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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission file No. 0-23930
TARGETED GENETICS CORPORATION
(Exact name of Registrant as specified in its charter)
Washington 91-1549568
(State of Incorporation) (IRS Employer Identification No.)
1100 Olive Way, Suite 100
Seattle, WA 98101
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206) 623-7612
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
PREFERRED STOCK PURCHASE RIGHTS, $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ________
Indicate the aggregate market value of voting stock held by nonaffiliates
of the Registrant as of March 10, 2000: $487,060,066
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock as of March 10, 2000:
Title of Class Number of shares
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Common Stock, $.01 par value 36,344,346
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DOCUMENTS INCORPORATED BY REFERENCE
(1)Portions of the Proxy Statement for the Annual Meeting of Shareholders
to be held on May 12, 2000, are incorporated by reference into Part III of
this report.
2
PART I
ITEM 1. BUSINESS
Forward-Looking Statements
Some of our statements in this annual report on Form 10-K are forward-
looking statements that involve risks and uncertainties. In making these
statements, we rely on a number of assumptions and make predictions about the
future. Our actual results could differ materially from our expectations for a
number of reasons, including the risks described in the section entitled
"Factors Affecting Our Operating Results, Our Business and Our Stock Price" in
Part II, Item 7 of this annual report. You should not rely unduly on these
forward-looking statements which apply only as of the date of this report. We
undertake no duty to publicly announce or report revisions to these statements
as new information becomes available that would cause us to change our
expectations of the future.
Overview
Targeted Genetics Corporation develops gene therapy products and
technologies for the treatment of acquired and inherited diseases. We have
assembled a broad base of core technologies that we believe has the potential
to address a significant number of these diseases and we believe that we have
expertise that will enable us to develop products based on these technologies.
We have two lead products under development for the treatment of cystic
fibrosis and cancer. We believe that our success in developing these initial
products would demonstrate the value of our core technologies and their
potential to treat numerous other diseases.
Our business strategy is based on the following five key principles:
Multiple gene delivery systems. We believe that different disease targets
will require different methods of gene delivery. The best gene delivery method
for a particular disease will depend on the type of cell to be modified, the
duration of gene expression desired and the need for in vivo (inside the body)
or ex vivo (outside the body) delivery. Therefore, our strategy has been to
develop multiple gene delivery systems. Our systems are based on three
different vector technologies: adeno-associated viral (AAV), synthetic and
retroviral. We believe these systems will give us the flexibility to develop
gene therapies for a broader range of diseases than we could develop using a
single gene delivery system.
Emphasis on product development infrastructure. We believe that an
abundance of basic research is being conducted in the area of gene therapy,
and that those who are capable of translating that research into products will
derive significant value. A great deal of discovery research has been focused
on gene therapy techniques, but much less effort has been focused on the
creation of the product development infrastructure necessary to move concepts
through preclinical studies and clinical trials into the commercial realm.
Therefore, we have focused the overwhelming majority of our efforts on
establishing product development expertise in the areas of preclinical
biology, process development, manufacturing, quality control, quality
assurance, regulatory affairs and clinical trials. We believe that this
product development focus will increase the probability of our reaching the
market with products before our competitors.
Clinical proof of concept. We believe that by providing strong evidence of
the clinical benefit of our products, we will generate significant value
enhancement for our shareholders. Although most experts believe that gene
therapy will be a powerful approach to treating diseases in the future, many
believe that this is a long-term proposition. We believe that we have two lead
products with significant potential to demonstrate clinical proof of concept
in the near term: tgAAV-CF for cystic fibrosis and tgDCC-E1A for cancer. We
expect both of these products to be in Phase II clinical trials in 2000, with
the possibility of entering pivotal clinical trials in 2001. We believe that
proof of concept in cystic fibrosis and cancer will serve to demonstrate the
value not only of our two lead product candidates but of our AAV and synthetic
gene delivery technologies as well.
Pipeline development. We believe that there is tremendous long-term
potential for the use of our gene delivery systems to treat additional
diseases. The infrastructure we have built to support the development of
tgAAV-CF and tgDCC-E1A should, over time, to support new products based on our
AAV and synthetic gene
3
delivery systems. Similarly, the knowledge and expertise we gain in developing
our two initial products should apply to our future products under
development. We believe that we can derive significant future value by
leveraging our infrastructure, knowledge and expertise with additional
pipeline products. Currently, we have ongoing preclinical product development
activities in the areas of hemophilia, rheumatoid arthritis, cardiovascular
disease and HIV vaccines.
Long-term value retention. We believe that our products under development
have significant long-term potential. Therefore, it is important to us that we
retain a substantial financial interest in the sales of commercial products
that result from our work. For products based on our AAV delivery system, we
intend to retain, at a minimum, manufacturing rights to all products that we
develop. We have retained worldwide commercial rights to tgDCC-E1A. We plan to
maintain our tgDCC-E1A rights and to develop the product internally until we
can enter a collaborative transaction that will allow us to achieve
substantial long-term participation in tgDCC-E1A's potential downstream
commercial revenues.
The following table summarizes our product development programs:
Program/Product Research Preclinical Phase I Phase II Phase III
--------------- -------- ----------- ------- -------- ---------
AAV Vectors:
Cystic Fibrosis (tgAAV-CF).....
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Hemophilia A...................
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Rheumatoid Arthritis...........
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Cardiovascular Disease.........
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HIV Vaccine....................
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Synthetic Vectors:
Head and Neck Cancer (tgDCC-
E1A)..........................
--------------------------------
Ovarian Cancer (tgDCC-E1A).....
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Metastatic Cancer .............
------------
In addition to our gene therapy technologies, we have patents and expertise
in cell therapy that may prove to be extremely valuable. Our expertise enables
us to isolate potent disease-specific cytotoxic T lymphocytes (CTLs) from
small samples of patient blood and to efficiently multiply them to large
numbers for reinfusion to the patient. We believe that this technology and
expertise could support development of a series of immunotherapies to treat
infectious diseases and cancer. Key to this technology is our proprietary
Rapid Expansion Method (REM), for which we received our first patent in 1998.
Using REM, we can grow billions of CTLs from individual cloned cells over
several weeks, while preserving the cells' specific disease-fighting
capabilities. We also believe that REM has utility in the areas of genomic
target validation, antigen discovery and vaccine development.
Clinical Product Development Programs
tgAAV-CF
Cystic fibrosis is the most common single-gene deficiency affecting the
Caucasian population, afflicting approximately 24,000 people in the United
States and 60,000 people worldwide. The disease is caused by a defective
cystic fibrosis transmembrane regulator (CFTR) gene, which results in a build-
up of mucus in the lungs, leading to chronic infections, loss of lung function
and early death. Current treatments for cystic fibrosis relieve only symptoms
of the disease, and cannot cure the disease or stop its progression.
Based on our research and development to date, we believe that tgAAV-CF may
be superior to other gene therapy approaches for the treatment of cystic
fibrosis, due to the duration of its effect and lack of toxicity. In
preclinical studies in rabbits, we were able to detect expression of the CFTR
gene in the lung for periods of up to six months with no side effects. These
results were supported in similar studies in rhesus monkeys, in which gene
transfer occurred in up to 50% of targeted airway cells and gene expression
persisted for up to six months.
4
Based on these preclinical data, we began our clinical program in late 1995 to
evaluate the safety and feasibility of using tgAAV-CF as a treatment for
cystic fibrosis lung disease. tgAAV-CF has been granted orphan drug status by
the United States Food and Drug Administration (FDA).
Our first clinical trial, which began in late 1995, was a Phase I open-
label, single-dose clinical trial at Johns Hopkins University and the
University of Florida. In this trial, we administered tgAAV-CF to eight
cohorts of adult cystic fibrosis patients at increasing dosage levels. We
administered a liquid form of tgAAV-CF to the right lower lobe of the lung,
using a bronchoscope, and to one nostril of each of 18 patients. The results
of the trial indicated that the product was safe with no apparent side
effects. We recently reopened this trial to treat patients at higher dosages.
Our second clinical trial began in late 1995 at Stanford University. We
designed this trial as a Phase I/II trial, in which tgAAV-CF was administered
to the maxillary sinuses of cystic fibrosis patients with chronic sinusitis.
We completed the Phase I part of this trial, designed as a dose escalation
study, in 1996. A total of ten patients were enrolled and 15 sinuses were
treated, in five cohorts with increasing doses. The results of the trial
indicated that tgAAV-CF was safe and well tolerated with no resulting
inflammatory response or other side effects, even after repeated delivery.
Administration of tgAAV-CF, furthermore, resulted in consistent gene transfer
and persistence of the gene for at least 70 days after treatment. In addition,
the dose level was established for the Phase II part of the trial, in which 23
patients received tgAAV-CF in one sinus and a placebo in the other. The Phase
II part of the trial was completed in mid-1998. The results of the trial
indicated that the drug was safe and well-tolerated in all patients treated,
and that markers of inflammation were reduced in the treated sinuses.
In December 1998, we began a Phase I clinical trial to test the safety of
aerosol delivery of tgAAV-CF to the whole lungs of CF patients. The clinical
trial, for which patient enrollment was completed in early 2000, was conducted
at three sites: Stanford University, the University of Washington and Harvard
University. We treated twelve patients with a single dose of tgAAV-CF in the
study, three each at four increasing dosage levels. We are compiling and
analyzing data from this study and expect to present the results in the first
half of 2000. We plan to begin a Phase II clinical trial, in which patients
will receive multiple doses of tgAAV-CF, in mid-2000.
In November 1998, we entered into a license and collaboration agreement
related to tgAAV-CF with Medeva Pharmaceuticals, Inc., a subsidiary of Medeva
PLC (Medeva). Under this agreement, Medeva received exclusive worldwide
marketing rights to tgAAV-CF in exchange for agreeing to provide significant
funding to Targeted Genetics. The section below entitled "Research and
Development Collaborations" provides a detailed description of this
relationship.
tgDCC-E1A
Cancer is the second leading cause of death in the United States, with over
one million new cases diagnosed each year. Cancer arises when the genetic
pathways that control normal cell growth and division are disrupted. Some of
these pathways are regulated by cellular oncogenes or tumor inhibitor genes.
Cancer can result from the structural alteration and abnormal expression of
cellular oncogenes or from mutation or deletion of tumor inhibitor genes.
Our product candidate for the treatment of cancer uses our proprietary
synthetic delivery system, called DC-Chol, to deliver the E1A gene locally to
cancer cells. We call this product tgDCC-E1A. E1A is a gene from the
adenovirus type 5, a common cold virus. Dr. Mien Chie Hung and his colleagues
at University of Texas M.D. Anderson Cancer Center (M.D. Anderson) have
performed tests that indicate that E1A can function as an inhibitor of the
HER-2/neu oncogene, which is known to be overexpressed in many cancers.
Preclinical mouse studies indicate that tgDCC-E1A inhibits expression of the
HER-2/neu oncogene, inhibits growth and metastasis of cancer cells and
increases significantly the long-term survival of the mice. We have worldwide
rights, under patents filed by Dr. Hung, to the use of the E1A gene as a tumor
inhibitor.
5
Other research, conducted by Dr. Steven Frisch and his colleagues at the
Burnham Institute, has indicated that E1A has other anti-tumor effects
unrelated to the inhibition of HER-2/neu expression. In vitro experiments have
shown that E1A, when introduced to a variety of tumor cells, can alter tumor
cells so that they appear to revert to normal cells and lose their malignant
characteristics. Furthermore, in vivo studies in mice involving tumor cells
not overexpressing HER-2/neu indicated that administration of E1A reduced
tumor growth rates. In pre-clinical studies we also found that E1A makes tumor
cells susceptible to being killed by certain chemotherapeutic agents. We have
worldwide rights to patents filed by Dr. Frisch that are complementary to
those filed by Dr. Hung.
Our first Phase I clinical trial of tgDCC-E1A began in 1996 at M.D.
Anderson, Rush Presbyterian Medical Center in Chicago (Rush) and Virginia
Mason Medical Center in Seattle. In this trial, patients with ovarian or
breast cancer received weekly doses of tgDCC-E1A for up to six months. We
conducted the trial as an interpatient escalating dose study delivering doses
of tgDCC-E1A into the peritoneal cavity (intestines) of the ovarian cancer
patients and into the pleural cavity (lungs) of the breast cancer patients. We
designed this trial to assess safety, levels of gene transfer and expression
and tumor response. We treated a total of 18 patients through the trial's
completion in early 1998. The results indicated that clinicians can safely
administer the drug in biologically active amounts and that the E1A gene was
present and active in tumor cells. Additionally, in some patients, we observed
decreased levels of HER-2/neu expression and decreased numbers of tumor cells.
Our second Phase I clinical trial began in early 1997 at M.D. Anderson,
Rush and Wayne State University in Detroit. In this trial, we administered to
patients with inoperable primary head or neck tumors or metastatic breast or
lung tumors up to ten weekly doses of tgDCC-E1A, injected directly into the
tumor. We conducted the trial as an interpatient escalating dose study with
four dose levels and treated a total of 18 patients through the trial's
completion in early 1998. The objectives of the trial were to assess safety,
levels of gene transfer and expression and tumor response. The results
indicated that the drug was safe and that the E1A gene was present and active
in tumor cells. Additionally, in a majority of the patients, tumor growth was
inhibited or treated tumors shrank in size, or both.
Based on the data obtained from the two Phase I clinical trials described
above, we began a Phase II clinical trial of tgDCC-E1A for head and neck
cancer in October 1998. We completed this trial, which we conducted at five
cancer centers, in the fall of 1999, treating a total of 23 patients. We are
compiling and analyzing the data from the study and expect to present the
results in the first half of 2000.
In late 1999, we began the first in a series of clinical trials testing
tgDCC-E1A administered in combination with chemotherapeutic drugs. In this
Phase I clinical trial, we will treat ovarian cancer patients with advanced
stage disease with a combination of tgDCC-E1A, Taxol and Cisplatin, at
increasing dosage levels. We anticipate enrolling up to 21 patients in this
study, which is ongoing at the University of Arizona and M.D. Anderson. We
expect to complete patient enrollment in this clinical trial by the end of
2000. Also in 2000, we plan to begin additional clinical trials of tgDCC-E1A
in combination with chemotherapeutic drugs in head and neck cancer and,
potentially, other cancers.
Preclinical Product Development Programs
Hemophilia A
Hemophilia A is a hereditary disorder caused by the absence or severe
deficiency of Factor VIII, a blood protein essential for proper coagulation.
According to the National Hemophilia Foundation, approximately 14,000 people
in the United States live with hemophilia A. Worldwide, there are
approximately 50,000 hemophilia A patients. Hemophilia A patients face
spontaneous, uncontrolled internal bleeding that can lead to restricted
mobility, pain and, if left untreated, death. These serious, acute bleeding
incidents are generally treated with either recombinant or naturally-derived
Factor VIII protein. If slow chronic bleeding is not treated, however,
progressive, irreparable physical damage can result. In addition, both
recombinant and naturally-derived Factor VIII protein is expensive, and the
naturally-derived protein from human serum may carry blood-borne pathogens,
such as HIV, EBV (Epstein Barr Virus) and hepatitis C.
6
We believe that there is strong rationale for the development of a gene
therapy product that could be administered prophylactically to hemophilia A
patients in order to prevent bleeding incidents for the following reasons:
. the disease results from a single gene defect that is well understood
and has been validated by the development of a protein therapy;
. overproduction of Factor VIII has not been shown to be harmful,
therefore eliminating the need for precise regulation of gene
expression;
. researchers believe that production of just 5% of normal levels of
Factor VIII could stop the chronic bleeding incidents in hemophilia A
patients;
. high costs and safety issues prevent protein therapies from being
administered prophylactically, thereby creating an unmet need among
hemophilia patients; and
. the current global market for Factor VIII protein products, which is
estimated at $1.2 billion, not including hospitalization costs,
represents a significant market opportunity.
We also believe that AAV vectors represent the most promising means of
creating an effective gene therapy product for the treatment of hemophilia A.
The characteristics of AAV vectors, including the demonstrated safety profile
and their ability to persist in cells and express genes for extended periods
of time, should provide important advantages compared to competing gene
delivery methods. Additionally, AAV vectors have been shown to express genes
efficiently in liver cells, the site from which Factor VIII protein is
normally produced in the human body. We have invested in significant
infrastructure to support the development of tgAAV-CF, which we believe can be
efficiently adapted also to the development of a Factor VIII AAV vector
product.
In 1999, we entered into an agreement with the University of North Carolina
at Chapel Hill to gain exclusive access to patent applications filed on a
novel approach for using AAV vectors to deliver the Factor VIII gene. In its
native form, the Factor VIII gene is too large to fit into an AAV vector. Dr.
