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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2001.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO
________________.
Commission file number 0-22170
EPOCH BIOSCIENCES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 91-1311592
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
21720 23rd Drive SE, #150, Bothell, WA 98021
(Address of principal executive office, including zip code)
(425) 482-5555
(Issuer's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Check whether the issuer (1) filed all reports to be filed by Section 13 or
15(d) of the Exchange Act during the past 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 [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity as of the latest practicable date.
Class Outstanding at July 12, 2001
----- ----------------------------
Common Stock, $.01 par value 25,639,677
Page 1 of 19
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EPOCH BIOSCIENCES, INC.
INDEX TO FORM 10-Q
Part I. Financial Information Page Number
Item 1.Financial Statements........................................................ 3
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 6
Item 3.Quantitative and Qualitative Disclosures About Market Risk.................. 16
Part II. Other Information
Item 1.Legal proceedings........................................................... 17
Item 4.Submission of Matters to a Vote of Security Holders......................... 17
Item 6.Exhibits and Reports on Form 8-K............................................ 18
Note: Items 2, 3, and 5 are omitted, as they are not applicable.
Signature ............................................................................. 19
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EPOCH BIOSCIENCES, INC.
BALANCE SHEETS
(unaudited)
ASSETS
DECEMBER 31, JUNE 30,
2000 2001
------------ ------------
Current assets:
Cash and cash equivalents ................................... $ 12,122,461 $ 8,402,759
Accounts receivable ......................................... 197,686 413,891
Inventory ................................................... 77,201 197,193
Prepaid expenses and other assets ........................... 340,782 427,490
------------ ------------
Total current assets .................................... 12,738,130 9,441,333
Property and equipment, net ..................................... 3,596,652 3,662,797
Intangible assets, net .......................................... 3,938,453 3,735,600
Restricted cash ................................................. 629,622 651,949
Other assets .................................................... 31,905 21,234
------------ ------------
Total assets ............................................ $ 20,934,762 $ 17,512,913
============ ============
Current liabilities:
Accounts payable ............................................ $ 1,651,173 $ 272,364
Accrued liabilities ......................................... 793,506 909,465
Deferred revenue - current portion .......................... 337,611 342,657
Obligations under capital leases - current portion .......... 32,889 19,243
------------ ------------
Total current liabilities ............................... 2,815,179 1,543,729
Deferred revenue - less current portion ......................... 2,040,578 1,902,167
Deferred rent ................................................... -- 83,937
Obligations under capital leases - less current portion ......... 18,602 9,222
Stockholders' equity:
Preferred stock, par value $.01; 10,000,000 shares
authorized; no shares issued and outstanding ............ -- --
Common stock, par value $.01; 50,000,000 shares
authorized; shares issued and outstanding:
24,969,118 at December 31, 2000 and 25,639,677
at June 30, 2001 ........................................ 249,691 256,397
Additional paid-in capital .................................. 82,302,448 82,680,643
Deferred compensation ....................................... (63,922) (39,946)
Accumulated deficit ......................................... (66,427,814) (68,923,236)
------------ ------------
Total stockholders' equity .............................. 16,060,403 13,973,858
------------ ------------
Total liabilities and stockholders' equity .............. $ 20,934,762 $ 17,512,913
============ ============
See accompanying notes to financial statements.
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EPOCH BIOSCIENCES, INC.
STATEMENTS OF OPERATIONS
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
2000 2001 2000 2001
------------ ------------ ------------ ------------
Revenue:
Product sales .................................. $ 127,520 $ 1,135,441 $ 212,720 $ 2,156,684
License fees and royalty income ................ 13,184 134,040 26,370 162,192
Contract research revenue ...................... -- 500,000 -- 1,000,000
------------ ------------ ------------ ------------
Total revenue ................................ 140,704 1,769,481 239,090 3,318,876
Operating expenses:
Cost of product sales .......................... 11,647 748,139 28,687 1,626,867
Research and development ....................... 798,855 1,193,929 1,631,179 2,325,718
Selling, general and administrative ............ 745,773 1,135,361 1,347,379 2,138,139
------------ ------------ ------------ ------------
Total operating expenses ..................... 1,556,275 3,077,429 3,007,245 6,090,724
Operating loss ............................... (1,415,571) (1,307,948) (2,768,155) (2,771,848)
Interest income, net ........................... 274,629 117,689 400,823 276,426
------------ ------------ ------------ ------------
Net loss ..................................... $ (1,140,942) $ (1,190,259) $ (2,367,332) $ (2,495,422)
============ ============ ============ ============
Net loss per share - basic and diluted ........... $ (0.05) $ (0.05) $ (0.10) $ (0.10)
============ ============ ============ ============
Weighted average number of common shares
outstanding - basic and diluted ................ 24,786,698 25,632,619 23,152,798 25,534,198
See accompanying notes to financial statements.
