest rate of prime plus 1%. As of 12/31/97,
the Company had lent $200,000 to Vascular Genetics. The Company has appointed
two directors to the Board of Directors of Vascular Genetics.
(NOTE O) - NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net loss per
share:
Years ended December 31,
-----------------------------------------------------------
1997 1996 1995
----------------- --------------- -----------------
Numerator:
Net loss $(21,393,000) $(7,767,000) $(31,068,000)
================= ================ =================
Denominator:
Denominator for basic earnings per
share - weighted-average shares 21,525,283 18,630,986 15,723,144
================= ================ =================
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 21,525,283 18,630,986 15,723,144
================= ================ =================
Basic loss per share $(0.99) $(0.42) $(1.98)
================= ================ =================
Diluted loss per share $(0.99) $(0.42) $(1.98)
================= ================ =================
F-19
HUMAN GENOME SCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
(NOTE P) - EVENT (UNAUDITED) SUBSEQUENT TO DATE OF INDEPENDENT AUDITORS' REPORT
On March 2, 1998, the Company signed a ten year agreement with Transgene
S.A. ("Transgene"), based in Strasbourg, France, to develop gene therapy
products. Under the terms and conditions of the agreement, Transgene will have
the right to exclusively license, and sublicense, up to 10 genes and to develop,
manufacture and commercialize any resulting gene therapy products worldwide. The
two companies may also choose to co-develop and co-market the identified new
gene therapy products, and, in such case, commercialization rights will be held
by the Company for North America and by Transgene for Europe and will be shared
equally for the rest of the world's markets. Transgene will pay an initial
licensing fee and research funding in an amount equal to the proceeds to
Transgene from the Company's purchase of a 10% interest in Transgene. The value
of the 10% interest based on the anticipated close of Transgene's Initial Public
Offering (currently in process) would be approximately $25 million. Additional
payments to the Company are dependent upon the number of genes which Transgene
licenses and the accomplishment of certain milestones. Royalties on future
product sales and partnering revenues will be paid by Transgene to the Company.
On co-marketed products, the Company and Transgene will pay reciprocal
royalties.
F-20