Christopher Walsh of UNC developed a vector that contains a smaller version of
the Factor VIII gene, one that is missing a portion of the gene called the "B-
domain." In the human body, when clotting activity is required, a natural
process removes the B-domain to create an active Factor VIII protein. Dr.
Walsh's vector has been shown to produce active Factor VIII protein in a mouse
model. Furthermore, in the same model, Dr. Walsh has shown that when the gene
is transferred to liver cells, the gene expression persists for at least 12
months and the level of Factor VIII released into the bloodstream reached up
to 27 percent of normal levels. Based on these encouraging data, we are
collaborating with Dr. Walsh to move his AAV-Factor VIII vector into clinical
trials as quickly as possible. We expect to begin a Phase I clinical trial in
2001. We intend to design this clinical trial to establish safety and measure
Factor VIII protein levels that result from the administration of various
dosage levels of the product.
Metastatic Cancer
Based on our clinical testing of tgDCC-E1A, we believe that we have
demonstrated the potential of E1A as a tumor inhibitor. Therefore, we believe
that if we were able to deliver E1A systemically and reach tumor sites
throughout the body, we could significantly expand the utility of E1A as a
cancer treatment. We have developed a new formulation of E1A, called tgLPD-
E1A, that we believe has the potential to target cancer cells when
administered systemically.
tgLPD-E1A is based on a gene delivery vehicle called LPD that was developed
in collaboration with Dr. Leaf Huang of the University of Pittsburgh. The LPD
formulation, which contains lipid, polycation and DNA, results in the
formation of small, stable particles encapsulated in a lipid shell. In 1999,
we conducted tests of tgLPD-E1A in a mouse model of human breast cancer
tumors. In this study, conducted in collaboration with Dr. Mien Chie Hung of
M.D. Anderson, we administered tgLPD-E1A systemically to evaluate its ability
to inhibit tumor growth. The results indicated that the impact of tgLPD-E1A on
tumor growth was comparable to the impact observed with administration of
Taxol. Additionally, in mice that received both Taxol and tgLPD-E1A, the
inhibition of tumor growth was significantly better than with either agent
alone. Based on these encouraging results, we are preparing to begin a Phase I
clinical trial of tgLPD-E1A by 2001.
7
Rheumatoid Arthritis
Our interest in developing a gene therapy product for the treatment of
rheumatoid arthritis stems from our origins as a spinout from Immunex
Corporation. As part of that spinout, Immunex granted us a license to certain
Immunex technology for use in the field of genetic therapy. The TNF receptor
(TNFR) gene, which is the basis for Immunex's Enbrel product for the treatment
of rheumatoid arthritis, was included in that license. We believe that the
characteristics of AAV vectors make them well suited for delivery of genes to
joints. We are in the process of conducting preclinical experiments designed
to demonstrate the potential of delivering the TNFR gene to joints using AAV
vectors to provide sustained, localized production of the TNFR protein. We
envision an AAV-TNFR product as an attractive alternative to systemic TNFR
protein therapy in patients susceptible to infection or with disease symptoms
limited to one or several joints.
Cardiovascular Disease
We are collaborating with Collateral Therapeutics, Inc. to assess the
feasibility of an AAV-based product for the delivery of therapeutic genes to
the heart. Collateral has rights to a gene known as AC6, which it believes may
be useful in the treatment of congestive heart failure. Collateral is testing
AAV vectors in animal models to determine the feasibility of delivering AC6
with an AAV vector. If these preclinical tests are successful, we may
collaborate with Collateral to develop an AAV-AC6 gene therapy product.
Acquired Immune Deficiency Syndrome (AIDS)
We are collaborating with the International AIDS Vaccine Initiative and
Children's Hospital in Columbus, Ohio to develop a vaccine to prevent AIDS.
The vaccine will utilize our AAV vectors to deliver HIV genes with the goal of
eliciting a protective immune response against the virus. The collaboration
will extend for a period of up to three years, beginning in March 2000, and
will include development, preclinical and Phase I clinical studies. We have
the right to commercialize in industrialized countries any vaccine product
that may result from this development collaboration. We also have the option
to manufacture the vaccine for non-industrialized nations.
Core Technologies
We have assembled a broad range of core technologies that we believe will
allow us to address a number of different diseases. We believe that the three
different vector technologies on which our systems are based, AAV, synthetic
and retroviral, will give us the flexibility to develop gene therapies for a
broader range of diseases than we could develop using any single gene delivery
system. In the area of cell therapy, we believe that our technology and
expertise in isolating and multiplying CTLs could lead to development of a
series of immunotherapies to treat infectious diseases and cancer.
Gene Therapy
Overview. Gene therapy is an approach to the treatment and prevention of
genetic and acquired diseases that involves inserting genetic information into
target cells to produce specific proteins needed to correct or modulate
disease conditions. Proteins are the fundamental components of all living
cells and are essential to cellular structure, growth and function. Cells
produce proteins from a set of genetic instructions encoded in DNA, which
contains all the information necessary to control cellular biological
processes. DNA is organized into segments called genes, with each gene
containing the information required to express, or produce, a specific
protein.
An alteration in the function of, or absence of, specific genes causes
certain diseases, including inherited diseases such as cystic fibrosis and
certain types of cancer. Gene therapy may be used to treat these diseases by
replacing a missing or defective gene to facilitate the normal protein
production capabilities of cells. In addition, gene therapy may be used to
enable cells to perform additional roles in the body, such as enhancing the
function of the immune system to fight infectious diseases or cancer. Gene
therapy may also be used to inhibit production of undesirable proteins or
viruses within cells that cause disease.
8
A key factor in the progress of gene therapy has been the development of
safe and efficient methods of transferring genes into cells. For transfer into
cells, the gene is incorporated into a delivery system called a vector, which
may be derived from either viral or synthetic systems. The most common gene
delivery approach to date relies on viral gene transfer, whereby modified
viruses are used to transfer the desired genetic material into host cells. The
process of gene transfer can be accomplished ex vivo (outside the body),
whereby doctors remove cells from the patient, genetically modify the cells
and then reinfuse them into the patient, or in vivo (inside the body), whereby
vectors are introduced directly into the patient's body.
The use of viruses takes advantage of their natural ability to introduce
genes into host cells and use the host's metabolic machinery to produce
proteins essential for the survival and function of the virus. In gene therapy
applications, viruses are genetically modified to contain the desired genes
and to inhibit the ability of the virus to reproduce. Successful viral gene
transfer for diseases requiring long-term gene expression involves a number of
essential technical requirements, including the ability of the vector to carry
the desired genes, to transfer the genes into a sufficient number of target
cells and to enable the delivered genes to persist in the host cell. A number
of different viral vectors, including AAV and retroviral vectors, are being
used for potential gene therapy applications requiring long-term gene
expression.
Current synthetic vector systems generally consist of DNA incorporating the
desired gene, combined with various compounds aimed at enabling the DNA to be
taken up by the host cell. These in vivo gene delivery approaches include:
. encapsulating genes into lipid carriers such as liposomes, which
facilitate the entry of DNA into cells;
. complexing negatively charged DNA with positively charged cationic
lipids;
. injecting pure plasmid or naked DNA in an aqueous solution; and
. directing DNA to receptors on target cells by combining the gene with
proteins that bind to the receptors.
AAV Vectors. Together with our scientific collaborators, we have developed
significant expertise in the design and use of AAV vectors in gene therapy. We
believe that AAV vectors are particularly well suited for the treatment of a
number of diseases because:
. AAV has never been associated with causing any human disease;
. AAV vectors contain no viral genes that could produce unwanted cellular
immune responses leading to side effects or reduced efficacy;
. AAV vectors can introduce genes into nondividing or slowly dividing
cells;
. AAV vectors can persist in the host cell to provide relatively long-term
gene expression; and
. AAV vectors can be manufactured using methods utilized in the
manufacture of other biopharmaceutical products.
We are building a proprietary position in AAV through our development of or
acquisition of exclusive rights to inventions that:
. provide important enhancements to AAV vectors;
. demonstrate novel approaches to the use of AAV vectors for gene therapy;
and
. establish new and improved methods for large-scale production of AAV
vectors.
In addition to our tgAAV-CF clinical development program, we are conducting
preclinical experiments to assess the potential for delivery of genes to other
target cells using AAV vectors. Currently, we are evaluating the use of AAV
vectors in cells of the cardiovascular system, joints and the liver. As
resources become available to do so, we intend to examine, both internally and
through academic collaborators, the use of AAV vectors in additional cell
types.
9
Synthetic Vectors. We have exclusive rights to a significant body of
synthetic gene delivery technology based on cationic lipids. These synthetic
vectors are formulated by mixing negatively charged DNA with positively
charged cationic lipids, which promote uptake of genes by cells. These vectors
appear to be safe and they can be used in vivo as well as ex vivo. We believe
that synthetic vectors have several characteristics that make them
particularly well suited for the treatment of certain diseases, including:
. the ability to target a specific cell type;
. the relative ease of manufacture; and
. the ability to transfer relatively large segments of DNA.
We are working with Dr. Leaf Huang of the University of Pittsburgh to
develop a series of synthetic delivery systems based on his discoveries. Dr.
Huang's original DC-Chol system is used in our potential tgDCC-E1A cancer
product. We have an exclusive license to an issued U.S. patent on DC-Chol for
the treatment of cancer and certain other diseases. Also, we have obtained
from the University of Pittsburgh broad licenses to a series of Dr. Huang's
more recent discoveries in this area. In one of these discoveries, which we
call LPD, DNA is condensed and combined with cationic lipids to generate
particles of defined size that have significantly enhanced gene transfer
efficiency and stability in the bloodstream. We therefore believe that LPD may
be useful for delivery of genes by intravenous administration.
Enhanced Vectors. In July 1999 we began a collaborative effort with Elan
Pharmaceutical Technologies, a division of Elan Corporation plc, to focus on
developing enhanced gene delivery systems. We established a joint venture with
Elan, Emerald Gene Systems, Ltd., to focus on combining our AAV and synthetic
gene delivery technologies with Elan's drug delivery technologies. Elan's
contributed technologies include targeting ligands, permeation enhancers and
polymers. We plan to develop enhanced gene delivery systems that can be
systemically or orally administered and that will target the desired cells
within the body.
Retroviral Vectors. We believe that retroviral vectors may be well suited
for ex vivo genetic modification of rapidly dividing cells, such as T cells
and stem cells. We have a strong position in retroviral gene delivery
technology through our relationship with Dr. A. Dusty Miller, a leader in the
development of packaging cell lines for retroviral vectors. One of Dr.
Miller's inventions in this area is an improved retroviral vector packaging
cell line called PG13, which we have licensed exclusively from the Fred
Hutchinson Center Research Center. Our research has shown that vectors
produced in this cell line have improved efficiency for ex vivo transfer of
genes to human T cells and stem cells.
Cell Therapy
Overview. The immune system is the body's major defense mechanism against
disease. It functions through a complex interplay of components that allow the
body to detect foreign agents and defend against infections and diseases. The
immune system recognizes parts of proteins called antigens that are present on
the surface of diseased cells but are not present on normal cells. The immune
response to an antigen involves the integrated action of various classes of
white blood cells, including lymphocytes. There are two major classes of
lymphocytes, B cells and T cells.
T cells direct cell-mediated immunity by recognizing antigens on diseased
cells. The two main classes of T cells are CD4 cells and CD8 cells. In
general, CD8 cells are CTLs that recognize, contact and kill the diseased
cells. CD4 cells are primarily helper cells that coordinate the function of
other immune cells, including CTLs, by secreting growth factors known as
cytokines. CTLs are disease-specific: they individually recognize and bind
only to a single, specific antigen. Only in the presence of CD4 helper cells,
furthermore, do these specific CTLs proliferate to produce the large
population of antigen-specific CTLs required to elicit an effective immune
response.
In some diseases, the immune system fails to mount or maintain an effective
immune response. For infectious diseases and cancer, it is believed that this
failure may be associated with an inadequate CTL response.
10
For example, HIV infects and kills CD4 cells, which leads to subsequent loss
of CTL function and therefore to destruction of the immune system by the
virus.
Targeted CTLs. We have developed a highly targeted form of cell therapy,
with which we intend to produce a disease-specific immune response through the
infusion of large numbers of antigen-specific CTLs. In our Targeted CTL
program, antigen-specific CTLs are isolated from a small sample of the
patient's blood, multiplied to large numbers ex vivo and then reinfused into
the patient. In essence, these Targeted CTLs are intended to amplify the
natural disease-fighting function of the immune system relating to specific
infected or cancerous cells.
We believe that our Targeted CTL program represents an improvement over
other approaches to immunotherapy because:
. it is based on highly potent, cloned, antigen-specific CTLs;
. virtually all of the reinfused CTLs target the specific diseased cells;
and
. side effects may be reduced due to the uniformity and consistency of the
reinfused cells.
Our focus on Targeted CTLs originated from research conducted by Drs.
Philip Greenberg and Stanley Riddell, collaborators at the Fred Hutchinson
Cancer Research Center. These researchers conducted a Phase I clinical trial
to evaluate the use of cytomegalovirus (CMV) -specific CTLs to provide an
immune response against CMV in bone marrow transplant patients. This trial
represented the first use of cloned, antigen-specific CTLs. None of the 14
patients receiving the CTLs developed CMV viremia or disease. Dr. Riddell is
now conducting a Phase II clinical trial to follow up on the promising results
observed in Phase I. Other work by Drs. Greenberg and Riddell has shown,
moreover, that Targeted CTLs may be useful in treating HIV infection.
In 1998, we completed a preclinical study in which we administered Targeted
CTLs to chimpanzees chronically infected with hepatitis B virus (HBV). The
objective of the study was to establish safety of the therapy and,
potentially, obtain proof of concept that HBV-specific Targeted CTLs could be
promising as a treatment for humans infected with HBV. The preliminary results
of the study, which we presented in August 1998, indicated that the therapy
was safe and that there were trends toward efficacy, evidenced by a temporary
drop in viral burden, increased levels of liver enzymes and improvement in
liver condition. This study has given us additional reason to believe that
Targeted CTLs have potential to treat viral diseases.
Rapid Expansion Method. The Targeted CTL program is made possible by our
proprietary rapid expansion method, or REM, which we use to rapidly grow CTLs
for infusion into the patient. We believe that REM represents a significant
improvement over other methods of growing T cell clones. Using REM, CTL clones
can be multiplied over a thousand-fold in less than two weeks. We can grow
billions of CTLs from individual cloned cells over several weeks, while
preserving the cells' disease-fighting capabilities. We have seen consistent
results from REM both with CD8 and CD4 T cells. Furthermore, we have shown
that REM is effective for growing Targeted CTLs for a number of viral diseases
and cancers, such as HIV, CMV, HBV, malignant melanoma and prostate tumor
peptides. We have filed patent applications relating to the original REM
process and to subsequent process improvements on a worldwide basis. Since
1998 we have received one U.S. patent in this area.
11
Research and Development Collaborations
Celltech Group plc/Medeva PLC
In November 1998, we entered into agreements with Medeva Pharmaceuticals,
Inc. (Medeva), a subsidiary of Medeva PLC to develop and commercialize tgAAV-
CF, our potential gene therapy product for the treatment of cystic fibrosis.
Medeva committed to provide up to three years of funding (up to $5 million per
year) to support tgAAV-CF development and commercialization activities,
including:
. scale-up and validation of manufacturing processes;
. development and validation of analytical methods;
. conduct of Phase I clinical trials; and
. other activities in support of product testing and commercialization.
In addition to development and clinical support, Medeva agreed to pay the
costs of Phase II and subsequent clinical trials of the product. While we may
manage Phase II clinical trials in the United States, Medeva was assigned the
responsibility for conducting all other trials and securing worldwide
registration of tgAAV-CF. Under the terms of the tgAAV-CF agreements, we
granted Medeva an exclusive worldwide license to sell tgAAV-CF, but we
retained responsibility for manufacturing and supplying bulk tgAAV-CF product
to support clinical trials and product commercialization. Medeva agreed to
loan us $2 million to partially fund the construction of a pilot-scale tgAAV-
CF manufacturing facility. Medeva also agreed to loan us, under certain
conditions, up to an additional $10 million toward building a GMP
manufacturing facility for higher-volume production of tgAAV-CF.
In January 2000, Medeva merged with Celltech/Chiroscience to become part of
Celltech Group plc. Celltech has assumed Medeva's rights and responsibilities
under our agreements.
Assuming successful commercialization of the tgAAV-CF product, we could
receive a total of up to $54 million in license fees, development funding,
milestone payments, loans and equity investments connected with the
Medeva/Celltech tgAAV-CF agreements. Under a long-term supply agreement we
would also receive proceeds from sales of tgAAV-CF, assuming successful
commercialization, based upon a pricing formula intended to provide us with a
significant percentage of Celltech's net revenue from product sales. The
research and development funding agreement is effective through October 1,
2001, with options to extend the term if both parties agree. The long-term
supply agreement is effective for the term of the patents covering tgAAV-CF.