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EPOCH BIOSCIENCES, INC.
STATEMENTS OF CASH FLOWS
(unaudited)
SIX MONTHS ENDED JUNE 30,
-------------------------------
2000 2001
------------ ------------
Cash flows from operating activities:
Net loss ................................................................ $ (2,367,332) $ (2,495,422)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization:
Property and equipment .............................................. 75,578 329,674
Intangible assets ................................................... -- 184,515
Deferred stock compensation ......................................... 23,976 23,976
Stock compensation charge ........................................... 94,400 --
License rights ...................................................... 3,057 18,338
Issuance of common stock warrants for services ........................ 396,250 5,727
Interest accrued on restricted cash ................................... -- (22,327)
Deferred revenue ...................................................... (26,371) (133,365)
Deferred rent ......................................................... 83,937
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable ................................................. (21,379) (216,205)
Inventory ........................................................... -- (119,992)
Prepaid expenses and other assets ................................... (124,081) (76,037)
Accounts payable .................................................... 120,942 (8,117)
Accrued liabilities ................................................. 100,246 115,959
------------ ------------
Net cash used in operating activities ............................. (1,724,714) (2,309,339)
------------ ------------
Cash flows from investing activities:
Security deposit on new facilities .................................... (606,926) --
Investment in license rights .......................................... (250,000) --
Investment in leasehold improvements on new facilities................. (158,634) --
Acquisition of property and equipment ................................. (209,023) (1,408,819)
Acquisition of Synthetic Genetics ..................................... -- (357,692)
------------ ------------
Net cash used in investing activities ............................. (1,224,583) (1,766,511)
------------ ------------
Cash flows from financing activities:
Repayment of capital leases ........................................... -- (23,026)
Proceeds from sale of common stock .................................... 10,000,039 --
Proceeds from exercise of warrants .................................... 9,551,280 332,376
Proceeds from exercise of stock options ............................... 58,032 46,798
------------ ------------
Net cash provided by financing activities ......................... 19,609,351 356,148
------------ ------------
Net increase (decrease) in cash and cash equivalents .................... 16,263,804 (3,719,702)
Cash and cash equivalents at beginning of period ........................ 1,772,274 12,122,461
------------ ------------
Cash and cash equivalents at end of period .............................. $ 18,036,078 $ 8,402,759
============ ============
Supplemental disclosure of cash flow information -
Interest payments ..................................................... $ 157 $ 2,732
============ ============
See accompanying notes to financial statements.
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EPOCH BIOSCIENCES, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) NATURE OF BUSINESS
Epoch Biosciences, Inc. is developing and commercializing proprietary
technologies to enhance the study of genes. Our scientists are applying their
expertise in nucleic acid chemistry to develop products that improve current
methods of studying the genetic sequence, or genomes, of humans, animals and
plants. Our technology is based on our expertise in DNA chemistry, which allows
us to design, synthesize and modify synthetic DNA strands, or probes, that
selectively bind to the gene being studied. Using our DNA technology, we are
developing molecular tools and chemical compounds for improved genetic analysis.
We also manufacture and distribute specialty oligonucleotides through our San
Diego facility, including the recently launched Eclipse(TM) Probe System which
incorporates the performance advantages of some of our technologies.
We have adapted our chemical compounds and techniques to genetic
analysis systems developed by Applied Biosystems and Third Wave Technologies.
Our technology has broad potential in the developing field of genomics, or the
study of genes. Applications include the detection of infectious diseases,
diagnosis of inheritable diseases through prenatal testing, screening
populations to identify genetic markers that correlate with disease risk or drug
response, as well as any other genetic analysis based on DNA sequence
determination.
Our technologies are compatible with many of the genetic analysis
systems currently in use or in development. Just as microprocessors are found in
essentially all electronic appliances, our chemistries and technologies have the
potential to be incorporated in all genetic analysis systems.
(b) BASIS OF PRESENTATION
The unaudited financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required to be presented for complete financial
statements. The accompanying financial statements include all adjustments
(consisting only of normal recurring adjustments), which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. Certain 2000 balances have been reclassified to conform with
the 2001 presentation.
The financial statements and related disclosures have been prepared with
the presumption that users of the interim financial information have read or
have access to the audited financial statements for the preceding fiscal year.
Accordingly, these financial statements should be read in conjunction with the
audited financial statements and the related notes included in Epoch's 2000
Annual Report on Form 10-KSB as filed with the Securities and Exchange
Commission.
(c) LOSS PER SHARE
Basic loss per share is computed based on weighted average shares
outstanding during the reporting period and excludes any potential dilution.
Diluted loss per share reflects potential dilution from the exercise or
conversion of securities into common stock or from other contracts to issue
common
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stock. Our capital structure includes common stock options and common stock
warrants, all of which have been excluded from net loss per share calculations
as they are antidilutive, as follows:
AT JUNE 30,
------------------------
2000 2001
--------- ---------
Outstanding options 1,693,250 2,285,634
Outstanding warrants 1,549,348 383,333
(d) REVENUE RECOGNITION
We earn product revenues through sales of chemical products and reagents
to manufacturers for incorporation into their products, from the sale of
specialty oligonucleotides to end users in the research fields of genomics and
molecular diagnostics, from license fees for the use of our proprietary
technology and know-how, and by providing services to third parties for
performing research and development on their behalf. We also have product
royalty agreements that result in royalties to us upon ultimate sales of
products by our partners.
Revenues from product sales that require no ongoing obligations are
recognized when shipped to the customer and title has passed.
Up front license fees are recognized over the term of the agreement to
which the license fees correspond, which may extend to the expiration of the
underlying patents, and based on the terms and future performance obligations in
the underlying agreements. Deferred revenue principally represents license fees
received in advance.
Contract research revenues are recognized as the research and
development activities are performed under the terms of commercial collaboration
and supply agreements and government grants. Direct costs related to these
contracts and grants are reported as research and development expenses.
Royalty revenues are recognized when earned under the terms of the
related agreements, which is generally upon sale of products containing our
component products by our partner.
(e) CONCENTRATION OF CREDIT RISK
Credit is extended based on an evaluation of a customer's financial
condition and collateral is generally not required. The majority of revenues are
derived from private and public companies and public enterprises in the research
market in the United States.
One customer accounted for approximately 55% of revenues in the current
quarter and 54% of revenues in the current year to date. Revenues from this
customer were 96% of total revenues in the comparable quarter of the prior year
and 98% of revenues in the first six months of 2000. Accounts receivable from
this customer amounted to $57,000 at June 30, 2001, and $37,000 at December 31,
2000.
Another customer accounted for approximately 16% of revenues in the
current quarter and 18% of revenues in the current year to date. Revenues from
this customer were not material in the prior year.
2. SYNTHETIC GENETICS ACQUISITION
The Company acquired the assets of Synthetic Genetics, a provider of
specialty oligonucleotides in San Diego California, on November 15, 2000 in a
transaction accounted for as a purchase business
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combination. Accordingly, the assets and liabilities of Synthetic Genetics were
recorded at their estimated fair values at the acquisition date, and the results
of Synthetic Genetics operations have been included in the Company's results
from the acquisition date. The purchase price amounted to $3,788,194.
The following summary, prepared on a pro forma basis, presents the
combined results of operations for the three and six month periods ended June
30, 2000, as if the acquisition had been consummated as of January 1, 2000,
after including the impact of certain adjustments such as depreciation and
amortization on assets acquired.
Three Months Six Months
ended June 30, 2000 ended June 30, 2000
------------------- -------------------
Revenues $ 490,383 $ 1,003,061
Net loss (1,367,913) (2,735,296)
Net loss per share $ (0.06) $ (0.12)
The pro forma results are not necessarily indicative of what actually
might have occurred if the acquisition had been completed as of the beginning of
the period presented. In addition, they are not intended to be a projection of
future results of operations and do not reflect any of the synergies that might
be achieved from combined operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. That
Act provides a "safe harbor" for forward-looking statements to encourage
companies to provide prospective information about themselves so long as they
identify these statements as forward-looking and provide meaningful, cautionary
statements identifying important factors that could cause actual results to
differ from the projected results.
Other than statements of historical fact, all statements in this
Quarterly Report on Form 10-Q and, in particular, any projections of or
statements as to our expectations or beliefs concerning our future financial
performance or financial position or as to future trends in our business or in
our markets, are forward-looking statements. Forward-looking statements reflect
our current expectations and are inherently uncertain and our actual results in
future periods may differ materially from our expectations concerning our
projections of those results or of future business trends described in this
Quarterly Report on Form 10-Q. The sections below entitled "Certain Factors that
May Affect Our Business and Future Results" under Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
describe some, but not all, of the factors, risks and uncertainties that could
cause these differences, including but not limited to the possibility that
potential products utilizing the Company's technology may be ineffective or,
although effective, may be uneconomical to market; that third parties hold
proprietary rights that preclude Epoch or its licensees from marketing its
products; or that third parties may market superior products. Readers of this
Quarterly Report on Form 10-Q are urged to read those sections in their
entirety. In light of the significant uncertainties inherent in the
forward-looking information included in this document, the inclusion of
information should not be regarded as a representation by us or any other person
that our objectives or plans will be achieved. The forward-looking statements
contained in this Quarterly Report on Form 10-Q are made only as of the date of
this Quarterly Report on Form 10-Q and Epoch undertakes no obligation to update
or revise the forward-looking statements, whether as a result of new
information, future events or otherwise.