Celltech may terminate our tgAAV-CF agreements at will with 180 days notice.
Should Celltech exercise its termination right, all rights related to tgAAV-CF
would return to us.
Emerald Gene Systems, Ltd. and Elan Corporation, plc
In July 1999, we formed a joint venture with Elan International Services,
Ltd., a wholly owned subsidiary of Elan Corporation plc, named Emerald Gene
Systems, Ltd. The joint venture is based in Bermuda and is owned 80.1% by
Targeted Genetics and 19.9% by Elan. Emerald's purpose is to develop enhanced
gene delivery systems based on a combination of our gene delivery technologies
and Elan's drug delivery technologies. Emerald's research and development
program will be Elan's exclusive effort in the field of gene delivery and our
exclusive effort in the combination of our technologies with drug delivery
technologies. Generally, Emerald's research and development will be conducted
under contract by Elan and Targeted Genetics and Emerald will reimburse each
company for the costs of the research and development plus a profit
percentage. Elan and Targeted Genetics will fund the expenses of Emerald in
proportion to their ownership interests.
As part of our agreements related to Emerald, Elan has provided funding to
us as follows:
. a $5 million purchase of our common stock at the signing the agreements;
and
12
. a $12 million purchase of convertible exchangeable preferred stock at
the closing of the agreements, the proceeds of which we used to make our
initial investment in Emerald.
Elan has also agreed to provide additional funding as follows:
. an additional $5 million purchase of our common stock one year from the
date of our agreements; and
. a $12 million line of credit under a convertible note to fund our
ongoing investment in Emerald.
At Elan's option, the convertible exchangeable preferred stock can be
converted into common stock of Targeted Genetics or exchanged for an
additional 30.1% ownership in Emerald, which would result in 50/50 ownership
of Emerald.
Alkermes, Inc.
In June 1999, we entered into a strategic alliance with Alkermes, Inc. in
which we received exclusive rights to an important issued patent and other
pending patent applications related to AAV vector manufacturing. We believe
that the issued patent broadly covers a manufacturing method that is key to
making AAV-based products in a commercially viable, cost-effective manner.
Under the terms of our agreement, we issued to Alkermes 500,000 shares of
common stock and warrants to purchase two million additional shares of common
stock at significant premiums to market price at the time of the transaction.
Alkermes will also receive milestone payments and royalties on products
manufactured using the licensed patents
Relationship with Immunex Corporation
Targeted Genetics was formed in 1989 as a subsidiary of Immunex, a
biopharmaceutical company developing recombinant proteins as therapeutics. In
February 1992, we spun off as a separate company from Immunex and entered into
a technology license agreement with Immunex. In exchange for shares of our
preferred stock, which were converted into 1,920,000 shares of common stock at
the time of our initial public offering, Immunex granted us a worldwide,
exclusive field-of-use license for certain Immunex proprietary technology
specifically applicable to our gene therapy business. This technology relates
to gene identification and cloning, panels of retroviral vectors, packaging
cell technology, recombinant cytokines, DNA constructs, cell lines,
promoter/enhancer elements and immunological assays. In addition, the
agreement required Immunex to disclose to us, until February 1999, information
concerning improvements discovered or developed by Immunex relating to the
transferred technology such as new techniques, biological materials,
inventions, or developments. We have the option to acquire a nonexclusive,
worldwide, fully paid, royalty-free license and, in some cases, an opportunity
to negotiate the conversion of a nonexclusive license into an exclusive
license, to these improvements. Immunex currently owns approximately 7% of our
outstanding common stock.
Patents and Proprietary Rights
Patents and licenses are important to our business. Our policy is to file
patent applications to protect technology, inventions and improvements to
inventions that we consider important to the development of our business. We
also rely on trade secrets, know-how, continuing technological innovations and
licensing opportunities to develop and maintain our competitive position. To
date, we have filed or exclusively licensed 107 patent applications relating
to our product and technology development programs with the United States
Patent and Trademark Office (USPTO), as well as foreign counterparts of some
of these applications in Europe, Japan and certain other countries. Of these
patent applications, 29 patents have been issued or allowed by the USPTO.
In addition to the intellectual property that we own or have exclusively
licensed, we have licensed several issued and pending patents on a
nonexclusive basis. Among these are the two key patents that relate to the use
of AAV vectors for gene therapy licensed from the National Institutes of
Health (NIH) and the University of Florida Research Foundation. In addition,
we have acquired nonexclusive rights to the CFTR gene being delivered in our
tgAAV-CF product.
13
The patent positions of pharmaceutical and biotechnology firms, including
our patent positions, are uncertain and involve complex legal and factual
questions for which important legal principles are largely unresolved,
particularly with regard to human therapeutic uses. The coverage claimed in a
patent application may be significantly reduced before a patent is issued.
Consequently, we do not know whether any patent applications will result in
the issuance of patents or, if any patents are issued, whether the patents
will be subjected to further proceedings limiting their scope, whether they
will provide significant proprietary protection or whether they will be
circumvented or invalidated. Since patent applications in the United States
are maintained in secrecy until patents issue and patent applications in other
countries generally are not published until more than 18 months after they are
filed, and since publication of discoveries in scientific or patent literature
often lags behind actual discoveries, we cannot be sure that we or any
licensor were the first creator of inventions covered by pending patent
applications or that we or the licensor were the first to file patent
applications for these inventions.
We are currently indirectly involved in a patent interference proceeding
declared by the USPTO to determine priority of invention relating to the
nonexclusively licensed CFTR gene delivered in our tgAAV-CF product candidate.
As a nonexclusive licensee of the CFTR gene, we do not expect to directly
participate in the CFTR gene interference proceeding. If the eventual outcome
of the CFTR interference proceeding is unfavorable to our licensor, we may
have to obtain a license from the prevailing party in order to proceed with
development of tgAAV-CF. Costs associated with obtaining a license may be
substantial and could include ongoing royalties in excess of those we
currently pay under our existing CFTR gene license. Any license required in
this circumstance may not be available to us on acceptable terms, if at all.
Although we do not foresee material expenditures related to interference
proceedings, these proceedings could result in substantial financial costs to
us, even if the eventual outcome were favorable to us. Our patents, if issued,
may not be held valid or enforceable by a court and a competitor's technology
or product may not be found to infringe these patents. Litigation, which could
result in substantial cost to us, may be necessary to enforce our patents or
to determine the scope and validity of other parties' proprietary rights. If
the outcome of litigation were adverse, our business could be adversely
affected. We are unable to predict how courts will resolve any future issues
relating to the validity and scope of our patents, should they be challenged.
A number of pharmaceutical and biotechnology companies and research and
academic institutions have developed technologies, filed patent applications
or received patents on various technologies that may be related to our
business. Some of these technologies, applications or patents may conflict
with our technologies or patent applications. This conflict could limit the
scope of any patents that we might be able to obtain or result in denial of
our patent applications. In addition, if patents that cover our activities are
issued to other companies, we may be required to either obtain a license under
those patents or to develop or obtain alternative technology. A license may
not be available on acceptable terms, if at all, and we may not be able to
develop or obtain alternative technology.
As the biotechnology industry expands and more patents are issued the risk
increases that our processes and potential products may give rise to claims
that they infringe the patents of others. These other parties could bring
legal actions against us claiming damages and seeking to stop clinical
testing, manufacturing and marketing of the affected product or use of the
affected process. Litigation may be necessary to enforce patents issued to us,
to protect trade secrets or know-how owned by us or to determine the
enforceability, scope and validity of proprietary rights of others. This type
of litigation regardless of its merit, could result in substantial expense to
us and significantly divert the efforts of our technical and management
personnel. An adverse outcome could adversely affect our business. In addition
to any potential liability for damages, we could be required to obtain a
license to continue to manufacture or market the affected product or use the
affected process. Costs associated with any required license could be
substantial and could include ongoing royalties. Any license required under
any infringed patent may not be available to us on acceptable terms, if at
all.
In addition to patent protection, we rely upon trade secret protection for
our confidential and proprietary information. Other parties may independently
develop substantially equivalent proprietary information and techniques or
gain access to our trade secrets or disclose our technology. To protect our
trade secrets, we require our employees, consultants, scientific advisors and
parties to collaborative agreements to execute confidentiality
14
agreements. In the case of employees, the agreements also provide that all
inventions resulting from work performed by them while employed by Targeted
Genetics will be our exclusive property. These agreements, however, may not
provide meaningful protection of our trade secrets or adequate remedies in the
event of unauthorized use or disclosure of this information.
Competition
We are aware of a number of companies and institutions that are developing
or considering the development of potential gene therapy and cell therapy
treatments. These include other gene therapy companies, fully integrated
pharmaceutical companies, universities, research institutions, governmental
agencies and other healthcare providers. In addition, our potential products
will compete with existing pharmaceutical products that are based on
established technologies. Many of our competitors have substantially more
financial and other resources, larger research and development staffs and more
experience and capabilities in researching, developing and testing products in
clinical trials, in obtaining FDA and other regulatory approvals, and in
manufacturing, marketing and distributing products. We also compete with
others to acquire products or technology from research institutions or
universities. In addition, the competitive positions of other companies may be
strengthened through collaborative relationships with large pharmaceutical
companies or academic institutions. Our competitors may develop, obtain patent
protection for, receive FDA and other regulatory approvals for, or
commercialize products more rapidly than we do. If we are successful in
commercializing our products, we will be required to compete with respect to
manufacturing efficiency and marketing capabilities, areas in which we have no
experience. Our competitors may develop new technologies and products that are
available for sale before our potential products or that may be more effective
than our potential products. In addition, our competitors may manufacture and
market their products more successfully than our potential products. These
developments could render our potential products less competitive or obsolete.
Governmental Regulation
All of our potential products will require regulatory approval by U.S. and
foreign governmental agencies before commercialization in the applicable
countries. Human therapeutic products are subject to rigorous preclinical and
clinical testing and other premarket approval procedures administered by the
FDA and similar authorities in foreign countries. The FDA exercises regulatory
authority over the development, testing, formulation, manufacture, labeling,
storage, record keeping, reporting, quality control, advertising, promotion,
export and sale of our potential products. Similar requirements are imposed by
foreign regulators. In some cases, state requirements may also apply.
Gene therapy and cell therapy are relatively new technologies and have not
been extensively tested in humans. The regulatory requirements governing gene
and cell therapy products and related clinical procedures are uncertain and
are subject to change. Obtaining approval from the FDA and other regulatory
authorities for a new therapeutic product is likely to take several years, if
approval is ever obtained, and could involve substantial expenditures.
Moreover, ongoing compliance with applicable requirements may also require the
expenditure of substantial resources. We may encounter difficulties or
unanticipated costs in our efforts to secure necessary governmental approvals,
which could delay or prevent the marketing of our products.
The activities required before a new therapeutic agent may be marketed in
the United States begin with preclinical testing. Preclinical tests include
laboratory evaluation and may require animal studies to assess the product's
potential safety and effectiveness. Animal safety studies must be conducted in
accordance with the FDA's Good Laboratory Practice regulations. The results of
these studies must be submitted to the FDA as part of an Investigational New
Drug application, which must be reviewed and cleared by the FDA before
proposed clinical testing can begin. Clinical trials must be conducted in
accordance with the FDA's Good Clinical Practices regulations under protocols
that detail the objectives of the trial, the parameters to be used to monitor
safety and the efficacy criteria to be evaluated. Each protocol must be
submitted to the FDA as part of the application. The FDA's review or approval
of a study protocol does not necessarily mean that a trial successfully
demonstrating safety or efficacy will result. Further, each clinical trial
must be approved by and conducted under
15
the auspices of an independent institutional review board at the institution
at which the trial will be conducted. This board will consider, among other
things, ethical factors, the safety of human subjects and the possible
liability of the institution. This review board is also responsible for
continuing oversight of the approved protocols in active trials. A review
board may require changes in a protocol, and the review board may not permit
any given trial to be initiated or completed.
Clinical trials are typically conducted in three sequential phases,
although the phases may overlap. In Phase I, gene therapy clinical trials
generally involve a small number of patients, who may or may not be afflicted
with a specific disease, to determine the preliminary safety profile. In Phase
II, clinical trials are conducted with larger groups of patients afflicted
with a specific disease in order to establish preliminary effectiveness and
optimal dosages and to obtain additional evidence of safety. In Phase III,
large-scale, multicenter, comparative clinical trials are conducted with
patients afflicted with the target disease in order to provide enough data for
the statistical proof of efficacy and safety required by the FDA and others
for market approval. 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 patient risk is too high. Because gene
therapy products are a new category of therapeutics, we cannot be certain of
the length of the clinical trial period or the number of patients the FDA will
require to be enrolled in a particular clinical trial in order to establish to
its satisfaction the safety and effectiveness of the products.
After completion of clinical trials of a product candidate, we are required
to obtain FDA approval to market the product in the U.S. The FDA's legal
authority is defined in the Federal Food, Drug and Cosmetics Act. Our products
are regulated by the Center for Biologics Evaluation and Research. While we
expect this regulatory structure to continue, we also expect the FDA's
regulatory approach to evolve as it increases its scientific knowledge and
experience in gene therapy. Current FDA regulations relating to biologic
therapeutics require us to submit a Biologics License Application to the FDA
before the FDA will permit commercial marketing. This application includes
product development activities, results of preclinical studies and clinical
trials, and detailed manufacturing information. Unless the FDA gives expedited
review status, this stage of the review process takes at least one year. The
FDA may refuse to accept a Biologics License Application if it fails to meet
predetermined requirements.
The FDA is an agency focused on public health, reviewing all products for
safety and efficacy. Both standards must be met before the FDA grants product
approval. Should the FDA have concerns with respect to product safety and
efficacy, it may delay product review or request additional data. The FDA may
ultimately decide that our license application does not satisfy its criteria
for approval and might require us to do any or all of the following:
. modify the scope of our desired product claims;
. add warnings or other safety-related information; or
. perform additional testing.
Once approved by the FDA, marketed products are subject to continual FDA
review. Later discovery of previously unknown problems or failure to comply
with applicable regulatory requirements may result in restrictions on
marketing of a product or in its withdrawal from the market, as well as
potential criminal penalties or sanctions.
The FDA requires that manufacturers of a product comply with current Good
Manufacturing Practices requirements, both as a condition of product approval
and on a continuing basis. In complying with these requirements, we must
expend time, money and effort on a continuing basis in production, record
keeping and quality control. Our manufacturing facilities are subject to
periodic inspections by the FDA to ensure compliance. Failure to pass these
inspections could subject us to possible FDA action, such as the suspension of
manufacturing, seizure of product, withdrawal of approval or other regulatory
sanctions. The FDA could also require us to recall a product.
16
In addition to regulations enforced by the FDA, we are also subject to
regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation
and Recovery Act and other federal, state and local regulations. Our research
and development activities involve the controlled use of hazardous materials,
chemicals, biological materials and radioactive compounds. Although we believe
that our safety procedures for handling and disposing of these materials
comply with the standards prescribed by state and federal laws and
regulations, we cannot completely eliminate the risk of accidental
contamination or injury from these materials. In the event of an accident, we
could be held liable for any resulting damages, and any resulting liability
could exceed our financial resources.
Human Resources
At December 31, 1999, we had 92 full-time-equivalent employees, 72 of which
are directly involved in research and development. Of these employees, 16 have
Ph.D. or M.D. degrees. A significant number of our management and professional
employees have prior experience with other biotechnology or pharmaceutical
companies.
Executive Officers
The following table lists the executive officers of Targeted Genetics, who
will serve in the capacities noted until their successors are duly appointed
and qualified.
Name Age Position
------------------------- --- ----------------------------------------
H. Stewart Parker........ 44 President, Chief Executive Officer and
Director
Barrie J. Carter, Ph.D. . 55 Executive Vice President and Director of
Research and Development
James A. Johnson......... 43 Senior Vice President, Finance and
Administration, Chief Financial Officer,
Treasurer and Secretary
H. Stewart Parker managed the formation of Targeted Genetics as a wholly
owned subsidiary of Immunex and has served as president, chief executive
officer and director since our inception in 1989. She served in various
capacities at Immunex from August 1981 through December 1991, most recently as
vice president, corporate development. From 1991 to January 1993, Ms. Parker
also served as president and a director of Receptech Corporation, a company
formed by Immunex in 1989 to accelerate the development of soluble cytokine
receptor products. Ms. Parker is a member of the executive committee and the
board of directors of BIO, the primary trade organization for the
biotechnology industry. She received her B.A. and M.B.A. from the University
of Washington.