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The following discussion of Epoch's financial condition and results of
operations should be read in conjunction with the financial statements and the
related notes thereto included elsewhere in this Quarterly Report on Form 10-Q
and other documents Epoch files from time to time with the Securities and
Exchange Commission, including subsequent Current Reports on Form 8-K, Quarterly
Reports on Form 10-Q and Annual Reports on Form 10-K.
RESULTS OF OPERATIONS
OVERVIEW
The Company develops proprietary products with commercial applications
in the fields of genomics and molecular diagnostics, including specialty
chemistries, probes and other genomic detection systems. We sell some of our
products to end users, and also provide chemical intermediate products that are
utilized by our collaborative partners and other parties in the manufacture of
end-user products by those parties. The sale of chemical intermediates began in
December 1999, and grew steadily throughout calendar 2000 as our technologies
became more known and validated, and as we executed collaborative agreements
with Applied Biosystems and Third Wave Technologies, among others. In November
2000, we acquired the assets of Synthetic Genetics, a provider of specialty
probes. The transaction was accounted for using the purchase method of
accounting.
We report revenues in three categories:
- Product Sales, which include revenues from sales of chemical
intermediates, probes, and related genetic detection systems;
- License fees and royalty income, which reflects amortization of
license fees received for the transfer of technology and
know-how to our partners, plus contractual royalty payments
received for the sale by third parties of products that include
our technologies; and
- Contract research revenue, representing payments for research
and development performed under various collaborative
agreements.
REVENUES
Product Sales. Product sales increased to $1,135,000 in the quarter
ended June 30, 2001 from $128,000 in the comparable quarter of the prior year as
a result of higher levels of chemical intermediate sales to our collaborative
partners, and from the sales of specialty probes and genetic detection
chemistries to end users. Included in this quarter's revenues is $338,000
representing payments for a contractual minimum level of product purchases.
Product sales similarly increased to $2,157,000 for the six month period ended
June 30, 2001 from $213,000 in the prior year period as a result of the same
higher level of sales.
License Fees and Royalty Income. License fees and royalty income
increased to $134,000 in the quarter ended June 30, 2001 from $13,000 in the
comparable quarter of the prior year and increased to $162,000 for the six month
period compared to $26,000 in the prior year period primarily as a result of
product royalties received from Applied Biosystems in the second quarter of
2001. Such amounts represent royalties calculated and earned for a series of
reporting periods.
Contract Research Revenue. Contract research revenue increased to
$500,000 in the quarter and $1,000,000 for the six month period ended June 30,
2001 over the similar periods of the prior year as the result of research and
development activities under our agreements with Applied Biosystems that began
in August 2000 and with Third Wave Technologies that began in January 2001.
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OPERATING EXPENSES
Cost of Product Sales. Cost of product sales increased to $748,000 in
the quarter and $1,627,000 for the six months period ended June 30, 2001, from
$12,000 in the comparable quarter and $29,000 in the comparable six month period
of the prior year as a result of the increase in product sales. Costs as a
percentage of product sales, including contractual minimum payments in 2001,
rose from 9% in the quarter and from 13% for the six month period of 2000 to 66%
in the current quarter and 75% for the six month period of 2001 for a number of
reasons, including a significantly different product mix due in part to
inclusion of Synthetic Genetics' specialty probe business, the impact of
building manufacturing capacity through investments in capital equipment and
personnel that is not yet being fully utilized, and the existence of contractual
product pricing levels for certain chemical intermediate products.
Research and Development. Research and development expenses increased to
$1,194,000 in the quarter ended June 30, 2001 from $799,000 in the comparable
quarter in the prior year and similarly increased to $2,326,000 for the six
month period ended June 30, 2001 from $1,631,000 in the comparable period of the
prior year. The primary reasons for the increases include:
- Increased personnel costs of $213,000 in the quarter, and
$495,000 for the six month period, primarily as a result of
incentive compensation costs and increased headcount;
- Increased facilities and equipment expenses of $165,000 in the
quarter, and $333,000 for the six month period, related to the
new Bothell headquarters facility occupied in late 2000;
- An increase in chemical reagents and operating supplies expense
of $128,000 in the quarter, and $233,000 for the six month
period, resulting from increased headcount and activity; and
- Increased costs of $122,000 in the quarter, and $419,000 for the
six month period, included in cost of product sales for
personnel and other costs related to product manufacturing. This
amount will fluctuate quarterly depending on the time and
availability of personnel to conduct research and development
activities.
Selling, General, and Administrative. Selling, general, and
administrative expenses increased to $1,135,000 in the quarter ended June 30,
2001 from $746,000 in the comparable quarter in the prior year and similarly
increased to $2,138,000 for the six month period ended June 30, 2001 from
$1,347,000 in the comparable period of the prior year. The primary reasons for
the increase include:
- Increased facilities related expenses over the prior year period
of $44,000 for the quarter, and $102,000 for the six month
period, related to the new Bothell headquarters facility
occupied in late 2000;
- Intangible asset amortization charges of $92,000 for the
quarter, and $184,000 for the six month period, resulting from
the acquisition of Synthetic Genetics;
- Recruiting, relocation, and compensation expenses of $168,000
for the quarter and $277,000 for the six month period, related
to the addition of two vice presidents late in the first
quarter; and
- Increased sales, marketing, and administrative expenses of
$245,000 for the quarter, or $455,000 for the six month period,
from the Synthetic Genetics division acquired in late 2000.
These increased costs were partially offset by reduced costs in 2001
over 2000 which were primarily:
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- In the first quarter of 2000 we paid $150,000 in expenses
associated with a warrant call and private placement;
- In the second quarter of 2000 we issued a warrant valued at
$94,000 in exchange for public relations services;
- In the second quarter of 2000 we paid $94,000 in fees to The
Nasdaq National Market associated with our being relisted on the
exchange; and
- Increased costs of $29,000 in the quarter, and $84,000 for the
six month period included in cost of product sales for personnel
and other costs related to product manufacturing. This amount
will fluctuate quarterly depending on the time and availability
of personnel to conduct research and development activities.
Interest Income, net. Interest income, net, decreased to $118,000 in the
second quarter of 2001 compared to $275,000 in the second quarter of 2000 and
similarly decreased to $276,000 in the six month period ended June 30, 2001 from
$401,000 in the comparable period of 2000 as a result of lower average cash
balances available for investment and lower realized interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Operating cash and cash equivalents amounted to $8,403,000 at June 30,
2001, a $3,720,000 decrease from December 31, 2000 balances. In addition, we
have long term certificates of deposit pledged under a security agreement for an
operating lease amounting to $652,000 at June 30, 2001. Such amounts are
classified as restricted cash on the accompanying balance sheets, and are not
considered part of cash and cash equivalents.
Cash used in operations during the six months ended June 30, 2001
amounted to $2,309,000 as a result of our net loss of $2,495,000 adjusted for
certain non-cash reconciling items and fluctuations in working capital accounts,
including:
- An increase in accounts receivable of $216,000 as a result of
increased product sales; and
- An increase in inventory of $120,000 as a result of stocking
higher levels of chemical intermediates and other materials to
support higher product sales.
Cash used in investing activities amounted to $1,767,000 in the six
months ended June 30, 2001. Acquisition of property and equipment totaled
$1,409,000, including $1,013,000 in payments for capital expenditures made
during the fourth quarter 2000 for leasehold improvements and capital equipment
for our new facilities. We also paid $358,000 in acquisition related costs in
2001 for our November 2000 purchase of Synthetic Genetics.
Cash provided by financing activities amounted to $356,000 for the six
months ended June 30, 2001, including the receipt of $332,000 from the exercise
of common stock warrants.
We believe that our existing cash and cash equivalents, together with
cash that we expect to generate from our operations, will be sufficient to meet
our capital needs for at least the next twelve months. However, it is possible
that we may need to raise additional funds to fund our activities beyond the
next year or to consummate acquisitions of other businesses, products or
technologies. We may be able to raise such funds by selling more stock to the
public or to selected investors, or by borrowing money. In addition, even though
we may not need additional funds, we may still elect to sell additional equity
securities or obtain credit facilities for other reasons. We may not be able to
obtain additional
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funds on terms that would be favorable to our shareholders and us, or at all. If
we raise additional funds by issuing additional equity or convertible debt
securities, the ownership percentages of existing shareholders would be reduced.
In addition, the equity or debt securities that we issue may have rights,
preferences or privileges senior to those of the holders of our common stock.
During 2000 and the first half of 2001 we spent approximately $925,000
on capital equipment to expand our San Diego manufacturing operations. We expect
that we will continue to make capital equipment and other investments in that
business prospectively as our operations expand. We may finance these purchases
from our cash and cash equivalents on hand, cash generated from our operations,
borrowings, equity offerings, or a combination thereof.
CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS AND FUTURE RESULTS
We have never been profitable and anticipate future losses
We have never been profitable. Since our formation in 1985, we have
generated limited revenues. As of June 30, 2001, we had an accumulated deficit
of approximately $68.9 million. We expect to incur additional losses as we
expand our research and development and related product commercialization
efforts. There is no assurance that we will ever become profitable or that we
will sustain profitability if we do become profitable. Should we experience
continued or unforeseen operating losses, our capital requirements would
increase and our stock price would likely decline.
There is a risk that our technology may not be effective or might not work
The science and technology of synthetic DNA-based products is rapidly
evolving. While we are beginning to produce and supply products to customers for
commercial use, the majority of our products and proposed products are in the
discovery or early development stage. The proposed products will require
significant further research, development, and testing. We face the risk that
any or all of our products and proposed products could prove to be ineffective
or unsafe, or be an inferior product to products marketed by others because our
products are based on new and unproven innovative technologies. Some of our
current research and development activities may not result in any commercially
viable products. If we do not have commercially viable products, we will not be
able to generate funds internally to support operations.
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We have limited manufacturing experience
While we have experience in researching and developing unique,
proprietary technologies to enhance the study of genes, and in manufacturing
oligonucleotides, our experience in manufacturing other chemical reagent
products is relatively limited. While we are beginning to produce and supply
products to customers for commercial use, we do not currently have the capacity
for high-volume production of our reagents. We will need to expand our reagent
manufacturing capacity in connection with our continued development and
commercialization of our products. Any delay or inability to expand our reagent
manufacturing capacity could materially adversely affect our reagent
manufacturing ability.
Energy shortages may adversely impact operations
California and Washington states, among other areas, are currently
experiencing shortages of electrical power and other energy sources. In
California, this condition has periodically resulted in rolling blackouts, or
the temporary and generally unannounced loss of the primary electrical power
source. The computer and manufacturing equipment and other systems in our
operating locations in San Diego, California and Bothell, Washington are powered
by electricity. Currently, we do not have secondary electrical power sources to
mitigate the impacts of temporary or longer-term electrical outages. It is not
anticipated that the power shortages will abate soon, and therefore, our
operating facilities may experience brown-outs, black-outs, or other
consequences of the shortage, and may be subject to usage restrictions or other
energy consumption regulations that could adversely impact or disrupt our
commercial manufacturing and other activities. We are evaluating the cost
effectiveness of secondary power systems that would reduce our dependency on our
primary power sources. The cost of such systems is not currently known.
There is a risk that we do not own exclusive rights to our technology and our
competition may have access to our technology, which may prevent us from selling
our products
We attempt to protect our proprietary technology by relying on several
methods including United States patents. We also have international patent
applications that correspond to many of the U.S. patents and patent
applications. The issued patents and pending patent applications cover
inventions relating to the components of our core technologies. The expiration
dates of these patents range from January 2010 to June 2015. We make no
guarantee that any issued patents will provide us with significant proprietary
protection, that pending patents will be issued, or that products incorporating
the technology from our issued patents or pending applications will be free from
challenges by competitors. Further, third parties may hold proprietary rights,
which precede our claims and, therefore, could prohibit us from marketing the
proposed products.
Some of our technology might infringe on the rights of others, which may prevent
us from selling our products
There is a great deal of litigation regarding patents and other
intellectual property rights in the biomedical industry. We were defendants in
one action of this kind, which we settled prior to 1997. Although patent and
intellectual property disputes in the biomedical area are sometimes settled
through licensing or similar arrangements, this kind of solution can be
expensive, if a license can be obtained at all. An adverse determination in a
judicial or administrative proceeding or our failure to obtain necessary
licenses could prevent us from manufacturing and selling our products. This
would substantially hurt our business.
We face numerous competitors and changing technologies which could make our
products obsolete
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Many companies do research and development and market products designed
to diagnose conditions based on a number of technologies and are developing
additional products using gene-based technologies. Many of these companies have
substantially greater capital resources, larger research and development and
marketing staffs and facilities and greater experience in developing products
than we have. Furthermore, our specific field in which we operate is subject to
significant and rapid technological change. Even if we successfully introduce
our products or proposed products, our technologies could be replaced by new
technologies or our products or proposed products might be obsolete or
non-competitive.
We will be dependent upon our Agreement with Applied Biosystems for a
significant portion of our revenues for 2001, and a reduction of sales under or
early termination of this Agreement would seriously harm our revenues and
operating results and would likely cause our stock price to decline
In January 1999, Epoch and Applied Biosystems entered into a License and
Supply Agreement pursuant to which we licensed some of our technology to Applied
Biosystems for use in its TaqMan 5'-nuclease real-time PCR assays, or tests
(Taqman is a registered trademark of Roche Molecular Systems, Inc.). In July
1999, we licensed our proprietary software, which speeds the design of chemical
tools used in the study of genes, to Applied Biosystems. In August 2000, the
agreement was amended to include Epoch manufacturing product for Applied
Biosystems. We will depend upon product sales to Applied Biosystems under this
agreement, and royalties from Applied Biosystems' sales of its Taqman assays,
for a significant portion of our revenues for 2001 and future periods. In
addition, we have incurred significant expenditures to date to equip our
facilities for the development of the assays we are developing under this
agreement.