Barrie J. Carter has served as executive vice president and director of
research and development since August 1992. For the previous 22 years he was
employed by the National Institutes of Health in Bethesda, Maryland, and from
1982 to 1992 was chief of the laboratory of molecular and cellular biology at
the National Institute for Diabetes and Digestive and Kidney Diseases. Dr.
Carter received his B.Sc. (Honors) from the University of Otago, Dunedin, New
Zealand and his Ph.D. in the Biochemistry Department of the University of
Otago Medical School. Before joining the NIH he then spent a period of
postdoctoral training at the Imperial Cancer Research Fund Laboratories in
London, England. His long-term research interests are in the molecular biology
of viruses, development of AAV vectors and gene therapy. Dr. Carter serves on
the editorial boards of Human Gene Therapy, as a section editor of Current
Opinion in Molecular Therapeutics and as an associate editor of Virology.
Since 1995, he has been an affiliate professor of medicine at the University
of Washington Medical School.
James A. Johnson serves as senior vice president, finance and
administration, chief financial officer, treasurer and secretary. He joined
Targeted Genetics in March 1994 as vice president, finance, chief financial
officer, treasurer and secretary and was promoted to his current position in
January 1999. He was employed by Immunex from January 1988 to February 1994,
initially as director of finance, and then as vice president, finance
beginning February 1990. While at Immunex, Mr. Johnson served as treasurer of
Targeted Genetics from our
17
inception in 1989. From November 1989 to January 1993, he also served as
treasurer and assistant secretary of
Receptech. He received his B.A. from the University of Washington.
ITEM 2. PROPERTIES
We currently occupy approximately 41,000 square feet of laboratory and
office space in two adjoining buildings in Seattle, Washington. The lease on
our primary facility, for approximately 36,000 square feet, extends to April
1, 2004 and has two five-year extension options. The average annual rent
payment for our main facility is approximately $550,000 during the current
five-year lease term. The lease on our adjoining office space, for
approximately 5,000 square feet, expires on March 31, 2004 and has two
additional five-year extension options. The average annual rent payment for
our adjoining office space is approximately $95,000 during the current term of
the lease. In order to continue to grow our AAV vector manufacturing
capability, we expect that we will need to expand our manufacturing operations
to a separate facility. In 1999, we began the process of identifying
alternatives for this expansion. Otherwise, we believe that our current
facilities, together with approximately 2,000 square feet of expansion space
remaining in our primary facility and additional expansion space available in
the adjoining office complex, will be adequate to meet our projected needs for
the next several years. Within that time frame, however, we could be required
to locate alternative facilities, depending on the extent of our company's
growth and development.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of the year ended December 31, 1999.
18
PART II
ITEM 5. MARKET PRICE OF THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
Our common stock trades on The Nasdaq National Market under the symbol
TGEN. At March 1, 2000, we had approximately 200 shareholders of record and
approximately 15,300 total beneficial holders of our common stock. We have
never paid cash dividends and do not anticipate paying them in the foreseeable
future. In addition, we are restricted as to the amount of dividends we can
pay under our loan agreement with Medeva PLC. The following table lists, for
each calendar quarter indicated, the high and low bid quotations for our
common stock as quoted on the Nasdaq National Market. These quotes reflect
inter-dealer prices, without retail mark-up or commission, and may not
necessarily represent actual transactions.
High Low
------ -----
1999
----
4th Quarter................................ $4.88 $1.25
3rd Quarter................................ 2.75 1.50
2nd Quarter................................ 1.81 1.44
1st Quarter................................ 3.06 1.31
1998
----
4th Quarter................................ $2.31 $1.31
3rd Quarter................................ 1.75 0.88
2nd Quarter................................ 4.25 1.31
1st Quarter................................ 3.13 0.97
On June 6, 1999, we issued 500,000 unregistered shares of common stock to
Alkermes, Inc. at an aggregate offering price of $812,500, along with warrants
to purchase an additional 2,000,000 shares of common stock. The warrants are
divided into two tranches: a warrant to purchase 1,000,000 shares of common
stock at a price of $2.50 expiring June 9, 2007 and a warrant to purchase
1,000,000 shares of common stock at a price of $4.16 expiring June 9, 2009. On
July 22, 1999, we issued 2,148,899 unregistered shares of common stock to Elan
at an aggregate offering price of $5 million. On August 9, 1999 we issued
677,392 unregistered shares of common stock to Medeva at an aggregate offering
price of $1.5 million. Each of these transactions did not involve a public
offering and therefore was exempt from registration under Section 4(2) of the
Securities Act of 1933.
19
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
-------------------------------------------------------------------
1999(1) 1998 1997 1996 1995
------------ ----------- ------------ ------------ ------------
Results of Operations
Revenue................. $ 6,847,993 $ 7,510,252 $ 1,327,585 $ 1,330,458 $ 174,625
Expenses................ 21,084,502 16,372,987 15,828,094 27,894,811 10,462,429
Loss from operations.... (14,236,509) (8,862,735) (14,500,509) (26,564,353) (10,287,804)
Net loss applicable to
common stock........... (27,030,648) (8,687,049) (14,187,774) (26,038,042) (9,922,284)
Basic and diluted net
loss per share......... (0.84) (0.33) (0.70) (1.59) (0.94)
Shares used in computing
basic and diluted net
loss per share......... 32,173,756 26,637,823 20,196,325 16,407,928 10,532,950
Financial Condition
Cash, cash equivalents
and securities
available for sale..... $ 7,153,269 $11,956,796 $ 5,037,821 $ 19,051,070 $ 14,442,562
Total assets............ 13,692,478 16,204,083 9,767,084 25,139,052 19,960,460
Long-term obligations,
including current
portion................ 3,267,071 2,072,044 2,547,324 3,378,420 3,286,508
Shareholders' equity.... 6,965,514 11,981,759 5,591,587 19,507,788 15,772,836
- --------
(1) Expenses increased in 1999 due to the Alkermes license fee write off
described in further detail in Item 7 of "Management's Discussion and
Analysis," in the subsection entitled "Operating Expenses". Net loss
increased in 1999 due to our 80.1% share of Emerald's losses, as described
in Item 7 in the subsection entitled "Other Income and Expense," and due
to the Alkermes license fee.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
We were incorporated in March 1989 as a wholly owned subsidiary of Immunex
Corporation and began operations as an independent company in 1992. Our goal,
both then and now, is to research and develop gene and cell therapy products
to treat acquired and inherited diseases. We now have two lead products in
clinical trials, tgAAV-CF for treating cystic fibrosis and tgDCC-E1A for
treating cancer, and several additional product candidates in preclinical
development. Since our founding, we have focused our efforts on technology and
product development, which we have funded primarily through the sale of equity
securities. In addition, we have endeavored to enter into product
collaborations with other companies as a means to obtain outside funding for
our programs and to broaden the application of our technology platform. We
have completed three collaborations to date that provide ongoing funding of
our research and development programs:
. a tgAAV-CF product development collaboration established, with Medeva
PLC in November 1998;
. a gene delivery technology development joint venture with Elan
Corporation plc, Emerald Gene Systems, Ltd. (Emerald), established in
July 1999; and
. an AAV-based AIDS vaccine development program with the International
Aids Vaccine Initiative (IAVI), established in February 2000.
Although our technology appears promising, we do not know whether any
commercially viable products will result from our research and development
efforts. We do not anticipate that we will have any commercial product
revenues for at least the next several years. Through December 31, 1999, our
accumulated losses total approximately $103.5 million. We expect to generate
substantial additional losses in the future, due primarily to the costs of our
preclinical and clinical development programs, developing our manufacturing
capabilities and preparing our products under development for
commercialization. We may never become a profitable company.
20
Results of Operations
Revenue
Our revenue results have fluctuated from year to year and will likely
continue to be volatile as we establish collaborations, complete
collaborations, enter into licensing agreements and recognize varying amounts
of revenue from our research and development activity. We had revenue of $6.8
million for the year ended December 31, 1999. Of this amount, $6.4 million was
generated from our tgAAV-CF collaboration agreements with Medeva. We earned
the remainder from a collaborative agreement with our affiliate, Emerald Gene
Systems, for research and development services in the fourth quarter of the
year. Although our 1998 revenue of $7.5 million was greater than our 1999
revenue, we believe that this does not reflect a meaningful trend because
revenue for 1998 included $6.0 million in fees earned up-front when we
established the Medeva collaboration. Revenue for 1998 also included
approximately $1.2 million earned from Medeva for product development efforts
in the fourth quarter of the year.
We had revenue of $1.3 million for the year ended December 31, 1997. This
amount included a $1.0 million product milestone payment related to our tgDCC-
E1A cancer product, which we received under a European development
collaboration that has since been terminated. Other revenue in 1997 consisted
of grant funding earned from research grants awarded by the National
Institutes of Health.
We expect our collaborative agreement revenue to increase in 2000. We
expect to realize significant revenue from our Medeva tgAAV-CF collaboration,
including research and development funding, revenue from the supply of tgAAV-
CF product for clinical trials and, potentially, payments upon the achievement
of important product development milestones. We also expect to receive
increased research and development funding from Emerald. In addition, our IAVI
collaboration should provide a new source of research and development funding.
Operating Expenses
Research and Development
Research and development expenses increased to $14.3 million for 1999 from
$13.3 million for 1998. The increase for 1999 compared to 1998 reflects
increased expenses related to the tgAAV-CF collaboration and, to a lesser
extent, costs incurred to support the Emerald joint venture. These increases
were partially offset by decreases in tgDCC-E1A development expenses. In 1998,
we had higher expenses related to the development of manufacturing methods for
tgDCC-E1A and paid a $1.0 million milestone payment in common stock at the
start of Phase II clinical trials. Additionally, 1998 results included
severance expenses we incurred when we downsized our operations early that
year.
Research and development expenses for 1998 remained approximately the same
as research and development expenses for 1997. The tgDCC-E1A manufacturing and
milestone expenses and severance expenses we incurred in 1998 generally offset
higher personnel and patent costs in 1997. We expect research and development
expenses to increase for year 2000 due to increases in staffing in the second
half of 1999 and early 2000 to support the Medeva and Emerald projects and
projected increases in external expenses necessary to support tgDCC-E1A
product development in 2000.
Technology License Fee
We incurred a noncash expense of $3.2 million in 1999 to acquire a
technology license from Alkermes, Inc. We acquired this license by issuing to
Alkermes 500,000 shares of our common stock and warrants to purchase up to
2,000,000 additional shares. We received from Alkermes an exclusive sub-
license to a patent related to the manufacture of AAV vectors, which we use in
our tgAAV-CF cystic fibrosis program, among others. We valued these securities
at $3.2 million, based on the market value of the common stock exchanged and
using the Black- Scholes model to determine the value of the warrants. We
expensed the entire value assigned to the license. While the technology we
acquired under the exclusive license has promise, we expensed the value of the
securities because this technology is in the early stages of development and
its technological feasibility has not been established. We had no technology
license fee expenses in 1998 or 1997.
21
General and Administrative
General and administrative expenses increased to $3.6 million for 1999 from
$3.0 million for 1998. This increase was primarily attributable to increases
in personnel costs, increased business development activity and investor
communications costs related to the formation of the Emerald joint venture.
General and administrative expenses increased to $3.0 million for 1998 from
$2.8 million for 1997. The increase was attributable to legal fees incurred
related to the Medeva transaction and increased investor and public relations
costs. These increases were partially offset by decreases in operating
expenses achieved through our February 1998 reduction in staff.
Other Income and Expense
Equity in Loss of Joint Venture
We recognized a $12.6 million loss in 1999 from our 80.1% equity share in
the loss of the Emerald joint venture. Emerald's losses for the year ended
December 31, 1999 included a $15.0 million noncash charge for an exclusive
license to Elan's drug delivery technology and $742,000 in losses attributable
to Emerald's research and development activities, which began in the fourth
quarter of the year. We expect to record additional equity in losses of
Emerald in 2000 and for the foreseeable future.
Investment Income
Income from marketable securities decreased to $426,000 for 1999 from
$440,000 for 1998 and $651,000 for 1997. The decreases in 1999 and 1998
resulted from lower average balances of cash available for investment.
Interest Expense
Interest expense has decreased over the last three years to $235,000 for
1999 from $265,000 for 1998 and $338,000 for 1997, because of declining
principal balances on our capital leases and installment loans. This expense
related to obligations under capital leases and installment loans we use to
finance purchases of laboratory and computer equipment, furniture and
leasehold improvements. We do not expect decreases in interest expense to
continue, since we plan to continue to finance our asset purchases under
leases or loans. We borrowed $1.0 million under a loan agreement with Medeva
in late 1999, and we may elect to borrow additional amounts from Medeva or
Elan in the future under existing loan commitments.
Year 2000 Issue
As of December 31, 1999 we completed our Year 2000 readiness evaluation and
compliance efforts. Since December 31, 1999 we have not encountered any Year
2000 compliance problems. Nonetheless, some problems related to year 2000
risks may not appear until several months after January 1, 2000. Year 2000
issues could include problems with third-party products or services that we
use or with which our information systems exchange data. Any problems that are
not identified and corrected successfully and completely could adversely
affect our business. We expect that the cost to fix any year 2000 problems
that may be identified, however, will involve internal labor-hours and will
not be material. The costs of our Year 2000 readiness efforts to date are less
than $100,000.
Impact of New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. This new statement, which is effective beginning in
2001, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. Statement No. 133 requires companies to
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting under
the standard. The impact of Statement No. 133 on Targeted Genetics' financial
position and results of operations is not expected to be material.
In December 1999, the Securities Exchange Commission issued Staff
Accounting Bulletin 101"Revenue Recognition in Financial Statements" which
provides the SEC's views on applying generally accepted accounting principles
to revenue recognition issues. The Company is currently evaluating its revenue
recognition policies and has not yet determined the financial statement impact
of this bulletin.
22
Liquidity and Capital Resources
Since our inception, we have financed our capital requirements through the
issuance of equity securities, revenue from collaborations and grants and
proceeds from leases and loans. As of December 31, 1999, we had cash, cash
equivalents and securities available for sale totaling $7.2 million, compared
to $12.0 million as of December 31, 1998. The decrease is attributable to our
use of cash to fund our operating losses and capital expenditures. Capital
expenditures of $1.9 million for 1999 reflected construction of and equipment
for a 100-liter scale AAV vector manufacturing facility within our corporate
headquarters. Our cash outflows were partially offset by cash inflows when we:
. issued 2,148,899 shares of our common stock to Elan in connection with
the Emerald joint venture, providing total proceeds of $5.0 million;
. issued 677,392 shares of our common stock to Medeva in connection with
our tgAAV-CF collaboration, providing total proceeds of $1.5 million;
and
. received loan proceeds of $1.0 million from Medeva in October 1999, to
partially finance the cost of establishing tgAAV-CF manufacturing
facilities for the supply of bulk product to be used in Phase III
clinical trials and for initial commercial launch.
Although we expect our expenses to continue to increase in 2000, we expect
revenue from Medeva, Emerald and IAVI to increase as well, substantially
offsetting expense increases. We also have contractual commitments for the
following cash resources:
. a $5.0 million equity investment by Elan;
. funds available under a $12.0 million convertible loan from Elan; and
. an additional $1.0 million of proceeds under our loan agreement with
Medeva.
In March 2000, we entered into a definitive agreement to sell 2,164,285
shares of newly issued common stock in a private placement. This transaction
added approximately $28 million to our cash position.
Our business strategy includes entering into additional collaborative
relationships with corporate partners to generate license fees, milestone
payments, research and development funding and, potentially, equity
investments, all of which would be used to fund our ongoing operations. We may
not be successful in establishing any additional collaborative relationships
or in maintaining our existing ones. Over the long term, regardless of our
partnering success, we expect that we will need to raise substantial
additional funds to continue developing and commercializing our products.
Factors Affecting Our Operating Results, Our Business and Our Stock Price
In addition to the other information contained in this annual report, you
should read and consider the following risk factors. If any of these risks
actually occur, our business, financial condition or operating results could
be adversely affected and the trading price of our stock could decline.
If we are unable to secure financing on terms acceptable to us for future
capital needs, we will be unable to fund continuing operations.
Developing and commercializing our potential products will require
substantial additional financial resources. Because we cannot expect
internally generated cash flow to fund development and commercialization of
our products, we will look to outside sources for funding. These sources could
involve one or more of the following types of transactions:
. technology partnerships;
. technology sales;
. technology licenses;
. issuing debt; or
. equity arrangements.
23
If we cannot obtain additional financing when needed or on acceptable
terms, we will be unable to fund continuing operations. In addition, if we
raise additional funds by issuing equity securities, our shareholders will
likely experience significant dilution of their ownership interest.