Either party may terminate the agreement upon 180 days written notice.
In the event that this agreement is terminated, our revenues would be adversely
affected. We would also have a major investment in facilities and equipment that
we might be unable to redeploy for new projects. These events would seriously
harm our business, financial condition and operating results and would likely
cause our stock price to decline.
The loss of key personnel could adversely affect operations by impairing our
research and our efforts to commercialize and license our products
Our performance is greatly dependent upon our key management including
our Chief Executive Officer, Dr. William Gerber, and technical personnel and
consultants. Our future success will depend in part upon our ability to retain
these people and to recruit additional qualified personnel. We must compete with
other companies, universities, research entities and other organizations in
order to attract and retain highly qualified personnel. Although we have entered
into agreements with our key executive officers, we make no guarantee that we
will retain these highly qualified personnel or hire additional qualified
personnel. We currently maintain no key man life insurance on any of our
management or technical personnel.
The value of our common stock could change significantly in a very short time
The market price of our common stock may fluctuate significantly. For
example, in the year 2000, our stock traded as high as $25.00 and as low as
$2.88. The rapid price changes Epoch has experienced recently, and throughout
our history, place your investment in our common stock at risk of total loss
over a short period of time. We are in the biotechnology industry and the market
price of securities of biotechnology companies have fluctuated significantly and
these fluctuations have often been unrelated to the companies' operating
performance. Announcements by us or our competitors
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concerning technological innovations, new products, proposed governmental
regulations or actions, developments or disputes relating to patents or
proprietary rights, and other factors that affect the market generally could
significantly impact our business and the market price of our securities.
Public opinion regarding ethical issues surrounding the use of genetic
information may adversely affect demand for our products
Public opinion regarding ethical issues related to the confidentiality
and appropriate use of genetic testing results may influence governmental
authorities to call for limits on, or regulation of the use of, genetic testing.
In addition, these authorities could prohibit testing for genetic predisposition
to certain conditions, particularly for those that have no known cure.
Furthermore, adverse publicity of public opinion relating to genetic research
and testing, even in the absence of any governmental regulation, could harm our
business. Any of these scenarios could reduce the potential markets for our
products and technologies, which could materially and adversely affect our
revenues.
Government regulation of genetic research or testing may adversely affect the
demand for our products and impair our business and operations
Federal, state and local governments may adopt regulations relating to
the conduct of genetic research and genetic testing. These regulations could
limit or restrict genetic research activities as well as genetic testing for
research or clinical purposes. In addition, if state and local regulations are
adopted, these regulations may be inconsistent with, or in conflict with,
regulations adopted by other state or local governments. Regulations relating to
genetic research activities could adversely affect our ability to conduct our
research and development activities. Regulations restricting genetic testing
could adversely affect our ability to market and sell our products and our
technologies. Accordingly, any regulations of this nature could harm our
business.
Health care cost containment initiatives could limit the adoption of genetic
testing as a clinical tool, which would harm our revenues and prospects
In recent years, health care payers as well as federal and state
governments have focused on containing or reducing health care costs. We cannot
predict the effect that any of these initiatives may have on our business, and
it is possible that they will adversely affect our business. In particular,
gene-based therapeutics, if successfully developed and commercialized, are
likely to be costly compared to currently available drug therapies. Health care
cost containment initiatives focused either on gene-based therapeutics or on
genetic testing could cause the growth in the clinical market for genetic
testing to be curtailed or slowed. In addition, health care cost containment
initiatives could also cause pharmaceutical companies to reduce research and
development spending. In either case, our business and our operating results
would be harmed.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method
business combinations completed after June 30, 2001. Statement 141 also
specifies the criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. Statement 142 will require that goodwill and intangible assets
with indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will
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also require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The Company is required to adopt the provisions of Statement 141
immediately and Statement 142 effective January 1, 2002. Furthermore, any
goodwill and any intangible asset determined to have an indefinite useful life
that are acquired in a purchase business combination completed after June 30,
2001 will not be amortized, but will continue to be evaluated for impairment in
accordance with the appropriate pre-Statement 142 accounting literature.
Goodwill and intangible assets acquired in business combinations completed
before July 1, 2001 will continue to be amortized prior to the adoption of
Statement 142.
As of the date of adoption, the Company expects to have unamortized
goodwill in the amount of $2,152,000 and unamortized identifiable intangible
assets in the amount of $1,381,000 all of which will be subject to the
transition provisions of Statements 141 and 142. Amortization expense related to
goodwill was $15,000 and $77,000 for the year ended December 31, 2000 and the
six months ended June 30, 2001, respectively. Because of the extensive effort
needed to comply with adopting Statements 141 and 142, it is not practicable to
reasonably estimate the impact of adopting these Statements on the Company's
financial statements at the date of this report, including whether any
transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Epoch's financial instruments include cash and short-term investment
grade debt securities. At June 30, 2001 the carrying values of Epoch's financial
instruments approximated their fair values based on current market prices and
rates. It is Epoch's policy not to enter into derivative financial instruments.
Epoch does not currently have material foreign currency exposure as the majority
of its international transactions are denominated in U.S. currency. Accordingly,
Epoch does not have a significant currency exposure at June 30, 2001.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Mordecai Jofen, as Trustee of the Harbor Trust, f/k/a The Edward Blech
Trust v. Epoch Biosciences, Inc., United States District Court for the
Southern District of New York, Case No. 01 CV 4129
The Harbor Trust ("Trust") (formerly the Edward Blech Trust) filed a
complaint against the Company on May 16, 2001, alleging the breach of a
March 29, 1996 letter agreement ("Agreement") between the Company and
David Blech. Pursuant to the Agreement, upon payment of a pre-existing
debt owed to Epoch by Blech (the "Ribonetics Debt"), the Company was to
release to Blech from escrow warrants to purchase 500,000 shares of
Company stock. Blech assigned all of his rights under the Agreement to
the Trust. The Trust's claim is based on the Company's alleged failure
to timely register the stock underlying the warrants, allegedly
resulting in damages to Blech and/or the Trust of $10 million, based on
the peak trading value of the Company's stock. The Company has filed a
motion to dismiss the complaint based on, among other things, the
position that Blech and the Trust have never had rights to receive or
exercise the warrants because Blech failed to perform a condition
precedent, i.e., payment of the Ribonetics Debt. Further, the warrants
expired pursuant to the Agreement in June 2000.
No trial has been scheduled in the case. While the Company believes it
has a strong position, it is not possible at this time to state the
likelihood of an unfavorable outcome because of the inherent
uncertainties of litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An Annual Meeting of Stockholders was held on May 24, 2001.
(b) The following persons were duly elected to serve as directors of
the Company.
Frederick B. Craves, Ph.D.
Richard L. Dunning
William G. Gerber, M.D.
Herbert L. Heyneker, Ph.D.
Kenneth L. Melmon, M.D.
Riccardo Pigliucci
Sanford S. Zweifach
(c) Purpose of the Annual Stockholders Meeting:
(1) Election of Directors. To elect the following seven
nominees to serve as directors until the next annual
meeting of stockholders or until their successors are
elected and have qualified. The following is a
tabulation of votes for each of the proposed seven
nominees for election as directors of the company.
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For Against Abstain
--- ------- -------
Frederick B. Craves, Ph.D. 19,193,928 1,559,410 --
Richard L. Dunning 19,193,928 1,559,510 --
William G. Gerber, M.D. 19,193,928 1,559,410 --
Herbert L. Heyneker, Ph.D. 20,715,028 38,310 --
Kenneth L. Melmon, M.D. 20,715,028 38,310 --
Riccardo Pigliucci 20,715,028 38,310 --
Sanford S. Zweifach 19,193,928 1,559,410 --
(2) To approve an amendment to the Company's Incentive Stock
Option, Nonqualified Stock Option and Restricted Stock
Purchase Plan - 1993 to increase the number of shares
subject thereto by 1,250,000 to a total of 2,750,000.
The following is the tabulation of the votes.
For Against Abstain
--- ------- -------
20,550,019 154,549 48,770
(3) To ratify the appointment of KPMG LLP as independent
auditors of the company for the fiscal year ending
December 31, 2001. The following is the tabulation of
the votes.
For Against Abstain
--- ------- -------
20,572,363 165,938 15,037
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(a) EXHIBITS
10.27 Employment agreement dated March 8, 2001 by and between
Epoch and Merl F. Hoekstra
10.28 Employment agreement dated February 28, 2001 by and
between Epoch and Bert W. Hogue
(b) REPORTS ON FORM 8K
None
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Epoch Biosciences, Inc.
Date: August 13, 2001 By: /s/ Bert W. Hogue
------------------
Bert W. Hogue
Vice President and Chief Financial Officer
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EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
10.27 Employment agreement dated March 8, 2001 by and between
Epoch and Merl F. Hoekstra
10.28 Employment agreement dated February 28, 2001 by and
between Epoch and Bert W. Hogue
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