We have a history of losses and may never become profitable, which could
result in a decline in the value of our common stock and a loss of your
investment.
We have generated small amounts of revenue and incurred significant net
losses since we began business. As of December 31, 1999, we have incurred
losses totaling $103.5 million. We expect to continue to incur substantial
additional losses in the future, due primarily to the following factors:
. all of our products are in a testing phase and have not received
regulatory approval; and
. we will likely spend significant amounts on operating expenses.
We may never generate profits, and if we do become profitable, we may be
unable to sustain or increase profitability on a quarterly or annual basis. As
a result, the trading price of our stock could decline and you could lose all
or part of your investment.
If our clinical trials are unsuccessful or we do not receive regulatory
approval for our products, which are in the early stage of product
development, we may be unable to generate sufficient revenues to maintain our
business.
We do not yet have products in the commercial markets. All of our potential
products, including tgAAV-CF, our cystic fibrosis product candidate, and
tgDCC-E1A, our cancer product candidate, are in research and development or in
early-stage clinical trials. We cannot apply for regulatory approval of our
potential products until we have performed additional research and development
and testing. Our clinical trials may not demonstrate the safety and efficacy
of our potential products, and we may encounter unacceptable side effects or
other problems in the clinical trials. Should this occur, we may have to delay
or discontinue development of the potential product that causes the problem.
After a successful clinical trial, we cannot market products in the United
States until we receive regulatory approval. If we are unable to gain
regulatory approval of our products after successful clinical trials and then
commercialize and sell those products, we may be unable to introduce and sell
a quantity of products sufficient to maintain our business or secure
additional financing to fund our operations.
Delays or unexpected costs in obtaining approval of our products or complying
with governmental regulatory requirements could decrease our ability to
generate revenue and make funding our operations more difficult.
The regulatory process in the gene and cell therapy industry is costly,
time consuming and subject to unpredictable delays. Accordingly, we cannot
predict with any certainty how long it will take or how much it will cost to
obtain regulatory approvals for clinical trials or for manufacturing or
marketing our potential products. Delays in bringing a potential product to
market or unexpected costs in obtaining regulatory approval could decrease our
ability to generate revenue and make it more difficult to obtain additional
financing necessary to fund our operations. In addition, all manufacturing
operations are subject on an ongoing basis to the current Good Manufacturing
Practices requirement of the Food and Drug Administration. While we currently
anticipate that we will be able to manufacture product that meets this
requirement, we may be unable to attain or maintain compliance with current or
future Good Manufacturing Practices requirements. If we discover previously
unknown problems after we receive regulatory approval of a potential product
or fail to comply with applicable regulatory requirements, we may suffer
restrictions on our ability to market the product, including mandatory
withdrawal of the product from the market. This, or an unexpected increase in
the cost of compliance, could decrease our ability to generate revenue.
24
Failure to recruit patients could delay or prevent clinical trials of our
potential products, which could cause a delay or inability to introduce
products to market and a resulting decrease in our ability to generate
revenue.
Identifying and qualifying patients to participate in testing our potential
products is critical to our near-term success. The timing of our clinical
trials depends on the speed at which we can recruit patients to participate in
testing our products. Delays in recruiting or enrolling patients to test our
products could result in increased costs, delays in advancing our product
development, delays in proving the usefulness of our technology or termination
of the clinical trials altogether. If we are unable to timely introduce
potential products to market after successful clinical trials, our ability to
generate revenue may decrease and we may be unable to secure additional
financing.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Our success depends in part on our ability to protect our proprietary
rights. We own or have licenses to patents on a number of genes, processes,
practices and techniques critical to our present and potential products. If we
fail to obtain and maintain patent protection for our technology, our
competitors may market competing products that threaten our market position.
The failure of our licensors to obtain and maintain patent protection for
technology they license to us could similarly harm our business. Patent
positions in the field of biotechnology are highly uncertain and involve
complex legal, scientific and factual questions. Our patent applications may
not result in issued patents. Even if we secure a patent, the patent may not
afford adequate protection against our competitors.
We also rely on unpatented proprietary technology. Because this technology
does not benefit from the protection of patents, we may be unable to
meaningfully protect this proprietary technology from unauthorized use or
misappropriation by a third party.
Intellectual property claims and litigation could subject us to significant
liability for damages and invalidation of our proprietary rights.
As the biotechnology industry expands, the risk increases that other
companies may claim that our processes and potential products infringe on
their patents. Defending these claims would be costly and would likely divert
management's attention and resources away from our operations. If we infringe
on another company's patented processes or technology, we may have to pay
damages or obtain a license in order to continue manufacturing or marketing
the affected product or using the affected process. We may be unable to obtain
a license on acceptable terms.
Our potential tgAAV-CF product uses our proprietary AAV delivery technology
to deliver a normal copy of a CFTR gene to which we have rights under a
nonexclusive license. The United States Patent and Trademark Office has
declared an interference proceeding to determine the priority of invention of
this gene. While we do not expect to directly participate in the CFTR gene
interference proceedings, we have an interest in the outcome. If the eventual
outcome does not favor our licensor, we would have to secure a license to the
CFTR gene from the prevailing party to continue with development of tgAAV-CF.
The costs of licensing the CFTR gene could be substantial and could include
royalties greater than those we currently pay. If we cannot secure this
license on acceptable terms and on a timely basis, we may be unable to develop
or deliver our potential tgAAV-CF product, which could result in decreased
ability to generate revenue and difficulty in obtaining additional financing
to fund our operations.
If we or our business partners are unable to successfully market and
distribute our products, our business will fail.
We have no experience in sales and marketing. To market any products that
may result from our development programs, we will need to develop marketing
and sales capabilities, either on our own or with others. We intend to enter
into collaborations with corporate partners to utilize the mature marketing
and
25
distribution capabilities of our partners. While we believe that these
collaborative partners will be motivated to market and distribute our
potential products, our current and potential future partners may not commit
sufficient resources to commercializing our technology on a timely basis.
Furthermore, our present or future collaborators may pursue the development or
marketing of competing products. If our business partners do not successfully
market and distribute our products and we are unable to develop sufficient
marketing and distribution capabilities on our own, our business will fail.
The intense competition and rapid technological change in our market may
result in pricing pressures and failure of our products to achieve market
acceptance.
We presently face competition from other companies developing gene and cell
therapy technologies and from companies using more traditional approaches to
treating human diseases. Most of our competitors have substantially more
experience and financial and infrastructure resources than we do in the
following areas:
. Research and development;
. Clinical trials;
. Obtaining FDA and other regulatory approvals;
. Manufacturing; and
. Marketing and distribution.
Consequently, our competitors may be able to commercialize new products
more rapidly than we do, or manufacture and market competitive products more
successfully than we do. This could result in pricing pressures or the failure
of our products to achieve market acceptance.
In addition, gene and cell therapy are new and rapidly evolving fields and
are expected to continue to undergo significant and rapid technological
change. Rapid technological development by our competitors could result in our
actual and proposed technologies, products or processes losing market share or
becoming obsolete.
If we do not attract and retain qualified personnel and scientific
collaborators, we will be unable to successfully and timely develop our
potential products and may be unable to generate sufficient revenue to
maintain our business.
Our future success depends in part on our ability to attract and retain key
employees. We have programs in place to retain personnel, including programs
to create a positive work environment and competitive compensation packages.
Because competition for employees in our field is intense, however, we may be
unable to retain our existing personnel or attract additional qualified
employees. If we experience turnover or difficulties recruiting new employees,
our research and development could be delayed and we could experience
difficulties in generating sufficient revenue to maintain our business.
Our success also depends on the continued availability of outside
scientific collaborators to perform research and develop processes to advance
and augment our internal research efforts. Competition for collaborators in
gene and cell therapy is intense. If we are unsuccessful in recruiting or
maintaining our relationships with scientific collaborators, we could
experience delays in our research and development or loss of access to
important enabling technology.
Our limited manufacturing capability may limit our ability to successfully
introduce our potential products.
We currently do not have the capacity to manufacture large-scale clinical
or commercial quantities of our potential products. To do so, we will need to
expand our current facilities and staff or supplement them through the use of
contract providers. We may be unable to obtain or develop the necessary
manufacturing capabilities. If we cannot, we will be unable to introduce
sufficient product to sustain our business.
26
Our use of hazardous materials to develop our products exposes us to liability
risks and the risk of regulatory limitation of our use of these materials,
either of which could reduce our ability to generate revenue and make it more
difficult to fund our operations.
Our research and development activities involve the controlled use of
hazardous materials. Although we believe that our safety procedures for
handling and disposing of these materials comply with applicable laws and
regulations, we cannot eliminate the risk of accidental contamination or
injury from hazardous materials. If a hazardous material accident occurred, we
would be liable for any resulting damages. This liability could exceed our
financial resources. Additionally, hazardous materials are subject to
regulatory oversight. Accidents unrelated to our operations could cause
federal, state or local regulatory agencies to restrict our access to
hazardous materials needed in our research and development efforts. If our
access to these materials is limited, we could experience delays in our
research and development programs. Paying damages or experiencing delays
caused by restricted access could reduce our ability to generate revenues and
make it more difficult to fund our operations.
The costs of product liability claims and product recalls could exceed the
amount of our insurance, which could significantly harm our results of
operations or our reputation and result in a decline in the value of our
stock.
Our business activities expose us to the risk of liability claims or
product recalls and any adverse publicity that might result from a liability
claim against us. We currently have only limited amounts of product liability
insurance, and the amounts of claims against us may exceed our insurance
coverage. Product liability insurance is expensive and may not continue to be
available on acceptable terms. A product liability claim not covered by
insurance or in excess of our insurance or a product recall could
significantly harm our financial results or our reputation. Either of these
could result in a decrease in our stock price, and you could lose all or part
of your investment.
Market fluctuations or volatility could cause the market price of our common
stock to decline.
In recent years the stock market in general and the market for
biotechnology-related companies in particular have experienced extreme price
and volume fluctuations, often unrelated to the operating performances of the
affected companies. Our common stock has experienced, and is likely to
continue to experience, these fluctuations in price, regardless of our
performance. These fluctuations could cause the market price of our common
stock to decline.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
This item discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates.
Interest Rate Sensitivity
Short-Term Investments
As of December 31, 1999, we had short-term investments of $3.1 million.
These short-term investments consisted of highly liquid investments with
original maturities at the date of purchase of between 18 months and two
years, with an average maturity of less than one year. These investments are
subject to interest rate risk and will decrease in value if market interest
rates increase.
We performed a sensitivity analysis on our investment portfolio as of
December 31, 1999. This analysis was based on a modeling technique that
measures the hypothetical market value change that would result from an
increase in market interest rates of 100 or 200 basis points over a six-month
and twelve-month time horizon. The market value changes resulting from a 100
or 200 basis-point increase in short-term treasury security yields were not
material because all of our investments held as of December 31, 1999 mature in
2000.
Because we expect to hold most of these investments until maturity, we do
not expect the realized value of these investments to be affected to any
significant degree by the effect of a sudden change in market interest rates.
Declines in interest rates over time, however, would reduce our interest
income.
27
Long Term Obligations
As of December 31, 1999, we had outstanding long term obligations,
primarily related to capital equipment leases, leasehold improvements and our
loan agreement with Medeva of $3.3 million, at fixed interest rates of up to
14.62%. Because the interest rates on our long term obligations are fixed, a
hypothetical 10 percent decrease in interest rates would not have a material
impact on our financial position. Increases in interest rates could, however,
increase the interest expense associated with any future borrowings. We do not
hedge against interest rate increases.
Market and Credit Risk
We do not use derivative financial instruments in our investment portfolio
to manage interest rate risk. We do, however, limit our exposure to interest
rate and credit risk by establishing and strictly monitoring clear policies
and guidelines for our fixed income portfolios. At the present time we limit
to one year the maximum average maturity period of securities in our
investment portfolio. Our guidelines also establish credit quality standards,
limits on exposure to duration and credit risk criteria. We do not expect our
exposure to market and credit risk to be material. As of December 31, 1999, we
had a concentration of accounts receivable with one of our collaborators.
Equity Price Risk
Our equity price risk is limited to the risk inherent in our ownership of
80.1% of Emerald, our joint venture with Elan, and an immaterial equity
interest we have in another biotechnology company. Accordingly, we do not
hedge against equity price changes.
Foreign Currency Exchange Rate Risk
We realize all of our revenue in dollars and receive substantially all of
our cash from Medeva's U. S.-based operations and Emerald's Bermuda-based
operations. Therefore, we do not believe that we have any significant direct
foreign currency exchange rate risk and we do not hedge against foreign
currency exchange rate changes.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Targeted Genetics Corporation
We have audited the accompanying balance sheets of Targeted Genetics
Corporation as of December 31, 1999 and 1998, and the related statements of
operations, shareholders' equity, and cash flows for each of the three years
in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as 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 Targeted Genetics
Corporation at December 31, 1999 and 1998, and the results of its operations
and its cash flows for each of the three years in the period ended December
31, 1999 in conformity with accounting principles generally accepted in the
United States.
Ernst & Young LLP
Seattle, Washington
March 1, 2000
29
TARGETED GENETICS CORPORATION
BALANCE SHEETS
December 31,
---------------------------
1999 1998
------------- ------------
ASSETS
------
Current assets:
Cash and cash equivalents....................... $ 4,100,798 $ 1,870,841
Securities available for sale................... 3,052,471 10,085,955
Accounts receivable............................. 1,391,394 102,359
Receivable from joint venture................... 445,818 --
Prepaid expenses and other...................... 269,864 387,408
------------- ------------
Total current assets.......................... 9,260,345 12,446,563
Property, plant and equipment, net................ 4,021,466 3,299,253
Other assets...................................... 410,667 458,267
------------- ------------
$ 13,692,478 $ 16,204,083
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable................................ $ 2,278,338 $ 1,664,074
Payable to joint venture........................ 594,699 --
Accrued payroll and other liabilities........... 586,856 486,206
Current portion of long-term obligations........ 1,160,174 1,171,836
------------- ------------
Total current liabilities..................... 4,620,067 3,322,116
Long-term obligations............................. 2,106,897 900,208
Shareholders' equity:
Preferred stock, 6,000,000 shares authorized
Series A preferred stock, $.01 par value,
400,000 shares authorized, none issued and
outstanding at December 31, 1999 and 1998..... -- --
Series B preferred stock, $.001 par value,
12,015 shares authorized, issued and
outstanding at December 31, 1999, none
authorized at December 31, 1998............... 12,390,513 --
Common stock, $.01 par value, 80,000,000 shares
authorized, 34,019,175 and 30,652,375 shares
issued and outstanding at December 31, 1999 and
1998, respectively............................. 98,122,922 88,455,138
Accumulated deficit............................. (103,532,432) (76,501,784)
Accumulated other comprehensive income.......... (15,489) 28,405
------------- ------------
Total shareholders' equity.................... 6,965,514 11,981,759
------------- ------------
$ 13,692,478 $ 16,204,083
============= ============
See accompanying notes to the financial statements.
30
TARGETED GENETICS CORPORATION
STATEMENTS OF OPERATIONS
Year Ended December 31,
---------------------------------------
1999 1998 1997
------------ ----------- ------------
Revenue:
Collaborative agreements............ $ 6,402,175 $ 7,192,048 $ 888,335
Collaborative agreements with
affiliates......................... 445,818 -- --
Other............................... -- 318,204 439,250
------------ ----------- ------------
Total revenue..................... 6,847,993 7,510,252 1,327,585
------------ ----------- ------------
Operating expenses:
Research and development............ 14,291,066 13,327,152 13,043,288
Technology license fee.............. 3,200,000 -- --
General and administrative.......... 3,593,436 3,045,835 2,784,806
------------ ----------- ------------
Total operating expenses.......... 21,084,502 16,372,987 15,828,094
------------ ----------- ------------
Loss from operations.................. (14,236,509) (8,862,735) (14,500,509)
Equity in loss of joint venture....... (12,609,699) -- --
Investment income..................... 425,726 440,478 650,892
Interest expense...................... (234,653) (264,792) (338,157)
------------ ----------- ------------
Net loss ............................. (26,655,135) (8,687,049) (14,187,774)
Accretion of dividend on preferred
stock................................ (375,513) -- --
------------ ----------- ------------
Net loss applicable to common stock... $(27,030,648) $(8,687,049) $(14,187,774)
============ =========== ============
Basic and diluted net loss per share.. $ (0.84) $ (0.33) $ (0.70)
============ =========== ============
Shares used in computation of basic
and diluted net loss per share....... 32,173,756 26,637,823 20,196,325
============ =========== ============
See accompanying notes to the financial statements.
31
TARGETED GENETICS CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Preferred Common Other Total
Stock Preferred Stock Common Stock Accumulated Comprehensive Shareholders'
Shares Stock Amount Shares Amount Deficit Income Equity
--------- ------------ ---------- ------------ -------------- ------------- -------------
Balance at December 31,
1996................... -- -- 20,136,468 $ 73,115,362 $ (53,626,961) $ 19,387 $ 19,507,788
Net loss--1997......... -- -- -- -- (14,187,774) -- (14,187,774)
Unrealized losses on
securities available
for sale.............. -- -- -- -- -- (14,206) (14,206)
------------
Comprehensive loss..... (14,201,980)
Exercise of stock
options............... -- -- 15,380 8,414 -- -- 8,414
Exercise of warrants... -- -- 59,266 277,365 -- -- 277,365
------ ------------ ---------- ------------ -------------- --------- ------------
Balance at December 31,
1997................... -- -- 20,211,114 73,401,141 (67,814,735) 5,181 5,591,587
Net loss--1998......... -- -- -- -- (8,687,049) -- (8,687,049)
Unrealized gains on
securities available
for sale.............. -- -- -- -- -- 23,224 23,224
------------
Comprehensive loss..... (8,663,825)
Sale of common stock
and warrants, net of
issuance costs of
$158,046.............. -- -- 8,666,667 12,841,954 -- -- 12,841,954
Sale of common stock to
Medeva, net of
issuance costs of
$153,100.............. -- -- 750,000 1,129,400 -- -- 1,129,400
Issuance of shares as
milestone payment..... -- -- 875,134 1,000,000 -- -- 1,000,000
Exercise of stock
options............... -- -- 149,460 82,643 -- -- 82,643
------ ------------ ---------- ------------ -------------- --------- ------------
Balance at December 31,
1998................... -- -- 30,652,375 88,455,138 (76,501,784) 28,405 11,981,759
Net loss--1999......... -- -- -- -- (27,030,648) -- (27,030,648)
Unrealized losses on
securities available
for sale.............. -- -- -- -- -- (43,894) (43,894)
------------
Comprehensive loss..... (27,042,542)
Issuance of Series B
Convertible
Exchangeable Preferred
stock................. 12,015 12,015,000 -- -- -- -- 12,015,000
Accretion on preferred
stock................. -- 375,513 -- -- -- -- 375,513
Sale of common stock to
Medeva, net of
issuance costs of
$13,548............... -- -- 677,392 1,486,452 -- -- 1,486,452
Sale of common stock to
Elan, net of issuance
costs of $57,347...... -- -- 2,148,899 4,942,653 -- -- 4,942,653
Issuance of common
stock and warrants to
Alkermes, net of
issuance costs of
$17,500............... -- -- 500,000 3,182,500 -- -- 3,182,500
Exercise of stock
options............... -- -- 40,509 56,179 -- -- 56,179
------ ------------ ---------- ------------ -------------- --------- ------------
Balance at December 31,
1999................... 12,015 $ 12,390,513 34,019,175 $ 98,122,922 $ (103,532,432) $ (15,489) $ 6,965,514
====== ============ ========== ============ ============== ========= ============
See accompanying notes to the financial statements.
32
TARGETED GENETICS CORPORATION
STATEMENTS OF CASH FLOWS
Year Ended December 31,
------------------------------------------
1999 1998 1997
------------- ------------ -------------
OPERATING ACTIVITIES:
Net loss......................... $ (27,030,648) $ (8,687,049) $ (14,187,774)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Equity in loss of joint
venture....................... 12,609,699 -- --
Expenses paid with common
stock......................... 3,200,000 1,000,000 --
Depreciation and amortization.. 1,614,019 1,635,797 1,641,151
Increase in accounts
receivable.................... (1,289,035) (59,198) (3,528)
Increase in accounts receivable
from joint venture............ (445,818) -- --
Increase (decrease) in current
liabilities................... 586,193 485,259 (190,996)
Decrease (increase) in prepaid
expenses and other............ 62,347 (143,769) 42,317
Decrease (increase) in accrued
interest on securities
available for sale............ 79,608 (65,746) 162,497
------------- ------------ -------------
Net cash used in operating
activities.................. (10,613,635) (5,834,706) (12,536,333)
------------- ------------ -------------
INVESTING ACTIVITIES:
Purchases of property, plant and
equipment....................... (1,856,199) (238,623) (704,896)
Purchases of securities available
for sale........................ (483,014) (17,664,960) (814,251)
Maturities and sales of
securities available for sale... 7,392,996 11,693,951 12,130,074
Increase in other assets......... -- (15,000) (50,000)
------------- ------------ -------------
Net cash provided by (used
in) investing activities.... 5,053,783 (6,224,632) 10,560,927
------------- ------------ -------------
FINANCING ACTIVITIES:
Net proceeds from sale of capital
stock........................... 6,467,784 14,053,997 285,779
Proceeds from equipment financing
transactions.................... 1,294,389 176,289 468,363
Loan proceeds from collaborative
partner......................... 1,000,000 -- --
Payments under capital leases and
loans........................... (1,347,877) (1,311,952) (1,299,459)
Accretion on preferred stock..... 375,513 -- --
------------- ------------ -------------
Net cash provided by (used
in) financing activities.... 7,789,809 12,918,334 (545,317)
------------- ------------ -------------
Net increase (decrease) in cash and
cash equivalents.................. 2,229,957 858,996 (2,520,723)
Cash and cash equivalents,
beginning of year................. 1,870,841 1,011,845 3,532,568
------------- ------------ -------------
Cash and cash equivalents, end of
year.............................. $ 4,100,798 $ 1,870,841 $ 1,011,845
============= ============ =============
Cash paid during the year for
interest.......................... $ 202,883 $ 264,702 $ 338,157
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING AND FINANCING
ACTIVITIES:
Preferred stock issuance in
exchange for interest in joint
venture......................... 12,015,000 -- --
Equipment financed through
renewal of capital lease........ -- 594,983 --
See accompanying notes to the financial statements
33
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Nature of Operations
Targeted Genetics Corporation ("Targeted Genetics" or the "Company") is
developing gene therapy products for the treatment of certain acquired and
inherited diseases. Targeted Genetics was incorporated in the state of
Washington in March 1989. The Company's operations constitute one business
segment.
2. Summary of Significant Accounting Policies
Cash Equivalents
Targeted Genetics considers as cash equivalents all short-term investments
with a purchased maturity of three months or less that are readily convertible
into cash and have insignificant interest rate risk. Cash equivalents, valued
at cost that approximates market, consist principally of money market accounts
and short-term government obligations. All other investments are reported as
securities available for sale.
Securities Available for Sale
Securities available for sale consist primarily of corporate debt
securities and U.S. government notes, all of which mature within one year.
Targeted Genetics currently classifies its entire investment portfolio as
securities available for sale. Such securities are stated at market value,
with the unrealized gains and losses included as a component of shareholders'
equity. The cost of debt securities in this category is adjusted for
amortization of premiums and accretion of discounts to maturity, which are
included in investment income. Realized gains and losses and declines in value
judged to be other than temporary on securities available for sale are also
included in investment income. The cost of securities sold is calculated using
the specific identification method.
Fair Value of Financial Instruments
The carrying amounts of financial instruments such as cash, and cash
equivalents, investments, accounts receivable and accounts payable reasonably
approximate fair value because of the short-term nature of these items. The
Company believes the carrying amounts of the note payable and capital leases
obligations approximate fair value because the interest rates on these
instruments change with, or approximate, market interest rates.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation of furniture
and equipment is provided using the straight-line method over the assets'
estimated useful lives, which range from three to seven years. Furniture and
equipment under capitalized leases are amortized over the life of the lease.
Leasehold improvements are amortized over the life of the improvements or the
term of the lease, whichever is shorter. Amortization of assets recorded under
capital leases is included with depreciation expense.
Stock Compensation
As permitted by the provisions of Financial Accounting Standards Board
Statement No. 123, Accounting for Stock-Based Compensation, the Company has
elected to follow Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for its
employee stock option grants and apply the disclosure-only provisions to
account for its stock option plans. The Company does not recognize any
compensation expense related to the plans since all options are granted at
fair market value on the date of grant. Options granted to consultants are
accounted for using the Black-Scholes method prescribed by Statement 123 and
are subject to periodic revaluation over their vesting terms.
34
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Revenue under Collaborative Agreements
Revenue under collaborative agreements is recognized according to the terms
of the collaborative agreements. Nonrefundable product license fees that are
not dependent on future performance are recognized as revenue when received.
Up-front signing or licensing fees that are dependent on future performance
are recognized ratably over the period in which the related work is performed.
Milestone revenue is recognized upon the achievement of the related milestone
and when collection is probable. Revenue earned from the performance of
research and development is recognized over the period in which the related
work is performed. Advance payments received in excess of amounts earned are
classified as deferred revenue.
Net Loss Per Share
Basic net loss per share is computed based upon the weighted average number
of common shares outstanding during the period. The Company's diluted net loss
per share is the same as its basic net loss per share because all stock
options, warrants and other potentially dilutive securities are antidilutive
and are therefore excluded from the calculation of diluted net loss per share.
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 amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. This new statement, which is effective beginning in
2001, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. Statement No. 133 requires companies to
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting under
the standard. The impact of Statement No. 133 on Targeted Genetics' financial
position and results of operations is not expected to be material.
In December 1999, the Securities Exchange Commission issued Staff
Accounting Bulletin 101 Revenue Recognition in Financial Statements which
provides the SEC's views on applying generally accepted accounting principles
to revenue recognition issues. The Company is currently evaluating its revenue
recognition policies and has not yet determined the financial statement impact
of this bulletin.
3. Significant Concentrations
The Company's collaborative agreement with Medeva PLC, provided 87%, 88%
and 0% of revenue in fiscal years ending December 31, 1999, 1998 and 1997,
respectively. See note 8. At December 31, 1999 and 1998, amounts receivable
from Medeva represented 76% and 100%, respectively, of the Company's accounts
receivable balance. The Company does not require collateral or security
related to receivables and has historically had no losses on uncollectible
accounts. Accordingly, no allowance for bad debts has been recorded.
35
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
4. Securities Available for Sale
All securities available for sale at December 31, 1999 mature within one
year. Securities available for sale consisted of the following:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------ ---------- ---------- ------------
December 31, 1999:
U.S. Treasury securities
and obligations of U.S.
government agencies...... $ 3,067,960 $ -- $ (15,489) $ 3,052,471
============ ======== ========= ============
December 31, 1998:
U.S. Treasury securities
and obligations of U.S.
government agencies...... $ 6,184,441 $ 6,106 $ -- $ 6,190,547
U.S. corporate securities. 3,873,109 22,370 (71) 3,895,408
------------ -------- --------- ------------
$ 10,057,550 $ 28,476 $ (71) $ 10,085,955
============ ======== ========= ============
Unrealized gains and losses on securities available for sale consisted of
the following:
Year Ended December 31,
------------------------------
1999 1998 1997
--------- -------- ---------
All gains (losses)........................ $ (39,336) $ 37,909 $ (15,564)
Less reclassifications to net loss:
Gross realized gains.................... (8,059) (19,940) (4,448)
Gross realized losses................... 3,501 5,255 5,806
--------- -------- ---------
Unrealized gains (losses)................. $ (43,894) $ 23,224 $ (14,206)
========= ======== =========
5. Property, Plant and Equipment
Property, plant and equipment consisted of the following:
December 31,
-----------------------
1999 1998
----------- -----------
Furniture and equipment............................ $ 5,522,248 $ 4,240,248
Leasehold improvements............................. 5,567,091 4,625,027
----------- -----------
11,089,339 8,865,275
Less accumulated depreciation and amortization..... 7,067,873 5,566,022
----------- -----------
$ 4,021,466 $ 3,299,253
=========== ===========
Depreciation expense totaled $1,531,420 in 1999, $1,491,702 in 1998 and
$1,492,406 in 1997.
The Company has leased furniture and equipment, primarily laboratory
equipment under agreements deemed to be capital leases. The total cost of
leased furniture and equipment capitalized at December 31, 1999 and 1998 was
$3,784,055 and $2,857,915, respectively, with related accumulated amortization
of $2,489,772 and $1,553,880 at December 31, 1999 and 1998, respectively.
36
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
6. Long-Term Obligations
Long-term obligations consisted of the following:
December 31,
---------------------
1999 1998
---------- ----------
Capitalized lease obligations....................... $2,055,062 $1,705,375
Note payable to collaborator........................ 1,018,689 --
Deferred state sales tax............................ 193,320 308,609
Other............................................... -- 58,060
---------- ----------
3,267,071 2,072,044
Less current portion................................ 1,160,174 1,171,836
---------- ----------
$2,106,897 $ 900,208
========== ==========
Future aggregate principal payments related to long-term obligations are
$1,141,485 in 2000, $606,346 in 2001, $419,129 in 2002, $77,115 in 2003 and
$1,004,307 in 2004.
The Company has an agreement with Medeva/Celltech under which, subject to
certain circumstances, Medeva/Celltech will loan the Company up to $2.0
million. Loan proceeds are unsecured and are required to be used to partially
finance the cost of establishing tgAAV-CF manufacturing facilities for the
supply of bulk product to be used in Phase III clinical trials and for initial
commercial launch. As of December 31, 1999, the Company has borrowed $1.0
million under the agreement. No amount was borrowed at December 31, 1998.
Interest on borrowings is payable annually in arrears at a rate that is 150
basis points over the one-month LIBOR rate, but not less than 5% nor more than
7% per year. The Company recognized $18,689 of interest expense in 1999.
Principal is due and payable in November 2003, or earlier if the cumulative
net product sales of the Company's cystic fibrosis product equal or exceed
$60.0 million. The loan agreement contains financial covenants including
limits on the Company's ability to declare or pay dividends. The Company can
at its option, and with Medeva's consent, repay the loan with its common stock
at any time during the loan term, at a conversion price equal to the average
closing price of the common stock over a twenty-day period preceding the
repayment date.
7. Shareholders' Equity
Series B Preferred Stock
In July 1999, Elan International Services, Ltd. purchased $12,015,000 of
the Company's Series B preferred stock in conjunction with the formation of
the Emerald Gene Systems Ltd. ("Emerald") joint venture. See note 13. This
preferred stock bears an annual dividend of 7%, accrued semi-annually and
added to principal. The Series B preferred stock is convertible until July
2005, at Elan's option, into the Company's common stock, at a price of $3.32
per share. As of December 31, 1999 the Company had accrued dividends of
$376,000. Elan's holdings of the Series B preferred stock were convertible
into 3,732,106 shares of the common stock as of December 31, 1999. The Company
would issue 5,740,548 shares of its common stock if Elan were to elect to
convert its preferred stock to shares of common stock as of July 21, 2005, the
expiration of the conversion option. Alternatively, Elan has an option to
exchange the Series B preferred stock and all accumulated dividends for a
30.1% interest in Emerald. This exchange option is exercisable up to six
months after the completion of a research and development program that is
currently anticipated to be 36 to 48 months in length. This exchange right
will terminate if the preferred stock is converted into common stock, unless
the conversion occurs as a result of a liquidation or certain transactions
involving a change of control of the Company.
37
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Should the Company liquidate or wind-down its operations, the agreement
gives Series B preferred shareholders priority over common shareholders with
respect to the assets legally available for distribution to shareholders. The
Series B shareholders' liquidation preference is at par value. The Company has
redemption rights to these shares only in certain instances involving change
of control. Holders of Series B preferred stock are not entitled to vote
together with holders of common stock with respect to election of directors or
other corporate governance matters.
Warrants
In June 1999, the Company issued warrants to purchase 2,000,000 shares of
its common stock to Alkermes, Inc. These warrants were issued in two tranches
of 1,000,000 shares each. The warrants expire in June 2007 and June 2009 and
are priced at $2.50 and $4.16 per share, respectively. See note 9.
In 1998, the Company completed a private placement of common stock and
warrants, which resulted in net proceeds of approximately $12.8 million.
Warrants to purchase a total of 4,333,333 shares of common stock were issued
in the transaction, with an exercise price of $2.00 per share and an
expiration of April 2003.
The Company has outstanding warrants to purchase a total of 126,016 shares
related to equipment financing, consulting and license agreements. These
warrants have a weighted average price of $4.42 per share and expire between
May 2001 and March 2004.
At December 31, 1999, 6,459,349 shares of common stock were reserved for
all outstanding warrants.
Shareholder Rights Plan
The Company has adopted a shareholder rights plan, under which it has
distributed a dividend of one right for each outstanding share of common
stock. These rights could cause substantial dilution to certain persons or
groups that attempt to acquire the Company on terms not approved by the
Company's Board of Directors.
38
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Stock Options
The Company has three stock option plans. Beginning in 1999 the Company
began granting all options from the 1999 Stock Option Plan (the "1999 Plan"),
and discontinued grants from the other two plans. The 1999 Plan provides for
option grants of up to a maximum of 1.5 million shares of common stock to
employees, directors and officers of the Company and consultants, agents,
advisors and independent contractors who provide services to the Company.
Generally, options vest in even quarterly or annual increments over a three-
to five-year period. All options expire ten years from date of grant. As of
December 31, 1999, options to purchase 1,175,125 shares were available for
future grant under the 1999 Plan. The following table summarizes activity
related to the Company's stock option plans:
Weighted Average
Shares Exercise Price
--------- ----------------
Balance, December 31, 1996..................... 1,214,414 $ 3.57
Granted...................................... 571,728 3.75
Exercised.................................... (15,380) 0.55
Canceled..................................... (74,060) 4.42
---------
Balance, December 31, 1997..................... 1,696,702 3.62
Granted...................................... 1,269,277 1.49
Exercised.................................... (149,460) 0.55
Canceled..................................... (955,933) 3.61
---------
Balance, December 31, 1998..................... 1,860,586 2.42
Granted...................................... 835,265 1.94
Exercised.................................... (40,509) 1.39
Canceled..................................... (214,000) 2.51
---------
Balance, December 31, 1999..................... 2,441,342 2.26
=========
During 1999, options were exercised at prices ranging from $0.55 to $2.25
per share. Options for 1,094,420, 628,785 and 611,465 shares were exercisable
at December 31, 1999, 1998 and 1997, respectively. In 1998, the Company
offered active employees, except executive officers, the opportunity to cancel
previously awarded stock option grants with exercise prices greater than the
current market price of common stock and be granted the same number of new
options at the closing market price on the grant date. Substantially all
eligible employees elected to replace their previously awarded stock option
grants, resulting in the cancellation of options to purchase 531,550 shares at
an average price of $3.77 per share and the issuance of options to purchase
the same number of shares at $1.22 per share. The new options awarded under
this offer vest over a three-year period, 25% upon the date six months after
the grant date, 25% upon the date twelve months after the grant date and 6.25%
at the end of each three-month period thereafter.
The following table summarizes information for outstanding and exercisable
options at December 31, 1999:
Outstanding Exercisable
------------------------------ ------------------
Weighted
Weighted Average Weighted
Range of Average Remaining Average
Exercise Exercise Contractual Exercise
Prices Shares Price Life Shares Price
-------- --------- -------- ----------- --------- --------
$0.50--$1.22 647,890 $ 1.07 7.38 426,476 $ 1.03
1.38-- 1.72 624,125 1.63 8.98 111,216 1.68
1.94-- 2.25 577,717 2.13 8.69 110,934 2.13
2.50-- 6.25 591,610 4.29 5.64 445,794 4.31
--------- ---------
0.50-- 6.25 2,441,342 2.54 7.68 1,094,420 2.54
========= =========
39
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
In conformity with the provisions of Statement No. 123, Accounting for
Stock-Based Compensation, the Company has elected to follow the intrinsic
value method allowed under that statement for its stock option plans and
present pro forma disclosures using the fair value accounting approach. Had
compensation costs been recorded, the following amounts would have been
reported:
1999 1998 1997
------------- ------------ -------------
Net loss--as reported......... $ (27,030,648) $ (8,687,049) $ (14,187,774)
Net loss--pro forma........... (27,985,273) (9,512,398) (15,068,834)
Basic net loss per share--as
reported..................... (0.84) (0.33) (0.70)
Basic net loss per share--pro
forma........................ (0.87) (0.36) (0.75)
The fair value of each option is estimated on the date of grant using the
Black-Scholes multiple-option approach pricing model with the following
weighted average assumptions:
1999 1998 1997
------- ------- -------
Expected dividend rate.......................... Nil Nil Nil
Expected stock price volatility................. 0.908 0.814 0.696
Risk-free interest rate......................... 5.05% 5.38% 6.53%
Expected life of options from vest date......... 3 years 3 years 3 years
The weighted average fair value of options granted during 1999, 1998 and
1997 was $1.94, $1.11 and $2.51 per share, respectively. Compensation expense
included in these pro forma amounts may not be representative of the effects
on pro forma earnings for future years
As of December 31, 1999, the Company had reserved a total of 13,807,922
shares of common stock for issuance pursuant to conversion of preferred stock
and stock options.
8. Collaborative Agreements
Celltech Group plc Agreement
In 1998 Targeted Genetics entered into a series of agreements (the "CF
Agreements") with Medeva. In January 2000, Medeva merged with
Celltech/Chiroscience to become part of the Celltech Group Plc. Celltech has
assumed Medeva's rights and responsibilities under our agreements. Targeted
Genetics and Medeva are collaborating to develop on a worldwide basis the
Company's tgAAV-CF gene therapy product for the treatment of cystic fibrosis.
Upon signing the CF Agreements, Targeted Genetics received a license and
technology access fee of $5.0 million and a milestone payment of $1.0 million
related to the start of Phase I clinical trials for the aerosolized version of
the tgAAV-CF product. Medeva agreed to pay up to $5.0 million per year for
three years to fund the Company's tgAAV-CF research and development activities
and certain Phase I clinical trial expenses. In addition, Medeva agreed to pay
the costs of Phase II and subsequent clinical trials of the product. Assuming
successful development and regulatory approval, Celltech will have the
exclusive right to market the product on a worldwide basis. Under a long-term
supply agreement, the Company will manufacture and supply bulk product to
Celltech under a pricing formula constructed to compensate with a fixed
percentage of Celltech's net product sales. The research and development
funding agreement is effective from October 1998 to October 2001, with options
to extend the term if both parties agree. The long-term supply agreement is
effective for the term of the patents covering the Company's tgAAV-CF
technology. Celltech has the option to terminate the CF Agreements at will
with 180 days notice. Should Celltech exercise this right to terminate the CF
Agreements, all rights related to tgAAV-CF technology would return to the
Company. The Company recognized $6.4 million and $7.0 million of revenue under
the CF Agreements in 1999 and 1998.
40
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Under separate agreements, Medeva agreed to purchase $3.0 million of
Company common stock and, subject to certain provisions, to loan the Company
up to $12.0 million. Medeva purchased $3.0 million of common stock in two
tranches: 750,000 shares of common stock for $1.5 million upon signing of the
stock purchase agreement in 1998 and 677,392 shares of common stock for $1.5
million in 1999. Subject to certain conditions, the Company can draw up to
$2.0 million to partially fund construction of facilities to support Phase III
trials and initial commercialization. At December 31, 1999, the Company has
drawn $1.0 million. See note 6. Under certain conditions, Medeva agreed to
loan us up to an additional $10 million toward building a manufacturing
facility compliant with the FDA's Good Manufacturing Practices guidelines for
higher-volume production of tgAAV-CF. No amounts have been drawn under the
$10.0 million commitment.
Elan Corporation plc
In July 1999, the Company and Elan formed Emerald, a joint venture to
develop enhanced gene delivery technology and products.
Elan has agreed to loan the Company up to $12.0 million under a convertible
promissory note agreement to support its share of the joint venture's research
and development costs. The note has a six-year term, accrues interest at 12%
per year. The note and related accrued interest are convertible into the
Company's common stock at conversion prices set at 150% of the average closing
price of the Company's common stock for the 60 trading days ending two
business days before the time the Company draws loan proceeds. The note
agreement includes provisions allowing the Company to convert the debt into
the Company's common stock at the lesser of the current market price or the
conversion price, at its option. As of December 31, 1999, the Company has not
drawn on the note.
The Company also entered into an agreement with Elan that requires Elan to
purchase up to $10.0 million of the Company's common stock at a premium to
market price. Elan purchased $5.0 million of Targeted Genetics' common stock
in connection with closing of the joint venture transaction, or 2,148,899
shares. At the Company's option, Elan will purchase an additional $5.0 million
of Targeted Genetics common stock in July 2000 at 120% of the market price at
that time.
9. Alkermes License
On June 9, 1999, the Company entered into an agreement with Alkermes, Inc.
to acquire the exclusive rights to a patent for the manufacture of AAV
vectors. The license to this technology, first developed by Children's
Hospital in Columbus, Ohio, covers the use of cell lines for the manufacture
of AAV vectors and expands a previously acquired limited field license to
these rights. The Company issued 500,000 shares of its common stock and
warrants to purchase a total of up to 2,000,000 additional shares in exchange
for this technology license. See note 7. Under the terms of the license, the
Company is responsible for endeavoring to commercialize the technology.
Additionally, the Company is obligated to make milestone payments as products
using this technology reach clinical trial and regulatory milestones. The
Company is also obligated to pay royalties upon the sale of AAV products or
sub-licensing of the licensed technology. The Company recorded a $3.2 million
non-cash charge with respect to the Alkermes license in its 1999 operating
results, because the underlying technology is not complete and the Company
will have to invest significant resources to develop and prove its commercial
feasibility.
10. Lease Commitments
The Company leases its research and office facilities under two
noncancellable operating leases that expire beginning March 31, 2004. The
leases may be extended under two additional five-year renewal options at the
then-prevailing fair market value rental rate.
41
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Future minimum payments under noncancellable leases at December 31, 1999
were as follows:
Operating Capital
---------- ----------
Year Ending December 31:
2000.............................................. $ 617,713 $1,147,974
2001.............................................. 634,451 655,783
2002.............................................. 664,447 408,263
2003.............................................. 681,185 81,321
2004.............................................. 177,810 5,115
Thereafter........................................ -- --
---------- ----------
Total minimum lease payments........................ $2,775,606 2,298,456
==========
Less amount representing interest................... 243,394
----------
Present value of minimum capitalized lease payments. $2,055,062
==========
Rent expense under operating leases for the years ended December 31, 1999,
1998 and 1997 was $587,000, $533,000 and $533,000, respectively.
11. Employee Retirement Plan
The Company sponsors an employee retirement plan in accordance with Section
401(k) of the Internal Revenue Code. All employees at least 21 years old are
eligible to participate in the plan. Contributions made into the plan are at
the discretion of the board of directors. The Company incurred $90,181, $0,
and $99,426 of expense in 1999, 1998 and 1997, respectively, related to
contributions to the plan.
12. Income Taxes
At December 31, 1999, the Company had net operating loss carryforwards of
$70.1 million and research and experimental credit carryforwards of $1.8
million. The carryforwards are available to offset future federal income taxes
and begin to expire in 2008. The Company has provided a valuation allowance to
offset the excess of deferred tax assets over the deferred tax liabilities,
due to the uncertainty of realizing the benefits of the net deferred tax
asset. The valuation allowance increased by $3.9 million in 1999 and $2.8
million during 1998.
Significant components of the Company's deferred tax assets and liabilities
were as follows:
December 31,
-------------------------
1999 1998
------------ ------------
Deferred tax assets:
Net operating loss carryforwards.............. $ 23,828,000 $ 20,354,000
Research and experimental credit
carryforwards................................ 1,815,000 1,628,000
Depreciation.................................. 842,000 721,000
Other......................................... 185,000 97,000
------------ ------------
Total deferred tax assets....................... $ 26,670,000 $ 22,800,000
============ ============
Valuation allowance for deferred tax assets..... $ 26,670,000 $ 22,800,000
============ ============
Utilization of federal income tax carry-forwards is subject to certain
limitations under Section 382 of the Internal Revenue Code. The Company's past
sales and issuances of common stock have resulted in "ownership changes" as
defined under Section 382, that may result in limitations on the future use of
some portion of the net operating loss carryforwards.
42
TARGETED GENETICS CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
13. Joint Venture
In July 1999, the Company and Elan formed Emerald, a joint venture to
develop enhanced gene delivery technology and products. At the time the joint
venture was formed, Elan purchased $12,015,000 of the Company's Series B
convertible exchangeable preferred stock. See note 7. The preferred stock is
convertible, at Elan's option, into Targeted Genetics common stock or into
shares representing a 30.1% interest in Emerald, increasing Elan's ownership
in Emerald to 50%. Targeted Genetics used the proceeds of the convertible
exchangeable preferred stock sale to purchase its 80.1% interest in Emerald.
Emerald used these proceeds to pay $15.0 million to Elan for a license giving
Emerald exclusive rights to use Elan drug delivery technologies within the
gene delivery field.
The Company formed Emerald by issuing Emerald preferred and common stock
valued at $15,000,000 to Targeted Genetics and Elan. The Company currently
owns an 80.1% interest in Emerald and Elan owns 19.9% (non-voting). While
Targeted Genetics owns 100% of the voting common shares, Elan and its
subsidiaries have retained significant minority investor rights that are
considered "participating rights" as defined in the Financial Accounting
Standards Board's Emerging Issues Task Force Bulletin 96-16, Investors'
Accounting for an Investee When the Investor Has a Majority of the Voting
Interest but the Minority Shareholder Has Certain Approval or Veto Rights.
Elan's participating rights prevent the Company from exercising control over
Emerald. Accordingly, the Company does not consolidate the financial
statements of Emerald but instead accounts for its investment in Emerald under
the equity method of accounting.
The condensed financial information of Emerald as of December 31, 1999 and
for the period from July 21, 1999 (date of inception) through December 31,
1999 is as follows:
Current assets............................................. $ 2,250
-------------
Total assets............................................... $ 2,250
=============
Current liabilities........................................ $ 744,696
Total shareholders' equity................................. (742,446)
-------------
Total liabilities and shareholders' equity................. $ 2,250
=============
Revenue.................................................... $ --
Technology access fee...................................... 15,000,000
Operating expenses......................................... 742,446
-------------
Net loss................................................... $ (15,742,446)
=============
Included in the Company's December 31, 1999 balance sheet are a $445,818
receivable from Emerald for services performed by the Company for Emerald and
a payable to Emerald of $594,699 for the Company's 80.1% share of Emerald's
funding requirements as of December 31, 1999. The Company expects to advance
Emerald its share of the required funding and collect the $445,818 Emerald
account receivable during the first quarter of 2000. The Company is required
to provide additional funding to Emerald as needed in relation to its
ownership interest in Emerald.
14. Subsequent Events
On March 1, 2000, Targeted Genetics announced that it had entered into a
definitive agreement for the placement of 2,164,285 shares of newly issued
common stock that resulted in gross proceeds to the Company of $30.3 million.
43
AUDITORS' REPORT
To the Shareholders of
Emerald Gene Systems, Ltd.
We have audited the balance sheet of Emerald Gene Systems, Ltd. as at
December 31, 1999 and the statement of loss shareholders' deficit and cash
flow for the 166 day period then ended. 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 audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform an audit to obtain reasonable assurance 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.
In our opinion, these financial statements present fairly, in all material
respects, the financial position of the company as at December 31, 1999 and
the results of its operations for the 166 day period then ended in accordance
with accounting principles generally accepted in the United States.
Ernst & Young
Chartered
Accountants
February 29, 2000
Hamilton, Bermuda
44
EMERALD GENE SYSTEMS, LTD.
(Incorporated in Bermuda)
BALANCE SHEET
December 31, 1999
(expressed in United States dollars)
1999
------------
ASSETS
Current assets
Prepaid expenses................................................ $ 2,250
============
LIABILITIES
Current liabilities
Accounts payable and accrued expenses........................... $ 6,350
Due to related party (Note 3)................................... 277,502
Due to shareholders (Note 3).................................... 460,844
------------
744,696
------------
SHAREHOLDERS' EQUITY
Share capital (Note 5)............................................ 12,000
Contributed surplus (Note 6)...................................... 14,988,000
Deficit........................................................... (15,742,446)
------------
(742,446)
------------
$ 2,250
============
See accompanying notes.
45
EMERALD GENE SYSTEMS, LTD.
(Incorporated in Bermuda)
STATEMENT OF LOSS
For the 166 Day Period Ended December 31, 1999
(expressed in United States dollars)
1999
-------------
Revenue......................................................... $ --
Expenses
License fee (Note 4).......................................... 15,000,000
Research and development (Note 3)............................. 723,320
General and administrative expenses........................... 19,126
-------------
Net loss........................................................ $ (15,742,446)
=============
See accompanying notes.
46
EMERALD GENE SYSTEMS, LTD.
(Incorporated in Bermuda)
STATEMENT OF SHAREHOLDERS' DEFICIT
FOR THE 166 DAY PERIOD ENDED DECEMBER 31,1999
(expressed in United States dollars)
Preferred Common Total
Preferred Shares Common Shares Contributed Accumulated Shareholders'
Shares Amount Shares Amount Surplus Deficit Deficit
--------- --------- ------ ------- ------------ ------------- -------------
Balance at July 19,
1999................... -- $ -- -- $ -- $ -- -- $ --
Issuance of common
shares................. 7,491 7,491 1,199,478 1,206,969
Issuance of preferred
shares................. 4,509 4,509 13,788,522 13,793,031
Net loss--1999.......... -- -- -- -- -- (15,742,446) (15,742,446)
----- ------- ----- ------- ------------ ------------- ------------
Balance at December 31,
1999................... 4,509 $ 4,509 7,491 $ 7,491 $ 14,988,000 $ (15,742,446) $ (742,446)
===== ======= ===== ======= ============ ============= ============
See accompanying notes.
47
EMERALD GENE SYSTEMS, LTD.
(Incorporated in Bermuda)
STATEMENT OF CASH FLOWS
FOR THE 166 DAY PERIOD ENDED DECEMBER 31, 1999
(expressed in United States dollars)
1999
------------
Operating activities
Net Loss....................................................... $(15,742,446)
Adjustment to convert to a cash basis
Prepaid expenses............................................. (2,250)
Accounts payable and accrued expenses........................ 6,350
Due to related party......................................... 277,502
Due to shareholders.......................................... 460,844
------------
(15,000,000)
Financing activities
Proceeds from issuance of common shares........................ 7,491
Proceeds from issuance of preferred shares..................... 4,509
Increase in contributed surplus................................ 14,988,000
------------
15,000,000
Changes in cash, and cash at end of period....................... $ --
============
See accompanying notes.
48
EMERALD GENE SYSTEMS, LTD.
NOTES TO THE FINANCIAL STATEMENTS
December 31, 1999
(expressed in United States dollars)
1. Operations
The company was incorporated July 19, 1999 in Bermuda. The company is owned
by Elan International Services Ltd. ("EIS") a wholly-owned subsidiary of Elan
Corporation plc, and Targeted Genetics Corporation ("TGC"), holding 19.9%
(non-voting shares) and 80.1% of the shares respectively. The primary
objective of the company is to carry on the business of the development,
testing, registration, manufacturing, commercialization, and licensing of
"Products" (as defined in the Subscription, Joint Development and Operating
Agreement ("JDOA") dated July 21, 1999 between EIS, TGC and others). The focus
of the collaborative venture will be to develop the "Products" using the Elan
Intellectual Property, the TGC Intellectual Property and the Emerald
Technology pursuant to the JDOA.
2. Significant accounting policy
The company follows accounting principles generally accepted in the United
States. Significant accounting policies are as follows:
(a) Research and development costs
Research costs are charged as an expense of the period in which they are
incurred. Development costs are deferred to future periods if certain criteria
relating to future benefits are satisfied and if the costs do not exceed the
expected future benefits.
(b) Use of estimates
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amount of
revenues and expenses during the reporting period. Actual results could differ
significantly from those estimates.
3. Related party transactions
The following table summarizes the company's related party transactions for
the period:
1999
--------
Research and development costs
To companies related through common ownership.................. $277,502
To shareholders................................................ 445,818
These transactions are in the normal course of operations and are measured
at the exchange amount, which is the amount of consideration established and
agreed to by the related parties.
At the end of the period, the amounts due to related entities are as
follows:
Due to shareholders............................................. $460,844
Due to companies related through common ownership............... 277,502
These balances are unsecured, and interest free with no set terms of
repayment.
49
EMERALD GENE SYSTEMS, LTD.
NOTES TO THE FINANCIAL STATEMENTS--(Continued)
December 31, 1999
(expressed in United States dollars)
4. License Fee
During 1999, the company paid a license fee to Elan Corporation plc in the
amount of $15,000,000 to acquire rights to certain Elan intellectual property.
5. Share capital
1999
-------
Authorized, issued and fully paid:
6,000 voting common shares, of par value $1.00 per share......... $ 6,000
1,491 non-voting common shares (with option to convert into
voting common shares after July 21, 2001), par value $1.00 per
share........................................................... 1,491
3,612 non-voting preferred shares, of par value $1.00 per share.. 3,612
897 non-voting preferred shares (with option to convert into
voting common shares upon exercise of Exchange Right)........... 897
-------
$12,000
=======
6. Contributed surplus
Contributed surplus represents share premium on amounts contributed by
shareholders in addition to their subscription to the issued share capital.
7. Year 2000 Issue (unaudited)
The Year 2000 Issue arises because many computerized systems use two digits
rather than four to identify a year. Date-sensitive systems may recognize the
year 2000 as 1900 or some other date, resulting in errors when information
using year 2000 dates is processed. In addition, similar problems may arise in
some systems which use certain dates in 1999 to represent something other than
a date.
Although the change in date has occurred, it is not possible to conclude
that all aspects of the Year 2000 Issue that may effect the entity, including
those related to customers, suppliers, or other third parties, have been fully
resolved.
8. Taxes
Under current Bermuda law the company is not required to pay any taxes in
Bermuda on either income or capital gains. The company has received an
undertaking from the Minister of Finance in Bermuda that in the event of such
taxes being imposed the company will be exempted from taxation until the year
2016.
50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
(a) The information required by this item concerning our directors is
incorporated by reference to the section captioned "Election of Directors" in
the proxy statement for our annual meeting of shareholders to be held on May
12, 2000. We will file the proxy statement within 120 days of December 31,
1999, our fiscal year end.
(b) The information required by this item concerning our executive officers
is provided in Part I of this annual report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
section captioned "Executive Compensation" in the proxy statement for our
annual meeting of shareholders to be held on May 12, 2000.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
section captioned "Principal Shareholders" in the proxy statement for our
annual meeting shareholders to be held on May 12, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
51
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following Financial Statements are submitted in Item 8 of this report.
Page(s) in
10-K
----------
Targeted Genetics Corporation Report of Ernst and Young LLP,
Independent Auditors............................................... 29
Targeted Genetics Corporation Balance Sheets at December 31, 1999
and 1998........................................................... 30
Targeted Genetics Corporation Statements of Operations for the years
ended December 31, 1999, 1998 and 1997............................. 31
Targeted Genetics Corporation Statements of Shareholders' Equity for
the period from December 31, 1996 through December 31, 1999........ 32
Targeted Genetics Corporation Statements of Cash Flows for the years
ended December 31, 1999, 1998 and 1997............................. 33
Targeted Genetics Corporation Notes to Financial Statements......... 34-43
Emerald Gene Systems, Ltd. Report of Ernst and Young Chartered
Accountants, Independent Auditors.................................. 44
Emerald Gene Systems, Ltd. Balance Sheet at December 31, 1999....... 45
Emerald Gene Systems, Ltd. Statements of Operations for the 166 day
period ended December 31, 1999..................................... 46
Emerald Gene Systems, Ltd. Statements of Shareholders' Equity for
the 166 day period ended 1999...................................... 47
Emerald Gene Systems, Ltd. Statements of Cash Flows for the 166 day
period ended 1999.................................................. 48
Emerald Gene Systems, Ltd. Notes to Financial Statements............ 49-50
2. Financial Statement Schedules
All financial statement schedules have been omitted because the required
information is either included in the financial statements or the notes
thereto or is not applicable.
3. Exhibits
3.1 Amended and Restated Articles of Incorporation (Exhibit 3.1) (D)
3.2 Amended and Restated Bylaws (Exhibit 3.2) (D)
3.3 Articles of Amendment of the Company, filed with the State of (K)
Washington on July 21, 1999 (Exhibit 1.8)
4.1 Rights Agreement, dated as of October 17, 1996, between the Company (C)
and ChaseMellon Shareholder Services (Exhibit 2.1)
4.2 Registration Rights Agreement, dated as of July 21, 1999, by and (K)
among the Company and Elan International Services, Ltd. (Exhibit
1.2)
4.3 First Amendment of Rights Agreement, dated July 21, 1999, between (K)
the Company and ChaseMellon Shareholder Services (Exhibit 1.9)
4.4 Warrant to purchase 2,000,000 shares of common stock of the (J)
Company, issued to Alkermes, Inc. on June 9, 1999. (Exhibit 10.38)
10.1 Form of Indemnification Agreement between the registrant and its
officers and directors
10.2 Form of Senior Management Employment Agreement between the (D)
registrant and its executive officers (Exhibit 10.2)
52
10.3 Gene Transfer Technology License Agreement, dated as of February
18, 1992, between Immunex Corporation and the Company*
10.4 PHS Patent License Agreement-Non-Exclusive, dated as of July 13,
1993, between National Institutes of Health Centers for Disease
Control and the Company*
10.5 Patent License Agreement, dated as of December 25, 1993, between
The University of Florida Research Foundation, Inc. and the
Company*
10.6 Research and Exclusive License Agreement, dated as of January 1, (E)
1994, between the Company and the Fred Hutchinson Cancer Research
Center* (Exhibit 10.9)
10.7 PHS Patent License Agreement--Exclusive, dated as of March 10, (E)
1994, between National Institutes of Health Centers for Disease
Control and the Company* (Exhibit 10.10)
10.8 License Agreement, dated as of March 28, 1994, between the Company (E)
and the University of Michigan* (Exhibit 10.13)
10.9 Patent and Technology License Agreement, effective as of March 1, (A)
1994, between the Board of Regents of the University of Texas
M.D. Anderson Cancer Center and RGene Therapeutics, Inc.*
(Exhibit 10.29)
10.10 First Amended and Restated License Agreement, effective as of (A)
October 12, 1995, between The University of Tennessee Research
Corporation and RGene Therapeutics, Inc.* (Exhibit 10.30)
10.11 Amendment to First Amended and Restated License Agreement, dated (B)
as of June 19, 1996, between The University of Tennessee Research
Corporation and RGene Therapeutics, Inc.* (Exhibit 10.1)
10.12 Second Amendment to First Amended and Restated License Agreement, (G)
dated as of April 17, 1998, between The University of Tennessee
Research Corporation and RGene Therapeutics, Inc.*
10.13 Revised License Agreement, effective as of October 1, 1996, (D)
between the University of Pittsburgh of the Commonwealth System
of Higher Education and the Company* (Exhibit 10.21)
10.14 License Agreement, dated as of March 15, 1997, between the Burnham (E)
Institute and the Company* (Exhibit 10.23)
10.15 Exclusive Sublicensing Agreement, dated June 9, 1999, between the (J)
Company and Alkermes, Inc. (Exhibit 10.36)
10.16 Common Stock Purchase Agreement, dated June 9, 1999, between the (J)
Company and Alkermes, Inc. (Exhibit 10.37)
10.17 License Agreement, dated as of August 31, 1999, between the
Company and the University of North Carolina Research Center**
10.18 Master Agreement, dated as of November 23, 1998, between the (H)
Company and Medeva Pharmaceuticals, Inc.* (Exhibit 1.1)
10.19 License and Collaboration Agreement, dated as of November 23, (H)
1998, between the Company and Medeva Pharmaceuticals, Inc.*
(Exhibit 1.2)
10.20 Supply Agreement, dated as of November 23, 1998, between the (H)
Company and Medeva Pharmaceuticals, Inc.* (Exhibit 1.3)
10.21 Common Stock Purchase Agreement, dated as of November 23, 1998, (H)
between the Company, Medeva Pharmaceuticals, Inc. and Medeva PLC*
(Exhibit 1.4)
10.22 Credit Agreement, dated as of November 23, 1998, between the (H)
Company, Medeva Pharmaceuticals, Inc. and Medeva PLC* (Exhibit
1.5)
53
10.23 Securities Purchase Agreement, dated as of July 21, 1999, between the Company, Elan (K)
Corporation and Elan International Services, Ltd., a wholly owned subsidiary of Elan
Corporation (Exhibit 1.1)
10.24 Funding Agreement, dated as of July 21, 1999, among the Company, Elan International Services, (K)
Ltd., and Elan Corporation, plc (Exhibit 1.3)
10.25 Subscription, Joint Development and Operating Agreement, dated as of July 21, 1999, among (K)
Elan Corporation, plc, Elan International Services, Ltd., the Company and Targeted Genetics
Newco, Ltd. * (Exhibit 1.4)
10.26 Convertible Promissory Note, dated July 21, 1999, issued by the Company to Elan International (K)
Services, Ltd. (Exhibit 1.5)
10.27 License Agreement dated July 21, 1999, between Targeted Genetics Newco, Ltd. and the (K)
Company * (Exhibit 1.6)
10.28 License Agreement, dated July 21, 1999, between Targeted Genetics Newco, Ltd. and Elan (K)
Pharmaceutical Technologies, a division of Elan Corporation, plc * (Exhibit 1.7)
10.29 Olive Way Building Lease to Olive Way Building Lease, dated as of November 20, 1993, as
amended between the Company and Ironwood Apartments, Inc. (successor in interest to
Metropolitan Federal Savings and Loan Association)
10.30 Office Lease, dated as of October 7, 1996, between Benaroya Capital Company, LLC and the (D)
Company (Exhibit 10.26)
10.31 1992 Restated Stock Option Plan (Exhibit 99.1) (F)
10.32 Stock Option Plan for Nonemployee Directors (Exhibit 10.34) (E)
10.33 1999 Stock Option Plan (Exhibit 99.1) (I)
21.1 Subsidiaries
23.1 Consents of Ernst & Young, independent auditors
27.1 Financial Data Schedule
27.2 Emerald Gene Systems Ltd. Financial Data Schedule
- --------
* Portions of these exhibits have been omitted based on a grant of
confidential treatment from the Securities and Exchange Commission. The
omitted portions of these exhibits have been filed separately with the
SEC.
** Portions of these exhibits have been omitted based on a request of
confidential treatment filed with the Securities and Exchange Commission.
The omitted portions of these exhibits have been filed separately with the
SEC.
(A) Incorporated by reference to the designated exhibit included with the
Company's Registration Statement on Form S-1 (No. 333-03592) filed on
April 16, 1996, as amended.
(B) Incorporated by reference to the designated exhibit included with the
Company's Quarterly Report on Form 10-Q for the period ended June 30,
1996, filed on August 12, 1996.
(C) Incorporated by reference to the Company's Registration Statement on Form
8-A, filed October 22, 1996.
(D) Incorporated by reference to the designated exhibit included with the
Company's Annual Report on Form 10-K for the year ended December 31,
1996, filed on March 12, 1997.
(E) Incorporated by reference to the designated exhibit included with the
Company's Annual Report on Form 10-K for the year ended December 31,
1997, filed on March 31, 1998
(F) Incorporated by reference to the designated exhibit included with the
Company's Registration Statement on Form S-8 (No. 333-58907), filed on
July 10, 1998.
(G) Incorporated by reference to the designated exhibit included with the
Company's Annual Report on Form 10-K for the year ended December 31,
1998, filed on March 10, 1999.
(H) Incorporated by reference to the designated exhibit included with the
Company's Current Report on Form 8-K, filed on January 6, 1999.
54
(I) Incorporated by reference to the designated exhibit included with the
Company's Registration Statement on Form S-8 (No. 333-78523), filed on
May 14, 1999.
(J) Incorporated by reference to the designated exhibit included with the
Company's Quarterly Report on Form 10-Q for the period ending June 30,
1999, filed on August 5, 1999.
(K) Incorporated by reference to the designated exhibit included with the
Company's Current Report on Form 8-K, filed August 4, 1999.
(b) Reports on Form 8-K
We filed a Form 8-K on December 15, 1999 to revise the factors included
under "Risk Factors" in Amendment No. 3 to the Company's Registration
Statement on Form S-3 (No. 333-86509) and in Post-Effective Amendment No. 2 to
the Company's Registration Statement on Form S-3 (No. 333-51625) to comply
with the SEC's plain English requirements.
55
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.
TARGETED GENETICS CORPORATION
/s/ H. Stewart Parker
By: _________________________________
H. Stewart Parker
President and Chief Executive
Officer
Date: March 22, 2000
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 on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ H. Stewart Parker President and Chief March 22, 2000
____________________________________ Executive Officer,
H. Stewart Parker Director (Principal
Executive Officer)
/s/ James A. Johnson Senior Vice President, March 22, 2000
____________________________________ Finance and
James A. Johnson Administration, Chief
Financial Officer,
Treasurer and
Secretary (Principal
Financial and
Accounting Officer)
/s/ Jeremy L. Curnock Cook Chairman of the Board, March 22, 2000
____________________________________ Director
Jeremy L. Curnock Cook
/s/ Jack L. Bowman Director March 22, 2000
____________________________________
Jack L. Bowman
/s/ James D. Grant Director March 22, 2000
____________________________________
James D. Grant
/s/ Louis P. Lacasse Director March 22, 2000
____________________________________
Louis P. Lacasse
/s/ Nelson L. Levy, Ph.D. M.D. Director March 22, 2000
____________________________________
Nelson L. Levy, Ph.D. M.D.
/s/ Mark Richmond, Ph.D. Director March 22, 2000
____________________________________
Mark Richmond, Ph.D.